Outsourcing in the Software Development Industry
(initial draft working paper)
Satwiksai Seshasai and Amar Gupta
Massachusetts Institute of Technology
September 29, 2003
Abstract
Outsourcing of IT based services and allied services is receiving increasing attention
both at business and political levels. Some business executives believe that
outsourcing of these services can provide their companies with the major cost
benefits by allowing goods and services to be produced at the most economic prices
without the traditional barriers of national boundaries and corporate boundaries.
At the other extreme, trade unions and unemployed individuals blame many
economic woes to outsourcing. In some respects, the situation is similar to the one in
the seventies and early eighties when US automobile companies began to have some
of the automobile parts be produced in Mexico and other countries. Respected
visionaries at that time came to the conclusion that the imposition of new laws to
prevent manufacture of these parts would actually be detrimental, in the long-run,
to US companies and US economy. This paper attempts to analyze the impact of
outsourcing on various constituencies in the US and abroad to see the overall impact
to each constituency with the objective of defining appropriate models that are
likely to offer the optimal benefits in the long run.
With a growing labor market abroad, and a challenging economic situation at
home, software firms both large and small are making the push to outsource development
to highly skilled engineers in less expensive labor markets abroad. In the services-sector,
Forrester Research estimates that over 3 million jobs, or 2 percent of all American jobs,
will move off-shore 1 . Forrester’s report predicts that 8 percent of computer related
positions can ultimately be transferred offshore within 12 years 2. The Merrill Lynch
report puts the IT consulting outsourcing market at $10 billion for 2002. At the Satyam
Computer Services’ global customer summit earlier this year, over 80 US firms indicated
that outsourcing has saved them 25 to 40% annually3. These numbers will only continue
to increase in the coming years, exposing a greater and greater need for software firms to
carefully understand and implement more efficient processes for outsourcing
development, and combat potential political forces which may not understand the full
benefit of outsourcing opportunities to our national economy.
While many software firms are exploiting the opportunity for outsourcing, there
are still many benefits to be derived from taking advantage of emerging communications
and infrastructure technologies. The difference in time zones between the United States
and many eastern nations provides the potential for around-the-clock concurrent
development of software, much like the multi-shift production model for manufacturing.
With software, there is a need to develop robust knowledge transfer mechanisms, for both
knowledge management on a daily basis, and to preserve an ongoing knowledge
repository for the project. Rich collaboration technologies must be developed and
exploited to provide the video, audio and instant messaging capabilities to properly
communicate between geographically and culturally separated teams. This effort would
involve an understanding of both the existing technology as well as the business needs,
and provide a strategy for efficient and results-driven collaborative development.
Improved development cycles would provide much more stable software at a much lower
cost, and allow the U.S. workforce to concentrate on design and development of features
rather than software maintenance.
Dr. Shailendra Palvia, co-founder of the Center for Global Outsourcing, has
pointed out that small and medium size companies are currently hesitant to enter the
outsourcing market, but once they do, the impact will be tremendous 4. A Forbes report
recognizes the many factors, which contribute to a particular country’s success in a
particular market: infrastructure, culture, language, education, and many others 5 .
Because of many of these factors, both the Forbes report, and a similar report done by
Merrill Lynch on the IT consulting industry conclude that India is the most preferred
destination for outsourcing 6 . The key is to educate the companies both on the
opportunities as well as the process, and develop an understanding of what is best done
offshore.
In addition to technology-driven process improvements, the cost structure for
outsourcing has significant potential for improvement. IT costs for collaboration, as well
as hardware costs, will rise tremendously as outsourcing becomes more and more popular.
Analysis is required to determine the true cost of outsourcing to determine the
circumstances under which outsourcing will be truly beneficial. In those cases which do
not meet the threshold for providing useful cost savings, deeper investigation has the
potential to reveal re-engineering methods which will save costs in the long run. One
such example would be using the same hardware across borders for testing, exploiting the
time zone differences. Of course, there would be bandwidth and cost implications for
this, and thus investigation is required to understand the structure of this environment.
The push across all software firms is to do more with less, and an analysis of potential
improvements in the use of IT and hardware resources will help accomplish this goal.
Evidence already exists that the government is paying attention to the issue of
outsourcing, but policies have yet to mature enough to incorporate the benefits of
outsourcing. Instead, political pressure has led policies to encourage barriers to
outsourcing. States such as Maryland and New Jersey are considering laws which would
prevent the outsourcing of government IT jobs to abroad, and also require call center
employees to identify themselves by their real name and the location they are based in
(thereby discouraging outsourcing of technical support). Much of the legislation
currently being proposed seeks to use the power of government contracts to curb
outsourcing. In Michigan, the law proposed is to limit state contracts from firms which
hire foreign employees to ensure that “scarce state dollars are invested at home”
according to the representative who proposed the bill7. Many other bills being proposed
across the nation use the government’s authority in granting H1-B and L1 visas to combat
companies who replace American jobs with offshore workers8. Most of these pieces of
legislation are in the nascent stages, and have yet to take into account the full impact on
the taxpayers.
These policies seem to fail to consider the long-term impact of such decisions on
citizens. For example, keeping IT jobs in the United States will undoubtedly be more
expensive, and these costs ultimately will be transferred to the taxpayers. With most U.S.
states struggling with their budget this year, fiscal considerations should lead states to
consider the positive benefits of outsourcing, just as the private sector has done in the
past few years. A McKinsey Global Institute report estimates that of the approximately
$1.45-$1.47 of value derived from every dollar spent offshore, U.S. firms receive $1.12$1.14, while foreign firms receive only 33 cents of the value9. Another McKinsey report
cites that if income taxes paid by H1-B visa holders, and software and service imports by
India are considered, outsourcing has an aggregate benefit to the U.S. economy of $16.8
billion10. Another factor to be considered is that the average age of the U.S. working
population is declining, and in coming years US Census figures indicate that the U.S. will
require an additional 15.6 million workers to maintain the current working population in
201511. Policy analysis is required on this front to model the impact of outsourcing as it
relates to the public sector, and provide guidelines to drive local, state and federal
governments’ decisions around outsourcing.
The issues discussed above contain many similarities to those faced by the
automotive industry years ago, as it undertook the outsourcing of many jobs to countries
such as Mexico. At the time, many felt that too many U.S. jobs were being sent off-shore,
and the impact to the U.S. economy would certainly be negative. Leading research of the
time, such as that of Lester Thurow, suggested that competition required the United
States to outsource manufacturing or risk losing in the global market to other countries
that could produce cars cheaper and better. The long-term benefits of maintaining a
model where design and prototyping was maintained as a core competency of U.S.
engineers, while production was outsourced to cheaper labor markets were proposed and
then demonstrated in the years that followed. The software industry is in a similar stage,
with the push to outsource growing while the pressure to maintain U.S. jobs in the shortterm mounting.
The resources at M.I.T. provide fertile ground to carry out the essential research
required to facilitate and improve the outsourcing process in the software industry.
M.I.T.’s Productivity from Information Technology (PROFIT) Initiative at the Sloan
School of Management has experience in developing knowledge based systems which
model complex tasks such as collaborative engineering. Graduate students in the M.I.T.
Technology and Policy program have a deep interest in multi-stakeholder
interdisciplinary issues such as this. Research centers such as the Center for
Coordination Science and Industrial Performance Center are also interested in related
research. The opportunity exists in this area to provide significant value both to
companies abroad looking to gain outsourcing contracts, as well as software firms in the
United States looking to maximize their investment in outsourcing.
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2
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3
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4
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1
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7
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8
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9
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10
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11
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5
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