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The Offshore Equation

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InformationWeek – by Paul McDougall

Earlier this year, managers at the Bekins Co., a moving and relocation-services company in Hillside, Ill., were looking for a better way to match customer demand with available trucks and drivers. Top execs asked VP and chief technology officer Randy Valentino to find a technology solution. The catch: Bekins has upped its return-on-investment requirements significantly for funding new development projects and now insists on payback within two years. "In the past, 36 months would have been supportable," Valentino says.

To meet the tougher ROI policy, Valentino turned to a company that provides application-development services from India at a fraction of the cost of what he would have paid U.S. developers. As a result, Bekins, with projected revenue for 2004 of about $220 million, is set to deploy technology that will help it better serve customers and boost sales.

There's no hotter hot-button issue than offshore outsourcing, both within the IT community and, due in no small part to election-year rhetoric, across the country. And business-technology managers find themselves caught in the middle. While there's little doubt the offshoring of IT jobs has brought hardship to thousands of domestic programmers and other computer-industry professionals, there's growing evidence the practice has an upside for at least some groups of high-tech workers, many businesses, and even the economy as a whole. The low costs afforded by offshoring mean a green light for IT projects that otherwise wouldn't get funded and an influx of venture capital that's supporting a new wave of tech startups.

Offshore development lets Bekins keep its IT costs in check, VP and chief technology officer Randy Valentino says.

For Valentino, it wasn't a question of taking jobs from Americans. "There was no other way to make the business case for this," he says. For Bekins' route-management application, Valentino turned to Enterprise Solutions & Technologies in Irvine, Calif., which hooked him up with subcontractor Infokall Inc., a developer of wireless applications. Infokall maintains a development center in the Indian city of Chennai. Valentino accessed highly skilled Java 2 Enterprise Edition developers for less than half of what he would have paid locally to create a $400,000 automated routing and dispatching system that Bekins will use to better match capacity with demand. "The right equipment will go to the right cities and we'll get better yields," he says.

There's more than anecdotal evidence to support the notion that offshoring could result in a net gain for the United States. From 2003 through 2008, U.S. businesses will save $20.9 billion using offshore IT resources, according to a study released in March by research firm Global Insight. The study, commissioned by the Information Technology Association of America--a group comprised of IT manufacturers that support offshoring--also predicts that the U.S. gross domestic product will be $124.2 billion higher in 2008 than it would be if offshore resources weren't available. The reason: Offshoring helps prevent inflation, which in turn leads to increased investment and spurs economic activity of all sorts.

A perhaps more-neutral, though still hotly controversial, assessment of outsourcing's overall impact came from a McKinsey Global Institute report, published last year, that contends the U.S. economy captures more than three-fourths of the benefit for every dollar of corporate spending outsourced to India. Since the savings let companies invest in emerging technologies and business ideas that create jobs, the report concludes, the U.S. economy gets as much as $1.14 in return for every dollar spent on outsourcing.

Many large U.S. companies have been offshoring for years, either through deals with third-party outsourcing firms, both domestic and foreign, or by establishing their own IT operations overseas. In its own facilities and through an outsourcing relationship with Hewlett-Packard, consumer-goods company Procter & Gamble Co. uses application developers in India, the Philippines, and Poland while maintaining higher-level development centers in the United States. P&G's offshore developers produce business applications "at a fraction of the cost" the company would pay domestically, says Linda Clement-Holmes, the company's director of infrastructure services. The savings help to keep a lid on the price of common household items such as Tide detergent and Crest toothpaste, she contends. "Anything we can do to get our product on the shelf cheaper is a good thing for consumers," Clement-Holmes says.

Undoubtedly, there's a free-market ruthlessness to the offshore equation. First Index Inc. is a provider of E-marketplaces for the manufacturing industry and maintains dual headquarters in Whippany, N.J., and in Hampshire, England. Last year, CEO Russ White axed the company's U.K.-based IT staff and replaced them with contract personnel out of Belarus provided by EPAM Systems LLC. White says his U.K. workers were "competent," but now he has access to "world-class talent" through EPAM. "As a small business, I can't compete with Microsoft for the best and brightest talent in the West, but I got that by looking East," he says. In the process, First Index lowered its monthly IT costs from $55,000 to $22,000.

Pete Hilliard, senior VP of human resources at Agile Software Corp., a maker of product-life-cycle-management software, says his company let three IT employees go earlier this year from its headquarters in San Jose, Calif., after handing over network-management operations to Opsource Inc., which maintains a network-management center in Bangalore, India. The move helped Agile lower its overall IT costs by 15% to 20%, but equally important, Hilliard says, is that the company improved network monitoring. "They have technology that gives us a more robust monitoring perspective. We couldn't find anything like that from a competitor, be it foreign or domestic," he says. Because Opsource uses personnel in both its Indian and U.S. facilities to monitor Agile's networks, the company gets round-the-clock coverage that it didn't have before. "It's a tremendous benefit," Hilliard says.

Michael Treacy, a former professor at MIT's Sloan School of Management, isn't surprised by this. "There are, both from a capability and cost perspective, things you can do that would not be done and businesses being built that would not be built" were it not for offshoring, Treacy says.

Treacy is co-author of the best-selling book The Discipline Of Market Leaders (Perseus Books Group, 1997) and chief strategist of Gen3 Partners, a venture-capital firm. Earlier this year, Treacy and some partners invested about $5 million to launch Airgain Inc., a Carlsbad, Calif., company that will develop and sell smart antennas. Conventional antennas are passive--that is, they catch only the signals that wash over them. The search for a better way led Treacy to Russia. He hired a group of Russian scientists and programmers to tap existing Russian research in phased-array radar and tweak the technology for use in wireless broadband networks. The result: a smart antenna that actively seeks out broadband signals and then focuses in the direction of the source. The antennas can lock on to broadband signals at a range 10 times greater than their conventional counterparts.

The Upshot Offshore development allows many companies to employ high-quality talent they wouldn't otherwise be able to afford.

While offshoring has meant hardship for a significant number of American programmers, it benefits other groups of high-tech workers such as project managers.

There's evidence that offshoring benefits the U.S. economy as a whole by, for example, keeping inflation in check.

Through its compelling cost-benefit equation, offshoring is helping to bring back to the IT industry some of the venture capital that was lost in the dot-com bust.

Treacy estimates the venture would have cost at least $15 million to launch had he paid domestic rates for research and development. He doubts he could have raised the additional funding. "It would have been a $15 million gamble that few people would have been willing to take because there was no certainty you could take phased-array radar and move it into this application," Treacy says.

Many venture capitalists fled the tech industry after the dot-com bust, but offshoring offers pumped-up risk-reward ratios that are luring them back. The result is new companies creating new products with benefits that could ripple throughout the economy. For instance, Airgain's technology is a key part of a system purchased by the Southern California city of Cerritos to create a low-cost, community wireless broadband network in an effort to attract more business while bridging the town's digital divide.

Still, if offshoring has the potential to raise all boats, some workers are caught in its turbulent wake. In 2002, the United States lost more than 540,000 IT jobs, according to the Labor Department. Not all those can be ascribed to offshoring, but groups such as the Washington Alliance of Technology Workers, an affiliate of Communications Workers of America, have called for limits to the practice or, at the very least, that some of the savings companies gain from offshoring should be used to retrain affected workers for higher-level jobs.

Offshoring isn't just about cheaper labor. India leads the world in the number of IT services shops that have obtained Carnegie Mellon's CMM Level 5 designation--the industry's highest quality rating for programming. Meanwhile, Eastern Europe, Russia, and former Soviet republics are home to many of the world's top mathematicians. "If I need complex logistics algorithms, absolutely I go to Eastern Europe and Russia," says Treacy, who notes that in those countries "mathematicians are treated like all-stars, while there's not one in 100 Americans who could even name a single mathematician."

Treacy believes that as more and more companies focus on strategic functions that are closely aligned with their businesses goals, they'll outsource a greater portion of their business-technology requirements--to both domestic and offshore workers. Businesses eventually will outsource a full 80% of their IT operations, with half of that going offshore, he says. "This isn't a choice," Treacy says. "This is like gravity."