Hidden costs of offshore outsourcing: an analysis of offshoring decisions

Abstract

Offshore outsourcing has grown phenomenally as a form of industrial organisation in recent times and has also been viewed as a strategic move by rms to out-compete their rivals. The gains from this exercise may however not necessarily be at par with expectations due to the presence of a host of hidden costs which have been documented in the literature. This paper tries to address and analyse the nature of strategic interaction that takes place in the decision to offshore, in the presence of signals with imperfect precision to players (i.e. rms seeking to offshore their jobs to lower cost destinations) in a Cournot framework. It offers insights into the decision making process and outlines policy suggestions for countries which are potential hosts to offshore outsourcing. Amongst other important conclusions it is found that the precision of signals about the hidden cost and the range of possible hidden costs play a crucial role in determining offshoring destinations. Updating of information about hidden costs leads to dierent equilibria including the possibility of herding in offshore outsourcing.