Offshore outsourcing and ownership of facilities with productivity concerns

We examine how companies may create appropriate portfolios of onshore/offshore facilities. Such decisions are complex due to demand volatility, payoff uncertainty, decentralization, productivity differences, and location uncertainties. We study a Build-Operate-Transfer (BOT) scenario where an offshore supplier builds a facility and trains workers and the principal leases it for a period before purchasing it. The parties participate in BOT only if both are better off in relation to continued leasing. The decisions of the principal and supplier include the size, unit price, and productivity of the offshore facility and an appropriate experience level for managing it. We show how economic equilibrium can be restructured to overcome productivity concerns. Although productivity improvements help both parties, we find that the principal stands to gain more. Such improvements should be scheduled early if the principal is sufficiently experienced in offshore operations and delayed if the on-the-job learning is rapid. We establish that the principal should not purchase the facility if productivity cannot be maintained at a pre-purchase level. We also find that an experienced principal can benefit the supplier, not just herself. We develop simple rules for assessing the viability of offshore outsourcing and for allocating budget for productivity improvement.