The Less than Great Divide: Onshoring Gaining Ground | Sherpas in Blue Shirts

When conducting outsourcing cost/benefit analyses for clients, a typical comparison includes the existing internal total cost of process ownership and the hypothetical future state cost structure, consisting of retained sub-processes, governance overlays, and externally provided services. The externally provided services often assume a certain offshore component, as labor arbitrage has historically been one of the most powerful cost optimization strategies. But this is no longer necessarily true. In fact, our clients are increasingly asking us to analyze domestic labor arbitrage opportunities, and there are cases in which we advise a client heavily leaning toward an offshore solution to take a closer look at onshoring or nearshoring options, as they may reveal healthy cost savings potential without any change in risk exposure.

For example, here are a few of my recent client engagements:

Call center operations of a Canadian client – relocation of its operations from the Greater Toronto area to New Brunswick or Prince Edward Island may deliver as much as 20 percent savings on the basis of the fully loaded FTE cost.

IT applications maintenance and development – a risk-averse Chicago-based client can reduce its blended operating cost per FTE from ~$140,000 to $110,000 annually by relocating its IT support to Springfield, IL or Sioux Falls, SD. In these alternative locations it will still maintain access to a four-digit annual pool of college graduates with relevant degrees.

F&A functional support for the Brazilian operations of a large international conglomerate – offshoring of selective F&A functions from Sao Paolo to, say, Monterrey, Mexico, can generate 50 percent savings per fully loaded FTE cost. However, as the import of services in Brazil is subject to draconian duties, the entire cost savings potential is essentially eroded. However, relocation of its operations to low cost cities in northern Brazil, such as Belo Horizonte or Belem, can generate almost equal savings

I attribute all this increased interest in onshoring to a number of factors.

First, geopolitical/location risks have substantially increased in the last couple of years…think Arab Spring, drug trade-driven violence in Mexico, and numerous natural disasters in Latin America and Southeast Asia. Changed perceptions and realities require a more sophisticated risk mitigation strategy, which obviously adds to the governance cost in traditional offshore delivery models.

Second, most global firms have already addressed their secondary, non-critical processes via some outsourcing and/or offshoring frameworks. However, continuous cost pressures and increased levels of competition are forcing them to look at their retained cost components, which typically include more critical processes, and that’s where domestic labor arbitrage reveals its full potential.

Third, increased regulatory requirements in banking, healthcare, and other industries have imposed incremental solution constraints, making internal/domestic scenarios more attractive.

Fourth, fast growing economic centers are now facing talent pool shortages, with demand exceeding supply due to the extreme concentration of business activity in a single geography. As such, establishing a regional presence in such cities as Sao Paolo, Shanghai, or Moscow comes at a two to five times cost premium compared to other cities in their parent countries.

Finally, the overall slowdown of the world economy is positively contributing to domestic labor arbitrage trends. Offshoring to India or Philippines has been historically driven not only by ultra low cost opportunities but also by the abundance of local labor resources. And although there is interdependency between the cost of resources and their availability, increased unemployment rates have pushed the resource pools in various low cost domestic locations above the minimally required size, justifying a more detailed location analysis.

All in all, onshoring is evolving as a viable sourcing option, and along with traditional offshoring scenarios – externally sourced or captive – should be included in any location analysis.

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