Labor Arbitrage in Nearshore Outsourcing is Dead Declares Gartner’s Karamouzis

The offshore services sector has come a long way since the nascent years of coding and platform development, moving to infrastructure, remote management and knowledge processing, among other things. The next growth cycle, however has a distinctly Darwinian flavor, says Research Vice President at Gartner, Frances Karamouzis. Labor arbitrage, Karamouzis says, is no longer the main motivating factor in the Nearshoring decision-making process. Although there will always be a difference in the wage rate, if a service company is not providing value beyond labor arbitrage –such as high quality employees or the level of IT services– there may be no benefit to continue using them after the fiscal year expires and the impact of lower wages has been calibrated.

Pure Value

In June 2010, after an observatory trip to Eastern Europe, Karamouzis forecasted that “the global market will undergo an important shift from pure labor based driven models for value to Intellectual Property (IP) driven models.” One year on, the analyst recounts that although the market is “seeing many Knowledge Process Outsourcing (KPO) offerings based on IP, a lot more proves to be industry specific Business Process Outsourcing (BPO) operations.”

“As more globalization happens there is going to be a normalization of what are minimum levels of business requirements“

Generally, a five to ten year cycle is required before these services can take hold, and it requires large investments. She points to Chile as having “extreme depth with KPO, providing high skilled labor as opposed to handing off specs and having the coding done.”  This shift enables providers to offer a lot more services and deliver them from a wider variety of staff. Additionally, a byproduct of these types of services is that technicians have the opportunity to move into a different class, shifting the socio-economic fabric of a society, thereby creating a whole new consumer group where they didn’t exist before.  “One of the reasons why Brazil is interesting is because the economy is flourishing, and you have a whole new crop of consumers for business services, and that creates a whole new dynamic,” Karamouzis said.

Decline of Risk

Just like any industry, Nearshoring faces challenges. Karamouzis points out clients need to look at the vendor profile, the laws associated with the transactions, treasury risks and risks around security. While these areas might seem to be a matter of common sense, they are also easy to overlook. “As more globalization happens there is going to be a normalization of what are minimum levels of business requirements are, so over time risks will go down. If you went to India 20 years ago and tried to do what you today it would be different because it wasn’t the norm to have data centers, or power generators. Now they are is normal requirement to do business with the US. Even things like fluency in English have increased over time as more companies want to transact business.”

Karamouzis doesn’t view the effect of the current US debt crises on Nearshoring as more onerous or less onerous than other industries. “You are dealing with vendors in one country and consumers in another; both are impacted because buy and sell is happening. The fact is that our economies are very tethered where an economy like Greece impacts the US – I don’t think the Nearshore industry is immune to that, it is equally susceptible.”  Economic considerations are one factor that can possibly drive companies to repatriate their Nearshore operations, but Karamouzis hasn’t seen a mass exodus. “New business is going to places like Latin America but I would not characterize that as repatriation.”

Nearshore Americas recently published an article about the repatriation of contact center operations from India back to the US and the UK, to which Karamouzis responds, “If you look at the last ten years you will see that clients felt what they contracted with for voice services in India was not what they got, they didn’t do the right research, or due diligence. They could get better actualization in Costa Rica for example. In outsourcing it is common place when someone isn’t happy they switch vendors, which is a little more prominent in the way it sounds to end user, but the percentages are not much different.” She has seen, however, a steady increase in “Rural Sourcing” or “Home Sourcing” due to regulatory, tax or political issues, over the last five to seven years, but not the double-digit growth rate experienced by Nearshoring.

Looking to the future Karamouzis believes that Brazil, Mexico, Argentina, Chile and Costa Rica will enjoin to become a competitive force to India and China. Of course, each country will specialize in different services, for example, “Chile is very important for KPO, Brazil can be a mighty force for financial services.” Karamouzis forecasts M&A activity will increase in Latin America, but not on the scale that is seen in China or India. “These countries are small in comparison. There are lots of companies scouting Latin America to get a foothold in the market.”

In the end, Nearshoring is a “survival of the fittest” game and if a company doesn’t offer a viable product over time they will phase out. “This industry is difficult because it is fragmented. The market share of the top ten vendors is not more than 25% combined; 75% of the providers are small to mid sized players and it is difficult to establish significant brands. It is a very Darwinian business.”