A Hard Look at Popular Outsourcing Myths

Survey: Offshoring does not cost developer jobs

2007-01-24T20:34:00Z

This is an interesting survey that was published this month in InfoWorld. Many people blamed offshoring for job losses between 2001-2005. (It's difficult to still blame it post 2005, since IT employment is now higher than it was in 2001). It's much easier to find a simply understood scape-goat (like offshore outsourcing) than to look at the more complicated, but relevant contributors to the 2001-2005 decline, such as the cyclical nature of the economy and the fall-out from over-investment in the dot-com mania.

http://www.infoworld.com/article/07/01/11/HNsiaa_1.html

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Survey: Offshoring does not cost developer jobs
Lack of engineers in U.S. is cited by software companies as reason for increasing offshore work

Offshoring of software development by software companies is not costing Americans jobs, according to a report being announced Thursday by the Software & Information Industry Association (SIIA).

The association is releasing its Global Software Development Survey Report, which surveyed 114 American-based software companies last year. In a conclusion that stateside developers probably would not find surprising, SIIA found that software companies are increasing offshore software development efforts. However, companies are not looking to displace American workers, said David Thomas, executive director of SIIA.

[Talkback: Have your say about the SIAA survey.]

"[Offshoring] was used almost entirely as a form of expansion, not as a replacement," Thomas said.

"There's a lot of negative talk," that is particularly political, about offshoring costing American jobs, Thomas said. "That's not really the case."

The biggest challenge for software companies was they could not build development teams fast enough in the United States because of a shortage of both engineers and H-1B visas, Thomas said. Offshoring provided a way to leverage existing developer teams, he said.

SIIA found that 57 percent of offshore participants have significantly increased offshore work in the past 18 months. Many plan to continue to do so.

Sixty-eight of the companies surveyed had offshore operations while 46 did not.

Growth was cited as an important or critical driver for 84 percent of respondents doing offshoring; increasing speed to market and productivity were the next most important drivers.

SIIA said respondents claim to be meeting 80 percent to 100 percent of cost-saving goals. But gains in productivity appear to be less-than-expected.

Seventy-three percent of respondents report a positive impact on profits and two-thirds claim the quality of work is above average compared to the onshore staff. Twenty-five percent rate the quality as excellent or outstanding.

The research found that some companies underestimate what is needed to succeed and how much effort is necessary for adaptation. This situation is exacerbated by a tendency to think in the short term, focusing on goals such as cost-cutting.

No single business model was cited as being optimum for offshore development. About half of respondents worked with an offshore provider while a third operated a subsidiary or captive. A quarter utilized a hybrid model of both approaches, SIIA said.

Companies not doing offshore development cite concerns including product quality, loss of control, fear for intellectual property and impact on internal staff morale. Some 91 percent of those not offshoring said loss of control was somewhat important or very important in their decision to not take the offshore route.

SIIA is a trade association for the software and digital content industry.

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Ian Ippolito

Outsourcing causes U.S. IT employment to hit all time HIGH record?

2006-05-08T19:59:00Z

Many people have argued strongly that offshore outsourcing is bad for U.S. workers in the IT industry becuase it causes a massive loss of jobs. Many go on to conclude that it is "un-American" to outsource.

These same people may have been surprised on April 24th, 2006. On that date, Information Week (which normally commiserates with anti-outsourcing sentiment) hit the stands with it's latest and startling figures on the outsourcing debate. Contrary to the massive job losses predicted by outsourcing critics (including many Information Week reporters and those who constantly write letters to the IW editors), the cover reported that IT employment had hit an all time HIGH record. It also stated that job satisifaction and security are up and that the average manager's median income has climbed as high as to be on the cusp of six figures!

The cover:

The cover states "Our research reveals a surprisingly robust job market, even as the threat of offshoring looms large".

The results may have been suprising to Information Week. But they were no surprise at all to anyone familiar with the basic of free trade theory. In fact they were completely expected.

Where is the growth coming from? Free trade theory predicts that the rise of outsourcing would cause a loss of lower paying jobs (as they go overseas). But it also predicts an increase in U.S. higher paying jobs. And as the article shows, this is EXACTLY what is happening. Programmers decreased 20% since 2001. But higher paying manager jobs more than made up for this (increasing by 91,000 jobs). And of course, demand for such manager jobs is increasing, which means that salaries are going up too (close to the six figure range)!

Why is this happening? I call it the "affordability magnification effect". You can read more about it in my other blog entry on the topic.

"That's great for the economy and the IT industry as a whole", some would say. "But what bout those heads-down coders? What do they do?" If that describes you, you need to get out of your cubicule and turn off your PC and learn more advanced management skills. Yes, that includes project management skills and it also means learning people management skills. To some coders that might be worse than having no job at all. If so, that is a choice they can make. But it is not accurate to prented that there is no choice. On the other hand, those that do choose to adapt, are guaranteed to do better off finanically than they did before outsourcing came along. 91,000 new managers will attest to it.

Offshore outsourcing causes U.S. wages to skyrocket?

2006-02-07T17:09:00Z

If offshore outsourcing is causing U.S. IT employment (as some claim), then why did the Yoh Index of Technology Wages report released today (http://news.yahoo.com/s/zd/20060206/tc_zd/170810) find that "Hourly wages for tech professionals hit a record high during the fourth quarter of 2005"? Obviously there is more here than meets the eye.

The report goes on to say that "since the fourth quarter of 2001, wages for high-impact technology professionals have risen nearly 11 percent". This provides even more backing to what I've said in this forum before. The main cause of the tech bubble bursting and the unemployment in IT from 2001-2004 was caused by the excesses of irrational overinvestment by Wall Street and venture capitalists. Offshore outsourcing was scapegoated as the reason becuase it was much easier to understand and pushed more emotional buttons. But this thin rationale is showing more and more holes by the day.

Outsourcing did cause some jobs to be lost (mostly heads down programming jobs). And as we've seen from the U.S. job data in earlier postings, it also caused even more higher paying management jobs to be created in the U.S. The data shows that the U.S. is stronger becuase of outsourcing, not weaker.

But what kind of boring newspaper headline would that make?

What is free trade?

2005-09-19T01:43:00Z

Offshore outsourcing is very closely related to free trade. It’s so close, that your view on both is probably the same. However a lot of people with strong opinions about both, are unaware of the theory of free trade. With a gap like this, how can we expect rational discussion to occur between the two sides? This article was created to attempt to bridge that gap.

So what is free trade? Free trade is just a theory that states that when 2 countries choose to trade goods or services, BOTH countries will always end up better off (than if they had chosen not to do so).

That’s a very strong assertion, and one that not everyone would agree with. So exactly how does free trade justify this?

It does this by first pointing out something that everyone can agree on…that virtually every country has a different environment (economic, climatic, political, and social) than any other country. Everyone agrees that people with different skills and backgrounds will have different strengths and weaknesses. This idea extends that concept and says that the same is true for countries as well. (This is concept is sometimes called “comparative advantage”.)

In the U.S. we are very good at producing a lot of things. From the light bulb to todays high tech products, almost all of them were invented in the U.S. And everyone can also agree that we really stink at lo tech things like making canoes by hand (even though it is done very proficiently in some countries). We also are not so hot at some agricultural things like growing coffee beans, or harvesting bananas.

So if we were to choose not to trade at all…and we wanted bananas…we would be forced to some pretty extreme measures. Since the climate in the U.S. is not ideal for bananas (at least not those big, juicy types like the Chiquita bananas), we’d have to create immense greenhouses and artificially control the temperature. The money spent doing this, would be much more expensive than simply purchasing them from Brazil…leaving the country as a whole with less money to spend than it had just trade for them.

Worse, in order to convince even our own citizens to purchase our artificially grown U.S. bananas, the government would have to paying some of the banana growers’ expenses to lower the price and make it competitive. If that happened, the companies would be reporting profits, but in reality the country as a whole would still be paying for it…and we would be slowly sucked dry.

Again that is a pretty strong statement. Does it stand up when walking through some detailed numbers?

To keep things simple…lets pretend that there are only 2 countries in the world (the U.S. and Brazil) and 2 products in the world (cars and coffee). And to further simply things lets pretend that our billion dollar economy is actually only $100. So in a year, a person “running” our economy (which will be us), has $100 to “spend”. We could spend it on producing goods and services ourselves, or on purchasing them from other countries. Let’s also pretend that Brazil’s smaller economy gives it $10/year to spend.

What happens as the year goes on?

The U.S. is really good at manufacturing cars, because we invented the automobile. We also have an innovative hi-tech industry capable of creating world-class factories to create these cars. On the other hand, we aren’t so hot at growing coffee. We don’t have the best climate for it, and while our educational system is much more advanced than Brazils…it also means we don’t have hordes of lesser educated agricultural workers. Picking beans isn’t that mentally demanding, but even though our workers are over-educated for bean-picking, they will need and expect to be paid a higher wage.

Brazil on the other hand, is really good at growing coffee, because of its perfect climate and huge agricultural work force. And it could theoretically manufacture cars, but due to lack of a hi-tech industry, it would be very expensive and require a lot of things top be done manually. This of course means more defects which are expensive to fix.

If you like charts…here is what the above looks like numerically. Below is the cost of each country to create a car or coffee, and also what it could sell that product for.

            Car (sells for $10)              Coffee (sells for $2)
            ------------------------         ------------------------
Country
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U.S.:     $5 to make each one        $3 to make each one
Brazil:  $50 to make each one       $1 to make each one

If you’re in charge of Brazil, and you have to decide what your country is doing for the year…what do you do to maximize your scarce resources?

Maybe you would have aspirations to be a car manufacturer. What would be better for patriotism than a national car? So you decide to make it a national priority. You copy the designs of every car blueprint you can get your hands on and you create somewhat crude, but workable factories where the car is assembled by hand. Drawing your inspiration from Yugoslavia’s Yugo, you decide to call it the BrazilO. our $10 per year allows you to produce 1/5 of a car every year. It’ll take 5 years, so you won’t be able to pay the workers anything for the first 5 years. But that’s a minor detail…after all this is a national priority and they are willing to sacrifice a little for the greater good! And after 5 years, the first BrazilO proudly rolls off the assembly line to much fanfare.

However, the owner of the company tells you that there is a small problem. The BrazilO company spent $50 to make a car, but cars only sell for $10. BrazilO has got to start paying those workers after 5 years of nothing, but they can’t make their payroll without a profit. And if BrazilO fails, there will be a revolt on your hands…maybe even a coup (gulp)!

So, as the Brazilian government, you give Braizlo Corp a little “help”. You subsidize the car industry by paying $45 from your treasury. (Thank goodness your predecessor forgot to take a little bit of gold that was stashed in his bank account before he was forced out). That does the trick! Now it only costs BrazilO Corp $5 to make the car…the “same” price as it costs those U.S. manufacturers. So BrazilO sells the car for $10 and makes a profit…and you look like a genius to your fellow Brazilians! Only a few people actually notice that as a country, you still had to pay $50 for that car…it just came from a different pocket. And as a country, you’ve lost 500% (100%/year). If you’re smart, you’d realize that a few more “successful” years like this one and the Brazilian treasury will be empty, and you’ll need to find a new job. Preferably out of the country.

That didn’t turn out so well. So instead let’s imagine that you choose to take a different course of action and grow coffee instead. You’re really good at that, so you can create 10 units with your $10, and they sell for $2 each. So at the end of just the 1st year the Brazillian Coffee Company has spent $10 and earned back $20…a profit of $10. Instead of losing money, your country is now $10 richer than it started off. And who knows…maybe with that $10 you might even buy a fancy new U.S. car for your personal transportation?

Compare the 2 scenarios. In the first, you chose to do something you weren’t good at, and you lost 100% of your money each year with your subsidy. In the second, you focused on what you were good at, and made so much money that you actually ended up having enough money to buy a car with the excess. It’s like the difference between night and day.

Some might argue that this is obvious for Brazil. But what about the reverse situation for the larger country. Surely that is a different story…right? Let’s see…

As the U.S. president you have decided that you our dependency on foreign coffee may eventually cause a coffee crisis to occur if we were to get into a dispute with Brazil. With our armed forces practically living off of the stuff…national security is at stake. So you decide that as a country, we are not going to trade for our coffee…but instead are going to grow it all ourselves.

The challenges are large, because the U.S. climate just isn’t suited to growing coffee…at least not the kind anyone will drink. But by putting the best engineering minds to work on the problem, you are able to turn excess land in Arizona into the largest greenhouse in the world. Amazingly the climate is pretty close to what occurs in Brazil. And then you inspire our top biochemists and geneticists to bridge the rest of the gap by creating a new breed of coffee bean that will grow and taste exactly the same as Brazillian coffee, even under those slightly different conditions. It’s a triumph of modern science.

Once the coffee beans ripen, we have to pick them. The workers we have available are graduates of our U.S. educational system, and they are a bit over qualified for this low-skill job. Even though it’s mindless, they expect and need to be paid a higher wage…otherwise they won’t be able to afford to eat. Starving citizens don’t make for good press reports, so you decide it’s best for all concerned to simply hire as many as you can. Unemployment drops to less than .01% and everyone hails you as a rain maker.

There’s a small nagging problem though. All of these scientific marvels didn’t come cheaply. Fortunately you’re able to write off all the research costs using obscure budget methods so that no one realizes what happened until the year 2050…which is AFTER they’ve already completed your bust addition on mount Rushmore.

However, there’s still a problem. The U.S. Coffee Company accountant informs you that operating the greenhouses and paying all the workers means that it costs us $3 to operate to grow 1 unit of coffee. The problem is that Brazillian coffee is selling at only $2. If something isn’t done quickly, the politicial fallout could be of biblical proportions.

So you fix the problem in the usual way. You denounce Brazil for unfairly taking advantage of the budding U.S. coffee industry. It’s unjust that arbitrary chance has given them a position closer to the sun during the growing season! You are going to step in and protect U.S. workers and companies. You proudly announce that the U.S. Coffee company is going to be subsidized! It will pay only $1 for each unit of coffee, because U.S. tax payers will pay the other $2. The press hails you as a “compassionate coffee-er” and your poll numbers soar! And instant success follows. The U.S. Coffee company quickly announces that the 33 units of coffee they made, fetched $2 a piece and the profit is $66-$33=$33. You score another political notch in your belt.

Unfortunately, a lonely accountant in the OMB secretly tells you the bad news. The country as a whole is still paying $3/unit…the $2 is just being paid from the taxpayers instead of the U.S. Coffee company. So as a country we are spending $99 to earn $66—which means we’re bleeding a $33 loss each year. He tells you that those tax cuts that you planned for the next term are not looking quite so “doable” after all. And neither is your salary nor his. He’s not so happy about that and you’re afraid he might leak it to the press. Oh boy.

What would be a smarter thing to do? Let’s say that you chose to stick to doing what you could do best…manufacturing cars. Now you can make 20 of them and sell them for $10 each. Your $200 of revenues - $100 of expenses = $100 of profit. With that amount of money, not only is the country much better off, but the excess could be used to buy 20 units of coffee.

Again, look at the huge difference. In the first example you subsidized coffee and you lost $33/year. In the second, you stuck to what you were good at and made $100/year.

This is the idea behind free trade. Whether you agree with it, or disagree, I hope this helped in your understanding of the theory.

You traitor...you took my $1 and gave me back $1.12!

2005-08-20T11:10:00Z

How many times have you heard that offshore outsourcing is unpatriotic? (If you need a reminder, see "Benedict Arnold CEOs are shipping American jobs overseas"). Did you know that the McKinsey Global Institute reports that "for every $1 outsourced the United States gains between $1.12-$1.14."? If every American were that "unpatriotic", we wouldn't need patriots any more. But don't just take McKinsey's word for it. See what the stodgy but reliable U.S. Bureau of Labor statisitcs have to say about it, in my other blog entry about the IT employment rebound and the boom in new IT management jobs.

The old saying goes "What was old is new again". The blog quoted above puts the current situation into historical context quite well when it says, "Machine diggers took the jobs of workmen with spades. At the time, there were people who objected. ... Despite specific jobs being lost, the total number of jobs has increased."

(The original article being commented on is an article by Bruce Bartlett titled "How Outsourcing Creates Jobs for Americans" )

What happened to the "Giant Sucking Sound" of Offshore Outsourcing?

2005-08-06T10:00:00Z

The conventional wisdom is that offshore outsourcing has been very bad for the U.S. Information Technology workforce. After all, now that a company can transfer the work of a $50/hour U.S. programmer to an equally skilled programmer in India or Romania and pay only $5/hour for the same job, what are U.S. workers to do? Ross Perot once famously described the result as the “Giant Sucking Sound” of jobs moving overseas. Virtually every newsgroup, blog and magazine editorial quotes anecdotal evidence of someone who has lost a job in the recent down turn as validation of this theory. Almost all make dire predictions of the end of U.S. I.T. dominance .

     It’s too bad that none of these people took the time to notice that the U.S. Bureau of Labor and Statistics survey last month showed the number of jobs in U.S. IT has rebounded to the highs of 2001. (see “Reliving the summer of 2001” in InformationWeek) If they had, we would have heard a completely different type of “Giant Sucking Sound”… a whole lot of people holding their breaths while forced to ask themsleves “If offshore outsourcing is the awful bogey man I believe it to be…then WHY ARE THE JOBS STILL HERE?”

     U.S. IT moves in cycles. 2001 was the height of the excesses of the dot com bubble (remember when people wouldn’t take a new job unless they got a 50% raise AND could bring their pet in to work?). And what goes up unfortunately must always come down. But when people lose jobs, the pain is real, and human nature is such that we need to blame something or someone for the injustice. And who is a more convenient and defenseless scapegoat than foreigners who can’t speak for themselves or defend themselves?

     You’d think we’d know better about foreigner scape-goating. Remember when the Japanese were buying up marquis U.S. properties in the 1990s like Rockefeller Center? Everyone predicted they were going to own the country. That never happened. Their real-estate bubble busted, they had to leave town and haven’t been sighted since.   And you’d think we’d know better from history about making simple assumption. In the 1700’s, the English gave themselves premature coronaries, because they obsessed over the fact that they couldn’t grow enough trees to power the wood power plants. The invention of the coal based steam engine propelled England into the industrial age, and reduced the dreaded “wood shortage” to a historical footnote.

    Outsourcing HAS had an effect on U.S. I.T. but it has NOT been what the convention wisdom predicted. And understanding it is the key to having a real understanding of outsourcing.

The survey data shows that there are about 16% less programming jobs than in 2001. Everyone knew that heads-down coders would be affected by outsourcing (although that isn't exactly true either...something we'll examine further in another blog posting). On the other side of the ledger, I.T. management jobs have skyrocketed about 20% (70,000). Almost no one realized that those jobs would explode and practically offset the loss in programmers. And a person managing work tends to be paid higher than the people actually doing the work.

Where did these management jobs come from? I call it “Affordability Magnification”. Say you’re a typical IT manager in a small to midsize company with a budget of $1,000,000 for programming. Before outsourcing you ran 4-5 projects a year. Now those projects are just 1/10th the cost. If you still run 4-5 projects, you are going to have a ton of money unspent at the end of the year. The CFO would be more than happy to take it from you and give it to some other department next year…so you can't allow that to happen. Instead, you’ll of course spend every last dime. And you’ll run 40 projects and hire a bunch of new project managers to manage them. And that is what we are seeing.

To those who think this is a surprising idea…I recommend a trip to the library (or Wikiopedia) and a quick read of economics 101. Outsourcing is based on free-trade, and free trade predicts that when 2 countries trade…BOTH benefit, not just one. This is counter intuitive for all the reasons mentioned earlier. But free-trade predicts that people in each country will realign from jobs that the country can do less efficiently, to jobs the country can do more efficiently. And that makes both countries stronger. And that is what we’re seeing.

Yes, this does mean pain and problems for those affected…some of whom have invested years of training. And as a society we should be helping those people with benefits and retraining. But we also need perspective as well. Just like the economic cycle we talked about earlier…this is a cycle and not a novel thing at all. Disruptive technology is constantly displacing old industries as it creates newer and better ones. How many 8-track cassette engineers do you know of? Are any groups pushing for a ban on CDs to protect this specialized profession? And this cycle isn’t even unique to our century. For centuries, scribes (people who could write) were prestigious and highly paid for their advanced skills. But when the printing press was invented and took off in the 15th century, the scribe felt the pain of sudden unemployment. The cost of books dropped by a factor of 300, scribes made the shift to other professions, and society as a whole is more literate and better off than it was before. Today, there is no “scribe in America” program that advocates the banning of printing presses to protect the jobs that U.S. scribes are entitled to.

So anyone that says that outsourcing has caused some unemployment is correct…and some heads-down coding jobs have left the U.S. for good. But anyone who says that outsourcing hasn't also created new jobs, and is somehow unpatriotic because of it...is simply uninformed.

By Ian Ippolito