Quality, Incentives and Inspection Regimes in Offshore Service Production: Theory & Evidence

The term “offshore outsourcing” (or “offshoring” for short) is widely used these days, particularly in the context of a debate on the trade-off between efficiency gains leading to producer and consumer surplus versus labor losses. The term refers to the phenomenon of firms outsourcing their entire back-office operations to off-shore third party service providers who execute these processes for them. Expert estimates suggest that the off-shore BPO industry will grow from $123.6 billion in 2001 to over $230 billion in 2015 [Forrester (2003), Gartner (2004)]. The growth of off-shore outsourcing in recent times has been extraordinary not just in scale (as evidenced by the dollar volume of business) but also in scope: Currently, offshoring includes diverse services requiring a wide range of expertise such as equity research, financial analysis, transaction processing, insurance claims management and underwriting, supply chain coordination and tax accounting. While there is some research on the trade-offs between cost and quality in the outsourcing of information systems development, there is little if any, research that investigates the emergent phenomenon of outsourcing of business processes to offshore labor regimes and the attendant trade-offs that buyers and suppliers face between monitoring of work, inspection of output, wage arbitrage gains and the extent of control that managers can exert across the boundaries of the firm. Two issues are critical in determining the quality of service of offshore providers: Monitoring (supervision to measure adherence to prescribed quality standards and performance metrics, and enforce these standards) and Incentives (to ensure that service providers make the right investments and trade-offs in meeting customer requirements). In a service supply chain, unlike in the production of physical goods, the production and distribution of purely information goods involves just the flow of digitized information. Our study of offshoring of services was two-pronged: First, we studied the process production of four firms (recognized as leading offshore service providers) in three countries, and gathered data through both survey instruments and by capturing the parameters of the contract (discussed in greater detail in the empirical section). One of the unusual features of the offshoring environment in services is the wide variance in the way incentives and penalties are structured into the contract. Unlike in the case of most physical products where the cost of inspecting the buyer’s quality is a fraction of the cost of production of goods, in the case of services, the cost of inspecting a unit volume of output could be