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Think Globally, Act Rationally

January 5, 2004
Related Topics: Outsourcing

One hundred years ago, millions of poor Europeans and Asians, lured by smooth-talking promoters telling of plentiful jobs and instant riches, made the dangerous journey to America. None found the streets of gold they had been promised, and some failed to thrive. But many worked hard, endured and eventually found the true path to prosperity.

    On this November day in 2003, a hundred or so high-ranking executives of large and medium-sized corporations, many of them descendants of successful immigrants, are gathered in a luxury hotel in Houston for a conference titled "Competitive Advantages of Outsourcing to India." From the meeting room’s dais a series of confident men, some with exotic accents, flash their PowerPoint presentations and declare that the path to riches now leads away from America, halfway around the world.

    Their audience pays close attention. Sending American jobs overseas, or "offshoring," is perhaps the most talked-about corporate strategy of the young 21st century. What’s talked about most, at least in closed-door industry conferences like this one, is the fact that amazing savings can be obtained by outsourcing information technology and business-process tasks to vibrant emerging economies like India. That giant country, say the experts, is currently the most employer-friendly because offshoring pioneers Ireland and Israel have maxed out their surplus labor pools, and salaries in those two countries have risen. In contrast, college graduates in India earn one-tenth to one-fifth the salaries of their American or Western European counterparts. In the ranks of low-wage countries, India is followed by the Philippines, China, Russia and Eastern Europe, and Central and South America. Canada is an interesting "near shore" alternative because its much smaller wage differential can sometimes be offset by its closeness, both geographically and culturally, to the United States.

    While rock-solid figures are hard to come by, the amount of business that is outsourced to these countries and others is rising rapidly. In 2001, according to a study by McKinsey & Co., offshoring was a $25.75 billion industry. McKinsey estimates a growth rate of 30 to 40 percent a year over the next five years. Another prediction, quoted by several at the conference, was made by Forrester Research last year. Despite the fact that only 60 percent ofFortune 1,000 companies have yet begun offshoring, Forrester has estimated that over the next 15 years, 3.3 million U.S. service-industry jobs and $136 billion in wages will be relocated abroad.

    Unfortunately, it’s easy to get caught up in all the enthusiasm and miss the sound of history repeating itself. In truth, as even offshoring proponents will admit, corporate emigration is more often than not a risky journey. It’s not appropriate for every company, and while most businesses survive the trip and a select few eventually hit their financial targets, there are numerous economic, managerial, political and cultural problems to navigate along the way. The biggest problem, however, is that many managers don’t appreciate the hazards until it’s too late.

India, Inc.
    The keynote speaker at the offshoring meeting in Houston is Som Mittal, an Indian businessman with 25 years’ experience in the information technology industry, who is a former managing director of Compaq India. "Anything that can be outsourced can be offshored," Mittal says. By sending work like computer coding, document scanning, customer-service call-center staffing and payroll processing to his country, companies can achieve a 20 to 25 percent gain in productivity, he says. By offshoring their work to Indian vendors, American and multinational companies can reduce their labor costs and increase or decrease their workforces quickly to reflect peaks and valleys in production.

    But there are other important factors to consider, Mittal says. By sending their work to Indian subcontractors, American companies can also reduce their investment in equipment and increase or decrease their workforces quickly to reflect the fluctuations in demand. During the past decade the Indian government has embraced free trade and cleared away much of its legendarily suffocating bureaucracy.

    Because the Indian workday begins when the American workday ends, companies can conduct labor-intensive activities, like software testing, both at home and abroad and save time by having the work continue around the clock. All educated Indians speak English fluently, a legacy of British colonialism. The Internet and fiber-optic technologies make worldwide communication cheap and reliable. As workforces in America, Europe and Japan are graying, the population of Indians under 25 will increase by 47 million by 2020. Each year the Indian educational system turns out 3 million college graduates, most of whom will happily become new members of a burgeoning middle class. "And remember," Mittal says, "when many of them wake up, they’ll brush with Colgate, eat Kellogg’s cornflakes and drive to work in a GM car."

    The speakers who follow him describe how much-admired American companies like Hewlett-Packard, General Electric, Citibank and IBM have had great success with offshoring. How self-contained knowledge-industry enclaves have sprung up in cities like Mumbai (Bombay), Hyderabad and Bangalore, home of the John F. Welch Technology Center. How young software engineers or customer-service representatives can vault into affluence on salaries of $10,000 a year. Only occasionally do the speakers mention problems with erratic power grids, obdurate local officials, inexperienced managers and unmotivated employees.

    Just before lunch, however, a no-nonsense attorney named Mark Riedy, a partner in the firm Pillsbury Winthrop, reads his sobering treatise "Adverse Government Actions Facing the Outsourcing Industries." In a stern voice he summarizes the approximately 20 anti-offshoring bills now under consideration in the United States at the federal and state levels. He mentions the current controversies over H-1B and L-1 visas, and the possibility that the flow of foreign workers into and out of the United States could be sharply curtailed. He details a pending Indian government proposal to start taxing the offshoring-related dollars streaming into and out of that country. Last, he describes some potential problems created by sending intellectual property, such as software code, and private personal information, such as medical records, overseas.

    The attendees settle a bit more deeply into their seats, but during a half-hour break they rise and surround the speakers eagerly. One of the experts answering a steady flow of questions is Juergen Reiners, Hewlett-Packard’s director of global shared services, who has built and run operations in Germany, Belgium, France, Singapore, Japan, India, Mexico, the United States and the United Kingdom. Earlier, he participated in a panel discussion titled "The Value of Outsourcing to India: The Customer Perspective." A visitor elbows his way through the circle and asks him whether offshoring operations are always successful. Reiners smiles. "Fifty percent of them fail," he says quickly, before turning to another questioner.

A world of decisions
    It’s now several days after the Houston meeting, and Reiners is asked if that 50 percent failure rate is accurate. "Oh, yes. That’s the right figure," he says during a hurried telephone interview from his office at H-P. The basic reason for the high failure rate, he explains, is that executives at parent companies, whether intentionally or not, sabotage the offshoring project from the beginning.

    "Sometimes they’re set up in the wrong location," he says. "Or they don’t get the funding and staffing they need. They’re squeezed from day one. They’re not seen as an asset, but as something for people to hate." They’re hated, Reiners says, because in many companies offshoring is initiated for the wrong reasons, begun without proper planning and assigned to managers who are ill equipped to handle problems.

The basic reason for the high failure rate, is that executives at parent companies, whether intentionally or not, sabotage the offshoring project from the beginning.

    The first big hurdle is resisting the hype and misconceptions about offshoring. Among the worst reasons for offshoring ever heard by Bob Cecil, vice president of EquaTerra, a consulting firm that specializes in outsourcing and offshoring, was "My CEO sat next to Jack Welch on an airplane. That’s why we’re here at this meeting." Just as bad, says M.M. Sathyanarayan, head of Global Development Consulting Inc., of Cupertino, California, is the common error of equating the differential between U.S. and offshore salaries, the so-called "labor arbitrage," with expected savings from offshoring.

    Sathyanarayan recounts the story of a client, a Silicon Valley software-development firm, that hired him after experiencing a 50 percent employee-turnover rate at its operation in India. "I talked to one of the executives. The guy complained to me, ‘We’re a training ground for other companies to poach people from.’ I asked him what was his business model, what kind of cost savings he expected. He said he expected to save about 75 percent." The consultant asked him what kind of salaries he paid. "He said, ‘Not quite competitive in the marketplace but close enough.’ " This company, concludes Sathyanarayan, went to India purely to pinch pennies. "Which meant they were unwilling to do what it takes to make it work."

    What it takes, veterans say, is a willingness to "settle" for savings in the 30 to 40 percent range, realistically predict the advantages and drawbacks as they apply to a particular business, and then methodically plan the operation before committing serious money and labor to it. The first question, obvious but often bypassed, is whether the operation can be more efficiently performed overseas than at home. A rule of thumb is that basic back-office functions, unconnected to the "core competencies" of the company, should be the first to make the trip.

    "Where the offshore solution is advantageous is with rule-based decision making," says Lesley Pool, chief marketing officer for the Dallas outsourcing firm ACS. "We’re talking about fairly repeatable and automated tasks where adherence to guidelines is clear-cut, like payroll and ledger functions." Well-known success stories include those of giants like Citibank and Perot Systems, which have sent jobs like credit-card-balance retrieval and medical-record scanning overseas. Legendary horror stories often involve Silicon Valley start-ups that have taken their new, unproven software products and "thrown them over the wall," i.e., sent them offshore to underqualified and undersupervised personnel for further development and/or customer support.

"Where the offshore solution is advantageous is with rule-based decision making. We’re talking about fairly repeatable and automated
tasks where adherence to guidelines
is clear-cut, like payroll and
ledger functions."

    The next major decision is determining what type of offshore presence to establish. There are two basic models. Wholly owned, or "captive," offshore subsidiaries have the advantage of being under total control of the onshore company, so that the offshore labor force concentrates entirely on its needs. This model also tends to attract long-term commitments from employees and managers. Disadvantages include high initial investment and the temptation to turn offshore employees into second-class corporate citizens performing relatively menial tasks with substandard benefits. This invites high turnover. Conversely, sending the most interesting work overseas can "hollow out" an onshore operation by convincing American employees that the road to advancement lies elsewhere.

    The other model, known as "shared services," avoids most of those drawbacks by relying on offshore contractors to hire, manage and pay the foreign employees working on offshore tasks. Its obvious advantage is lower initial investment. Disadvantages include longer lines of communication, less control over important projects and the risk of productive employees being transferred to projects for other clients.

    In any case, far more time must be devoted to managing and monitoring offshore employees. "General Electric did it right," says Robert Kennedy, a professor of corporate strategy and international business at the University of Michigan Business School. "They spent money up front to hire topflight managers, and several months training them, integrating them into the GE way."

    Juergen Reiners says that when you set up offshore operations, you need strong support at every level of the company. "You need to hire great people and you need to be on the road and visit to listen, fix issues, give [the employees and their managers] a role to play." Other experts counsel providing at least six months of cross-training for offshore managers and their American counterparts, and one stateside liaison for every 4 to 10 offshore managers. To maintain communication despite the time-zone difference, work hours can be adjusted to provide at least two hours of overlap daily.

    M.R. Rangaswami, cofounder of the Sand Hill Group of San Francisco, which specializes in research on the enterprise software industry, says that American firms that send foreign-born executives back to their home countries have an immediate advantage. "When they apply their American salaries back there, they enjoy a tremendous standard of living, and they’re perfectly equipped to address language and cultural issues." These issues, even in English-speaking countries, can be formidable.

    Peter Schneeberger, owner of Samudra Software, a shared-services provider in the coastal city of Vishakhapatnam, says that managers must be prepared to handle cultural differences such as the importance of weddings. During the three months viewed as the most auspicious time for weddings, for example, up to half his staff is out of the office. What is even more significant, he says, is that the educational system emphasizes rote learning over independent research, and most relationships are more hierarchical, family and caste dependent than Americans are used to. He says that his employees expect a lot of direction. "You can’t just say, ‘This is the project. You’ll be reporting to this person.’ I try to break it down to some degree, but they don’t respond so well to me," Schneeberger says. "We emphasize a team concept, but at the same time they work better with direction."

Trouble on the home front
    The entire direction of offshoring angers American workers, who worry that they’ll be losing their jobs to what have been described derisively by critics as "cybercoolies." They’ve found sympathetic ears at such organizations as the AFL-CIO and the Communications Workers of America, and are forming advocacy groups such as The Organization for the Rights of American Workers and Mad in USA. Offshoring advocates of the kind found at the Houston conference and many other business gatherings counter with free-market logic that they find compelling—and say that displaced workers should have patience. The unstoppable growth of offshoring, they say, is nothing to worry about. It’s merely a periodic restructuring of the American economy, much like the industrial revolution or the Rust Belt migration to service and information jobs of the last three decades. They’re confident that the problem will sort itself out and lead to a more dynamic economy in 5 or 10 years.

    Just how dynamic is summarized by Sand Hill’s Rangaswami. "Be ready for America to rebound," He writes in a company report on offshoring. "Unions kept wages high as manufacturing companies rushed overseas in the 1970s. Software workers are not represented by unions. That means that wages for developers and other workers will drift down to a more palatable level. At the same time, the tech staffing crunch in India is driving wages up. When the delta between the two becomes smaller, software companies must decide whether it makes sense to begin growing technical staff in the United States again. Could America’s highly skilled developers become offshore staff for overseas vendors and software developers?"

Workforce Management, January 2004, p. 40-45 -- Subscribe Now!

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