Lineamiento para evaluar la propuesta

Based on the literature review and the findings of the exploratory P2 study on post-contract political risk exposure among offshoring practitioners, a series of proposed correlations between offshoring flows and political risk constellations were hypothesized for empirical testing in P3.

According to the literature review, the perception is that since offshore outsourcing modalities have less capital at stake and no physical facilities at risk on the ground, political risk considerations are a less significant concern. However, according to the exploratory research findings in P2, the distribution and attributes of political risk in the context of contract-based offshoring engagements, were very similar to those of captive engagements. Applying the new political risk typologies for offshore outsourcing identified in the exploratory research, the relationship between offshore outsourcing and political risk is explored. The research first analyses the effect of political risk on predicting offshore outsourcing flows, and secondly, compares offshore outsourcing and regular FDI in terms of the sensitivity to political risk in their offshore engagements. The research is guided by the following hypothesis:

Hypothesis 1: Offshore outsourcing activities, as a non-equity and contract-based modality, are less sensitive to political risk considerations than general inward Foreign Direct Investment (FDI) in the choice of offshore locations.

The findings of the exploratory research further suggested that the nature of offshore political risk exposure revolves increasingly around policy and legal predictability, including institutional capacity, confirming the relevance of incorporating institutional differentiations in the determination of external

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uncertainty. The findings supplement emerging research suggesting that determinants of foreign investment flows should be extended beyond the traditional factors like government stability, internal/external conflict and ethnic tensions, to also include aspects of local corruption, quality of bureaucracy and law and order (Busse and Hefeker, 2008). Other research argues that using a narrow political risk definition in exploring uncertainty in the formal external environment is suboptimal, contending that government quality is a better proxy for determining external uncertainty. (Slangen and Tulder, 2009). On this basis the research explores the impact of institutional and regulatory factors in predicting contract-based offshoring flows.

Hypothesis 2: When the institutional and regulatory factors in the host country are strengthened, the volume of overall (ITO/BPO/KPO) contract-based offshore outsourcing will increase.

The further association of Knowledge-based Outsourcing (KPO) with loss of IP, policy change on foreign ownership and contract enforcement risks, suggested that institutional capacity i.e. legal enforcement of IP rights and contracts becomes increasingly important as the knowledge content and value of services are enhanced. The findings imply that the company specific risk profile changes subject to the level of service value or knowledge content involved in the offshoring engagement and that risk should be considered in the context of low versus high knowledge content or value of the services as a key distinction for the nature and level of exposure. Hence for purely transactional work most firms appear comfortable outsourcing to third-party, while for high-end activities they prefer to keep the process internal through a captive entry mode or under strong IP regulation.

Hypothesis 3: When the institutional and regulatory factors in the host country are strengthened, the offshore outsourcing volumes of business activities with a higher knowledge content (KPO) is likely to increase.

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1.5.8.1 Methodological selection and process

The application of quantitative methods and regression analysis to political risk research is a common approach within the political risk research domain (See Annex. C.2).To analyse the significance of the hypothesises the research applied a linear multiple regression methodology based on aggregate and activity specific (ITO, KPO and BPO) offshoring volumes generated from the IMF Balance of Payment (BoP) database to function as the dependent variables. For the purpose of identifying appropriate data sources to operationalize the identified political risk indicators as independent variable datasets, a comprehensive review of existing governance and country indicators was conducted (See Annex C.1) and a dataset compiled from various sources, including the ICRG Index and the Global Competitiveness Index (GCI) from the World Economic Forum (WEF). As research on offshore outsourcing has been hampered by the absence of available data, one additional contribution of this research is the design and compilation of a dataset capturing location specific offshore outsourcing flows and the corresponding break-down into ITO, KPO and BPO specific categories (For more detail see P3 methodology in Section 4.3).

The main application of the regression variate was to determine the relative importance of the individual political risk indicators in determining offshoring flows across entry modes and business activities (ITO/BPO/KPO). The methodology further allowed for a measure of the individual impact of each political risk variable as a predictor of offshore flows, as a means for classification of relative importance and potentially forming the basis for developing a weighted risk index.

1.5.8.2 Key findings of the study

Firstly, the quantitative research validated that political risk is a genuine issue of concern in offshore outsourcing, despite being contract-based, and therefore technically a means of “outsourcing” risks to the suppliers. The research indicated that the 12 identified political risks accounted for 38.0% of the variability in the offshoring outsourcing flows implying that concerns about service disruptions

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and/or cost implications of external uncertainties features as a factor in considering supplier and location choice.

The findings further highlight a consistent overlap of key predicative variables, including intellectual property protection; quality of bureaucracy and burden of customs all significant at <0.001 for both for offshore outsourcing and captive activities. This is a significant finding as it highlights that for both captive and outsourcing activities, institutional and regulatory factors in the host country are a key concern. Furthermore, it is indicated that the domestic market size is a key external business variable for both modalities suggesting an interlinkage between entry mode strategies, and that offshore outsourcing should not be seen in isolation from companies longer-term market entry considerations.

The important distinction between offshore outsourcing and captive activities identified from the research, is not whether political risk is a concern, but specifically what kind of political risks is a concern. The research yielded significant and positive relationships with intellectual property protection and bureaucracy, for both offshore outsourcing and captive activities, while captive engagements were also significantly related to security and internal/external conflict related variables. The findings confirm logically that political risks, like security and conflict, will have a higher impact on investments with a physical presence including captive manufacturing plants or service centres, while contract-based outsourcing and captive activities will be equally concerned with risks concerning IP loss and quality of bureaucracy.

Another interesting finding is that the innovation capacity associated with offshoring locations appear to be a stronger predicative feature for contract- based offshoring than for captive engagements. This findings suggest that while captive engagements is often designed as a means to access foreign markets or leverage labour arbitrage for manufacturing, offshore outsourcing is often more than a cost consideration and also a means to access foreign talent and knowledge for competitive advantage. As these talent pools may not be available

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on the home market, or cost restrictive, offshore outsourcing becomes a tool for tapping into accessible innovation centres around the world.

Secondly, the results validated the findings of the exploratory research, by confirming a positive relationship between offshoring flows and institutional and regulatory factors. The research findings highlighted a positive and significant relationship between both intellectual property protection and the quality of bureaucracy, and increased inflows of contract-based offshore outsourcing activities. The findings validated the hypothesis that “When the institutional and

regulatory factors in the host country are strengthened, the volume of overall (ITO/BPO/KPO) contract-based offshore outsourcing will increase”.

Thirdly, the research analysed activity specific offshore activities and mapped the political risk accounting for the highest variability in the offshoring flows. The findings showed a dispersed distribution of political risk variables across ITO, BPO and KPO engagements, confirming the relevance of also analysing offshore according to the nature of the offshoring activity, rather than solely as a consolidated industry. Despite the mixed results from the cross-industry analysis, the research obtained a significant (and positive) coefficient for intellectual property rights protection with a very high beta-value for KPO activities, a significant but lower positive relationship for BPO and no indicated importance for ITO activities. Hence, for KPO outsourcing flows, a positive relationship with intellectual property protection, with the highest Beta value, was noted. While a statistical positive relationship was noted between KPO outsourcing flows and intellectual property rights protection, the research does not establish the basis for causality, however suggests a partial validation of hypothesis #3: When the

institutional and regulatory factors in the host country are strengthened, the offshore outsourcing volumes of business activities with a higher knowledge content (KPO) is likely to increase.

In terms of external business variables, domestic market size and basic electricity and telephony were found to be the most important factors across all offshore activities. While the need for a functioning basic electricity and telephone

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infrastructure is intuitive it is surprising in the sense that most of the offshoring activities are assumed to take place in developing economies, and hence the infrastructure requirements will, despite any cost incentives, bring a natural limit to offshoring flows to many economies. More surprising is perhaps the effect of a large domestic market, as contract-based offshoring is generally assumed to serve external entities i.e. through call centre activities, IT application management etc. The pull-effect of larger markets, and positioning of contract- based offshore outsourcing activities in potential domestic markets, suggests that offshore outsourcing could be considered part of a larger market entry strategy. As potential host countries compete to attract offshore activities as a basis for enhancing employment and knowledge transfer opportunities into their economies, it would be prudent to take note of the perceived importance of strengthening institutional and regulatory factors. If the host country is seeking to attract contracts within the areas of R&D, it would be especially important to ensure that the appropriate IP regulatory frameworks are in place, while for the more labour intensive BPO activities, a well-functioning labour market and minimal bureaucracy would have a high impact.