Cost Savings: Does It Trump All other Outsourcing Considerations? | Sherpas in Blue Shirts

Posted On January 9, 2012

One of our clients recently asked our Location Optimization practice to validate its intention to relocate certain back-office support from one Latin American country to another. As the client’s primary driver was cost savings, we used that as the initial analysis point. Our preliminary analysis found that on the basis of the fully loaded operating cost per FTE, the relocation could result in as much as a 50 percent cost reduction. Further investigating into this issue we also found that the local currency in the outbound country appreciated almost 50 percent during the last decade, while the local currency in the inbound country depreciated by 50 percent within the same timeframe. While our complete assessment of this offshoring opportunity returned many additional pros and cons, the main conclusion was that the overall upside economics of this relocation could potentially erode or completely evaporate if the local currencies significantly shifted in the opposite direction over time, which of course is a distinct possibility in today’s globally disrupted economic environment.

This client engagement was atypical for a couple of reasons. First, when offshoring a labor-intensive back-office function within the same region, potential savings of such great magnitude are not very common and they typically come at the cost of increased geopolitical risk, e.g., when a Japanese company establishes a captive somewhere in Southeastern Asia. Second, while risk associated with local currency must always be an integral part of any location analysis, it typically is never the most important evaluation criterion. Traditionally, offshoring has been utilized for relocating operations from high cost, developed countries, which entails dealing with relatively stable currency at least for the outbound location. And despite the high probability of wild inbound location currency fluctuations, the overall economics of the deal are not threatened by this factor alone, because offshored cost is typically just a fraction of the initial cost.

Speaking about possible risk mitigation strategy, in our opinion, any currency hedging may help only in the short- to medium-term, while offshoring is typically targeting a longer timeline because it entails substantial transition cost, which can be recovered only over extended period. And as any type of measures related to relocation of operations are quite traumatic, including the risk of operational disruptions, they are therefore not something a company wants to do repeatedly.

However, this client engagement example demonstrates the emergence of a new class of short-term opportunities that can be exploited by cost-conscious companies, especially when these opportunities are limited to secondary, non-critical processes. An increasing number of external service providers are developing “instant capacity building” tools and offerings that are modular and discrete. Essentially, utilizing these “country in a box” type of solutions, a company can minimize the time/risk of getting in and out of a country while simultaneously achieving significant cost savings.

Granted, the short-term value of such an approach is appealing, but any decision on location optimization should not be driven solely by labor arbitrage considerations. Attractive economics should be complimented by various benefits beyond cost savings, be they access to the wider pool of resources, conversion of fixed to variable costs, a more sustainable delivery footprint requiring less governance effort, etc.

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