The Difference Between Offshoring vs. Outsourcing

Updated: 29 Jul, 2021 | Bill Peatman

Offshoring and outsourcing are often confused. Outsourcing means contracting a service to a third party. Offshoring means contracting a service to a third party in another country--outsourcing by definition doesn't mean you're obtaining a service outside the U.S., but that is often how the term is used and understood. There are plenty of businesses that outsource services within the U.S., such as:

  • HR benefits like 401K and health care plans

  • Accounting and payroll services

  • Legal services

There are several reasons companies outsource services:

  • To reduce labor costs

  • To access specialized services

  • To focus on core business competencies

  • To deliver short term or seasonal projects

  • To get hard-to-find skills

  • To find talent faster

Offshoring vs. Outsourcing

Offshoring is the term that we should use to specifically describe outsourcing work to companies or individuals in another country—outside the borders of the United States (Mexico and Canada, for example, are not technically offshore). "Outsourcing vs. Offshoring" doesn't mean there's a conflict, just that using the terms interchangeably can be confusing. Outsourcing is associated with moving jobs overseas, but that's not always the case so that the distinction can be an important one.

Specialized Outsourcing Services

There are also more and more specialized outsourcing businesses in the U.S. and abroad. These include:

  • Manufacturing Outsourcing—companies hire another business to manufacture their products
  • Business Process Outsourcing (BPO) -- hiring specialized companies for back-office tasks like customer service and data processing
  • IT Outsourcing –a business's information technology infrastructure is hosted and managed by a third-party
  • Software Development Outsourcing—contracting with a company to build software products
  • Project Outsourcing—specialized help is needed to deliver a complex project

Again, not all of these are functions are outsourced offshore. For example:

  • Medical device contract manufacturers build prototypes and production products in the U.S.
  • U.S. accounting firms audit publicly traded U.S.-based companies
  • U.S. IT companies build and manage other business's cloud-based infrastructures

Offshoring is one method of outsourcing and has primarily to do with the location of the companies or individuals contracted to perform specialized services.

Offshoring Economics

Companies usually offshore services to developing countries where wages are low to reduce costs. These savings get passed on to the customers, shareholders, and managers of these companies. Offshoring has been criticized for hurting the U.S. economy by cutting jobs.

The idea that offshoring hurts the U.S. economy has been challenged. A McKinsey study, "Offshoring: Is it a Win-Win Game," found that every dollar offshored generates $1.45 in new revenue, with $1.12 of that revenue returning to the U.S. and 33 cents going to the offshore nation. Those 33 cents represent about $20 of equivalent spending power in a country like the Philippines.

Benefits of Offshoring to Businesses

The primary driver of offshoring is cost reduction—70 percent of businesses move services overseas to reduce expenses. The second biggest reason companies offshore services is for fast access to labor pools in countries with a much better ecosystem for specific business functions. As the offshoring industries of India and the Philippines have grown, for example, the countries' educational and professional systems have adapted to create mature training infrastructures and talent pipelines. It takes an average of four months to hire an individual in the United States, and with offshoring, businesses can get entire teams up and running in a few weeks.

Benefits to Offshore Nations

Offshoring also benefits the economies of developing countries and can help stabilize nations. The $100 billion offshoring industry in India has made it the world's third-largest economy. India's offshoring sector specializes in software development and IT services. The Philippines has grown to lead the world in BPO offshoring, with the industry generating $27 billion in revenue and supporting 1.3 million jobs.

India and the Philippines lead the world in offshoring due to their high English proficiency, growing literacy and education rates, and strong work ethics. The countries rank first and fifth in the Top 50 Digital Nations by global consultancy Tholons.

Risks of Offshoring

Offshoring (and outsourcing when used to describe offshored jobs) has come under criticism. Companies that offshore face some reputation risks due to the perception that they are moving "American jobs" overseas. As McKinsey found, the economics of offshoring is not black and white. There are other risks of offshoring:

  • Project failure or missed deadlines and ensuring legal battles over blame
  • Communication issues that slow projects down
  • Changes in offshore nations' political and economic requirements that disrupt business
  • Lack of control over outcomes

While the benefits of outsourcing and offshoring overlap, they don't share the same risks. Outsourcing in the U.S. doesn't risk alienating consumers over lost jobs or risk political, social, or economic unrest.

Offshoring vs. Outsourcing Post Covid

The Covid pandemic and the shift to all or mostly remote work has blurred the lines between outsourcing, offshoring, and directly hiring full-time workers. When everyone is remote, does it matter whether employees are down the street or on the other side of the world? In an increasingly digital economy, more services can be delivered online and from anywhere. Coincidentally, the gig economy leads more workers to pursue independent contracting, whether in Silicon Valley or Manila, giving workers more agency and giving employers more flexibility to staff on-demand from any geography.

New Models of Offshoring

While offshoring traditionally means handing off projects or processes to an overseas company, new models of outsourcing are emerging that accelerated during the pandemic. One is to hire individuals and teams overseas and blend them with your domestic teams as virtual co-workers. Online marketplaces like Upwork make it possible to hire individuals for projects and ongoing work. Managed service providers like Prialto hire, train, and manage virtual administrative assistants in Guatemala and the Philippines to work with U.S.-based executives and teams. Another managed service provider, Andela, employs, places, and supports software developers from African nations to work with U.S. tech companies.

Managing Uncertainty

Managed service offshoring gives businesses the ability to scale up and scale back as needs change. Companies also have more control over their operations because they bring offshore workers onto their teams rather than farming out work to another company. This kind of control is vital as customers have more power and more choices than ever before, and the quality of the customer experience is paramount. You can find the right employee for the right job, regardless of your business's location.

The managed service model of offshoring also gives overseas workers more than a gig—the managed service provider trains, supervises, pays, provides benefits and career paths that aren't available to independent contractors or marketplace workers. The employees work for the service provider, so the risks involved in political or social disruption are on that company. The good news is that you don't need to manage the employee's performance. That's up to the service provider.

Offshoring vs. Outsourcing: Conclusion

The most significant difference between offshoring and outsourcing is the location of the business you contract with to provide services. The second biggest difference is that offshoring involves some risks that domestic outsourcing avoids. A third option, managed offshore service providers, augments your team with the specialized skills and oversight you need with little overhead and risk on your part.

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About the Author: Bill is Prialto's senior content marketing manager and writes about the future of work and how businesses can be more productive and successful. His work has appeared in the World Economic Forum Agenda blog and CIO magazine.

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