Information Technology | Higher education » Outsourcing in the software development industry

Outsourcing in the Software Development Industry (initial draft working paper) Satwiksai Seshasai and Amar Gupta Massachusetts Institute of Technology September 1529, 2003 Abstract Outsourcing of IT based services and allied services is receiving increasing attention both at business and political levels. Some business executives believe that outsourcing of these services can provide their companies with the major cost benefits by allowing goods and services to be produced at the most economic prices without the traditional barriers of national boundaries and corporate boundaries. At the other extreme, trade unions and unemployed individuals blame many economic woes to outsourcing. In some respects, the situation is similar to the one in the seventies and early eighties when US automobile companies began to have some of the automobile parts be produced in Mexico and other countries. Respected visionaries at that time came to the conclusion that the imposition of new laws to prevent

manufacture of these parts would actually be detrimental, in the long-run, to US companies and US economy. This paper attempts to analyze the impact of outsourcing on various constituencies in the US and abroad to see the overall impact to each constituency with the objective of defining appropriate models that are likely to offer the optimal benefits in the long run. With a growing labor market abroad, and a challenging economic situation at home, software firms both large and small are making the push to outsource development to highly skilled engineers in less expensive labor markets abroad. In the services-sector, Forrester Research estimates that over 3 million jobs, or 2 percent of all American jobs, will move off-shore 1 . Forrester’s report predicts that 8 percent of computer related positions can ultimately be transferred offshore within 12 years 2. The Merrill Lynch report puts the IT consulting outsourcing market at $10 billion for 2002. At the Satyam Computer Services’

global customer summit earlier this year, over 80 US firms indicated that outsourcing has saved them 25 to 40% annually 3. These numbers will only continue to increase in the coming years, exposing a greater and greater need for software firms to carefully understand and implement more efficient processes for outsourcing development, and combat potential political forces which may not understand the full benefit of outsourcing opportunities to our national economy. While many software firms are exploiting the opportunity for outsourcing, there are still many benefits to be derived from taking advantage of emerging communications and infrastructure technologies. The difference in time zones between the United States and many eastern nations provides the potential for around-the-clock concurrent development of software, much like the multi-shift production model for manufacturing. With software, there is a need to develop robust knowledge transfer mechanisms, for both knowledge

management on a daily basis, and to preserve an ongoing knowledge repository for the project. Rich collaboration technologies must be developed and exploited to provide the video, audio and instant messaging capabilities to properly communicate between geographically and culturally seperated separated teams. This effort would involve an understanding of both the existing technology as well as the business needs, and provide a strategy for efficient and results-driven collaborative development. Improved development cycles would provide much more stable software at a much lower cost, and allow the U.S workforce to concentrate on design and development of features rather than software maintenance. Dr. Shailendra Palvia, co-founder of the Center for Global Outsourcing, has pointed out that small and medium size companies are currently hesitant to enter the outsourcing market, but once they do, the impact will be tremendous 4. A Forbes report recognizes the many factors, which contribute to

a particular country’s success in a particular market: infrastructure, culture, language, education, and many others 5 . Because of many of these factors, both the Forbes report, and a similar report done by Merrill Lynch on the IT consulting industry conclude that India is the most preferred destination for outsourcing 6 . The key is to educate the companies both on the opportunities as well as the process, and develop an understanding of what is best done offshore. In addition to technology-driven process improvements, the cost structure for outsourcing has significant potential for improvement. IT costs for collaboration, as well as hardware costs, will rise tremendously as outsourcing becomes more and more popular. Analysis is required to determine the true cost of outsourcing to determine the circumstances under which outsourcing will be truly beneficial. In those cases which do not meet the threshold for providing useful cost savings, deeper investigation has the potential to

reveal re-engineering methods which will save costs in the long run. One such example would be using the same hardware across borders for testing, exploiting the time zone differences. Of course, there would be bandwidth and cost implications for this, and thus investigation is required to understand the structure of this environment. The push across all software firms is to do more with less, and an analysis of potential improvements in the use of IT and hardware resources will help accomplish this goal. Evidence already exists that the government is paying attention to the issue of outsourcing, but policies have yet to mature enough to incorporate the benefits of outsourcing. Instead, political pressure has led policies to encourage barriers to outsourcing. States such as Maryland and New Jersey are considering laws which would prevent the outsourcing of government IT jobs to abroad, and also require call center employees to identify themselves by their real name and the location

they are based in (thereby discouraging outsourcing of technical support). Much of the legislation currently being proposed seeks to use the power of government contracts to curb outsourcing. In Michigan, the law proposed is to limit state contracts from firms which hire foreign employees to ensure that “scarce state dollars are invested at home” according to the representative who proposed the bill 7. Many other bills being proposed across the nation use the government’s authority in granting H1-B and L1 visas to combat companies who replace American jobs with offshore workers 8. Most of these pieces of legislation are in the nascent stages, and have yet to take into account the full impact on the taxpayers. These policies seem to fail to consider the long-term impact of such decisions on citizens. For example, keeping IT jobs in the United States will undoubtedly be more expensive, and these costs ultimately will be transferred to the taxpayers. With most US states

struggling with their budget this year, fiscal considerations should lead states to consider the positive benefits of outsourcing, just as the private sector has done in the past few years. A McKinsey Global Institute report estimates that of the approximately $1.45-$147 of value derived from every dollar spent offshore, US firms receive $112$114, while foreign firms receive only 33 cents of the value 9 Another McKinsey report cites that if income taxes paid by H1-B visa holders, and software and service imports by India are considered, outsourcing has an aggregate benefit to the U.S economy of $168 billion 10. Another factor to be considered is that the average age of the US working population is declining, and in coming years US Census figures indicate that the U.S will require an additional 15.6 million workers to maintain the current working population in 2015 11. Policy analysis is required on this front to model the impact of outsourcing as it relates to the public sector, and

provide guidelines to drive local, state and federal governments’ decisions around outsourcing. The issues discussed above contain many similarities to those faced by the automotive industry years ago, as it undertook the outsourcing of many jobs to countries such as Mexico. At the time, many felt that too many US jobs were being sent off-shore, and the impact to the U.S economy would certainly be negative Leading research of the time, such as that of Lester Thurow, suggested that competition required the United States to outsource manufacturing or risk losing in the global market to other countries that could produce cars cheaper and better. The long-term benefits of maintaining a model where design and prototyping was maintained as a core competency of U.S engineers, while production was outsourced to cheaper labor markets were proposed and then demonstrated in the years that followed. The software industry is in a similar stage, with the push to outsource growing while the

pressure to maintain U.S jobs in the shortterm mounting The resources at M.IT provide fertile ground to carry out the essential research required to facilitate and improve the outsourcing process in the software industry. M.IT’s Productivity from Information Technology (PROFIT) Initiative at the Sloan School of Management has experience in developing knowledge based systems which model complex tasks such as collaborative engineering. Graduate students in the MIT Technology and Policy program have a deep interest in multi-stakeholder interdisciplinary issues such as this. Research centers such as the Center for Coordination Science and Industrial Performance Center are also interested in related research. The opportunity exists in this area to provide significant value both to companies abroad looking to gain outsourcing contracts, as well as software firms in the United States looking to maximize their investment in outsourcing. 1 Skawinski, Kamil Z. “What is to become of the

American IT worker?” California Computer News, http://www.cnmagcom, September 2003 2 Nanda, Tanmaya K. “India top outsourcing destination for US firms” India Abroad September 12, 2003 3 “Outsourcing saves up to 40% annually, feel IT firms.” Business Standard, May 14, 2003 4 Mozumder, Suman G. “Most US firms scared to death of outsourcing” India Abroad, August 22, 2003 5 Nanda, Tanmaya K. “India top outsourcing destination for US firms” India Abroad September 12, 2003 Subramanian, Anusha. “Outsourcing consultants have India bias: Merrill Lynch report” Business Standard, November 28, 2002. 7 Arora, Vasantha. “Proposed Michigan bill to ban outsourcing contracts” Hindustan Times, August 12, 2003. 8 Nanda, Tanmaya K. “Bills galore to check outsourcing” India Abroad September 12, 2003 9 “Offshoring: Is it a Win-Win Game?” McKinsey Global Institute, San Francisco, August 2003. 10 Endleman, Gary. “Fall Guy: US Immigration and the Myth of Offshoring”

National Association of Software and Service Companies (NASSCOM) Media Room, http://www.nasscomorg, September 2003 11 “US may be forced to get across age bar, outsource jobs.” Economic Times, September 17, 2003 6