AARHUS SCHOOL OF BUSINESS AND SOCIAL SCIENCES

OFFSHORING: NATURE OF THE ACTIVITY

VS. HOST COUNTRY CAPABILITIES Author: Juan Carlos Pedraza M.

Supervisor: Robson S Rocha, Associate Professor

November, 2011

Master Thesis

Department of Management

Msc. In International Business

Acknowledgements

To my family in Colombia,for their support.

I want to thank my supervisor, Professor Robson S Rocha, for his patience and for guiding me in key moments of the writing process.

Abstract

In developing countries the new model for competitiveness is the one that explores the idea that the traditional competitive advantages such as natural resources, and exploitation of the fertile land were not factors that generate the expected growth. To that end, the state of affairs is changing towards the development of competitive advantages built around technological innovation, the generation and dissemination of knowledge and human capital development. International trade not only opens up economic opportunities for developing-country exporters, but it also provides access to foreign capital and technology that, through enhanced competition and innovation, can offer national and foreign consumers more choice in terms of quality and price. One development that has fueled the growth of service exports is the growing trend among companies in high-income countries to outsource back-office and other service functions to take advantage of the advanced skills and lower labor costs of specialized service providers. The offshoring industry has grown significantly and in many cases exceeded expectations from the early days and at the same time, the geography of offshore delivery has expanded to include a large number of countries specializing in different parts of the service-production ecosystem. But there are obstacles on the road, and one of those is related to the nature of the activity and the degree of complexity that can be acquired in a period of time.

The main objective of this paper is through a literature review explore the relatedness between: the nature of the activity offshored and the development of country capabilities.

Table of Contents Introduction ................................................................................................................................. 3

1.1 Problem formulation ......................................................................................................... 6

1.2 Structure of the thesis ...................................................................................................... 7

1.3 Delimitation ....................................................................................................................... 7

2. Methodology ........................................................................................................................... 9

2.1 Motivation ......................................................................................................................... 9

2.3 Literature sampling ........................................................................................................ 11

3. Offshoring ............................................................................................................................. 13

3.1 What goes from Outsourcing to Offshoring ................................................................. 13

3.2 Approach to Offshoring ................................................................................................. 17

3.3 Offshoring market and debates .................................................................................... 20

3.3.1 Political and economic debate ............................................................................... 22

3.4 Offshoring definitions and business models ................................................................ 24

3.5 Drivers of offshoring ....................................................................................................... 27

3.5.1 Access to new markets........................................................................................... 28

3.5.2 Enhancing efficiencies: the role of technological developments ........................ 28

3.5.3 Cost saving .............................................................................................................. 29

3.5.4 Emergence of new drivers: access to talent ......................................................... 30

4. The nature of the activity and its relation with offshoring ................................................. 34

4.1 Nature of the activity ................................................................................................. 35

4.1.1 Knowledge ............................................................................................................... 36

4.1.1.1 Codifiability ........................................................................................................... 37

4.1.1.2 Repetition ............................................................................................................. 38

4.1.1.3 Innovativeness ..................................................................................................... 38

4.1.1.4 Process maturity .................................................................................................. 38

4.1.1.5 Modularity ............................................................................................................. 39

4.1.1.6 Complexity ............................................................................................................ 39

4.1.2 Customer contact .................................................................................................... 41

4.2 Types of offshoring activities ................................................................................... 43

4.2.1 Front-office services ............................................................................................... 44

4.2.2 Back office services ................................................................................................ 44

4.2.4 Business Process Outsourcing and Offshoring - BPO&O ................................... 46

4.2.5 Information Technology Outsourcing - ITO .......................................................... 46

4.2.6 Knowledge Process Outsourcing - KPO ............................................................... 47

5. Host country capabilities ..................................................................................................... 49

5.1 Definition ......................................................................................................................... 51

5.2 Types of capabilities ...................................................................................................... 51

5.3 Benefits ........................................................................................................................... 51

5.4 Transition ........................................................................................................................ 51

6. Conclusion and challenges ................................................................................................. 52

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Introduction

The last few years have witnessed major changes in business environments of different industries worldwide. Progressively, there has been a shift away from national markets as distinct entities, protected from each other by trade barriers, towards a system in which national markets are merging into a single global market (Hill and Jones, 2001).

It is no secret that the gradual integration of national economies into the global market with the gradual deregulation of trade in goods, services and flows of capitals has generated an increased competition between firms because they constantly require new business strategies and models in order to achieve increasing levels of quality and competitiveness. As McIvor (2005) suggested, at the same time, the boundaries of many industries span internationally with competitors existing in both home an international markets. Increasing competitive rivalry has reduced the profits of many organizations and forced them to reduce costs, improve customer responsiveness and quality.

In developing countries the new model for competitiveness is the one that explores the idea that the traditional competitive advantages such as natural resources, and exploitation of the fertile land were not factors that generate the expected growth. To that end, the state of affairs is changing towards the development of competitive advantages built around technological innovation, the generation and dissemination of knowledge and human capital development.

To facilitate these changes the role that developing countries are playing in both trade of goods and services is fundamental. International trade not only opens up economic opportunities for developing-country exporters, but it also provides access to foreign capital and technology that, through enhanced competition and innovation, can offer national and foreign consumers more choice in terms of quality and price.

By the same token, for developing countries, services play a key role in increasing economic growth and productivity as they are essential inputs to many activities

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that help improving financial intermediation, infrastructure, the use of information technology and communications (ICT), the increase of the quality of education, health and the efficiency of the public system.

One important economic and social phenomenon that has fueled the growth of service exports, especially in developing countries (DC) or low cost countries (LCC) is the growing practice among firms in high-income countries to outsource back-office and other service functions to take advantage of the advanced skills and lower labor costs of specialized service providers. Many developing countries and LCCs have substantial untapped potential to satisfy this demand for business functions in, for example, the accounting, engineering, IT, and legal service sectors.

In order for developing countries to catch upand reach per capita income levels similar to those of the richest economiesproductivity and competitiveness are crucial. Improving productivity is the most important challenge for Latin American and Caribbean countries (IDB, 2010), and although the mechanisms for achieving these goals vary according to country conditions, all of them seem to follow the same pattern: working to transform the agrarian and industrial economies into services and knowledge-based economies. And one way to achieve this goal could be through offshoring only if: both firms (customers and suppliers) and countries can take specific measures to help clear supply and demand more efficiently in this nascent global market (Farrell et al, 2006).

The offshoring industry has grown significantly and in many cases exceeded expectations from the early days. At the same time, the geography of offshore delivery has expanded to include a large number of countries specializing in different parts of the service-production ecosystem (AT Kerney, 2011). For example, service suppliers today need not choose between Asia, Europe or America for their offshore operations. Instead, they should decide how to balance operations across regions in order to develop a global package with multiple time zones, high levels of efficiency and a close proximity to clients (Gereffi et al, 2009).

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In the case of Latin America, the segment of outsourcing and offshoring has grown significantly during the last years. The outsourcing industry in Latin America is growing faster than any other region. Even in the current economic crisis, it is estimated that the outsourcing industry in Latin America grew between 5.5 and 6 percent in 2009 (KPMG, 2010). Different factors could explain this phenomenon. One could be that developing countries are exporting not just traditional services, such as transportation and travel (or tourism) services, but also modern services, notably high-value, skill-intensive services, such as computer and information services and other business services (Groover et al, 2011).

Furthermore, the part of the value chain that can be performed offshore has increased in value-add and complexity as we continue to see new types of services being handled remotely and across borders. An increasing number of corporate functions have become mobile, that is outsourceable offshore. Besides, the sophistication of these relocable functions has been increasing steadily: not only simple functions such as entering data or answering simple phone calls are outsourced to remote countries but also complex tasks such as financial analysis. In a way, there is a real globalization of white-collar jobs (UNCTAD, 2005)

And this last scenario of increasing complexity and the evolution of the nature of the activity that is offshored represents a major challenge for developing countries and developing country firms (DCF) competing to be the preferred destinations for business development related to offshoring. Since the type of function that is being offshored determines the location where this can be most effectively provided, the impact of offshoring on developed countries and emerging markets alike depends on its potential magnitude and the pace at which it develops (Farrell, 2006). And this is very important since initially, host countries build their attractiveness for offshoring (both captive centers and offshore outsourcing) around a relatively narrow set of capabilities. While offshoring processes are constantly refined, standardized, or simply are acquiring an important degree of sophistication, countries would also need to upgrade their capabilities in order to claim foreign direct investment in an attempt to gain competitive advantages, especially taking

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into consideration that, while economic crisis potentiate the benefits of investing in developing countries, low cost is no longer a key differentiator among offshoring destinations.

1.1 Problem formulation

The main objective of this paper is through a literature review explore the relatedness between: the nature of the activity offshored and the development of country capabilities.

This cause-effect relationship opens the possibility to discuss and propose the following hypothesis:

The above scenarios are needed to define the following research question:

To answer the research question the following sub-questions are going to be answered:

a. How has the concept of offshoring developed?

b. How can the nature of the activity be defined?

c. What types of activities can be identified?

d. What kinds of activities are considered for offshoring, what are their characteristics and its relationship to the level of knowledge and level of customer contact?

e. What kinds of requirements are necessary to carry out certain business activities?

How might the nature of offshoring activities affect the development

of host country capabilities?

The nature of offshoring activities might influence the upgrade of the

capabilities of a host country (developing country or low cost country).

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f. What is a set of capabilities of a host country?

f. How can the concepts of upgrade of competitive advantages and the building of absorptive capacity facilitate the interaction between the nature of offshoring processes and host countries?

1.2 Structure of the thesis This master thesis is divided into six chapters.

Chapter 1: Introduction, Problem statement, Motivation, Delimitation and the contents of the thesis.

Chapter 2: Includes description of the methodology used to develop the thesis.

Chapter 3: Dedicated exclusively to the concept of offshoring. This chapter contains a literature review covering the basic differences between outsourcing and offshoring, followed by a more detailed explanation of offshoring. This chapter aims to elucidate the evolution of the concept of offshoring as a current reference both academic and practical level. This chapter also includes the references to why for offshoring low cost is no longer a key differentiator.

Chapter 4: This chapter contains a review of the nature of the activity, its relation with the concept of complexity related to offshore processes and their impact on developing countries, as recipients of the investments related to the progression of offshoring.

Chapter 5: This chapter is dedicated solely to the host country capabilities, with an emphasis on its definition and the identifying the types of capabilities with direct relation to offshoring.

Chapter 6: The final chapter includes the conclusions and challenges.

1.3 Delimitation

This thesis is taking into account the interaction between three different elements: offshoring as an alternative for companies to generate growth, employment and

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income sources; the nature of the business activities that are offshored (especially to low cost countries); and finally, the host countries set of capabilities (the ones that gives countries a degree responsiveness to the changing trends in offshoring).

Figure 1: Relationship model

Source: Own work

Initially, a differentiation between outsourcing and offshoring was made because of the confusion that these two terms still generate. Once this differentiation is made, throughout this thesis the topic of offshoring will be treated as a whole, this means that there will be no differences between the different offshoring business models (Offshore outsourcing, offshore development centers and Captive Shared Services).

- Similarly, through this thesis, offshoring will be discussed from the services sector perspective and the unique attributes of the business activities.

- This work deals mainly with the nature of business activities subject to offshoring processes. Clarification is made because it is possible to find literature references to the complexity of sending one process to another country (referred to as "complexity of transferring functions")

- Here it is important to make a clarification regarding the extension of the thesis. Given that countries represent different operating environments for firms, it is not possible to give a general view about the effect of the complexity of the offshoring business processes in specific countries, so

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2. Methodology

The main purpose of this chapter is to present the methodology used to develop the thesis. The central focus is the study of available literature on the subject of offshoring, including the nature of the business activity and its effect on the capabilities of a host country; therefore, the methodology used to develop this study was the literature review. This chapter also includes the explanation of the tools used for the development of the literature review, based on two authors specialized in this area.

According to Hart (1998) literature review is defined as the selection of available documents (both published and unpublished) on the topic, which contain information, ideas, data and evidence written from a particular standpoint to fulfill certain aims or express certain views on the nature of the topic and how it is to be investigated, and the effective evaluation of these documents in relation to the research being proposed. In the same vein, according to Machi and McEvoy (2009), a literature review is a written document that presents a logically argued case founded on a comprehensive understanding of the current state of knowledge about a topic of study.

2.1 Motivation

The motivation for this thesis has as its starting point the confluence of three important trends in international business especially in emerging economies from Latin America (e.g. Andean countries, Chile, Argentina and Uruguay), and one trend in the offshoring practice (also noted in the literature).

First, there is the increasing influence of the international trade in services in the region. As Cattaneo et al (2010) explains that the service sector is the key to economic growth, export competitiveness, and poverty reduction. The trade in services has grown more rapidly than the trade in goods and the share of the trade

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in services in overall trade has been increasing for much of the last three decades. The potential of the trade in services has remained largely overlooked and untapped by developing countries. A number of reasons could be evoked, including the widespread and persistent idea that services, as opposed to goods, are nontradable. In recent decades, technological obstacles to trade in services have been removed. The latter can be evidenced in the recent trade agreements negotiated in the region (e.g. Free Trade Andean Countries and United States), where the chapter on trade in services has been the subject of interesting debates and deep negotiations.

Second, the renewed momentum gained by industrial policies to generate growth and development in Latin American countries. As mentioned earlier, the governments of South America are working in order to transform the agrarian and industrial economies into services and knowledge-based economies.

Third, it is possible to identify the growth of outsourcing, and offshoring operations in the region. Latin America's proximity to the U.S. consumer market serves it well as a services hub. With a growing Spanish-speaking population in the United States and English proficiency continuing to grow in Latin America, customer service activities will naturally increase. Latin America, similar to other regions, presents a kaleidoscope of skill sets (AT Kerney, 2011).

Beyond trends, another reason for deciding to write on this subject was the initial literature review on the issues of outsourcing and offshoring. The result indicated that much of the literature and available studies were focused on the study of benefits and impacts of sourcing strategies in firms and the effect of wages in both developed countries (resulting from the outsourcing of white-collar jobs) and in developing countries. The subjects that were continuously left outside of the discussions and received little attention are related to the nature of the processes/activities that are offshored (and their different levels of complexity) and the ability of developing countries to upgrade their set of capabilities in order to offer firms a stable but also flexible business environment to respond positively to market needs.

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Finally, there is another special motivational aspect in the debate and is that the economic crisis of recent years changed the perception of business and helped firms to start the diversification of offshoring possibilities outside traditional destinations such as China, India and the Philippines. The tendency to seek destinations that offer quality and low cost is increasing, the geography of offshoring is shifting and countries in Latin America (i.e. Colombia) can take advantage of this situation. Although part of the success of this growth as a destination for offshoring is due to an interesting interaction between the public and private sector with the aim of upgrade the set of capabilities of the country in topics such as: financial attractiveness, people skills and availability and business environment.

2.3 Literature sampling

The thesis is based mainly on a study of the literature on offshoring, the nature and complexity of processes offshored, the upgrade of the business environment and the building of absorptive capacity. Literary sources used were primarily secondary. The main source of information was the website of the State and University Library (http://en.statsbiblioteket.dk/). The literature search process followed the steps suggested by Blumberg et al (2005, p. 162) What steps??. Similarly, I have resorted to using the Social Science Citation Index. For example, this was a very useful tool since the initial search of articles on offshoring through the State and University Library yielded a result of 18,155 articles.

When making a more detailed search for articles, I used popular databases such as EBSCOhost, Emerald, ABI/INFORM Global, Journal of International Business Studies, ProQuest, among others, with different combinations of keywords, although all related to the central topics of the thesis (e.g. offshoring, offshore outsourcing, nature and complexity of offshored processes, offshoring and developing countries, absorptive capacity, among others). For search strategies, I commonly used the advanced search options of the search engines to limit results, and for example, articles in newspapers and book reviews were not taken into

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account. When it was possible all searches were restricted to academic peer-reviewed publications. In order to supplement the search, I expanded it to books from the ASB Library. For example, in the case of offshoring, being the main topic of discussion the search resulted in 7 books.

The literature search process shows an interesting finding that fits with what many authors have written in their articles. Figure 2 shows the growth in the number of publications in specialized journals on issues related to offshoring. This topic is not new but its study and importance in the academic and business levels has grown in interesting ways in the last five years.

Figure 2 Offshoring citation report

Source: Social Science Citation Index/Journal Citation Report

Based on these results, I chose articles that covered the period of increased activity of publishing (2004-2011) combined with the prominence of article documented by citations or the source. As Blumberg et al. 2005 explains, the more an article has been cited, the more it has been appreciated by other scholars.

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3. Offshoring

3.1 What goes from Outsourcing to Offshoring

The main objective of this first section is to present (a) the basic differences between the concepts of outsourcing and offshoring, following by (b) a much broader definition of offshoring and how the concept has developed in recent years.

a) What is the difference between outsourcing and offshoring?

Before starting it is necessary to briefly mention two aspects that are crucial to firms today. At first instance, globalization is transforming the economic outlook of large firms in developed countries; and is driving and enabling firms to develop global sourcing models and service chains to both remain competitive and tap into global talent, resources and capital pools; globally distributed R&D structure to more effectively enter new geographic markets (NASSCOM, 2010). These service chains and sourcing models are applied to the production of goods and services. And second, economic crisis re-emphasized the importance of cost savings and improving efficiency via outsourcing, taking into account the access to qualified personnel as an important strategic driver and low cost no longer a key differentiator (NASSCOM, 2010).

Although this thesis deals mainly with the topic of offshoring, it is worth making a few clarifications. As Chakrabarty (2006) well specified, outsourcing and offshoring are two of the terms that have become very popular lately, but this two words also lead to confusion and misunderstanding. Likewise, both terms are regularly used in public debates and academic research, but they are often weakly defined (Pyndt and Pedersen, 2006) or a large number of terminologies are already being used, and as the business world explores and experiences new information system (IS) sourcing alternatives, newer terminologies will be coined, and existing terminologies may be subjected to multiple interpretations.

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Figure 3 allows us to ascertain at a glance the main difference between the two terms. The term offshoring is often associated with outsourcing but neither implies the other (Olsen, 2006). The two basic sourcing strategies are insourcing and outsourcing. Insourcing implies that the service provider is a client entity, while outsourcing implies that the service provider is a non-client entity.

It is important to keep offshoring and outsourcing decisions distinct: they are location choice and mode choice decisions, respectively. A factor that encourages outsourcing might at the same time discourage offshoring in favor of exporting from the home country or choosing a third country (Markusen, 2005).

Figure 3 - Relationship of offshoring and outsourcing

Source: Biro Feher, 2005

More deeply, outsourcing involves the sourcing of goods and services previously produced internally within the sourcing organization from external suppliers. As defined by Gereffi et al (2009) outsourcing is, therefore, the act of contracting a special function or service from a legally separate unit (outside the boundaries of the company) rather than using the companys own internal resources and capabilities (in-house provision), but with one important condition, whether or not to outsource is the decision of whether to make or buy (Power et al, 2006). Hill (2009) observed that historically, most outsourcing decisions have involved the manufacture of physical products. However, in recent years, the outsourcing decision has gone beyond the manufacture of physical products to embrace the

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production of service activities, something that was also noted, transferred and applied to other activities in the firms by McIvor (2005) when he mentioned that outsourcing has progressed from involving only peripheral business activities towards encompassing more critical business activities that contribute to either maintain the competitive position of the firms or act as a source of competitive advantage in the long term.

De Vita and Wang (2006) propose taxonomy of the concept of outsourcing is divided into three phases. These phases capture the traditional basic features of outsourcing and its key factors are related to: efficiency, cost savings, focus on core competences, sourcing complimentary capabilities, innovation and adaptation of flexible solutions for customers, and business process transformation. The most important development of this taxonomy is that many of the important factors of outsourcing are shared with the concept of offshoring. Authors like Doh et al (2009), Youngdahl and Ramaswamy (2008), Dedrick et al (2011), Mithas and Whitaker (2007) echo these basic features but applied to offshoring. It is also possible to establish a similarity between the features and offshoring drives.

Offshoring refers to when the service provider is located in a country which is geographically far away from the clients country (Chakrabarty, 2006), performed in house (offshoring) or by sub-suppliers (offshore outsourcing) (Pyndt and Torbesen, 2006). Figure 4 helps us to conceptualize and widen the difference between the terms, although the definition of offshoring will be expanded in the next chapter of this thesis.

Offshoring can occur through varied mechanisms including (a) creating a subsidiary in another country and moving work between organizational units, (b) contracting directly with individual workers in another country, (c) contracting with a service firm in another country, (d) contracting with a multinational organization having offices in the offshoring firms home country with sources of labours across nations, and (e) acquiring a subsidiary (Kumar et al, 2008 :448).

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Figure 4: Illustrative matrix of insourcing, outsourcing and offshoring

Source: Olsen, 2006

So far, the types of business activities subject to outsourcing or offshoring have not been taking into account. The figure 5 shows the different types of services sourcing types and their strategic value to the firm. It also serves to corroborate the current capacity of fragmentation and modularization of the activities carried out by firms/firms in various economic sectors, that can be exploited in various forms of outsourcing, and that at some point may become offshoring activities. Similarly, this figure shows how offshoring processes are refined, standardized, or simply are shape to acquire a degree of sophistication and complexity.

Figure 5: Types of services sourcing types

Source: Javalgi et al, 2008

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Conventional/tactical outsourcing: often short-term and applied to specific projects or problems. Tactical outsourcing tends to be function-specific and with the following characteristics (Verizon, 2007):

Reduces operating expenses Creates cost predictability Minimizes risks Leverages skilled resources Counteracts poor economic condition

Strategic outsourcing: used to describe a longer-term relationship in which both parties invest to develop a partnership approach to developing IT services

Improves corporate performance Achieves globalization Focuses on core business activities Enacts major organizational changes Gains strategic partner

Transformational outsourcing: In transformational outsourcing, firms transform by comprehensive reorganization and streamlining of its business processes and technology infrastructure and the outsourcing of IS needs, in order to reduce costs and improve services (Sparrow, 2003, p. 10).

Thus, the core driver of the latest form of global outsourcing (i.e., both onshore and offshore) is the heightened organizational and technological capacity of firms in decoupling and coordinating a network of remotely located in-house and external suppliers performing an intricate set of activities (Mudambi, 2008).

3.2 Approach to Offshoring

Now that the main differences between outsourcing and offshoring have been presented, it is time to delve deeper into the nature of the term offshoring. Thus, the purpose of this section is to answer the following question:

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b) How has the concept of offshoring developed over time?

The initial observation about the concept of offshoring is that it is a subject that has had a significant spread in recent years as a field of study, and that also has become a trend in the business and managerial world, because it affects company's cross-cutting practices/disciplines such as: international purchasing, sustainable competitive advantages of firms and countries, comparative advantages, make or buy decisions, make or buy alternatives, supply chain management and the concept of core competences. As stated by Lewin and Couto (2006), offshoring has become mainstream practice across industries and the adoption of offshoring practices is following an exponential growing pattern.

As Doh (2005) also suggested, the acceleration of offshoring real or perceived may challenge established theoretical orthodoxy regarding the operation of the global economy generally, and management practice, in particular. Likewise, the different number of scenarios in which the concept has spread, make it difficult to establish a typical definition of this practice. Equally, other topics currently addressed in articles about offshoring include the implications offshoring has on organizations innovativeness as well as productivity (C. Jahns et al., 2006).

To understand more about the concept of offshoring, it is necessary to refer to when global sourcing strategies began to gain relevance for firms in their search for improving competitiveness, performance and efficiency. According to Kotabe and Mudambi (2009), in the last two decades, we have witnessed three waves of global sourcing. The first wave took place in the early 1980s, with emphasis on the global sourcing of manufacturing activities with a special consideration on the results of implementing more global and complex supply chains.

The focus of the second wave started under the guise of re-engineering of processes (C. Jahns et al., 2006), and the research focus were both manufacturing and services. In the services segment, firms started eliminating or outsourcing their in-house information technology (IT) departments that had grown substantially, and this represented the growth of specialized providers. Basically,

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IT itself had become commoditized and the goal was to reduce costs. During this period, production was mainly outsourced or offshored to low cost countries (Pyndt and Pedersen, 2006) since firms located in developed countries often found that labor costs were high, compared to the value that was added to their products (Kotabe and Mudambi, 2009).

Finally, as suggested by C. Jahns et al (2006), the focus of the third and current wave of cost reduction clearly lays on services and the transfer of white collar jobs to low wage countries. This represents two different scenarios. First, firms want access to foreign markets in order to tap into new sources of skilled workers (knowledge acquisitions competence development concerns), to position themselves in rapidly growing markets (Treffler, 2005., Kotabe and Mudambi, 2009) and second, thanks to the constant transfer of knowledge between firms (demand-side and supply-side), the offshoring of an increasing number of white-collar jobs from developed to developing countries presents a significant economic opportunity to any developing nation having a low-cost and educated workforce (Mullan et al, 2008). Lastly, during this current wave, firms are seeking the access to specific resources (specialized components or technical expertise). Future plans indicate even greater growth in innovation offshoring, since firms are realizing that in order to remain competitive; they will have to drive the next wave of innovation by innovating globally (Lewin and Couto, 2006).

The current high level of interest in offshoring is a logical extension of the large-scale outsourcing phenomenon that occurred in the 20th and early 21st centuries (Weber, 2004) although offshoring has existed as an organizational and societal issue since the dawn of the Industrial Revolution (Davis, 2004). In that respect, offshoring is not a new phenomenon; it shares many of the underlying issues of outsourcing that are discussed by economists, international business, information technology researchers, and others (Davis et al, 2006). Today, economic cross-border transfers do not merely include final goods and services, but increasingly encompass the exchange of knowledge, people, and various intermediate activities in the value chain. (rberg Jensen and Pedersen, 2011)

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3.3 Offshoring market and debates

Offshoring is a phenomenon in constant growth, mainly affected by changes in technology and process standardization. No one knows how big offshoring will become because there is no consensus on how to collect data that corresponds to appropriate definitions of services in this industry (Sako, 2005). The total market for all offshore service exports is estimated to have been $32 billion in 2001. The fastest growth is expected in the offshoring of IT-enabled services, which is forecast to expand from $1 billion in 2002 to $24 billion in 2007 (UNCTAD, 2004). Generally, countries do not have data for these types of service exports and there are no specific trade codes to track this information. Additionally, firms have little incentive to disclose this information (Gereffi et al., 2009)

Paradoxically, the growth of offshoring (slow) has benefited by the current economic crisis. In several countries the firms have begun to make major changes in its administrative and operational structures. Many firms have used the recession as an opportunity to focus heavily on eliminating waste and streamlining poor process flows (NASSCOM, 2010).

In these circumstances both offshoring and outsourcing have emerged as tools to connect markets and global economies. In the same vein, the speed of adaptation and reaction of firms to market conditions has increased considerably, affecting the product lines and services offered. For associations like the National Association of Software and Services Firms (India) - NASSCOM, 2010 was going to be the year of offshoring, as firms emerge out of recession they were going to look at offshoring as a competitive enhancer. Market segments to consider were: Banking, Financial Services and Insurance (BFSI), healthcare, retail, remote infrastructure management (RIM), business process outsourcing (BPO) including analytics, data modeling, research and legal process work, and finally application development management (ADM).

This superficially indicates that as firms perfect the decision process on the activities that are offshored, the activities also gain a greater degree of complexity.

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The following figure (figure 6) shows that to counter the effects of economic crisis, the trend in business is to look for destinations both natural and new locations for the development of offshoring projects. The figure also shows the growth of the market for Business Process Sourcing, suggesting that the number of activities had grown in number and relevance.

Figure 6 Global Sourcing Market Size (USD billion)

Source: NASSCOM, 2010

Here it is possible to identify another important trend that explains the rise of offshoring in the last years: the emergence of new destinations to outsource.

Beyond BRIC (Brazil, Russian Federation, India and China) Tier I (or most attractive country) sourcing destinations, there are more than 120 developing countries competing for foreign investments, whether in the form of offshore captive centers, delivery centers of world leading suppliers or through services provided by local suppliers (Kotlarsky, 2010).

According to the 2009 AT Kearney Global Services Location Index, eight Latin American countries, including Argentina, Brazil, Chile, Costa Rica and Mexico, are among the top 50 most competitive international locations for offshoring services

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(AT Kearney, 2009b). Other countries such as Colombia, Guatemala, Peru and Uruguay have been identified as important countries to watch (Gartner, 2009, Gereffi et al, 2009).

The latter is consistent with the motivation to write this thesis. For example, Colombia is beginning to be considered as a major destination country for offshoring activities. This country is now considered to be the 43rd main destination for services location according to the 2011 A.T. Kearney Global Services Location Index.

3.3.1 Political and economic debate

Apart from the growth of new destinations, the term offshoring in addition to its academic and practical relevance has acquired political and economic importance.

Politically speaking, offshoring has generated considerable debate, mainly in the United States, where 36 of the 50 states of the Union have implemented strong standards against the idea of offshoring. Politicians are using global services offshoring as an easy scapegoat for current economic woes and high unemployment levels in their home countries, stoking resentment against globalized firms and their foreign host countries (AT Kearney, 2011).

What's more, every day there is growing opposition from pressure groups, especially Unions. However, in other developed countries like the UK, political sentiment towards offshoring is much more positive. The political speech is moderate and more comprehensive as it is understood that offshoring opens the door for British firms to invest in other countries and benefit them from the positive aspects of globalization.

About the economic importance of offshoring in the past several authors have written books and studies that have covered the concept so broad and deep highlighting both positive and negative aspects of offshoring. Of course the idea is not to focus this thesis in the discussion of the economic effects that offshoring brings but these effects are simply set out to help cover the entire concept.

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Critics were quick to point that the new wave of white-collar offshoring as a major contributor to the poor performance of the U.S labor market, although the importance of offshoring relative to productivity growth, the bursting of the IT bubble, and other forces remains murky owing to incomplete data (Bosworth et al., 2004). However as pointed by Agrawal and Farrell (2006), focusing the offshoring debate in job losses misses the most important point: offshoring creates value in four ways. Cost savings, new revenues, repatriated earnings and redeployed labor. As pointed by AT Kearney (2011), firms are responding to intensifying cost-cutting imperatives by moving operations offshore.

The above is explained from the viewpoint of the company and effects, but if one go deeper from the consumer perspective, it will be possible to find that customers are not, in general, sympathetic to offshoring. Offshore centers almost have to outperform the domestic alternative to achieve customer acceptance (Smith, 2006). On the negative side one could mention that the pressure generated by consumers, the need for excellent service, the log-product delivery cycles, and political pressure, offshoring has suffered a backlash and the immediate effect is that in recent years the topic that has taken relevance is: reshoring. Reshoring is the firm decision to send back to the country of origin business activities that are not achieving significant growth in terms of cost savings, generation of new services or customer responsiveness. In the same vein, reshoring could also be the result of the lack of ability of the firm to control and monitor the flow of knowledge, information, processes to the vendors and their performance.

Contrary to what occur in other parts of the world, the political debate over outsourcing and offshoring in Latin America is still very bland. Generally, the topics of discussions are related to the protection of workers rights, immigration reforms, intellectual property protection and educational reforms. Despite the growth of the service trade in the region, the manufacture of products and the agricultural sector still plays a very important role. For example, in the last years Latin American countries have been those that have best withstood the first wave of the global financial and economic crisis and have continued to grow apace, thanks in large

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part, precisely to the high price they have kept to the raw materials and agriculture products. A sharp fall could compromise, or at least slow, this remarkable growth.

Following the economic sphere, in Latin America there is great expectation about the economic benefits the growing influx of firms wanting to invest and develop projects of offshoring could bring, and despite growing concern about job losses, the tradable services (or offshoreable) are still growing in countries of the regions as their economies turns global. There is still plenty to do but in some countries, these benefits are now a reality, for example, Brazil excels in IT and is a strong platform location for software developers and systems integrators. Mexico is becoming a more prominent Business Process Outsourcing (BPO) location, as it supports the United States with both Spanish and English. Meanwhile, Chile has emerged as a niche destination for R&D and analytics, while Costa Rica and Argentina continue to grow their offshore services presence despite facing some decline in cost-competitiveness (AT Kearney, 2011).

3.4 Offshoring definitions and business models

Offshoring still delivers a very vague and confusing definition, although many articles agree that prior to the turn of the 21st century, offshoring described the fragmentation and spread of production processes across many countries (Gereffi et al, 2009), and its productivity enhancing effects generally are small in manufacturing plants while being of a somewhat greater magnitude for firms in the services sector, including areas such as telemarketing services and software development (McIvor, 2005). For IT firms, offshoring is part of a larger trend toward the globalization of software under which software products and software services are created throughout the world and sold throughout the world (ACM, 2006).

There is no universal definition of offshoring (Treffler, 2005) and the term is in fact used to describe a multitude of scenarios (see Table 1), as it seldom explicitly in literature. Furthermore, academic research on offshoring often lacks a theoretical

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framework based on economic theories for argumentation or testing (C. Jahns et al., 2006).

Table 1 Sample of Offshoring definitions

Author(s) Definition Gereffi and Fernandez-Stark (2010)

The provision of a function or service beyond national, rather than firm, boundaries.

Chakrabarty (2006) The service provider is located in a country which is geographically far away from the clients country, this is also known as global sourcing. The term offshoring is often used to broadly imply nearshoring too.

Sako (2006) Offshoring occurs when firms move productive activities overseas, whether they are conducted by separately owned suppliers or by fully owned (captive) subsidiaries.

Olsen (2006) Contracting out business activities to foreign providers. Offshoring refers only to international relocations. The term offshore outsourcing therefore only covers the relocation of jobs or processes to an external and internationally located provider.

Brown and Wilson (2005) Offshoring or offshore outsourcing refers too contracting a company that is geographically distant. Performing or sourcing any part of an organizations activities at or from a location outside the companys home country.

Davis et al (2006) Offshoring is defined as the provision of organizational products and services from locations in other countries, whether they are actually overseas or not.

IDC (2010) Offshore, including nearshore, involves leveraging lower-cost regions from which to "source" either project-oriented or outsourced IT and business services.

Crin, 2009 Offshoring describe the situation in which a firm relocates some stages of production abroad, to either one of its affiliates or an unaffiliated supplier.

Doh, Bunyaratavej and Hahn, 2009

Offshoring of services can be defined as the transnational relocation or dispersion of service related activities that had previously been performed in the home country.

rdberg Jensen and Pedersen, 2011

Disaggregation, relocation, and reintegration of activities and business processes across borders, also known as offshoring.

More specifically, the business practice of offshoring focuses on the relocation of labor intensive service industry functions to locations remote to the business center, such as India, Ireland or the Philippines (Power et al, 2006), in this case offshoring involves the transfer of their production only abroad, either intra-firm, inside the subsidiaries of the mother-company abroad (captive offshoring), or

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extra-firm, to other firms (external offshoring). (Margulescu, S and Margulescu, E, 2010).

As mentioned above, offshoring helps the firms capture opportunities offered by globalization, since it has also been facilitated by economic integrationparticularly through liberalization in foreign direct investment (FDI)and by diaspora networks (Engman 2010). This is closely related to what Farrell (2006) pointed out: from the emerging country perspective, offshoring is just a new variant of FDI. In practice, offshoring is a consequence of the international division of labour and of globalization, which includes economic activities concerning services to be relocated to regions where investments can yield the greatest returns (C. Jahns et al., 2006).

When making a thorough review of the definitions of offshoring is possible to identify different elements related to: geographic location (domestic or remote) and contractual/legal variations. From the delimitation of these elements come different models to carry out processes of offshoring, although the most common are: the business model of internal development or captive offshoring, the model of acquisitions and the outsourcing model.

The figure (figure 7) below shows the offshoring models synthesized by C. Jahns et al (2006):

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Figure 7 Offshoring Business Models

Source: C. Jahns et al., 2006

Then, taking into account the contractual/legal dimension and the geographical dimension, the three models of offshoring are: offshore outsourcing, offshore development centers and captive shared services. In turn, these models reflect: the make alternative (shared services are kept internally but are housed offshore/captive shared services), the joint venture (partnership agreement/offshore development centers) and the buy alternative (firms sell projects to foreign firms to be executed completely offshore with low-cost, local labour afterwards/offshore outsourcing).

3.5 Drivers of offshoring

Offshoring has become significantly more strategic and is becoming integral to the conduct and perform of business (Lewin and Couto, 2006). This scenario also has been potentiated by the continuous shifts of business environments. For example, three important changes that enable firms to capture the opportunities offered by globalization are often referred to as political deregulation and the new openness consensus among political coalitions in developing countries, technological developments and economic and competitive pressures to reduce costs, and

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improve productivity (Olsen 2006, Pyndt and Pedersen, 2006, Treffler, 2005, Metters and Verma, 2008).

The dynamics of the drivers of offshoring is also evident from the firm perspective. In this regard, Lewin and Couto (2006) suggests that the companies pursuing the cost-savings benefits are those who have little familiarity and skills with the development of offshoring strategies, while companies with experience in offshoring processes and strategies besides cost savings take into account other factors such as access to qualified personnel, improving business processes and speed up their access to specific markets.

In addition to the definitions of offshoring and the models that arise from it, another interesting aspect of offshoring is how its driving forces have evolved over time.

3.5.1 Access to new markets

Over the past thirty years, product and financial markets have been liberalized, which has given rise to regional trade agreements like the EU (European Union), NAFTA (North American Free Trade Agreement), ASEAN (Association of Southeast Asian Nations) and MERCOSUR (Southern Common Market), among others. In addition, WTO (World Trade Organization) works to eliminate the remaining obstacles and to secure mutually open, transparent, and non-discriminating markets for goods, services, capital and technology (Pyndt and Pedersen, 2006). Despite this positive scenario, annual surveys on offshoring showed that the weight of access to new market as a driver for offshoring is decreasing in importance (Lewin and Couto, 2006).

3.5.2 Enhancing efficiencies: the role of technological developments

Regarding technological developments, in the past decade or so, advances in information and communication technologies have made it possible for more and more of these services to be produced in one location and consumed elsewhere they have become tradable (UNCTAD, 2004). Information and communication technologies (ICT) enables the digitization, encoding and standardization of

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knowledge and, consequently, the production of a wide range of services which can be de-coupled, fragmented or modularized, the resulting components being relocatable, in order to obtain cost or quality advantages, economies of scale or other advantages. Thus, the arbitrage strategies of various factors on national and international level have become feasible in the sphere of services (Margulescu S and Margulescu, E, 2010). At the same level of importance, historically, services were considered non-tradable and offshoring was confined to the manufacturing sector. However, the evolution and diffusion of ICT has increased the availability of offshore services in the global economy in recent years. Face-to face contact between the client and the provider in traditional trade is being replaced by remote service centers in the new knowledge era (Gereffi, Castillo and Fernandez Stark, 2009). In general terms, ICT plays an important role in facilitating firms decisions over both whether to outsource and offshore services (Abramovsky and Griffith, 2006) and also in the type of activities to be developed abroad.

Another major contribution of the development and advancement of ICT has been the improvement in response times to customers. The evolution of call centers is a good example; its cost structure has developed during last years enabling the transformation of the after sales services and the customers services strategies.

The offshoring of tradable services potentially affects firms in all sectors, and may have wider implications than the fragmentation of manufacturing (UNCTAD 2004). As an example, what began with the outsourcing of basic information technology (IT) services to external firms now includes a wide array of activities known as business process outsourcing (BPO) and higher value services associated with knowledge-process outsourcing (KPO), such as research and development (R&D), which were previously considered core functions of the firm (Gereffi, Castillo, Fernandez Stark, 2009).

3.5.3 Cost saving

In theoretical perspective, transaction cost theory helps to explain why the offshoring trend/practice has grown significantly in recent years and is now a

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reference for both managers and academics. This theoretical framework is in particular useful to understand that in order to achieve efficiency in the processing of information it is important to take into account not only the asset specificity but also the specialized governance structures associated to the type of transactions, the frequency at which transactions are conducted are the uncertainty surrounding transactions.

Cost saving was considered by early practitioners and for a long period of time the main trigger of offshoring and the reason behind its growth, and low labor countries as the main offshoring destinations (Sparrow, 2005; Van Gorp et al, 2007, Cerruti, 2008, Bunyaratavej et al. 2010) since there has been a wave of reforms aimed at integrating low cost countries into the world economy. But at the same time this also could be a misleading view for one special reason, 85 percent of U.S offshoring is with other OECD countries (Treffler, 2006) where there are similarities in wages and the cost saving is minimal.

Cost advantages can for example be realized through less-restrictive work rules (e.g. regarding wages and dismissal), lower land and facility costs, cheaper raw materials (for manufacturing), intermediate parts and components (as well as low technology costs), host country location, the sourcing model adopted, the proportion of onshore to offshore work, management overheads and productivity levels at the offshore company (Cho, 1988, Fagan, 1991, Weidenbaum, 2005, in Van Gorp, 2007; Sparrow, 2005).

3.5.4 Emergence of new drivers: access to talent

Today firms are looking beyond issues related to cost reduction through labor arbitrage and relocation of operations in developing countries. Offshoring is now motivated by a combination of environmental pressure, efficiency, and competitive pressure (Tate et al, 2009) also, partly by a change in the mindset of managers and strategies of firms to access high labour turnover in local facilities, access to specialist service providers, access to qualified personnel, improve speed to

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market, risk management, and optimization of processes (McIvor, 2005, NASSCOM, 2010).

Clearly, this does not only benefit firms on the demand side but also directly benefits the countries that are traditional destination for offshoring, encourage the emergence of new offshoring destinations and firms in the supply side. And as McIvor (2005) pointed out, greater competition from offshore product and service providers can act as a stimulus for local providers to achieve productivity improvements and higher levels of innovation. These levels of innovation and productivity management are the prime example in the growth of technology centers in developing countries.

This is directly related to the aforementioned competitive pressure. Moreover, if one want to see the impact of offshoring in the services market it is possible to find that it has become highly competitive, and differentiation of service offerings and leverage of inherent advantages, including cultural and language affinities, set the scene for keen competition between offshoring destinations (Kotlarsky, 2010).

Other factors associated with competitive pressures include wage differentials, interest rates, development of capital markets and capital costs. In addition to repatriated earnings and cost savings, Farrell (2005) argues that offshore outsourcing helps developed countries to increase their export sales (and therefore employment), since it stimulates the macroeconomic growth of developing countries and therefore increases also their imports.

If one discuss about the type of environmental pressure, one might find that the factors that drivers of offshoring are related with are: the education level of employees in the supply side, including age, social structure, and skill in using foreign languages.

One of the drivers that most developments have had in recent years is definitely the access to qualified personnel. For the firms strategically speaking, the ability to offshore depends on there being a pool of well-educated job candidates offshore, a sizable gap between their pay expectations and those of their peers in the

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employers home market, robust distributed communications technology, a set of liberal trade rules, and growing confidence among firms in the stability of emerging markets (Farrell, 2006). For the host country, have a qualified pool of candidates has a direct influence on national policies for education and innovation. In practice, countries should respond to the needs of the market with investment in education programs specifically targeted at sectors of the economy that that can be positively influenced by flows of offshoring. In general terms, the offshoring of an increasing number of white-collar jobs from developed to developing countries presents a significant economic opportunity to any developing nation having a low-cost and educated workforce (Mullan et al, 2008).

On the other hand, when mention the topic of efficiency is valid to say that is related to the use and development of technological, communications and transport infrastructure of a host country. These factors serve to reduce the geographical distance as a result of forward international outsourcing process, and also allow the firms to enhance efficiencies, improve service levels and improve response times to customers. Similarly, it may also offer reduced time to market, access to foreign markets, facilitate, and create business opportunities for the development of new products for niche markets. International outsourcing allows firms to focus on what they do best, freeing up capital to be reinvested in research and development and more productive activities (Engman, 2010).

In the 2007 Service Provider Survey Report from The Duke Center for International Business Education and Research (CIBER) and the International Offshoring Research Network (ORN) it was mentioned that offshoring is no longer just about lowering costs by moving manufacturing and back-office operations to labor-efficient locations like China and India. Nor is it about modularizing and outsourcing transaction intensive IT operations and business processes. More than ever, offshoring is about sourcing the talent needed to sustain the innovation engine of a company. Figure 8 shows the influence of different drivers for offshoring in the companys decision to offshore.

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Figure 8 - Drivers for offshoring

Source: Duke Offshoring Service Provider Survey 2007 2009 in NASSCOM, 2010

The confluence of new drivers such as access to talent, increasing speed to the market, offshoring as part of a growth strategy, offshoring as a way of access to new markets and offshoring as a way to improve service levels suggests that for the firms offshoring is no longer perceived as a strategy to generate profits and grow in the short term, and has evolved into an important tool to achieve strategic benefits in the long-term (Lewin and Couto, 2007).

From a country perspective, it is important to know if the confluence of new drivers are the result of the adoption of a structured and methodical model to capture the benefits of offshoring to secure benefits and growth of a particular segment of the economy of the country, or simply a short-term plan to potentiate quick wins, but more importantly, to determine whether the search for strategies to foster the growth drivers is the result of a replica of positive offshore model/experiences (other countries) or the adoption of a model adjusted to the reality of the country.

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4. The nature of the activity and its relation with offshoring

We have seen how different elements linked to the concept of offshoring have evolved and how the concept of offshoring has become a crucial strategy for firms. In like manner, offshoring is also a major challenge for host countries, institutions and policy makers. This becomes clear when countries start down the path to grow as a preferred destination for offshoring activities, while at the same time, understand and manage the increasing sophistication of the range and volume of work done offshore. As an example of this challenge, among the key emerging markets, e.g. Middle East and Africa, Central and Eastern Europe (CEE), South America and Asia, some attract more high-value activities, such as research and development (R&D) and knowledge-intensive processes, while other are competing mainly on labour costs, struggling to differentiate (Kotlarsky, 2010).

One of the main points of departure for discussing the influence of the nature of business activities subject to offshoring is the reconfiguration of value chains of firms. In developing countries, the effect of the reconfiguration (also disaggregation) opened new fronts for business activities that previously had no or less option of being offshored in as many different segments (i.e. procurement, call centers, legal and financial operations, R&D, reverse innovation, among many others). This suggest that there is a highly competitive market for countries whose offer includes an interesting mix of cost, access to talented workforce and stable external environment for firms.

In support of this observation, Offshoring Research Network 2006 survey findings indicate that the choice of offshore locations varies greatly by the function or process to be offshored and much less so by the industry of offshoring firms (Manning, Massini, and Lewin, 2008).

From the point of view of the firm, it has been argued that when the processes are complex they are unlikely to be offshored, and when the activities have acquired a degree of maturity, stability and modularity they are likely to be offshored. At first

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instance, this argument would seem very simple, but it is worth to go deep in the background to realize the impact of the nature of the activity within the context of offshoring. In the same order, as the following chapters unfold it will possible to see how the nature of the activity also becomes a factor of special consideration for the host countries.

Thus, the key subjects to be analyzed in the following paragraphs are: the growing diversity of services, and the effect of that diversity in developing countries. In that order, the main purpose of this chapter is to answer the following questions: a) How is the nature of the activity defined?, b) What kind of activities are considered for offshoring, what are its characteristics and its relationship to the level of knowledge and level of customer contact?, and c) What kind of requirements are necessary to carry out certain business activities?

4.1 Nature of the activity

c) How is the nature of the activity defined?

One important gap in the literature of offshoring was the generalization that was made on the business activities and their nature. Once the review of the definitions of offshoring was completed, it was possible to find expressions such as: tasks, activities, processes, business processes, services and operations, among others, without finding significant differences between them. In recent years, several authors have begun to highlight the differences between activities with a common point: the importance of knowledge (Maskell et al, 2007, Manning et al, 2008, Neely et al, 2011, Youngdahl and Ramaswamy, 2008 and 2010, rdberg Jensen, 2009, Doh et al, 2009)

Within the literature on offshoring, the nature of the activities is considered to have special weight as a factor influencing the decision process of offshoring (Doh et al. 2008, rberg and Pedersen, 2010, Dedrick et al. 2011). This is fully referenced in the "Foundational conceptual model of offshore sourcing factors" proposed by Dedrick et al (2011). Along with firm-level management practices and capabilities,

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and the economic drivers, the authors referenced the nature of the activity being considered to be sent abroad as an important feature for firms with offshore operations.

In this section, the author will make a more detailed account of each of the elements that determine the nature of the business activity, based primarily on the following literary classification:

Figure 9 Literary classifications to understand the nature of the activity

Source: Own work

4.1.1 Knowledge For Youngdahl and Ramaswamy (2008) the nature of the activity is defined by two essential elements: the knowledge that is embedded in the work, and how much contact offshore service providers have with customers. Starting with knowledge, the authors made a distinction between tacit knowledge, i.e. the type of knowledge that cannot be codified and applied in repetitive activities; and explicit knowledge, which is easily transferable at any point where the activity occurs. Similarly, the

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authors establish a relationship between the level of knowledge and skills necessary to perform an activity, i.e., transactions that contain a high level of knowledge embedded will generate solutions with a significant degree of innovation and transformation capacity, while transactions will be more simple with a low or null component of change and innovation when the activity has any knowledge embedded.

This differentiation between the levels of knowledge embedded that is necessary to perform business activities makes it essential to look for different sources of talent that are not available locally, and that is why this simple relationship between demand and supply of knowledge could explain why, today, access to talented human capital is one of the main drivers of offshoring.

4.1.1.1 Codifiability The codification of knowledge is a facilitator of the flow and transfer of information throughout the service value chain (Dedrick et al. 2011, Mithas and Whitaker, 2007). However, throughout that chain of information it is possible to find some drawbacks, such as the transfer of tacit knowledge. Due to the nature of tacit knowledge, the information can be found in the form of mind maps, past experiences and beliefs that reside in the minds of individuals, and therefore are difficult to transfer to others. Tacit knowledge is a great tool to interpret information and is used by firms or organizations to develop high value-added activities and generation of innovation.

On the other side of the balance is the explicit knowledge, which by its nature is formal, codified, and can be easily shared. This knowledge can be transmitted through formal language and in a structured way.

Despite having different characteristics, the two types of knowledge are complementary. When knowledge is transmitted in a structured manner through written instructions, formalization of processes, or flow charts, it could be possible to understand processes that may be considered as complex. Finally, coding facilitates the analysis and transformation of business activities, because it provides input that allows the creation of knowledge and innovation.

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4.1.1.2 Repetition Following the ideas proposed by Peter Hill (1999), Doh et al (2009), proposes a new typology of offshoring service attributes in which the repetition is part of the dimensions of interest. The key of the repetition is the undifferentiated nature of services. Standardized activities tend to have low embedded knowledge, and could also be classified as explicit knowledge activities. Business processes with a high degree of repetition require a stable political and business environment, as well a sound legal system to protect their normal development. Activities related to back-office processing and call centres contain a high degree of repetition.

4.1.1.3 Innovativeness It is a key element in understanding how the of the activity influences in the process of offshoring. The capacity of innovation is the border that reminds us that offshoring is not only cost savings but also is generating new knowledge. Doh et al (2009) the location of specific offshoring business activities is highly influenced by innovation and at the same time, innovation is related to the development of business activities highly specialized that require highly qualified personnel. According to the 2007 Service Provider Report, this relationship between the capacity of firms to innovate, knowledge services and the access to qualified personnel is offering the highest profit margins to service providers and the highest savings to clients.

4.1.1.4 Process maturity Firms find easy to offshore mature and stable processes as opposed to unstable processes that cope with constant changes and requests from customers (Dedrick et al, 2011). The stability of a business activity generates benefits for the business and reduces the risk of failure. Process maturity could be linked with high performance because it is constantly challenging the firm to deliver its customer solutions with high standards, reliable, predictable, but most of all, efficiency. In the same order of ideas, process maturity could be achieved after a continuous process improvement conducted intra-firm by removing unnecessary load of work, identifying bottlenecks and increasing control throughout the whole value chain of the business activity.

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4.1.1.5 Modularity Tanriverdi et al (2007:283) define process business modularity as the extent to which a business process is loosely coupled, mature, and standardized enough to be separated from a firms other business processes, executed independently, and recombined without loss of functionality. There must be control mechanisms (i.e. use of standardized interfaces) to ensure the flow of information in order to identify early problems or bottlenecks, or simplify the communication between modules with specific inputs and outputs before they are recombined.

Modularity has a positive inference in the reduction of transaction, production and coordination costs. The key in the reduction of production costs is that with modularity it is possible to source processes from markets, since vendors offer standardized services reaching economies of scale. Coordination costs are reduced due to the action of specialized interfaces that serve as synchronization methods between processes. Finally, transaction costs are reduced due to the sense of lack of interdependence between vendors and firm.

4.1.1.6 Complexity Complexity is a very interesting area of study because, somehow, comprises almost all the factors that determine the nature of the business activity. The issue of complexity has been widely discussed from the standpoint of product manufacturing, as well as its influence on the buying and selling decisions of the firm. The opposite has happened for the services segment, where the literature is scarce. According to Standish (2008), the concept of complexity has two key features: complexity in terms of quality and complexity in terms of quantity.

Complexity in terms of quantity is related to the number of parts of a system and the relationships (connectivity) that emerge between them (parts). Another element that is taken into account when speaking of complexity is terms of quantity is the amount of information embedded in the system, meaning that, the more information circulates around the system, more complex will be considered. An additional element of study appear when the parts of the system performing a business activity through their different types of relationships exchange information. The message containing the information is the key to understand

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better the nature of the activity being sourced because it contains codified knowledge. Then, a relationship is observed between this additional element of study within the complexity in terms of quantity and the encoding of information in a way that can be transmitted easily across firm boundaries and geographic distance.

Complexity in terms of quality refers to the presence of emergence in the system, or the exhibition of behaviour not specified in the systems specification (Standish, 2008). Here one can perceive a close relationship with another element that determines the nature of business activity subject to offshoring. When a business activity comes to a state of maturity and stability is easier to predict its behaviour along the value chain mainly because in the medium/long term obstacles to develop the activity are clearly and easily recognized. When a system is unstable or there are many requests the customer, it is more difficult to manage offshore, and therefore less likely to be moved (Dedrick et al, 2011).

Novak and Eppinger (2001) also studied the relationship between product complexity and the supply chain. Specifically, they identified three main elements in product complexity: a. the number of product components to specify and produce; b. the extent of interactions to manage between these components, and c. the degree of product novelty. The authors applied these elements to examples in the automotive industry. In reviewing these elements it might be possible to establish a relationship with the factors that determine the nature of business activity.

The first element, the number of product components needed to produce is related to the effects of adding new components to an activity and the need to monitor its performance as part of a system or process. In offshoring the modularity is key concept in the linking of different activities performed independently. The authors mention that adding more parts (in an assembly line) adds to the coordination needed to ensure vehicle development. In offshoring the modularity calls for close and frequent coordination in order to solve problems in a short period of time.

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The second element in product complexity is the interaction between components and their interconnections. Once again, modularity seems to be the direct relationship with the factors that define the nature of the activity, due to the ability of modularity in the regulation of relations of interdependence between the parts of a system and the flow of knowledge activities. When modularity is high, offshore strategies are easier to perform, whereas when the modularity is low, knowledge activities are difficult to separate and execute in remote locations. On the other hand, the interaction between components of a system could be considered as interactions between customers and vendors and the different requirements that are suggested by customers to implement different business activities.

Finally, the third element in product complexity is the degree of product novelty. Following the application in the automotive industry, the authors suggest that a set of interactions is needed every time there is a new interface or technology inside the system. This position is very similar to the one observed in the first element and the need to establish coordination mechanisms to ensure that the work done in one part of the process is not going to affect the next stages.

4.1.2 Customer contact The second essential element that helps define the nature of the activity is the service contact. Hill (1999) suggests that among consumers and producers reciprocal relationships exist due to the nature of services: one cannot exist without the other and a service must be provided to another economic unit (i.e. buyer-supplier relationships, or HQ-subsidiary relationships).

Doh et al, 2009 also look after this analysis by mentioning that international offshoring and international services trade are related to the extent that the output of offshoring activity provides a service to an internal or external customer. This flow of information between supplier and customer is affected by operating conditions in host countries. Factors such as infrastructure, technology and level of interaction with a foreign language are required to support real-time person to person information interactions.

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Clemens and Aron (2004) raised an interesting debate about the need to change the idea that complex business activities should be developed only within the firm. The logic of maintaining the complex processes within the firm is related to the risks associated with the execution of the activity and the risks associated to the relationships between the parts of a system.

First, strategic risks are those that result from interactions between vendor and customers, and are presented in three ways: opportunistic renegotiation, poaching and principal-agent problem.

Poaching is the result of lack of control mechanisms for information flows in a vendor-customer relationship. The absence of these mechanisms facilitates the loss of control of intellectual property and reuse of information for the benefit of the vendor. The reuse of information means that key parts of processes that contain a high percentage of information can be used by the vendor to generate profits, either by selling it to the same or new ones. The authors explain it in a very clear way, the reason that outsourcing complex tasks appears more dangerous is that simple operations do not teach the vendor much, but complex operations may teach the vendor a great deal in terms of pricing strategy, trade secrets or classified information (Clemens and Aron, 2004).

Opportunistic renegotiation refers primarily to relations of interdependence and their levels of vulnerability. Interdependence is generated by the type of investments that make the parts of a system. For example, when one activity is considered for offshoring, investments are needed for the training of the workforce to understand and develop the activity. These investments will regulate the contractual relationship between the parties.

Principal agent problem refers to the different attitudes taken by vendors when developing an activity. Many times the customer's objectives are not aligned with the objectives of the vendor and instead of being a collaborative relationship between the parts; the relationship deteriorates when the quality of the result is not expected.

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Second, the operational risks or those associated with the implementation or execution of the activity. Clemens and Aron (2004) explains that they are the inevitable result of the difficulty of coordinating complex operations across great distances, with imperfect information, and with limited understanding due to cultural differences, language differences, or lack of shared context and experience.

This approach suggests that operational risks seem to be more aligned with the capabilities of a host country, whereas strategic risks are related to the elements that determine a relationship between vendor and customer. In this regard, the framework proposed by Clemons and Aaron (2004) serves to perfectly fit the elements that define the nature of business activity and have been exposed in the preceding paragraphs. For example, coordination costs are greatly influenced by a country's ability to provide stable infrastructure to promote the exchange of information between the parts of a system, likewise, the process of offshoring are greatly affected by the difficulty of having a staff with sufficient technical knowledge and educational preparation for development of activities with different loads of embedded knowledge. The authors also emphasize the importance of cultural differences between vendors and customers in terms of knowledge and management of a common language that benefits the transit of the activity and its message through the value chain.

4.2 Types of offshoring activities

d) What kinds of activities are considered for offshoring, what are their characteristics and its relationship to the level of knowledge and level of customer contact?

According to UNCTAD (2004) there are three sectors (figure 10) representing the main categories of services offshoring: call contact centers; IT services centers; and shared services centers. These three categories implicitly suggest customer contact and knowledge integration the same way as proposed by Youngdahl and Ramaswamy (2008).

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Figure 10: Definitions of export-oriented FDI projects related to offshored services

Source: World Investment Report, UNCTAD (2004)

From the study of the interaction between vendor and customer, several authors have identified different types of classifications of services. One of the most important is that proposed by Chase (1978), which provides a differentiation between front-office services and back-office services, the major difference being the level of contact maintained by the service providers with customers.

4.2.1 Front-office services For example, for the front-office services customer participation is much more active both in the process of production and development of the business activity, even until the time of delivery (Youngdahl and Ramaswamy, 2008). This includes the concept of empowerment of employees of the vendor, in order to facilitate contact with the customer. The ultimate goal is to achieve flexibility, reliability and quality in real-time decisions to be taken, and to do it is important that employees have excellent training and possess the knowledge necessary for the continuity of service.

4.2.2 Back office services In the case of back-office services, approach differs in terms of the activities performed by employees and the level of contact with the customer. Normally the activities are characterized by the high level of standardization, maturity and stability. Likewise, the modularization of activities is easier with this type of services.

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The result of the merger and evolution of knowledge and customer contact produces a fundamental change in the behavior of service providers and the environment or context in which they operate. The task execution routines are quickly replaced by the ability of the foreign affiliates or the foreign suppliers to solve problems and develop more complex processes that require a high percentage of knowledge and that often res