Offshore Software Development

Myths, Facts, and Opinions

The term “outsourcing” became popular in the 1990’s. During that time, white-collar workers experienced, for the first time, the kind of job shifts that many blue-collar workers had experienced in prior decades. History has shown that significant job shifts have coincided with major industrial and technological revolutions. For example:

• In the early 1800’s, the Industrial Revolution caused major job shifts. The Luddites were a group of English textile work ers who protested – often by destroying textile machines – against changes resulting from the Industrial Revolution that they felt threatened their jobs.

• In the mid 1950’s, Japan’s infrastructure was re-built in the years immediately following the end of WWII. During this time, Japanese companies adopted revolutionary manufacturing innovations such as Statistical Process Control. Japanese companies could manufacture products at higher quality and lower cost than US companies could. Thousands of US manufacturing jobs were shifted to Japan.

The Giant Sucking Sound

The number of US manufacturing jobs shifting overseas was so great that Ross Perot (former presidential candidate and founder of EDS) quipped that the jobs leaving the US created what he called a "giant sucking sound" as workers left for other countries.

In the 1990’s, the Internet sparked the latest job shifting upheaval. As Third World countries built infrastructure and added broadband capability, knowledge workers could now be located in many parts of the world. The Giant Sucking Sound has gotten louder as knowledge workers have been pulled into the great vortex…

This month, we will explore the offshoring phenomenon – looking at the impact on the US economy, typical problems encountered by organizations who offshore software development work, and the most contentious issue - is it really as cheap as they say?

Terms

Before we begin, several terms need to be defined.

• Outsourcing
  
  Outsourcing is the delegation of non-core operations or jobs from internal production to an external entity (such as a subcontractor) that specializes in that operation. Outsourcing is a business decision that is often made to focus on core competencies. (Source: Wikipedia)
  
  Outsourcing is the term originally applied to work sent overseas. Many people still use this term. However, work that is “outsourced” isn’t necessarily sent offshore. Work may be sent to a company located in the US that specializes in some particular aspect of a business process that, as indicated above, is not part of the organization’s core competencies.

• Offshoring
  
  Offshoring is relocating business processes to a lower cost location overseas. (Source: Wikipedia)

• Onshoring or Homeshoring
  
  Onshoring or homeshoring is relocating business processes to a lower cost location in the US, usually in smaller cities where workers can work at lower cost than in larger urban areas.

• Nearshoring
  
  Nearshoring is a form of outsourcing in which business processes are relocated to locations that are geographically close to the US. (Source: Wikipedia)

• Knowledge worker
  
  One who works primarily with information or one who develops and uses knowledge in the workplace. (Source: Wikipedia)

Myths, Facts, and Opinions

As with earlier upheavals, the job shifting of knowledge workers is very emotional and very political. It has generated lots of press, created lots of myths, few facts, and many opinions. Smart people disagree on many aspects of this highly controversial topic.

To help sort this out, I will try to address the myths, the facts, and provide some opinions about the following topics related to offshoring:

1. Is offshoring to blame for the so-called “jobless recovery”?
   
   
2. What kinds of problems have organizations involved in offshoring software development and QA work had to address?
   
   
3. What are the real costs associated with offshore development and QA?

I will also identify resources so you can learn more about this important topic.

1. Is offshoring to blame for the so-called “jobless recovery”?

Many people agree that the US is experiencing a “jobless recovery” as the economy recovers from the 2001 recession. Some people believe that the dramatic increase in offshoring is the cause for this “jobless recovery”. Let’s look at the myths, the facts, and some opinions.

Myths

Some people believe that the dot.com meltdown and not offshoring was the primary cause for the loss of jobs since 2000. A McKinsey & Co. report states:

• “A related myth is that service-sector offshoring is responsible for the anemic job creation during this economic recovery. Critics [of offshoring] frequently point out that more than two million American jobs have been lost since 2000. But nearly all jobs lost were actually in manufacturing, not service sectors.” [1]

It seems that the real myth in this report is that all of the jobs lost since 2000 were “…in manufacturing, not service sectors”.

Facts

Now, let’s look at some facts…

Forrester Research estimates that 3.3 million white-collar jobs, representing $136 billion in wages, will move offshore in the next 15 years.

A report on offshoring and its impact on the “jobless recovery” prepared by the Brookings Institute stated that:

• “The immediate, or impact effect of an increase in offshoring activities is a reduction in U.S. employment. That effect takes two forms. For some firms it leads to a cessation of operations and to permanent layoffs of currently employed U.S. workers. In other cases firms may not need to layoff existing employees, but do reduce new hiring they would have undertaken had they not decided to rely on foreign production to meet their needs. Employment will fall relative to what it otherwise would have been.” [3]

A recent article in the Boston Globe stated that:

• “While corporate profits rose 62 percent from the end of the 2001 recession until early 2004, labor compensation rose only 2.8 percent.” [2]

Opinions…

Clearly the statement in the McKinsey Report that “…all jobs lost were actually in manufacturing…” [1] is not accurate. Many jobs in software development and QA were also lost and these job losses can be directly attributable to offshoring activity.

Most software industry consulting and research firms believe that offshoring will see significant increases over the next several years as US companies continue to take advantage of tax loopholes by shifting software development work overseas. [14] In fact, Stan Lepeak, VP of the META Group, stated that:

• "The growth [in offshoring] will come from application development or software development…" [14]

And, there are those who believe that offshore outsourcing is a good thing that will help invigorate our economy and force changes in the way the software industry operates.

Read the McKinsey Report on Offshoring…

2. What kinds of problems have organizations involved in offshoring software development and QA work had to address?

As you might expect, software companies involved in offshoring have had some problems…

Myths

Some software companies who have problems developing software here in the US seem to believe that by sending their development work offshore, it will magically get done right, on time, and for a lot less money.

Facts

Ed Yourdon observed that:

• “…in order to make offshoring work, you need a much more formal management structure, and a set of formal, rigorous, well-defined ‘processes’ that can be carried out by knowledge workers in some other part of the world. In the software business, this means that companies whose IT organizations are operating at SEI-CMM level 1 or 2 will have a tough time sending their development projects to India.” [4]

A recent survey [5] of companies actively involved in offshore projects, identified the kinds of problems encountered and their perceived severity:

“Between 20% and 30% of the companies reporting in this survey indicated they had had ‘major’ problems in each of nearly 20 categories. The most commonly reported problems were knowledge transfer problems and cultural problems.” [5]

Summary of Alera’s Offshoring Survey…

Opinions…

A disciplined development environment and effective management controls are prerequisites before companies should consider offshoring. Companies that have problems developing software in the US should expect those problems to be magnified a hundred fold when their development and QA resources are half-way round the world.

The absurdity of “offshoring-mania” is illustrated in this recent article:

• “[…] Boston-based TH Lee is urging the companies it invests in to ‘build offshoring into the business plan from day one.’ If management doesn't ‘get it, […] venture firms need to drive the thinking’ about hiring offshore.” [6]

How many startups have you seen that have the disciplined software development environment and effective management controls Ed Yourdon believes are required for offshoring to be successful? It seems that the venture capitalists desire to “drive the thinking” in this area will lead to more failures than successes.

3. What are the costs associated with offshore development and QA?

The primary reasons offshore development has grown so dramatically are the tax loopholes and the lure of low cost labor. Highly skilled labor in countries like India, China, the Philippines, and others are paid a fraction of what their US counterparts are paid. But labor costs aren’t the whole story…

Myths

The business press is replete with articles on the bargain basement labor rates available from offshore development firms (see [2, 12, and 13]). Claims of 80% percent savings are frequently touted. A recent article in CIO Magazine stated:

• “The current stampede toward offshore outsourcing should come as no surprise. For months now, the business press has been regurgitating claims from offshore vendors that IT work costing $100 an hour in the United States can be done for $20 an hour in Bangalore or Beijing. If those figures sound too good to be true, that's because they are.” [7]

Facts

When something seems too good to be true, it usually is. As many people have pointed out, labor costs are only one of the many costs of offshoring…

• “Bargain-basement labor rates tell only a fraction of the story about offshore outsourcing costs. The truth is, no one saves 80 percent shipping IT work to India or any other country. Few can even say they save half that. What many execs leading the charge offshore fail to appreciate is that it takes years of effort and a huge up-front investment to arrive at even a modest level of savings. Vendor selection and initial travel costs add 1 percent to 10 percent to the real cost of a deal. It takes three months to a full year to hand the work over completely to an offshore partner and set up necessary network infrastructure, adding another 2 percent to 3 percent to total cost. Then there are costs from transition-related productivity slumps—on average, application development efficiency declines 20 percent during the first two years of a contract. Once the work is transitioned, the costs of ongoing management contribute another 6 percent to 10 percent above the contract cost.” [7]
  
  Read more about The Hidden Costs of Offshoring…

Howard Rubin, VP of the META Group, recently conducted a study of 100 companies based in New York City [15]. One company he surveyed figured it would cost about $20,000 in salary per person offshore. However, the company wound up spending closer to $45,000 per person after including costs for offshore management, infrastructure, training, and other related costs. A similarly qualified onshore resource located in Syracuse or Buffalo NY would earn about $53,000 – hardly a significant cost savings.

Read Howard Rubin’s Study…

And here’s some data from a recently conducted survey of companies involved in offshoring [5]:

Nearly 10% of the companies surveyed had negative cost savings.

Opinions…

Labor costs in offshore countries are increasing at a faster rate than labor costs in the US. A VP of an offshore IT development firm stated that:

• “Despite annual wage increases of 15% to 20% for IT staffers in India, the cost of technology operations there won't edge upward, Hebert argues.” [8]

Hard to imagine with 15-20% increases in labor costs, the cost of offshore development isn’t going to increase. The way they plan to do this is to force turnover by using lower cost and obviously, lower skilled labor as the more experienced staff become too expensive. More turnover means more disruption, more training required, more management issues, etc…

In the not too distant future, the gap between labor costs for offshore and onshore knowledge workers will diminish to the point where there is no significant cost savings to be realized by sending this work offshore. What will those companies investing heavily in offshore development do when this happens? Most likely, they will be in a position of not having sufficient onshore resources in place to take advantage of this shift in labor expenses. And, much of their domain knowledge will have been transferred offshore…

Emerging Trends

Can US-based businesses find knowledge workers in the US that can compete with the lower wages paid to offshore knowledge workers?

The answer is yes.

Onshoring is bringing work that was done offshore, back to smaller cities in the US where labor costs are more competitive. The onshoring movement is starting to take hold as businesses involved in offshore development are looking at the real cost of offshore development – not just the labor cost – and realizing that they are not saving as much money as they expected…

A backlash against corporations that send US jobs offshore has also been gaining steam. At least 8 states have legislation pending that would prohibit government entities from sending government work offshore. And Congress is taking up this cause as well. No less than 8 bills were introduced in 2004 to limit the number of US jobs sent offshore and to close tax loopholes that make it attractive for companies to do this.

Dealing with the backlash from a CIO’s perspective…

The backlash is already starting to affect US businesses. Check out this recent story about call centers:

• “But offshoring, sending service calls overseas, has sparked a backlash, many analysts say, and some companies have begun rerouting calls back to centers in the United States after receiving complaints about the quality of service. ‘I haven't spoken to anyone who's been successful in our arena going overseas,’ said Al Gordon, executive vice president of customer service for Tweeter Home Entertainment Group. ‘As much as these call centers try to cover the fact that they're in a different country, it becomes pretty apparent to the customer when you have an instance that requires a high degree of touch.’
  
  The result: Tweeter, based in Canton, shelved the idea of moving its customer service overseas and kept the facility in Canton [Massachusetts].” [9]

The Bottom Line…

In my opinion, offshoring has resulted in significant job shifting. The ivory tower economists would have us believe that this is somehow good for our economy. Hard to convince someone who’s been out of work for many months that this is for the greater good.

We need to exploit the resources we have here in the US, develop lower-cost knowledge worker centers in smaller US cities, and compete more aggressively with our counterparts in other parts of the world. We also need to increase undergraduate enrollment in software engineering and IT programs at our colleges and universities. Legislation to close tax loopholes that make offshoring attractive can also help.

Many small to mid-sized software companies who have been involved with offshoring have had significant problems. Several of these companies are relatively low maturity organizations looking for a quick return on investment. The few companies who have managed to be successful at offshoring have learned that you need to take the long view. Offshoring won’t pay dividends in the short term – it may actually cost more.

Offshoring can work if organizations are willing to:

• take a long term view – significant returns require at least 2-3 years…

• invest heavily in training and knowledge transfer – since most offshore knowledge workers have little domain expertise in your product areas…

• recognize and effectively deal with cultural differences

Furthermore, organizations must have a proven track record of successful software development in the US before they can ever hope to be successful shifting jobs to Third World countries.

That’s my story and I’m sticking to it…

Pay it Forward

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Norm Kerth is a highly respected consultant who developed the Project Retrospective techniques discussed in the July-Aug newsletter. He was in a serious car accident and suffered a disabling brain injury. As a result, he cannot work and lives on a very limited income. You can help recognize his contribution to our industry by sending a small donation. Checks can be made payable to Norm Kerth Benefit Fund and sent to Norm Kerth Benefit Fund c/o Process Impact, 11491 SE 119th Drive, Clackamas, OR 97015-8778. You can also visit Karl Weiger’s website (Process Impact) for more details about contributing to the fund. Thanks.