Will the U.S. Recession Mean the End of Offshore Outsourcing?

The economic recession in the U.S., and President-elect Barack Obama's tax incentive plan, will change the economics of some business process outsourcing areas. Could offshoring go the way of the dinosaur?

I recall sitting on a panel at an outsourcing conference in New York City back in 2004 when the major spike in offshore outsourcing kicked into gear. There were protesters outside, demonstrating their frustration about U.S. jobs "moving offshore". In response, an attorney declared, "outsourcing provides a great opportunity for the U.S.—we can "offload low-value jobs and focus on higher-value, more innovative work". I recall thinking to myself, even then, that that argument didn't quite add up.

While it sounds like a nirvana, the reality is we're competing globally for labor, for making cheaper, better cars, for delivering good quality IT services, for delivering quality finance, HR and supply chain support. If the U.S. is to truly deliver "higher-value", the government needs to invest in education programs that develop this talent. The reality is that the rest of the world caught up. People in Chennai, Manila, Bucharest, Guatemala City, Guangzhou, etc. are being trained to compete with American, British, French and German workers, and the Internet and new technology have been a huge enabler to make this happen. A good friend who works for one of the leading India-based BPOs recently suggested, "We should bring over the training leaders from the top Indian outsourcers and have them work with U.S. businesses to get their act together".

What continues to irk me, is that industry has become so focused on making its quarterly numbers that it has taken its eye off the long-term picture. We saw this financial meltdown coming—and did nothing (wasn't the Asian crisis of the '90s warning enough?). We are seeing further deterioration of the environment—and still do little. We saw the U.S. automotive industry grind down to its current predicament—and have done nothing. And we are seeing the IT and business process outsourcing industry rapidly develop across the globe—and have blissfully ignored it to meet these cost-containment targets.

And how to we respond? Bailouts. We're now talking about bailing out the failing automotive industry. How did it come to this? Years of greed, a deterioration of our work-ethics, and developing nations eager to get a taste of what we have. It's as if we had a major cardiac arrest and are now hoping we can recover fully from open-heart surgery.

And this time when we do recover (and we will), we simply have to make sure this never happens again. Some will argue this is all about natural economics of globalization and a free market—and they are probably right. However, this time we have truly reached an inflection point.

How the outsourcing landscape will change in this new economy

What is clear, is that shipping jobs offshore isn't necessary very healthy for the rising U.S. unemployment rate.

What's more, many offshore service providers are now focused on taking on more high-value work activities for their clients, in addition to routine transaction work. For example, once you have your general ledger run from a service provider in, say Chennai, what is now stopping that provider taking on higher-value accounting services, such as budgeting/forecasting and business intelligence? That provider basically owns and understands much of the revenue cycle of that client, hence the natural next step is to move up the process value chain.

And if your current provider won't move up the value-chain, there is a proliferation of KPO providers willing and ready to take on higher-value offshore work. Moreover, while a firm may have been enjoying good quality COBOL programming from Brazil, what's stopping that provider offering systems architecture work for their client, which is among the costliest onshore IT services?

The global battle for jobs is well underway

President-elect Obama has recently stated that he intends to give U.S. firms tax-breaks to source work onshore. While he hasn't yet outlined exactly how he plans to do this, it is likely that he initially will provide benefits for buyers, as opposed to the providers, to source work to onshore U.S. locations.

This is the opposite strategy of the Indian government's STPI (Software Technology Parks of India) tax scheme, which gives tax-breaks to new Indian organizations (mainly suppliers) in the region of 10 percent to 20 percent for their first 10 years of inception, designed primarily to bolster its software industry, but also directly applies to its service providers.

Look at it this way; you can hire staff in low-cost U.S. locations for a low as $25K a year for back-office administrative work. If you can reduce that further, to $22K a year as a result of tax incentives, and the cost of health-care is reduced/subsidized, the price differential with locations such as Lat-am and India is minimal.

IT services, on the other hand, are significantly cheaper (often four-times) in locations such as India and China for all levels of development and support services, hence a small tax-break for U.S. businesses is not going to make a great deal of difference in the grander scheme of things.

Bottom-line: Tax- incentives can work in some BPO areas, but unlikely to impact IT outsourcing.

For BPO services, the U.S. is still in the game

The issues surrounding client/employee contact still favor onshore services (even though offshore services are improving by the day), and there is still a great supply of mid-level executives who will be anxious to keep their jobs in the forthcoming months. With significant incentives to keep work onshore, I can see the U.S. stepping up as a serious BPO location. Not a bad thing for the BPO industry, as long as the service providers invest wisely in attaining the right onshore/offshore balance within their delivery infrastructures.

Moreover, the onus on sourcing we're going to see from the restructuring financial services industry is going to entail a delicate balance of onshore/offshore BPO work. If the major financial services firms struggle to sell off their Indian captives, we may well see several of them scale-down their offshore dependence and seek onshore services as an alternative.

For IT services, it's looking a bit late to pull much of this back

In India, for example, IT services have become the life-blood of the country's economy, and skills in basic programming are widely available for mainstream applications.

Even if U.S. wage rates for programming work come down significantly, there is also a major issue with the fact that the quality of many IT services delivered from offshore locations is now consistent.

The core battle is with services needed from business-process architects and staff with deep industry-specific expertise. We have seen many of the leading offshore providers invest in their onshore delivery centers over the last year—and we can expect to see continued significant competition between the incumbents and offshore providers in the coming months for onshore-related work.

It's about accepting that we now operate in a global economy and that we are competing at a level where we need to work as hard, and as smart, as the next nation. I hope President-elect Obama can help instill a new work culture in the U.S. The U.S. people want change, and they have voted in a President promising change. The core question now is whether they are really prepared to change.

Phil Fersht is research director of Global Business Services & Outsourcing at AMR Research.

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