The Impact of Distance on Offshore Business Relationships

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The Impact of Distance on Offshore Business Relationships


Authors:



Aubert, Benoit (benoit.aubert@hec.ca) (corresponding author)

Rivard, Suzanne (suzanne.rivard@hec.ca)

Templier, Mathieu (mathieu.templier@hec.ca)

HEC Montréal and CIRANO

Abstract


Offshoring can reduce the production cost of an activity. At the same time, it can generate additional management costs. This paper develops a model explaining the main drivers of the efforts required to manage offshore activities. Results show that distance plays an important role in the determination of the effort level. However, it is not simply a cultural or geographical but a more complex notion labelled “perceived distance”. IT played an interesting role in the determination of effort. It facilitated a higher formalization of the information exchanged and mitigated the impact of geographical distance on the effort required.

1. Introduction

The phenomenon of globalization and the recent opening of new markets have transformed the environment within which organizations operate. Organizations are frequently forced by strong competitive pressures to overcome new hurdles arising from a deteriorating balance of power with their clients (Baily and Farrell, 2004; Trefler, 2005). Consequently, it becomes necessary to cut costs and restructure in a perennial quest for new modes of organization that will allow productivity targets to be met.

In a context such as this, some firms will opt to relocate some of their operations. Only recently extending to the service sector, the rationale for offshoring mirrors that for outsourcing—a desire to boost profitability and cut costs more aggressively. The rapid development of IT is seen to create opportunities here, appearing to erase barriers created by distance and opening new horizons to firms.

Intuitively one can anticipate that offshoring an activity might lower production costs while at the same time generate extra costs or efforts in order to manage the activity. However, the key drivers behind these required efforts are not completely understood. This paper seeks to develop a model explaining what are the main antecedents of the efforts required to manage offshore activities. The role of distance and the effect of technology are investigated.

Data was collected from twelve organizations offering services to clients in a wide variety of countries. The respondents were based in three main regions: Atlantic Canada, Western Europe, and Eastern Europe.

Results show that distance plays an important role in the determination of the effort level. However, it is not simply a cultural or geographical distance that influences the effort. A notion of perceived distance emerged from the interviews. This construct depended on the traditional components of distance as well as the quality of the relationship history between the client and the supplier. IT played an interesting role in the determination of effort. It facilitated a higher formalization of the information exchanged and mitigated the impact of geographical distance on the effort required.

1.1 Context


Trade in services has nearly doubled during the past ten years (Jensen and Kletzer, 2005). This pattern echoes the trend we observed during the heyday of offshoring manufacturing activities (Van Welsum and Reif, 2005). Van Welsum and Reif (2005) demonstrate that certain sectors, including business services, financial services, and a variety of administrative support services are more vulnerable than others to this phenomenon.

Trefler (2005) recognizes that offshoring hinges on two central factors: improvements in the IT sector and advancing policies of openness in developing countries.

Extraterritorial offshoring raises concerns regarding employment. According to Forrester Research Inc., 3.3 million administrative jobs will be affected by extraterritorial offshoring by the year 2015 (Drezner, 2004). The long-term fallout of offshoring could be positive—the overall share of U.S. jobs affected will only be about 0.2 % annually. The ensuing savings may, in turn, fund new investments in the economy.

Benefits to the economies of developing countries can be substantial. Outsourcing certain activities may help some companies remain profitable and spur investments, thus preserving jobs (Baily and Farrell, 2004).

“There is no universal definition of Offshoring” (Trefler, 2005). Some confusion surrounds the concept of offshoring. Outsourcing is a management mode that externalizes a firm’s activities, partially or in their entirety, to another firm. The phenomenon of offshoring specifically refers to the geographical displacement of the functions or activities. Offshored functions or activities may continue to be managed by the same company. Thus, the two concepts are orthogonal.

Offshoring is not new, but it is currently expanding at an unprecedented rate (Ferguson, Kussmaul, McCracken, and Robert, 2004). According to Drezner (2004), significant recent developments in IT have facilitated, or even made possible, offshoring. Offshored activities are increasingly complex, and offshored services increasingly sophisticated (Trefler, 2005). Workers in low income countries, such as India and China, are now highly qualified (Trefler, 2005) and possess distinctive competencies. IBM, for instance, seeks not only low wages, but also specific skills and a workforce made up of reputable employees (Hamm, 2006).

Offshoring is associated with many objectives, and those frequently mentioned include lower costs, a more flexible workforce that can easily be adjusted according to need, new and distinctive competencies, and the benefits of around-the-clock operations thanks to staggered time zones (Ferguson et al., 2004).

Baily and Farrell (2004) identify costs as the single most important factor in the decision to offshore. This study will seek to explore the role of information technologies (IT) in the structure of management costs of offshored activities.




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