Outsourcing vs. Offshoring

Outsourcing is used by companies to contract specific tasks or processes out to a third party.

Offshoring, on the other hand, is the process of moving tasks or processes overseas that were once performed in-house.

In truth, there are a few different outsourcing strategies and offshoring is one of them.

Both practices are similar in that the work is assigned to a third party that operates externally.

Both also increase productivity, reduce costs, and provide access to specialist labor or knowledge.

Despite these similarities, there do exist a few differences. These are explained below.

Aspect	Outsourcing	Offshoring
Definition	The practice of contracting out certain business functions or processes to a third-party service provider, often in a different location.	The practice of relocating specific business processes or functions to a foreign country to take advantage of lower costs or specialized skills.
Scope	Can encompass a wide range of business functions, including customer support, IT services, accounting, manufacturing, and more.	Primarily involves relocating specific business processes or functions that can be performed remotely, such as customer service, software development, or data entry.
Location	The service provider can be located locally or in a different region, but not necessarily in a foreign country.	Involves the transfer of business processes or functions to a foreign country, often in a region with lower labor costs.
Purpose	Mainly driven by the desire to focus on core competencies, reduce costs, access specialized expertise, and improve efficiency.	Primarily driven by cost reduction, taking advantage of lower labor costs, tax incentives, or access to a specific talent pool.
Control	The hiring company retains control over the outsourced process or function but relies on the service provider’s expertise to deliver results.	Involves a significant degree of control relinquishment, as the offshore team or partner manages the relocated function.
Risks	Risks include communication challenges, potential loss of intellectual property, and dependence on the service provider’s performance.	Risks include cultural differences, time zone challenges, regulatory compliance issues, and geopolitical factors.
Benefits	Offers access to specialized skills, cost savings, scalability, and the ability to focus on core business functions.	Provides significant cost savings, access to a global talent pool, and potential tax advantages.
Examples	– Outsourcing customer support to a third-party call center. – Outsourcing IT services to an external provider.	– Offshoring software development to a development team in India. – Offshoring back-office functions to a service center in the Philippines.

Table of Contents

Understanding Outsourcing

In essence, outsourcing refers to the practice of contracting work out to individuals (freelancers) or companies in another country.

These entities are not considered part of the organization and usually have the freedom to work as they please under the proviso that deadlines are met and adequate results are produced.

Outsourcing benefits

In a 2020 global survey on why companies outsource, Deloitte found that the following reasons were most popular:

Cost reduction (70% of respondents). Hiring in-house specialists increase overheads.
Flexibility (40%). This pertains to shorter, more flexible contracts and the commoditization of services.
Speed to market (20%). This is influenced by the microservice architecture which enables the continuous deployment of complex applications.
Access to tools and processes (15%), and
Agility (15%).

Outsourcing risks

Companies are sometimes forced to share proprietary information with third parties during their relationship.

To minimize the chances of theft, prior due diligence on a contractor is vital.

There may also be communication issues that arise from differences in time zone, culture, or language.

Understanding offshoring

Offshoring is perhaps a more substantial initiative where crucial business processes or operations are moved to another country.

Unlike outsourcing, where work is performed by external entities, offshoring operations remain under the control of the company.

Offshoring benefits

Many companies use offshoring to reduce manufacturing costs, but there are other important benefits such as:

Less stringent rules and regulations – with fewer impediments to production, the company can increase revenue and profit.
Incentives – some countries offer incentives to companies willing to establish a presence there. In the wake of COVID-19, India and some countries in Europe and Africa are offering various tax deductions, subsidies, and cash grants to lure foreign investment.

Offshoring risks

The risks of offshoring are similar to those that are present in outsourcing – particularly if either operation is conducted in a vastly different culture or region.

Organizations that move core operations overseas sometimes suffer reputational damage as employees lose their jobs in the domestic market.

They can also be subject to various geopolitical risks, with labor unions in the United States actively lobbying Congress against offshoring.

Other states in the USA are considering legislation to avoid working with firms that offshore to developing countries with cheap labor.

Key takeaways:

Outsourcing is used by companies to contract specific tasks or processes out to a third party. Offshoring is the process of moving tasks or processes overseas that were once performed in-house.
Offshoring is one of a few different forms of outsourcing, which means they share similarities. Both involve work assigned to a third party that operates externally and both share similar cost reduction benefits.
The key difference between offshoring and outsourcing is that in the former, operations remain under the control of the company in question. Offshoring also tends to be used for core operations such as manufacturing, while outsourcing is popular for smaller tasks and services that help a business remain flexible and agile.

Recap: Outsourcing vs. Offshoring

Outsourcing:

Definition: Outsourcing is the practice of contracting specific tasks or processes to a third-party individual or company, often located in another country. The third-party entity operates externally and is not considered part of the organization.
Benefits: Companies outsource for various reasons, including cost reduction, increased flexibility through shorter contracts, speed to market enabled by microservice architecture, access to specialized tools and processes, and improved agility.
Risks: Risks associated with outsourcing include the need to share proprietary information with third parties, potential communication issues due to time zone, cultural, or language differences, and the importance of conducting due diligence to minimize the chances of data theft or security breaches.

Offshoring:

Definition: Offshoring involves moving critical business processes or operations to another country while keeping them under the control of the company. It is a more substantial initiative than outsourcing, and offshored operations remain a part of the organization.
Benefits: Offshoring is often used to reduce manufacturing costs, benefit from less stringent rules and regulations in some countries, and take advantage of incentives offered by certain countries to attract foreign investment.
Risks: Offshoring shares some risks with outsourcing, particularly related to cultural or regional differences. Companies that move core operations overseas may face reputational damage if domestic employees lose their jobs, and they might encounter geopolitical risks and opposition from labor unions or legislative bodies.

Case Studies

1. Customer Support:

Outsourcing: A tech company based in the USA contracts a call center in the Philippines to handle customer support inquiries. The call center operates independently from the tech company but follows guidelines provided.

Offshoring: The same tech company decides to set up its own customer support center in India. The employees in India are directly employed by the tech company, and the center is managed as an extension of the main company.

2. Manufacturing:

Outsourcing: A toy company in Germany contracts a factory in China to produce toy parts. The Chinese factory produces parts for various other companies as well.

Offshoring: The German toy company sets up its own factory in Vietnam, directly employing local workers, and manages the production process.

3. Software Development:

Outsourcing: A startup in Canada hires a software development agency in Ukraine to develop its mobile app. The Ukrainian agency handles multiple clients and projects.

Offshoring: The Canadian startup opens a software development office in Poland, hires local developers, and manages the development process directly.

4. Data Entry:

Outsourcing: A healthcare provider in the UK contracts a data entry service in India to digitize patient records. The service provider works with various clients and sectors.

Offshoring: The UK healthcare provider sets up its own data entry center in South Africa, employing local staff to digitize records.

5. Accounting and Finance:

Outsourcing: A restaurant chain in Australia hires an accounting firm in Malaysia to handle its bookkeeping and financial reporting. The firm offers services to multiple businesses.

Offshoring: The Australian restaurant chain establishes its finance and accounting department in the Philippines, managing all financial tasks with its own employees.

6. Human Resources:

Outsourcing: A tech giant in the USA uses a recruitment agency in Ireland to find and hire talent for its European branches. The agency services various clients.

Offshoring: The tech giant opens its HR department in Spain to manage recruitment and other HR tasks for its European operations.

7. Research and Development:

Outsourcing: A pharmaceutical company in Switzerland contracts a research lab in Brazil to conduct specific tests. The lab works on various research projects for different companies.

Offshoring: The Swiss pharmaceutical company establishes its research lab in Singapore, employing scientists and researchers directly to work on its projects.

8. Marketing and Design:

Outsourcing: A fashion brand in Italy hires a digital marketing agency in Thailand to manage its online advertising campaigns. The agency has a portfolio of diverse clients.

Offshoring: The Italian fashion brand sets up its marketing and design team in Indonesia, directly overseeing its campaigns and designs.

9. Logistics and Distribution:

Outsourcing: An e-commerce platform in Spain contracts a logistics company in Morocco to handle its shipping and deliveries in North Africa. The logistics company has other e-commerce clients as well.

Offshoring: The Spanish e-commerce platform establishes its distribution center in Egypt, managing its logistics operations directly for the African market.

10. Legal and Compliance:

Outsourcing: A bank in Japan hires a legal firm in the UK to handle its international compliance issues. The firm provides legal services to multiple financial institutions.

Offshoring: The Japanese bank opens its legal and compliance office in Hong Kong, employing its lawyers and compliance officers to handle international regulations.

Context	Outsourcing	Offshoring
Information Technology (IT)	A company contracts an external IT service provider to manage its helpdesk support, software development, or network administration.	A company establishes a subsidiary or partners with an overseas firm to handle IT tasks, such as software development, quality assurance, or technical support.
Customer Support	A business outsources its customer service operations to a third-party call center located within the same country.	A company offshores its customer support operations to a call center in a different country with lower labor costs.
Manufacturing	A company subcontracts the production of certain components to a local manufacturer to reduce costs and focus on core activities.	A company relocates its manufacturing processes to a foreign country where labor and production costs are lower.
Accounting and Finance	A business outsources its bookkeeping and payroll tasks to an accounting firm within its own country.	A company offshores its finance and accounting functions to a dedicated team or service provider in a country with cost advantages.
Human Resources	A company hires an external HR agency to handle recruitment, employee benefits administration, and HR compliance.	A business establishes an offshore HR center to manage recruitment, payroll, and HR-related tasks for global employees.
Digital Marketing	A business contracts with an external agency to manage its digital marketing campaigns, content creation, and SEO efforts.	A company sets up an offshore digital marketing team in a country with skilled professionals to handle online marketing activities.
Research and Development	A company outsources specific R&D projects to research firms or labs located nearby.	A company offshores its research and development activities to a dedicated team in a country known for expertise and cost savings.
Data Entry and Processing	An organization outsources data entry and data processing tasks to a domestic data entry service provider.	A company offshores data entry and processing tasks to an offshore location with a lower cost of labor.
Legal Services	A law firm outsources document review tasks to a legal process outsourcing (LPO) company within the same country.	A law firm offshores document review, contract drafting, or legal research tasks to a legal service provider in a country with cost advantages.
Content Creation	A company outsources content writing and graphic design tasks to freelance professionals or agencies locally.	A business offshores content creation tasks to international content agencies or remote freelancers in countries with competitive rates.

Related Frameworks, Models, Concepts	Description	When to Apply
Outsourcing	– The business practice of hiring a party outside a company to perform services or create goods that traditionally were performed in-house by the company’s own employees and staff. Typically done to reduce costs or improve efficiency.	– Used by companies looking to reduce labor costs, access specialized expertise, or improve focus on core business activities.
Offshoring	– The practice of relocating a business process from one country to another—typically an operational process, such as manufacturing, or supporting processes, such as accounting. Often done to take advantage of lower costs or more favorable economic conditions.	– Suitable for businesses aiming to reduce production costs or to expand into new markets by setting up production or service facilities in countries with lower operational costs.
Nearshoring	– Transferring business or IT processes to companies in a nearby country, often sharing a border with the target country. This is typically sought to reduce travel times, improve communication due to closer cultural links, and enable better time zone alignment.	– Applied when companies need to outsource but want closer geographic and cultural alignment for better collaboration and communication.
Inshoring	– The practice of bringing processes handled by third-party firms overseas back to the country where the business operates. This can be driven by a need for greater control over quality and intellectual property, or public and political pressure.	– Utilized when quality control or political reasons make local production or service provision more favorable.
Business Process Outsourcing (BPO)	– A subset of outsourcing that involves contracting the operations and responsibilities of specific business processes or functions (e.g., payroll, customer service) to a third-party service provider.	– Often used to improve efficiency or reduce costs in non-core areas such as customer service, HR, or accounting.
Knowledge Process Outsourcing (KPO)	– Outsourcing in which knowledge-related and information-related work is carried out by workers in a different company or by a subsidiary of the same organization. This subsidiary may be in the same country or overseas, where it can perform cost-effectively.	– Applied when specialized knowledge or expertise is required that is not readily available in-house or domestically.
Supply Chain Management (SCM)	– The management of the flow of goods and services, involving the movement and storage of raw materials, of work-in-process inventory, and of finished goods from point of origin to point of consumption.	– Critical in optimizing operational efficiencies and ensuring the effective flow of goods, services, and information across all parts of the supply chain.
Contract Manufacturing	– A form of outsourcing where a firm hires another company to produce parts or entire products on its behalf. This is common in international business where companies take advantage of lower labor costs and favorable regulatory environments.	– Employed by companies looking to scale production without significant investment in facilities or to leverage specialized manufacturing capabilities.
Strategic Alliances	– A cooperative agreement between business entities to pool their resources in pursuit of common goals, while remaining independent organizations. These alliances may involve technology transfers, sharing of production facilities, co-marketing, and other forms of collaboration.	– Used when companies need to combine efforts to access new markets, share resources, or optimize complementary strengths without full mergers or acquisitions.
Vertical Integration	– A strategy where a company expands its business operations into different steps on the same production path, such as when a manufacturer owns its supplier and/or distributor.	– Applied to control more of the supply chain, reduce dependency on suppliers, and secure streams of critical materials or market channels.