Few business trends in recent memory have garnered the type of attention that outsourcing has. Driven by increasingly strong pressure to cut costs and focus on core competencies, companies are continuing to look to outside firms to handle non-core business functions such as collections, customer care, and human resources. In the 1990s, many companies in the U.S. began looking into offshoring, sending work over to places such as India and the Philippines. Recently, however, numerous issues have emerged with the offshore model, and executives are starting to look to nearshore providers for their business process outsourcing needs. At Virgo Capital, we believe the nearshoring model offers a unique value proposition when compared to domestic and offshore outsourcing providers, and that it represents an attractive opportunity for the right investors.

With a global market size approaching $300 billion, business process outsourcing (BPO) is nothing new. Beginning in the 1980s, companies such as American Express began offshoring their outsourcing projects, a trend which became mainstream in the 1990s. Until lately, it was not unheard of for managers to expect cost savings of up to 80% from offshoring. A recent study by Ventoro LLC, however, suggests 10% to 20% is more realistic after factoring in all savings and costs. While these savings are still substantial, they do come at a price – poor communication, cultural differences, physical distance to the location, and unstable governments are often cited as issues with offshoring. In fact, these problems have been so great that one in three executives has had to bring a project back onshore after having taken it offshore. Domestic providers mitigate many of these concerns but do not help cut costs, which of course sets the stage for the emergence of nearshoring.

Providing a hybrid solution between domestic outsourcing and offshoring, nearshoring is the outsourcing of business functions to vendors in countries geographically closer to the US. The industry is growing rapidly, and we believe there are four primary drivers to this growth – cost savings, quality and stability of the workforce, geographic proximity, and stable, friendly governments. Michael Flock, Managing Director of Flock Advisors, addresses the first two points in noting that “from the customer’s perspective, nearshoring provides all the benefits of offshoring, without a lot of the negatives. As a result, the trend of moving call centers and collection centers outside the U.S. but inside the hemisphere is exploding. The cost advantage of Mexico, the Caribbean, and Central America is almost equal to India and the Philippines, but even more importantly, the employees understand the credit culture. They are also well educated, and depending on the country, don’t have the same accent problems that have surfaced elsewhere.” In addition to the attractive labor costs, many countries offer tax credits and other incentives for companies willing to locate operations within their borders. Furthermore, nearshore destinations tend to have stable governments who recognize the importance of data security and intellectual property protection, and their geographic proximity allows for clients to monitor their projects closely.

Some of the earliest adopters of the nearshore model are companies in the collections industry. Collections companies assist businesses in pursuing unpaid debts, helping to recover billions of dollars annually on behalf of various credit granting institutions. Rather than attempt to collect on the defaulted debt in-house, credit grantors learned years ago that this task is best handled by a third-party. Such collections companies, which are essentially call centers, were among the first to relocate offshore but were also the first to realize that the quality of high-touch customer contact calls suffered in the hands of someone half a world away. As a result, Canada, Mexico, and the Caribbean, among other locations, have become popular places to relocate this work. Several recent statistics confirm the growth of nearshoring. A recent Business Insight study projects a 17% growth rate in Mexican outsourcing revenues through 2008, and the Caribbean is now home to 85 call centers compared with 45 in 2002. Over 80% of this growth is attributable to contact centers fulfilling projects for Fortune 1000 and other large US corporations.

By providing many of the same benefits of offshoring while allaying a number of its concerns, we believe that nearshoring is well positioned for further rapid growth. We anticipate nearshore destinations like the Caribbean and Canada will continue to take market share from popular offshoring locations like India and the Philippines. While some industries like collections are already taking advantage of this trend, we believe nearshoring will spread to other sectors just as offshoring did in the 1990s. Nearshoring is especially attractive because it provides an improved version of a successful business model in a comparatively underpenetrated, undercapitalized and highly fragmented marketplace. Given the right platform, a strong management team, and experienced financial partners, we believe that the nearshore outsourcing industry represents a promising investment opportunity.