- Labor arbitrage is when companies source labor from regions with more cost-effective human resource solutions.
- Some methods of labor arbitrage include outsourcing, offshoring, automation or HR arbitrage, and crowdsourcing.
- Three primary reasons for the popularity of labor arbitrage are an abundance of talent in developing areas, advances in communications technology, and big data.
When companies are struggling with budget limitations, they may feel as though hiring any new employees is out of the question.
However, finance and procurement leaders can take advantage of labor arbitrage to even things out a bit. This way, they don’t have to put as much of a freeze on hiring or trim other areas of spending — labor arbitrage.
Labor arbitrage occurs when companies look for ways to source labor from lower-cost countries or regions, typically by outsourcing production work or other types of labor-intensive tasks.
However, as new technologies have emerged in recent years, companies are now able to automate many of these tasks, using software and automated processes to complete them instead.
This has led to a new type of labor arbitrage known as “HR arbitrage”, where companies use automation to reduce their spending on labor-intensive HR tasks like recruiting, hiring, onboarding, training, and managing employee performance.
Overall, while it is important for companies to be mindful of their spending, they should not be afraid to take advantage of labor arbitrage and other strategies that can help them save money while still growing their business.
This article discusses labor arbitrage and how companies use this to reduce resource costs.
What is “labor arbitrage”?
The term “labor arbitrage” refers to a situation where a company tries to save money by hiring workers from countries where labor costs are lower.
For example, a company might hire workers in the Philippines or India to perform some of its back-office work such as processing payments.
The decision to pursue labor arbitrage is usually driven by cost considerations. For example, if a company can cut its payroll costs by 10%, it might decide to outsource some of its back-office operations to a low-cost location.
What are the key drivers of labor arbitrage?
There are several key factors driving labor arbitrage, including:
1) The increased availability of skilled workers in developing countries. In the past, high-quality talent was scarce in most developing countries. But today, many emerging market economies produce large quantities of skilled workers, particularly in the areas of IT and BPO.
2) The emergence or improvement of communications infrastructure. In the past, it was difficult to communicate with people in different countries due to a lack of bandwidth and poor infrastructure. But today’s advances (including faster internet speeds and video conferencing tools) have made it easier to develop remote teams.
3) The advent of cloud-based technologies and “big data” analytics. In the past, companies had a hard time sharing data across locations due to bandwidth limitations and security concerns. But today’s technologies have made it easy for businesses to store their data in the cloud or analyze vast amounts of complex information.
Strategies Used in Labor Arbitrage
There are several strategies that companies can use to take advantage of labor arbitrage. These include:
Outsourcing or offshoring production work
The most common strategy is to outsource part of your operations to a location outside your home country.
Offshoring is the process of shifting business operations to a country with lower labor costs. The practice took off in the late 1990s when companies began setting up captive centers in developing countries. This was driven by improved telecommunications and increased demand for large-scale IT operations.
Although it can be costly, moving your back office to a new captive center has the potential to save you money in the long run.
Offshoring revolutionized businesses and countries when it was first established, and many large companies have had their service operations offshore for years now. Midsize and small businesses are quickly following this trend.
In the past, this was primarily limited to locations such as China and India, but today’s world has opened up many more options, including the Philippines.
Firms wanted to save up even more. Hence, after spending time and resources to build their own captive centers in offshore locations, many firms sold these captive centers to outsourcing providers and bought back the service on a contractual basis.
Highly-specialized providers are in an advantageous position. By specializing in certain back-office functions, they can accommodate several different clients and deliver services more efficiently and effectively than captive centers. As such, firms that were late to the offshoring trend went straight to the outsourcing model. They essentially transferred capabilities from in-house to external vendors and from onshore to offshore at the same time.
Today, however, the pendulum is swinging back toward captives. The impetus for the outsourcing business model was cost-effectiveness. Now, however, firms have become concerned about other factors as well.
For IT, for example, security has become the primary factor for choosing captives over external outsourcing providers. Outsourcing IT capabilities can leave firms vulnerable in areas such as data integrity and chain of custody for example.
Crowdsourcing or leveraging the “gig economy”
In some industries, companies are using new platforms to connect with freelancers in order to get work done.
For example, a company might launch a crowdsourced platform that allows marketers and designers in different countries to collaborate on digital marketing campaigns. By leveraging the skills and expertise of a global network, companies can save money while still getting high-quality work done.
Another example is crowdsourced product development platforms like Kickstarter or Indiegogo. These platforms allow individuals to submit ideas for new products, which are then funded by stakeholders. If a product receives enough votes and funding, it can then be brought to market.
Overall, crowdsourcing offers a unique opportunity for firms to leverage the expertise and skill sets of individuals around the world rather than relying only on internal resources. This allows companies to get more work done in less time, while also allowing them to tap into talents they might not have access to otherwise.
It remains to be seen whether these platforms will continue to grow and evolve in the coming years, but for now, they are a major force in shaping how firms innovate and remain competitive.
Automating or “offloading” labor-intensive HR tasks.
As companies have started to automate many of their operations, there has been a growing focus on automating HR functions as well. This includes using software and other tools to perform recruiting activities, onboarding new employees, managing performance reviews, and more.
Technological advancement has allowed robots to perform tasks only humans used to perform; this has great implications for industry rationalization and labor markets.
This so-called “second machine age” has caused many to fear for their careers as robots are believed to be poised to replace them in the workplace.
For highly-skilled laborers, there’s nothing much to worry about losing their jobs to robots, as J.P. Gownder, vice-president and principal analyst at Forrester Research, believes that ‘humans will find themselves working side by side with robots, rather than being replaced by them.
But those performing tasks that are massive in volume and are repetitively boring, they are at risk of automation.
Related: Robots are Coming After Our Jobs
Automation is attractive to many firms because back-office employees spend roughly one-quarter of their time on repetitive, rules-based tasks – the ones that are easy to automate.
Moreover, robotic process automation (RPA) software processes operations three times faster than the average human (with no absences, no errors, no diminishing returns, and works around the clock). RPA can produce savings between 25 and 50 percent in select back-office processes.
Indeed, RPA has significant implications for human resource arbitrage as well.
The important question to ask then becomes: How fast can firms adopt this new technology? Can traditional outsourcing providers be quick enough to adapt before their business model becomes obsolete?
Outsourcing providers compete on their ability to hire and manage large groups of employees across various locations. For outsourcers, automation can be a way to stay competitive when most other sources of savings have already run dry. But for those who do not adapt fast enough, automation poses risks.
Offshoring itself was an industry disruptor when it was first introduced in the 1990s. Today’s emergence of automation is no exception. The industry is ever-evolving and firms are always recalibrating the use of outsourcing, offshoring, or of “no location” models. For companies, they must always reassess how they deploy talent. For countries, while challenges are mounting, the global services industry is vibrant and presents great opportunities to develop their economies.
Are you interested in learning more about labor arbitrage? Or do you have experience using one of these strategies yourself? Let us know in the comments below!
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