Macro economic issues of offshore outsourcing

Index

Figures

Glossary of Acronyms

Summary

1. Conceptual introduction
1.1 Outsourcing
1.2 Outsourcing in offshore markets
1.3 IT outsourcing

2. Reasons for offshore outsourcing
2.1 Advantages of offshore outsourcing
2.2 Facts of some developing countries
India
Vietnam
Russia
China
Middle and East European countries
2.3 Excellence or inferiority of the offshoring services

3. Problems with offshore outsourcing
3.1 Risks and problems of outsourcing
3.2 Problems in developing countries
3.3 Barriers between western and developing countries

4. Consequences for western countries
4.1 Current and future IT outsourcing trends
4.2 Consequences for the western IT branch
4.3 Consequences for the national economy of Germany
4.4 Development of unemployment in western countries
4.5 Crossover of the offshoring trend towards other economic areas

5. Possible solutions
5.1 Creation of new jobs
5.2 Adjusting screw of macroeconomic parameters
5.3 Future of offshore outsourcing

6. Conclusion

Bibliography

Figures

Fig. 1 Offshore Outsourcing Project Types

Fig. 2 Cost reduction is considered the main benefit from offshoring

Fig. 3 IT outsourcing markets in Germany and Europe

Fig. 4 The international hunting line

Fig. 5 Seasonally adjusted gainful employment and unemployment in Germany

Glossary of Acronyms

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Summary

Topic of this paper are the macro economic issues of offshore outsourcing.

First inland and offshore outsourcing are described, especially focused on IT outsourcing.

Then reasons for IT offshore outsourcing are illustrated. Popular offshore markets are introduced and the advantages are shown.

In the next chapter, problems and risks of offshore outsourcing are explained. Both the more general view and IT specific problems and risks are described. Here general problems as well as problems of IT outsourcing are mentioned.

Then consequences of the offshoring trend are illustrated. Apart from consequences for IT branch, especially consequences for national economies of western countries, e.g. Germany, are viewed in detail. There can be short term and long term consequences. Future offshore outsourcing trends help to understand the effects. The development of unemployment caused by offshoring is one main focus.

Furthermore offshoring trends in other white collar work besides IT are shortly described.

At the end this the paper develops an idea about possible solutions for western countries. Potential reactions of the government and suggestions on how to create new jobs are presented in detail.

The paper finally ends with a small conclusion.

1. Conceptual introduction

1.1 Outsourcing

Outsourcing is an invented word of “outside”, “resource” and “using” and means the long term branching out of previously self done services to an external vendor (Allweyer, T., Besthorn, T. and Schaaf, J., 2004). This vendor will do the work for the company. “Classical” outsourcing takes place in the same country. In this case, the vendor often takes over employees of the outsourced section.

In former times outsourcing has taken place only in areas like canteen, supply and security, in the last 15 years outsourcing became popular in all major sections of a company like production, R&D, financial services, telecommunication and IT.

Outsourcing is done to realize saving potentials, to transfer fix costs into variable ones, to get a higher service level and to free resources and focus on core competencies and strategic goals (Pohl, A. and Onken, B. R., 2003). More details will follow.

Apart from to complete outsourcing, there are other ways of outsourcing.

“Outtasking” or “selective outsourcing” is the assigning of single and middle term oriented tasks to an external vendor.

“Multisourcing” or “multi-vendor-outsourcing” is a complete outsourcing not to a single vendor, but different tasks to different vendors (Söbbing, T., 2002).

Outtasking and multisourcing are not the main focus of this paper, therefore they will not be discussed in detail.

1.2 Outsourcing in offshore markets

When outsourcing doesn’t take place with a vendor within the home country of the company, but with a vendor from a different country, outsourcing is called “offshore outsourcing”, “offshoring” or “international outsourcing”.

Popular offshore markets are in developing countries (DCs) like India, China, Vietnam and in Middle and East European Countries (MEECs). In these countries more and more vendors appear on the scene.

Opposite to inland outsourcing, tit is very unusual for the vendor to take over employees from the outsourcing company.

1.3 IT outsourcing

At IT outsourcing, own responsibilities of the IT department are given to an external vendor. The service level can reach from only advice to individual implementation and maintenance of hard- and software (Bräutigam, P., 2004) up to outsourcing of the complete IT department. Several services are often bundled in one outsourcing deal.

As Fig. 1 shows, most popular is outsourcing of programming individual software, but other tasks are gaining more popularity.

IT outsourcing is often connected to the use of newest technologies and processes by the vendor, which have not been used before by a company. This issue will be discussed in detail later.

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2. Reasons for offshore outsourcing

2.1 Advantages of offshore outsourcing

Obviously the most important reason for companies to outsource is to save money. Wages for IT personnel in DCs are much lower as in western countries. Experience shows, that cost reductions of 25 up to 45% can be achieved through outsourcing (Parikh, M., Saranjit, A., 2002).

In a study 75% of managers said “considerable”, when asked how big the cost advantage between Germany and MEECs is (Beyer, T. et. al, Fig. 8, 2004). But as Fig. 2 shows, the actual cost savings differ between the companies. Other expected benefits of offshoring, like better service quality, are mentioned here as well.

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Another point is the lack of high skilled personnel in western countries. Especially during the IT boom around 1997, in a number of countries within the EU, there where far to less IT people. The efforts of DCs to educate high qualified people now bears fruits and more and more DCs have very well trained IT personnel.

A further point is the possibility to adjust services or projects more flexible, depending on what the company needs. Also there is - especially contrary to Germany – more flexibility at daily and weekly working hours.

2.2 Facts of some developing countries

Looking at reasons and consequences of offshore outsourcing without analyzing the qualities of some popular offshoring countries is hardly possible. Therefore popular DCs are briefly described.

India

India is the most popular country for outsourcing. Also in daily press - especially in Germany - people can read about companies offshoring to India. Indian IT Specialists are in the view of German managers acknowledged, particularly since the federal government attracted these people to work in Germany with a work permit called “Green Card”.

Following the U.S. American trend, India has become a popular offshore country also for European companies.

The turnover in the Indian IT sector has increased exponentially in the last years, from 2 Billion US$ in 1994 to 12.2 Billion US$ in 2001 (Singh, N. 2002). There are about 2500 vendors. 63% of them are serving U.S. markets and 26% European markets (Singh, N. 2002). One big advantage of India is, that most people speak English fluently (Schramm, J., 2004).

Bill Gates said about the Indian IT sector: „Three years ago India was emerging as an IT superpower. Today the country is handling most sophisticated projects in the world [...]. I am impressed with the talent we have in our India development center and the quality of the software being developed“ (Pohl, A., Onken, B. R., 2003).

Vietnam

Vietnam, a socialist country in south east Asia, is one of the newer entrants in the IT offshoring business.

It has big industrial parks, where most of the IT companies reside (Chidamber, S.R., 2003).

Vietnam has reached a big economic growth in the last decade, 6.8% by 2001 (Statistisches Bundesamt, 2002), and its ICT Sector has gained a significant percentage of the economy growth (Chidamber, S.R., 2003).

Experts believe that the Vietnamese ICT sector has big growing potential and will play a increasing role for the economy (EU Counselors, 2003).

Russia

Russia is popular, because it has very good IT specialists. A world bank member said about the Russians: “Since the Russian education system continues to be heavily weighted towards math and science, Russian scientists are often considered the best in the world. Consequently, Russian IT companies present an attractive investment opportunity because these businesses can draw upon Russia’s large "intellectual resource" of world-class scientists and engineers” (Riabov, S., 2003).

Although the market, with about 4 billion US$ in 2002, is relatively small, it has a good growing potential. Especially the offshore centers in Moscow, St. Petersburg and Novosibirsk are well positioned in the market (Lekaeva, I., 2002).

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