How cultural differences influence the level of transaction costs in Offshoring projects

Examination Thesis, 2012

20 Pages, Grade: 9


The influence of cultural differences on the level of transaction costs in Offshoring projects

1. Introduction

In the last 10-12 years the Offshoring strategy became very popular. Companies increased to outsource parts of their processes and services to low-wage countries such as India or Czech Republic. And the use of the Offshoring strategy by the European and American companies is increasing year by year. Today the current Offshoring market size has a value of about 145 Billion Dollars, until 2015 it is estimated at about 500 Billion Dollars (XMG Global, 2011). This implies how important the Offshoring strategy got and is going to get. The reasons why companies are performing the Offshoring strategy are pressures coming from diverse directions: increasing material costs, entrance of more foreign competitors on the local market, higher customer expectation, etc. And companies regard Offshoring as way to cope with these diverse pressures so that they can stay competitive on the market. The biggest benefit what companies are expecting with Offshoring is the cost reduction by outsourcing their processes to countries where the wages are low. But this simple cost calculation by looking mainly on the amount of wage differences does not always function, but rather will lead to the failure of an Offshoring project. There are more costs which have to be considered, especially when engaging with a partner from another culture and perhaps from a far distance country. And here I am going to look closer on one essential part of the Offshoring costs, namely the transaction costs. I am going to analyse what the Offshoring transaction costs are and how they are related to different level of cultural differences. I especially will focus on the question if higher cultural differences causes higher transaction costs.

For this I will have to work out the whole basic topic beginning from what Offshoring is to explaining the different Cultural Dimensions Theories and Transaction Costs Theories until applying both theories and ideas on an example with two countries, one having more and one having less has cultural similarities to the outsourcing company.

2. Offshoring

First of all it is necessary to get an idea what Offshoring is. Therefore I will focus in this first chapter on the basic aspects of Offshoring such as the definition of Offshoring, what types of Offshoring exists, the motivations for doing Offshoring and the question which processes can be outsourced.

2.1 Offshoring Definition

One of the most important steps into this topic is to make the notion of Offshoring clear. But this step can not be easily solved by giving one clear definition of Offshoring, because there is no standard definition that exists (Yager, Hite, Nilson, 2004). The reason for this is that during the past years many different as well as similar strategies and processes were related to the Offshoring process. This has caused that in the literature one can find many different terminologies, which are related to Offshoring, and one can even find in the books that different terminologies were just mixed up such as using merely the word Outsourcing instead of using the word Offshoring, though there is a difference between Offshoring and Outsourcing (Harrison, McMillan, 2006). But nevertheless there is one core idea which facilitates it to understand the idea behind Offshoring: "Offshoring means the procurement of goods and services across national boundaries" (Kennedy, Sharma, 2009: 69). So the central aspect is moving processes or services across countries. But before we go deeper into the dimensions of Offshoring and into the different terminologies it is necessary to refine the above mentioned idea of Offshoring a little bit more. One of the major decisions, when conducting the Offshoring strategy is to choose the country to which a company wants to shift its processes. India for example is one of the most known Offshoring countries to where several European and American leading companies have shifted their IT processes. For example IBM has now about 40% of their workforce in India (The Economic Times, 2010). And this is due to the fact that India has not only a huge amount of IT experts, but also it belongs to those countries where the income of the educated personnel is low in comparison to the income of similar educated experts in the own country. These countries belong to the so-called low-wage countries[1]. Thus the idea of Offshoring can be refined by adding the information that the company's processes are typically shifted to low-wage countries.

2.2 Offshoring terminologies

The next step is to define the Offshoring types and how other similar terms differentiate from the core idea of Offshoring. According to Kehal and Singh there are about 50 terminologies which are closely related to sourcing out a process (Kehal, Singh, 2006). The following small extract of terms should only give an idea, how many types of terms exist (Plankenhorn, 2009):

illustration not visible in this excerpt

One good approach into the understanding of this list is to differentiate between two major types of sourcing strategies by using the region as criteria[2]: Offshoring and Outsourcing where in both cases the region is the factor to differentiate whether a terminology fits to the idea of Offshoring or Outsourcing[3].

illustration not visible in this excerpt

2.3 Offshoring types

As seen above in the list there are different terms which are related to the general idea of Offshoring. Here again the idea can be broken down to several specific terms where each of those specific terms fits to a given situation. In the following list I will only focus on the main used terminologies:

illustration not visible in this excerpt

Onshoring : When the service provider is also located within the same country, then it is called Onshoring. A good example is if a German company shifts his production process to the Eastern part of Germany as there still exists wage differences (Pande, 2011).

Nearshoring : Nearshoring describes the outsourcing to neighbour countries, for example a German company shifts his IT-department to a neighbour country such as Hungary or Czech Republic or in the case of an American company who shifts his production process to Mexico (Manning, Massini, Lewin, 2009).

Farshoring: In comparison to Nearshoring Farshoring describes the outsourcing to a far low-wage country, such as a shifting processes from USA to Asia. In the media the word Farshoring is not used much, instead the terminology of Offshoring is used, as the idea of Offshoring is also associated with far distance (Haq, Khan, Tariq, 2011).

What is also important to know is whether the Offshoring partner belongs to the same enterprise group or is just a non-affiliated firm. In the first case where the partner belongs to the same firm (e.g. if it is a subsidiary of the enterprise) then it is called Offshoring In-Sourcing, In-house Offshoring or just Captive Offshoring (Palugod, Palugod, 2011). In the second case of a non-affiliated firm it is called Offshoring Outsourcing (Kehal, Singh, 2006).


[1] The Global McKinsey Institute made an Offshoring study in the year 2005 where they also classified several countries in a range from low-wage to mid- and high- wage countries. Countries like India, China, Malaysia as well as several Eastern European countries (e.g. Romania, Poland, Estonia) and South American countries (e.g. Argentina, Mexico, Brazil) were classified to the low-wage countries (Farrell, Laboissière, Rosenfeld, Stürze, Umezawa, 2005).

[2] The factor region is only one criteria how one can categorize the different sourcing strategies. In this topic this makes sense to use the criteria region. In other cases, where the research area is different, other categories such as financial dependency, degree of external sourcing, number of companies participating at this sourcing process, etc. make more sense. This would lead then to different results.

[3] Not every strategy can be clearly assigned to either Offshoring or Outsourcing. One example is the Twoshoring. This is a "combination of local outsourcing and offshore contracts in low-wage countries". (Plankenhorn, 2009: 20).

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How cultural differences influence the level of transaction costs in Offshoring projects
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Offshoring Transaction Costs Williamson, Hofstede Hunt Culture, BPO KPO ITO cultural dimensions Trompenaars Bounded Rationality Opportunism
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Wasim Ali (Author), 2012, How cultural differences influence the level of transaction costs in Offshoring projects, Munich, GRIN Verlag,


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