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Offshoring Is Dead: How to Thrive in the New World Order

Posted by Andy Singleton on Tue, Oct 09, 2007
  
  
The practice of “offshoring” - hiring people from countries with low wages to replace high-cost Americans – is sputtering to an end. The dollar is at record lows, and offshore economies are booming. The Internet and global economic growth have equalized wages for top software talent. Surprisingly, this has happened because offshore workers are getting richer, rather than Americans getting poorer. The transition has big implications for our economy, and for our business strategies. Low cost cannot be achieved just by selecting the right country to open an office. We have to get smarter about running truly global teams. The business opportunities no longer come from cost cutting, but from a surge in demand worldwide.

WHAT HAPPENED?

For Americans, the golden era of software offshoring lasted from about 1995 to 2005. This was the time right after the fall of the iron curtain when the dollar was strong, and post-socialist and post-communist countries endured low wages. You could hire a well-trained engineer in Russia, Ukraine, or India for about $8 per hour, fully loaded cost, as compared with $50/hour for an equivalent American. That wasn't just a marginal cost advantage. It was a big, big, 6 to 1 advantage that allowed companies to do things that would not have been possible otherwise, and fueled rapid growth in outsourcing (a code word for offshoring).

Things are very different in 2007. My supplier in St. Petersburg, Russia, reported that his labor costs are up 200% in the past two years. Talented Indians, the good guys, cost as much as Americans. When you consider that the turnover in India is much higher, and turnover costs money, Iowa beats India. As India and Russia inflated in the last four years, Ukraine became the low-cost supplier of development talent. Now, top Ukrainian developers have figured out how to charge world rates, which are about triple what they were getting from the body shops two years ago.

So, what happened in these cases? Russia's oil-fueled economic boom has driven up costs. India, once considered a bottomless well of raw talent, has had such success building an outsourcing business (and failure in providing good education to the rural poor), that it created a shortage of engineers. The Chinese economy has been growing so fast that engineers are not available for offshore work. When the pollution cleared out of the skies over Ukraine, it turned out to be a green and pleasant land, with a budding democracy, right next to the land of the rising Euro. Want a real estate hint? Some of my best developers are moving to the Ukraine.

The common thread here is global economic growth. The world economy has reportedly grown faster in the last ten years than in any other decade on record. In the cities of the developing world, cell phone towers, dust, and diesel fumes rise over the greatest building boom the world has ever seen. This creates rising demand for software talent outside the US.

WHAT ARE THE IMPACTS?

During its run, offshoring has reshaped the world economy in big ways. As the effects of offshoring slow, we should look for these trends to slow or reverse:
  • Low inflation. Inflation around the world was suppressed by the fact that goods were getting cheaper because they get made in cheaper places. That's over. Imported goods are better represented by oil, up 200% in recent years, or by developer labor. Inflation is back.
  • High corporate profits, achieved rather easily because lower costs make margins better. American companies can no longer coast on the simplistic strategy of merely moving to a cheaper place.
  • Rapid growth of exporting economies. Indian companies can no longer coast on the simplistic strategy of selling "resources" in countries with higher pay rates.
  • Limited wage growth in America. Watch out for those Indian recruiters. They're hiring here now.
The old organizational model was called “outsourcing” - finding a cheap location and building a staff there to handle some subset of centrally-planned work. It's an inefficient and obsolete model. Outsourcing is not what we do at Assembla. At Assembla, we build unified teams where every team member, regardless of nationality, can step up to handle the most important tasks that need to be done. There is no “out” and “in”. And, we find the best person for the job regardless of location.

Our software industry needs to be smarter now. In the next few years, we will focus on joining the global boom, rather than holding down costs. We will use our global networks to find the best available talent, and mobilize it as quickly as possible, to go after global opportunities.


Developers in the “offshore” world have doubled their incomes in just a few years. That amazing gain has been achieved without equivalent pain in America. There was a period of about 5 years when it seemed crazy for Americans to study software, because their wages were being set offshore at a lower level than they could get in other professions. However, software wages have recovered across the board, and people with entrepreneurial skills to weave global talent into made-in-America innovation have done very well.

We brokered our first online staffing transaction on the Assembla site last week, for which we collected a few (depreciating) dollars in an American bank. The transaction was initiated by an Indian entrepreneur, who had received a job from a bigger Indian company, and subcontracted some work to an individual in Moldova.

Now, if you want to work with smart people trapped in a low-wage economy, you have to go to places like Moldova, the home of the world's only elected communist government. But you won't find many. The total population of Moldova is smaller than a lot of Chinese cities you have never heard of. Elsewhere in the world, freedom is making people richer, fast.

Freedom can work here in America. America has attracted more than it's share of talented people, with fantastic results. Recently, the flow of talent has gone into reverse. Our immigration policy is hostile. Our civil rights record is blemished. Visitors are fingerprinted at the airport. Student visas are difficult to obtain. We may think we are protecting our land and jobs, but instead of sealing the good stuff in, we are increasingly shutting it out. It's time to open up again.

And it's time to work smarter. The global economic boom is grinding down the simple offshoring opportunity – to buy things cheaply. The opportunity that it churns out is more sophisticated – to sell goods and services on a global scale.

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COMMENTS

I couldn't agree more; the trend should go after hunting for the best talents and best fit around the world no matter how cheap/expensive it is.

Corporate profits striving buy cheap sell high will not stand very long, cheap resources are no longer cheap and high pays are not anymore high so strategies should change.

The internet is a great place to live; you can have your best team members from all over the globe with the dissolved boundaries thanks to the internet.

Thanks for the great heads up post

posted @ Wednesday, October 10, 2007 8:10 PM by Nader Soliman


The off shoring phenomena is the most recent example of basic economic theory. All economies that encourage competition REQUIRE that business owners seek and exploit a lower cost of production to maximize profitability and remain competitive. Lower cost advantages MUST BE tested or a business owner will be unable to compete. However, in a global economy opportunities can be found farther away and things move much quicker. Because of the availability and low cost of telecommunications, internet infrastructure and other essential tools for business, there are more opportunities for business people to find and exploit these global differences and economic arbitrage opportunities. It is easy to see why the press would position outsourcing as being different this time (it sells lots of newspapers) but the basic underlying premise is rooted in basic economics.



In the 21st century, as in every example since the industrial revolution, a purely low cost advantage is fleeting. The only true competitive advantage is innovation. The difference in the 21st century is that if you can partner with the right people, and leverage a good working relationship, it can mean billions of dollars in market cap.

posted @ Wednesday, October 10, 2007 11:03 PM by Dan Tyre


I agree with Andy's point that offshoring is getting more expensive. I might add that the quality isn't getting any better either. I have 2 stories to tell that demonstrate these 2 points. I frequently use the various freelance sites out there such as iFreelance.com and ScriptLance.com. I posted a project there recently and, of course, most of the bids were from Indian firms. My bidding range was $3000-$5000 USD. The Indian firms consistently bid near the upper part of the range, almost always near $5000 and sometimes even greater - that surprised me. The Canadian, American and Australian bidders bid in the lower half of that range, hardly going above $4000. They seemed to understand the requirements quite clearly and I was impressed with the accuracy of their understanding. The Indian firms just didn't have the same level of understanding and sometimes I felt they just weren't reading the specs I sent them at all. I awarded the project to a Canadian that delivered the quality I was looking for, above even what I was expecting. N.B. Outsourcing has been a problem for Canadian workers as much as it has been for American and I'm sure for all other "western" economies. The second story demonstrates these 2 points on a corporate scale. I was recently working as the sole SAP ABAP programmer on a project in Tampa, FL. The client had stipulated in their contract that they wanted all ABAP programming, except the lead programmer, offshored. My company agreed to handle the offshoring since it had offices in cheaper parts of the world, namely Malaysia. Our Malaysian office was billing at 1/3 the American rates. Soon did I learn that their performance was at 1/5 the rate at which more highly skilled American/Canadian perform. This compromised the project and made me look bad. Had we stuck with lock consultants we have finished our work ahead of schedule and save the client some money. I quit just before the project went live, leaving my former company and the client with no one to manage those kids in Malaysia. I wanted to make my point very clear. To this day, I stand by my principle, and will only work with foreign consultants of a high caliber.

posted @ Thursday, October 11, 2007 12:12 AM by John Palermo


I think you can find inefficient programming in any country (has anyone else ever noticed this fact?), and I have found that people with lower billing rates are often better than those charging higher rates. However, I agree with the basic point of your story, which is that you get problems if you select developers based on rate and location, rather than actual productivity. Qualifying the right team is the most important determinant of success.

posted @ Thursday, October 11, 2007 12:32 AM by


I think Andy's right on. I'm a government researcher trying to help the government get out of its own way to leverage best practice in the information processing world. Productivity is where you find it. Collaboration is expensive; don't do it to be touchy feely, but do it and do it efficiently when and if there's clear mutual benefit. Easy to say... hard to do. Glad to hear the Assembla team is making progress.

posted @ Friday, October 12, 2007 8:54 AM by Chris Gunderson


Andy:

Thanks for a reality check on the offshoring of America's IT workforce...at least in some sectors! As an ex-IT worker in his late 30s, I can say I eventually grew tired with the never-ending treadmill of upgrade, patch, fix, repair, and fix again. Job security, one might say, but I found it stilting and very unsatisfying. There was a time, not so long ago, when IT drove things to happen. Now, it's just a commodity like electricity. Well, not exactly like electricity, as you don't have to reboot the fuse panel and patch the software in it on a daily basis. Ha! Also, there were too many very cross end-users, and no matter how hard I tried to find a way to just deal with the machines, the bad mojo always seemed to creep into even the darkest of server closets. I cross-posted on your piece to http://blog.innovators-network.org The Innovators Network is a non-profit dedicated to bringing technology to startups, small businesses, non-profits, venture capitalists and intellectual property experts. Please visit us and help grown our community!

Best wishes for continued success,

Anthony Kuhn
Innovators Network

posted @ Monday, October 15, 2007 10:52 PM by Anthony Kuhn


Thanks for the link. I saw a speech by the head of Google Apps where he pointed out that "100 years ago, big companies had a VP of Electricity". Most don't anymore, because electricity is a reliable utility that the vendor takes care of. The point was that having a CIO or VP of IT would become equally obsolete as online services get better and can provide IT services at a bigger scale. That will be a good thing because we can all get more interesting jobs.

posted @ Tuesday, October 16, 2007 2:31 AM by


Your first sentence appears to make an empirical claim--that hiring by American firms of non-American-citizens abroad to do work (i.e. write code) is declining--and all following sentences discuss mechanisms to produce such an outcome. Yet nowhere in your entry do I see any empirical evidence for your claim. Are fewer non-American-citizens being hired to write code abroad? Are they writing less code? Are their products (e.g. KLOC) a smaller share of the total? What exactly is "sputtering to an end," and do you have any empirical basis for that claim?

posted @ Wednesday, October 17, 2007 11:49 AM by Tom Roche


Your article mentions only the costs of offshoring, but nothing about productivity. That's how software projects are managed in the US. Managers only know costs. I've yet to see a software project where the manager understands productivity. Few software managers would even know how to measure their developers output so they base everything on the one side of the equation they can see: costs.

Dan Tyre mentions that reducing costs is required by basic economic theory. I would put it another way. Basic economics require that businesses understand what it costs to produce a certain unit of output, but in software the output is ignored.

The re-inshoring phenomena was in the news about three years ago. At that time the cost advantage still favored offshoring, but companies were finding that they weren't getting acceptable quality from offshoring so their savings were illusory. Some projects cut their costs dramatically by offshoring, but they got software that didn't work. The value they received for their investment was 0. They re-inshored to get better value.

posted @ Wednesday, October 17, 2007 11:51 PM by Dean Schulze


Dean, your point that productivity is the most important factor in total cost is correct. The productivity difference between individuals and teams is 5 to one, the cost difference between teams is smaller. However, I don't agree with the claim that "re-inshoring" a project is a reliable way to improve productivity. If you have effective management, you should be equally likely to get high productivity regardless of location. That's my goal. In that situation, relative costs do become important. It's clear that on a macro, aggregate level, they have a big effect, and that's what this article is about. I discuss productivity in all of my other posts.

posted @ Thursday, October 18, 2007 12:23 AM by


I experienced a number of difficulties working with offshore model. The things that didn't work for me were linguistic and cultural differences (especially with Indian and Chinese co-workers), geographical/time zones distance and in most cases no proactive thinking and working.
In contrast to the offshoring model I really like the nearshoring model (http://en.wikipedia.org/wiki/Nearshoring) which solves most of the issues of first model.
For example, in last few years western European countries benefit from hiring developers from Romania, Slovakia, Hungary, Serbia, Croatia and other countries in the region that have very well educated professionals and are still working for low rates.
While I mostly agree with the original point I would still go with nearshor model getting the benefits from both low rates and good quality.

posted @ Sunday, March 16, 2008 3:40 PM by Sasa


Your assessment of the dynamics of economic markets is short-sighted and over-reaching. In the last five years, the dollar has dropped about 35% to the Euro, 15% to the Yen, and 15% to the Rupee (rough numbers). This does not explain the shift of offshore development costs. These costs have risen from one sixth the cost of the US hour to one half. Surely you don't expect people to believe that prices have tripled because the dollar's value has shifted by 35%.
Yes, local economies have boomed. The global economic boom, as Andy sees it, certainly has inflated the cost of living everywhere. But this is not why the cost of a developer hour is what it is today. Developers continue to be gainfully employed in places such as New York, Tokyo, and other places much more expensive to live in than Moscow. These higher wages are offered because development isn't commoditized.
What are the true dynamics here? Prices are driven by perception and availability. An offshore hour becomes much more valuable as the offshore developer a) demonstrates the value of her general education, and b) becomes more educated in specific domains. The truly important question isn't what would happen if an offshore developer comes, but what if he leaves? Russian oil did not raise developer prices. India's inability to educate their rural poor did not either. Insatiable demand did. Andy is right about this part, the demand of automated infrastructure in a world of cell phone towers and diesel fumes creates this incredible growth of demand.
I think Andy got it right about innovation domestically. It takes local eyes and global hands to get things done these days. But it's not happening because local costs of living are so incredibly less than they are in the United States. And it's not going away because their global "boom" has been so incredibly impressive. A look at the headlines of any paper should convince a thinking person that the global trends are not just about a ten-year trend in local costs of living.
It takes me about one day to get all the kinks worked out for a new project: server access/setup, repository checkouts/setup, documentation setup, bug management setup, communication policies agreed to, system architecture, etc. This makes it economical to set me up on projects in Ontario, Portland, Salt Lake, Virginia, and London. It really doesn't matter where I am, it matters what my perceived value is.
We're all interested in creating value. But I'm not looking for the last bastion of cheap development labor. I'll never spend an hour looking for the next Monrovia, but I will spend an hour looking for specific kinds of talent that will make projects successful. The economics discussed by Andy are the economics of inelastic goods and services, but developer costs are elastic. The economics of software developers of the last decade have shown this to be true. The things to watch are software architecture, design, training, cognitive systems, communication systems, agile practices, etc. To be able to assemble a crack team of developers that delivers steadily and on time and for an economically responsible rate will have as little to do with local economies as what my mailman had for breakfast.

posted @ Saturday, April 05, 2008 4:55 PM by David Richards


One thing with your article is you don't understand inflation.
Inflation is NOT the rise of prices - inflation is the increase of the money supply. Rising prices is simply a side effect to inflation.

posted @ Wednesday, May 28, 2008 11:44 AM by Luke


I disagree with the inflation comment. Inflation CAN be caused by the increase of money supply, but is not determined by it. For instance, in many developing countries, inflation and hyper-inflation was caused by printing money. But the economic cycle is:
greater money supply -> greater spending -> more elasticity of price -> rising prices (inflation) -> government's inability to make purchases given tax base -> greater money supply.
Alternative cycles for inflation involve central bank changing lending rates (de facto money supply changes), increased demand for a product, increased confidence in the economy, decreased supply, etc.

posted @ Wednesday, May 28, 2008 6:41 PM by David Richards


As an owner of a nearshore development firm (U.S. and Colombia), I don't agree with the overall premise of the article. We are doing very well, as companies recognize they can decrease variable cost and send non-mission critical projects to a low-cost, high quality provider. We don't specifically market ourselves as an "offshore" company - it just so happens that our development team isn't colocated. If recent reports by Gartner, Forrestor or IDS are any indication, the rate in growth of outsourced, offshore services is only growing (even though overall revenue growth for many of these firms has slowed)...

posted @ Thursday, July 09, 2009 6:22 PM by Mark Adkins


Sorry, but America cannot satisfy its own needs for talented programmers, that's why the practice of outsourcing or "offshoring" IT-jobs will continue.

posted @ Monday, July 05, 2010 11:50 PM by outsource to ukraine


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