The promise of offshoring

It’s a hot-button issue to be sure, but business customers using offshore services say the decision to move jobs overseas stems from some real pragmatic concerns.

Take VF Corp., one of the world’s largest apparel companies whose brands include Lee jeans, Tommy Hilfiger and The North Face. The company, with some 550 IT staff domestically, has been increasing its use of offshore resources the past few years and says cost cutting wasn’t the only driver.

“In general, we were having trouble finding resources and keeping them in (certain) technologies at the level we wanted,” says Eric Anthony, vice-president of IT services at the firm in Raleigh, N.C. “In India, they were pumping these guys out left and right …. Look at the deal here: We’ve got very highly paid SAP programmers that we could hire in the U.S. — and they’re hard to find. Or we could go to India and find very talented SAP programmers immediately at 35 per cent to 40 per cent lower cost.”

Increasingly, companies are looking at outsourcing as a way to boost efficiencies by offloading IT tasks that don’t provide a competitive advantage. At its Outsourcing Summit 2004 in May, Gartner Inc. said outsourcing will account for 53 per cent of the worldwide IT services market this year and will make up 56 per cent of the market by 2007.

Hand-in-hand with that comes an increase in using offshore outsourcing service providers as a growing international talent pool. This, combined with lower communications costs, makes managing a worker thousands of miles away as easy as having the employee in a local office.

Companies say the biggest benefit of using offshore providers is cost savings because wage rates overseas can be as low as one-tenth of what comparable workers earn domestically. But companies also are seeing other benefits, such as increased flexibility — the ability to grow and reduce the number of workers, 24/7 work schedules because of time differences and access to a broader range of IT expertise.

Challenges also exist with issues such as language and cultural differences, time zone barriers and unfamiliarity with offshore providers, according to a report IDC released in May. Nevertheless, with CIOs being asked to do more with less, interest in the offshore option is growing, especially with companies such as IBM Corp. and Accenture Ltd. beefing up their offerings abroad.

Forrester Research Inc., which made waves in 2002 when it released a study predicting that 3.3 million U.S. services jobs would move offshore by 2015, increased that estimate in May to 3.4 million. The firm also said that in the near term the use of offshore resources would grow 40 per cent faster than originally expected, from just less than 590,000 jobs to about 830,000 jobs by the end of 2005.

At the same time, analysts note that while IT jobs undoubtedly are being pushed offshore, the number is actually a minuscule percentage of overall IT positions. Forrester, for example, points out that the number of jobs shifted offshore in 2003 — 315,000 — represents less than one per cent of all jobs in the affected categories.

As compared with outsourcing in general, a study conducted by the Information Technology Association of America and Global Insight found that offshoring accounted for just two per cent of the total US$10 billion outsourcing market today and will increase to six per cent of a US$31 billion outsourcing market by 2008.

Why now?

“Where IT offshoring really became mainstream was during the Y2K period,” says Partha Iyengar, a research vice-president at Gartner. “Now companies are saying if this worked so well for Y2K, why don’t we look at this for ongoing outsourcing? It gives us better quality than we’re able to achieve on-site and significant cost savings.”

Ravi Kalakota, CEO of E-Business Strategies, and co-author of Offshore Outsourcing, Business Models ROI and Best Practices, says the use of offshore IT services is maturing from its Y2K roots to handle not only application development and maintenance, but also to support large packaged application deployments and business-process outsourcing.

“Is all this hype? Definitely not,” he says. “Offshoring is moving up from the food chain from being a two-year-old into a four-year-old or five-year-old. It’s able to do more things now.”

The IT industry is following a familiar path when it comes to outsourcing. Manufacturing, for example, has been using offshore arrangements for decades as a way to drive down costs and boost production. In the 1990s, the production of IT hardware moved offshore, resulting in price reductions of 10 per cent to 30 per cent, according to a policy brief that Catherine Mann, senior fellow at the Institute for International Economics, published in December.

Those price reductions, coupled with increased productivity, resulted in an additional US$230 billion in gross domestic product for the U.S. between 1995 and 2002, Mann says. Meanwhile, IT software and services became an increasingly important part of overall IT. Mann notes that between 1993 and 2001, the increase in IT hardware spending was 6.7 per cent, while growth in software and services was nearly double that at 12.5 per cent.

“In the face of this demand, and enabled only since the mid-1990s by the Internet and standardization of methods, software and services are now beginning to be produced globally,” she writes in the brief titled, “Globalization of IT Services and White Collar Jobs: The Next Wave of Productivity Growth.”

“Just as for IT hardware, globally integrated production of IT software and services will reduce these prices and make tailoring of business-specific packages affordable, which will promote further diffusion of IT use and transformation throughout the U.S. economy,” she continues.

While some of those IT jobs will go abroad, new opportunities will open in the U.S., she says.

“As more sectors of the economy and more businesses use the IT packages in the U.S., high-skill jobs to design and tailor IT packages will increase in the IT sector, and jobs demanding the skills to use these IT packages effectively will diffuse throughout the economy,” Mann writes.

The Bureau of Labor Statistics says that occupations requiring IT skills will grow at three times the rate of job growth in the overall economy during the next 10 years.

Real life, real impact

Still, real-life issues of job losses have created a backlash and made offshoring a hot political issue.

“The pressure (on IT jobs) will continue,” E-Business Strategies’ Kalakota says. “As long as the economy does not improve, or trudges along the bottom, the pressure on IT jobs is going to be quite severe. Now, if the economy starts picking up and more hiring starts because there are just more projects, then the IT pressure might steadily decrease, for a while at least.”

Kalakota notes that economists and others point to the creation of new jobs in the long run, “but we don’t live in the long run. We have to put food on the table today.”

Increasingly, companies are paying attention to the very real impact offshoring is having on IT workers who find themselves jobless. Already, there is legislation pending in Congress that would extend benefits to IT workers who have been displaced as a result of jobs moving offshore. Corporations such as IBM, which plans to move an additional 3,000 jobs offshore by year-end, are extending benefits of their own.

“We’ve set up a couple of different funds for those people that had those jobs,” says Clint Roswell, a spokesman for IBM. “There is a (US)$750 million commitment from our chairman (Sam Palmisano) to develop hot skills jobs and train people for them, and of that $750 million, (US)$400 million is for workers here in the United States.”

In March, Palmisano also announced the US$25 million Human Capital Alliance fund, which is aimed at retraining IBM employees with new skills and then placing them in positions with IBM or one of IBM’s partners.

“We understand the circumstances here and it’s been somewhat fast in the way it has unfolded, but we realize that training and retraining and retooling is something that has to be done over and over again in the IT industry,” Roswell says. “Offshoring has hastened it a bit for us.”

The upside

Those with the right skills will be able to take advantage of the evolving IT economy that will include offshoring as one factor that will actually boost IT transformation at home, analysts say.

“The net impact is actually positive because what you’re getting with offshoring is substantial cost reductions,” says Nirvikar Singh, professor of economics at the University of California-Santa Cruz. “Some of that may go straight to the bottom line, but a lot of that savings will go into hiring people to perform other tasks. It can go into trying to reach new markets, it can be used for other kinds of investments that will generate jobs somewhere else.”

A study by the McKinsey Global Institute published last summer found that for every US$1 corporations spend offshore, the U.S. economy gets US$1.14 in return because of lower prices and new job opportunities. More specifically, corporations using offshore services stand to save US$0.58 for every US$1 they spend offshore, McKinsey says.

“What numbers (like the Forrester numbers) neglect is the fact that a country like the United States goes on creating new kinds of jobs, and that’s what happened in manufacturing,” Singh says. “I guess people are worried now because we replaced manufacturing jobs with services jobs and they’re saying, ‘Now services jobs are going overseas.’ What’s going to replace them are other kinds of services jobs.”

General Electric Co. (GE), for example, has had a global presence since the late 19th century and began offshoring IT-related functions in the mid-1990s. While GE continues to expand its workforce internationally — adding about 100,000 jobs in foreign countries during the past 10 years — the company also has maintained its 160,000-strong employee base domestically, says GE spokesman Peter Stack.

“It’s pretty clear that with the shifting nature of our U.S. employment composition (from primarily manufacturing-based to services-based positions), that a large number of IT and service jobs have been created in the past 10 years in the United States,” he says. “They would be more high-tech and dedicated to high-growth businesses.”

At the same time, Stack makes no excuses for GE’s use of international workers, saying that in addition to cost savings, it’s imperative to have a foreign presence to operate as a global company.

“We have realized a lot more than a basic cost arbitrage through different types of offshore presence,” he says. “GE is an extremely global company to begin with. We derive about 40 per cent of our revenue outside the U.S., and the same per cent of our workforce is housed outside the U.S.”

“There are tremendous bases of employees for us to use to global advantage … and they’re usually GE employees and support GE businesses, not just in the United States,” he continues. “It’s not as though a function or job or process done in the United States has been ended and moved offshore. Frequently it’s a process or a job or a function that’s being designed for optimum efficiency, and we’ll take advantage of the fact that we have this employee talent pool to draw from in this location or that location. Cost is a huge factor. But one of the reasons we don’t want to quantify it is it’s not the sole factor or sole determiner, and cost at the expense of quality or efficiency is a concession that we absolutely won’t ever make.”

A growing trend

For its part, VF Corp. has anywhere from 100 to 130 overseas workers focused on IT projects that range from a technical service desk handled by offshore services provider Patni Computer Systems Ltd., to SAP programming, to software development and maintenance. Anthony says VF is continuing to evaluate what IT tasks would make sense to outsource and expects to increase the use of offshore services.

“Outsourcing to us is a bigger question, not necessarily offshoring. We look at outsourcing and ask, ‘Does it make business sense to do more outsourcing?'” he says. “The only way we feel that a company can come in and outsource and save you money is to leverage the offshore model.”

A study IDC published in May found that 26 companies using offshore service providers currently spend about 5.4 per cent of their IT budgets on offshore resources, but plan to increase that percentage in the next year or two by about 25 per cent.

“Driving this increase in spending for offshore services … is the need to drive down costs,” the report says.

Anthony says that costs savings aren’t the only benefit he’s seeing. He says the ability to increase and decrease IT resources as needed is particularly important.

“If I have a project that requires 10 people today to design it and then 40 people to build it and four people to implement it, in an offshore relationship I can ramp up and ramp down like that,” he says. “But if I had to hire 40 people domestically and only needed them for four months, that would be very difficult.”

While he says that VF hasn’t had to add new positions to manage offshore relationships, that has been the experience of other companies using offshore providers.

Healthcare technology company St. Croix Systems, for example, has added sales positions and product managers as a result of its offshore projects. The Cambridge, Mass., company began using offshore service provider i-Vantage to set up its own subsidiary in Hyderabad, India, last year to increase software development.

Troy Kenyon, president and CEO, says the company cut its development costs by about 50 per cent and has gotten to market more quickly than it would have if it had to hire developers in the U.S. That, he says, has resulted in the need to bring on more workers locally.

“For us, offshoring was entirely an expansion. We had no one replaced here and, in fact, we brought in more folks in the United States to work as project managers,” he says. “We also got to the point where we needed more sales people more quickly.”

Meeting challenges

MedSite Inc., which provides online marketing and education services to the medical community, uses offshore provider Epam Systems Inc. to outsource some of its application development work to Minsk, Belarus.

Jason Hogg, COO at the New York company, says that having developers located in different time zones provides a continuity to the application development cycle. But he also says time, cultural and language differences could have posed real problems.

“We’ve mitigated those problems by having an in-house representative from Epam as a point person,” he says.

“That person sits and works with MedSite here, which enables them to ask a lot of follow-up questions and become an integrated member of the company. They also are able to communicate with the people offshore. So we have a single point of contact, project management in one centralized place. That is definitely a benefit.”

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