Impacts of risk and service type on nearshore and offshore investment location decisions: an empirical approach.

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RESEARCH ARTICLE

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Impacts of risk and service type on nearshore and offshore investment location decisions: an empirical approach.

Abstract:

* Offshoring of services has gained considerable attention in management circles. However, little empirical research has explored the emerging sourcing alternative of nearshoring, despite the fact that firms situate about one out of five projects abroad in a nearshore location as opposed to an offshore location.

* We empirically assess the impact of economic and risk factors regarding firms' services location choices between offshoring and nearshoring. We find these factors influence firm decision-making regarding services offshoring location choices, and that these factors are more or less important to firms depending on whether the firm offshores relatively higher versus relatively lower skill services.

* Offshoring firms appear willing to trade off some gains in one area (lower wages) to mitigate costs in others (higher risk), and that the factors that drive nearshoring are qualitatively different than those that influence offshoring.

Keywords: Nearshoring * Offshoring * Services * Foreign direct investment

Introduction

Although offshoring of manufacturing is not a new phenomenon, offshoring of services--especially professional and information services--has become a critical component of business efforts to reduce cost and to increase access to talent. Services were long believed to need to be produced and consumed where customers were; however, due to rapid advances in technology and communications, many services such as data entry, telemarketing and accounting can now be conducted remotely in locations distant from the firms' core processes. As has been well-documented in the business press, the expansion of this sector of the economy has been extremely rapid: according to the United Nations Conference and Trade and Development (UNCTAD) (2004), global offshoring of services was about $ 32 billion in 2001. The Gartner Group predicts it will reach $100 billion in 2011 (O'Sullivan 2008), up from $50 billion in 2007 (Overby 2006). More recently the trend toward increased offshoring of business services has continued despite the financial crisis and ensuing global recession of 2008-2009. For example, U.S imports and exports of goods dropped by 34% and 27% between April 2008 and April 2009. However, imports of business, professional and technical services (such as IT services offshore outsourced to places like India) actually increased by 4% year on year over this time period (Economist 2009).

One feature of the offshoring phenomenon that has gone largely unexamined, particularly from an empirical perspective, is the simple reality that some firms offshore to countries that are very close--geographically, economically, and institutionally--while others offshore to more distant and distinct locations. For manufacturing, there are obvious benefits associated with offshoring to such nearby countries because of reduced transportation costs and the related ability to capitalize on faster turnaround times in a conventional supply chain involving physical delivery via trucks, rail or ships (see Salvador et al. 2002, for an examination of geographical proximity in manufacturing). However, since many services can now be rapidly delivered electronically at very low cost, the traditional advantage of nearshoring--offshoring to locations that are geographically proximate to the home market--appears to be much less salient in the case of services. As we discuss more fully below, nearshoring is conventionally defined as the relocation of work from the home country to a geographically proximal host country which has a strong economic integration agreement with the home country. On the other hand, offshoring is defined as the relocation of work from the home country to a non-proximate hos...

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