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Offshoring fix: bring the work to Australia

ACS staff, Information Age

21/08/2004 14:29:00

Introduction This policy document draws on the content of two reports prepared for the ACS: the Whitehorse Strategic Group “Study of ICT Outsourcing and Offshoring in Australia” and the Access Economics paper, ”Economic Perspectives on Offshoring”. For a more comprehensive understanding of the issues, this policy statement should be read in conjunction with these two reports which are available on request.

For the purposes of this paper, outsourcing is defined as tasks, processes or job functions which are performed on behalf of an organisation by a third-party supplier. Similarly, offshoring is defined as any outsourced work that is sent to another country, although this document deals exclusively with ICT offshoring.

The focus of this paper is offshoring to other countries. The ACS believes Australia has a world-class software development sector and could benefit enormously from positioning itself more strongly as a key offshoring destination to try and attract offshoring projects here.

Overview The Australian ICT sector is emerging from the most significant downturn of its history and currently faces some critical challenges to its ongoing success.

The 2003 ACS ICT Employment Survey, released in February this year, indicated that unemployment amongst ACS members averaged 10.6 per cent during 2003. This was down from the 2002 figure of 12.4 per cent, but remains well above the national unemployment rate of 6.3 per cent.

The OECD has linked both ICT usage and ICT production to economic growth and future living standards, highlighting the importance of Australia having a strong and thriving domestic ICT sector.

According to the Whitehorse Study of ICT Outsourcing and Offshoring in Australia, April 2004, an estimated 7000 ICT jobs have shifted offshore to date. Whitehorse based this figure on the average employees per $ million revenue in the ICT services sector and then extrapolated from the value of ICT services trade. That figure is projected to rise to 11,000 by 2008.

The recent Booz Allen Hamilton report, “Outsourcing Globally – Trends and Implications of Offshoring for Australia”, details a Forrester Research survey of 57 large companies within Australia and New Zealand which found half had already offshored functions or intended to do so by the end of 2004.

The ACS believes Australia now faces the challenge of carefully managing the impact of this rise in offshoring.

This is why the ACS is calling for a “soft landing” in relation to offshoring. While there is clearly no single solution that will work for every stakeholder, this policy encourages sound cost benefit analysis through the ACS Offshoring Cost-Benefit Checklist*.

This will help to prevent organisations from jumping into offshoring or over-offshoring (with insourcing corrections later) in a mistaken belief that it is something that must be done because everyone else is doing it. By using this checklist, a company can ensure that its decision to offshore or not, and to what degree, is made for the right reasons. It will also help ensure that organisations do not offshore 400 now and hire back 250. Proper measured decision making with the ACS Offshoring Cost-Benefit Checklist will achieve a “Soft Landing” for the local industry.

There is of course no “soft landing” for any individual who is displaced by offshoring. To address this, we would also like to encourage the Government to provide reskilling opportunities for any workers whose jobs are offshored and who lose employment as a result.

Australia as an offshoring destination When considering the offshoring debate, it’s also important to remember that Australia has benefited in the past from instances where overseas organisations have offshored ICT projects to Australia. One positive response to the potential threat posed by offshoring is for Australia to recognise and identify our relative strengths in the areas of software architecture, software testing and project management, among others, and more actively promote these capabilities to the rest of the world.

Australia offers numerous benefits as an offshoring location, including: • Stable and supportive political environment • Highly educated and productive workforce • Strong pool of ICT skills • Cost effective labour market • High standard of living • Attractive environment, climate and culture

While Australia already has much to commend it as an offshoring destination, the ACS Offshoring Working Party has identified that changes to the Australian taxation regime could significantly enhance our ability to attract offshore contracts.

Risks and benefits of offshoring Listed below are some of the top pitfalls and benefits associated with offshore outsourcing, as determined by META Group and other sources.

Potential pitfalls • Cost savings are often overstated • Security concerns are complicated • Intellectual property is at risk, especially in emerging markets • Most users do a poor job identifying, vetting, engaging and managing any outsourcing provider, much less one that is offshore • Language problems, culture and work-style barriers create real problems • Managing globally distributed teams and projects is very difficult • Offshore service provider maturity varies enormously • Geopolitical (eg. Iraq war, terrorism) and related (eg SARS) events impact costs and risks • Ensuring regulatory compliance can significantly complicate things • Potential loss of competitive domestic ICT market if offshoring not handled responsibly • Complexities in managing legal and contractual obligations • Complexities in repatriating profits or savings to Australia • Difficulty in planning and managing disaster recovery

Potential benefits • Cost reduction • Promote growth • Increase competitiveness • Improve service levels • Alleviate worker shortages • Acquire cost/viable access to new/different skills and services • Enable refocusing of scarce resources elsewhere • Discharge or exit commoditised/low value-add activities • Support new market penetration • Leverage external economies of scale • Gain greater operational efficiencies • Gain greater productivity and flexibility • Spread or reduce risk • Enable cross-border alliances/partnerships

Organisations considering a proposal to offshore part of their ICT organisation must weigh up the potential benefits and risks of this approach before making a decision. The ACS Offshoring Cost-Benefit Checklist (available from the Society, details at the end of this document) will assist in this process.

Offshoring and a future skill shortage Australia’s long-term ICT future is promising, but Australian parents and young people are not currently seeing this industry as offering a viable career. Continuing headlines about the high unemployment rate and new offshoring decisions are exacerbating the situation.

Over the past two years, first preferences for ICT-related university courses dropped a total of around 50 per cent nationally, resulting in lower tertiary entrance scores for many courses in the first year, and lower total enrolments in ICT courses in the second year, 2004.

With employment prospects expected to improve over the next few years, the impact of the reduced student pipeline and the impending retirement of the baby boomer generation is predicted to result in a skill shortage greater than any we have experienced thus far.

The ICT sector is extremely dynamic. What is hot and what is not changes every year. The challenge many technologists face is that of the “Ground Hog Day”. In most professions, individuals grow their skills over a five-year period through the change process of encountering, adopting and learning new ideas as part of their job. However, many ICT workers will relive the same year five times as they operate in roles that require them to focus completely on a particular technology.

In this scenario, there is very little time to identify and learn new skills. Employers push these workers hard to meet project timetables and often don’t make it a priority to reskill them.

It is fundamentally true that modern workers are responsible for their own skills and the reason many ICT professionals join the ACS is to encounter new trends and participate in free or subsidised professional development.

Offshoring highlights an existing problem – ICT workers need to continually acquire new skills. For Australia to be a potential offshoring location, we need our workers (both new graduates and mature workers) to have the right skills at the right time.

Globalisation and protectionism Globalisation allows nations to specialise in what they do best and provides opportunities through trade for all nations to grow richer as each nation benefits from the skills and productivity of others.

Long term, this is good news for ICT. As the pie (national income or national output) grows, the ICT sector often tends to command an increasing proportion of the larger pie.

The opposite of globalisation is protectionism. The lessons learned from Australia’s experience with tariff barriers are they do not protect jobs beyond the short-term period and they damage the economy in the medium and long term as they encourage inefficiency.

By better enabling offshore competitors to compete with Australian suppliers, globalisation can help to sharpen the performance of the domestic ICT sector and encourage it to operate more efficiently.

Nevertheless, as a society we must never forget that in the short term, an ICT workforce facing redundancy represents a series of individual human misfortunes. We have an obligation to create “a soft landing” and to ensure that those made redundant are offered the opportunity for reskilling (and job placement support).

The ICT hype cycle The ICT sector has historically been littered with new panaceas that are hyped up, creating a rush to purchase them without a full business case.

The justification is that “everyone else is doing it – we have to match them to be competitive”. Invariably, there is a correction and reaction to all the hype, then market reality sets in and investment only takes place through a real business case.

When this mind-set is applied to offshoring, an organisation could rush into it, make 400 employees redundant. However, once the correction occurs, they might realise that only 150 needed to be made redundant, forcing an extremely difficult rehiring exercise. A soft landing occurs through educating the market that we need to avoid the hype and correction and move straight to a thorough cost benefit checklist – the ACS Checklist – to minimise not only individual human tragedy, but also business losses sustained as a result.

Offshoring and corporate reputation Any organisation that offshores without weighing up both costs and benefits (including quality of service) within a rigorous framework is likely to create negative perceptions and unpredictable customer service levels. In effect, the organisation could “get caught with its pants down”, resulting in highly visible instances of businesses deciding in haste and then repenting at leisure.

In a survey of 1500 CEOs released at the World Economic Forum in January 2004, 92 per cent of respondents said they believed the long-term success of an organisation is linked first and foremost to corporate reputation, with profitability, return on investment and stock market performance paling into relative insignificance by comparison.

A business has a fundamental responsibility to maximise the efficiency of its operations. It is not selfish or unpatriotic for a business to source imports from overseas and it makes good business sense if such a move actually provides best value for money on a sustainable basis. While cost is a key criterion in making business supply decisions, other criteria must also be considered. Otherwise firms face the kind of situation which spawned the old adage, “buy cheap, buy twice”.

Organisations also have an obligation to their stakeholders to conduct rigorous cost benefit analysis.

Quality of service is a critical benefit to assess, but one that is frequently overlooked because of the difficulty in quantifying it – it is often the organisation’s customers who provide the real metric down the track, when it is too late.

Because quality is often ignored in business decision-making, this could bias offshoring decisions because offshore suppliers may lack local knowledge, which could lead to higher costs and or reduced customer satisfaction with the final product or service. This in turn further impacts on corporate reputation.

It is critical to the success of an offshoring arrangement that the Australian customer should retain full control of the arrangements and manage the service itself. Otherwise, an offshoring company could manage the business relationship to its sole advantage.

Quality considerations An essential part of assessing quality is the track record of alternate suppliers. Again, it is easier to assess the track record of the domestic supplier than of a possible offshore alternative with a seductive sales process. It is not in an organisation’s best interests to go with the cheapest supplier if that supplier cannot provide the service or goes out of business. In any offshoring exercise, the cost of changing providers can be high. The cost of changing back to an insourced arrangement can be even higher.

Each offshore supplier can provide staff turnover rates. While quality multinational employers are sought after, employee turnover rates in developing countries are sensitive to salaries paid. This rate can be controlled by negotiating with the supplier to pay a higher price for the service to guarantee a lower turnover rate. A 25%+ staff turnover rate will dramatically affect quality and productivity so enterprises should plan to factor in a staff turnover rate that meets their requirements.

Any offshoring decision should only be made after undertaking a trial program which takes into account the quality and sustainability of the services provided. Certainly, that pilot needs to be benchmarked against other alternatives, including the current supplier or internal workforce.

The importance of factoring in short- and medium-term exchange rates The “costs” of short-term decision-making may be accentuated if offshoring decisions are based on current values of the exchange rate. As discussed, decisions should be made considering the medium- and long-term exchange rates.

While it is normal that an offshore supplier may offer a fixed price contract in $A terms, this isn’t the end of the story. Exchange rate pressures may force the supplier to reduce its costs and service levels and force renegotiations. Consideration ought to be given to possible changes in price when the contract comes up for renewal. This is particularly the case if the costs are high, to revert back to the previous condition.

Movements in exchange rates can be sizeable and can occur without warning. Current values of exchange rates can often be quite different from longer-term average values. There are two sides to the exchange rate to consider. Australia is a modern industrialised economy with stable growth and low inflation. Despite this economic stability, movements in the $A against other major currencies have been marked. On the other side, it is important to factor in that there is a natural tendency for the currencies of developing nations to appreciate over time.

The appropriate exchange rate to apply to offshoring decision is a long-term rate. Clearly, using US48 cents as it was in 2001 or US80 cents in early 2004 would be inappropriate.

Also critical to the impact of exchange rates and potential viability of an offshoring contract is the political and geopolitical environment of the offshoring vendor. This is an area where Australia enjoys a strong advantage over many of the leading offshoring contenders.

Asymmetric decision costs and the policy of least regret One issue usually neglected in cost benefit analysis is the need to consider the costs of making a wrong decision. In offshoring, the stakes are high, as businesses are gambling with individual lives and customer service levels. It will be very expensive to move to an offshore supplier and/or over offshore (later realising that too much was offshored), only to find that has been unsuccessful and then have to insource it back.

In particular, the following add to these costs: 1. Difficulty in rehiring en mass 2. Lack of internal resources to manage this process and new staff 3. Loss of control and understanding of the previous ICT infrastructure and environment

Even if a straight cost benefit analysis favours offshoring, there is good reason to hasten slowly.

Time perspective It is essential that offshoring decisions are not made solely on the basis of short-term time horizons which can lead to being caught up in the hype of “we need to do this”. Some factors which encourage short-term decision-making, as detailed in the Access Economics report, include: • Following the latest management trends on a perception that they are safe to follow. Often published benefits of trends are firm-specific and might not translate well to other businesses; • New broom – a new CEO or CFO is appointed and analysts are keen to see a new approach; • Short-term profits resulting from a quick financial analysis without considering a loss of benefits over the long term that may be left for others to manage; i.e. a two-lane bridge on a three-lane freeway. • Failure to adequately examine long-term implications – it is well documented that may companies only identify the hidden costs of offshoring after the decision is made, as customer satisfaction levels decline due to cultural, language and distance differences. Other factors that could potentially unhinge an offshoring contract include geopolitical instability, lack of security, stolen IP, legal liability, poor governance and risk management.

Appropriate response to ICT offshoring While the US Government has legislated to ban offshoring of any government contracts, the ACS proposes instead that the use of its Offshoring Cost-Benefit Checklist will ensure a responsible approach to offshoring and the reskilling of displaced ICT workers. In the long term, this is the best approach for our nation and its ICT industry.

The ACS is calling for: 1. The Federal Government to develop guidelines for Commonwealth departments and agencies which take into account the ACS Offshoring Cost-Benefit Checklist; 2. The Federal Government to publicly endorse the ACS Offshoring Cost-Benefit Checklist as appropriate for major Australian companies; 3. The Federal Government work with the ACS and other bodies to improve and enhance access to existing schemes for reskilling and retraining of “displaced” ICT employees; 4. The Federal Government work with the local ICT industry to encourage the development of onshoring opportunities and to provide an agency dedicated to marketing Australia’s ICT capabilities; and 5. The development of industry policies (including R&D) which will enable Australian ICT SMEs to produce new products and services that build Australia’s capacity to share in the economic gains of ICT sector growth industry.

*To get a copy of the ACS Offshoring Cost-Benefit Checklist, please contact the ACS Chief Executive at execsec@acs.org.au or (02) 9299 3666.