Recognizing and Reducing Offshore Location Selection Risks | Sherpas in Blue Shirts

Posted On May 17, 2012

A recent article in BusinessWeek, Argentina Tries the Chavez Way, triggered my thinking about the increased role of geopolitical risk in location selection and overall risk mitigation. In the last decade, Argentina became the “darling” of global services given considerably lower resource prices than in neighboring Brazil, a stable society with deeply rooted democratic principles, etc. But the country’s geopolitical risk profile substantially changed recently. Its economy has stagnated from defaulting on its national debt, pseudo-populist movement groups are promising “quick and easy” fixes to the existing problems, and the trend of nationalizing privately owned businesses is expected to continue, given the views of the current political leadership. None of this yet puts Argentina’s geopolitical risk profile outside of the acceptable range. But we’ve seen from examples around the world that, in the absence of more efficient measures, it may be very tempting for a government to divert public attention from internal problems to some newly introduced external threat. For instance, consider what would happen to the country’s business environment if something similar to the almost forgotten conflict over the Falkland Islands suddenly escalated.

Now think about Colombia, whose geopolitical risk is moving in the opposite direction. While 15 years ago it couldn’t have bought a place on the global services location map, for the last two years its stock market gained an impressive ~50 percent due to various successful measures against FARC, drug cartels and other instability factors. Now, BPO and IT delivery centers are mushrooming in Colombia, driven by an abundance of relatively inexpensive but highly qualified labor resources. Given the large size of the young population in Colombia, as well as steady adherence to open market principles, it is believed the country will continue gaining attractiveness as a global services hub. And it is already considered the second largest IT services market in Latin America.

The point of this blog is not to discuss specific country’s risk profiles, but rather to remind readers that such wild swings must be factored into location analyses, similar to how attorneys approach terms and conditions from a worst-case scenario.

Although labor arbitrage was the primary driver – and continues to be important – in offshoring location decisions, typical global firms are becoming increasingly ready to exploit economies of scale. If a company’s offshore delivery is currently split among several locations – say, Argentina, Philippines, and Romania, each serving a respective region – it is quite tempting to consider some consolidation initiative through formation of a mega-large shared services center, and that’s where increased exposure to specific location risk kicks in as a decision factor.

Obviously, increased volatility in geopolitical risk is just one of many aspects an organization should factor into cost/benefit analysis, and the analysis must be tailored to each organization’s specific situation. That said, here are several general thoughts to consider:

  • There’s no question that it’s very difficult to walk away from an opportunity to reduce your annual cost by, say, US$20-50 million through aggressive optimization of your delivery footprint. But all those savings could get wiped out by billion dollar losses if something goes wrong and disruptions cascade throughout the entire value chain. Therefore, it makes sense to “hedge” such optimization opportunities by developing a customized risk mitigation framework that includes maintaining some “cold” and “warm” alternative sites, and a relocation strategy.
  • Level of acceptable location selection risk varies from company to company, and depends in part on whether the goal is just to achieve cost parity with industry peers, or if a lighter cost structure is expected to become the source of competitive advantage. But remember that any company implementing a low cost competitive strategy must take on some degree of risk.
  • You can reduce some of your risk by using a reputable third party service provider instead of building your offshore presence from scratch, as managing location risk is one of providers’ core competencies, and global providers operate multiple delivery centers across the globe. With properly structured terms and conditions, your outsourcing provider will monitor and proactively manage your risk exposure, including geopolitical concerns.

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