'Made in China'. These 3 short words demonstrate that when it comes to sourcing low cost goods, retailers have the ability to think globally. Few major retailers could compete today without global product sourcing strategies - but when it comes to sourcing back office services such as IT and accounting, the retail sector is emphatically insular. With the exception of the public sector, retailers lead the way in ignoring the potential of 'offshore' back office services. Is this a cause for alarm, or is there a good reason to steer clear of offshoring?

Offshore laggard, outsourcing leader?

To diagnose this problem, it's important to be clear about definitions. Outsourcing is simply the subcontracting of work, to a service provider like Accenture or IBM. Offshoring is the parallel but separate practice of setting up back office activities in a remote location like India or Poland. Increasingly, offshore sourcing is focusing on the so-called 'Business Process Outsourcing' functions of HR and Finance, rather than the initial focus areas of call centres and IT. (Offshoring is often wrongly equated with outsourcing, but it can also be achieved 'in-house' by setting up a subsidiary).

This distinction between offshoring and outsourcing is significant. Retailing, from grocers to vertically integrated brand retailers, is no stranger to outsourcing. Particularly in IT and customer contact, retailers have made substantial investments in outsourcing. In fact retailing today depends on outsourcing in a whole series of areas - from supply chain management and logistics, procurement, merchandising, to payroll or facilities management. Research by Pierre Audoin estimates that the UK retail outsourcing sector will grow to £1.2b by 2009, with a sustained growth rate of 10% each year for 5 years.

By contrast with outsourcing, the number of retailers relocating back office work to low cost global locations is very small. A recent McKinsey report noted that the pace of adoption is 'slow relative to other industries, representing just 0.1% of retail employment in high-wage countries by 2008 - most retailers are not involved at all in global resourcing and those who are involved are only leveraging a small portion of their potential.' A similar perspective is expressed by the back office service providers, such as Abhijit Banerjee, Strategic Sourcing Principal at the leading Indian outsourcer Infosys: 'Retailers are traditionally selective and tend to wait for concepts to be proven sufficiently before jumping on the bandwagon - UK retailers have been slow to exploit offshoring compared to financial services, telecom, manufacturing and even utilities.'

So by the standards of other industries, UK (and European or US) retail back offices remain overwhelmingly national operations. Are they missing a trick - what is the case for retail offshoring?

The case for offshoring

The fundamental driver of offshoring is cost reduction, enabling firms to tap into labour costs as little as 15-25% of wages in western countries. Factoring in extra setup and technology costs, offshoring can reduce operating costs for these functions by between a half and a third. Given that a typical retail back office represents 10% of total costs, these are sizeable savings. This is particulary important as most retailers continue to face razor thin margins and continuing pressure to deliver better value.

This means that money spent on offshore facilities goes further than it can onshore. As just one illustration, a number of retailers are starting to take advantage of offshore 'analytics' services, such as sales and marketing data mining. Staffed by MBAs and PhDs, these teams carry out high value data mining and number crunching at a fraction of the cost of their onshore alternatives. For example, Indian outsourcer TCS has a well establshed Retail Analytics team, working on assessing sales channel performance for a leading US retailer.

In addition to the cost benefits of 'labour arbitrage', offshoring also provides access to scarce and high quality talent. In IT for example, India has the highest concentration of top-rated 'CMM level 5' development centres in the world - the US has none. As a result, offshoring increases the capability of back office functions, whilst reducing costs. And there are other side effects of offshoring, particularly if the outsourced route is chosen, such as releasing management to focus on higher value tasks. For example, one UK retailer recently outsourced finance processes offshore, enabling the Finance Director to focus on setting strategy, rather than chasing spreadsheets and reporting deadlines.

In short, back office offshoring is helping retailers to get the most out of their back office spend - making IT more effective, finance and accounting more accurate, insightful and timely, and liberating HR staff to focus on the most valuable tasks such as building closer relationships with employees.

Retail pioneers

These are not academic arguments. There are a handful of offshore pioneers who have bucked the trend of industry indifference by embracing offshore sourcing models. Perhaps unsurprisingly, the list is dominated by the more globally minded names such as Tesco in the UK, Carrefour in France, and Dell and Amazon in the US.

Tesco's Hindustan Service Centre is one of the best examples of back office offshoring in the retail industry. Opened in May 2004, by end of 2005 the centre is expected to have over 700 employees, with a focus not only on IT development and maintenance, but also finance and accounting activities. Amazon recently announced plans to ramp up its offshore capabilities with a software research centre in Cape Town. Dell recently announced plans for a 4th customer care centre and a new product development centre in India.

The list may not be particularly extensive, but for the pioneers the overwhelming trend is one of accelerating investment, as pilots prove successful and senior executives gain confidence in the offshore model. In other words, the business case for offshoring is being proven in practice. So what is holding the rest of the sector back?

The practical challenges

Retailing may have a steadily growing list of offshore evangelists, but success is far from guaranteed. Dell's decision to relocate an Indian call centre back to the USA in 2003 has been widely cited as a warning on the dangers of offshoring. There have been other such examples, and there will be further setbacks where retailers are unprepared for the realities of global sourcing.

Ultimately offshoring remains a complex challenge, and success requires thorough planning and management. Each situation will involve a different a range of factors, but few offshoring projects will work unless they:

• Generate support - The entire organisation needs to understand the rationale for offshoring. The starting points for this are a compelling business case, and sponsorship from the senior executive team.
• Design the solution in detail - A careful balance must be struck between offshoring the right processes, and retaining strategic activities at home. This needs to be mapped out in detail in terms of process, systems and people.
• Reach sustainable sourcing agreements (offshore outsourcing only) - Where the offshoring activity will be conducted by a third party, make sure that the sourcing deal provides the basis for a long term working relationship, and is not just an exercise in gamesmanship and haggling.
• Plan and manage change - The HR dimensions of offshoring, such as redundancies and redeployment, are among the most complex faced during the whole process. Consultation and communication plans need to be developed from day 1.
• Retain responsibility - Offshoring does not mean that the back office can be forgotten about. The organisation needs to continuously monitor and interact with the offshore facility, whether outsourced or in-house.

Offshore hang-ups

These challenges can tax the management of any firm considering offshoring. But for retail companies, there is an additional set of challenges - widely held misconceptions that together explain why retail has been so slow to embrace offshoring:

• "Retail is too local for offshoring"
  Sceptics observe, correctly, that most retailing is driven by the demands of doing business locally. As a result, local store operations naturally dominate the costs and thinking of most retailers. But despite this basic fact, many processes such as finance, HR or IT, have basically no requirement for physical proximity. McKinsey estimates that 'the theoretical maximum percent of global resourcing of jobs in the retail sector is 3.1 percent.' This may sound small, but in a world of narrow margins, this should not be overlooked - in developed economies including the US and UK, this equates to 4.5 million retail employees. And as online retailers continue to prosper free of the constraints of store operations, the likes of Amazon, Dell and eBay are placing offshore at heart of their plans.
• "Retail systems are too different"
  Retail systems are often based on highly tailored industry-specific technologies, or poorly integrated legacy applications - or both. As a result, there is a widespread sense that retail back offices are too dependent on local, niche skills to go offshore. This underestimates that depth of skills that are available offshore and the growing appetite of offshore providers to target specific industriess. Many service providers now have dedicated retail offshore verticals, and offshore technical teams specialising in retail applications such as Retek or JDA.
• "Offshoring is just for the global elite"
  The retail pioneers in offshoring have been predominantly global players, and most firms don't have the scale or resources of a Tesco or Carrefour. But the opportunities for the middle market are changing. The average offshoring deal size is getting smaller, as suppliers becoming increasingly experienced and competitive. Five years ago, a typical offshore business case may have needed 100-150 resources to be worthwhile. Today offshore service providers are happy to take on projects of 15 workers, or less if they are trying to break into a strategic industry (such as retail). And some commentators, such as Abhijit Banerjee, see lack of scale as an incentive in itself: 'mid-size retailers have more to gain as they perhaps lack the internal expertise and management time to provide [world class] services.'

A few smaller and UK-only retailers, such as Roadchef or Somerfield, have pushed aside these misconceptions and joined the global offshore elite in recent years. This trend looks set to continue, particularly as the middle market starts to consider offshoring. In addition, it seems highly likely that retail consortia, such as Baugur, Rubicon or Mosaic, will join in and use offshoring as the next step in their efforts to rationalize and integrate their growing portfolios.

Ultimately, retail decision makers will continue to be distracted by 'more strategic' projects in merchandising, store operations or elsewhere. Offshoring remains one of many investment options, and for many it will simply not be the right sourcing decision. But no retailer can afford any longer to rule out offshoring without careful consideration. Not least because there's a growing body of offshore believers in the retail sector - hoping to keep the offshore advantage to themselves.