JANUARY 5, 2004

By Christopher Kenton

The Changing Face of Offshore Programming

Yes, it's still the cheaper option -- but the price differential is shrinking fast, and the hidden costs can be fierce

After nine months of exposure to the overseas outsourcing market, I'm ready to give an update on the realities of outsourcing for small businesses. This is an emotionally charged issue for a lot of people in the U.S., so let me start by saying up front that the results are mixed. Like a lot of larger businesses, I've discovered a number of hidden risks and costs. While I don't think those issues will end the trend of sending jobs to cheaper labor markets, I do think the wholesale enthusiasm for outsourcing overseas is quickly waning.

I'm not going to recount all the issues and arguments about why I started exploring overseas labor markets, as it tends to spark an explosion of angry mail. Instead, I'm going to stick to the results I've experienced, and some trends that I've seen that confirm my belief that while outsourcing represents a serious risk to the stability of our economy, I doesn't spell the end of American enterprise, as many critics claim.

Let's start with the details. Since the first project I outsourced to Argentina and wrote about in this column, I've worked on projects outsourced to Brazil, to multiple groups in India, and I've reviewed proposals from China, Poland, the Philippines, Taiwan and Russia (see BW Online, 4/11/03, "The Woman behind the Code"). On every project that I considered outsourcing, I also solicited bids from American programmers, and about 60% of the time, Americans won the business. I see no sign of that success rate diminishing for American programmers, and in fact, I see a few signs that lead me to suspect it may grow.

A big disclaimer here: I'm dealing with outsourcing on a per-project basis. There are forces shaping my market that don't apply to big companies outsourcing overseas, so my views are limited to small businesses and not to the market as a whole. The one thing that I believe applies to both small and large businesses is that hidden costs add up quickly.

CUT-PRICE EDUCATION. The first thing area of hidden costs relates to project management -- costs that are included when you have a development team under your own roof. That sounds obvious, but in practice, it's eye-opening. I've spent a lot more time than I expected in project management, quality assurance, contract issues, and communication. These issues have added significantly to the bottom-line costs of outsourcing. In some ways, however, they have also provided me with a valuable education.

I've realized that with programmers under my own roof, I used to get away with a lot of shaky project practices in scope management, discovery, documentation, and testing. If you don't have these processes well under control, outsourcing will burn you severely. If you don't know what I'm babbling about, don't even think about outsourcing overseas. It may sound cheap and easy, but I've seen two companies get in over their heads, and with disastrous results.

The second area of hidden costs relates to business risks and requirements. As many outfits doing business overseas for the first time are discovering, there are few reliable standards for intellectual property protection and contract enforcement. A contract is only as strong as your ability to effectively enforce it. If you can't afford the enormous costs of fighting an international legal battle, you should think twice about sending anything proprietary overseas. In a future column, I'll tell you about two companies I know fighting legal battles over intellectual property (IP) stolen by overseas vendors.

RISKS AND REWARDS. One strategy for dealing with IP risks is to break a project up into components that can be outsourced to different vendors, all blind to the complete project. One of my clients requested this kind of arrangement so it could benefit from cheap labor costs on a piecemeal basis, but the added cost of project management and integration required to bring the separate pieces back together eliminated most of the savings while introducing new risks in quality control.

And this brings up the third area of hidden costs I've discovered with my own outsourced projects -- quality control. While the general quality of projects I've outsourced overseas has been high, I have employed local programmers to provide oversight on both the outbound and inbound side of project deliverables. Call me crazy, but I don't think it's smart to deliver a code base with comments and variables written in a language you don't understand.

A general strategy that some companies use to deal with all of these risks is to outsource the project to a domestic company with overseas development partners. The local company takes on all the risk and accountability for the project. But there are risks here, too. One of my clients who took this route discovered that while their localized vendor was passing along savings on programming labor, it was front-loading costs on project management, which is where they make their money. I don't say that impugn every domestic outsourcing agency, as I'm sure there are some good ones, but you better know the pitfalls before you sign up.

EXPANDING EQUILIBRIUM. All of this has led me to be very particular about the types of projects I'm personally willing to outsource overseas, and to be increasingly diligent about my own project management process to ensure that I actually realize the margins I expect. In general, I'm outsourcing non-sensitive projects that include a significant programming labor component. Anything sensitive, including projects with intellectual property or risky e-commerce components, goes first to a trusted American partner who can, in turn, outsource whatever they're comfortable sending out. To me, it's just not worth the risk of winding up in court over something that provides marginal savings -- savings that seem to be diminishing regularly.

I mentioned in one of my contentious articles on outsourcing that I didn't believe the trends that have caused the epidemic of outsourcing would continue indefinitely (see BW Online, 4/25/03, "Grasping, Greedy, Unpatriotic? Not Me"). My major arguments were that overseas labor costs would rise with increasing demand, and that increasing patronage would gradually empower workers overseas and inspire more of the local labor regulations and controls that add to labor costs in the U.S. One of those trends is already happening, at least in the labor markets I've been exploring.

Six months ago, I could find high-level programmers in India willing work for $15 an hour, vs. the $100-plus an hour I was paying Americans for the same work. In only six months, that rate has climbed to $25 an hour in India, while my domestic rates have dropped to around $35-$50. On the last project I bid out, two proposals from India came in higher than domestic contractors. Admittedly, I'm in a very small sector of the larger market, and it's too soon to tell even here whether the trend will last, but I've heard similar reports from other businesses (see BW Online, 12/2/03, "U.S. Programmers at Overseas Salaries").

COLD COMFORT, HIGH HOPES. The speed with which this trend popped up suggests not so much that outsourcing overseas is already losing it's value, but that the factors driving cheap labor in foreign markets are a lot more fluid than we may believe -- especially in countries with the talent and infrastructure to provide quality of service.

In the end, I believe labor markets will equalize more rapidly than we might think -- just how long that takes is a question I can't honestly address. I realize that's of small comfort to the American developers who are out of work this holiday season, or to those taking a much smaller wage than they enjoyed three years ago. If you're one of them, I can only say that I understand your circumstance more than you might think.

Despite what some readers seem to think, writing this column doesn't make me wealthy or successful. The truth is that I'm still struggling mightily to recover my own business after the recession, and glowing economic numbers notwithstanding, the outcome is still far from clear. All I can do is continue to work as hard as I can in the new year, and to try to understand what it takes to run a viable and honorable business in a global economy that I truly believe in the long run will provide a better world for my son. Happy New Year.