Can Obama turn the USA into a competitive sourcing location?

Manhole-laBeing ineligible to vote in this country, I’ve been an amused observer of one of the the most enthralling and contentious elections in years - and trying to understand how each candidate will impact the future of the global outsourcing industry.

What is clear, is that shipping jobs offshore isn’t necessary very good for the local unemployment rate – the age-old argument of focusing US staff on “higher-value” work is wearing a bit thin these days.  What’s more, many offshore service providers are now focused on taking on more higher-value work activities for their clients, in addition to routine transactional work. For example, once you have your general ledger run from a service provider in, say Chennai, what is now stopping that provider taking on higher-value accounting services, such as budgeting/forecasting and business intelligence?  That provider basically owns and understands much of the revenue cycle of that client, hence the natural next step is to move up the process value chain. And if your current provider won’t move up the value-chain, there is a proliferation of KPO providers willing and ready to take on higher-value offshore work.  Moreover, while a firm may have been enjoying good quality COBOL programming from Brazil, what’s stopping that provider offering systems architecture work for their client, which is among the costliest onshore IT services?

We’ve now been sucked into a global employment war for sourcing services, and from what I was hearing from Mr Obama today, he intends to give US firms tax-breaks to source work onshore.  I’m not sure exactly how he plans to do this (he seems to have a lot of good intentions without getting specific on how he plans to execute), but it wouldn’t surprise me if he plans to initially incent buyers, as opposed to the providers, to source work to onshore US locations.  This is the opposite strategy of the Indian government’s STPI tax scheme, which gives tax-breaks to new Indian organizations (mainly suppliers) in the region of 10-20% for their first 10 years of inception, designed primarily to bolster its software industry, but also directly applies to its service providers.

Look at it this way, you can hire staff in low-cost US locations for a low as $25K a year for back-office administrative work.  If you can reduce that further, to $22K a year as a result of tax incentives, and the cost of health-care is reduced/subsidized, the price differential with locations such as Lat-am and India is minimal.  IT, on the other hand, is significantly cheaper in locations such as India and China for all levels of services.

Here’s my take:

For BPO services, the US is still in the game.  The issues surrounding client / employee contact still favor onshore services (even though offshore services are improving by the day), plus the fact that there is still a great supply of mid-level executives who will be anxious to keep their jobs in the forthcoming months.  With significant incentives to keep work onshore, I can see the US stepping up as a serious BPO location.  Not a bad thing for the BPO industry, as long as the service providers invest wisely in attaining the right onshore/offshore balance within their delivery infrastructures.  Moreover, the onus on sourcing we’re going to see from the restructuring financial services industry is going to entail a delicate balance of onshore/offshore BPO work.  If the major financial services firms struggle to sell off their Indian captives, we may well see several of them scale-down their offshore dependence and seek onshore services as an alternative.

For IT services, it’s looking a bit late to pull much of this back.  In India, for example, IT services have become the life-blood of the country’s economy, and the skills in basic programming are widely available for mainstream applications.  Even if US wage rates for programming work come down significantly, there is also a major issue with the fact that the quality of many IT services delivered from offshore locations is now consistent.  The core battle is with services needed from business-process architects and staff with deep industry-specific expertise.  We have seen many of the leading offshore providers invest in their onshore deliver centers over the last year – and we can expect to see continued significant competition between the incumbents and offshore providers in the coming months for onshore-related work.

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10 Comments

  1. Robert Jakobson
    Posted October 13, 2008 at 7:01 pm | Permalink

    Phil,

    I know that the common view is that the horse has left the gate on pulling IT back to America but I would say that’s largely supported by a misunderstanding of who really is charge on IT purchasing and what their motivations are.

    I just got off the phone with someone who informed me that, in certain locations, a major US service provider has actually gone to bringing overseas help here to the USA, paying them around $6.50 an hour plus housing, etc., to bring IT workers here to the USA at an “affordable” wage. (And yes I’m trying to verify this report with someone else so – take that as you will, but it’s not the first time I’ve heard this story.)

    So there is still “business” here in the states, which implies that the customers are here. It’s scary that you can essentially bring over labor – provide them room and board and it’s economical – but not all that shocking.

    If the issue were simply one of can we bring IT back to America I’d say certainly. It definitely can, and should, be done if possible. And I don’t say this in a protectionist mode of thought. I say this from the view that there is a big enough economy for IT globally that we can, and should be competing. What is killing us is that firms – and I chose IBM as a whipping goat for this for good reason – choose to use the purchase power of overseas IT staff to drive foreign economics initiatives of their own.

    This is in some cases coming back to haunt them. Look at the recent Unionizing in places like China and the former Soviet States with IBM and other companies. As the costs to get the cheap labor go up – we’ll see more and more businesses re-think or re-evaluate their strategies. Where opening plants in countries before was done to accomodate labor needs its in some cases becoming necessary to do business.

    When a business decision isn’t driving a cost this is a bad thing. So – there’s opportunities on multiple fronts to reclaim at least some of the IT business share we’ve lost.

    Now can Obama do this? No. It can’t be done by a man, or even by the government to any successful or meaningful level because neither of those two groups do our corporate leaders respond to. Can you make it more cost effective? Sure and that helps – it helps a lot. But the end of the day it comes down to can you make it a long term growth strategy for that business. I’ve seen the bits and peices of such plans from the Obama camp but we’ll need to see how much and how many of those peices actually get put into play after our other elected officials (often lobbied heavily by both corporate and overseas concerns) have their say on it.

    I don’t see him harming the American IT situation, in fact it will certainly help but can they turn the tide? That’s going to require that enough pressure be kept on those (both corporate and elected) — and it requires as much encentive as punitive efforts.

    Robert

  2. Posted October 13, 2008 at 8:41 pm | Permalink

    The time zone shift is an important consideration for many, and in the area of customer service it is still very comforting to hear what might be identified as an American accent.

    What I am hoping Senator Obama is referring to is in applying methods that would enable cost efficiencies that would be very competitive with doing the same work offshore. I have created an initiative that would significantly change the way people work in the US. Implementation of the initiative would not only open many now untapped markets in the US but also make use of current markets much more cost efficient. I am hoping that as the new Administration looks to reduce the US dependence on foreign energy sources it will also look at various methods of reducing demand for energy.

    For more information on my initiative take a look at the links below.

    Links:
    http://www.caro.cc/download/communitycommercecenters-digest.pdf
    http://www.caro.cc/download/communitycommercecenters-2col.pdf
    http://www.caro.cc/download/communitycommercecenters.pdf

  3. Posted October 13, 2008 at 8:43 pm | Permalink

    It would make sense to do so, but it seems to contradict his whole message about tax cuts and who should get them. he seeks economic justice by taxing the wealthy, even though tax revenues would go down as a result, all in the name of fairness. To do what you would suggest sounds like a good idea, makes sense, but seems to contradict the concept of fairness, from what I have heard him say. I guess targeted tax cuts for the “rich” is ok and fair, depending on your perspective of fair.

    Michael Gardner

  4. Posted October 14, 2008 at 6:18 am | Permalink

    Can Obama (or anybody else, for that matter) change offshoring trend dramatically? Probably yes, to a limited extent, but offshoring bubble is already deflating anyway, as the results are far from what was expected.

    Just a limited perspective, from an aerospace/defense point of view:

    The immediate future does not look good in aerospace offshoring/ outsourcing, except for some limited manufacturing opportunities.

    Most of the big players in aerospace /defense reached an “end of the cycle” moment of truth, after years of investing in outsource/ offshore expansion. So, as I said, after years of investing in development projects start up, infrastructure, and development, the end results are dismal. Most of the companies have seen the overall costs going up (quite fast, in line with the outsourcing hype) but the net present value is still in the negative territory. On top, the bad US economy, plus the subsequent cash crunch, contract / delivery cancellations, delivery slowdown etc. do not help much either.

    The original concept / model (as originally emerged some 10-15 years ago) was to invest gradually, for long term, to allow know-how and resources to build up and reach the critical mass, after which companies would collect the benefits (low costs, high NPV/IRR or low payback period, etc,etc). It did not happened yet, at least not with some high visibility projects (I won’t give any specific references, for the obvious reasons).

    Though most of the big players are keeping a “straight face”, saying that the aerospace outsourcing works well and dandy (specifically aerospace product design and development), in real terms, the results are quite less than positive, financially speaking. I would compare with (as a joke) with the real estate market / mortgage pre-crash time, when almost everybody was saying that things are going well except for some glitches, just weeks and days before crumbling.

    There are a lot of reasons for the lack of (overall) positive output: cultural differences, high complexity, communication barriers, technology gap and understanding, lack of international management experience, business differences, local dynamic work force, local steady and rapid cost increases, bureaucracy artificial barriers, local corruption etc, etc, etc.

    On the positive side, as positive output, I would mention: exploring (and learning) the limits and capability of offshoring / outsourcing, building up connections with the local players in the industry, acquiring international management expertise, building up brand presence, etc, etc , though they may not bring immediate positive financial outcome.

    George Rotaru

  5. Victor Jensch
    Posted October 14, 2008 at 6:35 am | Permalink

    Hello Phil,

    I cannot see how Obama can make the tax breaks large enough to off-set the cost advantages of sourcing services from overseas.

    There is no question that US on-shore service is excellent, especially since service providers have the in-house knowledge of US culture. Off-shore service providers still have a long way to go to match this, and I doubt whether they ever will.

    However, price competitiveness is the key factor here. Can US on-shore providers compete successfully on price, taking into account government subsidies? If Obama implements tax breaks, off-shore providers will compensate with even lower prices. They have an abundance of cheap labour, and they are hungry – hungry to learn and to better themselves. They cannot afford to lose the US market.

    I do not believe the US can come back and turn the service sector around, unless Obama takes a dual on-shore approach: tax breaks AND “let’s be American, and support America.” Turning pride for one’s home country for the betterment of the nation is possibly a more powerful tool than monetary values alone.

    I consider the service-related-product industries to be different to service only industries. Here Obama may have the clout to successfuly implement tax breaks, if he also implements greater duties and quotas. Volume restrictions coupled with increased off-shore products, and faster local order-to-payment cycles has the potential to be successful in a relatively short period of time.

    Targeting markets, and offering fixed capital incentives will also attract on-shore growth. Combine these, and add in the patriotiism angle, and there should be a strong movement towards on-shore recovery.

    The question arising out of the implementation of one or various of these policies, is, how will it/they influence international trade agreements in the short, medium and long term? Should the US be looking after itself first before trying to look after the world’s problems?

    In-flight instructions in the case of decompression, state, “First put your own oxygen mask on, before putting masks on your dependents.” Why? If you black-out without oxygen, there is every likelihood that you will not have saved your dependents. The result would be the demise of your whole family.

    Is the USA not in the same boat?

    Victor

  6. Posted October 14, 2008 at 6:38 am | Permalink

    Others have made good points, so let me just add this: competitiveness of a services sourcing location is primarily driven by cost and quality of talent. Sure – there are dozens of other factors – such as real estate, tax, political risk etc. However, their impact is small compared to these two factors.

    So the question really becomes: can a president make a significant change in the cost or quality of American talent in a 4-year term? That will give you the answer you’re looking for.

    Avneet Jolly

  7. Senthil
    Posted October 14, 2008 at 7:54 am | Permalink

    Phil,

    I do agree that the wage inflation in India has touched roofs in the past 3 years. But still for $22K we can recruit much better tech savvy resources in India than in US. The offshore cost arbitrage still exists and I doubt that the same will go away in near future at least for the next 3 – 5 Years.

    Senthil.

  8. Posted October 14, 2008 at 8:01 am | Permalink

    Senthil,

    I am talking about BPO staff for $22K (in lowest cost US locations, with a tax break, and not including health benefits) – certainly NOT IT staff. IT developers in the US cost a lot lot more than that (try 4x), which is why bringing back IT programming work is a tall order for the US government,

    Phil

  9. Siddhartha
    Posted October 14, 2008 at 12:15 pm | Permalink

    If we try to make inferences on detailed policy positions beyond Sen. Obama’s cry against ‘giving tax breaks to those shipping jobs outside’ then it seems to be around three broad areas and none of them include very large IT or BPO play:

    1. Small businesses – It was focus of yesterday’s speech on ‘J-O-B-S’ as this is the segment which creates most American jobs. This is where Sen. Obama has been most vulnerable with Republicans saying that his tax increase in above 250K bracket will impact small businesses (his much publicised exchange with the Ohio voter who in his door-to-door campaign questioned him on the same issue couple of days back). This is also a sector where least no. of jobs can be outsourced anyway.

    2. Manufacturing specially Auto – Not only is (or rather was till Sen. McCain pulled out) Michigan a competitive state for Presidential elections, but Democrats in Congress had also been stressing on the bailout for the Auto sector when the Wall Street bailout was being discussed. Some of Government support may be tied to ‘creating American jobs’ but most of it, if any, will have impact on manufacturing outsourcing rather than Services

    3. Green Jobs – His positions sounds a bit like Tom Friedman’s ET revolution but this is more vision than policy.

    While there is standard Democrat rhetoric about ‘building roads and bridges to create jobs’, it is difficult to see how eitherof the three mentioned above or Infrastrcuture spending would work against outsourcing in a big way. Sen. Obama has talked about withdrawing tax breaks from those who ship jobs outside but those who understand American tax codes better would need to enlighten me on which sectors are the ones that ‘outsource a lot and enjoy significant tax breaks as well’ (unfortunately my understanding of politics is much better than that of taxation!)

  10. Charles Ziegler
    Posted October 14, 2008 at 1:53 pm | Permalink

    Hi Phil,

    I agree with everything you said except for one – I do not believe that the United States is a viable BPO location. First, you have Canada to the north with an equality educated and employable labor pool at a lower cost combined with lower infrastructure and operating costs. Ten years ago, it’s what made Canada the Near Shore solution, and I expect that trend will continue.

    Senator Obama’s tax break is a bit like spitting into the ocean. Feels good, but makes no difference. You have to look at the total cost. Labor, infrastructure, operating, costs and taxes. The U. S. has priced itself out of the market compared to APAC. However, maybe President Obama/McCann can fix all of that. He can lower wages across the country. He can convince the individual states to lower their taxes along with the federal taxes. He can convince companies to drop the price of their goods and services – he does all of that and he still can’t make it work.

    Why? The aging of the work force. The United States is staring down the barrel of a labor shortage of unprecedented proportions. Young people, who make up the bulk of BPO employees, only work in a contact center until they have the ability to move into a better, higher paying job. Many companies in the BPO sector still refuse to recognize the dwindling labor pool. They have no plans in place to higher older workers. And they don’t need plans as long as they can dump their centers overseas, where the work force is young, educated and without many other prospects.

    So unless the U. S. opens its doors to a flood of young, English speaking, educated workers, competitiveness is out the door. The same holds true to Canada by the way, so ultimately the question may not be can the U.S. be competitive, but will American’s accept 90+% of their BPO handled offshore.

    Maybe we should ask Bill Gates’ opinion on that.

    Charles

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