The Politics of Outsourcing

A host of new companies--and countries--are trying to grab a piece of the U.S. IT outsourcing business, and picking the right partner has never been more complicated. Terrorism, religious strife, changing governments, the threat of nuclear war, and failing national economies all are issues that need to be considered when weighing whether to outsource overseas.

Many of these issues weren't even on the radar screen a year ago, much less major factors in outsourcing decisions. But in the past year, the world has seen the terrorist attacks of Sept. 11, the threat of nuclear war between India and Pakistan, continued violence in the Mideast, economic problems in South America, and many other developments that could affect outsourced IT work in other countries.

Business-technology managers are paying closer attention to world events as overseas outsourcing companies--still relatively minor players in the outsourcing market--compete for a larger share of the pie. The Aberdeen Group estimates that offshore outsourcing represents about 2 percent of the $400 billion market for global IT services. But most of the growth is taking place overseas. Most overseas outsourcing vendors report annual growth rates of 30 percent to 40 percent, while U.S. IT services firms struggle to meet last year's numbers. Aberdeen says that while 37 percent of the businesses it surveyed recently say they use more than one outsourcer, only 14 percent say they outsource to more than one country.

The trend of outsourcing to many places around the world is immature, but it's growing, Aberdeen analyst Stephen Lane says. "There are certain skills in certain places and differing rates--that's what it's about at the end of the day," he says. When shopping for vendors, he cautions businesses to concentrate on what's important. "Companies focus on the country first and the supplier second," he says. "But countries don't deliver services, suppliers do."

India is the clear leader, but its role is still small. All of India's IT work combined came to about $7.7 billion for 2001. In contrast, IT services firm Accenture billed $11 billion for the same period.

India's position as an IT outsourcing leader faced a big threat earlier this year when the border dispute between India and Pakistan grew heated and the specter of war between the two nuclear powers became a real possibility. India has sometimes jokingly been described as the back office for many of America's prominent businesses because of its many outsourcing companies. So the threat of war concerned many U.S. businesses that increasingly rely on Indian workers to develop applications, answer help-desk calls, and provide other types of IT services. War, or at least a serious threat that service could be disrupted, would have provided an opening to fledgling outsourcing firms in countries such as Russia and China that hope to duplicate India's success.

Indian firms were quick to reassure U.S. clients that there was no cause for alarm. Many pointed out that their development sites in Bangalore and Chennai were well out of range of a potential nuclear strike by Pakistan. Fortunately, tensions eased and the threat of war faded.

Northwestern Mutual was one of the businesses worried about the possibility of war. "Of course there was concern," says Phil Zwieg, VP of IS at the nation's leading provider of individual insurance policies. "But that's all in the past."

Northwestern uses Indian outsourcing firm Cognizant Technology Solutions Corp. for a variety of tasks. At the time, Zwieg was in constant communications with executives at Cognizant about backup, preparedness, and the political situation. Zwieg was assured that there would be no interruption of service, and it turned out those assurances were correct. Now, business is back to normal, and Zwieg says he isn't considering going elsewhere.

Not every CIO is eager to embrace the idea. Jane Landon, VP and CIO at Prudential Insurance Co. of America, describes herself as a reluctant convert. Landon got into offshore outsourcing because she was given a project that had to be completed in seven months, and she faced penalties if it wasn't done on time. It also would have put her in front of the chairman of the board to explain the missed deadline. So she put six key staffers on the project and outsourced the rest. The results were good, and now offshore outsourcing is a regular part of her IT operations.

With the volatility in the financial-services industry, outsourcing is especially crucial now, she says. "I can take my offshore people down to zero on two weeks' notice," she says. "But I couldn't do that in the U.S." Another benefit: She expects a 55% savings as the company moves forward with other offshore projects. "Whatever I get from my outsourcing vendor is 10 times what I can get from my own people," she says.

Cost savings are one of the main reasons that businesses use offshore outsourcers. The Aberdeen Group says overseas labor rates can save a customer up to 65%, compared with using a U.S. company. But once project-management costs and other overhead are factored in, the savings typically amount to 45%.

As offshore outsourcing gains credibility, Landon and other business-technology managers may soon have more choices. While India has already made a name for itself as the gold standard in call centers, help desks, and application and network maintenance, Russian companies, whose IT pros enjoy an excellent reputation in math and engineering, want to do application development. There's a large talent pool of Russian engineers available to the commercial sector, more than 1 million, according to an estimate from the World Bank.

Luxoft, a Russian software development and outsourcing firm, saw a slowdown in business in the months after Sept. 11, CEO Dmitry Loshinin says. Luxoft, a member of the IBS Group, a large Russian IT holding company, employs more than 2,000 IT professionals. Many potential customers revised their IT plans following the terrorist attacks, and their new IT strategies included outsourcing, Loshinin says. And then after the India-Pakistan standoff, they wanted to ensure stability. "Large companies want several vendors in several different countries," Loshinin says. "Russia is just beginning to appear on the radar of these companies. We spend a lot of time to convince them to work with Russian programmers."

This year, Luxoft's largest outsourcing customers have been financial-services companies. Much of the work is in developing mission-critical applications where security is paramount, although work in other areas is picking up, too. A typical project costs around $1 million and takes between six months and one year, Loshinin says. "Ninety-five percent of our clients repeat the business. It can develop into a large deal."