Spanish Offshoring: Growing Trends in a Globalized World

Spanish Offshoring: Growing Trends in a Globalized World

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Project Offshoring Research Network 4th Survey Report (December 2010) Prof. Enric Ricart, Profesor Ordinario de Dirección Estratégica, IESE Soledad Rossetti, Research Assistant, IESE Maria Bakardjieva, Research Assistant, IESE

Index INTRODUCTION 5 DEFINITIONS 5 THE STUDY 7 THE SPANISH SAMPLE 7 CONCLUSIONS 19 6 IESE - University of Navarra

Introduction The phenomenon of offshoring (transferring some corporate activities to foreign countries) is of growing importance for companies, employees and governments. An increasing number of activities and functions are being taken away from corporate headquarters and moved to faraway countries, sometimes on other continents. This delocalization is continuously increasing in terms of importance and added value for the company and the types of activities it encompasses, such as product design and R&D. Globalization is one of the key factors that facilitates this third wave of offshoring of functions with a certain added value. In comparison, the second wave was centered on the offshoring of predominantly low-skilled IT and customer service functions, while the first wave was primarily focused on activities related to production. Given the scope that this phenomenon has gained in recent years, both in the business and in the academic world, IESE initiated an academic study of service offshoring, i.e., offshoring of white collar workers. The result was the study titled El Offshoring en España. Causas y consecuencias de la deslocalización de servicios (IESE, 2006), which focused on the importance of this phenomenon in Spain. Today we are presenting the 4th publication of results of this survey titled Spanish Offshoring: Growing Trends in a Globalized World. This edition reflects on the growth of the phenomenon in terms of the number of companies involved in such activities and those that are considering offshoring. Furthermore, it studies geographical preferences, perceived risks, and the processes, functions and activities needed to be successful. Moreover, this report makes a comparison with the information from the previous editions, which allows us to identify the changes and trends of offshoring practices in Spanish companies. The study also includes comparisons with other countries represented in the Offshoring Research Network (ORN). The ORN is an international initiative started four years ago at Duke University s Fuqua School of Business (North Carolina, USA) under the leadership of Prof. Arie Lewin. His objective was to unite business and academics in order to share experience and knowledge about offshoring among different countries. Besides IESE Business School, the Spanish research partner in the project, other business schools are involved: Copenhagen Business School (Denmark), 1 Manchester Business School (United Kingdom), Rotterdam School of Management (Netherlands), Otto Beisheim School of Management (Germany) and Université Libre de Bruxelles - Solvay Business School (Belgium). 2 Definitions Due to the fact that offshoring is a developing phenomenon, there is still some uncertainty regarding the different terms used to talk about it. Following are some key terms: Outsourcing Outsourcing refers to the externalization of a company s non-core activities. Outsourcing processes are generally conducted by specialized companies that are better prepared to implement the necessary changes than the outsourced company itself. When a company in another country is involved, the correct term is offshore outsourcing. Nearshore outsourcing refers to projects outsourced to a different country, but one on the same continent. Some of the main purposes of taking these actions include the desire to free up cash, personnel, time and facilities for activities in which the firm holds competitive advantage. Firms with strengths in other areas may outsource data processing, legal matters, manufacturing, marketing, payroll accounting and other aspects of their businesses to concentrate on what they do best and thus optimize their efforts. 1 Ustün, T. B. et al. (eds.), Disability and culture : universalism and diversity, Hogrefe and Huber, Seattle, 2001. 2 Ustün, T. B. et al. (eds.), Disability and culture : universalism and diversity, Hogrefe and Huber, Seattle, 2001. IESE - University of Navarra 7

Offshoring The term offshoring comes from the words off and shore, and refers to activities that are conducted far from the place of origin. Traditionally, it referred to fishing in the mountains, due to the distance from the seashore. When referring to companies, offshoring involves moving resources, functions and/or activities, i.e., transferring them to another country. There are two main types of offshoring: the transfer of blue collar workers (i.e., production), which has been very common for years as an alternative strategy to reduce costs; and the transfer of white collar work (i.e., services), which began much more recently and includes activities with greater added value. Models of offshoring Captive Center The company establishes a subsidiary or local office in the chosen country. This creates a captive center to which the desired activities can be brought. Offshore Outsourcing This consists of a combination of offshoring and outsourcing. This means that the company subcontracts an activity to a provider operating in a different country. Alternative models There are many other models that combine different features of the two models mentioned above. For example, companies may subcontract providers only in the initial stage of offshoring in order to use their knowledge of the local market and thus facilitate the integration process. Other approaches include subcontracting a third party that does not operate in the destination country to subcontract a national provider or to participate in joint ventures. 8 IESE - University of Navarra

The Study The study is part of an online survey prepared by the Offshoring Research Network and its aim is to study the perceptions of business owners with regard to offshoring. The sample consisted of three types of companies: - companies involved in offshoring - companies not involved in offshoring, but which plan to begin offshoring - companies that do not participate in offshoring and do not plan to All of the countries participating in the Offshoring Research Network use the same questionnaire. This ensures that national and international comparisons are relevant and true. The main objective is to give business owners in Spain a reference point when deciding whether or not to pursue this business model. This research publication includes comparisons with the studies done in the United States between 2006 and 2009. 3 Even though the results are not representative of the general situation in these countries, but rather that of the companies studied, it is certainly possible to see differences between Spain and the rest of the participants. The Spanish Sample The survey was sent to executives in Spain. Among them were members of management boards, HR managers and other executives. The survey was sent to more than 4,000 executives at companies in a wide variety of sectors, such as financial and banking services, technology, energy, traveling and leisure, the automotive industry, hospitality, environmental corporations, engineering and telecommunications. Between 2006 and 2009, 173 companies responsible for 448 offshored units filled out the survey. Of them, 93 companies completed the entire questionnaire, while 80 only partially completed it. As noted, this is not a representative study for the general situation of all companies in Spain, but does provide a general overview of key aspects and trends associated with offshoring. Of the 111 companies that reported the total number of employees in the company, the distribution was as follows: Figure 1: Sample Demographics Of a total of 89 companies in the 2006 2008 sample that identified the industry in which they operate, the majority were in manufacturing, followed by professional services and finance and insurance. Other reported industries included software, retail, agriculture, construction, education, pharmaceuticals, telecommunications, and oil and gas. A large proportion (37%) of the companies that responded identified Other as the focus of their business. 3 Lewin, Arie Y. Next Generation Offshoring. The Globalization of Innovation. Offshoring Research Network 2006 Survery Report. IESE - University of Navarra 9

Figure 2: Industries in the Sample For the purposes of this study, some functions were grouped together under a common title to provide a clearer understanding of trends. Thus, Product Development includes functions ranging from R&D and design to engineering and manufacturing. At the same time, Administration includes finance, accounting and HR. Figure 3a and Figure 3b show the percentage distribution of the companies based on the degree to which they have adopted offshoring. A total of 173 companies responded to this question between 2006 and 2009. Of them, 57% have either implemented offshoring practices in their business or are considering doing so in due time. Figure 3a: Companies from the Entire 2006 2009 Sample and Their Positions on Offshoring Between 2006 and 2007, out of 143 companies in the sample, 57% were either offshoring already or were considering it. The 2008 2009 sample consists of 30 companies, of which 50% were either offshoring or considering doing so, while the other 50% were firmly not interested in this option at the time. 10 IESE - University of Navarra

Figure 3b: Comparison between Companies Positions in the 2006 2007 and 2008 2009 Samples Keeping in mind that the second sample is significantly smaller than the first, it is questionable whether valid conclusions can be drawn by only looking at this information. In Spain, the types of services most offshored are product development (particularly engineering), IT and procurement. Figure 4 shows the types of functions offshored by implementation, where the sample accounts for companies that are either considering or already involved in offshoring and represent a total of 331 offshored implementations, of which 277 were studied from 2006 to 2007 and 54 were studied from 2008 to 2009. Figure 4: Commonly Offshored Functions. Comparison between 2006 2007, 2008 2009 and 2006 2009 IESE - University of Navarra 11

Based on the research previously done by ORN, we can conclude that the most commonly offshored functions by the U.S. and Spanish companies resemble each other. Nevertheless, Spain seems to be more reluctant to offshore knowledge-based services such as research and development, IT and software development, while these services have already taken on significant importance in the offshoring scope of the United States. On the other hand, significant growth can be seen in the offshoring of product development functions in Spain. There has been a clear movement over the years (Figure 5) from offshoring low-expertise-level services to offshoring knowledge-based functions and responsibilities such as IT, research and development and software development. This is the most definitive characteristic of the third wave of offshoring. Instead of exporting functionality with low skill value, companies have started to trust and even look for external knowledge, skills and expertise for research and development. For example, as shown in Figure 5, offshoring IT services has steadily increased in recent years. In the sample, 35 offshored business implementations started their activity before 2002. Another 35 offshored implementations started working in the period from 2002 to 2004. Between 2005 and 2006, 42 implementations were offshored to other countries. Another 32 implementations were offshored between 2007 and 2008. Not only did the types of responsibilities undergo certain changes in offshoring practices, but so did the preferred countries for offshoring. Out of a total sample of 306 offshoring implementations for which this question was answered (270 in 2006 2007 and 36 in 2008 2009), the preferred offshoring destination for Spanish companies was Latin America (with a particularly high percentage of offshoring in Mexico). In 2008 2009, however, Spanish companies frequently decided to remain on the continent and establish offshored implementations in Western, Central and Eastern European countries, which account for 24% of the total in the 2008 2009 sample. Figure 5: Types of Offshored Activities Based on Year of Implementation 12 IESE - University of Navarra

Figure 6: Preferred Offshore Destination Based on Offshored Implementations 10% 3% 1% 6% 1% 1% 14% 42% 14% 3% 1% 5% 1% 2% 12% 31% 6% 3% 6% 8% 28% 11% 11% 11% 10% 7% 1% 5% 14% 11% 10% 8% 1% 6% In a sample of 222 offshored implementations with an identified function and location for offshoring, there were evident geographical preferences defined by the particular functions that the offshored implementations would have to execute. Thus, call centers offshored to Latin America and Mexico accounted for 58% of all offshored call centers. The percentage remained very high in other functions such as IT (56% in Latin America and Mexico), procurement (64% in Latin America and Mexico) and software development (55% in Latin America and Mexico). IESE - University of Navarra 13

Figure 7a: Preferred Destination by Function in Spain (2006 2007 Sample Only) Note: Marketing and Sales functions have been excluded from the graph, since the companies that reported offshoring these activities did not specify the location. The overall sample consisted of 253 companies that reported the function and location of their offshored implementations. Overall, it can be seen that although Latin America has remained a favorite for offshoring of Spanish companies, other regions are also becoming increasingly popular. 14 IESE - University of Navarra

Figure 7b: Preferred Destination by Function in Spain (Both Samples Included) As can be seen in the graph, there are specific patterns in the preferred offshoring locations for administration and product development. Spanish companies seem to prefer to keep their administrative activities closer to home, which makes Western Europe the most popular destination for offshoring, followed by Mexico and Latin America, locations that share the same language, thus making communication easier. On the other hand, product development functions IESE - University of Navarra 15

are offshored predominantly to Europe (Eastern and Western Europe), which supports the hypothesis that distance is still a deciding factor when undertaking offshoring. Nevertheless, the runner-up was India, which has become known as a potential pool of innovation and technical know-how. Latin America remains a common choice as well, mainly due to the language and, it is safe to assume, because Spanish companies already feel familiar with the environment, as they have a long history of offshoring to that market. Figure 8: Destinations of Small vs. Large Companies A small company is defined as any company which answered this question with between 1 and 1,000 employees. A medium-sized company has between 1,001 and 5,000 employees, while a large company has over 5,000 employees. Small companies seem to be much more adventurous in terms of preferred locations than big corporations. This may be due to several reasons, the most important of which could be that medium-sized companies are generally more flexible and mobile than large companies, where bureaucracy considerably delays the implementation of procedures. Large companies can also afford to offshore to more expensive destinations (such as India instead of Western Europe), which decreases the perceived risks of cultural differences and the lack of managerial control, as shown in Figure 10. The main reasons for offshoring are summarized as follows. Of the 174 companies that answered this question from 2006 to 2009, 37% identified low labor costs as one of the key reasons they would consider offshoring. In the 2006 2007 sample, 40% of the offshored implementations (57 companies) were done for that reason, while in 2008 2009 that percentage dropped to 27% (8 companies). Flexibility and capacity for innovation, on the other hand, was not considered a factor in 2006 2007, but gained leading importance in 13% of the companies in the 2008 2009 sample. Much like in the United States, saving on labor costs is the primary driver for implementing offshoring practices. In the United States, almost 90% identified this factor as important or very important, while in Spain the percentage for the same period was 54% and this factor led as a key benefit of offshoring. The second strongest driver in the United States has been the desire of companies to grow and the opportunity to fulfill the goals set in their growth strategies (around 60% of the companies identified this as a leading factor). In Spain, this also remained a key driving force, with a total of 42% of companies rating it as important or very important. As information technology is one of the most commonly offshored functions in the United States, it is only natural that access to qualified personnel was ranked as the third most important driver with nearly 60%. In Spain, this factor remained very important as well, with a total of 31% of the companies rating it as important or very important. However, it needs to be combined with another driver, namely the domestic shortage of qualified personnel, which was rated a factor by an average of 29% of the survey participants in the United States and by 22% in Spain. 16 IESE - University of Navarra

While cultural differences were the predominant concern in the 2008 2009 offshored implementations sample, of the 30 companies sampled in this period, 28% stated that they would be most concerned about the potential loss of internal capabilities and progress power, while 37% pinpointed the lack of managerial control as another significant risk that they were taking. Figure 9: Main Perceived Benefits of Offshoring IESE - University of Navarra 17

With respect to the United States, the trends seem to remain similar, as over half of the companies identified the risk of losing service quality as important or very important, while the percentage of Spanish companies was 47%. Similarly, both American and Spanish corporations were concerned about losing production efficiency by offshoring their activities. Figure 10: Main Perceived Risks of Offshoring 18 IESE - University of Navarra

Figure 11: Preferred Model of Offshoring Based on Offshored Implementations Product development activities (manufacturing, engineering, etc.) and procurement were the two functions most commonly implemented using captive methods of offshoring, while call centers and IT were mostly left to external providers. IESE - University of Navarra 19

Table 1: Offshored Activities Based on Number and Type of Model in the 2006 2007 Sample Function CAPTIVE % EXTERNAL % Call Centers 10 30% 23 70% IT 14 44% 18 56% Marketing and Sales 4 50% 4 50% Product Development 33 66% 17 34% Procurement 21 78% 6 22% Software Development 7 64% 4 36% Total 89 55% 72 45% Table 2: Offshored Activities Based on Number and Type of Model in 2008 2009 Sample Function CAPTIVE % EXTERNAL % Call Centers 0 0% 1 100% IT 1 50% 1 50% Product Development 1 10% 9 90% Software Development 0 0% 2 100% Total 2 13% 13 87% Table 3: Offshored Activities Based on Number and Type of Model, 2006 2009 Function CAPTIVE % EXTERNAL % Call Centers 10 29% 24 71% IT 15 44% 19 56% Marketing and Sales 4 50% 4 50% Product Development 34 57% 26 43% Procurement 21 78% 6 22% Software Development 7 54% 6 46% Total 91 52% 85 48% Table 4: Expected Savings Due to the Implementation of Offshoring Expected Savings Percentage Number of Companies Executing + Considering Offshoring 32% 41 Executing Offshoring 31% 24 Considering Offshoring 33% 17 Achieved Savings 29% (14 companies have identified achieved savings) 20 IESE - University of Navarra

Conclusions The data gathered by the ORN and its Spanish center at IESE between 2006 and 2009 demonstrate a general trend of growth and spread of the activities offshored, as well as the location chosen and the approaches to this strategic decision. As noted above, this is not a representative study for the general situation of all companies in Spain, but does provide a general overview of key aspects and trends associated with offshoring, as summarized below: The offshoring of knowledge-based activities has slowly increased in recent years Basic services remain the main type of activities being offshored in Spain. Nevertheless, in recent years there has been a certain notable trend of companies starting to offshore more complicated tasks such as research and development. Although this is still in its early stages in comparison to the United States, it could be inferred that the change will be gradual and permanent rather than sporadic and temporary. Customer service, basic IT services, engineering and manufacturing, however, remain the most popular activities being outsourced to distant geographical locations. Latin America remains a preferred destination Latin America (including Mexico) remains the primary location chosen by businesses. Some major reasons for this are low labor costs, the common language and the fact that there is less risk of cultural differences for Spanish companies than in many other geographic locations. Nevertheless, the 2008 2009 sample showed a certain shift of preference in favor of Eastern and Western Europe. Despite the obvious language differences, some connections could be made between the traditional associations relevant to some parts of the world as companies move towards outsourcing more high-skilled labor. Nevertheless, an overall evaluation of the situation shows that many companies (31%) are able to find qualified personnel not available in their home countries and pinpoint this as a very important advantage of offshoring. Size is important There is an evident tendency of preferences for offshoring locations based on the size of the company. Bigger companies seem to focus more on countries in Latin America (including Mexico) and Western Europe. Smaller companies, on the other hand, have a more diverse portfolio of locations where they offshore, including Eastern Europe, India and China. The rise of new regions There seems to be a certain trend to change the geographic location of companies from what might historically be seen as traditional destinations. Furthermore, not only are companies entering new countries, but they are also reviving their offshoring practices in countries closer to home. Particularly in Spain, corporations tend to offshore closer to home throughout Europe (Western, Central and Eastern). Three primary reasons to offshore The deciding factors that determine a company s need to offshore could be divided into three main groups: strategic, tactical and operational. Although strategic reasons still remain very influential, more and more companies identify financial savings as the main driving factor. Strategic reasons included part of the growth strategy (25%), competitive pressure (23%), business process redesign (22%) and part of the global strategy (17%). Financial reasons are key drivers of offshoring: lower labor costs (38%) and other lower costs (22%). Further factors that influence the offshoring decision are better service levels (21%), access to qualified personnel (20%) and domestic shortage of qualified personnel (14%). Costs, language and talent are the key determining factors of location When deciding on a particular location, Spanish companies primarily consider the factors of costs, language and qualified personnel. Changes in perceived risk The primary risk factors in implementing an offshoring solution shifted from 2006 to 2009. Legal uncertainties and intellectual property issues were no longer considered leading risk factors. Greater importance was given to political instability (7% in 2006 2007 and 23% in 2008 2009), lack of control (28% in 2006 2007 and 37% in 2008 2009) and loss of internal capacity and process knowledge (22% in 2006 2007 and 40% in 2008 2009). IESE - University of Navarra 21

Externalization of the offshoring process for functions of lesser value Spanish companies that employ external providers do so for tasks and functions of lower added value, such as call centers and basic IT functions. Knowledge-based activities, such as product and software development and R&D are kept captive. Less savings than expected Savings due to offshoring were reported at 29%, while the general expectation of the companies was that they would reach 32%. 22 IESE - University of Navarra

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