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Maintaining the Low-Cost Advantage

Anxiety about the cost of offshore wages may be misplaced.

May 29, 2004
Related Topics: Compensation Design and Communication, Outsourcing, Benefits

While wage disinflation and deflation are sweeping through advanced high-cost economies, wages are rapidly growing in the low-cost nations now popular as offshoring and sourcing destinations. U.S. companies that offshore work to and source from low-cost locations are concerned that this broad trend may diminish the massive cost-savings they can now achieve by moving work abroad and sourcing overseas. The anxiety is misplaced. Flat wages in the United States and strong wage increases in the low-cost countries will not substantially diminish the huge wage differential or reduce the labor-cost advantage of the low-cost destinations.

    The wage gap is so vast that a significant cost advantage will remain for decades even if current wage-growth trends continue. Also, any savings lost from higher wages in the low-cost countries will be offset by annual improvements in productivity and additional savings that occur as companies operating abroad begin to expand their scale, develop better relations with suppliers and grow local market share.

    Research by the Boston Consulting Group shows that the cost advantage will actually expand in absolute terms. If hourly total compensation for production workers in the top 11 low-cost countries increases by an average of 6.5 percent a year for the next six years, compensation will rise from $2.10 per hour to $3.06 per hour. If average U.S. compensation grows at its current rate, it will rise from $21.86 per hour to $25.34, and the beginning wage differential of $19.76 per hour will increase to $22.28.

    BCG estimates that exit costs for legacy assets and resources in high-cost countries range from $25,000 to $100,000 per full-time employee. For an industrial company moving the work normally handled by 200 FTEs, for example, the total one-time exit cost would be $5 million to $20 million. With labor costs in the low-cost locations totaling 10 percent to 20 percent of U.S. costs, however, significant exit costs can be quickly absorbed.

Workforce Management, October 2004, p. 67 -- Subscribe Now!

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