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Passage to India: IT Offshoring and How America Can Respond

by Gary Endelman

Gary Endelman The concern is clear and it is growing. Since the recession started in March 2001, the economy has shed nearly 2.6 million jobs. Unemployment in June 2003 stood at a nine-year high of 6.4%. Information Technology is at the very epicenter of our national anxiety. Not only our productive muscle, but our very ability to dominate the information age, seems to be under serious question for the first time. How can America respond?

A global economy depends on an orderly and predictable, though regulated, flow of human capital just as much as it does the swift but secure movement of investment capital. The rise in globalization has brought with it what Mark Regets, Research Fellow at the Institute for the Study of Labor in Bonn, Germany, calls a "global labor market." The business strategy of an IT giant like Oracle relies on such a global workforce to promote continuous product development and provide unbroken customer support on a 24/7 "follow the sun" basis. To assume that America always loses with IT offshoring to India is to operate under the mistaken assumption that this is a zero-sum game: they win, we lose. In fact, since India will spend most of the dollars it earns on purchasing US technology and related exports, the truth is that America gains when India, and other key trading partners, become more profitable. Recently, for example, Oracle announced it would hire 6,000 software developers in India. This became possible when Oracle, in partnership with Hewlett-Packard, won a big contract in India for the development of a database for all medical and government records. These 6,000 Indian software developers will liase with 41,000 Oracle software workers in several different countries, including those in San Mateo, California and Waltham, Massachusetts. The ability of companies like Oracle to maintain, even expand, domestic employment depends, in no small measure, on their ability to coordinate their workers in many different international locations. Oracle's interest in IT offshoring is neither shocking nor surprising when we realize, as the Los Angeles Times reported not long ago, that the IT goliath earns 28% of its profit from India, China and related Third World customers; 27% comes from Western Europe and Japan. Oracle's ability to make money abroad allows it to do the same at home with 45% of its $9.5 billion total revenue coming from the United States.

While offshoring to India is undeniably attractive, it is not without its problems. Let us not be so blinded by what offshoring can do that we fail to realize that the costs, both open and hidden, may also be much greater than advertised. It takes years of effort and major up-front investment to find a solid offshoring partner. "Someone working for $10,000 a year in Hyderabad can end up costing an American company four to eight times that amount," says Hank Zupnick, CIO of GE Real Estate. Not only can the cost of selecting an Indian vendor cost thousands of dollars, but Zupnick cautions it could take anywhere from 6 -12 months. Textron Financial's Chief Information Officer David Raspallo devoted six months and $100,000 to establish a transoceanic data line with Infosys in 1998 for Y2K work. It also cost Textron Financial an extra $10,000 per month to keep the network functional. Otis Elevator spent $420,000 on transition planning and did not recoup this outlay, or start saving a penny, for a full year. Ron Kifer, VP of Program Solutions and Management at DHL Worldwide Express, ran into major delays and additional costs when it took longer than expected to install the necessary hardware in India. Will Indian developers feel free when confronted with design flaws to speak up and offer suggestions? Will Indian vendors appreciate the need to create an automation system for credit cards? How much experience will they have? Dean Davison, VP of Service Management Strategies for the Meta Group, estimates that IT offshoring will result, on the average, in a 20% decline in application efficiency during the first two years as a result of cultural differences. He predicts that such a fall-off in productivity can add as much as 20% in additional costs to an offshoring contract. Attrition in offshoring is also a productivity killer. Attrition rates on a typical offshoring project can climb as high as 35% in India according to the National Association of Software and Service Companies (NASSCOM). Those American executives who expect an immediate return will be sorely disappointed. "You can't expect day-one or even six month gains," GE's Zupnick reminds us." You have to look at offshore outsourcing as a long-term investment with long-term payback." How many boards of directors or institutional investors will be that patient?

The cultural costs of offshoring must be factored in to any decision. Though India promises to enact data privacy rules, largely in response to pressure from the European Union's Data Protection Directive, it does not now have a data protection law. Observers anticipate that the Indian Parliament will soon enact such legislation to be enforced by a special appellate court created under India's Information Technology Act of 2000. While this is a positive sign, cautious CIO's will doubtless wonder how eager the Indian court will be to take action seemingly at variance with the country's cultural and commercial heritage. India's 1950 Constitution does not expressly recognize any right to privacy and it was not until 1964 that the Supreme Court of India found privacy to be even an implicit constitutional freedom. India can wait until 2005 to comply with the level of intellectual property protection mandated by the World Trade Organization to which India now belongs. In 2001, US federal and state regulators brought enforcement actions against the Bank of India for alleged violations of the Bank Secrecy Act as a result of not having in place a reporting mechanism to aggregate the value of multiple cash transactions. The Bank of India, while admitting no guilt, did agree to cease and desist from such practices and paid heavy monetary penalties. For the forseeable future, prudence suggests that data privacy and protection will come first, perhaps foremost, from a contract with teeth in it. Such concerns will not stop offshoring, but can slow it down and will certainly make it more expensive.

India is going to be the victim of its own success in attracting US IT offshoring business. The value of the Indian rupee will rise as more US offshoring enters the Indian economy. Since 70% of India's exports is denominated in dollars, when the rupee gains, the competitive advantage enjoyed by Indian IT vendors erodes. That is why each rise in the rupee is hardly an occasion for rejoicing and why a recent report that India's foreign reserves, once less than $1 billion as recently as 1991, are now close to $85 billion and still rising triggered urgent calls for intervention by the Bank of India to prevent the situation from getting any worse ( or better!). Even though US companies pay Indian IT vendors in dollars, these mean nothing to an Indian IT heavyweight like Infosys, whose expenses in India are in rupees. When the rupee appreciates, Infosys will get fewer rupees even though its American customer is paying the same number of dollars. So, Infosys will have less rupees from which to cover its expenses. Hence, an appreciating rupee eats away at Infosys' profits. If such appreciation continues for a few years, it will make it impossible for Infosys to provide an American outsourcer like IBM with services at all, since to do so would involve massive losses to Infosys. The only alternative for Infosys would be to hike prices to compensate for falling profit margins. It is thus entirely possible over time that it would be cheaper to do the work in the United States as opposed to India. Crazy as this sounds, this is precisely what happened in the automobile industry. Toyota, for example, now builds cars in this country because it costs less than in Japan.

Offshoring will end sooner than most of its champions or critics can ever imagine. To lower their costs, Indian IT service providers are even now themselves shipping work to cheaper places like China. In 1999, a study the NASSCOM predicted that the cost of hiring top drawer software engineers in India could match that of the United States in 15 years! Even running away to China would not help since there is no way to escape the centrifugal pull of the world's largest economy nor can China artificially depress the value of the yuan for very much longer in defiance of the international financial system. The Indians must confront the reality that continued massive offshoring will inevitably result in currency equalization much faster than wage rates will rise. Even though it will still be much cheaper to hire software engineers in India, the rupee will be so strong that this will no longer matter. The foreign exchange markets ensure that the very notion of a prevailing wage, contrary to what the USDOL thinks, is a transnational concept defined not by governments but by the international currency exchanges on a daily, perhaps hourly, basis. Those who worry about US wages falling, or wait for Indian wages to rise, are missing the point. Some of this will happen but almost all of such a fluctuation will be absorbed in the change in relative currency values. Already, there is mounting concern in India as the rupee is edging closer to dollar parity. If this ever happens, or even comes close to happening, the offshoring of IT work to India will come to a screeching halt.

Even more than the changes transforming India itself, an emerging revolution that is going to reshape the very nature of software development will soon usher offshoring off the stage. This will may not happen tomorrow, but it will happen soon and for good. Offshoring will become an outmoded system for software development within the next few decades. This is because offshoring depends upon a highly structured method of work that does not allow for close, constant, or genuine collaboration between sofware user and developer. As business models evolve, the need for these two groups to be co-located will become ever more urgent in order to facilitate faster and more powerful application development. Smaller teams and on-site work will replace offshoring as the paradigm for producing cost savings and enhancing productivity. The justification for offshoring will disappear to be replaced by a laser-like focus on agile computing methods that thrive on ad-hoc networking, peer-to-peer resource sharing, simplicity, integration, communication and constant feedback. All of this is simply impossible in an offshoring system in which the very absence of these traits makes possible the maintenace of legacy software systems at low cost and with minimal creativity. So long as software users will be in the United States, software developers thousands of miles away in India can never make agile computing work.

This is our opening; here lies the golden chance for America to respond. America needs to focus on retaining the next generation of computer technologies for it is in such innovation that mastery lives; India, or any other country for that matter, can have the rest. "Silicon Valley doesn't need to have all the tech development in the world," reminds Doug Henton, president of Collaborative Economics in Mountview, California. "We need very good-paying jobs. Any R&D that is routine can probably go." We need an economy, and an immigration system, that embodies the same virtues of agile computing that will put offshoring to India in mothballs: simplicity, transparency, creativity, and adaptablility. Immigration can no longer be seen as primarily a form of social outreach. It must be understood for what it has now become, a core strategy to employ the necessary human talent for the global economy in which all Americans work and on whose continued vitality we all depend. The qualities that until now have characterized our immigration system can no longer stand: unnecessary complexity; excessive micromanagement; fierce resistance to change; and a refusal to engage in open and honest communication with those most directly affected by it. Offshoring is not the enemy; it is merely a symptom of our own malaise. An immigration system with these values does not reflect, and cannot possibly serve, the American economy. Over the next few months, America can choose to turn inward and seek false protection against the future or boldly face up to its challenges and use immigration to create a global workforce to supercharge our globalized economy. The choice is ours to make. "Come my friends," Emerson told us long ago in words that seem no less relevant today, "it is not too late to seek a newer world."

About The Author

Gary Endelman practices immigration law at BP America Inc. The opinions expressed in this column are purely personal and do not represent the views or beliefs of BP America Inc. in any way.

The opinions expressed in this article do not necessarily reflect the opinion of ILW.COM.