Nearshoring is not a new phenomenon. Many major US and UK-based IT companies had been using the lower-cost employees of Canada and Ireland for many years until India, and to some extent the Philippines, became the dominant players attracting the largest slice of the offshore outsourcing pie. After targeting India and the Philippines as the prime destinations for offshoring technology and call-center jobs, major US and European companies are now looking towards Latin America, Canada and Eastern Europe to meet their offshoring requirements.

Nearshoring, as we know, was restricted to time insensitive tasks such as manufacturing, IT application development, remittance processing, medical transcription, and outbound tele-services in the past. However, as borders fade, commerce alliances grow, and technology connectivity improves, nearshore labor sources are increasingly becoming relevant for service and high-end work. Encouraged by the rapid dispersal of IT services jobs to India, and the resultant economic growth, countries throughout Europe are pitching themselves as the ideal nearshore locations. And many major players are leveraging the cost, and skill advantages available in their own backyard.

Companies all around the world are looking for the ‘right shore’ for their business services, and they now have unlimited options, combinations, and migration possibilities. And sometimes, rightshore for some, is nearshore.

Impressive List

Quiet a few companies have already formed shared-services centers to consolidate their back office and IT functions, often locating European hubs in lower-cost areas of Eastern Europe. The US-based IT services companies have also made significant investments in the Czech Republic, Hungary, and Poland, taking advantage of the abundant multiple language skills required to service the European market.

DHL, for example, is shifting activities from Britain to the Czech capital, where IT workers cost 30-40 percent less than their UK counterparts. They recently announced investment plans for 500 million euros over five years, and aim to employ 1,000 people in Prague to track customer shipments and billing in Europe.

Leading global services supplier, Accenture has plans to increase employees five-fold to 1,500 at its finance and accounting outsourcing center in Prague in five years, to offer hosting and outsourcing services, and bolster its software-development services in the region. GE, which has an IT and back-office support center has plans to ramp up manpower and employ 500 people in Budapest by the end of this year. Diageo has opened a back-office support center in Budapest, employing 300 people; and in Lodz, West of Warsaw. Also, financial major CitiBank Handlowy employs 300 people in a settlement center in Olsztyn, North of Warsaw, processing transactions for Poland, the Czech Republic, and Slovakia. They have plans to soon expand processing coverage to include Hungary and Romania. Process automation and improvement software maker Versata, has also decided to transfer its Bangalore development center in India to Halifax in Nova Scotia, Canada.

Interestingly, the leading Indian IT service companies are also preparing to set up operations in the new low-cost ‘nearshore’ locations of Central and Eastern Europe as businesses look beyond India for offshoring. Genpact, formerly Gecis, announced that it would open its next BPO center in Bucharest, Romania as part of the company’s larger global expansion strategy. The center will primarily serve the company’s European clientele, forming part of the 25 percent of the company’s workforce located outside India. Besides, TCS, Infosys, and Satyam are also setting up service centers in Eastern Europe to address their European market. TCS’ European clients include telecom firms Ericsson and Nokia, insurer AXA SunLife, Standard Chartered Bank, and Deutsche Bank.

At present TCS carries out work for its blue chip European client from India but chose Hungary to service its European clients. Similar is the case with Infosys and Satyam.

Nearshoring, as has been said earlier, is not a new phenomenon, but given the impressive list of companies looking at these new European destinations, one is forced to think why there is a renewed interest in nearshoring. Obviously, these countries must be doing something right or the existing hot bed of offshoring, India, is doing something wrong.

So why are firms nearshoring?

Buyer Satisfaction Dipping

Even though India has an abundant skilled human base as well as competitive costs, there are various risks that companies face when IT services are offshored to India. DiamondCluster International’s annual study of IT outsourcing found that the number of buyers satisfied with their ‘offshoring’ providers has fallen from 79 percent to 62 percent. In addition, the number of buyers prematurely terminating an outsourcing relationship has doubled to 51 percent. According to the DiamondCluster 2005 Global IT Outsourcing report, increased management complexity is a deterrent. The more the distance, the more the management complexity, and the cost of this additional management is an added hidden cost to the project not computed initially.

Even while cultural differences and lack of communication experience in India do create hurdles in a project, communication is also hindered by the time -zone differences. But that’s not all.

Productivity Concerns

Another important reason for firms nearshoring is that the promise of productivity continues to be elusive in global service delivery (GSD) operations. According to a TPI study on State of Global Service Delivery, expectations for productivity appear to run a course of unjustified optimism in the early years to a more rational expectation, by experience, in later years. Among respondents with less than a year of GSD experience, a mere 17 percent stated that their global productivity is reaching expectation. At the other end of the spectrum, among companies with five or more years of experience, there is a 40 percent satisfaction. By no means optimal.

This must be driving companies to look at destinations near home, beyond India, and other traditional offshore locations. Besides the US companies, numerous German firms realized that outsourcing services to the offshore destination like India could not fulfill their expectations. Instead of finding a solution to their cost problems they were confronted with new cost predicaments, which lead back to differences in culture, and language with their providers. For this reason, the number of German firms, which pursue nearshoring, is steadily increasing. Germany is the second largest outsourcer, mainly making use of cheaper costs in Eastern Europe.

In a study about offshoring strategies of European financial service providers, AT Kearny confirms the appeal of European nearshore locations in contrast to the conventional offshore destination-India.

The rising salary and lower productivity are serious concerns. The TPI report suggests that India is no longer the sole choice of location for a global company, as Brazil and China loom on the horizon, and Eastern and Western European firms find business easier across familiar borders. Srikanth Ramanujam, head of nearshoring IT Services group of Indosoft says, “As offshore outsourcing to India grows, other options like nearshoring are growing too. Over the next five years or so, labor costs in India will considerably go up due to demand and high attrition, lower input of fresh quality resources from Indian educational institutions, and higher labor costs paid out by MNCs such as IBM, Accenture, Oracle, which may lead general rates to go up over $30 per hour from India.”

Unmet Expectations in India

Many large multinational organizations that located their shared service centers in India did so, anticipating an unlimited supply of skilled labor. According to Gartner, this expectation, specifically for educated recruits with good English-language skills, has not been met – even though there are more than 2.5 million college graduates in India each year.

Gartner predicts that high staff attrition will occur as professionals switch companies to advance their careers, or improve their salaries. Although high employee attrition by itself is a manageable issue, a shortfall in qualified personnel will affect costs, as service providers offer employees better salaries, and benefits to stop the high attrition rates. Over time, these measures will blunt India’s competitive advantage, which it currently enjoys in the area of labor costs. The shortage will also impact upon the quality of staff employed by the industry, realizing which many companies are looking at other options like Canada, Mexico, and the Caribbean. Canada for instance, combined with solid infrastructure, possesses superior employee retention rates, and business process experience, despite high labor costs. Companies who are averse to high risks are looking at these countries for their offshore needs.

Satisfactory Skill Sets

According to Peter Ryan, a call-center analyst at Datamonitor says, “The EU-based firms are impressed with Central and Eastern Europe’s, and North Africa’s educated labor pool that is growing in its multilingual capability. An available work force that is located relatively close to major EU centers, combined with modern telephony infrastructures work in favor of nearshore outsourcing.”

There’s little doubt that offshoring offers significant financial benefits for companies across a wide range of fields and sizes. Undertaking such a venture, however, requires a cost benefit analysis that includes downsides such as political instability, language, and cultural barriers, and time zone differences.

While over 75 percent of companies (according to recent estimates) have decided that the potential benefits outweigh these costs, many potential outsourcers are willing to sacrifice some cost savings for significantly limiting their risk. Therefore, companies are increasingly looking at nations such as Canada, Mexico, and South America – the so-called nearshore destinations.

Ramanujam gives an interesting insight. He says that with offshore outsourcing maturing, companies are recognizing that the model may not suit all types of projects and the value offshoring offers, and the risk trade offs are different for different kinds of projects and services. Therefore, there seems to be a renewed interest in nearshoring. Consulting firm KPMG has stated in its Competitive Alternatives report, which compares business costs in North America, Europe, and Asia pacific, that a 110-person software firm would have annual costs of less than $8 million in Halifax. The costs in Boston, and New York topped $10 million and $11 million, respectively.

Those kinds of savings are passed on to companies contracting for software support. So organizations going to Canada see 15-20 percent cost savings, compared to outsourcing IT domestically, while, Mexico offers costs as low as one-third of what a company would spend onshore, said Atul Vashistha, CEO, neoIT.

The US service providers recognize the savings. Firms such as Keane and Compuware have set up nearshore locations in Canada. Big players such as CGI, EDS, and IBM also have nearshore operations, he adds.

Governments Offer Sops

Besides, many countries are offering sops to attract firms keen on offshoring and tap into the huge outsourcing pie.

Countries including Brazil, Nicaragua, Panama, and Costa Rica are aggressively adopting business-friendly policies ,and also marketing themselves as BPO friendly destinations. Dell and Procter & Gamble (P&G) are some of the major MNCs looking at the Latin American countries to source such services. P&G currently operates a 1,000-employees center in San Jose, Costa Rica to handle financial, and infrastructure systems support.

Countries such as Costa Rica also have an extensive social-security system that makes it easy to perform background checks. Intel, which has been manufacturing microchips in Costa Rica since 1998, recently launched a software division there, while call-center operator Sykes Latin America employs Costa Ricans to provide support to its corporate clients, thanks to the friendly regulatory environment.

Companies Leveraging NAFTA

Another reason why companies are looking at destinations in North America is primarily because of the North American Free Trade Agreement (NAFTA). Since nearshoring partners can take advantage of the NAFTA treaty, it is much easier for them to gain access for visas, besides NAFTA also ensures that intellectual property is protected.

Eastern European countries are proving attractive because of their relatively low-cost skilled labor force, attractive regulatory environment, and close proximity and cultural ties to Western Europe. Interestingly, all types of companies - large and small are nearshoring. For larger players, it is a question of adding nearshoring to their employee, inshore, consulting, and offshore mix. For smaller companies generally offshore outsourcing is not an option due to management overheads and higher risks, so they prefer local or nearshore vendors.

In conclusion, it may be said that the optimal outsourcing destination for any firm will depend on finding a successful match between its unique requirements and the services each destination may offer. Given the fact that there’s a much larger pie for all, nearshoring will continue to figure in company’s strategy. Robert Zahler, partner, Pillsbury Winthrop Shaw Pittman’s global sourcing group, believes that the industry will continue to see increasing capabilities of all sorts (i.e., information technology, business process, call centers, etc.) from various nearshore locations, just as these capabilities will continue to expand in India, China, and the Philippines.