Offshore Outsourcing’s Hidden Costs

Offshore Outsourcing’s Hidden Costs

Larry Dignan

Chris Heim knows he’ll have to eventually send some of his product development work to India, China or some other country.

The chief executive of HighJump Software, a supplier of supply-chain software based in Eden Prairie, Minn., has a rival that already has 200 developers in India, getting paid about $10,000 a year each. He has 80 developers in the U.S., where those skills are worth an average pay of about $80,000. “At some point we’ll have to do it,” says Heim. “I just don’t see the spread stopping.”

Heim, like other heads of U.S. information technology firms, has his reservations about hiring or renting talent in other countries that are not on his direct payroll. He worries about protecting HighJump’s intellectual property, if he provides source code to “outsourcing” companies that he hires at cheap wages to enhance his products. He worries about the morale of employees at home, who will worry whether their jobs are the next to disappear overseas. He’s even worried about whether he will be seeding the undoing of his own company, by giving a new set of smart outsiders the keys to his company’s intellectual property. “Are we training our future competitors?” asks Heim.

He doesn’t have the answers. But there are plenty of questions about the burgeoning practice of using inexpensive foreign labor to develop software; and its effect not just on the suppliers and users of information technology, but the U.S. economy itself and its tax base. If high-value jobs disappear, so also could the funding and the brains that will bolster homeland security. What happens if the U.S. winds up losing its technological edge? Will the tax base be gutted as well-compensated technology professionals lose their jobs? How long will it take for a displaced worker to get back to par with the salary lost? What will that worker do? What’s the impact on education? Or on national security?

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Despite those worries, how can you not consider employing offshore software programmers and stay in the game with cost-conscious competitors? Can companies offshore every piece of their businesses? How, as a technology project leader, do you manage, when not only the pieces of your network, but your people—in different disciplines—are spread globally?

No one knows all the answers. But, by the time better understanding emerges, it may not matter. Few executives are stopping long enough to ask questions because they have to cut costs to keep their jobs.

Next page: Economic effects of offshore outsourcing.

Offshore outsourcing in technology has been gaining momentum for years, but the movement was largely masked by the prosperity of the late 1990s. It became commonplace as companies prepared their infrastructure for potential Year 2000 problems. During the tech boom, offshore outsourcing was a way to alleviate a shortage of workers in the U.S. Today, offshore is a primary way to cut costs. Now the bandwagon—including the likes of J.P. Morgan Chase, IBM, Electronic Data Systems and a bevy of others—is rolling downhill.

But unlike manufacturing’s slower move offshore, technology is moving at its usual breakneck speed and the labor market may not have time to adjust. Consultancy Gartner Inc. projects that one out of 10 jobs at U.S.-based information technology product and services companies will move offshore by the end of 2004. For technology workers in corporations, one in 20 jobs will move offshore. Forrester estimates 3.3 million services jobs will go offshore over the next 15 years.

It’s possible educated workers can find new careers on the fly, but the more likely scenario is short-term displacement in careers that were coveted just three years ago.

Meanwhile, the economic effects behind moving technology jobs offshore may be larger than when manufacturing moved abroad. These higher-paid jobs contribute more to gross domestic product.

According to research firm, roughly 800,000 back-office jobs, a conservative estimate that includes a bevy of white-collar employees including programmers, will leave the U.S. forever over the next five years. Assuming a worker makes $60,000 a year, that’s $50 billion in lost wages and $60 billion in economic activity, assuming those workers buy other goods and services. Total tax loss: $13.4 billion. That’s a big number but a pittance considering the Pentagon says it has spent roughly $4 billion a month to fund military activities in Iraq since January.

Next page: Some in favor of restricting offshore outsourcing.

So far, the debate about offshore outsourcing has been framed by free-market proponents who believe that the U.S. economy will adapt and any displaced technology workers will move on to a yet-to-be-discovered “next big thing.” The aging of the U.S. populace, for instance, means that a large portion of experienced programmers and technology executives will be retiring over the next dozen years anyway; and there won’t be as many homegrown replacements as in the past as the baby boomers give way to Generations X, Y and Z.

On the other side are groups such as the Washington Alliance of Technology Workers, which wants Congress to impose limits on offshore outsourcing. According to executives using offshore outsourcing or pondering it, there’s more nuance to the debate.

“To a certain degree, your competitors are doing it and delivering products more cost effectively. You get to a point where you have to jump in that game whether you like it or not,” says Marge Putman, CIO of Relizon, a process-management company. “On the flip side, you look at what is that doing to the U.S. economy. It’s an economic balance, conscience balance and a moral balance. Of late, the economic balance is at the forefront. If the prevailing mindset out there continues, you have to wonder what point is the stopping point, and is there one?”

Next page: Rapid cost-benefit adoption.

Fast Change, Slow Response

For Ronil Hira, assistant professor at the Rochester Institute of Technology in Rochester, N.Y., the biggest concern about offshore outsourcing is that it’s a fast-moving trend with largely unknown implications for the U.S.

“This debate has been cast as ‘this is free trade vs. protectionism’,” says Hira, who testified before a House of Representatives committee in June. “I don’t think that’s the right way of thinking about it. That’s just one part of what’s going on. This is happening so rapidly that the labor market doesn’t have time to adjust. There’s a long lag for retraining, moving and those sorts of things.”

Hira’s biggest concern is that research and development for cutting-edge technology moves offshore. This is a development that is not apparent now, but likely in the future, he says. Currently, “commodity” jobs such as programming and coding are moving offshore, but analysts widely expect higher-level careers to also go abroad. Indeed, Forrester Research projects 288,281 management jobs offshore by 2015, up from zero in 2000 and 37,477 in 2005.

Hira says he isn’t opposed to offshore outsourcing, but argues it would be in the national interest to look before the economy leaps. “The way I see it right now, we don’t have a read on the magnitude, scale or scope of offshore outsourcing and what’s actually happening,” says Hira.

Before offshore outsourcing gets too far along, Hira says there should be a national fact-finding mission to get the following:

Conduct a census of what’s happening with the movement of

high-level professional and management jobs abroad. The survey should nail down: How many jobs have left in technology, what is the quality of the services, and how is trade affected?

Outline how the military would procure technology that originates outside of

the U.S.

Determine how losers will be compensated and detail retraining efforts.

Project short-term and long-term economic impacts, and define winners and losers.

“One fact that’s being overlooked here is that there are losers in this equation. There’s no free lunch in free trade. You can be principled about free trade, but if you don’t say how do we compensate and retool the losers you miss part of the equation,” says Hira.

Next page: Free market advocates respond.

Those who advocate procuring talent wherever it’s available at the best rates don’t dismiss Hira’s worries about moving development of cutting edge technology offshore and short-term pain for an educated workforce. However, they do argue that the U.S. economy will survive and thrive by embracing such globalization of resources and not circling the wagons.

Gerald Hanweck, a finance professor at George Mason University, says U.S. companies would be under pressure by global competitors using cheaper overseas talent, so it makes sense for domestic businesses to keep an edge.

“You may look at it as exporting jobs, but those jobs would be under pressure anyway,” says Hanweck. “From a free-market point of view when you have talent around the world that’s less expensive, you should be able to hire that talent.”

While acknowledging potential job displacement and likely flattening of technology salaries globally, Hanweck notes that competitive U.S. companies will maintain the tax base better than extinct ones that didn’t cut costs.

Ray Bingham, CEO of Cadence Design Systems, a chip-design company, has 1,000 offshore workers in India, China, Russia and even France depending on customer requirements and cost. In July, he told employees he was expanding in India and temporarily contracting operations in North America. “It was not a pleasant message,” says Bingham.

Nevertheless, that trend will continue even if business improves, he says. There will be more jobs created domestically, but growth won’t come close to matching hiring offshore, says Bingham, reflecting a common theme among executives.

Bingham says the short-term pain is worth the payoff of productivity. According to him, the U.S. economy has something the world doesn’t—velocity. That means Americans are uniquely suited to rip up a blueprint and reallocate capital to cook up another growth industry. Ultimately, U.S. workers will be more productive with the competition from other pools of talent around the world. The result: They will drive themselves to become more valuable, he says.

“It’s two edges of a knife,” he says. “Cadence employees realize it’s locally inconvenient, but a requirement for winning.”

Next page: Balancing business realities against career loss and change.

Technology managers in the trenches may not agree completely with Bingham’s big picture outlook, but they see using talent on a for-hire basis in locales around the globe as a way to survive.

“You either do it and sacrifice some positions to save the bigger piece, or are you really going to drive the company in a less-competitive position and lose the entire organization,” says James Fridenberg, vice president, policy management applications at Farmers Insurance Group. “It’s the lesser of the two evils. The U.S. has always prided itself on the survival of the fittest, and if we are not the lowest-cost provider of software services we need to find a new niche.”

Christopher Campo, 40, of Phoenix, is struggling to find his new niche. A former technology infrastructure manager, he’s been looking for work for 10 months. He may soon choose a new career, going back to school for accounting. Another option: pharmacist, which would require six years of school.

“I like what I do and I’m good at it, but I have to make a decision soon,” says Campo, who says the salary at his next job is likely to be lower.

For Hira, tracking workers like Campo is key to determining the effects of offshore outsourcing. “I hear a lot of people say ‘look at healthcare; there’s a shortage of nurses,'” says Hira. “So you’re saying to someone, you have your four-year electrical engineering degree, you’ve worked in the industry for 15 years and you’re in your late 30s with kids and you now have to go back and study nursing. Is that the answer?”

“That is the $64,000 question,” says Bradley Clark, manager of global resourcing at LexisNexis. “I don’t know how to get around that situation.”

Renewing the Economy

Clark, like other technology executives who use offshore suppliers of talent, wonders if the topic would get attention if the U.S. economy were creating jobs and growing 4% to 4.5% annually.

“If business were better there wouldn’t be so much doom and gloom,” says Clark. “Right now offshore outsourcing is one more brick to carry on your back. It’s a huge issue that’ll be around until the economy picks up.”

Perhaps. It’s possible the issue may stick around. Technology executives and analysts expect companies to continue using offshore resources even if business turns up. And the advance of communications networks will make it easier to simply move every project to the cheapest source of a particularly defined skill anywhere in the world.

Still, different companies draw different lines in the sand.

For Clark, LexisNexis’ data center will stay in the states because he considers it to be the company’s competitive advantage. Product development, however, can go offshore.

For Fridenberg, it makes sense to keep systems architects who know technology and how to meld it with the needs of an insurance company.

Peter Weber, CEO of SevenSpace, a company that manages infrastructure for the likes of CVS and FootLocker, and is planning a pilot for offshore development, won’t take his call centers offshore, contrary to most executives.

Weber says most of the calls SevenSpace gets won’t adhere to a script. Given that the call center is the first contact with customers, he’ll keep such centers in the U.S. Instead, he will move application maintenance, development and systems management positions offshore.

Next page: More offshore strategy, plus quality of life issues.

Weber also wants some face time before moving parts of his infrastructure offshore. He’s likely to bring overseas programmers and engineers to the U.S. for six months. The full cost savings is delayed since SevenSpace will have to house and feed his new workers, but the company will save as much as 80% when they go back to India, he says.

Even Bingham, an ardent supporter of offshore outsourcing who marvels at the creative destruction of the U.S. economy, has his limits. He says “core” research and development will remain domestic. Bingham’s job as CEO, the finance and legal teams, and the folks who cook up the strategy for Cadence will all stay stateside.

Would Cadence one day move its headquarters and operations elsewhere, altogether? Bingham says no way. Indeed, he argues that if the economy creates a lot of jobs, it’s likely that technology talent that currently resides in India and other countries will flock to the U.S. to start companies that will hire Americans and pay taxes, analysts say.

“The core technology development and strategy best resides where it is today,” says Bingham. “The reason is that this is the right place to be for the things that have to come together. The U.S. has unmatched infrastructure. The U.S. has a robust leading education system, venture capital, capital markets and an open, free legal system. It’s also a safe place to live. Most countries simply can’t replicate that.”

What You Should Know About H-1B Visas

What are they?

Restricted entry documents allotted to foreigners deemed “essential” to the U.S. workforce.

Why are they needed?

Offshore outsourcing often requires onsite managers imported from other countries.

What’s the fuss about?

Job losses in the technology sector and backlash to offshore hiring make H-1Bs an issue.

How many are there each year?

During the dot-com boom, Congress raised the annual cap on H-1Bs from 65,000 to 195,000.

Will 195,000 jobs go to foreigners?

No. The annual cap is due to revert to 65,000 when the most recent law expires October 1.

For More on H-1B Visas, go to:

Copyright © 2004 Ziff Davis Media Inc. All Rights Reserved. Originally appearing in eWEEK.