Examining The Services Of Offshore Outsourcing Information Technology Essay

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The present day popularity and strategic importance of offshore outsourcing as a sourcing mechanism for organizations did not happen overnight. Rather, it has evolved overtime and has been influenced by a number of factors, both internal and external to the organization. During this evolution, the process of offshore outsourcing has undergone significant changes. If cost reduction was the primary reason for pursuing offshore outsourcing during the initial years, today there are a number of reasons apart from cost reduction which fuels the offshore outsourcing fire. This change is also evident in the type of services offshored, offshoring destinations and the offshoring strategies adopted by clients and vendors. The purpose of this chapter is to understand this evolutionary aspect of offshore outsourcing and with this intention, the chapter is divided mainly into three sections. The first section discusses the offshore outsourcing origins and the services which were offshored during the initial years. The second section analyses how the offshoring has grown and finally, the last section discusses the present trends in offshore outsourcing.

When, where and for what services did offshore outsourcing start?

Offshore outsourcing as a business practice has been adopted by firms for a very long time and it has encompassed manufacturing, IT and back office services. However, it could be argued that the first wave of offshore outsourcing was mostly related to manufacturing, and was possible due to the disintegration of production processes and activities (Dedrick et al, 2010; Sturgeon, 2002).

Offshore outsourcing in the manufacturing sector started in the 1970s and 1980s when jobs in the US steel and textile industries were relocated from the north to the south (Kalakota, 2005). In the mid-1980s, production processes in manufacturing were also relocated from US and Europe to across the US-Mexico border and East Asia (Contributing et al). The main driving force behind this offshore outsourcing was cost reduction. Organizations from high cost economies believed that relocating production or assembly activities to low wage countries would enable them to align with the cost structures of their global competitors (Lewin & Peeters, 2006). However, it should be noted that during this earlier phase, highly skilled job such as engineering, R&D, marketing and administration was under the control of the parent company and usually located within the home country (Dedrick et al, 2010).

In the case of services offshoring, although it started attracting the attention of firms in a significant way during the 1980s and 1990s, there are references in offshore outsourcing literatures of services offshoring being adopted in a limited way during the 1960s and 1970s (Apte & Mason, 1995; Dossani & Kenney, 2007; Metters & Verma, 2008). One of the earliest IT related jobs to be offshored was data entry. For instance, data entry services had been contracted by Pacific Data Services to China since 1961 (Apte & Mason, 1995). In the 1970s, few US firms used to dispatch large batches of paperwork, not time sensitive, by ship to the Caribbean for processing (Metters & Verma, 2008). There are also instances of Indian engineers involved in software development work with clients on site, known as "body shopping", in the US during 1970s (Sharma & Loh, 2009; Dossani & Kenney, 2007; Lewin & Peeters, 2006).

One of the earliest and most prominent examples of offshore outsourcing involves American Express offshoring its accounts receivable to Tata Consultancy Services, an Indian software firm in 1979. This is an important milestone and can be seen as providing the much needed impetus to offshore outsourcing. The second major milestone was the establishment of captive technology centers in Bangalore, India by Texas Instruments and Motorola in the mid-1980s. This was followed by General Electric in 1990, when it established a joint venture with Wipro, India to develop and market medical equipments (Lewin & Peeters, 2006).

Apart from India, jobs were also offshored to locations such as Barbados and Ireland in the 1980s. For instance, in 1983 American Airlines established Caribbean Data Services in Barbados for handling offshored work. Initially, this offshore center was supposed to process information from used air tickets in order to determine the revenue for the airline, but towards the end of 1980s, it was also handling insurance paper work. These jobs were previously executed at twice the wage by workers in the US. The mode of operation involved flying in the physical airline ticket and insurance paperwork to Barbados by American Airlines flights and then sending back the results to US electronically via satellite. The early adopters of back office services in Ireland during the 1980s include McGraw Hill, New York Life and Metropolitan Life. McGraw Hill used the services for maintaining a subscription database whereas New York Life used it for processing claims related to health insurance (Metters & Verma, 2008).

How has offshore outsourcing grown?

The emergence and the evolution of the offshoring industry have been influenced by a number of factors. Although these factors have been discussed in great depth in chapter 6, some of these factors have been highlighted here in order to make this discussion on the evolution more meaningful.

One of the factors which had a major impact on offshore outsourcing was the ICT revolution. It can be argued to be the catalyst which was responsible for the emergence of the offshore outsourcing industry during the 1980s. Similar to the manufacturing industry wherein new transportation technologies accelerated the global reach of supply chains, new ICT technologies made it possible for firms to efficiently disaggregate their production processes (Gereffi et al, 2009). The reengineering movement of the 1990s also influenced the offshoring industry. An important part of the reengineering process was to examine, disaggregate and standardize all the crucial activities involved in the completion of a process (Hammer & Champy, 2001; Cole, 1994). The standardization process allowed the establishment of "pinch points" that facilitated handoffs, thereby allowing the separation, either geographically and/or organizationally, of work process (Gereffi et al, 2005; Jacobides & Winter, 2005; Dossani & Kenney, 2007).

This reengineering movement was synchronic and synergistic with the move by large firms to adopt industry standard software platforms. These global standard platforms persuaded the workforce to invest in software specific skills rather than firm specific skills, which was the case during the earlier legacy systems. This resulted in portability of skills between firms and investment in the development of these skills, not only in developed countries but also developing countries (Williamson, 1975; 1985). The outcome of these actions was the emergence of skilled and trained workforce in developing countries, making offshoring more attractive to companies since they did not have to make huge outlays on the training and development of the workforce.

From a cost perspective, these developments made it possible for locations such as India which were considered as distant locations to become increasingly proximate, even though some of the other characteristics specific to these countries, in particular, labor cost remained distant. This provided an opportunity for firms which had the capacity to span the physical distance and mobilize similar labor power to benefit from the opportunity of labor arbitrage. It should, however, be noted that although technology was necessary, it wasn't enough to convince organizations to move their activities offshore. The business decision makers had to be convinced that the offshore outsourcing was an acceptable and legitimate strategy and this was achieved partially by the assurances of business continuity and adequate levels of security. In this respect, international certifications such as Carnegie Mellon software certifications and the International Standards Organization certifications along with the adoption of quality practices, such as six sigma, assisted in providing the required assurances. Several Indian firms used these certifications as the basis for conveying their global class standards and in communicating that moving business process activity to India was not risky and unusual, but rather a part of the normal business strategy (Dossani & Kenney, 2007).

Beginning in 1993, large and reputed multinationals such as American Express, Texas Instruments, Motorola, General Electric, Hp, HSBC, and Citigroup started offshoring service related activities to India. The fact that the early pioneers of offshoring in India were reputed and elite firms helped in allaying the fears about offshore outsourcing to India. Additionally, it can be argued that offshore outsourcing proponents such as General Electric's CEO Jack Welsh and later Hewlett Packard's CEO Carly Fiorina and Dell Computer's Michael Dell were also instrumental in legitimizing offshore outsourcing (Dossani & Kenney, 2007).

In this evolution of offshore outsourcing, it is possible to identify three chronological phases. The first phase consisted of US firms establishing centers in India with the objective of providing services for their US and global operations. The second phase was characterized by the arrival of first generation of Indian entrepreneurs who were instrumental in taking the offshore services industry to a global level, and who today command approximately 40% of the market share globally. The present phase is marked by the aggressive growth and development of the offshore industry in new locations, such as Central and South America, Central and Eastern Europe, Russia, South Africa, Philippines, Australia, Israel, Egypt, Singapore, Indonesia, Malaysia, Spain, Ukraine and the Caribbean (Gereffi et al, 2009; Gartner, 2009).

Two significant trends which can be observed in the evolution of offshore outsourcing pertain to the scope of services offshored and the changing strategies adopted by service providers. A review of these trends helps in understanding how the offshore industry is evolving and adapting to changes in client requirements and the business environment.

With respect to the scope of services offshored, it has grown significantly over the years. Offshore outsourcing is no longer confined to IT services. As organizations gained offshoring experience and became more comfortable and the capabilities of service providers improved, business processes were included as part of the services that were offshored. Now days, offshore outsourcing includes knowledge intensive and innovation activities such as new product design and development, R&D and analytical knowledge services (Gereffi et al, 2009). According to a survey conducted by Offshoring Research Network, innovation services is one of the fastest growing services and after IT, the second most prevalent service provided by the offshore vendors. This trend is shown in figure 1. One of the reasons for this shift is the rise in the number of countries providing access to talent related specific to these activities forcing many organizations to offshore such activities. From the service provider perspective, one of the reasons for upgrading into such activities arises from the commoditization of traditional transaction intensive services such as finance and accounting, call center and IT application related development and maintenance activities due to which there is considerable pressure on profit margins. Offshore service providers are therefore looking to develop required capabilities and expertise in new markets such as innovation and R&D to reap higher profits (Couto et al, 2008).

Innovation services is the fastest growing.JPG

Figure : Growth in services over the years

Source: Duke University Offshoring Research Network 2007 service provider survey

The other important trend is with respect to the changing strategies adopted by service providers. As clients became increasingly comfortable with offshoring, they started demanding more services thereby forcing offshore service providers to develop new competencies and capabilities to satisfy those demands. In the context of global value chain framework, which was highlighted in the literature review chapter, this evolution is termed as upgrading. It is possible to identify four types of upgrading pursued by offshore service providers, namely, functional, process, product and inter-sectoral (Gereffi & Fernandez-Stark, 2010; Humphrey & Schmitz, 2002).

In functional upgrading, service providers acquire new functions with the intention of creating higher value added services. Examples of such transitioning up the value chain include:

The transition of large IT manufacturing firms to industries related to IT services. For instance, some of the leading offshore global service providers, such as Tata Consultancy Services (TCS), Wipro and IBM, initially started off as large computer manufacturers before moving into the services industry (Gereffi & Fernandez-Stark, 2010). Similarly, Automatic Data Processing upgraded from computer manufacturing activities related to mainframes and check printing machines to human resource outsourcing including payroll, tax and benefits administration (ADP, 2009).

The growth of Indian service providers from ITO to BPO services and several have also moved into the KPO sector. For instance, after establishing themselves as a leading service provider of BPO activities, WNS ventured into KPO with the establishment of Knowledge Services Division in 2003 (PR Newswire, 2003). Another example is Genpact, which was initially General Electric's BPO operation center in India. It expanded aggressively over the years and has moved from BPO to KPO. Today it employs approximately 1500 analysts with advanced degrees and qualifications providing services such as customer analytics, market research, risk analysis, and business intelligence form its Indian centers (Gereffi & Fernandez-Stark, 2010).

Offshore service providers offering specialized services. It can be seen that leading offshore service providers who initially services pertaining to simple and generic activities have now started providing highly specialized services for specific industries. For instance, TCS has six R&D centers related to IT, telecom, engineering & industrial solutions, travel & hospitality, retail and insurance. In addition to these, it has 40 patents and a number of applications, more than 200, pending (Tata Consultancy Services, 2009).

In process upgrading, the approach involves either the application of innovative technologies to the production system or the restructuring of present systems in order to generate the required services more efficiently. Examples of this type of upgrading include:

Infosys's application of the global delivery model, which it had refined and improved in the ITO sector, when it established its consulting firm in 2004. As a result it was able to improve upon the conventional consulting company model and deliver projects at a much lower cost compared to its competitors (William F. Achtmeyer center for global leadership, 2008).

The replacement of Capability Maturity Model (CMM) developed in 1989 for software development process by Capability Maturity Model Integration (CMMI) in 2007. As opposed to the application of CMM to just software sector, CMMI being a process improvement approach could be applied to any sector with the aim of improving the quality and efficiency of processes and functions (Software Engineering Institute, 2009).

In product upgrading, the approach involves shifting into more sophisticated service by increasing the complexity related to the products or services offshore.

Capgemini advises its new clients to implement its standard BPO services as opposed to the creation of new teams focused on the client's previous model. The advantage of this approach is that the client is able to benefit from the firms economies of scale as well as from the application of a highly refined and more efficient process that has evolved from the firms countless interactions with a number of its clients (Mongillo & Tasner, 2009).

In inter-sectoral upgrading, the approach involves the acquisition of competence or knowledge from a particular function to be implemented in another sector. Examples of this type of upgrading include:

ITO service providers leveraging the global delivery model to offer R&D services to diverse industries. Several Indian software companies have started to provide high skill R&D services via the transformation of their supply of low skill software services. This allowed them to make the transition from low value added services in the ITO sector to high value added functions which were part of the vertical chains. For instance, TCS by leveraging the strengths and competencies of its group companies, which are part of the TATA Holding Group, has setup innovation centers focusing on aeronautical and automotive industries (Tata Consultancy Services, 2009). Similarly, Wipro set up a center of excellence in innovation and R&D specifically targeting the telecom industry by acquiring the R&D unit of Ericsson in 2002 (Express Computer, 2002; SiliconIndia, 2002)

The expansion of offshore service providers across vertical chains. For instance, Infosys, which started as a specialist provider in the financial sector, today has clients across several industries such as manufacturing, retail, communications, media & entertainment, transportation and government (Gereffi & Fernandez-Stark, 2010).

As part of this discussion on how the offshoring industry has grown, it would be appropriate to shed some light on the business model that is adopted by the firms in the industry. Most of the leading firms pursue a similar business model known as "global delivery model" (Sako & Scho, 2009). This model comprises of a global network of client support offices, specialized delivery hubs in low cost destinations and the headquarter. This arrangement allows the global service provider to be in close proximity of their clients and understand their requirements and execute projects at the same time with the help of multidisciplinary experts spread across the different parts of the globe. For instance, Wipro, one of the leading Indian service providers offers services to its clients around the world by linking and coordinating activities between its large networks of global delivery centers, more than 60, via its customer support offices and India based headquarter. TCS, another leading provider, has global delivery centers established in countries such as Beijing, Hungary and Mexico in addition to other locations (Gereffi & Fernandez-Stark, 2010).

Where to and for what services has offshore outsourcing grown?

The growth in offshore outsourcing, both ITO and BPO, over the years has been phenomenal. For instance, in 1989, the global ITO market was estimated to be a US$ 9 to US$ 12 billion market, whereas in 2007, it was estimated to be between US$ 200 and US$ 250 billion. With regards to the BPO market, although smaller in comparison to the ITO market in 2008, it grew at a faster pace. It is also estimated that the global market for mainstream BPO activities would grow by 10% to 20% annually from US$ 140 billion in 2005 to US$ 350 billion by 2010 (Willcocks & Lacity, 2009). According to Gereffi et al (2009), although the global demand for offshore services is likely to expand, the growth will be different across each segment. Figure 2 illustrates this trend. They also estimate the demand for BPO services globally to increase at 25% between 2005 and 2010. ITO services is expected to grow at the similar pace, but in comparison to BPO and KPO its relative contribution is likely to decrease in 2010, an observation which is also made by Willcocks et al (2009).

Global demand for offshore services activity.JPG

Figure : Global demand for offshoring by activity

Source: OECD, 2008

Note: (e) Global offshore services market, 2005-2010 (US$ bn)

With respect to the activities offshored, it is possible to identify a shift from the previous years. Conventional offshore processes like IT are maturing whereas innovation related activities such as R&D, product development and engineering, that were considered as central and core processes of an organization are growing at 50% (Sharma & Loh, 2009). This is a clear indication that knowledge intensive and high end processes are increasingly being offshored to low cost destinations. According to Evalueserve estimates, the global KPO market is projected to grow from US$ 1.3billion in 2003 to US$ 16.7 billion by 2010 (Evalueserve, 2007). The growth is mainly visible in innovation related activities such as R&D and product development (Gereffi et al, 2009) and emerging areas include biotech & pharmaceuticals, data search management, animation & simulation and remote education & publishing. A number of global players such as AC Nielsen, Goldman Sachs and McKinsey have already started using India as a remote hub for their operations. It can also be seen that R&D development is shifting from the traditional model of central hub and decentralized federation model to a globally integrated network (Sharma & Loh, 2009). Global networked R&D, involving low cost sites and partners, are becoming the preferred model of many organizations (Andrew, 2007; Doz et al, 2006).

Another important development is the emergence of new offshore locations. Although India is still the preferred destination for offshoring, the industry is no longer India centric. China is actively trying to make its role and presence felt on the global sourcing arena (Willcocks et al, 2009). China's growing economy and national policies are persuading MNCs to consider it as an important part of their sourcing strategy. In addition to this, China offers an educated labor force and strong support of the government and is also trying to resolve issues related to security and intellectual property protection. Central and South America is another emerging offshore destination. A number of US firms are already offshoring work to this location, one of the drivers being the synchronous time zone. Of the South American countries, Brazil is able to attract a large number of firms due to its large population, its engineer's potential to develop innovations and the favorable support of its government for outsourcing industry. Chile and Uruguay have also been successful in attracting offshore work (Oshri et al, 2009).

According to Willcocks and Lacity (2009), organizations from Western Europe are also likely to offshore work related to IT and business processes to service providers based in Central Eastern Europe. In fact, it can be seen that some cities in these regions such as Budapest and Sofia are already being considered as a potential offshoring locations. Other locations which are striving to be part of the global ITO and BPO markets are countries from the Sub Saharan Africa such as South Africa, Botswana and Kenya (Oshri et al, 2009). Gartner has also identified a number of regions in the Middle East which are attractive destinations for offshoring (Gartner, 2009).

Amidst the emergence of these offshore destinations, the Indian offshore industry is upgrading and trying to maintain its leadership positions. The Indian offshoring industry has evolved significantly and is now moving up the value chain. Initially starting off as a provider of low skill services, it has transitioned into a provider of complex business process service and has also started offering high skill R&D services. The leading Indian firms such as Infosys, TCS and Wipro have diversified and shifted from software programming and related services to offering solution to business problems (Gereffi & Fernandez-Stark, 2010).