OFFSHORE OUTSOURCING: WHEN PUSH COMES TO SHOVE

Financial Times, UK
http://www.ft.com
December 1, 2004

IT Report

For thousands of workers in western countries - and for governments too - there can be little doubt about what the big employment issue has been this year. Wage rises, pensions and other concerns are taking a back seat as offshore outsourcing - and its potential threat to jobs - has been thrust to the top of the agenda.

The outsourcing of software development work and other low-profile activities to low-wage countries in the developing world - notably, India - has been going on for a decade without causing more than the odd ripple in the west. But the rapid development of overseas call centres and business process outsourcing (or BPO) has set alarm bells ringing for trades unions and politicians, while being widely welcomed by businesses seeking to reduce costs in the global economy.

In this article we assess how attitudes to offshore outsourcing vary round the world.

United States

Offshore outsourcing by US companies has been building up a head of steam for a couple years, writes Christopher Swann. But in 2004 the weakness of US job creation - coupled with the approach of the presidential election - conspired to make it an issue of public concern. Lou Dobbs, a leading CNN presenter, launched a slot on his show called “Exporting American” which denounced the evils of shipping jobs overseas. Once offshore outsourcing had been confined to low-end manufacturing jobs. Now it had started to menace the middle classes. At the early stages of the campaign John Kerry, the Democrat presidential candidate, gave great play to his plans to stem offshore outsourcing and lampooned president George W. Bush for his apparent acceptance of the trend. The threat of government action to deter outsourcing hung over the IT industry.

Now, this period of anxiety for the IT companies appears to have passed. As job creation rates have picked up the issue has faded from the headlines. The re-election of Mr Bush means that there will almost certainly be no attempt by the government to undermine the freedom of companies to use cheaper overseas workers. Although the issue no longer draws such fevered comment from political commentators, the use of offshore outsourcing continues to grow. The US IT industry believes it has become a financial necessity but has also argued that it benefits the economy as a whole.

A survey published earlier this year by the Information Technology Association of America and carried out by the consultancy Global Insight estimated that around 104,000 jobs in the US software industry had been displaced by the use of offshore outsourcing up to 2003. This includes jobs that were never created in the US, as companies expanded overseas but not in the home market. This is a relatively modest problem for the US - which has some 3.7m workers writing and implementing software. The number of jobs lost to offshore outsourcing pales in comparison with the number who were fired when the dotcom bubble burst in 2000 - an estimated 372,000. More than 268,000 IT and software services jobs have been lost for other reasons - including the mild recession of 2001 as well as productivity gains that have lowered the need for IT workers.

Nariman Behravesh, chief economist at Global Insight and co-author of the ITAA report, continues to believe that IT offshore outsourcing will be a source of net job creation in the US. “While global IT outsourcing displaces some IT workers, total employment increases as the benefits ripple through the economy,” he says. Lower inflation in the US as a result of cost savings, he argues, will provide a modest lift to real wages, which should encourage more spending and more employment. “The incremental economic activity that follows offshore IT outsourcing created over 90,000 net new jobs as of 2003 and is expected to create 317,000 net new jobs by 2008.”

Harris Miller, ITAA president, believes overseas outsourcing is an unstoppable trend. “The clients of an IT company are demanding a ‘blended rate’ - with a company having programmers that are paid $120,000 and programmers that are paid $20,000,” he says. “If a company does not have programmers in places like Hungary, India or the Philippines, they may not win contracts in the first place and so would actually have to cut back their US workforce.”

The ITAA believes that offshore outsourcing will continue but that there will also be more IT jobs within the US. Global competition should encourage US workers to raise their game, Mr Miller says. “When the US is challenged in an Olympic event, we do not suggest athletes from rival nations are forced to wear extra-heavy hats or weighted boots. Instead we try to get better ourselves. US IT workers still have an advantage on quality that they need to maintain and lengthen in order to compensate for the higher cost of workers here.”

The industry also says it needs to continue to hire overseas workers to service demand in fast-growing overseas markets such as China and India. “The kind of IT that will work in the US might not be quite appropriate for these markets and so it is vital to have workers on the ground,” says Mr Miller.

He points out that Intel, Oracle and Microsoft now make more than 50 per cent of their earnings in overseas markets. “The US IT industry is winning overseas and having great success at penetrating foreign markets,” he says. “It is pointless to start a trade war in an area where you are winning.”

The bulk of offshore outsourcing is low-end - i.e data entry, call centres, application maintenance. Mr Miller argues that US companies are also doing some higher-level work overseas. “It remains an open question as to whether high end IT work will be as affected as lower end functions,” he says.

Canada

In contrast to the US, the outsourcing debate in Canada is less about job losses than about what is needed to attract more outsourcing business from south of the border, writes Bernard Simon.

Canada already has a significant “near-shore” outsourcing sector, with industry estimates suggesting that about 150,000 people are employed in call centres and another 15,000 in information technology outsourcing.

Satyam Computer Services of India opened a software development centre last February in a suburb of Toronto. Part of the centre’s mandate is to expand Satyam’s outsourcing business in Canada. But Satyam also sees an opportunity to use Canada as a base to win more US customers.

Satyam’s Toronto centre, one of 19 similar facilities around the world, now employs more than 100 people. Sanjay Tugnait, Satyam’s country manager in Canada, says that, with Toronto on the same time zone as New York and less than two hours’ flying time from a third of the US’s population, a growing number of US companies view Canada as either an alternative or an addition to their outsourcing activities in India. Canada also has one of the world’s most sophisticated broadband networks

The September 2001 terror attacks have given Canada a new advantage as the US has tightened visa restrictions on Indian citizens and many other foreign nationals. “US visa restrictions are an issue, but it helps us,” says Mr Tugnait.

According to Robert Scott, a partner at PricewaterhouseCoopers in Toronto, it is sometimes easier these days for Indian executives to meet their US clients in Canada than south of the border.

Furthermore, Mr Tugnait notes, some US companies prefer to keep sensitive data relating, for instance, to disaster recovery and information security projects close to home.

Still, many Canadian companies - notably the big banks and telecommunications groups - outsource operations to India and elsewhere, and the pace is expected to accelerate. A recent PwC reports predicts that as many as 75,000 jobs could disappear by 2010.

A sharp rise in the Canadian dollar over the past three years, without a corresponding improvement in productivity, is blunting Canada’s competitive edge. “Earlier, I could have a 25 per cent-plus differential which I could offer US companies”, says Mr Tugnait. “Now, it’s only 20 per cent. It will make us work leaner and smarter”.

Sensing that Canada is losing ground, the Information Technology Association of Canada is pushing for a national outsourcing strategy. Canada must ensure “that it offers services that a global marketplace will value”, says Bernard Courtois, the association’s president.

For the time being, political opposition to offshore outsourcing is far more muted in Canada than south of the border. “Canadians have realised that they’re a smaller player in the global market and the options available to us are fewer,” says Mr Scott. Indeed, British Columbia’s business-friendly government is in the process of rewriting legislation to facilitate outsourcing after trade unions challenged the practice on the grounds that it violated privacy-protection laws.

United Kingdom

The UK has embraced its free market traditions when it comes to the debate about moving business offshore, writes Jonathan Moules.

A survey by the Confederation of British Industry, the employers’ body, found that 53 per cent of British companies were either considering offshore outsourcing or had already moved operations abroad.

IT support and development is the third most popular operation for offshore outsourcing by UK companies, after design work and the manufacturing of industrial goods. Most of those that have taken work offshore had moved it to India or China, although Poland and the Czech Republic are also popular for “nearshoring” operations.

The opportunity to cut costs is the main reason why companies move offshore. However, British companies also say they like India for the availability of skills and the widespread use of English.

Offshore outsourcing of business processes is still a minority sport, accounting for barely 10 per cent of the market, according to Nelson Hall, the business process outsourcing analyst. John Willmott, managing director, says: “It is happening. But to do it for a serious business process actually takes quite a long time.”

Research by Nelson Hall found that 80 per cent of companies that have followed the offshore outsourcing route felt their actions increased their competitiveness.

Financial services companies were the first to move business processes offshore. However, banks and insurers are also the most stubborn users of captive facilities, with 60 per cent of respondents from this sector telling Nelson Hall that they would use their own sites offshore rather than handing work to an outsourcing company.

There was also an appreciation of the broader benefits of offshore outsourcing, with 84 per cent of the survey respondents claiming that the process creates a net gain for the UK economy.

This is not to say that everyone has welcomed offshore outsourcing with open arms. There has been a backlash among both unions and employers in the UK. Amicus, the private sector union, has warned that offshore outsourcing would leave the UK a nation of “hairdressers” and “fat cats”. Financial services companies and brands such as Nationwide and NatWest have made great play of the fact that they do not use Indian call centres.

However, protectionism has been firmly opposed by all parties and even union officials signed up to the free trade agenda at a meeting with Patricia Hewitt, the trade and industry secretary, earlier this year.

There are even signs of co-operation between business and the unions. Barclays, the country’s third largest bank, signed a groundbreaking deal with Unifi, its main trade union, accepting that jobs will be exported abroad but agreeing to offer early consultation on any plans to move work offshore.

Martyn Hart, chairman of the National Outsourcing Association, says: “Offshoring seems to be gradually shaking off the negativity that surrounded it. Organisations are beginning to realise the real benefits that offshoring can bring if managed effectively.”

Australia

In Australia, offshore outsourcing has not yet happened to the same extent as in the US and UK, writes Virginia Marsh. “Where we’re at in Australia is that companies have not yet moved as aggressively [to offshore] as they have in the US and UK,” says John McCarthy, vice-president of Asia Pacific research at Forrester Research, the Boston-based IT consultancy.

But he says local companies are showing the same signs of interest as their US and UK counterparts did two or three years ago and that offshore outsourcing is likely to accelerate in the coming period. Indian providers - India is by far and away the preferred destination - have been stepping up their marketing activities in Australia, he adds.

As in other countries, travel companies, financial service providers and telecommunications groups have been among the pioneers. Telstra, the dominant telco, for example, has outsourced more than 500 IT jobs to India (although it stresses it has outsourced some functions to contractors, which have then taken some of the jobs offshore) while ANZ, one of the big four banks, has had a technology presence in Bangalore since 1989. This was related to its former ownership of Grindlay’s. When it sold the bank to Standard Chartered it opted to retain the operation where it employs about 530 at present.

“It allows us to access some technology skills which are not easily available in Australia, it provides a flexible work force which can be scaled around projects and it provides some cost advantages,” says ANZ, adding that it still employs 2,000 technology staff in Australia and New Zealand.

To date, much of the offshore outsourcing from Australia has involved what Mr McCarthy terms “commodity programming”. There has been relatively little offshore outsourcing, he says, of business processing operations such as call centres, although that could change. Just last month, for example, Optus, Australia’s second largest telco, announced it was setting up its first call centre in India. The new facility will begin with a modest 150 seats but is expected to grow over time although the company stressed it always expected to have several thousand Australia-based call centre employees. At present, it has nearly 3,500.

As elsewhere, offshore outsourcing has run into resistance, particularly from trades unions. Commenting earlier this year on Telstra’s plans to outsource IT jobs to India, Adrian O’Connell, national secretary of the Community and Public Sector Union said: “Laying off Australian workers at the same time as engaging cheaper foreigners is reprehensible and will damage Telstra’s corporate image. We are extremely dubious about whether there is a “skills shortage” in relation to this work. In fact, because of the downturn in the IT sector, there are hundreds of qualified Australians looking for jobs.”

Nevertheless, offshore outsourcing has not provoked nearly the same levels of angst in Australia as it has done in the US and UK: politicians have been prepared to defend it publicly and promote its potential advantages.

Bob Carr, premier of New South Wales, for example, said recently: “Outsourcing to India can’t be stopped by Australia or by the US or the UK governments. Having an open economy brings down costs. Manufacturing was taken to developing countries in the 1970s and 1980s. We are brave enough to recognise job loss as we had the same with the manufacturing industry, but this is temporary. We are losing jobs to India. That helps India to grow and the Indian middle class expands. It is going to be buying services, specialised manufacturers, holidays in Australia. We can’t lose from it.”

In addition, Australia is itself benefiting from offshore outsourcing, particularly in financial services. Deutsche Bank, for example, now runs its foreign exchange settlement operations from two global locations: London and Sydney. It has moved 250 foreign exchange, legal, accounting and other jobs to Australia in the past two years. Other examples include UBS, which has a large global IT support centre; IBM, which has a Japanese-language call centre and State Street, which has a regional custody business.

“We’re attracting jobs from the northern hemisphere to Australia, partly because of cost and partly because of the availability of skilled people,” says Chum Darvall, Deutsche Bank’s chief executive for Australia and New Zealand.

He dismisses fears that India will deprive Australia of IT work, saying the two countries can be complementary and that Australia can retain high-end, high-skill jobs.

Germany

Outsourcing in Germany has long been in the shadow of its European rivals, lagging behind France and in particular the UK for a long time, writes Richard Milne. But after a slow start consultants say it is catching up. The total German market - for non-captive outsourcing, including both domestic and offshore work - was worth more than €9bn in revenues last year, according to Pierre Audoin Consultants (PAC).

The country’s most emblematic deal was Deutsche Bank’s decision in 2002 to outsource a large part of its European IT operations to IBM in a contract worth about $2.5bn over its 10-year lifespan. It was the biggest contract involving a German company and led many to suggest optimistically that others in the finance industry could follow suit. But German banks and insurers have for the most part been cautious.

Leading the way has been the backbone of the German economy - its manufacturing companies. “Until last year 50 per cent of outsourcing was in manufacturing industry,” says Christophe Chalons, managing director of PAC Germany. “Manufacturing industry is very export-oriented so it is very competitive.”

Many companies such as DaimlerChrysler, the carmaker, went so far as to create IT subsidiaries before selling them off - in its case to T Systems, the market leader in Germany and the IT services business of Deutsche Telekom. But recently other companies have found offloading their IT subsidiaries more tricky, with retailer KarstadtQuelle taking longer than expected to sell its business earlier this year to France’s Atos Origin.

Foreign companies, apart from IBM, have found it relatively tough to break into the German market, with many privately citing the country’s restrictive labour laws as a significant drag on deals. Mr Chalons agrees: “There is not the same flexibility of employment laws. When you take over a lot of people in an outsourcing deal you have to make some people redundant but in Germany that is not so easy.” Nonetheless, analysts at Gartner believe deals such as T Systems’ contract with Deutsche Post in September show the country offers good growth opportunities to both domestic and foreign companies.

Still the focus in Germany is much more on IT outsourcing than on back-office. Although there is some evidence of a recent pick-up in BPO outsourcing in Germany, most consultants say companies remain cautious. Businesses are also more wary of offshore outsourcing than their UK and US competitors and when they do adopt this approach the destination is more likely to be eastern Europe rather than India for both geographic and cultural reasons. Recently German companies have brandished the threat of moving not just call centres abroad but whole factories and production lines to counter high wage costs and poor labour flexibility.

And the driver that is the public sector in many countries has been largely lacking in Germany. The most significant deal, involving the armed forces, was postponed earlier this year after the government put its first bidder under pressure over pricing. The breakdown of talks was symbolic for the sector as a whole, consultants say - companies and governments increasingly are seeking to lower prices as far as possible.

Italy

Outsourcing in general in Italy is growing. However, as in Germany, the movement of service job functions outside the country is still very rare, writes Adrian Michaels.

Gianfranco Casati, managing partner at Accenture for a region comprising Italy, Greece and emerging markets in eastern Europe and the Gulf, says the consultancy has signed two of the largest business process outsourcing contracts, one with Telecom Italia at the end of 2002 and one with La Rinascente, the retailer, in June 2003. They both involve more than 400 people, but not the relocation of jobs outside Italy. Mr Casati says Accenture would have to consult La Rinascente before pushing through a large structural change.

Italy has for a while however seen manufacturing move outside its borders, in particular to eastern Europe and China. In some cases it is extra manufacturing, in other words initiatives that do not lead to job cuts in Italy. In other cases, there are cuts, but they are driven by imperatives that are perceived to be larger than the optional savings realised from relocating call centres - such as a desire to keep businesses alive at all.

Andrea Samaja, a partner at PwC, the professional services firm, says that the high cost to Italian business of shutting down domestic jobs is a major deterrent of outsourcing outside the country. “Your organisation cannot be easily restructured in Italy due to local labour legislation,” he says, “Companies are required to make huge investments to cut local jobs.”

Since the main driver for international outsourcing is the ability to save money, Mr Samaja says it is far less attractive for Italian companies.

Mr Casati also points to the different economic structure of Italy, with its mass of small- and medium-sized companies. It has surprisingly few large companies for whom the incentive to move jobs outside the country would be large enough. “Outsourcing is about critical mass. The number of potential targets is less than you would normally expect from a country that is part of the G8.”

Mr Casati says there are cultural issues too. “There is no real appetite for offshoring of functions. Companies are concerned about the social implications and union reaction….and it’s not necessarily true that you can find plenty of Italian language skills in Bratislava.”

Mr Samaja adds: “Outsourcing information is not an easy task - Italian managements are often reluctant to share ownership of data.”

Nordic countries

The use of offshore services is still limited in the Nordic region, but local IT services vendors are taking the first steps towards offshore outsourcing, establishing their own offshore services operations or using subcontractors and partners, writes Rupini Bergstrom. At the same time, low-cost countries are playing an increasingly important role in the delivery of IT services in the Nordics.

“Offshoring is becoming an integral part of delivering services from low-cost regions and a means for offshore players from a variety of regions to build market presence in the major ‘onshore’ IT and business services markets such as the Nordic countries. With the ongoing need for customers to reduce costs, coupled with the proven capabilities of offshore players, IDC foresees considerable market opportunities for these players in the onshore markets and for local players looking to leverage offshoring as part of their service delivery capabilities,” says Esa Peltonen, IDC research manager.

Aside from Nordea, the largest bank in the Nordics, which outsourced its IT operations to IBM, it is almost exclusively telecommunications companies such as Ericsson, TeleDanmark (TDC) and TeliaSonera which have outsourced IT services offshore. Metso, a Finnish maker of forestry machinery has also outsourced IT operations out of Finland.

“Having started on a project basis with things such as customer application development, some are so satisfied that they’re broadening into application management,” Mr Peltonen says.

Indian companies definitely seem to be the preferred alternative. This is mainly because these companies are larger and have access to more resources in terms of staffing than, for example, Baltic countries such as Estonia where only 100 or so workers would be employed at any given time. Indian companies are also regarded as having a better knowledge of business processes.

In Estonia, where people speak relatively good Finnish, some companies have outsourced their IT helpdesk functions. On the whole, however, the trend seems to be for Nordic companies to acquire Baltic companies to get a customer base there and probably will only in the future use the Baltics as a base through which they can service the Nordic region.

Trade unions, meanwhile, have not been outspoken on the issue because offshore outsourcing so far is relatively limited.

Aside from Sweden and Denmark, which have very large listed companies, the Nordic region is made up of mainly medium-sized and small companies. Large end-user companies are best suited to dealing with offshore vendors because they have the resources and knowledge to work globally with all types of companies. However, in the SME sector there is demand for local representatives that take a project manager role and deal with the offshore service providers. However, it seems that the biggest offshore vendors are also hiring locals who speak the local language to deal with customers.

At present, offshore services providers such as India’s Tata Consultancy Services, Wipro, and Infosys will have only a moderate effect on the IT services industry in the Nordic region, with Nordic organisations’ spending with such companies accounting for only about 0.6 per cent of the total Nordic IT services market in 2004.

But demand will increase, says Mr Peltonen. “Companies are constantly looking for ways to cut costs and they are all involved in global businesses where there is increasing competition. In the Nordics, English language skills are good so offshoring is a fertile landscape in which to grow and it is easier for Indian companies to work here than, for example, southern Europe.”

Low-cost countries will increasingly have an impact on the delivery of IT services in the Nordics, though clients are much more likely to use intermediaries - IT services providers such as Accenture, IBM, Capgemini, and TietoEnator - than work directly with offshore service providers. Some Nordic organisations, particularly in telecoms services, have already established their own operations in India, eastern Europe and Russia.

“With all the discussion about China and India and globalisation, governments are starting to understand that they cannot intervene and set up protectionist barriers,” says Peltonen, “They have to find other means through which to improve the labour market and the economy. And, though trades unions will probably make some noise, I don’t think they have the power really to affect offshoring trends.”

Spain

Among Spanish companies, foreign-based customer services centres are rare, though many experts argue that rising business costs in the country are making Latin America look increasingly attractive, writes Mark Mulligan. In the broader context countries such as Chile, with a highly qualified workforce and sophisticated telecommunications system, have already become important satellite services centres for the large Spanish banks and utilities with heavy investments throughout the region.

With the explosion in immigration from Latin America and countries such as Romania, the Spanish ear has become accustomed to non-Castilian accents, clearing the way for broader social acceptance of dealing with customer service operators from other countries. For now, however, a consumer living in Spain will normally speak to a fellow resident when calling with an inquiry, order or booking.

One exception is Telefónica, the largest telecoms group, which has outsourced a lot of its customer service and marketing business to Atento, a 90 per cent-controlled spin-off with an important call centre in Morocco, across the Straits of Gibraltar. Although French is Morocco’s second language, textbook Spanish is spoken by a growing group of university graduates. Atento, which also operates in Latin America, has built a list of 400 clients in 12 countries since its inception in 2000.

Meanwhile, recent studies in Spain show a developing trend among mid-sized and large companies to outsource - or out-task - at least one non-core operation. Gartner Group puts growth in the outsourcing market at 19 per cent in the last two years, while IBM Business Consulting reckons that about 80 per cent of Spanish companies outsource one or more departments. For example, specialist companies are often contracted to manage payroll and human resources. According to IDC, Spain in 2002 accounted for 1 per cent of an estimated €8bn in global sales in this business. A study this year by one consultancy group suggests that about 30 per cent of Spanish companies outsource human resources tasks.

Like most other countries, IT development and maintenance and date storage are increasingly outsourced. Here, IBM and HP lead the market in Spain, although local companies are springing up in key business centres such as Madrid and Barcelona. Broad resistance by trades unions has been minimal. However, according to José Ramón Pin, head of studies at the IESE Business School in Madrid, employees who are “spun off” into outsourcing companies are resisting dramatic changes to working contracts.

“If you start a company from scratch to deal with, for example, payrolls, then there is no problem,” he says. “However, if an existing company turns its payroll department into a separate entity, then unions covering that specific operation tend to resist changes that they expect to constitute a less stable working environment.”

Switzerland

Switzerland is one of the less likely European countries to be affected by outsourcing, writes Haig Simonian. English may be widely spoken, but the country’s trio of national languages (German, French and Italian) limits the potential to shift service functions to locations such as India. Guttural Swiss-German is so unlike its notional mother language that even moving jobs to Germany would be difficult.

The scope for outsourcing is further restricted in financial services, which in Switzerland account for an unusually high 13 per cent of gross domestic product.

The rich foreigners attracted to Swiss offshore banking, for example, would not appreciate talking to a voice on the other side of the world for telephone inquiries. Switzerland’s legendary banking secrecy also imposes legal limits on client sensitive information that can be handled abroad.

While the banks have, accordingly, been reluctant to pursue offshore outsourcing, apart from limited software writing in India, the decentralised nature of many big industrial companies has been a further disincentive.

Nestlé, the world’s biggest foods group, has traditionally left power and decision making with national operating companies, greatly limiting headquarters scope for centralised savings through outsourcing.

But even Switzerland is aware of the pressures for change, admits Rudolf Ramsauer, chief executive of the Economiesuisse ((SIC)) employers’ federation. “It’s a huge theme. We’ve been used to losing industrial jobs for years. The real question is, what’s going to happen to services?” he asks. “I think it will happen more and more, and for very simple reasons: cost,” he says.

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