UNCTAD/WIR/2004 - World Investment Report 2004: The Shift Towards...

United Nations Conference on Trade and Development

WorldInvestmentReport

United NationsNew York and Geneva, 2004

2004 The Shift TowardsServices

In July 2003, Infineon Technologiesannounced the establishment of three newcentres, in Dublin (Ireland), Kista (Sweden) andMunich (Germany), to rationalize its customerlogistics management that had, till then, beenhandled in 19 European locations.1 The sameyear, British Telecom set up two call centres inIndia, in New Delhi and Bangalore, to deal withdirectory inquiries,2 and DHL, one of the world’sleading logistics companies, announced that itwould locate a centre in the Czech Republic tomanage IT services for i ts entire Europeanoperations. Most of DHL’s IT activities inSwitzerland and the United Kingdom would shiftto Prague, creating 400 jobs to start with, andgrowing to 1,000 over two years. Together withDHL’s regional centres in Malaysia and theUnited States, the European centre would blendinto a seamless IT infrastructure supporting thecompany’s global operations. Meanwhile, ACS(United States) announced that it was buildinga new 40,000 sq. ft. office complex in Accra,Ghana, to accommodate the growing demand forits data processing services that support clientsin the communications, healthcare and insuranceindustries.3 In 2004, the Bank of Americaannounced that it would establish a wholly-ownedaffiliate in Hyderabad, India, to undertake back-office operations for its units in the United States.The affiliate would employ at least 1,000 peopleby mid-2005. The bank had previouslyoutsourced software development to Indiancompanies such as Infosys Technologies inBangalore and Tata Consultancy Services inMumbai.4

***************What started some two decades ago with

the “offshoring” of IT services from the UnitedStates to India has gained momentum in recentyears. Similar cases of offshoring are nowreported almost daily in the media as servicesof all kinds are restructured and relocated.Offshoring of export-oriented services such ascall centres, business processes, drawing, testingand even research and development (R&D), is

gathering pace in response to the “tradabilityrevolution” in services.

Some of the offshoring is done internallyby moving services from a parent company toits foreign affiliates (sometimes referred to as“captive offshoring”, involving FDI), while someis outsourced internationally to third-partyservices providers (table IV.1). Many servicesare restructured among the developed countries;others are shifted to low-cost locations. Ofcourse, not all services are moving, but theprocess is in its infancy, and likely to gather pace.It may well mark the next stage in the evolutionof the international division of labour. Indeed,economic geographers see it as the cutting edgeof the “global shift” in productive activity(Dicken 2003).

The global shift in services offers largepotential benefits for countries at both ends ofthe process: the receiving countries gain jobs,skills, access to foreign markets and otherbenefits while the sending ones improve theircompetitiveness and can move into higher valueactivities. So far, most offshoring has taken placeamong developed countries, which underscoresthat it is not primarily a “North-South” issue. Infact, with a 25% share, Ireland leads the globalmarket for offshored IT and IT-enabled services.The increased tradability of services allowscompanies to reconfigure their production ofservices across borders, sometimes involving aninternational intra-firm division of labour toenhance their overall competitiveness. Hence,there are more factors than only cost differentialsthat determine where a service will be produced.Indeed, in many instances, companies areoffshoring services as much to improve thequality of the service produced, as to consolidateactivities in search of economies of scale and toaccess certain skills or markets – in short, to reapthe benefits of the new international division oflabour that is unfolding.

Although recent media attention maysuggest otherwise, to date, the magnitude ofoffshoring to developed and developing countries

CHAPTER IVCHAPTER IVCHAPTER IVCHAPTER IVCHAPTER IV

THE OFFSHORING OF CORPORATE SERVICEFUNCTIONS: THE NEXT GLOBAL SHIFT?

148 World Investment Report 2004: The Shift Towards Services

is relatively small, albeit growing fast. Over time,as companies learn how to manage theinternational production of services, developingcountries are likely to play a growing role asservice exporters. As in previous periods ofeconomic restructuring, new challenges will ariseas companies adjust and reconfigure theiroperations.

This chapter looks at the technological,economic, institutional and organizational factorsthat are catalysing the growth of offshoring, tracesthe role of FDI in the process and explores theimplications for host and home countries. Whilethe bulk of offshoring has so far been undertakenamong developed countries, the chapter paysspecial attention to the role of developing countriesand economies in transition in this process.

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1. The tradability of services

Offshoring reflects nothing less than arevolution in the tradability of services.Traditionally, most services have been “non-tradable” in that they require buyers and sellersto be in the same place at the same time. Unlikephysical products, they could not be tradedbetween parties located in different countries; ahaircut, for instance, is impossible to deliver acrossa distance. Many services, however, do not requirephysical proximity, but have usually taken placeface-to-face because of technical constraints,habits or customs. These services centre on the

exchange, storage, processing and retrieval ofinformation broadly defined.5 They have been non-tradable because:

• Some types of information (such as musicbefore the discovery of recording devices)could not be stored, and had to be producedand consumed instantaneously.

• Some information could be stored (such aswords or data in books or other written form),but not transmitted rapidly and economically(and in bulk) across countries for processing.

• Some information was processed in-house byenterprises because “it had always been so”;for example, i t was customary to doaccounting, archiving or designing internally.Some information exchange between serviceproviders and consumers traditionallyinvolved face-to-face contact, such as patientsmeeting their doctors or clients meeting theirlawyers or bankers for consultation.

New information and communicationtechnologies (ICTs) are dramatically changing thetradability of the information-centred set ofservices, in several ways (Sauvant 1990; Zimnyand Mallampally 2002).6 For example, all kindsof information can be stored by digitization. Andmuch cheaper and faster transportation allows theinstantaneous exchange of digitized informationand voice communication between peopleanywhere around the globe (provided the necessaryinfrastructure exists).7 In addition, customs andtraditions are being broken as people are inducedto use electronic media to acquire services theyhad previously only accessed by direct contact.In the business sphere, services traditionallyobtained in-house by firms are now being

Table IV.1. Offshoring and outsourcing – some definitions

Internalized or externalized production

Location of Internalized Externalized production (“outsourcing”)

Home country Production kept in-house at home Production outsourced to third-party service provider at home

Foreign country Production by foreign affiliate, e.g. Production outsourced to third-party provider abroad,(“offshoring”) - Infineon‘s centre in Dublin To local company, e.g.

- DHL’s IT centre in Prague - Bank of America’s outsourcing of software development to- British Telecom’s call centres in Infosys in IndiaBangalore and Hyderabad To foreign affiliate of another TNC, e.g.

- A United States company outsourcing data processing

”intra-firm (captive) offshoring” services to ACS in Ghana

Source: UNCTAD.

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externalized, and consultations between serviceproviders and customers are starting to take placeat a distance because face-to-face interaction isnot always deemed necessary.

The use of ICT allows knowledge to becodified, standardized and digitized, which inturn allows the production of more services tobe split up, or “fragmented”, into smallercomponents that can be located elsewhere to takeadvantage of cost, quality, economies of scaleor other factors. This makes it possible to producecertain services in one location and consume them(or use them in further production) in another– either simultaneously (e.g. informationprovided via call centres) or at a different time(e.g. data entry, software development). As arecent article puts it: “tasks that can be performedelsewhere are limited only by a manager ’simagination”.8 Such fragmentation exceeds thatin manufacturing.9 New technologies do not justmake services transportable; they also oftensimplify the tasks involved and so allow themto be relocated more easily.

The range of service products orfunctions affected by the fragmentation are huge.As a result, a wide range of services is alreadybeing exported, including by developingeconomies (box IV.1), whether relatively simplelow-value data (e.g. numbers entered into acomputer) or more sophisticated, high-value data(e.g. architectural designs, results of sophisticatedfinancial analyses, R&D, X-rays, films, softwareprogrammes, advertising clips).10 While someare service products of one industry, most aregeneric and cut across industries. They areneeded and widely used by individuals, firms inall industries, governments and non-governmentalorganizations (NGOs) and all types ofinstitutions. As with manufactures, it is possibleto categorize traded services according to skillrequirements. This exercise is useful for assessingthe potential of countries as exporters (box IV.2),but it needs to be refined and further developed.

Thus, progress in ICT has solved thetechnical problem of non-transportability and,for many services, that of non-storability.

Tradability is not just a matter oftechnology, however. Even when services aretechnically divisible and transportable, trade maynot take place for economic reasons (UNCTAD1994, p. 3; UNCTAD and the World Bank1994).11 For some types of services, proximityto markets, interaction with customers, trust andconfidence outweigh the possible benefits from

the benefits of arm’s length trade. But on thepremise of comparative advantage, increasedtransportabili ty does open the potential forconsiderable economic gains from specialization.With sharply reduced telecom costs and increasedbroadband width, cost differentials play outdirectly. Increased competition – itself aconsequence of falling transport andcommunication costs and liberalization – forcesenterprises to reduce costs, hive off functionsthat can be performed more efficiently byspecialized agents, and focus harder on their corecompetencies. This leads both to outsourcingwithin countries and to offshoring to locationsabroad. Governments, hospitals and otherinstitutions can also gain from offshoring whenunder pressure to economize.

The tradability revolution is alreadyvisible in the balance-of-payments data ofcountries (van Welsum 2004; Borga and Mann2003).12 In terms of imports of services, theUnited States has reported the largest increases,its share of global imports rising from 11% in1992 to 13% in 2002 (WTO 2004a).13 In “otherprivate services” imports, some of the fastestgrowth rates in the United States can be observedfor “computer and data processing services” and“accounting, auditing and bookkeeping services”,two categories that are closely associated withthe offshoring of services (table IV.2).Meanwhile, the largest increases in the exportmarket share of “other business services” and“computer and information services” are reportedby the United States, India, Ireland, the UnitedKingdom, Sweden, Spain, China and Israel, inthat order (van Welsum 2004).14

2. Limitations to offshoring

Not all services will relocate. Typicalfeatures of services with a high probability foroffshoring include (Bardhan and Kroll 2003, p.4):

• no face-to-face servicing requirement;

• high information content;

• the work process is telecommutable andInternet-enabled;

• high wage differentials with similaroccupations in destination country;

• low set-up barriers; and

• low social networking requirements.


The offshoring of services affects a widerange of service activities. The following are afew examples of services that are now exportedacross borders by various developing countries:

Audiovisual and cultural services includemotion picture and video tape production anddistribution; motion picture projection; radio andtelevision; radio and television transmission; soundrecording; recreational, cultural and sportingservices; and news agency services. Developing-economy exporters include Argentina, Brazil,Hong Kong (China), India, Mexico and Venezuela.

Business services encompass various back-office processes, customer interaction andtechnical support. Examples include abstractingand indexing, data entry and processing, electronicpublishing, legal transcription, litigation support,mailing list management, remote secretarialservices, technical writing, telemarketing,telesupport and web-site design. India is by farthe largest developing country exporter of suchservices, but more and more countries are enteringthe arena.

Computer and related services include theinstallation of computer hardware, softwareimplementation, data processing, databaseservices, maintenance and repair of officemachinery and equipment such as computers, andother computer services. Ireland, India and Israelaccount for much of the exports of these services,but there are also many other exporters.

Higher education and training servicesbenefit from new technologies that are makingpossible the inexpensive delivery of content inaudio and visual formats (or on the Internet),leading to a surge in cross-border education inelectronic format. Some developing countries areestablishing a presence in this market.

Financial services cover insurance andinsurance-related services, as well as banking andother financial services. Many developing-countryexports of these take the form of joint venturesor affiliates of large financial service TNCs fromdeveloped countries. Foreign affiliates provideservices not only to the parent company and thelocal market, but are also involved in exports tothird parties, including to other developing countrymarkets. Here too, India is a major player. In LatinAmerica, reinsurance firms are collaborating with

Box IV.1. Developing countries are exporting a bewildering array of services

providers of financial services and insurance firmsto offer a range of competitive new products.

Health services include medical, dental,nursing and paramedical services, hospital, socialand other human health services; these are amongthe most rapidly growing industries in the worldeconomy. Direct exports of related services includeshipment of laboratory samples, diagnosis, secondopinions and consultations via traditional postalchannels as well as via electronic means. Chinaoffers on-line diagnostic services to patients inTaiwan Province of China and some South East-Asian countries. In India, radiologists interpretcomputer tomography scans for hospitals in theUnited States. Medical samples go for diagnosisto Mexico from Central America, and somemedical facilities have their medical records orpatient interviews digitally transcribed inBangladesh, India, Pakistan, the Philippines andZimbabwe.

Internet-related services include the supplyof the Internet itself (telecommunication services),the supply of content, a mix of business services,audiovisual services and computer and relatedservices. Latin American Internet companies haveexpanded to other countries in the region buildingon the common language base. Hong Kong(China), Lebanon and Singapore are exporters totheir neighbours.

Various professional services, such as legalservices, accounting, auditing, taxation,architectural and engineering services, representsome of the most sophisticated areas of servicesoffshoring. This has been a difficult area fordeveloping countries to break into because of highskill requirements and problems in establishingcredibility in foreign markets. However, theirexports are growing. Commonly offshoredprocesses include bookkeeping for clients, tax co-sourcing solutions, document management,staffing and IT services. Architectural design andother services are also being exported. India,Singapore and several CEE countries are amongthe exporting countries in this category.

Animation production in India alone isexpected to surge, from $600 million in 2001 tomore than $1.5 billion in 2005. This is in responseto the fast growing demand from animation studiosto meet 2-D and 3-D requirements (Bajpai et al.2004).

Source: UNCTAD, based on Nielson and Taglioni 2004.

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Table IV.2. Growth in imports by the United States of selected services within the category ofbusiness, professional and technical services, 1992-2002

(Per cent and millions of dollars)

Type of service Average annual growth rate Value 2002

Computer and data processing services 31 1 057Accounting, auditing and bookkeeping services 21 716Management, consulting and PR services 17 1 188Research, development and testing services 16 1 040Training services 14 361

Memorandum itemsTotal business, professional and technical services 13 10 732Total other private services 11 69 436Total private services 7 205 234

Source: UNCTAD, based on Borga and Mann 2003.

As with manufactures, the categorization oftraded services by skill levels highlights the kindsof attributes needed for countries to becomecompetitive suppliers. Of course, these attributesdetermine service exports only when othernecessary conditions such as the investmentclimate, infrastructure and regulatory frameworkare in place.

Low-skill services. These are services withthe lowest entry barriers in terms of skills, scaleand technology. They include data entry or callcentres (although some call centres require higherskills, computer or technical support). They tendto need general – but not very high – levels offormal education, a working knowledge of therelevant language and/or basic computer skills.There are generally few economies of scale oragglomeration: a call centre may be viable with30 operatives in a site where there are no similarcentres or knowledge institutions. The level ofdevelopment of other services or manufacturingis not necessarily important for competitivenessin such activities. For this reason, there are likelyto be few positive spillovers in terms of supplierlinkages or skills creation.

Medium-skill services. These are complexservices that require more advanced skills, andmay offer considerable scale economies andagglomeration effects. Examples include financialand accounting services, standardizedprogramming work, routine data analysis andprocessing or back-office services such as ticketingand billing. Specialized training would generally

be required (and so also the necessary traininginstitutions). The building of competitivecapabilities may also call for a large local marketwhere the skills accumulate over time. Someservices may require a minimum critical mass ofdifferent skills in one location to provide the wholepackage.

High-skill services. This is the most creativeand skill-intensive end of offshored services, withthe most stringent entry requirements. Examplesinclude R&D (from all sectors), design services,architectural drawings, new software development,animation, medical testing or analysis andtechnology systems design. These requireadvanced skills at high levels of specialization,often with strong educational institutions. Theyinvolve agglomeration economies, with differentskills, enterprises and institutions interacting witheach other to share work, stimulate knowledgeflows and allow specialized skills to be fullyutilized. Needless to say, the location would haveto be attractive enough to retain a large numberof qualified personnel.

The line between the three types of servicesis not firm. The proposed categories are highlyaggregated, and there is likely to be considerableskill variation within each of them. Sincetechnologies change rapidly, activities may moveup or down the ladder from one year to the next.Nevertheless, the categorization is useful inmatching the growth of offshoring of services withthe potential for countries to export and becomecompetitive.

Box IV.2. Skills categorization of traded services

Source: UNCTAD.


There are a number of services or serviceprocesses that do not meet these criteria. Andthere are other limits to offshoring. There aretechnological limitations: many service functionscannot be digitized and/or separated from relatedactivities. Face-to-face interaction is still requiredat many points in the value chain of developing,marketing, delivering and maintaining a varietyof services. Proximity to customers is oftenimportant to gain knowledge of markets. Someprocesses are hard to manage cross-nationally;for example, creative and innovative processesmostly require close interaction and are thereforedifficult to separate and offshore.15 In somecases, a local presence is critical to understandtechnical requirements such as health-careregulations or legal codes. In others, theinformation to be processed may be personal,idiosyncratic, sensitive or confidential, increasingthe transaction costs involved and so limiting thedesirability of offshoring. Some countries requireparticular services to be provided by companiesestablished locally (in case of foreign companies,through FDI) (chapter V).16

Other legal factors that may limit theglobalization of IT-enabled services relate toareas where the marketplace is global, but thelegal jurisdiction is local. Professionalqualifications are one such example. Whereascertain accounting activities can be offshored,the final stamp of approval may need to be givenby a certified accountant in the home country.The lack of globally agreed privacy rules maysimilarly limit the globalization of IT-enabledservices. In the United States and the EuropeanUnion (EU), data-security issues have emergedas potential barriers to further offshoring. Legalrestrictions in a few developed countries to theoffshoring of services to protect jobs at home mayalso have a dampening effect on the trend(chapter V).

There are also limits to the supply ofappropriately educated workers. For example,among companies interviewed concerning thelocation of shared service centres for theEuropean market, the lack of language skills wasperceived to be the main obstacle to offshoring(IBM and Oxford Intelligence 2004). Continuedhigh levels of growth in offshoring to preferredlocations are likely to affect both the availabilityand cost of appropriate skills. Even in largeeconomies like India, shortages can lead to wageinflation and high levels of attrition, making theoffshoring proposition less attractive. The greater

the interest among companies and institutions torelocate services, the more efforts are needed byboth host governments and the private sector toincrease the supply of adequately trained labour.Shortages of skills in one location may also leadcompanies to consider other locations, thusopening the door for new entrants to become abase for exports of services.

Finally, based on their perceptions ofrisk, companies, even in the same country andindustry, differ significantly in their assessmentof the benefits from shifting the production ofa service abroad. For example, in the financialindustry in the United Kingdom, the Royal Bankof Scotland – in contrast to competitors such asBarclays and HSBC – took a decision not to shiftcertain services abroad (at least not for the timebeing).17 Thus, any assessment of the potentialfor services offshoring requires a careful analysisof corporate strategies.

3. Is the globalization of IT-enabledservices different from that ofmanufacturing?

As services become more open toefficiency-seeking FDI, information-intensiveservices can be fully subjected to the internationaldivision of labour and hence integratedinternational production (WIR93). WIR02analysed the emergence of integratedinternational production systems inmanufacturing and their impact on the exportcompetitiveness of developing countries. It notedthat export growth was more rapid in technology-intensive activities where such systems hadadvanced the furthest. However, the spread ofintegrated production systems in manufacturingwas uneven; there were cumulative agglomerationforces allowing first movers to pull ahead of laterentrants. While the forces driving thefragmentation and globalization of goods andservices production are similar, some notabledifferences exist (Bardhan and Kroll 2003; Mann2003):

• The Internet and associated IT hardware andsoftware have rapidly removed a basicbarrier to trade in IT-enabled services.Moreover, i t is structurally simpler tooffshore services in terms of resources,space and equipment requirements. Thus,the fragmentation of services, where it ispossible, proceeds faster than inmanufacturing. The need for adjustment

153CHAPTER IV

policies in importing countries maytherefore also be more important.

• The offshoring of tradable servicespotentially affects firms in all sectors, andmay have wider implications than thefragmentation of manufacturing.

• The offshoring of services affects mainlywhite-collar workers whereas the relocationof manufacturing involved primarily blue-collar workers.18 In manufacturing,considerable offshoring has taken place withrelatively low skill demands on theworkforce, compensating, as necessary, byimporting skills through on-the-job training.The skill intensity of some services beingoffshored is adding to concerns in developedcountries about the possible loss of white-collar jobs.

• Offshoring of services may be morefootloose than that of manufacturing becauseof lower capital intensity and sunk costs aswell as weaker links to local suppliers.Obviously, this applies more to lower skillthan to higher skill services.

In sum, many of the forces that havedriven the internationalization of manufacturingare increasingly at play for a growing numberof service functions. However, as the offshoringphenomenon may unfold faster, and because itis likely to affect corporate strategies in allsectors, it is all the more important to studycarefully its implications.

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The offshoring of service functions is stillat an early stage. The trend began with IT/software services in the 1980s19 and acceleratedin the 1990s as offshoring was used to cope withconcerns related to the Y2K problem.20 The earlymotivation was not just to lower costs but alsoto handle the surge in demand for such services,and to improve quality. In 2002, the market foroffshore outsourcing of IT-enabled services(mostly business process outsourcing) wasestimated at $1.3 billion – less than 1% of theglobal market for such outsourcing (Scholl et al.2003). However, a more complete picture ofoffshoring of services needs to take into accountcaptive production as well as international

outsourcing of such services as softwaredevelopment and other IT services, which are notcovered under IT-enabled services. The totalmarket for all offshore service exports wasestimated at $32 billion in 2001, most of whichwas supplied by Ireland, India, Canada and Israel,in that order (McKinsey & Co. 2003).

While assessments differ, virtually allobservers expect offshoring of services toaccelerate in the foreseeable future. Offshoreoutsourcing of business processes is expected togrow from $1.3 billion in 2002 to $24 billion in2007, raising the international share of the totalmarket from 1% to 14% in five years. Between2001 and 2003, the planned adoption of offshoreoutsourcing of business processes amongcorporate decision-makers in the United Statesrose by a factor of six (Scholl et al. 2003). Evenamong the world’s 1,000 largest companies, some70% have sti l l not offshored any businessprocesses to lower cost countries.21 In a 2004survey of the top 500 European firms jointlyundertaken by UNCTAD and Roland BergerStrategy Consultants (RBSC), only 39% hadexperience with offshoring of business services(UNCTAD and RBSC 2004). The respondingcompanies had already offshored some 20,000jobs, and 44% of all respondents said that theyplanned to offshore more in the next few years.Other studies confirm that more offshoring is inthe making:

• The number of call centres in Scotland withoffshore operations is expected to doublein the next five years (Taylor and Bain2003).

• In a study of mainly United Statescompanies, 25% had offshored someservices, and as many as 79% said theyplanned to offshore within two years (Bajpaiet al. 2004).

• In Japan, 23% of the corporate members ofthe IT-related trade association wereutilizing offshore services, especially inChina. While some Japanese companies haveset up call centres and back-officeoperations in Dalian, which has a large poolof Japanese speakers (Sasaki 2004), theystil l lag significantly behind theircounterparts in the United States in termsof services offshoring.

• Foreign affiliates exporting services fromIndia predicted in early 2003 that theiremployment would double over thesubsequent 12 months (Dossani and Kenney


2004). (Some examples of expansion plansof leading TNCs in the ICT industry in Indiaare presented in table IV.3.)

How big is the offshoring phenomenonlikely to become? Its future scope and dimensionsremain uncertain. It has a long way to go beforeit matures and settles down in pattern andlocation. An early assessment of the “outer limit”of the number of jobs for which long-distanceprovision is technically feasible and for whichcost savings of up to 30-40% would be plausible,suggested that 1-5% of the total employment inthe G-7 countries could be affected (World Bank1995). A more recent analysis concluded that themaximum number of jobs potentially subject tooffshoring from the United States was in themagnitude of 11% of jobs in all occupations, or14 million jobs (Bardhan and Kroll 2003).Estimates on the likely actual impact are muchlower. For example, one study has suggested that3.4 million service jobs are likely to have shiftedfrom the United States to low-income countriesby 2015.22 Another study concluded that 2million offshored jobs could be created in thefinancial services industry alone, and that thetotal number of jobs affected for all industriescould be in the area of 4 million.23

Even the financial and IT industries,which have spearheaded offshoring, are only atthe beginning of the international restructuringprocess. In banking, for example, large

opportunities remain for reorganizing operationsat a regional or global (rather than national) level.The best prospects are to be found in the highervalue, more strategic functions (IBM and OxfordIntelligence 2004). Further consolidation ofoperations that can be standardized and digitizedin combination with economies of scale, lowerlabour costs and a focus on core activities offerattractive prospects for offshoring by companiesfrom all sectors. If pioneering firms succeed inimproving their competitiveness, competitors arelikely to follow quickly. The unfolding of theprocess is difficult to forecast. There can beconsiderable inertia in organizational systems.Also, the technical changes involved ininternational restructuring can be expensive.Indeed, among European TNCs, increasedoffshoring is more likely to come from companiesthat already have experience in this field thanfrom newcomers (UNCTAD and RBSC 2004).

However, to the extent that offshoring isshown to pay off – as various surveys of UnitedStates and European TNCs seem to suggest (seebelow) – it is likely to spread across industriesand countries. Notwithstanding differences incorporate strategies, the standard benefits of aninternational division of labour andinternationalization of production apply to mostservice activities. Similarly, while offshoring hasso far been considered mainly by largecorporations, sooner or later small companies are

Table IV.3. Plans of TNCs in the ICT industry for offshoring of services to India, based oninformation available at the end of 2003

Company No. of employees Employees in India Plans for India office

Accenture 65 000 3 500 8 000 by August 2004Adobe Systems 3 250 185 250 in 6 monthsCadence 5 000 315 Doubling in four yearsCap Gemini 56 500 800 2 000 by December 2004Cisco 34 466 2 300 …Covansys 4 556 2 000 2 800 in one yearCSC 92 000 1 200 4 800 by 2004EDS 138 000 300 2 400 by 2005i2 2 800 1 000 Actively recruitingIBM Global Services 150 000 3 100 10 000 in 3 yearsIntel 79 200 950 3 000 by 2005Keane 5 819 623 2 000 by end 2003Logica-CMG 24 000 350 1 000 by end 2004Lucent 35 000 570 …Microsoft 55 000 200 500 in three yearsOracle 40 000 3 159 6 000 in one yearSapient 1 500 600 Will growSun Microsystems 36 000 700 Will growTexas Instrument 34 400 900 1 500 by March 2006Xansa 5 583 1 200 6 000 in a few years

Source: Roach 2004, pp. 90-92.

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likely to follow the larger trailblazers; in fact,some smaller TNCs are already exploiting theopportunities from offshoring (see e.g. box IV.3).

Benefits of offshoring are not confinedto the corporate sector; they can also be reapedby governments. For instance, tax authorities inhigh-cost countries can at present afford to checkonly a small number of tax declarations everyyear; by shifting some work to lower costlocations, they could raise the audit ratiosignificantly and improve their intake. Othergovernment services could also raise the qualityof their services while lowering their costs byoffshoring some segments of their work. And stillother official and private institutions couldfollow, as they seek to economize and becomemore efficient.

For some services, offshoring strategiescompete with automation trends. Whenautomation is preferred, jobs are likely todisappear in both developed and developingcountries. Prominent examples include basicbanking services that previously required face-to-face interaction, but are now often handledover the Internet. On the other hand, for many

other types of services, human interaction offersflexibility that automation does not. For complexactivities, a real time human interaction willremain crucial.

In sum, there are sound – some wouldsay compelling – reasons for the offshoring ofservices to grow and spread. TNCs will play avital role in this international restructuring ofactivities, directly by setting up captive offshorecentres or affiliates serving third parties, andindirectly by subcontracting work to local serviceproviders. The opportunities for all countries,not least developing and transition economies,to attract employment and income-creating workare significant, although at this stage, i t isimpossible to say exactly how significant. Theforces driving offshoring are powerful and theresulting economic benefits are a classicillustration of gains from trade and specialization.Competitive pressures on companies are likelyto spur further offshoring as managers are obligedto look for new ways to improve competitiveness.As companies learn how best to optimize servicefunctions internationally, and as they monitor themoves of their competitors, the process is likelyto gain momentum.

The bulk of offshoring of services has so farbeen undertaken by large firms – but smallercompanies are also starting to exploit opportunitiescreated by the increased tradability of services.Global Refund – a market-leading supplier offinancial services to enable travellers to collecttax refunds – is a good example.

Global Refund employs 800 peopleworldwide, in some 35 countries. It has its originin Sweden, but is legally registered in theNetherlands (mainly for tax purposes). Informationtechnology has made it possible to locate variousheadquarter functions to different locations: thechief executive officer is based in Switzerland,marketing and finance functions are located inSweden, IT and transaction processing functionsare run from Austria, and certain businesssegments are managed from Singapore.

As of early 2004, Global Refund was in theprocess of consolidating back-office work intotwo “centres of excellence” in Europe. Onceconsolidated, tried and tested, the company may,

as a second step, offshore these functions andestablish a foreign affiliate in a lower cost locationin either CEE or Asia.

The company has also chosen to offshoresome services through outsourcing. In onebusiness segment, all transaction processing workhas been outsourced to a local service providerin Singapore; software development for theEuropean market has been outsourced to a localcompany in Bulgaria; and software developmentto support the Asia-Pacific region is undertakenby a local company in India. There are also plansto establish a captive call centre in a low-costlocation.

The company views the offshoring ofservices as a necessary process to increasecompetitiveness. By consolidating certainfunctions in centres of excellence, it has been ableto reap economies of scale, avoid duplication ofwork, enhance worker skills, and thereby reducecosts as well as improve the quality of the servicesperformed.

Box IV.3. Smaller TNCs are offshoring too

Source: UNCTAD, based on company interview.


However, realizing the full developmentand competitive potential of offshoring will notbe easy. To date, a relatively small number ofcountries at different levels of development haveattracted most of the service activities that havebeen offshored. This tendency to agglomerate isstronger the more sophisticated the serviceactivity is, reflecting the need to access thenecessary levels of skills and infrastructurequality. Spreading the benefits more broadly, notleast in the developing world, means othercountries will have to increase their attractivenessand capabilities. Not only will they have to offerfavourable conditions for local and foreignservice providers, they will also have toovercome the first- mover advantages of thepioneers. On the side of developed countries,there is growing realization of the competitivebenefits of offshoring, but bridging the perceptiongaps and institutional and organizational inertiawill take time. There is, moreover, growingconcern about job losses and, underlying this,about the costs of adjusting to the emergingpattern of comparative advantage in services.

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1. What determines how offshoringis undertaken?

As noted above, offshoring – shifting anactivity abroad – can be done internally (captiveoffshoring) or through internationalsubcontracting or outsourcing (table IV.1). Anyoffshoring decision requires a firm to choose toremove a service function previously undertakenin-house at home and entrust it to a provider –either its own foreign affiliate or a third party– located outside the home country. The potentialfor offshoring of services may partly be gaugedby the progress in outsourcing of services at thenational level (box IV.4). After all , once acompany has outsourced an activity to anindependent supplier in its home market, a logicalnext step may be to explore similar set-ups inother locations, and, for instance, consolidate inone place the production of individual servicefunctions for the corporate network as a whole.Moreover, as domestic suppliers of outsourcedservices expand internationally, the scope foroffshoring also increases.

If it is economical to offshore a service,the principal has to decide whether to producethe service in-house (by setting up an affiliatein the chosen location) or to buy it from anindependent enterprise. A considerable proportionof all offshored services is produced by foreignaffiliates. According to balance-of-payments data,intra-firm trade accounts for more than 71% ofall imports of “business, professional andtechnical services” into the United States.24

Moreover, during the period 1997-2002, the valueof intra-firm imports of such services increasedfaster than unaffiliated imports (van Welsum2004; Borga and Mann 2003). In Europe, 45%of the largest firms with offshoring experiencehad offshored services to their foreign affiliatesor a joint venture set up abroad, whereas 48%of the companies had outsourced activities tothird party service providers (UNCTAD andRBSC 2004).

As il lustrated by Bank of America –mentioned in the introduction to this chapter –a company may choose to offshore two types ofservices to the same location (India) in differentways, outsourcing one (software development)to local providers while producing the other(back-office operations) in-house in a foreign

Box IV.4. Outsourcing at the nationallevel

The outsourcing of business processeswithin a country has existed in some form forcenturies. However, it really took off in theUnited States in the late 1980s, when companiesstarted to focus harder on their core activitiesand to tap the technological potential of ICT(UNCTAD 2003g). Large companies increasinglyoutsourced ICT functions to external serviceproviders, which also delivered and maintainedvarious data-related services. As the capacity tostore and transfer data at low cost rose, the scopeof outsourced operations and the number ofproviders expanded. Today, companies in allsectors undertake a broad range of businessprocesses outsourcing related to both front-office(customer interaction) and back-office services(data processing, finance, accounting, humanresources, knowledge services). The globalmarket for such outsourcing was estimated at$110 billion by end 2002, and is expected to growto about $173 billion in 2007 (Scholl et al. 2003).

Source: UNCTAD.

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affiliate. Similarly, ExxonMobil and GE set upaffiliates in Hungary to provide back-officeservices, while K&H Bank outsourced similaractivities to the Hungarian affil iate of thespecialized service provider, EDS. A range offactors affects these decisions.

First, a company usually opts for keepingan activity in-house when strict control of thatactivity is considered crucial, when hightransaction costs are involved (Buckley andCasson 1976) or when proprietary knowledge andinformation is sensitive, tacit , expensive toproduce, complex or idiosyncratic, but easy toreplicate (Dunning 1989). As in any economicactivity, the more strategic the service function,and the closer it is to the core competence of afirm, the less likely it is to be outsourced.25 Forexample, the financial services industry appearsto rely almost exclusively on internalized modelsof offshoring (Joyce 2002).26 Most offshoredR&D operations in India are performed byforeign affiliates. Examples include Oracle’s andTexas Instruments’ design and developmentcentres and GE’s R&D laboratory in Bangalore.27

Other TNCs such as Cisco, Hewlett-Packard,IBM, Lucent and Microsoft have also madeinvestments in R&D centres in India (Kapur andRamamurti 2001).

Second, the level of internal interactionassociated with an activity matters. A commonlycited risk with outsourcing is associated withcommunication difficulties with the vendor(Bajpai et al . 2004). For services that aretechnically separable, but involve closeinteraction with other (service, manufacturing,R&D) activities of the firm to be efficient, aninternalized solution is likely to be preferred. Incontrast, back-office operations and customerinteraction services that can be easilystandardized and separated from other activitiesare more likely to be outsourced. Thus, a numberof TNCs has outsourced routine, standardizedsoftware development to Indian companies, butinternalized more complicated development work(Kumra and Sinha 2003).28

Third, the availability of capable localfirms influences the choice.29 The emergence oflow-cost service providers in some developingcountries is a recent phenomenon (Huang andKhanna 2003; Zaheer and Rajan 2003; Kumraand Sinha 2003).30 For example, when TNCsstarted to transfer back-office functions to India,there were no local companies to which theycould outsource. American Express in 1993,

British Airways in 1996 and General Electric in1998 set up their own affiliates for this reason(Dossani and Kenney 2004; Riera et al. 2002),whereas latecomers to offshoring in the airlineindustry chose to externalize similar activitiesin that country. Delta Air Lines outsourced someof its call-centre reservations to Spectramind, aWipro subsidiary. Swiss International Airlines,Austrian Airlines and Sabena outsourced revenueand traffic accounting, cargo revenue accounting,passenger interline billing, navigation supportand frequent flyer programme administration toAFS, a wholly-owned affil iate of TataConsultancy Services, the largest Indian softwarecompany.31 Consequently, for more “mature”services that have been offshored for some time(such as software development), it is easier fora company to find a third-party supplier than inan area that is emerging (e.g. financial analysis).

Different business models may be chosen,depending on a host-country’s features. In thecase of shared service centres for the Europeanmarket, offshoring to India tends to involvemainly outsourcing, whereas offshoring to CEEcountries is likely to have a higher element ofinternalized solutions (IBM and OxfordIntelligence 2004). Other host-country factorsthat could deter outsourcing include weakproperty rights protection, cultural mismatchbetween home and host countries and a poor trackrecord of existing local vendors.

Fourth, larger scale activities are morelikely to be kept in-house when offshored. Unlessthe volume of work is large, it can be difficultto generate the required economies of scale toreap savings. Being a small player may also makeit more difficult to recruit the best talents.Outsourcing the activity to a better-knownspecialized service provider may be a solution.The higher the value added in the service functionperformed, the greater the incentive for thesourcing company to keep the activity in-houseto reap the full return on investment.

2. A new breed of TNCs providesservices globally

The expansion of internationaloutsourcing has contributed to the emergence ofa new breed of TNCs that supplies services ofother companies, rather l ike contractmanufacturers in manufacturing (Sturgeon 2002;WIR02, p. 139). Since outsourcing is the mostadvanced in the United States, most specialized


contract service providers also hail from there.Some have become global players by setting upforeign affiliates around the world, and are hencebecoming key targets for investment promotionagencies seeking to attract FDI into export-oriented services. One of the main advantagesof contract service provider TNCs is theirestablished links to clients in the United Statesand Europe. By developing a portfolio oflocational advantages through a global networkof their own affiliates, they have great flexibilityin offering tailored solutions to their clients.

In the call centre industry, the largestcontract service providers include Convergys,ICT Group, Sitel and Sykes – all from the UnitedStates (table IV.4). These companies have beenestablished for some time, but have only recentlyset up foreign affiliates in developing countries.Sykes, founded in 1977, set up its first contactcentre in a developing country (the Philippines)only in 1997. Convergys, the world’s leading callcentre company, set up its first developing-economy affiliate in 2000, and then expandedrapidly – by 2003, it had export-oriented centresin Argentina, Brazil, India, Indonesia, Mexico,the Philippines, the Republic of Korea,Singapore, Sri Lanka, Taiwan Province of Chinaand Thailand. Sitel’s export-oriented contactcentres are in Canada, Colombia, India, Jamaica,Mexico, Morocco, Panama and the Philippines.However, these centres account for less than 10%of the company’s worldwide business, i.e. thegreat bulk of activities are in developedcountries.32

While the main operations of thesecompanies remain in industrialized countries,those in developing countries are growing morerapidly in employment terms. Convergys’ Indianoperations, started in 2000 in New Delhi, hadexpanded to employ 3,000 people by April 2003,and another centre was being developed inBangalore for an additional 3,000 employees.Similarly, Sykes announced plans to expand its

Indian activities by 1,200 people during 2003(Dossani and Kenney 2004).

In business-process outsourcing and IT-related services, there are also a growing numberof external service providers. Some of the topcompanies are IBM Global Services, EDS,Accenture and Hewlett-Packard. In India, IBMis the largest foreign IT service provider withsome 15,000 employees, followed by Hewlett-Packard and Accenture, each employing 3,000people. EDS expects to reach similar levels ofemployment at the end of 2004.33

The emergence of contract serviceprovider TNCs makes it increasingly importantfor local suppliers in developing countries toexpand abroad and establish a global foothold.TNC clients expect a presence or support in manycountries, and often prefer to deal with one globalcontact of a single outsourcing company thanentering into multiple contracts with a range oflocal suppliers around the world. Companies thathave a global presence are better equipped tomanage an outsourced function effectively andcost efficiently across geographic areas.Accordingly, some Indian companies establishedaffiliates in the United States and Western Europesome time ago and are now starting to move intoCEE (see also chapter I). For example, in April2004, Infosys announced plans to invest $20million in a business consulting subsidiary in theUnited States to match rivals and counter apossible political backlash against outsourcing;34

Satyam plans to start a software-developmentcentre in the Czech Republic, Hungary or Polandin 2004, initially employing at least 100 softwareengineers; Tata Consultancy Services in 2003 setup a software development centre in Budapest,with 160 engineers, to serve its European clients;and Progeon, the back-office services arm ofInfosys, will open its first overseas call centrefacility employing about 150 people in the CzechRepublic later in 2004.35, 36

Table IV.4. Contract service provider TNCs offering call/contact centre services, 2003

Turnover Number of Year of Year of first offshore location

Company name ($ billion) employees establishment in developing country

Convergys 2.3 55 000 1998 2000 (India)ICT Group 0.3 11 000 1987 2002 (Philippines)Sitel 0.8 26 000 1985 2001 (India)Sykes 0.5 16 000 1977 1997 (Philippines)

Source: UNCTAD, based on information from company websites.

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In sum, there is l ikely to be moreconsolidation, and the structure of the industryrelated to the offshoring of services will becomeclearer.37 To the extent that customers requirethe ability to offer blended solutions (in whichsome work is done “onshore” and some offshore),it may become increasingly difficult for smallerservice providers with limited internationalexposure to compete successfully for largerprojects.

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1. FDI related to the offshoring ofservices is still concentrated

Most offshored services to date areconcentrated in a relatively small number ofcountries. Ireland, India, Canada and Israel (inthat order) accounted for over 71% of the totalmarket for offshored services in 2001, mostly insoftware development and other IT services(McKinsey & Co. 2003). But many otherdestinations are emerging as potential hostcountries. Due to rising labour costs in the mostpopular locations, competitive pressures andimproving host-country environments, thegeographic scope of locations for FDI in servicesis broadening. An assessment of the attractivenessof the 25 leading destinations for offshoringconcluded that India topped the list by far,followed by China, Malaysia, the Czech Republicand Singapore (A.T. Kearney 2004). Brazil led

in Latin America, South Africa was the leaderin Africa, while Canada and New Zealand werethe highest ranking developed countries.

Among large European TNCs, the patternis similar. Almost one-third of all offshoredservices projects have gone to India; WesternEuropean countries (e.g. Ireland, Portugal, Spain,the United Kingdom) have attracted 29% of allprojects, while CEE countries (e.g. Hungary,Poland, Romania) account for another 22%. Only8% of offshored services are located in LatinAmerica, and less than 4% in Africa (UNCTADand RBSC 2004). As projects offshored to Indiatend to be the largest ones, the country’s shareof the total number of jobs created to date throughoffshoring by the top 500 European firms exceeds50% of all jobs created.

FDI plays an important role in offshoring,although this is difficult to quantify owing to thelack of reliable data. In principle, FDI affectsoffshoring in two ways: through captiveoffshoring, and when specialized serviceproviders set up foreign affiliates to serve foreignclients. While such investments can create manyjobs, they typically do not generate large capitalflows. Consequently, they do not account forlarge shares in the FDI statistics.38 It may alsobe difficult to capture all the offshored serviceprojects by the existing industrial classification.It is possible, however, to examine the numberof TNC greenfield and expansion projects (ratherthan their value) in export-oriented services. Themain categories of such projects, discussedbelow, are back-office services (shared servicecentres), front-office functions (call/contactcentres), regional headquarters and IT services(including software development) (table IV.5).39

Table IV.5. Definitions of export-oriented FDI projects related to offshored services

Shared service centresCall/contact centre services (back-office services) IT services Regional headquarters

Help desk Claims processing Software development HeadquartersTechnical support/advice Accounts processing Application testing Coordination centreAfter-sales Transaction processing Content developmentEmployee enquiries Query management processing Engineering and designClaims enquiries Customer administration Product optimizationCustomer support/advice processingMarket research HR/payroll processingAnswering services Data processingProspecting IT outsourcingInformation services Logistics processingCustomer relationship Quality assurance management Supplier invoices

Source: UNCTAD and OCO Consulting.


While all these service functions can befragmented and made into parts of integratedinternational production systems, the locationaldeterminants as well as their potential differ.

Overall picture. The share of developingcountries and CEE in FDI projects related toservices offshoring is increasing, from 37% in2002 to 51% in 2003. Their share in the numberof jobs created reached 57% in 2003. The fourcategories of services discussed in this chaptermake up a significant proportion of overall FDIactivity. In 2002-2003, FDI projects in theseservices accounted for 12% of the total numberof FDI projects, and as much as 20% of all jobscreated by the same projects.

The data used here only capturegreenfield and expansion projects, and do notinclude acquisitions. However, data suggest thatgreenfield projects still dominate. In India, FDIin IT and IT-enabled services in 1998-2002comprised almost 90% greenfield investment,10% joint ventures and less than 1% acquisitions(McKinsey & Co. 2003).40 A study of Europeanshared service centres found that about 46% of

all centres had been established throughgreenfield investment, more than half involvedexpanding an existing facility, and only 3% werethe result of an acquisition (IBM and OxfordIntelligence 2004). This may be changing,however, as the outsourcing industry matures.For example, in April 2004, IBM announcedplans to acquire Daksh eServices, one of India’slargest independent IT-enabled servicecompanies, employing 6,000 people in India andthe Philippines.41 (Selected cross-borderacquisitions of Indian firms are presented in tableIV.6.) A European example of this possible trendis the € 2 million purchase in May 2004 of theHungarian call centre operator Marketlink byTranscom WorldWide, of Swedish origin butheadquartered in Barcelona.42 It is likely thatfurther consolidation will follow as companiesrespond to the moves of competitors (WIR00).

Shared service centres. Developingcountries and CEE economies attracted 65% ofall export-oriented FDI service projects in 2002-2003 (tables IV.7, IV.8), almost half going toIndia. In CEE, the key locations were Hungary,

Table IV.6. Selected acquisitions of Indian firms by foreign firms, 2003-2004

Foreign firm Indian firm Comment

Hughes Software Tenet Technologies Deal to increase HSS’ presence in Japan, where Tenet Technologies has Systems (US) an established presence.

GE India Engineering Analysis EACE was bought from Tata Consultancy Services to provide high-endTechnology Centre of Excellence engineering analysis, design and software development. Centre (US)

SPI Technologies Kolam Information SPI expects Kolam to contribute close to $3.5 million to its top line in (Philippines) Services the current financial year. The deal was for $4 million. Kolam’s work

spans editorial functions, from manuscript development to productionof books/journals and other activities.

WebEx CyberBazaar The acquisition of CyberBazaar (estimated at $4 million in cash) will Communications enable WebEx to provide multimedia web communication services for (US) the Indian services sector.

Perot Systems Vision Healthsource The deal was closed for $10 million. Vision Healthsource is a provider of Corporation billing, receivables and claims and business-process outsourcing (US) solutions for healthcare service providers. Perot Systems Corporation

describes itself as “a global provider of technology-based businesssolutions in selected industry sectors”.

Cognizant Ygyan Consulting The purchase price is approximately $2 million. Ygyan Consulting is a Technology Pune-based services provider. Solutions (US)

IBM (US) Daksh eServices The deal will increase the scope of IBM’s global network of 22 businesstransformation delivery centres by adding capabilities in India and thePhilippines. Daksh eServices will also bring an experiencedmanagement team to IBM in India.

Source: The Hindu Business Line (http://www.thehindubusinessline.com/cgi-bin/bl.pl?mainclass=15&subclass=345).

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the Czech Republic and Poland, especially forEuropean companies; Chile and Costa Ricaattracted some shared service centres for theAmericas; and China and the ASEAN countrieswere relatively well represented in Asia. Indeveloped countries, Ireland remained the leadinglocation. Financial and IT companies generatedmost of the projects, with the contract serviceprovider Accenture and Citibank as leadinginvestors (annex table IV.2).43 In terms ofprospects for shared service centres, 20% of theFortune 500 companies have not yet set up anysuch centres but could do so in the future, ascould smaller companies in order to save costsand improve competitiveness (IBM and OxfordIntelligence 2004). While India, China and thePhilippines are likely to be the most attractivelocations for global solutions, various studiesmention countries in CEE and Latin America ascandidates for regional shared service centres.In the case of pan-European shared servicecentres, Ireland is the preferred location, followedby Hungary, Poland and the Czech Republic(IBM and Oxford Intelligence 2004).

Call centres. More than half the 500 FDIprojects in call centres recorded in 2002 and 2003went to developed countries, notably Canada,Ireland and the United Kingdom.44 This suggeststhat geographical and psychic distance to marketsmatters, as do linguistic, cultural and otheraffinities – and that costs are not the onlydetermining factor. In Ireland, inward FDI hasboosted employment in related industries. In2003, two-thirds of all the people employed inthe Irish call centre industry worked in foreignaffiliates, mostly controlled from the UnitedStates (CM Insight et al. 2004). Irish call centresappear to focus on the high end of the market,providing telesales and marketing, customerservice and technical and software support forvarious industries (ibid., p. 160). In thedeveloping world, more than 80% of FDI in callcentres went to Asia, with India (60 projects),China (30), Malaysia (16) and Singapore (16)as top recipients. A number of countries in LatinAmerica and the Caribbean were also recipients,including Brazil , Chile, Costa Rica, Africaattracted only a few call centres, which went toEgypt, Morocco and South Africa. In CEE, 31projects were registered, with Hungary being themarket leader. Although developed countrieshosted more projects, the growth of call centreswas much higher in developing countries.

Half the call centre projects came fromIT companies and business service providers,followed by telecom and electronics companies.The preferred locations for call centres in the nearfuture include India, the Philippines, China,South Africa, Mauritius and the United ArabEmirates (UNCTAD interviews; CM Insight etal . 2004). However, due to languagerequirements, many other countries have goodchances of attracting FDI in call centres.

Regional headquarters (RHQs) have amuch longer history than the other categories ofoffshored services addressed in this section, andare not driven by labour cost differentials (seebelow). They are included in the analysis mainlybecause the services provided in them are export-oriented in nature, and because many countriesincreasingly seek to attract headquartersfunctions. Almost 40% of new FDI projectsrelated to RHQs in 2002-2003 went to developingeconomies, with China, Hong Kong (China),Singapore and the United Arab Emirates (Dubai)as the leading destinations in the developingworld. Brazil was the main location for LatinAmerica, and Hungary and Romania for CEE.Among developed countries, the United States,the United Kingdom and Canada were the toplocations. The IT industry was the source foralmost one-quarter of all projects, followed byelectronics and automotive industries. In termsof future prospects outside developed countries,the strongest candidates for new RHQs in Asiaappear to be the United Arab Emirates, Singaporeand China; in CEE, Hungary, the Czech Republicand the Russian Federation; in Latin America,Brazil; and in Africa, South Africa (UNCTADinterviews).

IT-related services. FDI projects in IT-related services were equally distributed betweendeveloping and developed locations. However,the number of IT service projects in developingcountries more than doubled in 2003, while indeveloped countries it grew by only 6%. Toplocations for offshored IT services in developedcountries were the United Kingdom, Germany,the United States and Australia. Asia dominatedamong developing regions. Of the more than 300export-oriented IT projects in developingcountries, 37% went to India, 19% to China and11% to Singapore. The Czech Republic attractedthe most projects in CEE, Brazil in LatinAmerica, and South Africa in Africa. Asked aboutthe potential future locations for FDI projects


Table IV.7. Export-oriented FDI projects in call centres, shared service centres, IT services andregional headquarters, by destination, 2002-2003

(Number and per cent)

Call centres SSCs IT services Regional HQs

No. of Share No. of Share No. of Share No. of ShareRegion/economy projects of total projects of total projects of total projects of Total

World 513 100 139 100 632 100 565 100 Developed countries 279 54 48 35 293 46 339 60

Western Europe 174 34 38 27 208 33 200 35EU 169 33 38 27 198 31 185 33

Austria 2 - - - - - 2 -Belgium 7 1 1 1 5 1 9 2Denmark 5 1 1 1 6 1 15 3Finland 2 - - - 2 - 1 -France 13 3 2 1 16 3 11 2Germany 20 4 1 1 34 5 22 4Greece 1 - - - - - 1 -Ireland 29 6 19 14 14 2 15 3Italy 6 1 - - 7 1 2 -Luxembourg 1 - 1 1 - - 1 -Netherlands 13 3 3 2 16 3 20 4Portugal 5 1 - - 3 - - -Spain 8 2 2 1 8 1 9 2Sweden 14 3 1 1 14 2 13 2United Kingdom 43 8 7 5 73 12 64 11

Other Western Europe 5 1 - - 10 2 15 3Norway - - - - 3 - 1 -Switzerland 5 1 - - 7 1 14 2North America 71 14 5 4 40 6 105 19Canada 56 11 3 2 14 2 25 4United States 15 3 2 1 26 4 80 14

`Other developed economies 34 7 5 4 45 7 34 6Australia 19 4 3 2 26 4 24 4Israel - - - - 2 - - -Japan 11 2 - - 16 3 8 1New Zealand 4 1 2 1 1 - 2 -

Developing economies 203 40 72 52 315 50 209 37Africa 7 1 1 1 10 2 4 -North Africa 4 1 - - - - - -Egypt 2 - - - - - - -Morocco 2 - - - - - - -Other Africa 3 1 1 1 10 2 4 -Mauritius - - - - 1 - - -Nigeria - - - - 1 - - -South Africa 2 - 1 1 6 1 3 1Senegal 1 - - - 1 - - -Tanzania, United Rep. of - - - - 1 - 1 -Uganda - - - - - - - -

Latin America & the Caribbean 29 6 5 4 22 3 10 2South America 13 3 4 3 16 3 7 1Argentina 2 - - - 1 - - -Brazil 6 1 - - 9 1 6 1Chile 4 1 4 3 5 1 1 -Uruguay - - - - 1 - - -Venezuela 1 - - - - - - -

Other Latin America & Caribbean 16 3 1 1 6 1 3 1Antigua & Barbados 2 - - - - - - -Costa Rica 4 1 1 1 - - - -Dominican Republic - - - - 1 - - -El Salvador - - - - - - 1 -

/...

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Table IV.7. Export-oriented FDI projects in call centres, shared service centres, IT services andregional headquarters, by destination, 2002-2003 (concluded)

(Number and per cent)


No. of Share No. of Share No. of Share No. of ShareRegion/economy projects of total projects of total projects of total projects of Total

Jamaica 1 - - - - - - -Honduras - - - - 1 - 1 -Mexico 5 1 - - 2 - - -Panama 2 - - - 1 - 1 -Puerto Rico 2 - - - 1 - - -

Asia 167 33 66 47 283 45 195 35West Asia 17 3 1 1 17 3 36 6

Bahrain - - - - - - 3 1Jordan 1 - - - 1 - - -Lebanon - - - - 2 - - -Qatar - - 1 1 - - - -Oman - - - - - - 1 -Saudi Arabia 1 - - - - - - -Turkey 2 - - - 2 - 1 -United Arab Emirates 13 3 - - 12 2 31 5

Central Asia 1 - 1 1 1 - 1 -Uzbekistan 1 - 1 1 - - - -

Southern, East and South-East Asia 149 29 64 46 265 42 158 28

Bangladesh 1 - - - - - 1 -China 30 6 4 3 60 9 38 7Hong Kong, China 2 - - - 14 2 37 7India 60 12 43 31 118 19 7 1Korea, Rep. of 5 1 - - 5 1 6 1Malaysia 16 3 6 4 8 1 17 3Pakistan 1 - - - - - - -Philippines 12 2 1 1 9 1 4 1Singapore 16 3 8 6 35 6 36 6Taiwan Province of China 4 1 - - 9 1 4 1Thailand 2 - 2 1 7 1 8 1

Central and Eastern Europe 31 6 19 14 24 4 17 3Belarus - - - - 1 - - -Bulgaria 1 - - - - - 1 -Czech Republic 9 2 6 4 5 1 - -Estonia - - - - 1 - - -Hungary 11 2 7 5 4 1 4 1Latvia - - - - 1 - 1 -Lithuania 1 - - - - - 1 -Poland 3 1 5 4 4 1 3 1Romania 1 - - - 2 - 4 1Russian Federation 1 - 1 1 4 1 2 -Serbia and Montenegro - - - - - - 1 -Slovakia 4 1 - - - - - -

Unspecified - - - - 2 - - -

Source: UNCTAD, based on data from OCO Consulting.


related to IT services, companies interviewed byUNCTAD mentioned India, the RussianFederation, Bulgaria, Albania, the Philippines,China, Mexico, the Czech Republic and theUnited Arab Emirates, in that order.

To sum up for 2002-2003:

• While the stock of FDI projects related tothe offshoring of services is larger indeveloped countries, the greatest dynamismis in developing economies. South andSouth-East Asia dominate FDI projectsrelated to the offshoring of services in thedeveloping and transition economies,accounting for 63% of all projects bynumber. The region’s dominance is greatestin IT services, where it accounts for almost80% of all FDI projects in the non-industrialized countries.

• A significant number of the recorded FDIprojects went to developed countries,implying that low wages, per se, do notaccount wholly for the pattern of offshoring.

• The locational determinants of offshoringof different services vary (see below).

• By industry of origin, firms in IT andsoftware dominate FDI projects in IT-relatedservices. IT companies are among the mostactive also in the other three groups of FDI

projects, but not dominant. Firms in businessservices and electronics account for mostcall centre projects. Financial service TNCsare significant in IT, and software firms inshared services. In regional headquartersprojects, manufacturers of electronics,transport equipment and pharmaceuticalslead.

2. Cost reduction and improvedquality are key drivers

Corporate strategies related to offshoringresemble those that have led companies torestructure their manufacturing operations.Technical changes that make for increasedtradability, together with liberalization ofinvestment and trade, induce companies torestructure (and fragment) their activitiesinternationally in order to protect or advance theircompetitiveness. TNCs can gain scale advantagesfrom consolidating service activities in onelocation and standardizing the services acrossthe globe. Offshoring, besides allowing acompany to lower its costs, can also help improvethe quality of the services produced.

Cost reduction is one of the primemotivations for offshoring. Various studiesconfirm that a large majority of companies cite

Table IV.8. Export-oriented FDI projects in services, by industry, 2002-2003(Number and per cent)


No. of Share No. of Share No. of Share No. of ShareIndustry projects of total projects of total projects of total projects of Total

Business services 116 22 24 17 - - 17 35Chemicals 3 0.6 1 0.8 1 0.2 15 2.8Electronics 42 8 6 4.4 4 0.6 57 10Energy 14 3 5 3.6 - - 15 2.8Financial services 30 6 40 29 2 0.3 32 5.7Food and drink 3 0.6 4 3 - - 20 3.5Hotels, tourism and leisure 3 0.6 2 1.5 - - 19 3Internet 12 2 1 0.8 - - 8 1.5IT and software 154 30 33 24 618 97.8 132 23Life sciences 7 1.3 3 2 - - 51 9Light industry 2 0.4 2 1.5 - - 20 3.5Machinery and industrial goods 18 3.5 1 0.8 - - 28 5Metals/mining 5 1 1 0.8 - - 10 1.7Telecom equipment 20 4 3 2 4 0.6 15 2.8Telecom services 30 6 - - 3 0.5 25 4.4Transport equipment 30 6 6 4.4 - - 55 9.7Other 24 5 6 4.4 - - 47 8Total 513 100 138 100 632 100 566 100

Source: UNCTAD, based on data from OCO Consulting.

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lower costs as the prime reason for setting upan offshore shared service centre (UNCTAD andRBSC 2004; IBM and Oxford Intelligence 2004;Bajpai et al. 2004; CM Insight et al. 2004). Costsavings can be achieved partly by seeking outlower cost locations, and partly by consolidatingoperations and reducing the cost of infrastructure,training and management. Any majorinternational bank that currently has, say, 50-60data centres with infrastructure, maintenance andspecialized skills, could consolidate operationsinto perhaps 5-10 such centres. This implies lessexpenditure on infrastructure and maintenance,as well as labour costs; it would also allow thedevelopment of centres of excellence. Suchconsolidation can entail considerable savings,especially (but not necessarily) if combined withlower labour costs. GECIS (United States)reportedly saves more than $300 million annuallyas a result of i ts offshored operations (boxIV.6).45 Similarly, it has been suggested that thebanking industry in the United States saved upto $8 billion during 1999-2002 by offshoringservices to India.46 About 80% of majorEuropean TNCs with experience in offshoringreport cost savings in the magnitude of 20-39%,and for another 10% of the companies the savingswere even higher (UNCTAD and RBSC 2004).Cost savings allow companies to lower theirprices or increase their profit margins – in short,to raise their competitiveness.

In call centres, labour costs account for50-70% of total costs in developed countries.Moving to India, where wages are 80-90% lowerthan in the United Kingdom, for example, is anattractive proposition (Outsourcing Insight 2001,p.11). However, the actual savings are smaller,since labour costs constitute a smaller share ofcosts in a developing country, while costs ofinfrastructure, training and travelling tend to behigher. Taking all these factors into account, costsavings in India are in the range of 30-40%, orperhaps higher when compared with the UnitedStates.47

But cost reduction is only part of thestory. As companies gain experience, they seeother benefits in the form of improved qualityof services. As some observers put it , someoffshoring companies “Went for cost, stayed forquality” (Dossani and Kenney 2004). Qualityimprovements were cited by large EuropeanTNCs as the third most important benefitachieved from offshoring (after reduced labourand other costs), often exceeding expectations

(UNCTAD and RBSC 2004). When the “back-office services” of the outsourcing firm becomethe “front-office services” of the service provider,the latter pays more attention to quality.Moreover, lower cost locations may offer bettereducated staff for the services than a developedcountry. For example, in India, the majority ofcall centre agents are university graduates whilethey tend to be school-leavers in industrializedcountries (Taylor and Bain 2003). Lower costsalso allow a company to carry more slack to meetpeak loads than is possible in a high-cost country,enhancing the quality of the service. Moreover,by outsourcing standardized, routine work,companies can focus scarce resources on theircore activities. Relocating some functionsoffshore may also be a way to cope with excessdemand, as was done by IT services in copingwith the Y2K problem in the run-up to the newmillennium, mentioned earlier.

In terms of locational determinants ,while cost reduction is also the leading factor,followed by availabili ty of labour with theappropriate skills, an additional key considerationis the quality of the infrastructure, notably cost-effective and reliable telecommunications andpower supply (Bajpai et al. 2004; UNCTAD andRBSC 2004; IBM and Oxford Intelligence 2004;Taylor and Bain 2003; Outsourcing Insight 2001).In addition, economic and political stability andthe legal and regulatory framework are important.The weight of each factor varies according to thenature of the service. For FDI projects relatedto call centres, shared services and IT services,particular importance is attached to theavailability of skills when selecting a location(figures IV.1 to IV.4). In general, a ready supplyof people with good secondary or tertiaryeducation and IT proficiency is important but notsufficient. Software development requires, inaddition, specialized engineering skills, back-office work may need skills in human resourcesor accounting, and call centres need skills incustomer interaction and marketing.48

Language skills are, of course, criticalfor call centres, and linguistic traditions play asignificant role in their location. Chile, Mexicoand Morocco have attracted call centres servingSpanish-speaking clients in the United States andEurope. Mauritius, Morocco, Senegal and Tunisiahost call centres for the French-speakingmarket.49 German-speaking centres have beenset up in the Czech Republic and Hungary.Japanese call centres have gone to China. Canada,


Ghana, India, Ireland, the Philippines and SouthAfrica host call centres serving English-speakingmarkets.50

For IT services, the presence ofuniversities and dynamic IT clusters matters.Capabilit ies in these areas are difficult fordeveloping countries to acquire: they take timeto build and enjoy cumulative agglomerationeconomies. This explains why IT centres tendto cluster in only a few sites; moreover, once thefirst offshoring work has been attracted, thereare potential learning benefits for first-movers

that reinforce their initial advantages. The patternpersists at the subnational level; for instance, inIndia, most of the software work is performedin a few cities (Kumar 2001a; D’Costa 2003).

Attrition and staff turnover are alsoimportant issues. Where these are high, costs risefor recruiting and training staff, and high turnovercan affect the quality of the service. Whereas callcentres in India have shown considerably lowerattrit ion rates than in the United States(Outsourcing Insight 2001), they are now slightlyhigher (30%) than in Ireland and the Netherlands

Figure IV.1. Low costs lead the locationdeterminants of call centre-FDI projectsin developing countries and economies

in transition, 2002-2003(Number of companies citing factor)

Source: UNCTAD, based on information from LOCOmonitor.

Figure IV.3. Market growth leads the locationdeterminants of IT services FDI projects in

developing countries and economiesin transition, 2002-2003

(Number of companies citing factor)


Figure IV.4. Market growth leads the locationdeterminants of regional headquarters FDI

projects in developing countries andeconomies in transition, 2002-2003(Number of companies citing factor)


Figure IV.2. Low costs lead the locationdeterminants of FDI projects in shared service

centres in developing countries andeconomies in transition, 2002-2003(Number of companies citing factor)


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(20-25%) and well above those of the UnitedKingdom (15%), the Philippines (10%) and SouthAfrica (7%) (CM Insight et al. 2004). Risinglevels of attrition in current hotspots may openup opportunities for new locations.

Telecom infrastructure and access remaincritical to attracting all types of IT and IT-enabledoffshored services. Telecommunications need tobe not only reliable and stable, but alsocompetitive. This is especially true for smallerlocations.51 In the case of call centres, telecomcosts can represent up to 40% of the total costin “low-income” locations. Moreover, due to thespecific quality requirements that apply to voicetransmissions, access to f ibre-optic l inks isimportant for countries that seek to attract callcentre activities.

Another factor affecting location is thetime zone of a host country relative to that of thehome country. For some services, especially thosethat need to be provided during normal workinghours, it is desirable to locate the service in thesame time zone as the customers. In other cases,there are advantages to being in a completelydifferent time zone, to offer 24-hour service.Cultural affinity may play a role in someoffshored services, particularly in call centres.However, where this is lacking, it can be (at leastpartly) developed. Some call centres in India, forexample, are training their staff in the accents,interests and traditions of United Statescustomers.52 The Indian company Akiko Callnethas more than 100 call centres in the country andhas launched a chain of 53 training institutes tocreate a pool of staff with the requisite skills.53

As already noted, the motives for thesetting up of regional headquarters differ fromthose of the other three categories of FDIprojects, and cost considerations take lowerpriority in the list of determinants. Regionalheadquarters provide high-level servicesemploying senior management and professionals,including a significant number of expatriates. Toattract such projects, locations need to offer agood quality of life, convenient air connectionsand access to competent suppliers of businesssupport services.54 Key location determinantsinclude proximity to customers (both external andnetworks of foreign affiliates located in theregion), market growth opportunities, access toa skilled workforce, a supportive business andregulatory climate as well as a high-qualityphysical and ICT infrastructure (figure IV.4).

Only a few developing economies currently meetall of these requirements. Those that do, such asthe United Arab Emirates (Dubai), Hong Kong(China) and Singapore, have been successful.Given the considerable agglomeration benefitsin the location of headquarters functions, it canbe difficult for newcomers to emerge as attractivecompetitors.

Many policy-related factors also affectthe location decisions of different offshoredservices. Some companies have been attractedto a location as a result of promotion by the host-country government (UNCTAD and RBSC 2004).In setting up shared service centres for theEuropean market, about 25% of all projectsinvolved interaction with development agenciesat some stage in the process (IBM and OxfordIntelligence 2004). In the same study, theprovision of grants and incentives also rankedamong the most important factors affecting thelocation decision. Interestingly, many companieschoose to offshore services to countries wherethey already have a presence. For large Europeanfirms, this has been the third most importantfactor for selecting a specific country in the CEEregion and the fifth most important factor whenoffshoring to Asia (UNCTAD and RBSC 2004).55

The same survey also showed that internallobbying of headquarters by a foreign affiliatecan affect the choice of location, indicating animportant role of after-care by investmentpromotion agencies to attract further offshoredservice activities (chapter V).

Success in attracting offshore serviceshas a cumulative dynamic of its own – successin one set of activities can lead to success inanother. India may be attracting services of allkinds (with the exception of regionalheadquarters, which are more attracted to otherlocations) because it has developed a reputationfor offering efficient and reliable services.“Bangalore” has become a brand name. Otherfactors may reinforce the reputation effect, suchas policy learning (successful sites make newentry easier as they learn to meet offshoringneeds), skill spillovers across activities, scaleeconomies in infrastructure and institutionalsupport. Offsetting these factors may be the costsof clustering: congestion, rising wages, staffturnover and other costs, and the risk of losingproprietary knowledge to competitors. This, inturn, may lead to dispersion, offering otherlocations an opportunity to attract FDI.


3. European TNCs offshore lessthan their United States rivals

As noted above, the practice of offshoringof services started in the United States. Even in2004, companies from that country dominate theoffshoring scene. For example, more than two-thirds of India’s exports of software services areto the United States. The patterns are similar inthe case of FDI projects (annex table IV.1). Firmsfrom the United States dominate, with two-thirdsof all IT service projects, 60% of all call centreprojects and 55% of shared service projects.

In general, European companies haveshown less inclination to offshore services. Inthe case of pan-European shared service centres,65% have been set up by TNCs from the UnitedStates (IBM and Oxford Intelligence 2004). Infact, as noted above, even among the largestEuropean TNCs, less than 40% have experiencewith services offshoring (UNCTAD and RBSC2004). Moreover, more than half of them do nothave any plans to pursue offshoring in the nearfuture. However, interest in offshoring variesconsiderably by European country, with the

United Kingdom following the most closelybehind the United States.56 In all four categoriesof export-oriented FDI projects analyzed above,the United Kingdom accounted for the largestshare of projects originating in the EU (annextable IV.1).57 These findings were confirmed inthe survey conducted by UNCTAD and RBSC.It showed that, while more than half ofresponding TNCs based in the United Kingdom(and in the Benelux countries) had alreadyoffshored some services, the corresponding figurein German-, French-, Spanish- and Italian-speaking countries was much lower.58

Although United Kingdom companieshave offshored some of their operations forseveral years, particularly to India, the trendaccelerated in 2003 (table IV.9). Offshoring hasmainly involved call centres, but also legalservices and various back-office functions (billingfor Thames Water; customer relations andpassenger revenue accounting for BritishAirways). At the same time, some companieshave deliberately decided not to offshore,59 anda few have moved operations back in responseto customer complaints. In the Netherlands, more

Table IV.9. Selected offshoring cases, United Kingdom, 2003-2004

Country and number of Service Company Function jobs or value involved

Financial services HSBC Back-office processing jobs 4,000 by the end of 2003 in(banking, insurance) India, China and Malaysia.

Another 3,500 wereannounced in June 2004.

Norwich Union/ Administrative insurance jobs; 350 2,350 in India by end ofAviva in call centres, 2000 in back-office 2004

and administrationLloyds TSB Call centre jobs 1,500 jobs in India by end 2004Barclays Back-office staff 500 to IndiaAxa 700, some to IndiaAbbey National Back-and-front office work 400 jobs to Bangalore

Distribution services Tesco Business support centre 350 to India

Telecommunication BT Call centre 2,200 by 2004 to India services

Transport services British Rail National Rail inquiries 600 to India

Health services NHS Fast-track centres offering surgery Non-UK health care providers,to NHS patients. Foreign providers including Netcare of Southrun mobile operating units. Netcare Africa, amounting to a total ofplans to bring over surgical teams £2 billion from South Africa on rotation onceevery 11 weeks

NHS £896-mn IT contract to modernize NHS Tata Consultancy Services(India) part of a consortium

Other government Greater London Software for toll charging A $10 million contract toAuthority Mastek

Source: UNCTAD, based on various newspaper articles in the United Kingdom.

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than 200 firms have offshored IT work to India,60

and it is estimated that 50,000 IT jobs will becreated in India over the next ten years.61

Among large European companies thathave experience with offshoring, most aresatisfied with the associated outcome: 83% statedthat projects were partly or entirely successful,while only 3% were of the opposite opinion(UNCTAD and RBSC 2004). In l ight of theconsiderable advantages reaped throughoffshoring, this raises questions related to thefuture competitiveness of companies that do notconsider such opportunities. If companies thatdo offshore become more competitive, others –in developed as well as developing countries –may be compelled to jump onto the bandwagon.

E. Impact on hostE. Impact on hostE. Impact on hostE. Impact on hostE. Impact on hostcountriescountriescountriescountriescountries

FDI in export-oriented services offers anumber of economic development benefits forhost countries. Key benefits relate to increasedexport earnings and the impact on the labourforce: job creation, higher wages and upgradingof skills. Jobs in IT-enabled or IT services aretypically better paid than in, for example,assembly work or other manufacturing activities.Given the short time needed to implement an FDIproject in such services, attracting offshoredservices can offer fast-track job creation,especially in locations where the skills neededalready exist. Obviously, this also means thatinvestment projects won may easily be lost; sunkcosts are typically low for simple operations, andthe risk of footloose behaviour is high – althoughthis risk diminishes the more skill-intensiveoperations are.

FDI related to the offshoring of servicesmay be desirable from a spillover perspective,especially if the exported services are alsosupplied to the domestic market. Positivespillovers in terms of raising the competitivenessof human resources and improvements in ICTinfrastructure and business services thataccompany significant services FDI benefit allsectors of the economy. Most of the associatedskills are readily transferable to other parts ofthe economy: skills involving computers, sales,languages, finance, accounting and softwaredevelopment are in high demand locally andinternationally. Moreover, negative spillovers interms of environmental pollution and exploitationof natural resources are likely to be limited.

The scope for upgrading has improvedas the nature of offshored services has evolved.Initially, most work tended to be in low-end IT-enabled services such as data entry and basicprogramming. These activities require only basiclevels of computer literacy and limited interactionbetween customers and suppliers. Foreigncompanies that set up the first back-officefunctions in India in the mid-1990s are nowoffshoring more sophisticated tasks as well, suchas software development and design, financialanalysis, architectural services, tax preparationand medical analysis.62 The upgrading of the skilland technology content of offshoring continuesas capabilities in developing-country suppliersimprove and firms in industrialized countries seethe potential for and economic benefits ofoffshoring.

Meanwhile, since export-orientedservices tend to be relatively skill-intensive andrequire advanced infrastructure, the scope forbroader development benefits outside the mostadvanced regions of an economy may be limited.There are also indications that the scope forlinkages between foreign affiliates and local firmsis small, especially in the area of softwaredevelopment (Kumar 2001a). Moreover, an influxof export-oriented services FDI may attract thebest skills to certain types of service activitiesthat, unless continuously upgraded, may moveon to another location as the competitive situationchanges. Increased competition for skills mayhave adverse effects on other industries of theeconomy. The experience of India and some otherdestinations of offshored services is reviewed next.

1. India

The offshoring of software developmentand, later, back-office and call centre services,has driven India’s rapidly expanding serviceexports. During the past decade, the value ofexports of software and other services jumpedfrom less than a $0.5 billion to $12 billion in2003-2004, according to the National Associationof Software and Service Companies(NASSCOM). In parallel, the export intensity ofthe Indian software and service industry rosefrom 58% to 78%, and the share of these servicesin total exports from India increased from 3%to 21% between 1996 and 2003 (RIS 2004).Whereas software exports still account for thelion’s share of these exports, IT-enabled serviceshave emerged as an increasingly importantcomponent, rising from $0.6 billion in 1999-2000


to the current level of $3.6 billion. Of India’ssoftware and service exports, 68% go to theUnited States and another 14% to the UnitedKingdom (Joseph and Parayil 2004).63 In 2001,India’s share of the global market for offshoreIT and IT-enabled services was estimated at 25%– second only to Ireland – while for offshore IT-enabled services only the figure was as high as67% (McKinsey & Co. 2003; Scholl et al. 2003).According to estimates by NASSCOM, themarket for IT-enabled services will continue togrow fast and could be worth $17 billion by2008.64

What has been the role of FDI in India’ssuccess as an offshore location?65 In softwaredevelopment, TNCs have played a key initial rolein the development of the Indian industry (seebox IV.5 for the case of Nortel Networks ofCanada). Some early entrants (such as TexasInstruments) led more TNCs to consider Indiaas an attractive location for offshored services.However, FDI has not been a dominant feature.In 2002, foreign affiliates accounted for 20% oftotal export revenues in the software industry.66

While foreign investors have created newsoftware jobs in India, most of them entered thecountry when the domestic industry was alreadywell developed (Kumar 2000). Today, leadingIndian companies (Tata Consultancy Services,Infosys Technologies, Wipro Technologies,Satyam Computer) are on par with, or even aheadof, many of their foreign rivals in terms ofprofitability.67 India has earned a strongreputation on account of high quality services.IT firms in India typically hold the necessaryquality certifications.68

In contrast, TNCs have played a criticalrole in India’s exports of back-office services(Patibandla and Petersen 2002; McKinsey & Co.2003). The IT-enabled service industry in Indiabegan to evolve in the early years of the 1990s,when companies such as American Express,British Airways, GE and Swissair set up theirown offshore operations in India. Today, a largenumber of foreign affiliates operate IT-enabledservices in India (table IV.10). According toNASSCOM estimates, foreign affiliates in 2002-2003 accounted for 58% of exports of offshoredbusiness processes; their share is expected toincrease in the next few years.69 TNCs haveprovided capital, knowledge and expertise, newinfrastructure, access to markets and fostered theformation of new companies (McKinsey & Co.2003).

Among IT-enabled services, companiesare offshoring to India customer care, finance,human resources, billing and payment services,administration and content development (tableIV.11). There is increasing offshoring ofupcoming service lines involving higher value-added activities such as engineering and design,knowledge processing and logistics. It has beenestimated that the industry generates about240,000 jobs. The customer-care segmentaccounts for about 39% of employment, and hasrecorded the highest growth rate in recent years.

The total number of foreign affiliates inIT-enabled services in India increased from 57to 102 between 1997/98 and 2002/03. As a result,the share of foreign firms in the total number offirms in this industry rose from about 13% to20%. These companies are concentrated in a fewIndian states, notably Karnataka, Maharashtra,Delhi, Tamil Nadu and Andhra Pradesh (tableIV.12). The export intensity is as high as 93%for foreign affiliates, whereas the correspondingshare for local firms was about 70%.

There is a high regional concentration ofexport production. Even within states, one or twometropolitan centres account for the bulk ofexports. Thus, Bangalore in Karnataka, Mumbaiand Pune in Maharashtra, Noida and Gurgaon inthe Delhi area, Hyderabad in Andhra Pradesh andChennai in Tamil Nadu are the centres of softwareand service activities. In terms of growth, duringthe past five years foreign firms have been moredynamic than their local counterparts, but thereis significant regional variation in the generationof export earnings and employment. Foreignaffiliates in IT-enabled services in Delhi, forexample, accounted for 24% of employment butonly 14% of exports in 2002/03. Conversely, inKarnataka, their share of employment was 23%whereas their export share was 45%.

Employment in foreign affiliates hasexpanded faster than in local firms during thepast five years. In software development, foreignfirms now account for about 20% of totalemployment; in IT-enabled services the share isabout 28% (RIS 2004). There is hardly anydifference in the employment intensity of foreignand local firms, but highly skill- and design-intensive activities generate fewer jobs than lessskill-intensive activities such as data entry. Insoftware development, the average employmentper $1 million of exports is in the order of 30persons. For the IT-enabled service industry as

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In 1989, Nortel (Canada) had itself set anambitious target of increasing its turnover from$6 billion to $20 billion by 2000. To achieve this,it started expanding its R&D capabilities for whichit required highly educated personnel. However,the company saw a serious constraint in terms ofa shortage of locally available scientific andtechnical skills. Enrollment in science andtechnology had already peaked in North Americaand the college-age population was declining. Thisposed a challenge for a company that used torecruit the top 10% of science students fromselected universities in North America. It thereforedecided to look globally for technical talent. Thus,the starting point was not cost savings, but the needto access the best and brightest skills.

This was when Nortel set its sights on India– it saw the potential of India’s nascent softwareindustry. India also offered the rule of law,democratic institutions, judicial and bankingsystems as well as process protection.Consequently, in the early 1990s, Nortel decidedto set up an offshore software development centrein the country. Another advantage was that the timedifference with North America allowed thepossibility of doing R&D 24 hours a day.Moreover, India was churning out thousands ofEnglish-speaking graduates with solid engineeringand programming credentials. While many of themheaded straight to North America and Europe forfurther study or to join TNCs, thousands morestayed back. Thus, Nortel found a pool ofprogramming talent available for less than 30%of the cost of a North American engineer.

Some hurdles remained. Colleagues in NorthAmerica were not convinced that the farming outof jobs to India was a good idea. Many managersworked hard to keep jobs at home to retain control.Some were dubious about the quality of Indianprogrammers. Still others were suspicious that theirnew Indian partners would share what they learnedwith Nortel’s competitors.

In Mumbai (then Bombay) and Bangalore,Nortel identified a number of companies, each ofwhich was awarded small R&D contracts. Amongthe jobs assigned was a project to convert softwarecode from one computer language to another. Otherassignments involved the development of toolsfor testing telecom software. From the outset, thegoal was to engage the minds of Indian engineersand steadily ratchet up the sophistication of the

work done on Nortel’s behalf. Whereas the Indianprogrammers completed most of the projectssuccessfully and Nortel began assigning morecomplicated jobs, some problems began to emerge.People in India were not familiar with workingin an environment with proprietary software andadvanced equipment, and required guidance.India’s top software companies at the time werevery good at handling chores involving thetranslation of software from one type oftechnology platform to another, but less adapt infinding imaginative approaches to creatingapplications or products. Moreover, India’scompanies were operating under severerestrictions: they could not raise money, list onstock exchanges or import computers for personaluse without government permission. In addition,at the time, telecom and power networks wereinefficient.

After 1991, the Government encouragedTNCs from the United States to set up operationsin India, which put pressure on India-based firmsto upgrade. In this phase, Nortel’s influence wascrucial; it encouraged Infosys and Wipro todevelop groups of employees who workedexclusively on Nortel projects. The programmerswere assigned their own offices and telephoneexchanges, and Nortel spent millions on satellitelinks, switches and other telecom gear.

To outsiders, the offshored group assignedto handle Nortel projects looked very much as ifthey were part of Nortel’s global workforce, andthe R&D units became known as dedicatedoffshore software development centres. Infosysand Wipro would eventually set up many suchcentres on behalf of dozens of the world’s largestTNCs.

The Indian firms learned quickly andgradually won the confidence of their Nortelcolleagues in North America. Indian programmersbegan getting international experience, particularlyduring the initial stages of most projects, whenthey, along with managers, spent time in NorthAmerica on customer sites to gain a detailedunderstanding of what was required. Most wouldthen return to India to write the necessaryprogrammes. Only a small part of this workinvolved leading-edge technology; when the NorthAmerican firms moved from one generation oftechnology to the next, they would hand overresponsibility for the older part to India andconcentrate on the newest products.

Box IV.5. Nortel Networks’ offshoring to India

Source: Bajpai et al. 2004.


whole, this figure is about 68 persons, and it is88 for content development and 79 for customercare. Thus, employment generation in softwareis only about half of that in IT-enabled services.

The services offshored to India appearto be moving towards higher value-added levels.Although it has been argued that Indian firms,by and large, still operate at a relatively low endof the value chain (Arora et al. 2000; D’Costa2003), some evidence suggests that they aremoving up fast (Joseph and Abraham 2002;

Kumar 2001b). Still, India is yet to make itspresence felt in the growing area of embeddedsoftware. Significant opportunities for upgradingalso exist in IT-enabled services. The earliestservices offshored by a company tend to berelatively standardized and of limited strategicimportance, but if the first attempts succeed, moresophisticated tasks tend to follow. For instance,in the processing of insurance claims, the firststep is to enter simple information into a standardform. The next step is to take over someinvestigation and valuation of claims. Later,

Table IV.10. Leading foreign affiliates in India’s IT-enabled service industry, 2003-2004

Number ofCompany Service lines employees

Accenture Pharmaceutical and insurance back-office functions, HR and procurementmanagement, IT support and customer relationship management 4 300

American Express Financial accounting, data management, information analysis and control,administration, staffing, payroll services 4 000

AOL Customer support, back-office operations 1 500-1 900AXA Business Services Claims processing, accounting, telemarketing, tax consulting, compliance,

financial analysis 800Convergys India Call centre services 3 000+Dell Customer support services 3 000EDS Data entry, phone-based marketing, payroll, credit cards, loans and mortgages,

medical and insurance claims 700Ford Business Services Center CAD, CAM, e-mail support services 500GE Capital Client services; remote IT help desk, software distribution; server services;

remote service support, data centre; network services; remote network support;application services; software quality assurance; payment services 11 500

Healthscribe India Medical transcription, data processing, hospital information services, customersupport, billing, claims processing, account receivable 1 200-1 250

HP Global eBusinessOperations Internal financial back-office for HP 1 500HSBC Electronic Data Account transactions, general accounting, credit/debit card services, cheque 4 500 Processing India processing, benefits administration, recruiting and staffing, payroll servicesJP Morgan Chase Transaction processing 1 200Sitel India Private Limited Customer support services 1 000Standard Chartered Banking operations, global HR support, software development and maintenance,

global treasury operations support, IT helpdesks 3 000

Source: UNCTAD, based on company interviews and press releases.

Table IV.11. Service lines in IT-enabled services in India, 2001-2004(Number of employees and millions of dollar)

2001-2002 2002-2003 2003-2004

Service line Employment Revenue Employment Revenue Employment Revenue

Customer care 30 000 400 65 000 810 95 000 1 200Finance 15 000 300 24 000 510 40 000 820Human resources 1 500 30 2 100 45 3 500 70Payment services 7 000 110 11 000 210 21 000 430Administration 14 000 185 25 000 310 40 000 540Content development 39 000 450 44 000 465 46 000 520Total 106 000 1 475 171 100 2 350 245 500 3 580

Source: NASSCOM 2004.

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accountants or engineers are allowed to identify“unusual” (fraudulent or exaggerated) claims(Dossani and Kenney 2004, p. 12). Theexperience of GE points in the same direction(box IV.6). Some Indian companies – such as

Kale Consultants, a Mumbai-based company –have diversified from software development intoIT-enabled services and deepened theirrelationships with foreign clients (Dossani andKenney 2004, p. 33).

In seeking to leverage its position as aleading destination for offshored services, Indiais seeking to diversify its exports. Currently, twocountries (the United States and the UnitedKingdom) account for 82% of the country’sexports of software and IT-enabled services. But,India may be in the process of harnessing itsgrowing trade relations with other economies inAsia, such as the ASEAN countries. To enhancethe productivity, efficiency and competitivenessof domestic users, to realize the potential forlinkages and spillovers and to promote economicgrowth, including at the regional level,70 astronger domestic market-orientation would help.Another related challenge is that the boom in thesoftware and IT-enabled service industry maylead potentially to adverse effects on other partsof the economy that compete with the IT industryfor skilled manpower (Desai 2000).

Table IV.12. Export intensity of foreign andlocal firms in India’s software industry,

by state, 2002/03(Per cent)

Location Foreign Local

Delhi 95 72W.Bengal 98 85Gujarat 0 74Maharashtra 85 76Andhra Pradesh 98 87Karnataka 94 76Tamil Nadu 89 77Kerala 0 84Others 80 70Total 93 70

Source: RIS 2004, based on data compiled from theNASSCOM Directories.

GE Capital International Services (GECIS)started operations in India in 1997 by providingcall centre customer support and back-officeservices, such as data entry and transactionprocessing to other GE companies. Sinceinception, the Indian operations havecontributed to cost savings of 40-50% (orabout $300 million annually) for GE.Employment in India has grown to more than11,500 jobs, and annual revenues stand at about$1 billion. India is now hosting the globalcompany headquarters of GECIS, which alsohas operations in China, Hungary and Mexico.

Gradually, GECIS India has generatedinternal pull from other GE companies bydemonstrating cost and quality benefits,investing in infrastructure and implementing so-called “six-sigma processes” to deliver improvedquality. GECIS India now provides services tonearly 300 processes from 30 internal GEbusinesses worldwide. For instance, 30% of allaccount closings for GE are done in India; thetarget is 100%.

In 2000, GECIS India started adding high-value products to its portfolio. At present, itoffers, for example, IT helpdesk, riskmanagement, actuarial services and loans andclaim processing, making it one of India’s largestproviders of back-office services. Continuedsuccess has led to ambitious plans for the future:GECIS plans to set up three new contact centresin addition to the present facilities at Hyderabadand Delhi, at an estimated investment of $83million. The company aims to become the largestprovider of remote services by capturing a 10%market share of global remote services.

GE has also offshored R&D work to India;it has leveraged the scientific talent pool of thecountry in its John F. Welch Technology Centerin Bangalore. Indian scientists and engineers areworking on R&D in such areas as electronic andelectrical systems technology, ceramics andmetallurgy, catalysis and advanced chemistry,polymer science and new synthetic materials andpower electronics. The centre, where two-thirdsof the employees have advanced educationdegrees, has already filed for more than 17patents.

Box IV.6. Upgrading offshored service operations in India: the case of GECIS

Source: NASSCOM 2004.


2. Other Asian locations

Apart from India, offshored services areplaying a growing role in several Asianeconomies. The Philippines is an attractivecountry for offshoring of business processesthanks partly to its cultural affinity to the UnitedStates and American-style English speakers. Italso enjoys a reputation as a stable, fast-growingeconomy with rapid telecommunication andtechnological advances.71 Although the labourpool is smaller than in India and costs aresomewhat higher, it is, nevertheless, frequentlyregarded as the closest competitor to India. Itscall centre industry in 2003 employed more than27,000 people, a figure that is expected to doublein 2004. Intel, Microsoft, Safeway and Kodakare among companies that have opened Filipinocall centres, most of which are located in Manila.There has also been rapid growth in sharedservice centres, due to a highly skilled workforcein accounting, software writing, architecturalservices, telemarketing and graphic design. AIG,Caltex, Procter & Gamble and HSBC operateamong the largest shared service or call centresin the country. Foreign companies have in thisway created many new jobs for college graduatesand boosted the country’s exports of services.72

In Malaysia, third-party call and contactcentres are growing at the rate of 100-200% since2000. One of the country’s strengths is theavailability of workers speaking English, Malay,Mandarin, Cantonese, Hindi and Tamil (MIGA2003). BMW, Citigroup, Dell, DHL, Ericsson,Hewlett Packard, HSBC, IBM and Royal DutchShell have all set up regional service hubs inMalaysia, while AIG and Motorola are amongcompanies with software development centresin the country.73 Singapore offers strong financialservice skills and excellent infrastructure, buthigh salary and real estate costs. It also targetsleading-edge offshore functions such as remoterobotics management, healthcare and geneticdiagnostics (A.T. Kearney 2004) and has becomeone of the key hubs for regional headquarters.Of the 7,000 foreign affiliates in Singapore, morethan 4,000 have been assigned regionalresponsibilities.

China may well be the next majordestination for the offshoring of services. Thecountry is becoming a key product-developmentcentre for GE, Intel, Microsoft, Philips and otherelectronics TNCs. Call centres for clients in Japan

and the Republic of Korea are springing up incoastal cities. Many industries are clustered incertain areas, with high-tech centres in Beijingand Shenzhen, financial services in Shanghai andHong Kong (China) as a global financial centre.A large pool of skilled people and low costs areChina’s key advantages, but language skills andcultural factors tend to tilt the scales in theopposite direction.

3. Latin America and the Caribbean

Brazil, Chile, Costa Rica and Mexicohave attracted some service production withrelatively low labour costs and proximity(important due to similar time zones) to theUnited States. Some 8% of all large EuropeanTNCs with offshoring experience have activitiesin this region (UNCTAD and RBSC 2004). AOLTime Warner, Unisys and Xerox are examples ofcompanies that are taking advantage of highinvestments in telecoms and IT infrastructure anda large and relatively low-cost labour pool.Procter & Gamble’s shared service centre in CostaRica provides support to 28 countries (box IV.7). Chilehas attracted FDI in shared services by, for example,BHP Billiton, Nestlé, Shell,74 Sodexo and Unilever.Advanced telecommunications at competitive costsare important strengths for Chile. The data on FDIprojects in export-oriented services showed that,for IT services, Mexico has attracted projects insoftware development and Brazil in advancedR&D production. A number of countries in theCaribbean have successfully attracted offshoredservices.75

4. Africa

In Africa, export-oriented FDI in serviceshas mainly been in call centres. South Africa isthe most prominent player, although countriessuch as Ghana, Mauritius, Morocco, Senegal andTunisia have also received investments linkedto offshore services. In 2003, there were morethan 400 call centres in South Africa, employingclose to 80,000 people. It is estimated that thenumber of work stations related to call centresand back-office services will increase by morethan 200% until 2007. To date, FDI in the SouthAfrican call centre industry has been quite limited(CM Insight et al. 2004), but EDS, Sykes andMerchants are among the largest call centreemployers in the country.76

175CHAPTER IV

5. Central and Eastern Europe

Several CEE countries offer a well-educated, multilingual workforce, competitivelabour and property costs, central location andgood infrastructure. For a number of Europeancompanies, offshoring in the same time zone isa more attractive option than shifting activitiesfurther away. With EU enlargement, some of thenew EU member countries also offer attractivelocations for regional headquarters. Accordingto one ranking, the Czech Republic offers themost attractive conditions for offshoring to CEE

(A.T. Kearney 2004). Among the largerinvestments in the Czech Republic in 2003 wereDHL’s decision to set up a European IT centre,creating 500 jobs; Accenture’s expansion of itsservice centre that could increase from 300employees in 2003 to 1,500 in 2008; and thetransfer of Philips’ European accounting servicesfrom Dublin to Lódz, creating 400 jobs.77 Polandwas the second most attractive CEE location,followed by Hungary (A.T. Kearney 2004).78 InIT services, countries such as the RussianFederation and Romania are emerging on theinvestors’ list.

Global Business Services is Procter &Gamble’s (P&G’s) worldwide shared servicesorganization. It provides back-office support tonearly 98,000 employees in over 80 countriesand comprises three centres: Manila (Philippines),Newcastle (United Kingdom) and San José (CostaRica). In the process of selecting these three citiesas locations for its Global Business Servicescentres, the company reviewed more than 120cities worldwide. The key reasons for choosingCosta Rica were the pool of highly educated andskilled labour, the country’s long-standingdemocratic tradition, an attractive cost structureand an investment-friendly approach to foreigninvestors.

The San José service center startedoperations in late 1999. By 2004, it was providing28 different services to 63,000 P&G employeesin 22 countries in North and South America. Thisincludes serving 58 plants and 15,000 retirees.Services delivered from Costa Rica includeemployee services such as payroll, benefits,relocation, travel expense accounting andcompensation; and accounting and financialservices such as cost accounting, banking,treasury and affiliate accounting, purchasing, andIT support.

Some of the main activities undertaken bythe Costa Rican centre include:

• Closing the books for 132 legal entities andmanaging 310 bank accounts in 35 differentbanks across 22 countries.

• Payroll and salary planning and compensationfor 57,000 P&G employees.

• Annual processing of some 2.5 millioninvoices and managing accounts payables inthe order of $24 billion.

• IT support to 5,000 sales representatives inthe United States.

Global Business Services has created 1,300high value-added service jobs in Costa Rica,thereby helping to mitigate the risk for brain-drain from the country. The local operation hasalso promoted the transfer of skills throughintensive training programmes. The company has“raised the bar” on recruiting and educationalstandards, reviewing over 12,000 résumés andrequiring applicants to demonstrate proficiencyin English and international accounting standards.

The company has recently become involvedin global negotiations with strategic partnersconcerning the outsourcing of some functionspreviously handled by P&G Global BusinessServices. The first strategic partnershipimplemented was with Hewlett Packard withregard to IT support services starting 1 August2003. From 1 August 2004, Hewlett Packard willalso handle the accounts payable services. InNovember 2003, a real estate company, JonesLang LaSalle, took charge of the facilitiesservices and, since 1 January 2004, IBM hasprovided employee services to P&G. Thesepartnerships will allow the centre in Costa Ricato attract higher value added work moreconcentrated in its core business activities. P&Gexpects more and more sophisticated services tobe handled by its Global Business Servicescentres in the future.

Box IV.7. Procter & Gamble’s shared service operations for the Americas

Source: Procter & Gamble.


FFFFF. Implica. Implica. Implica. Implica. Implications ftions ftions ftions ftions for homeor homeor homeor homeor homecountriescountriescountriescountriescountries

What is the likely impact of servicesoffshoring on home countries? In response to theexpansion of offshoring of services, there havebeen vocal reactions in both the United Statesand Europe. Concerns have been expressed thatthe growth of white-collar jobs in export-orientedservices in countries such as India, thePhilippines and the Caribbean signalsemployment losses in developed countries andpotential harm to their economies. Proponents,on the other hand, argue that the offshoring ofservices will be beneficial to developed countries.As one observer put it (Drezner 2004, p. 23):“believing that offshore outsourcing causesunemployment is the economic equivalent ofbelieving that the sun revolves around the earth:intuitively compelling but clearly wrong”.

It should be reiterated that this is notsimply a North-South issue. As noted above, asignificant share of offshoring takes place amongdeveloped countries. For example, Canada,Ireland and various Western European countriesremain among the most attractive locations forshared service centres in Europe (IBM andOxford Intelligence 2004), and more than halfof all FDI projects related to call centres in 2002-2003 went to developed countries. Lower wagesare thus not the only driver of services offshoring,and rich countries gain as well as lose jobs ina narrow sense.

Offshoring is essentially a manifestationof a shift in production in response tocomparative advantage. It offers all theadvantages – and costs – of such a shift. It is nota “zero sum game”, in which one party (thecountries receiving service work) gains at theexpense of the other party. On the contrary, itoffers three main benefits to developed countries.

• Offshoring, undertaken by companies toreduce costs and/or improve quality anddelivery, enhances their competitivenessand, by extension, benefits the homecountry. Conversely, companies that refuseto offshore, risk losing competitiveness tothose that undertake it.

• It enables the home (or importing) countryto shift to more productive and higher valueactivities. Economic dynamism depends onadaptation to changing comparativeadvantages, and offshoring is no exception.

As long as resources are mobile and workersmove to new jobs, such changes are not justbeneficial but also necessary for long-termprosperity. The impact is no different fromthat of technical change that makes somejobs redundant and creates others, generallyat higher wage levels. And it is no differentfrom the constant shifts in patterns ofcomparative advantage in manufactures thathave driven trade growth in the past.79

• Exporting host countries use some of theirexport revenues on imports of advancedproducts exported by the industrializedcountries.

At the same time, the current size of theoffshoring phenomenon needs to be kept inperspective. First, whereas offshoring is likelyto grow over time, most outsourcing remainspredominantly a domestic affair; only a smallproportion of all business-process outsourcingis international and, within that segment, muchis outsourced among developed countries (Schollet al. 2003). Second, there is no sign of offshoringleading to a decline of similar services in homecountries. Recent estimates undertaken on behalfof the United Kingdom Department of Trade andIndustry show that the number of call centres inthat country is likely to increase over the nextthree years, and that associated employment willincrease from below 500,000 in 2003 to 650,000by 2007.80 In the United States, employment incall centres is expected to grow from 3% in 2001to 5% of the workforce by 2010 (Mosher and Gist2002). Moreover, in both these economies,employment in those industries that are expectedto be the most affected by offshoring is in factshowing the fastest growth. Indeed, the numberof IT-related jobs in the United States is expectedto grow by 43% by 2010 (Mann 2003) – anexample of restructuring.81 Moreover, the 3.4million service jobs that are forecasted to beoffshored from the United States until 2015 (orabout 300,000 annually over the next 11 years)seem insignificant compared with the averagenormal turnover of some 4 million jobs everymonth.82

Jobs created in exporting locationsthrough offshoring do not equal jobs lost inimporting countries. As mentioned above, theoffshoring of services is sometimes done to copewith excess demand and in response to a shortageof adequately trained people at home. Amonglarge European TNCs, 79% of those withexperience in offshoring identified several ways

177CHAPTER IV

in which home countries benefit , includingthrough lower prices, improved competitiveness,increased skills and higher employment(UNCTAD and RBSC 2004).

Interesting parallels can be drawn withthe relocation of jobs in ICT-relatedmanufacturing, when assembly operations shiftedto East Asia. Together with technical progress,the globalization of hardware production cut theprices of ICT products, increased investment inICT hardware and contributed to higherproductivity and growth. Many new jobs emergedin the United States to integrate ICT equipmentinto the workplace and such jobs grew twice asfast as overall employment (Mann 2003). Theglobalization of IT-based services is likely to besimilar. In fact, it may diffuse higher productivityto activities and firms that did not share in theproductivity revolution of the 1990s (e.g.healthcare and SMEs). Services are morepervasive in their effects, and their benefits arelikely to be widespread. IT jobs are predicted togrow three times faster than total employmentin the United States, and the “second wave” ofproductivity growth based on IT-services couldeven exceed that in the 1990s. Lower cost ofinputs boosts economic activity, investment and,eventually, job creation. According to a recentstudy, the offshoring of IT services in this wayhelped create 90,000 net new jobs in the UnitedStates in 2003, and more than 300,000 net newjobs could be created by 2008 (ITAA and GlobalInsight 2004).

What about the “jobless recovery” in theUnited States? Employment in white-collarservice activities has not increased since 2001,as compared with an average annual gain of 5.5%over the past six cycles (Roach 2004). Isoffshoring to blame? Only to a very small extent.It may have affected some white-collar jobs butother factors are far more significant. Only 2.8%of all IT software and service jobs thatdisappeared in the United States between 2000and 2003 were lost due to offshoring (ITAA andGlobal Insight 2004). Data from the LaborDepartment in the United States show that only2.5% of all job losses during the first quarter of2004 (or 4,600 out of a total of 182,000redundancies) were the result of offshoring.83

Technical change is a far more important causeof job losses. Bank tellers, answering servicesand secretaries are replaced by automated tellermachines, voice-answering technologies andword-processing software. Further jobs will be

lost as software is developed to undertakecomputer programming and financial analysis.

Thus, somewhat paradoxically, aconsiderable part of the gains from offshoringwill be reaped by the importing countries, notablydeveloped economies. This conclusion wasconfirmed in another recent study that found thatmost of the benefits from offshoring flow backto the United States (Agrawal et al . 2003;McKinsey Global Institute 2003). Benefitsinclude lower prices to consumers, expandingmarkets for exports and higher corporate profits.This study concluded that the United States gainstwice as much as India from offshoring. For everydollar spent on offshoring to India, it found thatfirms in the United States reaped $1.12-$1.14 inbenefits.84

However, even if long-term benefits aresubstantial, there are short-term challenges toconsider. All shifts in comparative advantageentail adjustments at the micro level. Somepeople do lose jobs, and there is likely to be atransition period in which they search for newemployment opportunities. Countries with moreflexible labour markets stand a better chance toadapt. People may have to acquire new skills ormove to new locations to become employable.There are, in other words, real adjustment costs– the role of the Government is precisely tominimize or ameliorate such costs and make thetransition smoother and more efficient. Theinstitutional challenge for home countries is toease the transition process for those directlyaffected by offshoring, upgrade skills andincrease innovation. This does not requiremeasures to force service jobs to stay at home,but rather more constructive policies thatencourage education, training and R&D.Protectionist measures aimed at arresting theoffshoring trend would likely destroy rather thansave jobs in developed countries.

Countries need to prepare for suchadjustment policies. The tradability revolutionhas fundamentally changed the environment fordoing business and opened completely newopportunities for restructuring the production ofcorporate service functions across borders. Thisnew international division of labour has thepotential for producing considerable welfaregains for the world economy as a whole –possibly, in the longer-term, even moreconsiderable than in the case of manufacturingactivities.


1 See IDA Ireland, http://www.idaireland.com/news/showRelease.asp? storyid=205.

2 The centres, employing about 2,200 people,strengthened BT’s competitiveness and improvedcustomer services. “BT Retail announces extrainvestment in UK contact centres and confirms plansfor two centres in India”. Press release from BT, 7March 2003, http://www.bt.com/index.jsp.

3 “ACS announces creation of new technology centerin Ghana to support expanding local workforce”,www.prnewswire.com, 29 May 2003.

4 “Bank of America sets up Indian outsourcingsubsidiary”, IDG News Service, 18 February 2004.

5 Information here includes voice, words, data, picturesand any combination of these.

6 For early treatment of increased trans-border data flows,see UNCTC 1983a, b; UNCTC 1984a, b; Robinson etal. 1989; Sauvant 1986a, b.

7 The cost of one megahertz of processing power fellfrom $7,600 in 1970 to 17 cents by 1999. The cost ofsending 1 trillion bits of data plummeted from $150,000in 1970 to 12 cents by 1999. The entire contents ofthe United States Library of Congress can now betransmitted across the United States for $40, and soonit may be storable on one computer chip. In 1930, thecost of a minute’s telephone call from New York toLondon was $300 at today’s prices; today it is a fewcents (UNIDO 2002). It has also been estimated thatthe cost of an international 2Mbps fibre leased linein India dropped by up to 80% between 1997 and 2001(McKinsey Global Institute 2003, exhibit 5).

8 “Outsourcing: the myths and facts”, Wall Street JournalEurope, 1 March 2004.

9 On fragmentation of manufacturing, see Arndt andKierzkowski, eds. 2001. The trends in manufacturingare carried much further in services because they offergreater scope for separating processes.

10 For example, once the “expert system” for answeringquestions is written, anyone anywhere with sufficientskills can navigate through the decision tree on thecomputer screen and act like an expert. Spreadsheetsoftware with embedded equations and the ability todownload data implies that anyone with the requisiteskills can provide analysis for a financial enterprise.Computer programming, at one time akin to an art, hasbeen modularized and decomposed into three stages:design, implementation in computer code andmaintenance and repair (e.g. debugging). This is similarto accelerating the standardization of manufacturingprocesses in the traditional product cycle, allowingits diffusion to new locations.

11 Cultural factors may also inhibit trade. A case in pointis the disparate growth of home-working via e-mailin different countries and institutions, illustrating howsocial and work traditions can hinder the externalizationof services beyond a single company.

12 Data on trade in services, and especially intra-firmtrade, suffer from serious shortcomings (Kirkegaard2004).

13 During the same period, the shares of Germany andJapan, two countries in which the private sector hasundertaken less offshoring, fell by 0.6 and 2.7percentage points, respectively (WTO 2004a).

14 However, in the import statistics of the United States,India and Ireland do not feature among the top 10source countries. The leading suppliers of “other privateservices” in 2002 were the United Kingdom, Bermuda,Canada, Germany and Japan (Borga and Mann 2003).According to data from the United States Departmentof Commerce, Bureau of Economic Analysis, totalimports of (mode 1) services from India was only $80million in 2002, as compared to the $6.4 billionreported by IndiaStat as total services exports (mode1 and 3) to the United States and Canada (Kirkegaard2004).

15 See, for example, “Companies finding some computerjobs best done in U.S.”, New York Times, 28 April 2004.

16 This has long been true in insurance and banking. Inthe former case, it has been justified by consumerprotection. The quality of an insurance policy can bedetermined only when damage occurs (e.g. to a caror to health), while the premium payment takes placeat the time of purchasing a policy. In banking, it maybe justified by the need for prudential supervision toguarantee the safety and stability of financial systems.

17 According to the company: “The best outcome for ourstaff, shareholders and customers is to continue toemploy people in countries in which we operate,provided the fiscal and regulatory climate is supportiveof business”, The Guardian, 18 October 2003 (http:// w w w . g u a r d i a n . c o . u k / b u s i n e s s / s t o r y /0,3604,1065770,00.html).

18 For more on the educational profile of workers in IT-enabled services, see United States, Department ofCommerce 2003b, 2004b; Kirkegaard 2003.

19 Early examples include offshoring of data entry to Indiaand the Caribbean (UNCTC 1989c).

20 Y2K is short for “Year 2000”. Many computers neededupgrading of their software programmes to cope withthe change from year “99” to “00”.

21 See Forrester Research, 8 December 2003( w w w . f o r r e s t e r . c o m / E R / P r e s s / R e l e a s e /0,1769,867,00.html).

22 Forrester Research, cited in “Growth of offshoring mayaccelerate”, CNNMoney, 17 May 2004.

23 Deloitte Research, “The cusp of a revolution: howoffshoring will transform the financial servicesindustry”, www.deloitte.com/dtt/cda/doc/content/The-Cup-of-a-revolution-2003.pdf.

24 For “other private services” as a whole, thecorresponding figure was 47%.

25 Managers unfamiliar with (outsourcing and) offshoringmay also feel more comfortable with an in-housesolution (Kobayashi-Hillary 2004).

26 Some large financial service TNCs have establishedsubsidiaries in India, which export services. Theseinclude American Express, Citigroup, Fidelity, GECapital, HSBC and JP Morgan (Dossani and Kenney2004; “More ‘Can I help you?’ jobs migrate from U.Sto India”, New York Times, 11 May 2003).

27 “Is your job next?”, Business Week, 3 February 2003.28 “Protectionism hits the outsourcing industry”, IDG

News Service, 15 April 2003; “Opportunity on the line:the promise of business-process outsourcing istempered by questions of security, technology, andculture”, Information Week, 20 October 2003.

Notes

179CHAPTER IV

29 It can be demonstrated theoretically that adisproportionate improvement of skills and investmenttechnology in developing countries (compared within developed countries) will bring about a shift insourcing of services from developed to developingcountries (Grossman and Helpman 2002).

30 See also “Global designs for India’s tech king”,Business Week, 13 October 2003.

31 “On runway, will take off: airlines BPO has contributed$30 million to the total earnings of WNS”, IndianBusiness Insight, 31 August 2003.

32 Sitel is also considering new offshore centres in China,South Africa and certain CEE and Central Americancountries (company interview, March 2004).

33 “EDS opens offshore facility in India”, IT Management:Outsourcing , 18 June 2003.

34 See www.top-consultant.com.35 “India’s outsourcing firms have a new target: Europe’s

expanding eastern rim”, Dow Jones Newswire, 30 April2004.

36 Additional examples include Wipro, Birlasoft and HCLTechnologies all with operations in the United Kingdomand the United States; Datamatics Technologiesacquired CorPay Solutions (United States) for $9million in 2003 and is planning to acquire morecompanies in the United States, Europe and Canada.

37 In India, four trends towards industry-wideconsolidation have been noted (“Outsourcing in India:growing up”, The Economist, 22 May 2004). First, someforeign affiliates are thinking of selling some of theiroperations. Second, fast-growing Indian firms seeacquisitions – inside and outside India – as a way tosustain growth. Third, some contract service providerTNCs, such as IBM and Accenture, are acquiring localservice providers in the Indian market. Finally, thereis consolidation among Indian companies.

38 For example, in the case of India, average FDI intoservices offshoring totalled $300 million in 2001, orjust over 10% of the country’s total inflows of FDIthat year (McKinsey & Co. 2003).

39 The data used here are from LOCOmonitor, a databasedeveloped by OCO Consulting covering over 21,000greenfield and expansion projects (but not cross-borderM&As). While the database does not claim to becomprehensive, information on these FDI projectscomes from over 6,000 sources including companies’press releases, government websites and the media.

40 Examples of takeovers include Hinditron, acquired byTAIB Bank (Bahrain), and IIS Infotech, bought by FIGroup (United Kingdom). Joint ventures have beenestablished between British Aerospace and HindustanAeronautics; Bell South and TelecommunicationCorporation of India; and British Telecom andMahindra Group (Kumar 2000).

41 “IBM buys Indian back-office service firm”, Reuters(www.reuters.com), 7 April 2004.

42 “Call centre firm eyes expansion with new owner”,Budapest Business Journal, 3 May 2004.

43 Some 95% of all shared service centres serving theEuropean market have some type of financial servicefunctions and 23% provide an IT service (IBM andOxford Intelligence 2004).

44 More than 60 companies (mainly from the UnitedStates) use Ireland as a base for their European callcentres, employing 12,000 people.

45 “US firms saved $8 bn via local outsourcing”, BusinessStandard, 16 April 2003.

46 Ibid.47 Data from NASSCOM suggest that the direct cost per

employee in an Indian call centre are about $5.20 perbillable hour as compared with $27.80 in the UnitedStates (Dossani and Kenney 2004).

48 The Philippines Board of Investment, for example,actively uses the country’s large pool of trainedaccountants in its marketing efforts. According to theGovernment, the country boasts a larger number ofaccountants than India (information provided by thePhilippines Board of Investment). Companies such asProcter & Gamble and Caltex have selected thePhilippines as a base for shared services related tofinance and accounting.

49 France Telecom, SNCF (the French Railway company)and Altitude Marketing are examples of companies thathave set up call centres in Morocco (see Belghazi2000). Atento, of Spanish Telefonica, has set up callcentres with several hundred employees in Tangiers.

50 Ireland and the Netherlands, at an early stage,successfully established themselves as leading locationsfor pan-European call centres, leveraging theavailability of the many languages represented in theirpopulation, including foreign students. However, withincertain language regions, such as Scandinavia, manycompanies have set up local operations.

51 Low labour costs in India have made it viable forcompanies to import all their own telecom technologyfor the large call centres that have been established,while still operating at a far lower cost than indeveloped countries. For smaller countries, where thecapital outlay for telecommunications would beproportionately higher (because the centres would besmaller) an insufficient telecoms infrastructure couldhave a prohibitive effect on potential investors (Cohen2003).

52 See, e.g. “Online extra: the good life in a Bombay callcenter”, Business Week, 3 February 2003.

53 “Call centres to be India’s biggest job-maker”, TimesNews Network, 18 December 2003.

54 For example, Changi International Airport in Singapore,one of the largest air hubs in the Asia-Pacific region,handled more than 25 million passengers in 2003. InApril 2004, it was linked to 152 cities in 51 countries,with more than 3,400 weekly flights(www.chiangi.airport.com.sg).

55 See also IBM and Oxford Intelligence 2004.56 Some 7% of all pan-European shared service centres

are part of TNCs from the United Kingdom (IBM andOxford Intelligence 2004).

57 In terms of outsourcing, the United Kingdom aloneaccounts for 35% of the European market(“Outsourcing embraced in Europe as well”, CIOInformation Network, www.cioupdate.com, 18 March2004).

58 A few cases of offshore services have received attentionin Germany. For example, Siemens has located around2,700 software and accountancy jobs in CEE, and hasannounced that it will offshore 10,000 of a total of30,000 software development operations to low-wagecountries; SAP has opened R&D centres (productdevelopment and customer support) in China and India.It has established a presence in India where it is


planning to employ nearly 2,000 people by the endof 2004 (“Siemens to move 10,000 jobs to India, China,Russia”, Rediff.com India (www.rediff.com), 16December 2003). The accountancy arm of Infineonplans to expand its services activities in China in thenext five year from 800 to 3,300 employees (“Infineonbaut Werk und Entwicklungszentren in China”, HeiseZeitschriften Verlag (www.heise.de), 26 July 2003).

59 See footnote 17. Other examples are Northern Rockand Alliance & Leicester.

60 AND Publishers (electronic mapping), Philips, AtosOrigin, Logica CMG, ABN AMRO, Reed Elsevier andthe Dutch affiliate of EDS have all offshored services(article in Intermediair (www.intermediair.nl),November 2003).

61 Interview with Paul Tjia, GPI Consultancy, February2004.

62 See “Down and out in white-collar America”, Fortune,23 June 2003, pp. 43-47; “Commentary: outsourcingjobs: is it bad?” Business Week, 25 August 2003.

63 The share of Asian countries is estimated at about 8%,of which the Japanese market accounts for almost threepercentage points.

64 “A shadow called ‘outsourcing’”, Indiabiz News andResearch Services, Volume 1, Issue 13, June 2003, p.3.

65 Detailed data on FDI in the software and IT-enabledservices are not available. NASSCOM publishes adirectory of firms with details of software and servicefirms related to ownership, sales, employment, export,location, etc. It also publishes a directory of firms inIT-enabled services. The directory of software firmsincludes all the major firms, accounting for about 90%of the total software exports. The coverage of the IT-enabled services directory is about 60% of total exports.The analysis of the role of the FDI in the software andIT-enabled services is mainly based on the firm leveldata compiled from the two directories mentionedabove.

66 Based on information from NASSCOM directories.67 The operations in the United States of the best Indian

IT companies have shown productivity levels of 150%the United States average – comparable to the levelsof large United States service companies such asAccenture and EDS (McKinsey & Co. 2003, p. 11).

68 Some 60 IT companies in India currently hold so-calledCMM level 5 certification; this represents 72% of allIT companies with such certification in the world.

69 See NASSCOM-BPO Forum (http://bpo.nasscom.org/download/BPO_Captives_ GoodOmen_4_3rdParties.pdf).

70 As mentioned earlier, the software and IT-enabledservice industry remains confined to a few cities,

despite various state governments’ initiatives to attractsoftware investment to less developed regions.

71 See, for example, CM Insight 2004; Bajpai et al. 2004;A.T. Kearney 2004.

72 Information provided by the Board of Investment,March 2004.

73 A.T. Kearney 2004; MIGA 2003; “Why Malaysia”,Sigmax-E, 2003 (http://www.sigmax-e.com/).

74 For example, Shell has decided to locate its regionalcustomer service centre for Latin America in Santiago.The aim is further improvements in customer servicesand to reduce costs by centralizing and optimizingoperations. The centre in Chile will provide back-officeadministration and front-office (call centre) functionsto Argentina, Chile, Paraguay and Uruguay. Thecompany estimates that the centre will receive around75,000 calls per month relating to its fuel, lubricants,retail and asphalt businesses Invest@Chile (http://w w w . h i g h t e c h c h i l e . c o m / i n v e r s i o n i s t a s /last_investors.htm).

75 For example, Sykes has set up a call centre in ElSalvador employing some 500 people, and West Corp.employs 400 people in a call centre in Jamaica.

76 Information provided by Gauteng EconomicDevelopment Agency, South Africa, January 2004.

77 “Subcontracting and location decision in 2003”, RevueRégionale, 9 February 2004.

78 Hungary has attracted shared services FDI by suchcompanies as Alcoa, Avis, Diageo, ExxonMobil, GEand General Motors.

79 When Delta Airlines offshored services by setting upa 1,000-person call centre in India in 2003, thecompany saved $25 million and facilitated an additionof 1,200 reservation and sales positions in the UnitedStates (Drezner 2004, p. 27).

80 CM Insight 2004.81 In the United Kingdom, according to data from the

Office for National Statistics, employment in banking,insurance and other financial services – the industriesmost affected by offshoring – has increased steadilyover the past decade. Real value added in the businessservices and finance industries of the United Kingdomhas also increased and the balance of trade in computerand information services is positive and growing.

82 Data for the 12-month period ending June 2004 (http://bls.gov/news.release/pdf/jolts.pdf).

83 See http://www.bls.gov/news.release/pdf/reloc.pdf.Similar findings have been noted for Europe(Kirkegaard 2004).

84 An Indian study reached similar conclusions(NASSCOM and Evalueserve 2003).

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