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Vol. 6, No. 11 Printer Friendly PDF version

IT OFFSHORE OUTSOURCING: THE ELEPHANT IN THE ROOM

by E.M. Bennatan, Senior Consultant, Cutter Consortium

There is a lively debate going on about the pros and cons of offshore outsourcing. Some see outsourcing as a threat to a company's core competencies by providing technology and other types of expertise to those who could eventually become competitors. Others see it as an opportunity to become more efficient and more productive and to expand their business into broader global markets.

On a national level, even the US branch of the IEEE has taken a formal position on the subject and has come out quite strongly against unregulated offshore outsourcing. In a formal position paper, the US branch of the IEEE claims that not only is offshoring causing unemployment among US engineers, but also that it poses a very serious, long-term challenge to the US's leadership in technology and innovation [7].

But a recent Harvard Business Review (HBR) article sees things differently. Mark Gottfredson et al. state that the role of outsourcing is changing in the 21st century, and it is fast becoming a core strategic function [5]. The article reports that offshore outsourcing is by no means a US-only phenomenon; just over half of large firms in Europe, Asia, and North America use offshore outsourcers. But, the article continues, only a small percentage of them are highly satisfied with the results. Unexpectedly, the HBR article places most of the blame on the firms themselves. They have been slow to develop a comprehensive outsourcing strategy that will keep them competitive in a global economy. To realize the full potential of outsourcing, companies can no longer pursue the old peripheral and tactical view; they need to treat offshoring as a core strategic function. Essentially, offshore outsourcing has become the elephant in the room -- it can no longer be ignored.

The Cutter Consortium has been following the role of information technology within the context of the offshoring debate for the past several years. How common is IT offshore outsourcing, and, more importantly, how successful is it? Do the facts on the ground support the IEEE's concerns? And are the points raised in the Harvard Business Review article relevant to IT and software development? In particular, do IT companies see the elephant? Do they perceive outsourcing as a core strategic function?

This Executive Report provides some very interesting findings on these questions, based on a recent Cutter survey of more than 200 IT organizations. The conclusions provide some helpful insights into companies, specifically the outsourcing strategies they use, the effect outsourcing has on their employees, and the way outsourcing influences their business. The results become even more interesting when compared with a similar survey conducted a year ago [15]. While they cannot yet show a definitive trend, they do provide some valuable indicators about where this elephant is going so companies can either get out of its way or prepare to ride it.

HOW COMMON IS IT OFFSHORE OUTSOURCING?

How significant is the offshoring question? Is the intensity of the debate that it has sparked justified (or, in zoological terms, is the elephant really that big)? And is the controversy, as some people seem to believe, mainly a US issue? The topic has certainly drawn a great deal of interest from some prominent participants, including not only the IEEE but also the US Congress [10] and the United Nations [13].

Offshore outsourcing is not just a US issue; it is a global affair. It is global not only because of the countries on the receiving side, such as India, China, and the former Eastern Bloc countries, but because the outsourcers are global too. While the US is undoubtedly the largest offshore outsourcer, others include such countries as the UK, Germany, Japan, and even Israel.

This global perspective is also reflected in the more than 200 companies worldwide that responded to a Cutter IT offshore outsourcing survey (see Appendix A for a profile of the survey). The respondents represented an excellent global mix, with 46% coming from North America (of which 42% came from the US), 19% from Asia (of which 10% came from India), 17% from Europe, and the rest from South America, Australia/Pacific, the Middle East, and Africa (each with less than 10%).

An analysis of the data from around the world indicates that offshoring is by no means a minor phenomenon. The Gottfredson article, which looks at a broad range of industries, reports that 51% of large firms in Europe, Asia, and North America use offshore outsourcers [5], and the Cutter survey found that offshoring of information technology is not significantly different.

According to the survey data, 54% of responding companies have outsourced IT functions to offshore companies since 2000 (see Figure 1), up from 45% last year (2004). These are interesting numbers not only because they indicate that more than half of IT companies are now involved in offshore outsourcing, but also because they show a significant increase since last year.

Figure 1 -- Percentage of companies that have outsourced IT functions to offshore-based companies since 2000.

Of course to really appreciate the significance of the numbers, we need to understand what "have outsourced IT functions" really means. Is offshore outsourcing a marginal activity (that is, do most of the companies outsource a negligible part of their IT work?), or is it substantial?

Figure 2 shows how much IT work these companies are sending offshore. The largest group of companies (41%) stated that they outsource less than 10% of their IT functions, followed by 33% that outsource between 11% and 25% of their IT work. Interestingly, 26% of companies reported that they outsource more than a quarter of their IT functions (of them, 12% outsource more than half). So, clearly, offshoring is not a marginal activity, and it certainly appears to be growing to strategic proportions.

Figure 2 -- Percentage of IT functions that companies have sent offshore since 2000.

While IT offshoring is growing, companies have been relatively stable in the amount of work that they are sending offshore. Thus, the results shown in Figure 2 are similar to those from the prior year. In general, we see that few offshoring companies (i.e., companies that offshore IT work) are willing to offshore all or even most of the IT work, though many are willing to offshore a substantial part (more than 25%). Still, so far most have kept the percentage below 25%.

A comparison of the 2004 and 2005 results is significant because it suggests an interesting trend: the use of IT offshoring is growing among companies but has not been growing within companies. Is this finding related to Gottfredson's conclusion that companies' satisfaction with offshore outsourcing is limited? We will see later that this is only partly so, and, in fact, companies are now planning to expand the amount of future work that they will be sending offshore.

THE POSITIONS ON GOVERNMENT AND CORPORATE POLICY

Before examining the survey findings, we will clarify the positions held by the supporters and the opponents in the offshoring debate. Generally, supporters of offshoring cite a persuasive list of global business-related advantages that result from offshore outsourcing. Most of the opponents concentrate mainly on the loss of jobs and the loss of technological advantage in the outsourcing country. We will discuss some of the main arguments from each side of the debate.

We will then move on to the survey results and study the various points of view held by IT practitioners. In particular, the survey examined opinions about the advisability of government intervention (to offset the negative effect of offshoring) and corporate policy on the outsourcing of high-wage jobs (the conflict between a company's loyalty to shareholders, which calls for low costs and improved profitability, and loyalty to the employees who helped build the company and are at risk of losing their job).

The Supporting Position

The advantages of offshore outsourcing, according to a recent UN report [13], include not just lower labor and capital costs but also:

• A better utilization of time (the workday in India corresponds to nighttime in the US)
  
  
• High quality (due to an educated workforce and high motivation to succeed)
  
  
• Easy coordination (due to a knowledge of foreign languages -- especially English -- and local supportive legislation)
  
  
• Freeing up the outsourcing company to concentrate on its core business
  
  

A similar position is summarized in a report sponsored by the Information Technology Association of America (ITAA), which states:

Although "lower cost" is the most commonly cited reason for offshore outsourcing, intense global competition in an environment of slower growth and low inflation demands constant vigilance over costs. Due to the low costs and high quality, using offshore resources in selected countries makes good economic sense. Beyond the cost incentive, global sourcing provides several other practical benefits including: the ability of multinational organizations to efficiently stage 24x7 operations; the opportunity to customize products and services to meet local needs; and the means of geographically deploying workers and facilities to succeed in globally dispersed, highly competitive markets. [8]

As mentioned earlier, these are persuasive arguments, except that offshoring is not currently meeting expectations, as the survey data will show.

The Opposing Position

We previously mentioned the formal position announced by the US branch of the IEEE, the text of which states:

The offshoring of high wage jobs from the United States to lower cost overseas locations is currently contributing to unprecedented levels of unemployment among American electrical, electronics and computer engineers. Offshoring also poses a very serious, long term challenge to the nation's leadership in technology and innovation, its economic prosperity, and its military and homeland security. [7]

The position paper then goes on to recommend a string of government steps to control offshoring and to protect US jobs and technology.

There have been other prominent voices raised against offshoring that share the IEEE position to varying degrees. At a global technology summit, as reported in Forbes, the legendary former Intel CEO Andy Grove presented his position on the subject of offshore outsourcing with the words: "I'm here to be the skunk at your garden party" [9].

While Grove's opposition is less strong than that of the IEEE, his arguments are no less forceful. As summarized in the article, Grove's position is that "software and technology service businesses are under siege by countries taking advantage of cheap labor costs and strong incentives for new financial investment." Grove did not offer a solution, saying only that the government needs to help decide the proper balance between a company's responsibilities to its shareholders and to its employees. Otherwise, he said, companies will revert to their obligation to increase shareholder value.

The Positions of IT Companies

Where, between the supporters and the opponents of offshore outsourcing, are IT organizations and practitioners positioned? Some of the survey findings are quite interesting.

The survey asked about the most effective policy that high-wage countries like the US, Canada, the UK, or Germany can implement, at the national/government level, to offset the disadvantages (such as a loss of jobs) that their workers face from offshore outsourcing. According to the results, shown in Figure 3, the largest response (33%) is that governments should provide financial incentives for R&D to help create new, innovative products and industries. But this is followed by 25% who want governments to get out of the way and let the situation take care of itself.

Figure 3 -- The most effective policy a high-wage country like the US, Canada, England, or Germany can implement -- at the national/government level -- to offset the unemployment disadvantages that its workers face because of offshore outsourcing.

An obvious solution, proposed by 19% of the survey respondents, is for governments to provide financial assistance to train unemployed workers in new areas. Other responses include taxation to discourage offshoring (9%) and financial assistance to companies (7%); only 1% believe that offshoring should be prohibited through legislation.

These numbers have not changed significantly since the 2004 survey. Essentially, the data quite clearly shows a preference for minimal government intervention in the issue. And if the government is going to intervene, then it should do so by providing funding to help companies and individuals who are hard hit by offshoring, rather than by taxation and legislation.

The survey then asked how offshoring should best be handled on the corporate level. In particular, respondents were asked what IT employers in high-wage countries should do about the issue of replacing their high-wage employees with lower-wage offshore workers.

In Figure 4 we see that the respondents overwhelmingly believe (60%) that companies must help their employees become more productive through such measures as improved work processes and better automated tools. A similar response came from another 20% who state that companies should invest in the training of existing employees so that their contribution to the company can justify their higher salaries. Interestingly, the two extreme positions came from 11% who believe that companies should get the best and cheapest labor anywhere they can find it and 3% who believe that companies should refuse to replace employees through offshoring.

Figure 4 -- Actions IT employers in high-wage countries like the US, Canada, England, and Germany should take regarding replacing their high-wage employees with offshore outsourcing.

Here, too, there was very little difference from the previous year's results. And here again, the data is quite clear: most respondents believe that it is the employers' responsibility to help their employees become more efficient and more productive. Thus, with or without government help, companies need to face up to the challenge outlined by Grove and strike a fair balance between their loyalty to shareholders and their loyalty to their employees. It is, after all, common wisdom that loyalty to employees pays dividends to shareholders in the long run.

So what are the survey findings telling us? The two main principles are:

1. There is little enthusiasm for government interference (unless it is financial).

2. Companies cannot be allowed to abdicate their responsibility to their employees.

And it is noteworthy that these two principles have been consistently cited for two consecutive surveys. It will be interesting to watch the trend over the next few years to see whether governments and employers adopt policies in any way akin to these principles.

ARE OFFSHORE OBJECTIVES BEING ACHIEVED?

The survey examined the perception IT practitioners have of the advantages from offshore outsourcing. Most views were in line with the UN and ITAA reports mentioned earlier.

Figure 5 shows the various views about the main objectives of offshoring; the overwhelming response, with 60% of respondents, is cost reduction. This is distantly followed by productivity improvement, cited by just 9% as the main objective; faster turnaround, mentioned by merely 3%; better quality by 1%; and all of the above by 19% (3% said none of the above).

Figure 5 -- The most important objectives of or justifications for offshore outsourcing.

These findings clearly indicate that cheaper labor is the driving force behind IT offshore outsourcing ¹ (with productivity improvement providing a minor contribution). Once again, the results were fairly consistent with last year's survey (in fact, the 2004 results were even slightly more inclined toward cost reduction).

The Success of Cost Reduction

Next came a pivotal question. IT practitioners were asked how successful they think companies are likely to be in achieving their cost-reduction objectives through outsourcing. Here the responses were less positive (see Figure 6). Just less than half of the respondents give offshore cost reduction no more than a moderate grade (with savings between 10% and 30%), while 20% stated that success would likely be minimal (with savings of less than 10%).

Figure 6 -- Level of success anticipated in companies achieving their cost-reduction objectives through outsourcing.

Interestingly, 22% of respondents expect offshoring to reduce costs significantly or very significantly (16% expect savings between 31% and 50%, and 6% put savings at more than 50%). On the other hand, 24% of the responses were quite negative (20% said savings would be less than 10%, and 4% said they expect no savings at all).

So how does this pivotal question fare? Are IT practitioners satisfied with cost reduction due to offshoring or are they dissatisfied? Let us look at the cost-reduction success rates in Figure 7. This representation shows that perceptions are approximately normally distributed (the familiar bell-shaped curve), with most IT practitioners offering a midway view about the success of cost reduction through offshoring, while some have a negative view, and some have a positive view. Just as normal distributions in nature usually mean "as expected," ² we can say the same about cost reduction; thus, the results are neither particularly good nor particularly bad.

Figure 7 -- Level of success anticipated in companies achieving their cost-reduction objectives through outsourcing (as normal distribution).

The 2005 survey findings on the success of cost reduction were slightly less positive than last year's results: moderate and above declined by 6%. It is unclear whether this decline is statistically significant. A third year of data (i.e., next year's survey) will indicate whether the decline signifies a trend toward decreasing satisfaction.

In Figure 5 we saw that two of the other commonly mentioned benefits of offshoring -- productivity and quality improvement -- lagged far behind the leading choice of cost reduction. All the same, we examined the various views about the success or failure of these factors in order to produce a more complete picture of the degree to which the objectives are achieved.

The Success of Productivity Improvement

In the case of productivity, the results were not surprising. We might have guessed that offshoring had not produced any major success in productivity improvement, and, as we can see in Figure 8, that was indeed the case.

Figure 8 -- Level of success anticipated in companies achieving their productivity objectives through outsourcing.

IT practitioners were asked how successful they think companies are likely to be in achieving their productivity goals through outsourcing. According to the results, 41% of respondents believe that companies will be minimally successful (less than 10% improvement) or not successful at all. On the other end, 18% stated that companies will be significantly successful (31%-50% improvement) or very significantly successful (more than 50% improvement). Midway, 38% responded that companies would be moderately successful (10%-30% improvement).

Here again we can look at the distribution as an approximate normal curve (see Figure 9), but this time the curve is positively skewed (it leans to the left). This means that the IT practitioner's views lean toward a low level of success in productivity improvement through offshoring.

Figure 9 -- Level of success anticipated in companies achieving their productivity objectives through outsourcing (as normal distribution).

But the data in Figures 8 and 9 warrants some additional evaluation. How poor is a 10% improvement in productivity? Some companies may be quite pleased with it, and they would be even more pleased with an increase of up to 30%. Additionally, one of the objectives of outsourcing, according to the previously cited UN report, is to free up the outsourcing company to concentrate on its core business. If this is the case, then any increase in productivity might be considered a welcome benefit (as long as productivity does not decline). The conclusions, therefore, are mixed: on the one hand, the data shows that there are no expectations for major improvements in productivity, but on the other, there are probably no expectations for major declines either.

The data from last year's survey was slightly less skewed (i.e., more evenly distributed around "moderately successful"), but overall, the results were not significantly different. "Moderately successful" scored 45% in 2004 (compared to 38% in the 2005 survey), and "minimally successful" and "not at all" scored a combined 32% (compared to 41% in 2005). This means that, in the current survey, the negative views grew at the expense of the moderate views, while the positive views remained more or less the same as in the 2004 survey.

The Success of Quality Improvement

The findings on quality improvement were similar to the productivity results. Here, too, we might have guessed that offshoring had not produced any improvement in quality, and the data in Figure 10 indicates just that.

Figure 10 -- Level of success anticipated in companies achieving their quality objectives through outsourcing.

IT practitioners were asked how successful they think companies are likely to be in achieving their quality objectives through outsourcing. In this case, a sizeable 48% of respondents stated that companies would be minimally successful or not successful at all. On the other end, 18% stated that companies would be significantly or very significantly successful. The midway percentage was 31% who responded that companies would be moderately successful.

The approximate normal distribution in the case of quality improvement is slightly more positively skewed than for productivity (see Figure 11). This means that the IT practitioners lean even more toward expecting a low level of success in quality improvement than in productivity.

Figure 11 -- Level of success anticipated in companies achieving their quality objectives through outsourcing (as normal distribution).

We can make the same evaluation for quality as we did for productivity. The data is similar, as are the circumstances. Here, too, we can ask how poor is a 10% improvement in quality? Clearly, companies would be quite pleased with any level of quality improvement, and this would certainly be true of the "moderately successful" improvement percentages of between 10% and 30%. And, again, if concentrating on the outsourcer's core business is a major objective, then companies will most probably be satisfied as long as there is no decline in quality due to offshoring. So once again, the conclusions are mixed: IT practitioners do not expect significant quality improvements, but apparently they do not expect a decline either.

In comparison to the 2004 survey, the data this year was also more positively skewed (expectations for quality improvement were overall slightly lower), but in contrast to the productivity results, the additional skew for quality came from a slight decline in the "success" side of the curve.

THE IMPACT OF OFFSHORING ON EMPLOYEES

We have discussed some of the advantages and disadvantages for companies that are involved in offshore outsourcing. But no such discussion can be complete without considering the effect on the companies' employees.

The survey finding that IT staff members are concerned about job security did not come as a surprise; it is, after all, natural to be concerned when job opportunities are being reduced. But according to the survey data, this is a concern that continues even after a company makes the shift to offshore outsourcing; both before and after the shift, job security concerns remain around 46%.

Interestingly, a significant percentage of survey respondents are not yet sure how the prospect of losing jobs to offshoring will affect IT staff morale. The survey found that 36% from companies that have not yet joined the outsourcing club and 28% from offshoring companies say that it is too early to tell. This indicates that the jury is still out for a sizable proportion of IT employees. They are still uncertain whether, in the long run, they will benefit or suffer from offshoring. (It is interesting that there should be a significant percentage of IT employees who would think that they might benefit from IT offshore outsourcing.)

Apart from fear of job loss, there are other consequences that impact the employees of outsourcing companies, such as issues of morale or the diversity of available jobs and corporate positions.

We examined other positive and negative impacts of offshoring among employees, and we looked at the way offshoring affects their general outlook, their job satisfaction, and their job behavior. The results are presented in the following sections.

Employee Morale

How has offshoring affected employee morale? It would certainly not be surprising to find that many employees would be dispirited by the prospect of losing their job, especially if it was to low-paid overseas workers. But not necessarily all employees feel that way. Some may see this as an opportunity to train and acquire new skills at the expense of their employer, and others, with a broader outlook, may see it as good business that will replace mundane jobs with more advanced and interesting ones in-country. But is it unreasonable to expect this type of long-view thinking from people who are worried about losing their job?

The survey examined this subject and started by looking at the way IT employees respond to offshore outsourcing. The survey respondents were asked to grade the effect that IT offshoring has on the morale of their IT staff, using a scale from 1 (extremely negative) to 7 (extremely positive). The results, shown in Figure 12, are somewhat surprising. On the low end of the scale, 46% maintained that the effect on morale was negative (they graded 1, 2, or 3) -- this was predictable. The surprise came at the high end of the scale, where 27% stated that the effect was positive (they graded 5, 6, or 7). The midway point (grade 4) was chosen by 27% of the survey respondents; we will assume that this means that there was little or no effect on morale.

Figure 12 -- The effect of offshoring of IT functions on the morale of IT staff, rated on a scale of 1-7, with 1 being "extremely negative" and 7 being "extremely positive."

In analyzing the results, we cannot ignore the surprising 27% who view offshoring as having a positive effect on morale. It is not exactly what we would have expected. Likewise, we must also note that almost half hold the opposite view. This is certainly one point where it will be especially interesting to look at last year's data.

The 2004 survey on the effect of offshoring on IT staff produced different results -- there was no surprise. In last year's survey, 60% reported a negative effect on morale, and 16% reported a positive effect. This is more in line with what we might have expected. So does the change from 2004 to 2005 mean that IT staff members are adjusting to the reality of offshore outsourcing? Maybe, but it would be prudent to examine next year's data to see if the trend is genuine.

In the meantime, we can summarize the findings and say that the data indicates that the impact of offshoring on the morale of IT staff may not be as great as we might have thought. There appear to be signs that the staff is adjusting to the reality.

Employee Work Practices

Next we looked at the way the work of in-country IT staff is changing due to offshoring. We looked at both negative and positive impacts on the jobs that were not outsourced, and here, too, we found some interesting results.

First, the survey examined the negative impacts on IT staff work practices due to offshoring. The results, seen in Figure 13, show that the most common negative impact, reported by 66% of respondents, is the need for coordination between in-country and offshore workers. This should certainly not be surprising; the offshore workgroup functions as an extension of the outsourcing company, so, just as coordination is required between groups within a company, it would be required with groups in the extended company, too.

Figure 13 -- Negative impacts experienced by IT staff because of offshoring. (Respondents able to choose more than one response.)

However, many expert consultants on outsourcing recommend selecting highly separable (they call it "encapsulated") work for offshoring. This means that the interface between the offshore team and the outsourcing company should be simple and minimal. Thus, we can speculate that the 66% who decried excessive coordination with their offshore group are an indication that the offshored work is either not being well chosen or is not being well partitioned or encapsulated.

Far behind the 66% who mentioned coordination as a negative impact of offshoring, we find a weakening of the relationship between the remaining in-country IT staff and the other company business units, as reported by 27% of respondents. This is mainly a management planning problem and need not happen. We can assume that it may well be the result of slow adjustment, both by management and IT staff, to the reality of fast-growing outsourcing.

The reporting of two additional negative impacts is particularly interesting. Only 23% of respondents said that IT staff, as a result of offshoring, now work longer hours, and 15% said that they work harder. These numbers are not great, but they are not insignificant either. They do not paint a picture of all employees scurrying to save their jobs in outsourcing companies, possibly because not all IT jobs are at risk. Another negative impact cited was social: 19% miss former coworkers (we can assume that they will get over it). It is interesting to note that 15% stated that offshoring creates no negative impact on the IT staff of their company.

The 2004 results on the negative impacts of offshoring were similar, though not identical, to the 2005 findings. IT employees in outsourcing companies seem to have been working harder and longer hours in 2004: harder, 25% compared to 15% in 2005, and longer, 32% compared to 23% in 2005. Coordination continued to be the main grievance, and the "no negative impact" response was just slightly lower (13%, compared to 15% in 2005).

We next examined the positive impacts experienced by IT staff due to offshoring. The results, illustrated in Figure 14, show that the most common positive impact, reported by 49% of respondents, is that the IT staff handles fewer mundane or routine tasks. This is followed by 32% who stated that IT staff members are able to devote more time to strategic, "fun" work. Interestingly, 19% stated that the relationship between the IT staff and the other business units had improved (in the negative impact responses, 27% said that it had worsened), while 13% cited more training time, and 10% said more interaction between IT employees and their manager. A notable 27% of respondents stated that there are no positive impacts.

Figure 14 -- Positive impacts experienced by IT staff because of offshoring. (Respondents able to choose more than one response.)

While the 2004 survey provided a similar picture, the findings give more weight to the availability of strategic, more pleasurable work (41%, compared to 32% in this year's survey) and to increased interaction with the employees' manager (19%, compared to 10% in this year's survey). This may be a case of gradual adjustment to outsourcing (e.g., encouragement from the boss becomes less important ³ ); here too it will be useful to follow the numbers in next year's survey to see if this is indeed a genuine trend.

So has offshoring changed the way IT staff works? On the negative side, there has been movement toward longer hours, and relationships between units seem to have shifted somewhat, but these effects may well be temporary (they seem to be in decline). On the positive side, the main impact is that jobs are more interesting. But because offshoring continues to evolve, it would be unreasonable to expect these findings to be decisive. The next few surveys will show whether the interesting work does in fact remain in the outsourcing country and whether in-country workers will continue to feel increased pressure to justify their jobs by putting in longer hours.

THE OUTLOOK FOR OFFSHORING

How do IT companies expect their offshoring policies to evolve? Will more companies be moving IT work offshore, and, more importantly, will they be outsourcing more of their work? The survey examined IT companies' plans, and the findings were analyzed in order to plot probable offshoring trends (assuming that these plans will be implemented). This is an analysis that provides a glimpse into the future.

New Offshoring Companies

First, IT practitioners were asked whether their company plans to send some IT functions offshore in either 2005 or in 2006. From among those companies that were not already offshoring IT work, 20% said yes (down from 28% in 2004), and the remaining 80% said no (up from 72% in 2004).

IT practitioners from new offshoring companies were then asked about the percentage of IT functions that their company plans to send offshore, and the results are shown in Figure 15. A comparison to the results that we saw in Figure 2 shows that the new offshoring companies plan to outsource a more conservative percentage of their work than the veterans. Most (61%) plan to send less than 10% of their IT work offshore, followed by 30% that plan to offshore between 11% and 25% and 6% that plan to offshore between 26% and 50%; none plan to offshore between 51% and 75%, and 3% will offshore more than 75%.

Figure 15 -- Percentage of IT functions companies plan to send offshore (new offshoring companies).

These figures show a significant shift of new offshoring companies toward outsourcing less work than indicated by the results of the 2004 survey. In last year's survey, the results were closer to the percentages outsourced by the veteran companies. Last year, 49% said that they planned to offshore less than 10% of their IT work (compared to 61% this year), and 45% said that they would offshore between 11% and 25% (significantly more than the 30% this year).

These figures indicate a more careful approach by companies that are new to offshoring; they will start their experience with smaller batches of IT work than the veterans. What can we conclude from this data? We can assume that new offshoring companies believe that the learning curve is significant, and they are planning to start by taking a modest dip before plunging in. This conclusion is further substantiated by data on veteran offshoring companies (presented in the next section), which shows that as experience grows, companies tend to increase the amount of IT work that they send offshore.

Veteran Offshoring Companies

Next, companies that were already offshoring IT work were asked whether they intend to increase the amount of offshored IT work in 2005 or 2006. Here the response was overwhelmingly positive, with 81% saying yes (down from 92% in 2004), and 19% saying no (up from 8% in 2004).

Survey respondents from veteran outsourcing companies were then asked about the percentage of IT functions that their company plans to send offshore. Here the results were quite interesting (see Figure 16). The data shows a shift toward plans for higher levels of offshore outsourcing: 23% said that they plan to offshore less than 10%, but 36% said that they plan to offshore between 11% and 25%, 19% plan to offshore between 26% and 50%, and 18% will offshore more than 50% of their IT work.

Figure 16 -- Percentage of IT functions companies plan to send offshore (veteran offshoring companies).

The data in Figure 16 is, of course, consistent with the 81% of veteran offshoring companies that intend to increase the amount of work they send offshore. When comparing these results to last year's survey, we do not see any significant change in plans for offshoring among veteran companies. On the high end, there was a small increase: plans to offshore more than 50% of IT work is 18% this year, up from 13% in 2004.

Plans and Trends

The immediate question here centers on the existence of a possible trend: is the enthusiasm for IT offshore outsourcing growing or declining? Here, too, another year or two's worth of data would be required to make a definitive determination. But even if the data indicates a decline, the numbers are still overwhelmingly positive. The vast majority of offshoring companies will send more IT work offshore. And the number of offshoring IT companies can be expected to grow by about 20%. These are powerful findings, and they tell us quite a lot about a probable trend: offshore outsourcing is growing and at a considerable rate.

But what about the decline in the planned growth from 2004 to 2005? We have already considered the possibility that enthusiasm for offshoring is waning. But there is another way of looking at the data: as more IT companies get involved in offshoring, there are fewer new ones to join the club (at the start of this report, we said that 54% of IT companies have offshored IT work since 2000). Similarly, as companies outsource more IT functions, there are fewer left for growth.

Irrespective of whether the growth rate is increasing or slowing down, the survey indicates that IT offshoring is growing. We have also learned that IT companies plan to continue the growth of IT offshoring over the next one to two years. Beyond that, only future surveys will tell us, but apparently the current rate of growth will not be able to continue forever.

CONCLUSIONS

The survey data shows why offshoring has become the elephant in the room that can no longer be ignored and why IT companies must develop a corporate strategy to deal with it. The need to give the elephant the respect it is due (i.e., to deal with offshoring in a formal manner) is gradually becoming the accepted view. In a new book on the subject, American University's Erran Carmel and coauthor Paul Tjia open with: "Whether one is for it or afraid of it, we are convinced that managing offshoring is a competency that tomorrow's IT managers must learn" [2]. This notion is strongly supported by the offshoring survey findings.

The Key Findings

While the data shows that offshoring has not satisfied all the expectations of IT practitioners (most grade cost reduction, productivity increase, and quality improvement as moderate or less), the fact remains that it is a growing phenomenon. It is not just that most IT companies are already involved in offshore outsourcing, what is even more significant is that the vast majority of them plan to increase the amount of IT work that they send offshore. Add to that the fact that 20% of companies that have not been outsourcing IT work plan to join the club in 2006, and the message becomes even clearer.

The survey also finds that concerns about offshoring continue to exist among IT staff, but they are not as severe as we may have expected, and, more significantly, the concerns are slowly declining. There are even some indications that IT employees are beginning to adjust to the new reality of offshore outsourcing.

According to the survey findings, IT companies and practitioners are interested in government assistance to help make the adjustment to offshoring -- but not through legislation or other types of active government intervention. The preferred type of government aid is financial assistance in areas such as R&D (to produce new innovative areas of business) and training (to provide employees with new skills to replace the ones that were offshored).

One finding of particular interest is that companies are expected to demonstrate loyalty to their in-country employees by creating environments (better tools, processes, and training) that will help employees adjust and become more productive. This principle must be fairly balanced with the company's commitment to its investors, not as an act of charity but because it makes good business sense -- loyalty works in both directions.

Putting It All in Context

Cutter has been examining offshore outsourcing as part of a broader concept, which has also been debated for many years, called the global village (see my 2002 Cutter report on the subject [1]). This is a vision that has been evolving for several decades, in which global workforces are integrated and workers move freely between companies without necessarily moving physically from their country, town, or village.

Undoubtedly, the global village has not materialized, and some say the idea is utopian in nature. But recent advances in technology and strides toward a global market economy have fostered several steps toward this utopian vision. Undoubtedly, offshore outsourcing, especially of information technology work, is one of those steps -- albeit a controversial one -- in that direction.

As we have seen, the Cutter offshoring survey indicates that offshore outsourcing of IT work is expanding. How do these findings fit in with the broader global village picture? In this post 9/11 era, is the world continuing to shrink, or is it just that offshoring is expanding? And in the broader context of business and security, how sensible is it for companies to promote global workforce policies? In particular, is IT offshoring a safe business model?

While some doomsayers have been predicting the collapse of the global village, New York Times columnist Thomas Friedman arrived at a different conclusion. Following an investigatory visit to Silicon Valley two years after 9/11, he concluded that the US might be distancing itself emotionally from the world while the world is continuing to integrate [3]. And many large technology corporations are getting this message. For example, in the aftermath of 9/11, IBM announced that it intended to move more of its software design and other jobs overseas [6].

So if global integration is indeed the new reality, then offshoring follows naturally. Today, Friedman states in his latest book The World Is Flat that any new Silicon Valley startup would have little chance of finding funding without planning to offshore at least part of its work [4].

Is all this leading to the global village with a truly global workforce that can easily move between countries? The University of California's AnnaLee Saxenian appears to see this as a natural outcome of global integration. Saxenian opines that in some parts of the world the old dynamic of "brain drain" is giving way to one she calls "brain circulation" [11]. Most people instinctively assume that the movement of skill and talent must benefit one country at the expense of another. But thanks to brain circulation, movement of high-skilled workers between countries increasingly benefits both sides.

At the time of this writing, the free movement of workers between countries has certainly not materialized, other than within the European Union. To be realistic, it is highly unlikely that it will happen in the near future. But the rapid development of wire and wireless communications has enabled IT global integration to continue without the physical movement of large groups of workers. In fact, with some exceptions, the integration of technology workforces is progressing naturally with minimal government intervention, particularly in the US. And as we learned from the Cutter offshoring survey, many IT practitioners would like it to remain that way (one of the main survey responses was that governments should "get out of the way and let offshoring take care of itself").

How does all this translate into a sensible corporate strategy? Does it make sense for companies to continue to expand their IT offshoring (as the survey indicates they are doing) when parts of the global arena are unstable and risk-ridden? In a recent MIT Sloan Management Review article, Till Vestring, Ted Rouse, and Uwe Reinert tackled the question head on [14]. Their position is that companies should implement offshore outsourcing according to a broad strategy, rather than making individual decisions about individual countries.

The authors state that for companies considering offshoring, there are dangers in taking too narrow a geographical view. Every country presents a different mix of strengths and weaknesses. One country, for instance, may have very low labor costs but a high degree of political instability and a small domestic market. Another might offer a wealth of engineering talent but quickly rising labor rates. A third may have robust local markets but intrusive regulatory regimes and a weak transport infrastructure. Currency fluctuations may unexpectedly swell the costs of sourcing from one country, for instance, or a natural disaster may wreak havoc on a critical source of supplies. Thus, the authors suggest that offshoring is no different from any investment program that involves choices with widely divergent cost-and-benefit characteristics in that it makes sense to create a portfolio that balances risk and reward over both the short and long terms.

What then would be the success factors of such a broad offshoring strategy? In another recent MIT Sloan Management Review article, Robert Trent and Robert Monczka identify a set of features common among companies that excel at global sourcing. The features cluster into seven broad characteristics [12]:

1. Executive commitment to global sourcing

2. Rigorous and well-defined global sourcing processes

3. Availability of resources needed for the global sourcing initiative, including access to qualified personnel and budgets

4. Information technology systems that support data analysis on a worldwide level

5. Organizational design features that support the initiative, such as an executive committee that oversees global sourcing

6. Structured approaches to communication, such as regular strategy review sessions

7. Methodologies for measuring savings from global sourcing

This is an excellent reference list for companies to use in formulating their offshore outsourcing process and strategy. It will certainly help set expectations at a reasonable level in such areas as cost reduction, productivity growth, and quality improvement -- three areas where the Cutter IT offshoring survey indicates that expectations have not been reached. But, most of all, an organized offshoring strategy will ensure two basic things: (1) that companies offshore work when there are sound business reasons for doing so, and (2) that when a company offshores work, it will do so in a way that maximizes its benefit.

Returning to the two opening questions -- whether it is sensible for companies to promote global workforce policies, and, in particular, whether IT offshoring is a safe business model -- the answers are largely based on pragmatism.

First, indications are that global integration of technology workforces will continue to grow, and this is a reality that IT companies cannot ignore (yet another elephant). While IT security concerns are very real, they do not seem to deter the global integration trend. Apparently, the safety of IT systems may be a short-term consideration, but overall it does not appear to significantly affect offshoring (see Appendix B for a more detailed discussion of the subject).

Second, companies must make their decisions on offshoring on the basis of their own cost-benefit analysis (and not because offshoring is fashionable). As Vestring et al. have stated, piecemeal offshoring, without an overall corporate strategy, is not a good way to go about it. As we have seen, offshoring has become a major factor in global business, and IT companies must develop a corporate strategy to deal with it.

And finally, a sound approach to offshoring requires not just a corporate strategy but also an organized process for implementing the strategy.

Offshoring strategies need to be reevaluated from time to time because the global workplace is constantly changing. India and China, where much of the offshoring takes place, are surging ahead, but other countries are not far behind, and many new opportunities appear virtually every year.

Returning to Friedman's musings about the shrinking globe in The World Is Flat, he contemplates the growing international technology presence in Bangalore, India's Silicone Valley, and he wonders whether he is looking at the old world, the new world, or the next world. Based on the latest data, Friedman is probably looking at the changing world; it is a world in transition. True, it always has been, but never at such a rapid rate of change.

This rapidly changing global workforce must be factored in to the business strategies of IT companies. Over time, we can expect it to change the way companies outsource their work. In one example we may even see the law of connecting vessels ⁴ at work, whereby the changing workforce will gradually weaken cost reduction as the main justification for IT offshoring. This may well be reflected in future Cutter IT offshoring surveys, which, we expect, will also show that IT offshoring will continue to grow. Apparently, this elephant will be around for quite a while.

NOTES

¹Clearly cheaper costs include other factors besides labor, but we can safely speculate that cheaper labor is the main factor in this response.

²For the statistics minded, in this particular case the variance has little bearing.

³Yes, encouragement from the boss is always important, but when employees are insecure about their job, it is even more so.

⁴The law states that a liquid that flows freely between connecting vessels will rise to the same level in each vessel irrespective of its size and shape, if given sufficient time. This law of physics has been liberally applied to many fields in the social sciences, asserting that some phenomena (such as salary levels) will spread equally among populations over time, provided they can move freely.

REFERENCES

1. Bennatan, E.M. " What is Happening to the Global Software Village? Is There Still a Case for Distributed Software Development?" Cutter Consortium Agile Project Management Executive Report, Vol. 3, No. 1, January 2002.

2. Carmel, Erran, and Paul Tjia. Offshoring Information Technology: Sourcing and Outsourcing to a Global Workforce. Cambridge University Press, 2005.

3. Friedman, Thomas L. "Is Google God?" New York Times, 29 June 2003.

4. Friedman, Thomas L. The World Is Flat: A Brief History of the Twenty-First Century. Farrar, Straus and Giroux, 2005.

5. Gottfredson, Mark, Rudy Puryear, and Stephen Phillips. "Strategic Sourcing: From Periphery to the Core." Harvard Business Review, 1 February 2005.

6. Greenhouse, Steven. "IBM. Explores Shift of White-Collar Jobs Overseas." New York Times, 22 July 2003.

7. IEEE-USA. "Position: Offshore Outsourcing." IEEE New York, March 2004.

8. ITAA. "Executive Summary: The Comprehensive Impact of Offshore IT Software and Services Outsourcing on the U.S. Economy and the IT Industry." Prepared by Global Insights (USA), Inc., Sponsored by Information Technology Association of America (ITAA), March 2004.

9. Krim, Jonathan. "Grove Says U.S. Is Losing Edge in Tech Sector." Forbes, 10 October 2003.

10. Legard, David. "Congress to Take a Swipe at Offshore Outsourcing." Computerworld, 4 March 2004.

11. Saxenian, AnnaLee. "Brain Circulation: How High-Skill Immigration Makes Everyone Better Off." The Brookings Review, Winter 2002, Vol. 20, No. 1, pp. 28-31.

12. Trent, Robert J., and Robert M. Monczka. "Achieving Excellence in Global Sourcing." MIT Sloan Management Review, Vol. 47, No. 1, pp. 24-32, Fall 2005 (quoted from the summary).

13. UNCTAD Secretariat. "Business Process Offshore Outsourcing: Untapped Opportunities for SMEs." The United Nations Conference on Trade and Development, Document UNCTAD/SDTE/TIB/2005/6, United Nations, 2005.

14. Vestring, Till, Ted Rouse, and Uwe Reinert. "Hedge Your Offshoring Bets." MIT Sloan Management Review, Vol. 46, No. 3, pp. 27-29, Spring 2005 (quoted from the summary).

15. Yourdon, Ed. " Offshoring: Where We Are, Where We May Be Going." Cutter Consortium Sourcing and Vendor Relationships Executive Update, Vol. 5, No. 9, 2004.

APPENDIX A: THE SURVEY PROFILE

The survey was conducted in August 2005 among 230 IT organizations. ¹ The goal of the survey was to learn about the offshoring strategies and policies of IT companies and to examine likely trends in offshore outsourcing. The results came from a representative mix of both small and large companies (see Appendix Figure 1): 8% have up to 10 employees, 21% have between 11 and 100, 31% have between 101 and 1,000, and 40% have more than 1,000 employees.

Appendix Figure 1 -- Size of respondents' companies by number of employees (or division if completing the survey for their division).

The number of IT professionals was also well distributed (see Appendix Figure 2): 18% of the responding companies have less than 10 IT professionals, 27% have between 10 and 99, 29% have between 100 and 499, and 26% have more than 500 IT professionals (of them, 17% have more than 1,000).

Appendix Figure 2 -- Number of IT professionals that work in respondents' organizations (or division if answering for their division only).

From a business perspective there was an excellent representation of large companies (see Appendix Figure 3): 37% have more than US $100 million of revenues (of them 21% have more than $1 billion), 38% have less than $10 million, and the rest (25%) have between $10 million and $100 million.

Appendix Figure 3 -- Approximate annual revenues in US dollars of respondents' organizations (or division if completing the survey for their division).

Appendix Figure 4 shows that a large proportion of the people responding for their organization (62%) came from various levels of management; 22% were from senior management, 26% were from IS or IT management, and 14% were from project management. The remaining 38% includes software development and support staff and consultants.

Appendix Figure 4 -- Title that best fits respondents' job description.

Of particular interest is the fact that the survey results are truly global. Admittedly the largest group of respondents came from North America (48%), but Europe was also well represented (17%), as was India (10%), Australia/Pacific (8%), the rest of Asia (9%), and the Middle East and Africa (each 2%).

NOTES

¹To be statistically accurate, in some cases more than one response may have come from the same organization.

APPENDIX B: THE GLOBAL IT SECURITY PERSPECTIVE

A common concern about offshoring is related to the security of the IT systems and software being sent and developed overseas. The following discussion reviews this issue and explains how technology is getting increasingly better at combating the problem.

Software knows no borders, and thus its vulnerabilities are universal. Internet users are affected in similar ways in every country just as are corporate network users. Consequently, corporations and government IT network and software systems are just as much potential targets in Europe, India, Singapore, and Israel as they are in the US.

However, there is one aspect of software vulnerability with a decidedly offshore flavor that could potentially prejudice global outsourcing and distributed software development (DSD). Two years after 9/11, a New York Times investigatory report asserted that potential national security risks posed by computer software are growing as key programming is increasingly being performed outside the US. Officials are concerned, the report continued, that foreign spies may sneak illicit code into critical programs. They are also concerned that by developing critical software overseas, the US is losing dominance in information technology. But concern cuts both ways, the Times states, with the Chinese repeatedly charging that US military and intelligence organizations manipulate for espionage purposes US computer products sold in China [1].

Clandestine code, also called Trojan horses or sleepers, has been a concern of software developers for quite a while, but in some circles the reality of 9/11 has intensified the uneasiness with outsourcing, particularly offshore outsourcing. Though there are no significant indications that this concern is impacting global DSD in any great way, its influence on outsourcing could become significant in the future.

Another international vulnerability of software is business theft. As the president of a major software company once noted, software is peculiar in that you can steal it and still leave it there. International theft of software and digital storage media has become a major problem, primarily in countries that provide lax or no legal protection to copyright and patent owners. Copies of Microsoft, Symantec, and Oracle software can be purchased at a fraction of their official price in many countries around the world. This is true also of video game software and, of course, digital copies of music and movies. Though this problem is not a consequence of terrorism, it is a potential threat against the world business community. Here too technology is continually providing new protection methods for software and digital media, but as fast as the technology is developed, new illicit copying appears. For example, Sony Corp., which invested significant effort in video game copy protection schemes for its Playstation platform, discovered bootlegged copies of its games shortly after the platform was released.

REFERENCE

1. Markoff, John. "Uneasiness about Security as Government Buys Software." New York Times, 7 July 2003.

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