Beyond shared service centres: Three offshoring models

19 February 2020
“Nobody got fired for hiring IBM,” is an old saying that speaks to corporate risk aversion and the importance of reputation when choosing a vendor, among other things.

While the 108-year-old IBM is no longer the gold standard of technology companies, it is still an iconic American brand and employs nearly 400,000 people.

Perhaps surprisingly, that “iconic American brand” now employs 130,000 of its people in India, which is more workers than it employs in the United States. This remarkable shift in employment practices — known as offshoring — is yet another marker of the importance of cross-border activities in our globalized economy.

Another marker lies in the fact that IBM’s India operations are a far cry from the stereotypical call centres of decades ago. The New York Times explains that the work of the company’s India-based employees “spans the entire gamut of IBM’s businesses, from managing the computing needs of global giants like AT&T and Shell to performing cutting-edge research in fields like visual search, artificial intelligence and computer vision for self-driving cars.”

The reasons IBM and other companies offshore these kinds of high-value jobs to India, Poland, Malaysia, China and other countries are not hard to find. In India’s case, its universities produce an enormous number of qualified engineers each year, and local salaries are low relative to many advanced economies. In short, offshoring can result in considerable cost savings.

IBM’s current presence in India happened to stem from an exploratory 1993 joint venture with Tata. IBM regarded the venture as promising enough to eventually take sole possession of the entity. This evolution underscores the fact that there is no single route to offshoring operations, particularly when it comes to offshoring high-level work like engineering jobs. This posts describes three popular offshoring options, including traditional shared service centres, technology hubs and joint ventures.

First, though, I’ll briefly address some compliance-related concerns that apply to all three options.

Offshoring compilance concerns

Offshoring work can be part of a successful business strategy for a company of any size, from a corporate giant like IBM to a tech start-up looking to hire hard-to-find talent at reasonable rates. The practice of offshoring is now so widespread that an entire specialty industry has emerged to help companies find real estate, vet and hire local talent and otherwise get an offshoring centre up and running.

That said, businesses new to offshoring should keep in mind that just because the practice is now widely used and accepted doesn’t mean it comes without the compliance-related concerns of more traditional international expansion. Whether you’re considering offshoring in Southeast Asia, Eastern Europe or another region with a deep talent pool and favourable salary ranges, you need to consider the risks associated with immigration, permanent establishment, corporate and indirect taxation, transfer pricing, local social security and other payroll withholdings and remittances, and more.

To take just one example: If you’re sending employees from your home country on a long-term expat assignment to help establish an offshoring centre — which virtually all organizations do in such a situation — you’ll have to fulfil any local visa and work permit requirements, make payments to local social security and tax authorities on behalf of the expat (perhaps through a local shadow payroll while he or she remains on your host-country payroll), provide housing (and in some cases schooling for children) in a safe area, and more. If you also send employees on short-term expat assignments, they may trigger host-country reporting and filing obligations, even if in the end they don’t owe any local taxes.

Needless to say, even if you’re hiring a local company that specializes in providing offshoring set-up services, you should consult with an international expansion and operations expert to ensure you know all your risks and obligations up front and can set realistic budgets and timelines.

Now let’s take a look at three common offshoring models.

Offshore model 1 of 3: Shared service centre

Shared service centres (SSCs) can be established through a third-party vendor or as an owned entity by an organization in virtually any industry. SSCs are primarily designed to create efficiencies and cost savings by consolidating back-office functions of accounting, finance, compliance, payroll, accounts receivable, IT and other areas. This offshoring model might be called the traditional model, as it has been around for decades and is the kind of concern many people still immediately associate with offshoring jobs.

The best shared service centres are characterized by clear and measurable key performance indicators (KPIs) that promote cost savings and productivity. Thoughtful and competent corporate governance is also critical to any SSC. Sound corporate governance should among other things promote compliance with local laws and, where applicable, with the laws of other relevant countries. Compliance with data protection and other country-specific laws is particularly critical for SSCs, as they often serve the needs of internal and/or external clients on three or more continents.

While SSCs are typically associated with what’s commonly called “tactical” work such as processing payroll and performing IT and accounting functions, they are evolving. Increasingly, companies are using SSCs to perform more strategic functions such as supply chain support and procurement.

To promote economies of scale, SSCs are often large concerns, with hundreds of employees. As a result, securing a physical location in a safe area with adequate technological infrastructure and access to the required talent is critical. Those considering an SSC should consider hiring a thoroughly vetted local provider (or providers) to help with real estate selection and recruitment.

Offshore model 2 of 3: Technology hub

There are many terms for this emerging model, which in some sectors — including tech, pharma and life sciences — are rendering the old concept of shared service centre nearly obsolete. In addition to “technology hub” (or “tech hub”), these operations are called tech centres, development hubs, global capability centres and captive centres.

As these names imply, tech hubs are offshore subsidiaries or branches of a multinational organization similar to an SSC, but tech-hub employees provide valuable, highly-skilled services — such as engineering and software development — that aren’t traditionally associated with offshoring.

IBM’s presence in India is unusually large, but the example sheds light on the depth of India’s pool of skilled workers. That pool is being tapped into by organizations of all sizes, not just huge multinationals. Many start-up tech firms, for example, choose to start with a modest office of 20 or 30 engineers. Even a relatively small tech hub of this size can yield high returns, given the differences in typical salaries between India and countries like the U.S. and the UK.

Tech firms continue to be attracted to India’s increasingly crowded market. This month, the code-hosting platform GitHub announced that it is building an India subsidiary “from the ground up.” GitHub’s COO Erica Brescia is quoted as saying, “In building out a local team in India, our goal is to create stronger relationships with developers and support open source development across developers, maintainers and enterprises.”

Brescia’s comment highlights the importance of demonstrating a commitment to the target-country community by building and running an office staffed with and run by local employees. This kind of visible commitment can help attract talent in any tech-hub target country.

It should be emphasized that retaining tech talent in popular offshoring destinations is perhaps even more critical — and more difficult — than attracting talent. Given the rising number of tech hubs and foreign employers, there is no shortage of options for engineers in India, Poland, Malaysia, China and elsewhere. Understanding local competitive salaries and benefits, along with local cultural expectations, is critical to building a successful tech hub with high employee-retention rates.

Offshore model 3 of 3: Joint venture

Some companies choose to enter into a joint venture with a local partner (or partners) when offshoring. In some countries such as China, a multinational may be required in certain situations to enter into a joint venture with a local partner. This situation can lead to concerns about intellectual property protections and more. The New York Times article I mentioned earlier points out that IBM had a presence in India from 1951 to 1978, when it left after a “dispute with the government about foreign ownership rules.”

IBM expanded into India again in 1993, this time through a joint venture that has proved fruitful. The decision to partner with an already established company in India may have been a sign of caution after IBM’s initial ill-fated expansion. Indeed, entering into a joint venture for the purposes of offshoring can reduce some risks, including those related to building a local reputation, establishing a local entity, securing real estate and more. A joint venture can also produce almost immediate economies of scale and allow a company to enter a market more quickly than it could have done otherwise.

While IBM’s joint venture resulted in success, the joint venture model should be employed only after careful vetting of the local partner and gaining a full appreciation of joint-venture risks in light of local laws. Choosing the optimal local legal structure is important, and seeking third-party tax and legal advice will for most organizations be an essential part of the due-diligence process.

A company considering a joint venture should also spend considerable time conducting research on, and meeting with the management of, the potential partner to ensure that business goals and corporate cultures are aligned. A detailed business plan should be agreed on to help avoid disputes down the line. Any company entering into a joint venture should also retain expert advice to ensure it can exit on its own terms, that its intellectual property is protected, that there is an agreed-upon dispute mechanism in place, and has other protections in place under local law.

Each offshoring option I’ve described can be part of a successful long-term business strategy. Each option also offers its own unique set of risks, challenges and potential rewards that will in turn vary by target country. Understanding the compliance obligations, cultural expectations, and salary and benefits norms of each market can be daunting. Most organizations — no matter what their size — will want to partner with an experienced international expansion and operations specialist to gain that understanding during the due diligence process. Most will also choose to continue the partnership after they’re on the ground, so they can effectively manage their operational and compliance-related risks and maximize the considerable advantages of offshoring.