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January 19th 2013

S P E C I A L R E P O R T

O U T S O U R C I N G A N D O F F S H O R I N G

Here, there and everywhere

Outsourcing.indd 1 18/12/2012 18:52

1

EARLY NEXT MONTH local dignitaries will gather for a ribbon-cuttingceremony at a facility in Whitsett, North Carolina. A new production linewill start to roll and the seemingly impossible will happen: America willstart making personal computers again. Mass-market computer produc-tion had been withering away for the past 30 years, and the vast majorityof laptops have always been made in Asia. Dell shut two big Americanfactories in 2008 and 2010 in a big shift to China, and HP now makes onlya small number of business desktops at home.

The new manufacturing facility is being built not by an Americancompany but by Lenovo, a highly successful Chinese technology group.

Founded in 1984 by 11 engineersfrom the Chinese Academy ofSciences, it bought IBM’s Think-Pad personal-computer businessin 2005 and is now by some mea-sures the world’s biggest PC-mak-er, just ahead of HP, and the fast-est-growing.

Lenovo’s move marks thelatest twist in a globalisationstory that has been running sincethe 1980s. The original idea be-hind o�shoring was that Western�rms with high labour costscould make huge savings bysending work to countries wherewages were much lower (see boxoverleaf). O�shoring meansmoving work and jobs outsidethe country where a company isbased. It can also involve out-sourcing, which means sendingwork to outside contractors.These can be either in the homecountry or abroad, but in o�shor-

ing they are based overseas. For several decades that strategy worked, of-ten brilliantly. But now companies are rethinking their global footprints.

The �rst and most important reason is that the global labour �arbi-trage� that sent companies rushing overseas is running out. Wages in Chi-na and India have been going up by 10-20% a year for the past decade,whereas manufacturing pay in America and Europe has barely budged.Other countries, including Vietnam, Indonesia and the Philippines, stillo�er low wages, but not China’s scale, e�ciency and supply chains.There are still big gaps between wages in di�erent parts of the world, butother factors such as transport costs increasingly o�set them. Lenovo’s la-bour costs in North Carolina will still be higher than in its factories in Chi-na and Mexico, but the gap has narrowed substantially, so it is no longer aclinching reason for manufacturing in emerging markets. With moreautomation, says David Schmoock, Lenovo’s president for North Ameri-ca, labour’s share of total costs is shrinking anyway.

Second, many American �rms now realise that they went too far insending work abroad and need to bring some of it home again, a processinelegantly termed �reshoring�. Well-known companies such as Google,General Electric, Caterpillar and Ford Motor Company are bringingsome of their production back to America or adding new capacity there.

Here, there and everywhere

After decades of sending work across the world, companies are

rethinking their o�shoring strategies, says Tamzin Booth

A C K N O W L E D G M E N T S

CONTENT S

Many people helped in the prep-

aration of this report. In addition to

those mentioned in the text, the

author would like to thank Jim

Aisner, Duncan Aitchison, Juan

Alcacer, Sudin Apte, Pradipta

Bagchi, Riccardo Barberis, Suzanne

Berger, Jagdish Bhagwati, Lincoln

Crawley, Sebastien Duchamp, Phil

Fersht, Fritz Foley, Je�rey Heenan

Jalil, Je�rey Joerres, Rosabeth Moss

Kanter, Arthur Langer, Stan Lepeak,

Simon Matthews, Gerry Mattios,

Vipin Nair, Gary Pisano, Jonas

Prising, Harsha Ramachandra, Willy

Shih, Mark Stanton, Brion Tingler,

Michael Zakkour and Britt Zarling.A list of sources is at

Economist.com/specialreports

An audio interview with

the author is at

Economist.com/audiovideo/specialreports

SPECIAL REPORT

OUT SOURCING AND OFFSHORING

The Economist January 19th 2013 1

3 HistoryThe story so far

4 ReshoringmanufacturingComing home

5 EuropeStaying put

7 Home or abroad?Herd instinct

8 India’s outsourcingbusinessOn the turn

10 ServicesThe next big thing

11 RobotsRise of the softwaremachines

12 What to do nowShape up

2 The Economist January 19th 2013


SPECIAL REPORT

2

1

In December Apple said it would start making a line of its Maccomputers in America later this year.

Choosing the right location for producing a good or a ser-vice is an inexact science, and many companies got it wrong. Mi-chael Porter, Harvard Business School’s guru on competitivestrategy, says that just as companies pursued many unpromisingmergers and acquisitions until painful experience brought great-er discipline to the �eld, a lot of chief executives o�shored tooquickly and too much. In Europe there was never as much enthu-siasm for o�shoring as in America in the �rst place, and the smallnumber of companies that did it are in no rush to return.

Firms are now discovering all the disadvantages of dis-tance. The cost of shipping heavy goods halfway around theworld by sea has been rising sharply, and goods spend weeks intransit. They have also found that manufacturing somewherecheap and far away but keeping research and development athome can have a negative e�ect on innovation. One answer tothis would be to move the R&D too, but that has other draw-backs: the threat of losing valuable intellectual property in far-o� places looms ever larger. And a succession of wars and natu-ral disasters in the past decade has highlighted the risk that sup-ply chains a long way from home may become disrupted.

Third, �rms are rapidly moving away from the model ofmanufacturing everything in one low-cost place to supply therest of the world. China is no longer seen as a cheap manufactur-ing base but as a huge new market. Increasingly, the main reasonfor multinationals to move production is to be close to customersin big new markets. This is not o�shoring in the sense the wordhas been used for the past three decades; instead, it is being �on-shore� in new places. Peter Löscher, the chief executive of Sie-mens, a German engineering �rm, recently commented that thenotion of o�shoring is in any case an odd one for a truly interna-tional company. The �home shore� for Siemens, he said, is nowas much China and India as it is Germany or America.

Companies now want to be in, or close to, each of their big-

gest markets, making customised products and respondingquickly to changing local demand. Pierre Beaudoin, chief execu-tive of Bombardier, a Canadian maker of aeroplanes and trains,says the �rm used to focus on cost savings made by sending jobsabroad; now Bombardier is in China for the sake of China.

Lenovo, as a Chinese company, has its own factories in Chi-na. The reason it is moving some production to America is that itwill be able to customise its computers for American customersand respond quickly to them. If it made them in China theywould spend six weeks on a ship, says Mr Schmoock.

Under this logic, America and Europe, with their big do-mestic markets, should be able to attract plenty of new invest-ment as companies look for a bigger local presence in placesaround the world. It is not just Western �rms bringing some oftheir production home; there is also a wave of emerging-marketchampions such as Lenovo, or the Tata Group, which is makingRange Rover cars near Liverpool, that are coming to invest inbrands, capacity and workers in the West.

Such changes are happening not only in manufacturing butincreasingly in services too. Companies may either outsource IT

Sources: AlixPartners; McKinsey; Hackett

Companies’ intentions to change manufacturing source, worldwide, % of capacity

Change in US jobs because of outsourcing

F O R E C A S T

2009-11

2012-14 Offshore

26%

23%

16%

24%

9% 6%

19% 9%Move betweenlow-cost countries Reshore

Move betweenhigh-cost countries

Other transport equipment

Machinery

Metals and minerals

Paper and printing

Automotive

+95

+50

+21

+13

+6

Wood and furniture

Food and beverages

Chemicals, plastics,petroleum and coal

Textiles and clothing

Computers andelectronics

Other

-9

-18

-84

-284

-407

-70

60

70

80

90

100

2005 06 07 08 09 10 11 12 13 14 15

MexicoChina

India

Manufacturing outsourcing cost index% of US cost 2000-10, ’000

0

and back-o�ce work to other companies,which could be in the same country orabroad, or o�shore it to their own centresoverseas. Software programming, callcentres and data-centre managementwere the �rst tasks to move, followed bymore complex ones such as medical diag-noses and analytics for investment banks.

As in manufacturing, the labour-costarbitrage in services is rapidly eroding,leaving �rms with all the drawbacks ofdistance and ever fewer cost savings tomake up for them. There has been wide-spread disappointment with outsourcinginformation technology and the routineback-o�ce tasks that used to be done in-house. Some activities that used to be con-sidered peripheral to a company’s pro�ts,such as data management, are now seenas essential, so they are less likely to be en-trusted to a third-party supplier thou-sands of miles away.

Coming full circle

Even General Electric is reversing itscourse in some important areas of its busi-ness. In the 1990s it had pioneered the o�-shoring of services, setting up one of thevery �rst �captive�, or fully owned, o�-shore service centres in Gurgaon in 1997.Up until last year around half of GE’s in-formation-technology work was beingdone outside the company, mostly in In-dia, but the company found that it waslosing too much technical expertise andthat its IT department was not respondingquickly enough to changing technologyneeds. It is now adding hundreds of IT en-gineers at a new centre in Van BurenTownship in Michigan.

This special report will examine thechanging economics of o�shoring in the corporate world. It willshow that o�shoring in its traditional sense, in search of cheaperlabour anywhere on the globe, is maturing, tailing o� and tosome extent being reversed. Multinationals will certainly not be-come any less global as a result, but they will distribute their ac-tivities more evenly and selectively around the world, takingheed of a far broader range of variables than labour costs alone.

That o�ers a huge opportunity for rich countries and theirworkers to win back some of the industries and activities they

have lost over the past few decades. Paradoxically, the narrowingwage gap increases the pressure on politicians. With labour-costdi�erentials narrowing rapidly, it is no longer possible to point atrock-bottom wages in emerging markets as the reason why therich world is losing out. Developed countries will have to com-pete hard on factors beyond labour costs. The most important ofthese are world-class skills and training, along with �exibilityand motivation of workers, extensive clusters of suppliers andsensible regulation. 7


SPECIAL REPORTOUT SOURCING AND OFFSHORING

2

ONCE UPON A time the rich world’s manufac-turing �rms largely produced in the richworld for the rich world, and most serviceswere produced close to where they wereconsumed. Then Western �rms startedsending manufacturing work abroad on alarge scale. By the 1980s this was wellestablished. The movement was overwhelm-ingly in one direction: away from rich coun-tries to places where workers with adequateskills were much cheaper.

Whether openly stated or not, lowerlabour costs were almost always the chiefrationale. For many �rms their very survivalwas at stake, since new competitors wereundercutting them on price. This ofteninvolved shutting capacity in America andEurope as new factories were opened inChina, Mexico, Taiwan, Thailand, easternEurope or wherever o�ered the lowest costs.

The footloose, opportunistic philoso-phy of the time was best expressed by JackWelch, then chief executive of GeneralElectric, an American conglomerate. He saidthe ideal strategy for a global companywould be to put every factory it owned on abarge and �oat it around the world, takingadvantage of short-term changes in econo-mies and exchange rates.

The economic bene�ts of o�shoringhave been immense. For workers in low-costcountries it has meant jobs and rapidlyrising standards of living. Rich-world work-ers have been able to leave the drudge workto someone else. For companies lowerlabour costs have brought higher pro�ts.Western consumers have enjoyed access tomore goods at far lower prices than if pro-duction had stayed at home.

But o�shoring from West to East hasalso contributed to job losses in rich coun-tries, especially for the less skilled, yetincreasingly for the middle classes too. Ithas become the aspect of globalisation thatworkers in the developed world dislike andfear the most. Around a decade ago �rmsrealised they could use the internet to

o�shore information technology and back-o�ce work to places such as India and thePhilippines. India’s outsourcing industrytook wing and is still growing.

How many jobs in manufacturing andservices have left rich countries is thesubject of debate, since de�nitions areslippery and companies do not give outnumbers. If a factory shuts and another oneopens halfway round the world the e�ect isclear, but if a French �rm, say, keeps all itsworkers at home and adds capacity in Mo-rocco to sell into France, have jobs beeno�shored? Estimates of the overall numberscan vary by tens of millions, but Alan Blind-er, an economics professor at PrincetonUniversity, wrote in 2006 that sendingservice jobs abroad could cause some 40mAmerican jobs to disappear to India andother emerging countries.

Such dramatic forecasts caused wide-spread alarm. In a survey by NBC News andthe Wall Street Journal in 2010, 86% ofAmericans polled said that o�shoring ofjobs by local �rms to low-wage locationswas a leading cause of their country’s eco-nomic problems. France’s new Socialistgovernment has appointed a minister,Arnaud Montebourg, to resist �delocal-isation�. Germany’s chancellor, AngelaMerkel, worries publicly about whether thecountry will still make cars in 20 years’ time.

High levels of unemployment inWestern countries after the 2007-08 �-nancial crisis have made the public in manycountries so hostile towards o�shoring thatmany companies are now reluctant to en-gage in it. Public concern over the issue hasalso encouraged politicians to bash compa-nies that send their work abroad, com-pounding the e�ect. Barack Obama’s presi-dential campaign last year repeatedlyclaimed that his rival, Mitt Romney, hadsent thousands of jobs overseas when hewas working in private equity. Mr Romney,in turn, attacked Chrysler, a car �rm, forplanning to make Jeeps in China.

The story so far

O�shoring has brought huge economic bene�ts, but at a heavy political price



SPECIAL REPORT

1

IN 2005, A START-UP company from California called ET

Water Systems decided to move its manufacturing opera-tions to China. At the time there was a general exodus to Asia insearch of lower costs, recalls Mark Coopersmith, the �rm’s chiefexecutive. ET Water Systems, which builds sophisticated irriga-tion devices for businesses, quickly started losing money, notleast because it had so much capital tied up in big shipments ofgoods which took weeks to cross the oceans. Innovation su�eredfrom the distance between manufacturing and design, and qual-ity became a problem too.

When �ve years later Mr Coopersmith investigated the dif-ference between the total cost of production in China and Amer-ica, including the cost of shipping, customs duties and other fees,he was amazed to �nd that California was only about 10% moreexpensive than China. And that was just on the immediate num-bers, without allowing for the intangible bene�ts of making thedevices almost next door. ET Water Systems’ new manufacturingpartner, General Electronics Assembly, is in San Jose. As it hap-pens, the �rm’s owner has a Chinese background and a largeportion of its employees are of South-East Asian origin.

The number of �rms known to have �reshored� manufac-turing to America is well under 100. Doubtless many more aredoing so quietly. Examples range from the tiny, such as ET WaterSystems, to the enormous, such as General Electric, which lastyear moved manufacturing of washing machines, fridges andheaters back from China to a factory in Kentucky which not longago had been expected to close. Googlehas attracted a great deal of attention fordeciding to make its Nexus Q, a new me-dia streamer, in San Jose.

The reshoring movement has to bekept in proportion. Most of the multina-tionals involved are bringing back onlysome of their production destined for theAmerican market. Much of what theyhad moved over the past few decades re-mains overseas. And for many of the big-gest �rms the amount of work that theyare still sending abroad outweighs theamount that they are bringing back on-shore. Caterpillar, for example, is openinga new factory in Texas to make excava-tors, but has also just announced that itwill expand its research and develop-ment activities in China.

According to a survey conducted byHarvard Business School last year, many�rms are still deciding against basing ac-tivities in America. Professors MichaelPorter and Jan Rivkin asked HBS alumniwho were running businesses about theirchoices of location and found that manyof them were deciding to leave becausethey thought wages abroad were lowerthan at home. Another important reason,

though, was to be near customers in big new markets, which thisreport does not see as o�shoring in the conventional sense.Messrs Porter and Rivkin argue that �rms are now ready to re-consider o�shoring. They realise that in many cases they overdidit, and are discovering hidden costs in moving production a longway from home. But, the authors argue, America’s governmentis not making the country’s business environment attractiveenough for companies to want to come back.

Given the political pressure, it is natural for companies towant to publicise anything that looks like reshoring. Lenovo saysthat its decision to bring back computer-making to North Caroli-na was a way of looking after the �rm’s reputation as well asbringing direct business bene�ts. The Chinese �rm’s global sup-ply-chain chief, Gerry Smith, says he has received dozens of tele-phone calls from former university classmates to congratulatehim on the move.

But reshoring amounts to much more than public relations.It is being driven by powerful forces and will only get stronger. Ina survey of American manufacturing companies by the BostonConsulting Group (BCG) in April 2012, 37% of those with annualsales above $1billion said they were planning or actively consid-ering shifting production facilities from China to America. Of thevery biggest �rms, with sales above $10 billion, 48% came out asreshorers. The most common reason given was higher Chineselabour costs. The Massachusetts Institute of Technology lookedat 108 American manufacturing �rms with multinational opera-tions last summer. It found that 14% of them had �rm plans tobring some manufacturing back to America and one-third wereactively considering such a move. A study last year by the Hack-ett Group, a Florida-based �rm that advises companies on o�-shoring and outsourcing, produced similar results. It expects theout�ow of manufacturing from high- to low-cost countries toslow over the next two years and the reshoring to double overthe previous two years. �The o�shoring of manufacturing isnow rapidly moving towards equilibrium [zero net o�shoring],�says Michel Janssen, the �rm’s head of research.

Reshoring manufacturing

Coming home

A growing number of American companies are moving

their manufacturing back to the United States



2

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The crucial change that has taken place over the past de-cade or so is that wages in low-cost countries have soared. Ac-cording to the International Labour Organisation, real wages inAsia between 2000 and 2008 rose by 7.1-7.8% a year. Pay for se-nior management in several emerging markets, such as China,Turkey and Brazil, now either matches or exceeds pay in Americaand Europe, according to a recent study by the Hay Group, a con-sulting �rm. Pay in advanced economies, on the other hand, roseby just 0.5% to 0.9% a year between 2000 and 2008, says theMcKinsey Global Institute. In manufacturing, the �nancial crisisactually reduced pay: real wages in American manufacturinghave declined by 2.2% since 2005.

By contrast, pay and bene�ts for the average Chinese fac-tory worker rose by 10% a year between 2000 and 2005 andspeeded up to 19% a year between 2005 and 2010, according toBCG. The Chinese government has set a target for annual in-creases in the minimum wage of 13% until 2015. Strikes are be-

coming more frequent, and when they happen, says one execu-tive, the government often tells the plant manager to meetworkers’ demands immediately. Following labour unrest, wagesat some factories have gone up steeply. Honda, a Japanese car-maker, gave its Chinese workers a 47% pay rise after strikes in2010. Foxconn Technology Group, a subsidiary of Hon Hai Preci-sion Industries, a Taiwanese �rm thatdoes a lot of manufacturing for Apple andother big technology �rms, doubled payat its factory complex in Shenzhen after aseries of suicides. Its labour troubles arestill continuing.

The pushmi�

BCG used to argue that companiesunwilling to send their manufacturing tolower-cost countries were putting theirvery future in jeopardy. Now it says thatcompanies will bring manufacturingback to America from China. As soon as2015, says Hal Sirkin, a consultant at the�rm, it will cost about the same to manu-facture goods for the American market incertain parts of America as in China inmany industries, including computersand electronics, machinery, appliances,electrical equipment and furniture. Thatcalculation takes into account a wide vari-ety of direct costs, including labour, prop-erty and transport, as well as indirectones such as supply-chain risk.

After decades of complaining aboutAmerican and European workers’ highpay, cushy conditions and unreasonableexpectations, businesspeople now in-creasingly moan about Chinese workers.Their aspirations are rising and they areless willing to work long hours in boringfactory jobs. A new labour law intro-duced in 2008 brought in more protection

for workers, including the right to a permanent contract after ayear of employment, and workers are more aware of their rights.One consultant jokes that it is getting as hard to �re people in Chi-na as in France.

�China’s labour market is so overstretched that all the high-quality labour has been exhausted, you have to hire people withlesser quali�cations, and then quality becomes a problem,� says

Alain Deurwaerder, who until recentlyran a factory in Thailand for Ducati, anItalian motorbike-maker. Another Euro-pean chief executive complains about the�ightiness of his Chinese workforce: �Ifsomeone on the other side of the road of-fers 5% more pay, they go.�

Lorne Schaefer, the owner of JenloApparel Manufacturing, a Canadian-owned clothing company, opened a fac-tory in Liuzhou in southern China in2008 because he could no longer �ndworkers at home; second-generation Chi-nese and Vietnamese immigrants in Mon-treal, he says, no longer want to work inthe industry. Now he is having similarproblems in China. The latest generationof workers, thin on the ground because of

the country’s one-child policy, are not keen to toil in factories,nor do they want to work for companies that make goods for ex-port, since the quality standards are far higher than for domesticconsumption. So even in a labour-intensive industry such as tex-tiles, the cost bene�t that China o�ers is quickly eroding.

Higher labour costs alone are not enough to prompt com-

RESHORING IS LARGELY an Americanphenomenon. Although the migration ofjobs to Asia has caused plenty of angst inparts of Europe too, the continent haslittle hope of wooing back many of the jobsit has lost. There are some signs that inBritain �rms are starting to look for localsuppliers in order to simplify their supplychains. But China’s importance as a low-cost supplier to continental Europe willcontinue to rise, for several reasons.

First, Europe’s labour markets arestill fairly in�exible and costly, so even ifconditions in China and elsewhere arebecoming less favourable there is still asubstantial labour arbitrage to be had.Second, European �rms had been o�-shoring less in the �rst place. Culturalfactors are partly responsible; Germany’sMittelstand of mid-sized family �rms, forinstance, sell their products globally butare more inclined to make things in theirown backyard, says Hans Leentjes, headfor northern Europe of Manpower, anemployment agency. Europe has a high

concentration of family companies, andfamilies tend to be more loyal to theircountries of origin.

Companies in northern Europe are themost inclined to o�shore, whereas French,Spanish and Italian �rms have been heldback by political and social pressures.Restrictive rules on �ring employees meanthat it is di�cult and expensive to shutdown capacity at home. So for the timebeing European �rms, if anything, want too�shore more. Indian outsourcing �rmshope that Europe will provide them withtheir next decade of growth.

Many European �rms have exportedjobs to countries in eastern Europe. German�rms have sent work to a place even closerto home: former East Germany, where pay isstill lower than in the country’s west. FranceInc often looks towards Morocco and Roma-nia. This �near-shoring� avoids some of thetransport cost and cultural di�culties ofsending production to places a long wayfrom home, as many Anglo-Saxon compa-nies have done.

Staying put

European jobs are not coming back because few of them went in the �rst place

Pay for senior management in several emergingmarkets, such as China, Turkey and Brazil, now eithermatches or exceeds pay in America and Europe



SPECIAL REPORT

2 panies to leave China. The country has the world’s best supplychains of components for industry and its infrastructure workswell. Firms have already invested heavily in being there. Andcompanies that initially came for the low labour costs now wantto stay because it has become a huge market in its own right.Nonetheless, �the incremental decision to invest in new produc-tion capacity in China has become tricky,� says Gordon Orr, Asiachairman for McKinsey.

One answer is to invest in other low-cost countries, ofwhich there is no shortage. Myanmar, for instance, is attractinginterest now that the West is lifting economic sanctions. But thescale, skill and productivity of the labour force there, and incountries such as Vietnam and Cambodia, nowhere near match-es China’s, argues Mr Sirkin. And workers in those countries, too,are demanding better pay and rights.

Mexico, which has the huge advantage of bordering theUnited States, is increasingly attracting production destined forthe Americas that would formerly have gone to China. Averagepay for Mexican manufacturing workers is now only slightlyhigher than for Chinese ones, and the time it takes for goods totravel to North America is measured in days not months. Some�rms, such as Chrysler, a car company, are even using Mexico asa base to supply the Chinese market. The country has become animportant production hub for the aerospace industry. But Mexi-co’s poor infrastructure and highly publicised drugs-related vio-lence may deter some �rms.

Even as pay is rising rapidly in China, costs in America arefalling. The successful extraction of natural gas from shale hasdramatically lowered the price of energy. PricewaterhouseCoop-ers, an accountancy �rm, reckons that these lower American en-ergy prices could result in 1m more manufacturing jobs as �rmsbuild new factories. Companies such as Dow Chemical, a speci-ality chemicals �rm, and Vallourec, a French steel-tubes �rm,have announced new investments in America to take advantageof low gas prices and to supply extraction equipment.

�and the pullyu

Not only have American wages declined or are rising onlyslightly, BCG points out, but the dollar has been weakening. Theworkforce is becoming more �exible and productivity continuesto rise. High unemployment has brought a willingness to workfor lower pay, especially in southern states. These are mostly�right to work� states where individuals are free to decide wheth-er to give �nancial support to a trade union, so unions are lesspowerful there. The very threat that jobs will be outsourced willalso have played a role in keeping wages down.

Alabama, one such state, received a big boost last yearwhen Airbus, a European aeroplane manufacturer, said it wouldopen a big new factory. Airbus also plans to expand its produc-tion in Asia beyond its main factory in Tianjin, China, to be closeto fast-growing new markets. Fabrice Brégier, the �rm’s chief ex-ecutive, says that for skilled workers, �China is no longer a low-cost country.�

Big unions in America have sometimes been willing to letwages fall to keep jobs at home. In 2007 the United Auto Workersunion (UAW) accepted a two-tier wage structure under whichsome new blue-collar workers are paid only half as much as lon-ger-serving ones. In 2011, after the government had bailed outpart of the motor industry, the Big Three carmakers employedmore second-tier workers, reducing their overall labour costs.Ford has brought back production from China and Mexico toOhio and Michigan, thanks to a new agreement with the UAW.

As the example of ET Water Systems showed, transportcosts are playing a big part in reshoring. Rising shipping, rail androad costs are most damaging for companies that make goods

with relatively low �value-density�, such as consumer goods,appliances and furniture, according to a recent McKinsey reporton global manufacturing. That makes reshoring or nearshoringmore attractive. Emerson, an electrical-equipment maker, hasmoved factories from Asia to Mexico and North America to becloser to its customers. IKEA, a Swedish �rm that makes productsfor the home, has opened its �rst factory in North America as away to cut delivery costs, and Desa, a power-tools �rm, has re-turned production from China to America because savings ontransport and raw materials o�set the higher labour costs.

In the longer term reshoring will be boosted by the use ofadvanced manufacturing techniques that promise to alter theeconomics of production, making it a far less labour-intensiveprocess. 3-D printing, a process in which individual machinesbuild products by depositing layer upon layer of material, is al-ready being used in research departments and factories. Disneyis developing 3-D printed lighting for interactive toys, and saysthat in future the interactive devices inside such toys may beprinted rather than assembled by hand. Additive manufacturingmachines can be left alone to print day and night. For now theyare used mainly for prototyping and for complex parts, but in fu-ture they will increasingly make �nal products too.

Robots are already making a di�erence to the share of la-bour in total costs. Cheaper, more user-friendly and more dex-trous robots are currently spreading into factories around theworld, and they cost just the same in America as they do in Chi-na. Relative to the cost of labour, average robot prices since 1990have fallen by 40-50% in many advanced economies, accordingto McKinsey. Baxter, a new generation of robot made by RethinkRobotics, an American �rm, costs $22,000 apiece and is so safeand simple that it can be taught by an unskilled worker and oper-ate right next to real people.

Baxter and his ilk may mean there will be fewer manufac-turing jobs overall, but those that remain can stay close to a �rm’sdomestic headquarters. And even if the manufacturing activityitself does not employ many people, the supply chains thatspring up around it will create new work. 7



1

WHAT AND HOW much of its production to o�shore toother countries is one of the most important choices a com-

pany can make. France’s two big carmakers illustrate the point.PSA Peugeot Citroën, the younger of the two, has tried over timeto �nd cheaper places than around Paris to make its cars; in the1950s and 60s Citroën opened a factory in Brittany and startedmanufacturing in Spain and Portugal, the China and Vietnam oftheir time for o�shoring. Nowadays it makes cars cheaply in Slo-vakia and in the Czech Republic. But two-�fths of its global pro-duction is still in France, where it has seven expensive factories.One reason is that the company is family-owned, and familiestend to be particularly loyal to their countries of origin.

Renault, on the other hand, has determinedly pursued alow-cost strategy, setting up factories inMorocco, Slovenia, Turkey and Romania,and now makes only a quarter of its carsat home. Unsurprisingly, it is Peugeot thatis now in dire �nancial straits. Last au-tumn, amidst a �erce political storm, thecompany announced plans to stop carproduction at one of its biggest French factories, at Aulnay-sous-Bois, just outside Paris. But that may be too little, too late.

Yet there are also examples of highly successful companiesthat choose not to o�shore to any great extent, even in labour-in-tensive industries. Zara, the main clothing brand of Inditex, aSpanish textile �rm, is famous for making its high-fashionclothes in Spain itself and in nearby Portugal and Morocco. Thiscosts more than it would in China, but a short, �exible supplychain allows the �rm to respond quickly to changes in customertastes. It sells the vast majority of its out�ts at full price ratherthan at a discount. Its decision to stay close to home has becomeits main source of competitive advantage.

The practice of outsourcing is as old as business itself. A19th-century manufacturing company might have had its ownmachines but not its own �eet of horse-drawn drays to distributeits wares. The fashion for what to subcontract and what to keepinside the �rm has ebbed back and forth over time. At one time

the conglomerate, owning everything it could, was all the rage,but for the past few decades �rms have been outsourcing evermore of their operations, in the belief that as long as they keptthe �core� of their business in-house, the rest could safely be sentanywhere in the world.

That belief has not always turned out to be justi�ed. AfterBoeing, an aeroplane-maker, outsourced 70% of the develop-ment and production work on its new 787 Dreamliner to around50 suppliers, it su�ered huge delays because its outsourcing part-ners failed to produce parts on time. In 2005 Deloitte Consultinglooked at 25 big companies that had outsourced operations andfound that a quarter of them soon brought them back �in-house�because they could do the work them-selves better and cheaper.

But most companies outsource tosave money, so doing more of it has in-creasingly meant sending work to cheap-er countries. In 2003, according to TPI, acompany that advises on outsourcing,about 40% of all outsourcing contracts en-tered into by American and European�rms involved o�shore workers; that �g-ure has since risen to 67%. In turn, compa-

nies that decide to o�shore production often have little choicebut to outsource as well. Local �rms are often in a better positionto operate in a particular environment, and they may controlsupply chains. Most of America’s and Europe’s textile industry,for instance, subcontracts work to outside �rms in China, Viet-nam and Bangladesh. Production of consumer electronics islargely outsourced to huge contract manufacturers such as Tai-wan’s Foxconn and Quanta. This report concentrates on workthat is done overseas, either inside the �rm but in an o�shore lo-cation or outsourced to foreign contractors, because this part ofcorporate globalisation has caused the most controversy.

Most �rms do not give enough thought to choosing whereto produce. To an alarming degree, says McKinsey, �companiescontinue to indulge in herd behaviour� when deciding where tobase their operations and how to arrange their supply chains.Many of them, says the consulting �rm, simply follow each oth-er around to low-cost countries or allow themselves to be drawnin by governments waving wads of cash and other incentives.

David Arkless, head of government and corporate a�airsfor Manpower, which advises large companies on their loca-tions, recalls the story of two rival technology �rms from Idahosome years ago. One of them moved its production to the state ofPenang in Malaysia. The other, having seen its foe reduce its la-bour costs by half and slash prices by 15%, pursued it to exactlythe same place, he says. The pair quickly started competing forlabour with each other and local wages soared. Mr Arkless hasseen whole clusters of industries move to Shenzhen in tandem.�Within a year or so the labour costs go up to near the level of theoriginal place,� he says. Manpower advises Western �rms that iflabour makes up 15% or less of their product’s total cost, theywould do better not to o�shore. And even if the share is higher,there is usually scope for improvement at home. �Going some-where else for the sake of cheaper labour is usually a quick �xand avoids the real problems,� says Mr Arkless.

Companies rarely analyse past location decisions to see

Home or abroad?

Herd instinct

Companies need to think more carefully about how

they o�shore and outsource

1It still makes sense

Source: ISG

30

40

50

60

70

2003 04 05 06 07 08 09 10 11 12†

*Advised on by Information Services Group (ISG), an outsourcingconsultancy, which covers about half the total

†Year to date

Share of American and European companies’ outsourcing contracts* with an offshore element, %

Moving production a long way o� and separating itfrom research and development risks harming a �rm’slong-term ability to innovate



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whether they have proved right, note Michael Porter and Jan Riv-kin of Harvard Business School in a paper, �Choosing the UnitedStates�, published last year. One reason why companies rushinto o�shoring may be that they are looking for a quick solutionto existing troubles. According to �The Handbook of Global Out-sourcing and O�shoring�, by Leslie Willcocks, Julia Kotlarskyand Ilan Oshri, companies are most likely to consider o�shoringtheir operations when their pro�ts are already falling.

Two sets of strategic problems can arise from o�shoringproduction to another part of the world, especially if it is poorlythought out. The �rst of these concerns the logistics of supply.The more that �rms spread their operations around the globe,the more vulnerable they become to disruption from unexpect-ed events such as natural disasters or political unrest. The secondstrikes at the heart of what companies try to do: sell more andbetter widgets to customers than their rivals down the road. Of-ten, the more a �rm o�shores and outsources, the worse it will beat responding to customers quickly.

Ideas factory

Over the past few decades it became conventional wisdomthat factory jobs could be done cheaply in some far-�ung cornerof the world but more important innovation work should stayin-house in high-cost countries. Manufacturing was seen as justa cost centre, so it was often o�shored. Now many companiesreckon that production makes a big contribution to the success ofresearch and development, and that innovation is more likely tohappen when R&D and manufacturing are in the same place, soincreasingly they want to bring manufacturing back in-house.

Foreign suppliers of parts not infrequently turn into com-petitors, and for many companies the risk of losing intellectualproperty either through theft or imitation in China and else-where remains high. Indeed, says Richard Dobbs of the McKin-sey Global Institute in Seoul, big South Korean groups reckonthat American and European companies are making a mistake inoutsourcing as much manufacturing as they do, because this al-lows other �rms a great deal of insight into their processes. Theyshould know: Samsung, an electronics giant, was once an out-sourcing partner for several Japanese �rms but now dwarfs itsformer customers. South Korean �rms o�shore production to

their own factories overseas, but they seldom outsource. Many companies are now rethinking the outsourcing of

ever more important functions. Lenovo wants to own more of itscapacity in China and elsewhere; it gets better results from itsown facilities than from its outside contractors, says GerrySmith, the �rm’s global head of supply chain. That often meanstaking the work back home.

The most prominent current example of the opportunitiesand risks of o�shoring is the relationship between Apple andFoxconn. From a strategic point of view the partnership couldnot be more successful. In 2010 Foxconn took a huge chance byinvesting billions of dollars in building enough capacity in Chi-na to manufacture Apple’s iPhone on the scale required. It built auniquely �exible and responsive supply chain for the American�rm. On one recent occasion, according to a report in the New

York Times, Apple redesigned the iPhone’s screen at the last mi-nute and Foxconn woke up its workers in the middle of the nightto get the job done in time. �The reason Apple is what it is today isFoxconn,� says a consultant in Taipei who prefers not to benamed. The two companies, he says, are inextricably bound toeach other.

But Apple may be wishing it was not quite so dependent onFoxconn. After a spate of reports of poor working conditions forthe �rm’s employees (including excessive hours), Apple’s chiefexecutive, Tim Cook, ordered an investigation, and Foxconn ismaking a number of changes. Even so, the bad news has notstopped. In September Foxconn had to close a factory for a whilewhen a brawl among employees turned into a full-scale riot. InOctober the �rm admitted that it had employed �interns� asyoung as 14 in its factories. In December Mr Cook announcedthat Apple would bring some production of Mac computersback from China to America. He said the main aim was to createjobs in America, but the move may also appease critics of Ap-ple’s partnership with Foxconn. The Taiwanese �rm said that it,too, would expand its operations in America, explaining that im-portant customers wanted more work done there. 7

2Decisions, decisionsReshoring, selection of companies

Sources: Boston Consulting Group; PricewaterhouseCoopers; press reports; The Economist

Chesapeake Bay Candle

Production was shifted from China to

Maryland in 2011. The company will

export to China from there

Rising labour costs in China;

wanting to respond more

quickly to customers

Company What and where Why

Ford Motor Company

Production of medium-duty trucks is

moving from Mexico to Ohio, saving

2,000 jobs. Adding extra capacity to

a Michigan plant will save another

1,200

Thanks to an agreement with

the trade union, the firm can

now hire new workers at $14

an hour

Otis Elevator A factory is being moved from Mexico

to South Carolina

To keep R&D closer to

manufacturing and reduce

logistics costs

General Electric

Production of large household

appliances (eg, water heaters,

fridges) is being shifted from China

and Mexico to Kentucky

Having manufacturing, design

and development close

together; being more

responsive to customers

Sleek Audio Production of high-end earphones

has moved from Dongguan in China

back to Florida

Quality problems in China

IF TATA CONSULTANCY SERVICES (TCS), an Indian out-sourcing �rm, wanted to impress its customers with its de-

dication, it could do no better than take them to its engineering-services division in Bangalore’s Electronics City. In one room sitrows of young men working on computer simulations of crash-ing and accelerating cars. Next door is a laboratory full of en-gines and parts from TCS’s client, a big Detroit carmaker. It is fes-tooned with garlands of bright orange marigolds to celebrateDussehra, a Hindu festival. Next to one car engine is a shrine toDurga, a many-armed goddess. Celebrating everyday tools ispart of the festival. �We worship the car engines,� explains oneof TCS’s engineers. He sends photographs of the ceremony backto Detroit each year. The American car bosses, he says, are a littlesurprised but delighted to see their engines being prayed to.

However, they like to keep quiet about the work that getsdone in India. TCS is not allowed to name its customer (clue:Bruce Springsteen, Prince and Don McLean have all written

India’s outsourcing business

On the turn

India is no longer the automatic choice for IT services

and back-o�ce work



2

1

songs about its cars). Ten years ago TCS, part of the Tata Group,which includes Tata Motors and Tata Steel, did only very basicwork for the car �rm. Now it tests thousands of engine compo-nents, using computer models, and suggests improvements fortheir design.

For the o�shoring of manufacturing China is by far themost important destination, but in services most of the work hasgone to India. Of the ten leading cities for o�shoring, accordingto �The Handbook of Global Outsourcing and O�shoring�, sixare Indian. In 2008 India claimed 65% of all o�shored IT workand 43% of o�shored business-process work. Brazil, Russia andChina are also important, and by 2011as many as 125 o�shore lo-cations were o�ering IT and BPO services, but no other o�shor-ing destination has come close to India, with its huge supply ofIT and engineering graduates and its English-language skills.

Indian ingenuity

The painstaking work of Indian programmers has goneinto innumerable Western products, from cars to Disney car-toons to Microsoft’s Windows range of software. In 2004 Indianengineers in Mumbai created a virtual Oscar �gure for that year’sAcademy Awards which melted away like the liquid metalmachine in �Terminator 2: Judgment Day�. Nielsen, a ratings�rm on which America’s media industry depends, in turn reliesheavily on TCS for its data.

The killer application for the Indian �bodyshops�, as theywere originally known, was providing labour to perform simpleIT tasks at a very low cost. One of their �rst tasks was to checkthat the so-called millennium bug would not cause chaos in mil-lions of computer systems at the end of 1999. Indian �rms alsosaw rapid growth in business-process outsourcing (BPO), de-�ned as the export of routine work such as customer care or in-surance-claims processing, though IT services still have muchthe biggest share. Now, as demonstrated by TCS and the cargiant, India’s outsourcing vendors are taking on far more di�culttasks for multinationals in many �elds, such as testing new pro-ducts, design and complex analysis.

The panic about Western jobs arose because whereas thetraditional Western outsourcing providers, such as HP or Logica,used to employ mainly locals, the young Indian companies tookthe work o�shore. The big Western �rms themselves thenrushed to hire in India; IBM is now India’s second-largest private-sector employer, just after TCS. Companies can choose to o�-

shore IT and back-o�ce services either directly to a �rm head-quartered in India or �under the covers� via a Western �rm witha big o�shore presence, explains one consultant.

Hackett, a Florida-based �rm that advises companies onoutsourcing, estimates that over the period from 2002 to 2016 o�-shoring is likely to claim a total of 2.1m business-services jobs (in-cluding IT, human resources, procurement and �nance) at bigAmerican and European companies. Still more jobs will havebeen lost in business processes, including call centres and claimsprocessing. Hackett says that about 150,000 business-servicesjobs a year are still being shifted from Europe and America; theo�shoring of services remains in full swing. But the �rm also pre-dicts that the migration of services to India and to other o�shorelocations such as China and Brazil will slow down after 2014 andstop entirely by 2022.

The main reason for this startling prediction is that most ofthe easily o�shorable jobs have already gone. Pralay Das, anequity analyst with Elara Capital in Mumbai, estimates thatAmerican and European banks and �nancial-services �rmshave already o�shored about 80% of what they can reasonablysend to India and other o�shore locations.

A second reason is that a lot of the jobs that might havebeen o�shored by Western �rms in the coming years have al-ready been wiped out by productivity improvements. New jobsin Western economies tend to be of a more demanding, higher-level kind and are less likely to be sent abroad.

All this has sent the Indian IT and BPO industry into a funk.There are fears that it will either stop growing or be forced to ac-cept much lower pro�t margins as demand for its services falls. Itis clear that for Indian IT vendors, demand for traditional out-sourcing, meaning routine software and application develop-ment and maintenance, is already levelling o�, says Pankaj Ka-poor, an equity analyst at Standard Chartered Bank in Mumbai.The work used to roll in at you, explains an executive at one largeIndian vendor; now you have to go out and search for it.

It is not only that the o�shoring of jobs is reaching satura-tion point, but also that Western companies, after a decade of ex-perience, are changing their attitude to the practice. KPMG, a glo-bal consulting �rm, even announced �The Death ofOutsourcing� in a research paper last year. After all, o�shoringimportant tasks to an outside provider is quite a risky thing to doand carries signi�cant hidden costs. Companies in services aswell as manufacturing are now far more aware of the pitfalls.

Until recently the most important reason for companies to sendlarge chunks of important business functions abroad was todrive down costs. A decade ago wages in emerging markets werea tenth of their level in the rich world, an opportunity too goodto miss. During the recession of 2008-09, says Cli� Justice,KPMG’s leading expert on outsourcing and o�shoring, the raceo�shore accelerated, and more higher-value and complex workwas sent overseas too.

But now many companies are �nding that they lost theirconnection with important business functions, says Mr Justice.At the same time the cost advantage that drew �rms o�shore inthe �rst place is disappearing. Salaries for software engineers aregoing up rapidly and in�ation is high. For IBM, says BundeepRangar, chief executive of IndusView, an advisory �rm, the totalcost of its employees in India used to be about 80% less than inAmerica; now the gap is 30-40% and narrowing fast.

The industry also continues to have a huge labour turnover(see chart 3), which can mean quality problems. That is chie�ybecause the vast majority of the work being o�shored is repeti-tive and dull, and often well below the quali�cation levels of thepeople doing it. Increasingly, local industries such as retail, insur-ance and banking are o�ering more interesting jobs with bettercareer prospects than much of what is on o�er in IT and busi-ness-process outsourcing.

To be sure, much of the work that has gone to India in recentyears is more demanding, but in that part of the market the costof labour has soared. Good analysts and product developers inIndia and China are few and far between, so pay for such jobshas been rising by up to 30% a year. According to Mr Justice, payfor workers with such skills in India and China can be even high-er than in America or Europe, with all the disadvantages of beingseveral time zones away from head o�ce.

Reasons why not

When outsourcing abroad was still relatively new in the1990s, the idea was that outside partners would be better than in-siders at IT and back-o�ce work because they were specialists.And even if they were no better at it, at least they were a lotcheaper. This line of thinking is known inside the industry as�your mess for less�. It has now become clear that outside �rmsusually cannot do boring back-o�ce work any better and oftendo it worse. Many o�shore outsourcing relationships haveproved disappointing and some have ended in lawsuits.

Some chief executives found that outsourcing relation-ships turned sour after a few years. The boss of one global Euro-pean engineering �rm points out that outsourcing partners are

mainly concerned with their own pro�ts. �They give you a gooddeal for two to three years and then they suck your blood,� hesays. A �rm that outsources a lot of IT also risks losing its exper-tise in a key area and can get trapped in legacy systems, he adds.

Some American �rms that have outsourced a lot to Indiaand elsewhere are building �shadow capability� in services intheir home countries, says KPMG’s Mr Justice. Using uno�cialbudgets, he says, some chief information o�cers are hiring peo-ple back home to do the same kind of work that their o�shoreteams do, just to have them next door. Only a small number of�rms have gone to such extremes, yet the fact that it happens atall indicates the value that �rms place on proximity, says Mr Jus-tice. And some of the biggest original pioneers of outsourcing,including General Electric and General Motors, have already tak-en the plunge and brought their IT work home. 7

3Revolving door

Source: Company reports *Worldwide

Labour turnover in Indian outsourcing firms% of total employment in those firms

0

5

10

15

20

25

2006 07 08 09Financial years ending March

10 11 12

Wipro (voluntary)

Wipro

Tata Consulting Services*

HCLTechnologies

Infosys



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HARLEY DAVIDSON, A motorcycle-maker, had a di�culttime after the �nancial crisis and nearly took the road out of

Milwaukee, Wisconsin, its home town since 1901, to go in searchof cheaper labour. It stayed in the end, but had to prune othercosts. Last summer it announced it would outsource 70 informa-tion-technology and other back-o�ce jobs to India’s Infosys.�Just more and more of our great motorcycle company beingdone by other countries,� lamented one hog-owner from Penn-sylvania in an online forum on hearing the news. In fact, Infosyswill be serving Harley and other �rms from a new o�ce full ofAmericans in Milwaukee.

This is the 18th new o�ce Infosys has opened in America inrecent years. The company will hire a total of around 2,000 lo-cals in the year to March 2013, up on last year’s 1,200. Other big�rms are hiring at a similar level. According to NASSCOM, thetrade body for India’s IT sector, the industry has doubled thenumber of locals it has hired in America in the past �ve years. Itnow employs 280,000 people there and is planning to recruitmany more in the next few years.

So far companies are not reshoring services even on themodest scale seen in manufacturing. That is partly because in-formation goes down the wire, so rising transport costs do notplay a role. But as the previous section has shown, the o�shoringof services is slowing down because most of the work that canbe done remotely has already gone, and because �rms are be-coming more aware of the disadvantages of sending work to theother side of the world. More and more companies want IT andbusiness-process tasks to be done locally, especially when thework is complex and strategic. Indian o�shoring �rms are re-sponding by hiring in developed markets.

A survey of outsourcing executives by HfS Research in Bos-ton last summer found that America is seen as the world’s mostdesirable region for expanding IT and business-services centresin the next two years. India now comes second, despite its lowerlabour costs. Chief information o�cers once rushed to sendtheir software-development work o�shore, said CIO magazinelast year, but now they want to keep it nearby. The magazinecited the example of Standard & Poor’s, a credit-rating agency,

Services

The next big thing

Developed countries are beginning to take back

service-industry jobs too



2

1

which used to o�shore much of its IT work but now wants tosend it no farther away than three hours from Manhattan.

You do not have to go far outside the big cities to �nd thatcosts come right down. In a study of job-creation in AmericaMcKinsey found that workers for high-level IT support in thecheaper parts of the country cost less than in Brazil or eastern Eu-rope and just 24% more than in India. In a paper, �IT Services: Thenew Allure of Onshore Locales�, McKinsey’s consultants showthat labour costs in di�erent parts of America can vary by asmuch as 30%, with similar di�erentials between, say, the cost ofskilled IT workers in Paris and northern France, or eastern andwestern Germany.

Hiring locals certainly helps to placate public opinion, but

the business argument for it is even more important. Since mostroutine tasks have already been sent o�shore, low-cost vendorsare now trying to win higher-value work, such as managing hu-man resources and complex, multi-faceted projects. But to getthat kind of business they have to be near their clients. For exam-ple, one outsourcing vendor, Cognizant, with a CEO of Indianorigin and a big Indian workforce but headquarters in New Jer-sey, is currently taking market share from rivals such as Infosys.The Indian component of its workforce makes up about 60% ofthe total, compared with around 80-90% for TCS and others. Atypical recent deal, says Malcolm Frank, the �rm’s head of strat-egy, was one it did in 2012 with the American arm of ING, aDutch bank, under which Cognizant will take over business pro-cesses for insurance. Instead of sending the work to India, the�rm will open new centres in Iowa and North Dakota and takeon ING’s existing employees. �The client wanted local voices an-swering the telephones,� says Mr Frank, �and the economics ofthat part of the US means that the numbers work for us.�

Some big �rms which originally led the way in the o�shor-ing of services are now taking work back in-house and onshore.For most of the past decade, General Electric had been aiming tooutsource the vast majority of its global IT jobs, with most ofthat outsourced work going to India. When Charlene Begley, the�rm’s chief information-technology o�cer, recently re-evaluat-ed its global balance of labour, she found that half the IT workwas being done by outside providers and the �rm was losingsome of the skills it needed. With the rise of mobile devices andiPads, GE wanted to be able to develop new applications for cus-tomers far more quickly. Now the �rm is hiring 1,100 IT engineersfor a centre it opened in Michigan in 2009. The company has saidthat the new American employees will not replace GE’s o�shore

Fading advantage

Source: Offshore Insights Research *Management and logistics

4

0

20

40

60

80

100

120

0

5

10

15

20

25

30

2001 03 05 07 09 11 13 15

Indian programmer’saverage salary, $’000

Extra costs*,$’000 Labour

arbitrage, %US programmer's average salary, $’000

F O R E C A S T

ELIZA DOOLITTLE ENTERS the stage un-kempt and talking in a strong Cockneyaccent, but by the end of George BernardShaw’s play �Pygmalion� she speaks in amuch more ladylike fashion. Another Elizawas invented by Joseph Weizenbaum, ascientist from the Massachusetts Instituteof Technology, in the early 1960s. Hiscomputer program was named after Shaw’scharacter because it learned to speak moreclearly over time. It played the role of apsychotherapist, sometimes well enoughto convince patients that it was human.

Now a third Eliza, named after MrWeizenbaum’s invention, is set to turn theo�shoring business upside down. IPsoft isa young company started by Chetan Dube,a former mathematics professor at NewYork University. He reckons that arti�cialintelligence can take over most of theroutine information-technology andbusiness-process tasks currently per-formed by workers in o�shore locations.�The last decade was about replacinglabour with cheaper labour,� says Mr Dube.

�The coming decade will be about replacingcheaper labour with autonomics.�

IPsoft’s Eliza, a �virtual service-deskemployee� that learns on the job and canreply to e-mail, answer phone calls and holdconversations, is being tested by severalmultinationals. At one American mediagiant she is answering 62,000 calls a monthfrom the �rm’s information-technologysta�. She is able to solve two out of three ofthe problems without human help. AtIPsoft’s media-industry customer Eliza hasreplaced India’s Tata Consulting Services.

Mr Dube is sorry to see so much ofIndia’s intellectual capital being expendedon mundane, repetitive tasks. Much of thework that is o�shored is boring, which helpsto explain the industry’s huge labour turn-over (see chart, previous page). A smallBritish start-up, Blue Prism, has developeda software-development toolkit that allowspeople within a company to create their ownsoftware �robots� to automate businessprocesses. �Greetings from Robotistan,outsourcing’s cheapest new destination,�

Rise of the software machines

The attractions of employing robots

wrote HfS Research, an outsourcing blog.The economics of Robotistan are

certainly compelling. An onshore infor-mation-technology worker may cost$80,000 a year and an o�shore oneperhaps $30,000, wrote James Slaby,HfS’s research director, in a recent report.But Blue Prism’s robots cost at most$15,000 a year. They can perform onlyroutine, rules-driven tasks, but there areplenty of those about. One telecomscompany, says HfS, replaced 45 o�shoreemployees, costing a total of $1.35m ayear, with ten of Blue Prism’s softwarerobots, costing $100,000. The telecoms�rm then spent its savings of $1.25m onhiring 12 new people to do more in-novative work locally at its headquarters.

But nationality still plays a part.Because Indians often speak stronglyaccented English, the country lost a lot ofcall-centre business to the Philippines.Mr Dube’s Eliza will have a slight Ameri-can twang, modelled on a Filipino call-centre operator.



SPECIAL REPORT

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1

workforce, but the move is seen in the industry as an importantsign of the times. GE was one of the �rms that made it respect-able to outsource, so its decision to bring some of the IT workhome is expected to prompt other companies to follow.

The most prominent reshorer of services has been GeneralMotors. Like GE, GM has had plenty of experience with out-sourcing. Between 1984 and 1996 it owned EDS, a companyfounded by Ross Perot that pretty much invented the outsourc-ing industry. In July 2012 GM announced that it was reversing itsrule of outsourcing 90% of its IT work to other �rms. In a fewyears’ time it hopes to be doing 90% of the work inside the �rm.In the process it will be reshoring many of those jobs.

GM’s reasons for doing this may well apply to many other�rms too. �IT has become more pervasive in our business andwe now consider it a big source of competitive advantage,� saysRandy Mott, GM’s chief information o�cer, who has been re-sponsible for the reversal of the outsourcing strategy. While thework was being done by outsiders, he said, most of the resourcesthat GM was devoting to IT were spent on keeping things goingas they were rather than on thinking up new ways of doingthem. The company reckons that having its IT work done mostlyin-house and nearby will give it more �exibility and speed andencourage more innovation.

Don’t call us

Of all the back-o�ce work that has been outsourced, thecall-centre business is the one that has made the most abrupt exitfrom India. With information technology, outsourcing �rmssuch as TCS and Wipro are dealing with global companies, butwith call centres they are dealing with customers. �We just can’tget the accents right,� sighs one Mumbai-based outsourcing exec-utive. They tried hard to get workers in Bombay and Bangalore toenunciate their vowels just so. One recent web sketch showedoperators imitating Sean Connery, a Scottish actor, for the Scot-tish market. But many customers had trouble understandingthem and were infuriated.

For India, the call-centre business is �on its deathbed�, saysMr Kapoor. The Philippines has won a lot of work, thanks to itscultural a�nity with America. And many �rms, especially in �-nancial services, have brought call centres back to America, Brit-ain and Europe, often with the twist that to speak to someone inyour own country you have to pay extra. 7

5Keep it going

Source: “The Handbook of GlobalOutsourcing and Offshoring” by IlanOshri, Julia Kotlavsky, Leslie Willcocks

*Mostly offshored†Enterprise resource planning

‡Customer relationship management

European companies’ outsourcing* by department, %

0 10 20 30 40 50 60

IT infrastructure and data management

IT and technology consultancy

ERP†: maintenance, upgrades,implementations

Finance and admin, HR,call centres, sales, marketing

Software testing/quality assurance

Solutions design and systemsarchitecture

CRM‡: master data/customerexperience management

Data warehousing and businessintelligence systems

March 2009 March 2011

THE WEST HAS become so obsessed with losing vast num-bers of jobs to globalisation that its anxiety is now the butt

of jokes. The Onion, a satirical website, recently reported thatparents are outsourcing child care to India and Sri Lanka, usingcardboard boxes to ship their o�spring across the oceans.

A country’s overall level of employment is determined bymacroeconomic forces; trade and o�shoring a�ect the mix ofemployment and wages. Within particular industries, outsourc-ing and o�shoring have been among globalisation’s most dis-ruptive consequences. The threat of losing jobs to developingcountries has helped to depress middle-class pay in the richworld. But despite all the scares about job losses in the West, thetrend is already slowing and may soon start to tail o�. The mainfear in recent years has been the migration of white-collar work,which makes up the majority of jobs in rich countries. Yet o�-shoring has destroyed far fewer service jobs than originallyfeared, and in manufacturing, where blue-collar jobs in indus-tries such as computers, cars and textiles have been on the wanefor decades, reshoring could even bring a revival.

Mr Blinder of Princeton University was among the mostprominent economists to give early warning about the impact ofsending services abroad. In an article in Foreign A�airs in 2006he said that up to 42m American services jobs could eventuallybe lost; the shift could add up to a third industrial revolution.

It has now become clear that the worst fears have not been

What to do now

Shape up

For o�shored jobs to return, rich countries must

prove that they have what it takes



2

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realised. Nobody knows exactly what o�shoring has done toAmerican employment since 2006, but estimates by specialistconsulting �rms such as the Hackett Group, based on con�den-tial data from corporate clients, come up with relatively low �g-ures. According to Hackett, the net number of business-servicesjobs in big American and European companies lost between2002 and 2016 is likely to be around 3.7m, and only 2.1m of thosewill have been due to o�shoring. That works out at a loss fromthat cause of just 150,000 jobs a year. .

The �rm’s current estimate of how much has been lost andwhat is still to come is much closer to a forecast by Forrester Re-search back in 2004 that 3.4m American services jobs wouldmove o�shore by 2015, or about 300,000 jobs a year. McKinseyhas also been far more sanguine than Mr Blinder; it said in 2006that 11% of service jobs around the world could in theory be car-ried out �remotely�. In practice, it thought, only about 650,000jobs a year would be a�ected. So far the optimists have beenproved right.

The number one job-killer in America in recent years hasbeen the recession, says Mr Blinder: �Only a trivial percentage ofjobs has been claimed by o�shoring.� He thinks that the move toreshore some manufacturing jobs is important, even though thescale of it is still small, but that a wave of services o�shoringcould yet hit Western countries. The main reason is advances ininformation and communications technology that could allowmore and more senior and skilled jobs to be sent abroad. But itwould take big cost savings to justify having such sophisticated,�high-touch� services done at a distance, and those savings aregradually disappearing, as this report has shown. Pay for highlyskilled, English-speaking workers in developing countries whocould o�er such services is rising rapidly. And companies are be-coming increasingly concerned that o�shoring services may dolonger-term damage.

The best argument for locating activities overseas nowa-days is to be close to fast-growing new markets, and it will only

become stronger. McKinsey estimates that by 2025 developingeconomies will account for nearly 70% of demand for manufac-tured goods. Whereas in the past �rms treated such markets assources of cheap labour, they are now looking for a deep localpresence. ABB, for instance, has gone from having what it calls a�cost arbitrage� strategy for countries such as China to taking an�in country for country� approach, meaning that it wants notonly manufacturing but also functions such as product manage-ment and R&D to be based there.

Strong growth in emerging countries will also prompt theirown new multinationals to set themselves up as �local� in theWest. The Rhodium Group, a consulting �rm, says that Chineseinvestment in America has already created nearly 30,000 jobsthere, and that by the end of the decade Chinese �rms will em-ploy up to 400,000 Americans.

Will reshoring and the move of emerging-country multina-tionals into Western markets generate lots of new jobs in the richworld? The Boston Consulting Group thinks that reshoringalone could generate 2m-3m jobs in manufacturing by 2020, upto 1m of which would come direct from factory work and the restfrom support services such as construction, transport and retail.

A trickle, not a �ood

But it is important not to overestimate the impact of reshor-ing on jobs. Manufacturing work will often come back onlywhen it has been partly automated, so the number of jobs re-turning will be smaller than the number lost in the �rst place.Most companies that have recently built new facilities or ex-panded existing ones in America have brought in more automa-tion, says BCG’s Mr Sirkin. NatLabs, for instance, a Florida-basedmanufacturer of dental implants, reshored much of its produc-tion from China because it was able to automate a large part of it.The best that can be hoped for, says Michel Janssen of Hackett, isnot that millions of high-paying jobs will return and things willbe as they were before, but that �the leak of jobs out of Americawill be largely stopped.�

Governments around the world have used generous �nan-cial incentives in an e�ort to attract companies to move to theircountries. These range from hard cash and corporate-tax holi-days to cheap loans. For instance, back in 2005 Dell was prom-ised incentives worth up to $280m by the state of North Carolinaand the city of Winston-Salem to open a factory there. WhenDell pulled out in 2009 it had to pay back much of the $24m ithad already received. In 2007 North Carolina o�ered Google a$260m package to expand a server farm near the Blue Ridge

6The limits to reshoring

Source: Deloitte, The Manufacturing Institute

US companies, 2011, % of respondents

In which employee segments have skill shortages hindered your company’s ability to expand or improve productivity?

0 10 20 30 40 50 60 70 80

Skilled production(machine operators, technicians)

Production support(industrial engineers, planners)

Unskilled production

Sales and marketing

Scientists and design engineers

Management and administration(HR, IT, finance)Customer service(including call centres)

night shifts at its factory nearLiverpool, and the Big ThreeAmerican carmakers are in-creasingly working around theclock. At the same time car-workers in South Korea, oncethe sort of hard-working,poorly paid competition fearedin the West, succeeded in abol-ishing night shifts at Hyundaiand Kia, two big �rms.

But it is probably only inAmerica and Britain that labouris �exible enough to have agood chance of persuadingcompanies to reshore produc-tion. At the other extreme sitsFrance, where Arnaud Monte-bourg, the minister appointedto rebuild his country’s indus-try, late last year told LakshmiMittal, an Indian steel tycoon,that he was not wanted inFrance after his struggling com-pany, ArcelorMittal, tried toshut down blast furnaces.

And where �rms are ableto keep production onshore, it isoften thanks to immigrantworkers. Jenlo Apparel Manu-facturing relied on workers ofChinese and Vietnamese origin in Montreal, and ET Water Sys-tems reshored to a San Jose-based contractor employing workersof South-East Asian origin. An important element of the low-cost tier of American labour is immigration, both legal and ille-gal, from Mexico. �The more that free movement of people is al-lowed between countries, the less companies need to o�shore,�says Darryl Green, one of Manpower’s presidents.

Agencies providing temporary sta�, such as Manpower,play their part, allowing �rms to treat workers as a �exible re-source not a �xed cost. It is no accident that Manpower’s biggest

market is France. In Japan the labour mar-ket is also rigid. Back in 2007 Fujio Mitarai,chief executive of Canon, a maker of opti-cal products, said that temporary agen-cies had helped manufacturing �rmsavoid the �hollowing out� of industry. Butnow the government has restricted the

use of temporary workers. Along with the appreciation of theyen, that is prompting more o�shoring by Japanese �rms, saysManpower’s Hiroyuki Izutsu.

Lenovo’s North Carolina headquarters, inherited fromIBM, sits at the heart of the state’s Research Triangle Park, a re-gional cluster of universities and hi-tech businesses. It is an ex-ample of the sort of business ecosystem that is capable of draw-ing corporate investment from around the world. The areaboasts competitive costs, highly skilled workers, a close partner-ship with local universities and a business-friendly environ-ment. Unlike Dell, Lenovo is taking no money at all from the stategovernment for starting to manufacture at Whitsett.

Internally the �rm’s factories compete hard with each oth-er on cost, productivity and quality. It will quickly become clearif �Made in America� is a luxury or whether it creates sustainedvalue for the Chinese �rm. Tony Pulice, the �rm’s factory manag-er in North Carolina, is ready to show what his country can do. 7

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Future special reports

Previous special reports and a list of forthcoming ones can be found online: economist.com/specialreports

The Nordics February 2nd O�shore �nance February 16th Emerging Africa March 2nd The United States March 16th

SPECIAL REPORT


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Mountains�which the internet giant eventually declined. Companies are becoming more sceptical about short-term

enticements, and governments would do much better to workon the most useful and durable sort of incentive: the business en-vironment they o�er. In recent years policymakers have beenable to point to the global labour arbitrage as the obvious andoverwhelming reason why �rms o�shore. When Harvard Busi-ness School surveyed companies that were moving activitiesoutside America, it found that lower wage rates were the mainattraction for 70% of them. But a third also said that they weremoving out to get better access to skilled labour.

As the gap in worldwide wage rates narrows further, it willbecome more obvious that other factors, such as skills, labourlaw, clusters of industries, infrastructure, tax and regulation areplaying an ever more important role when companies decidewhere to put their production. Now that many �rms are takinganother look at their outsourcing and o�shoring policies, gov-ernments need to give them every reason to come back. �If com-panies are o�shoring because of �xable policy problems athome,� says Mr Porter, �that is unforgivable.�

Can’t get the sta�

In a recent report on global manufacturing, McKinsey saidthat in the near future the world is likely to have too few high-skilled workers and not enough jobs for low-skilled workers.Companies’ decisions on where to locate will increasingly bedriven by where they can �nd the skilled workers they need. In

2011 a survey of 2,000 American compa-nies found that 43% of manufacturing�rms took longer than six months to �llsome of their vacancies. The UnitedStates has a particular problem because itis producing too few college graduatesand too many high-school dropouts. InJapan, four-�fths of companies have pro-blems �nding technicians and engineers.As a result, many �rms will be unable toreshore because they cannot �nd workerswith the right skills.

Another big problem is labour �exi-bility, which still varies greatly from coun-

try to country. In Britain, says Hans Leentjes, president for north-ern Europe at Manpower, an employee can be �red by followingdue process and paying a week’s severance money for each yearworked. In Germany, by contrast, companies have to negotiate asettlement and pay between one and two months’ salary foreach year worked. The German employee can still go to courtand the company may have to reinstate him. �In a global econ-omy where �rms can go where they want, these di�erences havean e�ect,� says Mr Leentjes.

There are signs that labour in rich countries is becomingmore �exible at the same time as workers in Asia are slowly ac-quiring more rights. Multinationals now recognise America’slow-cost, �exible workforce as an important attraction. Spurredby the euro crisis, Spain and Italy have both introduced big la-bour-market reforms. Another sign of the times is that Westerncarworkers are willing to work night shifts again. In August lastyear Jaguar Land Rover, owned by Tata, announced the return of

Companies’ decisions on where to locate willincreasingly be driven by where they can �nd the skilledworkers they need

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