Date: Sun, 16 Nov 2003 16:58:01 -0800 From: Norm Matloff To: Norm Matloff Subject: SF Chron--offshoring may not save much money To: age discrimination/H-1B/L-1 e-newsletter http://www.sfgate.com/cgi-bin/article.cgi?file=/chronicle/archive/2003/11/16/BUGTR32G6L1.DTL&type=business San Francisco Chronicle No smooth sailing for offshoring Moving IT work overseas can have unexpected costs John Shinal, Chronicle Staff Writer Sunday, November 16, 2003 _________________________________________________________________ U.S. companies sending information technology work overseas merely to cut salary costs may find their savings are either disappointing or short- lived. The reason is that the unexpected costs of moving IT jobs to India and China, including skyrocketing salaries, are changing the financial equation of offshoring just as U.S. executives are rushing to adopt the practice. Interviews with business consultants, corporate executives, market analysts, venture capitalists and others who have looked closely at the trend revealed that much of the conventional wisdom about moving IT work offshore is, well, off base. "Too many companies are viewing offshoring as a tactical decision," said Gregg Rock, president and founder of BrainStorm Group Inc., an offshore consulting firm in Boston. Rather than make offshoring decisions on a project-by-project basis, "the decision needs to be a strategic one," said Rock, whose firm has organized 12 conferences this year that connect U.S. companies with overseas IT firms. Although the savings in sending IT work abroad can be substantial, they are not as straightforward as comparing salaries in India and Silicon Valley. It is true that salaries for software developers in India are a fraction of those paid in Silicon Valley. For example, software developers in Bangalore, the hub of the Indian IT service industry, make an average annual salary of about $12,000, according to a recent report from the Tech Strategy Group, a Redwood City consultancy that advises companies on offshoring. Similar jobs pay about $80,000 in Seattle and Silicon Valley, the report said. Yet salary costs are only about 50 to 60 percent of the total cost of moving work to India. Other costs, such as travel and infrastructure expenses, severance packages for laid-off U.S. workers and the increased time required to manage multiple development sites, result in total savings that are less than half what many executives expect. "Most companies are seeing a 30 to 40 percent cost advantage," by sending work to India, said M.R. Rangaswami, co-founder of the Sand Hill Group, a San Francisco consultancy. That figure is in line with a recent report by the Gartner Group that pegged the savings at about 40 percent. In the meantime, the salary gap between Bangalore and Silicon Valley is narrowing quickly. Salaries for software developers and other IT service professionals are rising about 20 percent a year in Bangalore, said Rahul Sood, co-founder and managing partner of the Tech Strategy Group. Bangalore is experiencing the kind of job-hopping and salary inflation that took place at Silicon Valley's high-flying tech firms in the late 1990s, said Sood, who earned a computer degree and MBA in India and who travels there monthly. Workers who switch jobs are commanding salary increases as high as 25 percent, he said. Although that rate of increase will slow as work moves to other Indian cities like Hyderabad and Chennai, which also have tens of thousands of skilled IT workers, surging salaries will cancel out more of the cost benefits of offshoring. "The salary arbitrage game has a limited life span," said Sood. Given that the financial savings of offshoring, while real, are not always straightforward, the decision to send IT work overseas should be made only after a company has examined a number of key factors regarding its finances, technology, culture and management processes. Otherwise, companies may find themselves with software development offices that have salary expenses equivalent to their U.S. centers, plus all the expenses associated with maintaining a presence half a world away. Some companies are beginning to get savvier about the process, said BrainStorm's Rock. In the last six months, a growing number of small businesses at his group's conferences, as well as those who participate in BrainStorm's online forums at www.goinstitute.org, have formed project management offices to explore offshoring. Other firms are turning to large Indian IT service companies like Wipro and Infosys and, increasingly, to the offshore operations of large U.S. players such as EDS, IBM, Unisys and Hewlett-Packard. The reason: The money saved by offshoring makes the practice attractive to companies that need to use their IT resources more efficiently. Among software companies, more than 80 percent of those resources are being used to maintain existing applications, according to a report done by Sood and his partner, George Gilbert, former head of technology investment research at Credit Suisse First Boston. Such work includes code testing to prevent bugs in new releases and fixing bugs and security holes in existing versions. However, to compete in a global environment, companies need to divert some of those resources to product innovation. Spending 15 percent of revenue on product development, as the average software company does, is not enough to drive innovation. "You can't get it done within those constraints," said Sood, former leader of the North American software consulting group for McKinsey & Co. That reality is driving companies to send their IT work overseas, which in turn frees up money for new product research. Yet, like every other management strategy that becomes the flavor of the month, offshoring software development isn't appropriate for every company. Young companies or small ones whose application development processes aren't mature or well-defined may be inviting disaster by shipping such work overseas, where it will receive even less control. "Companies without a disciplined development process are not ready to go offshore," said Sood. Jeffrey Immelt, chairman and chief executive of General Electric Co., told an IBM forum in San Francisco last week that a worldwide strategy must be preceded by a rigorous evaluation of all of a company's management procedures. "You can't go global until you have standardized processes in place," said Immelt, noting that more than half of his company's employees are overseas. Apart from the financial and management considerations of offshoring work, technology companies also must ask another crucial question before deciding to go offshore: Should they send core product development overseas? In most cases, the answer will be no, said Roger McNamee, general partner with Integral Capital Partners, a Menlo Park venture firm. Apart from their concerns over the theft of intellectual property, executives simply won't cede control over the design and development of a product that is central to the company's future. "If the way you develop (software) is central to the value proposition of your company, you'll keep that close to home," said McNamee. That is especially true for development of consumer products, such as Apple Computer Corp.'s iPod digital music player, for which "the interface is the product," he said. Conversely, any software development that is not an integral part of a company's products can become a commodity service, which will always go to the lowest-cost region, McNamee said. These days, that means India and China. Yet people who think of those countries merely as inexpensive places for back-office work or call-center services underestimate the strategic potential of offshoring, according to another Silicon Valley venture capitalist. "Taiwan and China have some of the world's best designers of wireless chips and wireless software," said Jim Breyer, managing partner of Accel Partners in Palo Alto. "And India has extremely talented software developers and designers." Tapping that brainpower will be essential for firms to compete in global markets, Breyer said. Research done by his firm suggests that companies that don't offshore at least 25 percent of their software development will be at a competitive disadvantage within three to five years. Breyer said he is a strong believer in the benefits of offshoring, but he expects some companies will fumble the process badly. Those that establish an overseas presence by buying a foreign firm will have problems if they try to impose their corporate culture on a foreign workforce. "I expect we will see some disasters," he said. E-mail John Shinal at jshinal@sfchronicle.com. ©2003 San Francisco Chronicle