OFFSHORE OUTSOURCING: THE IMPACT ON BUSINESSES

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1 OFFSHORE OUTSOURCING: THE IMPACT ON BUSINESSES Gregory W. Ulferts College of Business Administration University of Detroit Mercy P.O. Box 1900 Detroit, Michigan Tel: Terry L. Howard University of Detroit Mercy ABSTRACT The concept of outsourcing is a business practice that has gained momentum. However, many view this trend as a plague that is deteriorating American professional jobs. At the same time, many companies have incorporated outsourcing as a critical strategy in business planning. However, political opposition across the nation to outsourcing American jobs is strong. Legislatures without a doubt are going to introduce new bills or laws to prevent or at least limit offshore outsourcing. This paper investigates the advantages and disadvantages of outsourcing, the global market, and the political ramifications of outsourcing information technology, especially offshore.

2 INTRODUCTION The popularity of outsourcing continues to gain momentum in both the private and public sectors. In the mid-1990's, outsourcing was viewed as a viable solution to achieving cost control and production efficiency. Many companies began to incorporate outsourcing as a critical strategy in business planning. Today, because of historical successes, corporations are turning to outsourcing for a wide range of functions from logistics to human resources to customer relations. The reasons include cost, quality, performance, supplier pressure, access to special technical and application skills, and other factors. (Applegate, 2003) The government sector also is increasing its use of outsourcing. At one time, government outsourcing was primarily applied to contracts in areas such as maintenance, security, and food services. However, the government is finding it necessary to follow the commercial trend to outsourcing a wide range of functions, including information technology functions. (Office of Information Technology, 1998) Outsourcing is critical to U.S. organizations as they endeavor to become or remain competitive in the global economy. It is for this reason that this paper investigates the advantages and disadvantages of outsourcing, the global market, and the political ramifications of outsourcing information technology, especially offshore. IT OUTSOURCING Outsourcing is typically defined as when a buyer transfers ownership of a process to a supplier. Manufacturing, for example, has been using offshore arrangements for decades as a way to drive down costs and boost production. The IT industry is following a similar path. Before 1990 the major drivers for outsourcing were primarily: cost-effective access to computing power or system development skill, avoidance of building IT in house, access to IT skills, and access to special functional capabilities (Applegate, 2003). In the 1990s the production of IT hardware moved offshore, resulting in price reductions of 10% to 30%. Thus, if moving jobs offshore means lower costs, then a company can sell its products at a lower price, and everyone gains. When computer hardware began to be made abroad, prices plummeted. Therefore, if software prices decline, then small- and medium-size companies will be able to afford to adopt more technology solutions. (Mann, 2003; Haydik, 2004) Two factors have affected the growth of IT outsourcing: 1. Acceptance of strategic alliances - The value of strategic alliances is widely recognized and interrelated forces motivate their creation. 2. Changes in the technological environment - IT integration of internal systems with those of customers and suppliers and the process of changing organizational structure to compete efficiently in the global marketplace. According to a study by IDC, spending by US customers on offshore IT services will continue to concentrate heavily on applications, with most activity in the areas of custom application development, application management and systems integration. Global investment in offshore

3 IT services will grow from nearly $7 billion in 2003 to $17 billion by 2008, new research has predicted. It is predicted that the countries poised to win from this growth in outsourcing will be India, the Philippines and China, joined by central and eastern Europe. The procurement of IT services is not only growing as a share of the total IT services market, but is expanding from traditional IT services, such as application development and maintenance. (Intetics, 2003). GLOBAL MARKET Businesses are beginning to look outside of established outsource providers for a variety of reasons: cost, risk mitigation, specialized technology and language skills and proximity to the U.S. But the infrastructure to support IT services varies from region to region. India, China and Russia (among others) are churning out vast numbers of very bright and capable technology workers. These countries have discovered that the initial investment in a technology infrastructure is far lower than the initial investment in a traditional asset-intensive industry, i.e. manufacturing automobiles. With a sense of vigor and vision these nations have burst onto the tech scene in a very short time. Currently, India leads the pack as the prime location for offshore IT operations such as code maintenance, help desk and desktop maintenance. As the worker base becomes more skilled and as demand increases for India services, wages are increasing. Some economists feel that India's wages could rise so fast that they could push much of the offshore labor market from India to China and Southeast Asia in the next decade (where wages remain lower). Outsourcing service providers in African countries are at a more basic stage of growth than those in the Philippines. Although South Africa is already home to a handful of international services providers and homegrown providers, other countries on the continent are just beginning to build industrial parks to capture a share of the offshore outsourcing market. U.S companies, however, might not need to look very far abroad for outsourcing services, especially if cost is not the major issue, and language is a consideration. Canada has a telecom infrastructure virtually identical to the U.S. Mexico, however, offers some cost advantages and is particularly appropriate when Spanish services are required. (Swoyer, 2004) ADVANTAGES TO IT OUTSOURCING The drivers of outsourcing include general managers' concerns about costs and quality, breakdowns in IT performance, intense vender pressure, simplified general management, financial factors, corporate culture, eliminating an internal irritant, and other factors (Applegate, 2003). It appears that organizations that outsource for long term, strategic reasons often are more satisfied with the outsourcing results than those that outsource for short term, tactical reasons. U.S. companies cut or at times eliminate unwanted costs when jobs are outsourced to international suppliers. By doing so, these companies now have the freedom to be more flexible when making IT business decisions for their companies. Outsourcing is a means by which revenue is generated, production is improved, and the U.S. economy is increased. More resources are also made available which in turn provides quicker products to the marketplace. Moving certain business functions to other offshore companies allows a company to have no overhead costs. For instance, offshore companies provide their own facilities to do the work. There is no need to recruit, hire, or train new employees at all for the company. Also, other expenses related to employees such as insurance, worker's compensation, social security, and

4 company benefits are all gone. Offshore companies "pick-up" the tab where in the meantime U.S. companies are again cutting costs and increasing profits to boost the American economy. In deciding which company to choose, U.S. businesses can tap into an international pool of highly talented, experienced workers who can do the same skilled job at a lower price. With this in mind, any project that is handed over to a potential vendor will be placed under highly qualified proven individuals who work together effectively. U.S. companies are then able to vary their involvement however they wish. Having well documented processes in place for service jobs, corporations can trust that it will be completed on time, within project budget, and meets the specified criteria as given to the offshore vendor. It can be argued that outsourcing projects to offshore companies improves a company's main focus on the job at hand and not on unneeded tasks. (Kalakota, 2004) Coupling innovative approaches with offshore outsourcing can payoff for everyone. Consider the case of Net Scalar Inc., a Silicon Valley maker of network switches that speed online applications such as Google searches. It had to cut its 100-person staff to 55 in 2002 after the September 11 attacks dried up sales. To survive, it launched an operation in Bangalore. Roundthe-clock work in the U.S. and India helped it pack leading-edge data compression and security features into its latest product. Now, with sales jumping more than tenfold, to well above $10 million last year, it has boosted its U.S. staff to 105, even larger than before. (Hof, 2004) DISADVANTAGES TO IT OUTSOURCING As with all new initiatives that are implemented into a company's business strategy, there are some drawbacks to outsourcing. They include but are not limited to language and cultural differences, displaced American IT professionals, loss of intellectual property or trade secrets, foreign political infrastructure, hidden costs, unfamiliarity and lack of experience with offshore providers and their capabilities. All of the aforementioned weaknesses are important and significant for a company that is considering outsourcing. Language and cultural differences are the critical weaknesses that are causing some corporations to reevaluate which IT functions should be outsourced. One big name company that has decided to return certain offshore work to the U.S. is Dell Corporation. Dell brought back a technical support center after corporate clients complained about communication and service. Fundamental language and cultural differences derail the cost savings that are suppose to be achieved with outsourcing. The losses of intellectual property or trade secrets are threats to corporations because offshore workers come in contact with specific operations during the course of normal work. As part of learning operations, offshore workers can gain knowledge that can be applied to other projects down the road. This is a positive thing if these projects are done on the company's behalf. On the other hand, the company's accumulated knowledge may be applied to solutions for other customers at a later date. Since most offshore workers are employed as contractors, there is the distinct possibility that this knowledge will be applied to competitors' solutions. Various studies show that 20% to 35% of IT outsourcing contracts are not revived after they expire. Most customers in these cases are not satisfied with the quality and/or price of the services. (Intetics, 2003; Swoyer, 2004)

5 POLITICAL RAMIFICATIONS Losing jobs to offshore outsourcing has created a hot political issue in the United States. As long as the economy continues to struggle, the pressure to keep IT jobs in the U.S. will be strong. Today, state and federal legislatures are trying to discourage offshore outsourcing of IT jobs to foreign countries. In May 2004, Tennessee was the first state to pass legislation aimed at preventing offshore outsourcing of its IT services. The new law states that contractors that keep data entry, call center and other IT support jobs in the U.S. will receive significant preferential treatment during the bidding process on future new contracts. This is not surprising because many other states are considering similar actions too. Legislatures are being pressured to introduce new bills or laws to prevent or at least limit offshore outsourcing. Political opposition across the nation to outsourcing American jobs is strong. An amendment known as the Dodd Amendment, which was introduced in February, 2004 and passed in March by the Senate, is another step to stopping the needless exporting of American jobs. It prohibits offshore outsourcing of federal, state, and local government contracts where federal dollars are involved. However, the Dodd Amendment includes a provision that the Secretary of Commerce must certify that these anti-offshore outsourcing measures will not harm the U.S. economy. So far, the House of Representatives has yet to consider the Amendment as law yet and it is unclear what will happen in the future. Nonetheless, the issue is not going away. SUMMARY Outsourcing will continue to grow to be an accepted way of doing business as companies focus more directly on customer service and cost/budget reductions. As the concept becomes more accepted and outsourcing opportunities expand, the process will be more clearly outlined. Companies will accept outsourcing as another tool to improve services and reduce costs. Properly used, along with modular contracting, past performance initiatives, outsourcing will provide firms with the means to achieve excellence. Finally, firms will become comfortable with the entire process. They will approach outsourcing as a management tool that solves long term, strategic problems rather than short term, tactical problems. In doing so, companies will work with their alliances to realize successful outsourcing efforts. IT outsourcing will continue to be a critical strategy to efficient and effective business operations. There are obvious benefits that offset the disadvantages. However, the political ramifications are certain to drive the decision-making regarding the market exchange process.

6 REFERENCES Applegate, Lynda, Austin, Robert, & McFarlan, F. Warren (2003). Corporate Information Strategy and Management (6th Edition). New York: McGraw-Hill Irwin. Haydik, Bill (2004). Offshore Outsourcing: An Evaluation of Costs. Retrieved October 1, 2004 from Hof, Robert D. (2004). Now More Than Ever Innovation is the Answer. Retrieved March 1, 2004 from Intetics (2004) Case Study: Call Center System. Retrieved June 1, 2004 from Kalakota, Ravi, Offshore Outsourcing, Business Models ROI and Best Practices. Retrieved September 1, 2004 from Mann, Catherine (2003). Policy Brief. Retrieved January 15, 2003 from Office of Information Technology, IT Management Practices Division, General Services Administration, U.S. Government. Outsourcing Information Technology (February 1998). Washington D.C. Offshore Outsourcing Information Center. Swoyer, Stephen (2004) Enterprise Systems Outsourcing. Retrieved September 14, 2004 from