The outsourcing and offshoring industry is at a turning point. What began as a small-scale sector dedicated to application development, accounting, and payroll has become, as of 2008, an $80 billion global industry, addressing a range of business processes and technology services. As the IT services and BPO industry matures, however, challenges are emerging.

This reliance on a limited number of geographic regions—historically driven by the availability of highly skilled, low-cost labor in these areas—is exposing providers to a variety of location-specific risks. These include abrupt currency and wage fluctuations, intense competition for employees, and regulatory limits. While a narrow geographic concentration may result in lower labor costs at the outset, the overall risks are higher, according to our research. The same is true on a microlevel: our data show that when a delivery center in a large Indian city grows beyond 3,000 employees, costs spiral and performance begins to deteriorate.

Offshore service providers can mitigate these risks in the way a financial manager would—by diversifying their holdings. While diversification has long been the rule for investment decisions, outsourcing providers were under little pressure to change their lowest-cost-country approach until recently, when rising volatility in many favored offshoring markets began to impair providers’ ability to predict costs and manage talent needs. As a result, many are looking to address these vulnerabilities while still reaping a cost advantage.

Offshore delivery centers can accomplish this goal by diversifying their operations in two ways: on a macrolevel, by expanding their global footprints to reduce overconcentration in any one region; and on a microlevel, by broadening the range and scale of activities conducted in any one center. The result is a network approach to offshore delivery management that features centralized global delivery hubs and decentralized local or specialized service spokes. This next-generation model not only improves overall global delivery but also brings greater predictability to cost management while fostering better coordination, flexibility, and responsiveness—characteristics that can give global companies a sharper edge in this period of rapid change.