Difference between revisions of "Talk:IT Outsourcing: Economic and Policy Analysis"

Revision as of 03:39, 4 December 2004

Some considerations for the project: where the outsourcing predominantly goes to. Some of the main case analysis we could make are India or China. As for as IT outsourcing, I think India is the where most US firms are outsourcing to.

Reasons for this: living costs in India are low, India's government focuses alot of its policies to increase their worker's value in the IT sector. From a source (I will do more research on this), earning a $72,000 salary in India, you could live as if you had $100,000 in the US.

Bush administration encourages outsourcing. There was a recent release referring to outsourcing, and basically the Bush administration is mainly concerned with profit maximization, efficiency, but not American "equity". (Are Americans even at par with Indian workers in regards to education level?)

France enacted tax cuts for firms to discourage outsourcing. There are a few articles on this, but I have yet to read them indepth.

Even with tax cuts, firm expenses [including logistics such as operating expenses like high-speed internet access, janitor wages for its facilities, secretaries, airconditioning, complementary food in break rooms-- things often taken for granted at US firms] are much higher than in countries such as India.

India has a surplus of highly skilled, educated individuals, and they are willing to work for a lot less.

• what risks do we run when we outsource IT?

-Mandy

Economic considerations to outsourcing

On the US-firm side, the consideration of whether or not to outsource is made on the basis of a cost/benefits analysis. In this analysis, US firms take into account some of the following in determining whether they choose to outsource or not.

Costs: Increased transportation costs Increased competition from abroad Lower employee morale with lower employee wages and fear of losing jobs

Benefits: Lower cost of production of good Lower wages paid (due to lower standard of living) Cut costs go towards R&D, marketing, business development Decrease layoffs

On a policy leve (US government policy), we would consider the tradeoff between exploiting comparative advantages by outsourcing and the redistibutional effects of outsourcing (loss of lower-level jobs, decreased wages, increased competetiveness from abroad). Its important to confront the tradeoffs with the various costs and benefits to determine how the US should create policy, if at all, to speak to the issue.

User: mandy_c I think communication could be costly as well. And as far as money saved going into R&D, I think it might be a strong assumption. During an earlier discussion I had with someone, they pointed out to me that there are various things that a firm could do with increased profits. Some of these could be simply pocketing the additional profits to increase the value of their shares, or declare more dividends-- it mostly depends in where on the business lifecyle the firm is and whether R&D is a priority. But yes, you're right that it definitely increases the capabilities of the company to develop.

User: bradstr The series of articles (specifically "Sink or Schwinn") in the Nov 13th Economist has some good themes related to this: "Cheaper labor brings down production costs. This keeps companies competitive, raises profits and reduces prices as firms pass their lower costs on to their consumers....Companies spend their profits on improving existing products or introducting new ones. Customers buy more of the things they already consume, or spend the money on new goods and services. This stimulates innovation and creates new jobs to replce those that have gone abroad."

User: bradstr There may be some interesting data in a 2003 McKinsey Global Instituate Study to bolster the argument for global outsourcing. The fourth paragraph of this (Exploding the myths of offshoring - might require free registration to read) article says: "...offshoring creates wealth for the United States as well as for India, the country receiving the jobs. For every dollar of coprorate spending ousourced to India, the US economy...gains as much as $1.14 in return." I couldn't find the original source of the data, but the library may have premium access to McKinsey content. Quick update - this may be the original source of the data: Offshoring: Is it a Win-Win Game? (may require free registration)

Non-economic considerations in outsourcing

User: mandy_c I think one of the technological incentives to outsource are that older technology and processes can be outsourced to countries such as India, leaving US workers to devote more energy in R&D. But there are also many technological disincentives for outsourcing, one big one being the risk of "losing it all". If technology development and maintenence is outsourced, foreign agencies might not deliver what they had promised, or classified information might leak.

Analysis of existing public policies

I know that France has announced that it will enact tax breaks for 20 "competitiveness zones" in hopes that outsourcing will become less of an issue to its economy. I'm trying to find more information about what industries France is primarily concerned with, and what their ultimate concerns are.

I'm debating whether to take an international stand on research of public policies, or to stick with local ones such as San Jose's "living wage" ordinance that directly involves tech jobs.

I can approach it the following way:
1) Foreign country policies on outsourcing
2) Discussion of industry differences
3) Possible downfalls of the comparison
4) Domestic policies that effect outsourcing--minimum wage laws

US public policies to "manage" outsourcing

User: aamiralavi Im not convinced that these measures are necessary. Several of the articles that were posted claimed that the effects on the US workforce in the long-run will not be negative. Instead, outsourcing is a positive phenomenon in the long-run (its really only hits us in the short-run). Also, several of them showed that its more of the blue-collar jobs that are outsourced, so i dont think extra education would be that effective, unless we can move people from a level of education where they would be blue-collar to white-collar. I think once we do our economic analysis of outsourcing, we might find this to be true. This is because each country is working with its comparative advantage. This saves money for US firms to invest in other initiatives (or skim off the top), but also work towards long-run gains. So i think the policy alternatives (a-e) suggested in section 4 should be reconsidered because i think we still have to do our economic and technological to evaluate if we need to (or should) try and keep jobs in the US. Instead, we can focus on US policies towards outsourcing and maybe based on our sectoin 1 and 2 evaluation, if they should be relaxed or more restricted. I think a bigger issue is dealing with decreased US wages due to outsourcing.

User: jk37I agree with Aamir but maybe we need to do more research on that to decide. Anyway, I will collect the data as much as possible in the beginning. One thing that I am not sure of at this point is whether our research should be normative or not. Of course this should be also decided after our indepth reserach such as reviews on cons/pros and cost/benefit analysis of outsourcing as well as a comparative case study, followed by our discussion. But my question is whether we want to take sides in our conclusion. Or do we just suggest possible best (and alternative) policies like a bi-partisan policy think tank does? I think we need a consensus on this before we get started our research.

User: BradstrProf Maurer's instructions said that we were supposed to create a neutral policy paper. So, for policies, it seems like we should discuss the relevant policies that have been proposed and the pros/cons associated with them. I agree that policies such as penalties for companies that outsource are too far reaching. For bad policies such as this, I think we will find the cons will outweigh the pros. For education though, the paper that discusses outsourcing in Washington State (Global IT Sourcing: Impacts and Implications for Washington State) has some interesting thoughts on why and how our education of IT professionals could be changed to allow us to be better prepared for an increasingly outsourced economy.

The Paper

Introduction

In this brief we investigate the causes and effects of recent increased IT outsourcing to lower-waged countries. In the first section, we examine the economic considerations to outsourcing IT work abroad. The economic considerations include a cost/benefit analysis of the impact that outsourcing has on an individual firm and on the US market as a whole. This section provides insight into the economic incentives to outsource or not. Delving into the economics of outsourcing has important implications for policy because policy can alter decision making of whether to outsource or not by changing incentives.

We then analyze the non-economic issues involved in outsourcing. These include looking at the risks and benefits associated with project quality, public relations, employee morale, and time to market. We then address the educational curriculum in the United States, along with recent trends of views on the IT industry in the US. Through recent trend analysis we will provide an explanation for why outsourcing is a growing phenomenon.

Finally, we will examine the possible public policies and discuss their feasibility. Although offshoring is still small relative to the total U.S. job market, it is likely to increase in the future and the issue of offshoring across geographic and temporal boundaries requires detailed analysis of complex short and long-term issues, both on the national and international level. With careful consideration of all stakeholders mentioned here, and with thorough analysis of the strategies, outsourcing can be a “win-win” situation for all. Tough tasks remain to policymakers.

Economic Considerations for Outsourcing

Brillian, an American company based in Arizona, is an expert in display technology. Brillian outsources the creation of bits to create a top-end TV to Wilpro, an Indian technology company. Wilpro, in turn, sources the television’s bits and pieces from companies in America, Japan, Taiwan, and South Korea. After design and testing, assembly of the television passes on to a company such as Flextronics or Solectron, companies that boast the capability to provide the best quality services with the highest value added at lowest costs. These companies have facilities all over the Americas, Europe, Asia, and Flextronics has one in Africa as well. The purchaser of the television could pay with a credit card administered in Kuala Lampur and receive technical support from India. Thus, as we can see, outsourcing has created a worldwide network of businesses, with each corner providing their own expertise.

According to the Outsourcing Institute and Dun & Bradstreet study, in 2000 IT headed the list of outsourced functions with 28% of the share of outsourced functions. Further, according to the same study, the U.S. market for outsourcing was $100 billion in 1996 and it more than tripled to a market size of $345 billion in 2000. These facts lead to a great question. Why has outsourcing in the IT industry faced such explosive growth? Studying the reasons that outsourcing in the IT industry has grown so fast is essential because this trend is redefining the way that business is done. Before exploring some of the more prominent issues surrounding outsourcing in the IT industry, we will briefly look at some of the major functions that offshore companies offer.

There are a wide range of functions that are ripe for offshoring. This can include back office, customer contact, common corporate functions, knowledge service and decision analysis, or research and development. The criteria for generally more successful functions in offshoring are those that can be digitized or handled by telephone and ones where appropriate skills are available or easily developed at the offshoring center. Thus, less complicated functions were the first to be outsourced. This includes back office work where less skilled work such as basic data entry is performed. Even some higher-value works such as software maintenance, application development, and technical support, is also attracting considerable investment. The most skill-demanding work, however, has yet to play a large role in outsourcing. This includes decision analysis and research or development. As of 2000, the Outsourcing Institute and Dun & Bradstreet study found that the two most widely outsourced services in this group are support services and internet services.

Proponents of offshoring state that offshoring allows companies to take advantage of competitive advantages in the production of goods or provision of services. Economic theory suggests that exploiting comparative advantages makes firms more efficient and productive by focusing their energy on producing what they are best at while trading for goods or services from another firm that produces a different good relatively better than the first firm can. This specialization allows both firms to produce more of their specialty while trading for the goods that they did not produce. An important implication to this is that more of each good can be produced for cheaper, saving people valuable resources to spend on other goods.

A McKinsey&Company study shows that offshoring drives significant performance improvement. The study brakes down the savings into a 60-65% factor costs savings and a 5-10% telecom cost savings. However, there is an added 5% management cost (this gets us to 45-55% of original cost). From that point, there is another 30-40% savings on offshore cost base (from both task and process reengineering). This gets us to a cost base of 30-35% of the original cost, or a 65-70% savings.

Taking a look at the India offshore industry case from McKinsey&Company (MGI) offers further insight into the cost-savings that offshoring IT offers. India, which holds the second to largest offshored services market (with $7.7 billion of the market, second to Ireland with $8.3 billion) captured $0.33 from each dollar offshored by the US in 2002. $0.10 of the dollar goes to labor, $0.10 in profits is retained in the Indian offshoring service provider, $0.09 to the supplier, and another $0.04 goes to the central and state governments. The other $0.66 spent brakes down as savings accrued to U.S. investors and/or customers ($0.58), import of U.S. goods and services by providers in India ($0.05), and transfer of profits by U.S. providers in low-wage country to parent ($0.04). Thus, Americans capture $0.58 of savings for each dollar they offshore. These studies show that by outsourcing, the U.S. firm exploits the comparative advantage that overseas firms have in an aspect of production of their good. The overseas firm is able to produce the good at a much lower cost, allowing the U.S. companies the ability to shift resources to other productive capacities. A decade ago, U.S. companies began shifting much of their weight into IT services as much of the manufacturing has already been outsourced abroad. However, as IT services are also being offered abroad at lower cost and high quality, U.S. have been shifting their weight once again towards tailored services that require close interaction with customers. It appears as if U.S. companies are slowly losing their competitive advantages in the industry and finding fewer services to provide customers.

However, a large fear associated with offshoring is that jobs at home are lost when production is outsourced to lower income countries. In the short-run, jobs are lost. Studies by MGI estimate that about 11% of jobs in the economy, about 14.1 million jobs, are “at risk” to be offshored. The other 89%, or 113.8 million jobs, are in service industries such as retailing, catering, and personal care. This work, by its nature, cannot be moved abroad. In 2003, the number of jobs that were being offshored was 345,000, over triple the amount of outsourced jobs since 2000. Further, as functions outsourced moves from mechanization to more skilled labor, more and more white collar workers are being laid off from their companies as their jobs are shipped overseas.

However, proponents of outsourcing show that in the long-run new jobs are created. Because machines and foreign workers can perform the same work more cheaply, the cost of production falls. That means higher profits and lower prices, lifting demand for new goods and services. Looking back to the India example stated above, MGI estimates based on an analysis of historical U.S. reemployment trends that there is a $0.45-$0.47 added value when outsourcing due to reemployment of U.S. labor. Thus, this study suggests that not only does offshoring reduce costs, but also one dollar previously spent in the U.S. has a potential value of $1.45-1.47 dollars as labor is reemployed at home in other job functions. As evidence of growing job functions at home, offshoring in manufacturing has been accompanied by growth in services. From the 20 year period from 1983-2003, an average of 3.4 million net new service jobs have been created per year as compared to a total of 2 million jobs lost to outsourcing throughout the entire 20 year period. Yet again, there is uncertainty about jobs of the future because in the long run, most of them will involve producing goods and services that have not yet been invented. And finding a job to fit the unemployed skills depends on demand in the labor market and the opportunity, willingness, and ability of workers to retrain.

Now that we have examined some of the major issues associated with outsourcing in the IT industry, we shift our attention to policy that affects the incentives to outsource. Identifying key policies that can impact outsourcing in the IT industry is important because, as we have seen, not only is outsourcing in the IT industry a booming business, but the business is also evolving. If U.S. firms want to be able to capture the benefits of outsourcing, policies may need to be implemented to support U.S. industry as the industry changes.