Trends In Offshoring
Long gone are the days of offshoring being a matter of just dollars and cents. Here’s a look at some of the latest trends driving the continued growth of this phenomenon.
Offshoring, the process of moving business functions to another country (either keeping them in-house or using a third-party vendor), is often seen as necessary for large and midsize U.S. corporations to compete in the global marketplace today. Competitive pressure upon operating costs and product-to-market release times have forced thousands of companies to look for cheaper labor pools in countries such as India, China, and Russia.
Nearshoring is a form of offshoring in which a business activity is moved to a nearby country in order to avoid time zone or language barriers. Many U.S. companies have chosen to move business functions to Latin America, the Caribbean, and Canada. Though the term is derivative of offshoring, the Mexican-based IT services company Softtek copyrighted the term Near Shore in 1997, promoting Mexico’s proximity, cost structure, and international trade agreements as a more convenient alternative to offshoring.
Once primarily associated with manufacturing, offshoring now affects a variety of industries and functions. Booz Allen Hamilton, a global strategy and technology consulting firm, reports that engineering, design, and research are increasingly being performed outside companies’ home countries. Driven by the growing demand for more complicated consumer and industrial products and a shortage of skilled high-tech workers in the West, the offshoring of these services is expected to continue at a rapid pace.
More than one million U.S. jobs have already been moved offshore, and that figure is projected to jump to 3.3 million by 2015, according to Forrester Research Inc. By then, nearly 6% of today’s U.S. jobs will be moved overseas, the firm reports in its study, “Near-Term Growth of Offshoring Accelerating.” The report notes that while greater communication capability via the Internet was the initial driver of the offshoring trend, other more recent factors have fueled the movement. For one thing, even conservative companies are now willing to experiment with going offshore to protect themselves competitively. Also, overseas vendors have broadened their IT service offerings, and in many cases user companies are establishing “captive,” or self-owned centers, giving them greater control over their operations.
“Driven by flat budgets and an increase in end user-sponsored projects, CIOs see offshoring as a way of doing more with less,” analyst John C. McCarthy writes in Forrester’s report. “Instead of squelching activity, the increased press and savings have spurred senior executives to ask, ‘What is our offshore strategy?’”
Offshoring is even beating previous market expectations, according to the research firm XMG, whose latest study estimates the global outsourcing market will hit $297 billion by year’s end, with an estimated annual growth rate of more than 19%. The forecast includes IT, BPO (business process outsourcing) and call center services, as well as the onshore and offshore delivery of outsourcing services.
India continues to lead the way as an offshore destination, forecast to capture $34.1 billion in total revenue by the end of 2007, and claim an estimated 11.5% share of the global market, according to the XMG study. India’s advantages are its talent pool, including 350,000 college engineering graduates per year, and its English-speaking population, about 2.2 million people, according to the Zinnov research group. When offshoring emerged as a common business tool in the late 1990s, U.S. companies (and their customers) simply found it easier to communicate with vendors in India than vendors in other countries suitable for outsourced operations.
“Those are the key reasons for India,” says Vamsee Tirukkala, co-founder and managing principal at Zinnov, a company that assists other companies with offshoring strategies and operations. “Also, Indian companies have much more experience now. They have a 10- to 15-year head start over the others. They have a maturity of taking customer requests and delivering them.”
The leading Indian offshore service suppliers (such as Satyam, Wipro, and Infosys) have experienced tremendous growth in recent years, and have broadened their services portfolio, capturing up to 40% of the most sophisticated clients’ IT services spending, according to Forrester’s study.
Behind India in the offshoring race is China, with an estimated $13.1 billion in offshoring revenue by year’s end, and a 4.4% share of the global market. Following behind China are the Philippines and Malaysia, at $4.1 billion and $3.6 billion, respectively.
“While it is no surprise that India and China continue to lead amongst the offshore countries, our study also showed a noteworthy insight to those following the growth of other offshore countries in Asia,” says Lauro Vives, XMG president and chief analyst. “The Philippines is experiencing an unprecedented growth rate of 62% CAGR (compound annual growth rate) and will surpass Malaysia in 2007.”
It’s a complex formula that determines whether offshoring will work for a given company. Time and money savings are obvious, but not guaranteed benefits. But other factors, such as quality control and communication challenges, have kept some firms leery of offshoring. And as the “globalization” of business strategies has progressed in recent years, so have its costs—wages, real estate prices, and infrastructure have become more costly in some of the more prominent offshoring locations. A study by McKinsey Global Institute and Nasscom, India’s software industry association, showed that entry-level wages rose 13% per year between 2000 and 2004, and mid-level managers’ salaries climbed 30% annually during that time. Wages in India and the Philippines continue to rise by 11% and 8%, respectively, XMG reports.
Last year, Apple Inc. withdrew its plans to build a captive center in India that was expected to employ 3,000 workers. While Apple did not publicly discuss its reasons for the decision, Business Week reported it was likely cost-driven, with wages for software engineers and IT managers soaring. Other factors may have included India’s high rate of turnover, and competition for quality employees.
Indeed, some companies are not buying into the offshoring practice. Despite the highly publicized advantages in cost savings and other areas, some corporate executives are bucking the trend by staying home and expanding in rural America.
Atlanta-based Xpanxion, a global software engineering company and an early adopter of combining U.S. and Indian centers for outsourcing operations, moved its software testing and quality assurance operations from Pune, India, to Kearney, NE last year. The company, which still maintains some operations in Pune, refers to its business model as “cross-sourcing,” a combination of offshore, onshore, and local outsourcing. The company believes that having multiple geographic locations reduces risks and gives clients more cost-efficient services and real-time support.
Accenture—the global management consulting, technology services, and outsourcing company—recently signed a five-year agreement with the Confederated Tribes of the Umatilla Indian Reservation, near Pendleton, OR, to help manage Cayuse Technologies, LLC, a newly formed American Indian enterprise. Cayuse Technologies will provide U.S. companies with services including software development, call centers, and image and document processing.
“We’re responding to the tremendous demand among Accenture clients for outsourcing services performed by professionals within the United States, and Cayuse Technologies will help fulfill that demand,” says Randy Willis, a senior executive at Accenture. “Working with Cayuse Technologies also complements Accenture’s efforts to build and maintain a global workforce that mirrors that of its clients, employing diverse groups of people from different backgrounds, with a vast range of skills and experience.”
And another new trend is emerging in which some India-based companies are doing some offshoring of their own—in the U.S. Bangalore, India-based Wipro Technologies is opening a global software development center in Atlanta, where it will work with the University System of Georgia to educate and train nearly 500 employees. The company says its new center will enable it to provide localized and closer-to-customer service for its expanding technology services in the Americas.
“The work we’re doing requires more and more knowledge of the customers’ businesses, and you want local people to do that,” says P.R. Chandrasekar, president of Wipro Technologies. Wipro has a dozen offices in the U.S. and development centers in Brazil, Europe, China, Canada, and Mexico.
Despite this nascent “reverse-offshoring” trend, offshoring by U.S. companies will only become more common, researchers say, and the services being outsourced will continue to become more sophisticated.
Majority of Silicon Valley’s Top Firms Offshore in India
If California’s Silicon Valley is any indication, leading technology companies are counting on offshoring to deliver high-end products and services to their global clients. A study by the Zinnov research group of the top 50 Silicon Valley companies, comprised of 15 software developers, 27 hardware developers, and eight conventional or non-information-technology companies, found that 33 had operations in India.
The software companies, including Oracle and Symantec, are leading the offshoring trend in India, with 14 out of 15 from the Silicon Valley operating there, according to the study. In most cases, the companies are using in-house “captive” centers, in addition to using third-party vendors. Captive centers, ranging in size from 30 to 9,000 employees, are being used for core competency operations such as research and development, while third-party vendors are used for non-critical activities. The most common location in India is Bangalore, while some companies have a captive center presence in Delhi, Hyderabad, and Pune.
Hardware manufacturers from the Silicon Valley have concentrated their offshore operations in China, Taiwan, and Malaysia, thanks to the cheap skilled labor available there, but companies such as Texas Instruments, Motorola, and Intel have operations in India. Zinnov’s research found that 17 of the 27 hardware developers have captive centers in India, and 13 (including some that also have captive centers) use vendors (mainly for IT and infrastructure management and maintenance).
The eight conventional industries companies from the Silicon Valley group have taken a more conservative approach to offshoring, Zinnov reported, as only two have operations in India. These companies tend to offshore their sales offices or distribution networks, instead of large-scale operations, but their use of offshoring is expected to progress.
The Zinnov study concluded that more technology companies are finding they can gain competitive advantages thanks to offshore talent pools, lower costs, and shortened delivery cycles.
The Silicon Valley trend can be looked at as a microcosm for the global technology industry, according to Vamsee Tirukkala, managing principal at Zinnov, who notes that 60% of U.S. technology companies are offshoring in some way, especially as the prices of their products drop and they must find ways to cut costs.
“Companies can contain costs through multiple ways, and one way is offshoring,” Tirukkala says. “With lower costs and a faster time-to-market, companies find that they can take more risks and develop more products. That’s the reality today.”