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A Comparison of Onshore and Offshore Outsourcing

Compared to onshore outsourcing, prior evidence suggests that offshore outsourcing can provide a firm with greater cost savings and higher performance while exposing a firm to a greater risk of losing control of processes and information. Although offshore service providers can often leverage lower costs than onshore providers and thus generate greater savings, the distance between the onshore party and its offshore partner makes the management of the outsourced activity inherently difficult. Despite the increased risks, the potential for lower costs makes a compelling argument for deciding to select an offshore rather than an onshore partner. To examine this proposition, announcements of offshore- and onshore-outsourcing agreements were compared to determine if offshore announcements had a more positive effect on a firm's stock price than the onshore announcements. The average abnormal share price increase for onshore-outsourcing decisions was 0.30 percent. Although the mean abnormal return for offshore announcements was slightly higher than this, a statistical comparison of the two showed that announcements of onshore- and offshore-outsourcing arrangements did not generate increases in share price that were statistically significant from each other. In other words, any differences could be attributed to chance, and thus offshore outsourcing does not have a significantly more positive impact on shareholder wealth than onshore outsourcing. This suggests that the perceived benefits of offshore versus onshore outsourcing, such as lower costs and higher performance, may be offset by the higher potential risks associated with offshore outsourcing.

The Decline in the Value of Offshoring

There is also evidence that the cost advantages associated with offshore outsourcing have been diminishing in recent years. As more companies move operations to lower-cost countries, the demand for skilled workers in those countries has increased, driving up their value. For example, the annual wage increase in India over the past decade has ranged from 10 percent to 30 percent.29 The cost advantages offered by some offshore vendors have further deteriorated due a rise in the value of offshore nations' currencies compared to that of the contract granting firms' home currency.30 This shift in exchange rates is forcing some offshore vendors to increase the rates charged for services. The combination of declining financial benefits and increased controversy concerning offshore outsourcing leads us to propose that more recent offshore-outsourcing announcements will have a less positive effect on a firm's stock market value than earlier offshoring announcements.

To examine this proposition, the sample of offshore-outsourcing announcements was divided into three groups based on the announcement date. The first group contained announcements released before the end of 2000, the second group contained announcements released from 2001 until 2005, and the final group contained announcements released from 2006 until 2010. The day 0 mean abnormal return for announcements released before the end of 2000 group was 1.85 percent (82.76% of the announcements generated positive abnormal returns). In contrast, the announcements released from 2001 to 2005 generated an average abnormal return of -0.13 percent, and announcements released from 2006 until 2010 generated a mean abnormal return of -0.09 percent. A statistical comparison of these results found that the difference in the average abnormal return for the earliest and latest groups of announcements was significant, but that corresponding differences between the first two groups or the last two groups were not. The results can be interpreted as evidence that the value proposition associated with offshore outsourcing decreased significantly around the year 2001 and has not improved since. Again, using the hypothetical example of a firm with a market capitalization of $5 billion, the decreased mean abnormal returns represent a change in the anticipated wealth impact of an offshore-outsourcing announcement from an expected shareholder value gain of $92 million before 2001 to a loss ranging from $4.5 to $6.5 million after 2001.

Changes in the stock market's reaction to more recent offshore-outsourcing announcements are most likely the result of a combination of several factors. The increased value of offshore services coupled with higher exchange rates has driven up the bottom line costs of offshore outsourcing. The increase in media backlash against offshore outsourcing, along with increased recognition of the high level of risk involved with offshore arrangements, may also explain the observed variation between earlier and more recent announcements.31 An additional possible explanation for the decline in value associated with offshore outsourcing may be the overall decline in the stock market's valuation of all outsourc-ing.32 To investigate if the reduction in returns is unique to the offshore group, onshore announcements were examined to see if they experienced a similar reduction in mean abnormal returns occurring after 2001. Prior to 2001, the average abnormal return for onshore-outsourcing announcements was 0.42 percent, whereas after 2001 it declined to -0.12 percent. Although this decline parallels that for offshore announcements, a statistical test did not find the difference between pre-2001 and post-2006 announcements of onshore outsourcing to be significant. This suggests that the reduction in the abnormal returns for recent offshore announcements is not explained by an overall decrease in the value of all outsourcing decisions.

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