The New Nearshoring Game

The competition between nearshoring locations has intensified in recent years, with new locations pitching their attractiveness every year. However, the old game played by established nearshoring locations in Europe 5-10 years ago, is no longer sufficient to win business in 2016.

For one, there is little differentiation between locations to the extent that a pitch by one country would nearly be identical as the following. Add to that the shift by client firms from a sole focus on cost saving to greater emphasis on partnership, service value chain alignment and skills, all signaling the need to step-up the nearshoring game and consider new rules. In this article, I examine the rules of the new nearshoring game, and share the examples of several cases. I conclude with suggestions on how countries pitching their locations for nearshoring should play the new game.

Why Nearshoring is More Important Now than Ever By now we have had convincing evidence about several trends the European outsourcing sector has gone through that have affected nearshoring locations.

For one, European multinationals have increased their investments in captives and shared service centres in Central and Eastern Europe at a higher pace than investments for similar operations in India. We have reported in the past that since 2009, Central and Eastern Europe has witnessed significant growth in such operations while the pace of new SSCs and captive set-ups in India has declined. Further, we also reported that nearly 50% of European client firms have repatriated operations or indicated that repatriation is likely to be part of their future sourcing strategy, stating that their preferred alternative for offshoring is either nearshoring or bringing operations back onshore.

These changes have accelerated recently as sophisticated client firms have transformed their sourcing function and have introduced a GBS function in which any location, including nearshore, would be considered for their delivery centres. These trends have elevated the utilization of nearshoring locations for services. As more business goes into nearshore locations in Europe, European countries make extra effort to position themselves better to benefit from a larger piece of the cake.

However, another significant trend that we have witnessed in the outsourcing sector is the growing expectations from client firms to see value-adding services in the form of innovation delivered by their partners. Indeed, we have seen in the media quite a few examples of such value-adding services, perhaps most notably IBM’s Text for Life for Novartis. Further, many client firms have recently sought to align middle office operations, which was offshored in past years, with front office, in an attempt to tighten integration across the service value chain and seek untapped business opportunities to offer services to clients.

Such expectations by client firms signal a greater need for specialization, which in turn signals nearshoring locations to re-assess their nearshoring strategies.

The Old and New Nearshoring Game All outsourcing practitioners are aware of the great efforts certain European countries have put into promoting their services as attractive for outsourcing services. However, the general feeling among those who have taken interest in the attractiveness of European countries is that many nearshoring locations fail to differentiate themselves from the crowd. Most pitches regarding the attractiveness of a nearshoring location have emphasized the cost advantage, availability of skills, accessibility to cities via air or train travel and infrastructure of a location. Indeed, most country attractiveness campaigns have portrayed an accurate picture of the relative advantage of a particular location, sometimes compared with others. However, the general sentiment among outsourcing practitioners is that if you have read one country attractiveness report, you have read them all.

The great effort by many countries attempting to promote themselves as attractive nearshoring locations often results in an opposite outcome, i.e. instead of differentiating themselves, they join a commoditized game in which their distinct advantage has been overshadowed by what are considered to be prominent factors such as cost advantage and the supply of programming skills. While such a broad nearshoring strategy that is based on cost advantage and basic technical skills worked in the past, nowadays, a more refined strategy is needed – for the following reason:

It all comes down to a simple argument that combines two key success factors in the nearshoring sector:

playing the cost advantage game is a short-term game that might attract low-end activities to your country that are often labour intensive, characterized by low margins, and can easily be eroded. the attention in the outsourcing industry in 2016 is shifting to locations that can deliver higher value. Some recent examples are the flourishing Shared Services sector in Germany, or the massive investment in R&D centres in fairly expensive cities such as Shanghai and Beijing (China). Indeed, many outsourced services will remain offshore and some might get automated, but many other operations, such as middle office operations in the financial sector will need unique business skills to re-integrate them into the service value chains. In a similar vein, innovation delivered from nearshoring locations requires a differentiating set of technical and business skills that are unique and can hardly be found elsewhere. A good example of a location is Hangzhou in China, which has developed a cluster of unique capabilities and expertise around e-commerce with Alibaba as the main driver of that development, but with strong support from the local government. Indeed, Zhejiang province has invested in attracting second and third tier e-commerce firms to create one of the most powerful e-commerce clusters in the world. It is clear that the policy makers of Zhejiang province have made a decision to ‘play it niche’ rather than ‘play it broad’. Indeed, their pitch does not emphasize their relative cost-advantage or the quality of the Province’s infrastructure but rather the e-commerce programmes in local universities, the structure of the e-commerce cluster and the blue-chip clientele-base of the province.

So why should we take Zhejiang’s strategy as an example?

We argue that winning the nearshoring game in the long-term means excelling in today’s key success factors such as specializing in an innovative technology or developing a strong cluster of unique business solutions. Any other value proposition from a nearshoring location, in particular one that is primarily pitching the cost advantage of a location, is likely to result in a short-term advantage that will attract low-end services, get eroded over time and restrict its growth.

Growing a local outsourcing sector with a value proposition based on cost advantage is doomed to face challenges in achieving excellence and maintaining a long-term leadership.

Improving Current Nearshoring Positioning By now, we have quite a few examples of EMEA countries (e.g. Egypt, Latvia and Morocco) pitching themselves as attractive for nearshoring. The studies that backed up their PR campaigns have followed a similar formula in which several categories – cost, skills, infrastructure, risks, environment and market potential – have been examined to assess the attractiveness of each location. These studies also attribute a similar weight per each category, thus treating cost advantage as equal to the contribution of certain skills to the attractiveness of a location.

In my view, such an approach is problematic as it restricts the effect that some factors have on the attractiveness of a location. In other words, this approach drives locations to compete head-to-head assuming homogeneity rather than emphasizing the heterogeneity between them. What future country attractiveness campaigns should consider is to introduce a weight-scale per each category subject to the source of differentiation of the location. In other words, what we have been missing in past nearshoring campaigns is a clear understanding of what differentiates a location from the others and how such differentiation was captured in the study vis-à-vis the key success factors in the industry. Instead, we get the impression that all the factors like cost and market potential have equal weight, which is not the case.

Consider the market potential of Egypt as a service centre for the Middle-East and some European countries, compared with the availability of basic technical skills in Egypt. Market potential in this case should have had a greater weight than the availability of skills when considering the attractiveness of Egypt in the context of the technical support sector. Further, such an approach requires a far more refined analysis, in which locations concentrate on the attractiveness of a sector or a cluster rather than the entire country.

An example of is the work we have conducted in Portugal [1] as first step to understanding the attractiveness of the country as a nearshoring location. We have devised a framework, based on Debra Farrel’s study in which we computed the importance of each category vis-à-vis key success factors in the outsourcing industry. We have used input from numerous interviewees, a large survey, and discussions with stakeholders to compute the weights of each category. As a result, engineering services has been identified as one of the areas in which Portugal is differentiating itself from other nearshoring locations, while maintaining on par competitiveness in other technical areas.

Competing for Nearshoring in the Future: A New Framework We have reached the point where generic and broad nearshoring strategies do not work anymore. Instead of PR campaigns that highlight the cost advantage of a location, nearshoring strategies by promising locations need to devise a strategy that highlights their comparative advantage vis-à-vis contemporary trends in the outsourcing sector. Instead of ‘playing it broad’ with regard to the type of services EMEA nearshoring locations would like to attract, they actually need to ‘play it niche’ and put an emphasis on the specific services and clusters in which they have a competitive edge in terms of expertise, scale or an eco-system effect. Also, instead of pitching a single factor such as cost as the primary attractor, nearshoring locations need to look for the compounding effect of multiple factors that create a sustainable competitive edge.

Old Approach to Nearshoring

New Approach to Nearshoring

Generic marketing campaign

Targeted marketing campaign

Generic service analysis

Refined service segment analysis

‘Play it broad’ approach

‘Play it niche’ approach

Emphasize dominant factors (e.g. cost)

Explain the confounding effect

So, How Should The New Nearshoring Game Be Played? Our recent research suggests that emerging nearshoring locations should follow these steps:

Mapping Your Service Segments : Create an inventory of the more significant service segments provided by your local service outsourcing sector. For example, e-commerce in Zhejiang province, R&D services in the Israel, contact centres in South Africa.

Understand Key Success Factors : Analyze the Key Success Factor per each service segment. In some segments it will be about cost while in others it might be about talent or the combination of the two.

Relative positioning : Analyze the relative positioning of the various local service segments according to their performance vis-à-vis the key success factors of each segment. You will find out that some of your service segments do not possess the qualities needed to be a top player at the continent level as well as those that are unlikely to be competitive if pitched as part of your nearshoring offering. At the same time, you will discover which service segments have a strong position vis-à-vis the sector’s KSF thus enjoying a strong competitive edge.

Customize your nearshoring offering : Based on the above analysis, craft your nearshoring offering with maximum refinement of the offering per service segment/cluster as well as compared with other locations (where such comparative information is available).

We believe that this kind of a “new” nearshoring strategy will create highly-specialized nearshore locations and clusters that can compete globally on innovation and high-end services, develop top tier suppliers, and are able to defend their position.