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June 12, 2000

http://www.informationweek.com/790/outsource.htm

Offshore Outsourcing Nears Critical Mass

The IT talent shortage in the United States is driving more companies to use overseas developers

By Drew Robb

ntil recently, outsourcing software development to offshore suppliers was seen as a cost-cutting approach used by a few big U.S. companies to offload mainframe maintenance, Y2K, and assorted IT grunt work. Not anymore. Now, offshore outsourcing is nearing critical mass: Fast-growing Internet startups, midsize businesses, and dozens of major companies are using offshore suppliers not for maintenance, but to develop sophisticated new applications quickly.

The biggest reason is the shortage of U.S. IT talent. Companies say it's almost impossible to find enough good developers-and even the not-so-good ones cost a fortune. In contrast, areas such as India and Eastern Europe have access to thousands of programmers, many with Java and other Internet-related skills, available for $20 to $50 an hour. "Why spend months searching for a second-rate U.S. programmer when you can instantly find a first-rate one overseas at half the cost?" says John Tuder, CEO of Videos.com, a Dallas startup that's developing technology to deliver movies via set-top boxes and over the Internet.

Tuder spent much of Videos.com's first round of funding on software development, relying on Indian software firm Wipro Corp. to handle high-level architectural design and low-level coding. "I couldn't do half the development work [in the United States] for the same price and level of competence as I find in India," Tuder says. Videos.com uses 18 offshore programmers from Wipro, more staff than it has in Dallas-and Tuder expects that once second-round financing is completed, he'll be employing even more offshore workers. "They are on schedule and on budget with every aspect of a very large job," he says.

Among America's biggest companies, those using offshore programming include American Express, Aetna U.S. Healthcare, Compaq, General Motors, Home Depot, IBM, Microsoft, Motorola, Shell, Sprint, and 3M. General Electric uses four major Indian partners with dedicated facilities that employ 3,200 people who develop and maintain GE's systems, says Farley Blackman, a former director of offshore development at GE who's now CEO of outsourcing consulting firm StrategIM Corp. in Burlington, Vt. By 1999, "GE accounted for 8% of India's $4 billion software export business," Blackman says.

The trend is helping propel rapid growth in the IT economies of the supplier countries. In India, easily the biggest provider of offshore programming, IT exports have grown more than 55% a year for the past five years and are expected to reach $87 billion by 2008, according to a report McKinsey Group published last December. Some Indian services companies have become major suppliers in the process, such as Wipro, with $532 million in revenue.

But other countries are getting in on the act: According to research firm IDC, Mexico's offshore IT income will surge more than 80% to $30 million this year. "We've seen a steady increase in the use of offshore programming in recent years, and it's a trend that will continue for some time to come," says Rita Terdiman, VP and research director at Gartner Group. Besides India, Gartner sees IT expansion in places such as Egypt, Israel, Bulgaria, and Slovenia, she adds.

Russia has proved a good source of talent, according to Boeing Co.'s Commercial Aviation Group in Long Beach, Calif., which became aware of the skills available after it opened an office in Moscow. Rather than develop a state-of-the-art document-management system in-house, Boeing turned to IBS in Moscow. The system, called eMod, stores everything from Standard Generalized Markup Language text fragments to large graphics and video files.

"The eMod project is the Holy Grail of document management in that it stores a diverse range of content efficiently and has massive scalability," says Doug Alberg, senior manager at Boeing Commercial. "We simply defined the project at a high level and IBS took care of most of the details."

There are many other examples of big companies turning to offshore firms for sophisticated high-end projects. GE contracted India's Mascot Systems to Web-enable its legacy backbone and create an online invoicing system for its client base. Disney Co. hired another Indian firm, Pentafour, for high-end animation work. DaimlerCrysler's Mercedes-Benz division uses Infosys, also in India, for a variety of E-commerce assignments. Nortel Networks Corp. uses Wipro to write software for high-speed optical switches.

Many midsize companies and startups are also turning to offshore outsourcing, helped by improved international communications links and spurred by the need to get software developed quickly. "In the near future, it's the smaller and midsize companies that will profit the most by outsourcing offshore, as their expansion is often limited by an inability to find technical personnel," says Tom Lovely, president of Offshore Software Consulting, a Manchester, N.H., firm that specializes in hooking up U.S. firms with offshore partners.

Synxis Corp., a Denver application service provider that provides hospitality industry services, turned to Bulgarian programmers for a vital online hotel-reservation system. "This was more than time to market," says Art Blomberg, Synxis' director of hospitality development, "this was our do-or-die release. We'd made commitments to investors and clients that we had to fulfill."

Synxis' problem was that it couldn't find the Java programmers it needed. The company turned to Rila Solutions LLC, a New York firm that manages several large Bulgarian development facilities. Rila immediately assigned six programmers at $30 to $40 per hour, and the project met its deadline successfully.

Why Bulgaria? "Few realize that Bulgaria was actually the Silicon Valley of the former Soviet Union," says Rila CEO Christopher Hansen. Bulgaria was used by the Russians as a space-development center, he notes. In addition, IBM mainframes had been brought to Sofia, Bulgaria's capital, stripped down, and cloned for use behind the Iron Curtain.

In Bulgaria and other Eastern European countries, the university system was one of the few institutions to survive the fall of the Soviet Union. Almost every country in the region has a large network of colleges that produce far more IT graduates than are needed locally. That's why the Czech Republic, Hungary, Lithuania, Poland, Romania, and Ukraine, are starting to show up more on the offshore IT radar screen.

This availability of people trained in new technologies is one reason offshore services firms are being contracted to develop sophisticated new systems, in sharp contrast to the legacy systems maintenance associated with offshore programming in the past. "Low-cost 'body shop' work is declining rapidly," says Wipro CEO Vivek Paul. "With at least 30,000 highly trained software engineers in India and such a shortage in the States, it's no wonder we inherit so many mission-critical Internet and mobile technology-based projects."

U.S. businesses contracting with foreign IT-services companies cite the quality and availability of IT staff at least as often as the cost savings. "It's a well-kept secret that there are a lot of highly trained people, ready to work, in Russia," says Boeing's Alberg. "Certainly cost is important, but the sheer volume of IT resources is a competitive advantage."

Dick Jirsa, CIO at J.M. Smucker Co. in Orrville, Ohio, agrees. "Oracle programming is costing me a quarter of what it would here," he says. "But more important than that is the consistency and availability of resources, as well as responsiveness to our needs." Until recently, Smucker-a producer of jams, jellies, and preserves-relied exclusively on American companies to satisfy its IT outsourcing needs. Three years ago, it used as many as 20 outside contractors at its headquarters. Today only two remain, replaced offshore by India's Mascot Systems.

Jirsa complains of a heavy turnover in local consulting staff that sometimes halted progress due to retraining or delays in hiring replacements. He also cites rudeness and indifference to user concerns. "The Indians tend to be younger, more up-to-date technically, more energetic, and more customer-oriented than their U.S. counterparts," Jirsa says. "I've also found that younger American programmers tend to operate like drifters, skipping from company to company."

Jirsa isn't the only one to complain about homegrown talent. Stories abound of the arrogance of Silicon Valley hotshots who demand high salaries, stock options, and sign-on fees.

Another often-cited justification for offshore migration is quality. Indian companies such as Cognizant, Infosys, Mascot, Satyam, and Wipro go to great lengths to validate their work. Many of these large developers boast of having attained levels four or five of the Capability Maturity Model designed by the Software Engineering Institute, a U.S. government-funded organization. "When it comes to offshore quality, India, Ireland, and Israel are probably the best," says Gartner Group's Terdiman. "I recommend to clients that they only deal with Indian companies who are CMM Level 3 at least."

The institute's standard, developed to ensure quality in military software engineering, doesn't reflect well on the U.S. software industry. A March report by the institute concluded that offshore organizations achieve a higher maturity profile than U.S. firms. "There's a beta-testing mentality in America, with the result that software quality doesn't receive the emphasis it deserves," says Deb Mukherjee, chief technology officer at Farmer's Insurance Group in Los Angeles.

Farmer's uses 50 of Wipro's staff, mostly offshore, though a few remain on site. This work consists of two main sections: low-end maintenance and enhancement of legacy systems; and top-of-the-line Siebel customer-relationship management development and Oracle performance-tuning assignments. "This type of work is higher end than Internet development, with only a handful of people in North America who can do it," Mukherjee says. "We save a lot of money by utilizing Indian specialists."

Like many U.S. companies, Farmer's is using outsourcing as a way to keep up with the pace of technological change. "The IT landscape is changing so quickly that we no longer can afford to have technology as a core competency," Mukherjee says. "Our approach is to look to others for IT and develop a core competency in IT project management." A focus on project management is exactly what's needed when outsourcing development to offshore firms, according to U.S. executives. Whether the supplier is in India, Europe, or Latin America, project management can often be a weak link and should be given almost as much emphasis as software development itself, they say.

The Principal Financial Group, for instance, initially experienced communication and coordination challenges when working with its development partner in Mexico. Principal, in Des Moines, Iowa, works with Softtek in Monterrey, Mexico, on the development of a systems administration package used by its affiliates and branches in other countries. To resolve teething troubles, both sides worked together to install a frame relay connection and hire a bilingual project manager. "By focusing on improved communication, Softtek became very responsive to our needs," says Jim Allen, a senior IT analyst at Principal. "As we continue to grow, I can see us outsourcing a lot more of our development work to Monterrey."

To avoid management glitches-and to make it easier to win business with U.S. companies-offshore firms are establishing a stronger U.S. presence. Akshay Software International Inc. has 60 U.S.-based workers handling on-site development and coordination with clients. CEO Anant Viswanath recommends three ingredients for harmony between clients and offshore partners: putting in dedicated communication links, finding a supplier with a well-organized U.S. base, and appointing someone with full responsibility for project management.

Establishing U.S. offices may also reassure prospective customers who are worried about disputes with offshore services firms. Few would savor a lengthy legal battle waged in either India or Russia, but if offshore partners have a significant U.S. presence, there's the prospect of resorting to the American legal system. However, big companies with the resources to establish U.S. offices may not always be the best choice, says Lovely of Offshore Software Consulting. "Unless you have an established relationship with one of the big Indian firms, you may be better going to a smaller competitor who is more focused on your needs," he says.

The amount of coordination involved in offshore outsourcing leads some to suggest that small outsourcing projects should be avoided. It can take months to lay a solid foundation between partners, so fast-turnaround jobs may not succeed, particularly in a new relationship. "Longer projects or continuing maintenance-type tasks make better candidates to send offshore," Lovely says. "But once the lines get established, it isn't a resource that you'd ever want to get rid of. You can ramp it up at will, hire a core team that is dedicated only to your needs, and reduce costs considerably."

As offshore suppliers, such as the big Indian services companies, become more established and accepted, their prices will inevitably rise. However, there will still be bargains as suppliers from Eastern Europe, Latin America, and the Middle and Far East offer lower rates in order to enter the market. Another way to land a good deal, Lovely says, is to find an Eastern European or Indian who's just spent a few years in America and is moving back home to start an offshore business. "That usually guarantees you a great price from someone who has already established credibility in the home market," Lovely says.

With the U.S. Department of Labor predicting that 1.7 million IT jobs will be created this year-and that up to half of them may go unfilled-the continued growth in offshore development seems inevitable. "No one can grow as fast as they want to due to the chronic shortage of programmers," says Carlos Cashman, CTO of Opus360 Corp., a New York supplier of offshore development services. "It's all about supply and demand. The supply is abundant overseas and the demand in America will continue to grow."

Russia, the rest of Eastern Europe, Latin America, Jordan, and even China are gearing up to develop the software the West requires. And many U.S. companies are discovering that, as long as projects are carefully managed, entrusting foreign suppliers with systems development can be highly rewarding. Wayne Norris, manager of research and development at Santa Barbara, Calif., software provider Biopac Systems Inc., has four Russian developers working on site in California, with another in St. Petersburg, Russia. All are supplied by Contex, a Russian services firm. "While the price is certainly right, what is more important is that I trust my St. Petersburg resources to get the job done," Norris says.

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