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Offshoring. Strategies, Motives and Risks

von Mehrssa Jahanpanah (Autor) Maximilian Hoffmann (Autor)

Hausarbeit 2014 31 Seiten

BWL - Unternehmensführung, Management, Organisation


Table of Contents

Introduction: Why going global?


1 Different types of Offshoring
1.1 Farshoring vs. Nearshoring
1.2 Offshoring vs. Onshoring
1.3 Offshoring vs. Outsourcing

2 Historical development

3 Strategies for an entry into new markets
3.1 Direct investment and transaction strategies
3.1.1 Export
3.1.2 Licensing
3.1.3 Franchising
3.1.4 Joint Venture
3.1.5 Foreign Subsidiaries
3.2 Theoretical approaches of international corporate activities
3.2.1. The Product Life Cycle by Vernon
3.2.3 The eclectic framework by J. H. Dunning
3.3 Timing strategies
3.3.1 The diversification strategy
3.3.2 The concentration strategy

4 Motives for offshoring
4.1 Cost saving
4.1.1 Personnel costs
4.1.2 Location costs
4.1.3 Transportation costs
4.1.4 Cost reduction by Economies of Scale
4.1.5 Bargaining Power
4.2 Market proximity
4.3 Access to Raw Materials

5 Risks of offshoring
5.1 Loss of quality
5.2 Unqualified foreign employees
5.3 Image risk
5.4 Exchange rate risk

6 Criteria for the right target country

7 The most popular target countries
7.1 China
7.2 India

8 Examples
8.1 Nokia
8.2 Steiff

9 Conclusion


Introduction: Why going global?

Globalized companies regard the world as a big market. This aspect does not apply just for sellers’ market; also services can be relocated abroad because of locational advantages. The economic utilization of the market power plays a major role. Companies with a global demand can play with the markets and their competitors, because their competitiveness strategies are also global and they consider the interdependences of the market players. The reason for going global is on the one hand the opportunity to break into new markets, which includes new chances and new customers. The companies pursuit of resources and exhaust their locational advantages. The realization of these locational advantages is the reason for saving transportation costs and abolishing trade barriers. Furthermore the use of the global network is of great value: The companies make global experiences. Economies of scale in production, logistic, marketing and purchasing are lucrative and increase the profit Therefore there is also a reduction of the risks and the companies are able to conduct a product differentiation.

The aim of this term paper is to analyses to show how offshoring is spread in the markets, which theories exist, which motives companies have referring to chances of offshoring and the risks of offshoring. The paper is underlined by examples to show how offshoring in represented in practice. The conclusion is the tradeoff between risks and chances of the term. The term paper is divided into two parts:

The first part includes the theory of offshoring. A definition is given; the historical development and various market entry strategies are given. First a definition is given, followed by the different types of offshoring. The second chapter deals with the historical development. The third is about the strategies to entry into new markets. Companies have different possibilities like the export or the joint venture. The last part of the first part discusses the question which theories are important for the International Business. The second part of the term paper is about the different motives and risks which are relevant for companies with the idea to go offshore. Chapter four brings the motives of offshoring into focus. Companies gain advantages if they go offshore. The fifth chapter is about the risks. Different reasons which could be negative are mentioned. The next chapter deals with the criteria for the right target country, followed by the most popular target countries like China and India in chapter 7. By giving examples of companies, the theory of the term paper is translated to practical cases. In the last chapter the conclusion is given by weighing the risks and the chances of offshoring.


"Offshoring means the procurement of goods and services across national boundaries".[1]

Offshoring is no scientifically defined term and there are different ways of using the term. The term arises originates from the word “offshore“, what supposes to mean "sea war“ or "off the coast“, because US – American companies displaced their services of data collection in those areas like the Caribbean in the seventies and eighties of the last century.[2] Therefore offshoring is a type of relocation of tasks of companies in high – wage countries to low wage countries, as well as using the resources of the offshore countries. Often the tasks are taken over by external providers, but this is not essential. Regardless of the definition it is typical, that companies cross the country's frontiers and that the main motive usually the cost saving is.

1 Different types of Offshoring

1.1 Farshoring vs. Nearshoring

The two terms are geographical localization of offshoring. Farshoring means the relocation in far remote countries. The term of farshoring is only used, if a company relocates to another continent. Nearshoring – the relocation in close remote countries – argues the converse.

Nearshoring describes the relocation inside the continent, but beyond the home country of the company.[3] Countries of the eastern European expansion of the EU are considered for German companies to nearshore, for US – companies the relocation to Canada or Mexico.[4] The advantage of near shoring is that the countries offer a narrow cultural diversity, a marginal time lag and a geographical proximity. As a result of the geographical proximity there is a faster and cheaper availability.

1.2 Offshoring vs. Onshoring

Onshoring implies that the production or the service will be displaced inside the producing country of the employer, for instance a car factory, who receives doors from another company, which is in the same city.

1.3 Offshoring vs. Outsourcing

The terms “Outsourcing“ and “Offshoring“ are often used almost synonymously in much of the popular literature today. However there is a technical difference.[5] Outsourcing is a subcontracting of in former times created services of the companies. The created services can be awarded to service providers abroad, as well as to national service providers. The national process of subcontracting is called Onshore Outsourcing. Offshoring can also be a subcontracting to external service providers that is called Offshore – Outsourcing.[6] But frequently the services are constructed by the formation of subsidiaries or Joint Venture companies with involvement of local companies. This is called Captive Offshoring.[7]

Two examples to show the technical difference between offshoring and outsourcing:

Example for Outsourcing:

“General Motors, which is a US company, can outsource production of a certain car part to a Chinese company. This Chinese company, in turn, can outsource production of various components of that part to various other Chinese companies.

Example for Offshoring:

If General Motors opens a factory in China, and shifts production of a car part to the factory in China, it is offshoring but not outsourcing, it is still an American company running the factory rather than a Chinese one.“[8]

2 Historical development

The idea of relocating production into other countries is already in existence since the sixties and seventies after the Second World War. At that time the companies displaced their production in large scale to Japan. But already Henry Ford made use of a subsidiary with the company Ford - Werke – AG[9] In the 80th and 90th the industrialized countries transferred parts of their production to Latin America or South East Asia, especially the industrial sectors electro – technics and engineering. Technological progresses and novel business models were typical for this time. The container logistics and the internet were innovative for this period and changed life, because the attainment of information was facilitated and the companies decreased their costs of carriage.[10] The standardization of competition was established by law and was the reason that the competitive constraints among themselves rose. All these points supported the corporate internationalization and arranged the offshoring. The formation of the European internal market and the introduction of the Euro as a single currency forced and relieved the idea of offshoring. Over the past years China becomes increasingly important in the offshore sector. What has changed in the last years is the displacement of services, for example the IT – sector, because a growing number of companies relocates the location to India. There they can benefit from more favorable and highly qualified workers in comparison to German conditions.[11] The issue offshoring attracted attention with negative headlines. The best know example, the Finnish company Nokia has delocalized part of its production to countries of Eastern Europe, Romania, in order to reduce its cost with the result of a reduction of jobs in Germany.[12]

3 Strategies for an entry into new markets

A direct investment abroad has many chances and advantages, but also many risks and disadvantages. A bad investment abroad can lead to capital loss and in some cases it can even threaten the existence of the company. Therefore the international choice of location is a complex and multilayered decision process. Furthermore the location decision usually is not an one-dimensional decision problem, where potential alternatives for a criterion like cost reduction or the reduction of the way of transportation has to be found. It is a decision where always several goals has to be considered at the same time. In comparison to other corporate decision, the choice of location is hard to reverse and normally a long term decision. Before a company decides to relocate to another country, it has to think the several ways of entry to the new market. The right way of entry depends on the type of business. The companies have various possibilities for international action.

3.1 Direct investment and transaction strategies

3.1.1 Export

The normal way to entry into a foreign market is the export. Export means, if the company produces the goods in the originally country and exports them to new markets.[13] This type of entry implicates the smallest changes in the production and the organization. The condition for export is an unhindered payment transaction and goods traffic with marginal transport costs and duties.

There is a difference between direct and indirect export:

A - If there is an intermediary between Exporter and the foreign partner, then it is called indirect export. This has the advantage that the use of the knowledge of the intermediary is given and the Exporter can save time and money for the organization and the attainment of information. This method could be beneficial for the companies, because in case of a failure it is reversible, what means that the financial loss is not too high. But a disadvantage could be that the company has no ability to have own customer contact and to control because of the intermediary.[14]

B – The direct export includes a direct business relation between the Exporter and the foreign partner. Also as well as the indirect export, the direct way offers the reduction of costs and risks of the location setup. But high transport costs, global constraints and cultural acceptance problems in the targeted market are connected with the export.

3.1.2 Licensing

The licensing is a combination of patents and supportive products. As a product of intensive research and development work, licensing is typical for products with a strong technological background. The Licensee has the right to use the patents to produce, wherefore he pays licensing fees. The advantage is that the companies economize costs, but they can also lose control of the technological knowledge.

3.1.3 Franchising

Franchising differs from the usual licensing, that the Franchisees is also allowed to support logistics, organizations, marketing and the corporate management, apart from the right of using technology, trademarks and business name.[15] The central idea of franchising is a homogeneous presentation to the outside. The customers perceive the company as an entity. This could be an advantage, because the customer regain confidence and consume the product.[16] But in case of poor product quality the Franchisees has no possibility of control and cannot intervene directly.

3.1.4 Joint Venture

Joint Venture is a direct investment and an international joint venture is given, if at least two partners from different countries establish a joint undertaking with the aim to conduct joint activities. The properties, control and management of the new company are divided between them.

There are three variants of a joint venture:

A - Equity Joint Venture – equal allocation of shares
B - Joint Venture as subsidiary of a company
C - Joint Venture with asymmetrical distribution.

To give an example: VW in China

VW formed a joint venture with the Chinese automobile manufactures FAW in 1991. At the time of the foundation, the statuary requirement pretended that companies which want to be active in the Chinese market, had to do this only in a joint venture. VW contributed the technological know – how, while the Chinese partner proposed local knowledge.[17]

The advantages of the joint venture are the access to knowledge and acquirements of the local partner, which implicate political support and acceptance in the offshoring country and learning from the partner.[18] Furthermore both parts carry the risk. A disadvantage is the loss of control of the technological know – how, if the local partner starts to imitate and to use the information for own purposes. A joint venture often leads to a direct displacement of employments, because of the knowledge of the skilled workers, who are appointed. Thereby the consequence is a reduction of jobs in the native country.

3.1.5 Foreign Subsidiaries

Foreign subsidiaries establish a distribution network, which enables the direct customer contact in the foreign country and makes it easier to react quickly to their needs. Foreign subsidiaries are privately owned to the multinational company, including establishment, offices, subsidiaries, branches and representative offices abroad. A distinction is made between Foreign subsidiaries through merger a new formation, what is called Greenfield Investments, or acquisition. This kind of offshoring has the advantage that the companies can make their own experiences and expand their knowledge. The protection of the technological knowledge, the ability of the strategic coordination of global activities, the ability to use locational advantages and economies of scale and the proximate, independent presence in the foreign market is reasons for the formation of a foreign subsidiary.[19] But the high costs and risks by the specific investments and the difficulty of the perhaps at the beginning existing lack of knowledge could be a barrier and disadvantage for this method. It is a frequent practice that most of the companies enter the foreign market by a subsidiary. At a subsidiary the main office has the complete freedom of decision regarding to the corporate policy. Advantages are given by the direct market cultivation and customer proximity, because of the high extent of control. Furthermore the subsidiary is treated as a national company from the customers, what is very important for the image. Known examples for an acquisition of already existing companies are given in the automotive sector: the purchase of Opel by General Motors in 1929, the aborted fusion between Daimler-Benz with Chrysler or the buying of Dacia which was made by Renault.[20]


[1] Cf. Kennedy, Sharma, 2009, p.69

[2] Cf. Yager, Hite, Nilson, 2004

[3] Cf. Manning, Massini, Lewin, 2009

[4] Cf. Haq, Khan, Taria, 2011

[5] Cf. Harrison, McMillan, 2006

[6] Cf. Kehal, Singh, 2006

[7] Cf. Palugod, Palugod, 2011

[8] Cf. www.mtholyoke.ed

[9] Cf. About Ford,

[10] Cf. S.Baase, A Gift of Fire (2008)

[11] Cf. Eischen, Working Throug Outsourcing (2006)

[12] Cf. Virki, Tarmo: Nokia to cut 3500 jobs, close Romania plant,

[13] Cf. Yadong, Entry and Cooperative Strategies in International Business Expansion

Age (2008)

[14] Cf. Peng, Global Business (2009)

[15] Cf. Hoy ; Stanworth, J.: Franchising: an international perspective (2003)

[16] Cf. Sherman, Franchising & licensing: two powerful ways to grow your business

in any economy (2004)

[17] Cf. About Volkswagen,

[18] Cf. Foley, The Global Entrepreneur: taking your business international Age (1999)

[19] Cf. Howard, The Advantages of Foreign Subsidiaries

[20] Cf.


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offshoring strategies motives risks



Titel: Offshoring. Strategies, Motives and Risks