IT Offshoring Savings Declined for Past 5 Years

The average savings achieved by IT offshoring has declined for the past five years, even as companies expanded their offshore initiatives, Duke University's sixth annual corporate offshoring study found.

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CIO.com: The perceived connection between offshoring and domestic job loss has driven a great deal of anti-offshoring sentiment in the U.S. particularly given the current levels of unemployment in America. Yet just 34 percent of your respondents said offshoring had resulted in local layoffs.

Lewin: The more telling finding is the ratio of offshore employment to domestic employees. For most industries, it's a small ratio. But for software development, the ratio is very high. To me, this is a worrying signal. At time when unemployment is high, companies report that access to talent is the reason they are offshoring.

There are at least two factors at play. Small, entrepreneurial firms are far more likely to offshore innovation services than large companies. They need engineers. In some cases, the skills they need—like VSLI [very-large-scale integration] design—no longer exist in the U.S. In other cases, the venture capitalists ask the new firm, 'What is your innovation outsourcing strategy?' So even though the talent might exist in the U.S., the VCs believe that for speed to market, cost, or some other reason, the start-up firm ought to find a way to get the work done abroad. And they find that the passion and commitment to get work done offshore is higher than hiring someone in-house or on a part-time basis.

Secondly, there is a structural shift going on in the employment of technical talent. Companies are learning to substitute full-time positions with hiring engineers, programmers, and technical personnel on-demand for a particular project. That decreases the desirability of the profession to young people.

Another problem is that American companies no longer invest in keeping up the skills of their technical personnel. Unlike other countries who understand the importance of keeping up the technical skills of their people, they'd rather let them go. So unless the affected employees invest in themselves, at some point in their careers they become not employable.

We used to have a proud tradition of companies investing in maintaining their human capital. Some of the things I see are crazy. We have an example of a major technology company in this country, that rather than hire new people to replace those who are retiring, are engaging an Indian engineering company to in source their engineers do the work. When those people leave, where does that intellectual property go? Back to India in the brains of those people. Such practices only solve a short-term problem.

From a long-term point of view, the statistics are clear that fewer Americans are entering science and engineering careers as indicated by the number of advanced degrees awarded. The trend began in 1995. Part of our research approach is to look for "small, initiating events" whose impact may not be seen for a number of years. In 2003, Congress allowed the H-1B quota to lapse which greatly reduced number highly skilled workers that companies could bring in. The H-1B shortage was about 130,000 visas. In addition the cumulative shortage of American nationals earning advanced degrees in science and engineering reached about 49,000. Indeed, in 2004, the unemployment rates in almost all engineering subfields were at historical lows.

In 2008, something else has happened. Companies began to realize the strategic importance of entering new markets like Brazil and China and they needed learn how to do product development and other work in those countries. If you're Boeing, where is your source of major top line growth? It's not in the United States. Companies are facing the challenge of creating an organization and processes that are aligned with their new markets.

CIO.com: When you asked service providers about their biggest concerns, pressure on margins was number one. Should that concern customers at all?

Lewin: Customers will benefit greatly. The new variables [putting pressure on provider profits] are that some countries have developed national policies to attract the outsourcing industry. Go to Dalian, China and there are at least 200,000 Japanese-speaking Chinese doing work for Japanese companies. According to KPMG, the current value of executed contracts is $5 billion—just in Dalian. Many countries are following the lead of China to establish national aspirations to attract the outsourcing industry—Sri Lanka, Morocco, and Egypt.

The competition is not just among providers, but also between countries. At a new tech park being built outside of Shanghai, a deputy mayor told us that a million people will be conducting back-office work for financial services companies within five years. In India, the total number of employees directly employed in the provider industry is only about one million people.

CIO.com: Companies are starting moving up the value chain with their offshoring—32 percent of your participants indicated that they now offshore innovation services. But it's not clear what exactly is driving that. You found that 88 percent of those who offshore innovation services say access to qualified offshore talent is the driver, but less than a third say a domestic shortage of qualified personnel is a driver. And, as you note, unemployment rates in the U.S. have reached historical highs due to the recession. So what's going on here?

Lewin: It's important to point out that the vast majority of engineering work—86 percent, according to a study by [India's IT services trade group] NASSCOM and [consulting firm] Booz Allen Hamilton—is still done in the Western world.

But you have to watch for those small, initiating events. Those companies that let their engineers retire and didn't replace them are an early trend. What are all the factors that are going to drive innovation offshoring? I don't have a good answer for that. Different companies and different industries have different reasons.

It's all part of an emerging trend that we call the disassembly and reassembly of the organization. If you're the CIO, you're always in the hot seat because of the high cost of IT and because it is so highly visible at the level of C-suite. The CEO must be always questioning these costs. The pressure is always on. But there's still a lot to be done offshore. This is not the end of the story by any means.

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Copyright © 2011 IDG Communications, Inc.

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