The New Taboo

Is offshore outsourcing too politically charged for government?

by / March 26, 2004
In late 2003, a series of critical newspaper articles prompted Indiana Gov. Joseph Kernan to abruptly cancel a state contract that may have sent some systems development work overseas. The uproar convinced Kernan to launch an initiative encouraging use of homegrown talent in state agency contracts.

Indiana isn't the only place where anti-offshore sentiment is brewing. Bills in 28 state legislatures now seek to ban offshore outsourcing in state agency contracts. Sending technology work overseas may not be new, but it has become a political hot potato for many jurisdictions as more IT tasks are performed beyond U.S. borders.

Opponents contend offshore outsourcing steals high-paying jobs from skilled U.S. workers during a painful economic downturn. Proponents counter that offshoring provides better IT talent at a lower cost to taxpayers.

That debate won't end anytime soon. Analysts predict steady growth for offshore outsourcing over the next few years. And in states such as Texas, where contracts using offshore labor were awarded with little public outcry, it's a tool that might prove tough to ignore for cost-conscious agencies.

Outsourcing Under Fire
The decision by some states to ban offshore outsourcing in state contracts isn't surprising, given the sudden shift in public perception, said Martin Clague, CEO of Covansys, which offers various technology services, including application maintenance and development, through U.S.-based or offshore IT talent.

"That's just the emotion of the time," he said, adding that reviewing state RFPs over the last six months reveals that practically all RFPs now specify where a project must be completed, though some RFPs indicate a willingness to consider offshore outsourcing.

Some states have asked the company to submit two bids for comparison, Clague said -- one using in-state labor, and one with an out-of-state component.

Offshore outsourcing will see less consideration from states in the short term because of negative press, he said. But if one state acknowledges the value of offshore outsourcing and varies from the anti-offshore course, other states will consider it.

"State and local governments nationwide are facing severe budget shortfalls," Clague said. "At the same time, they are struggling to meet the service needs of an increasingly Internet-savvy constituency demanding e-government services. This will ultimately seek its own level, based on economics, causing states to reconsider offshore involvement."

Reasons Why
In early January, Intel CEO Craig Barrett set everybody on edge -- he said the era of the United States' lock on white-collar and high-tech jobs is over because U.S. IT professionals are losing their competitive advantage.

Recent research from the National Association of Software and Service Companies (NASSCOM), which promotes India's IT industry and fosters a business-friendly environment for companies setting up shop in that country, shows a significant increase in the number of IT professionals in India.

From 1986 to 2002, India increased its skilled IT workers from 6,800 to 522,000, NASSCOM said. Of those, 170,000 work in the IT software and services export industry; approximately 106,000 work in IT-enabled services; and more than 220,000 work in user organizations.

Based on current rates of high-school graduates going on to higher education, NASSCOM's research predicts the Indian IT industry will have a labor pool of approximately 17 million skilled workers by 2008.

Can the United States catch up? It could be difficult, observers say. The growing number of IT professionals abroad is one problem, and skill sets of the offshore work force are another.

"For at least six years, the curricula at the well known U.S. schools were teaching people how to design what the computer screen looks like graphically, how to draw people into the site, how to sell over the Web and intuitive computing," Clague said, arguing those skills aren't necessary now, and a lot of people are out of work as a result.

Displaced IT professionals who returned to school in 2002 to learn IT skills that do relate to today's marketplace won't start graduating until 2006, he said.

"That's agreeing that, in 2002, American IT workers started to go back to basic programming languages, data architecting, architecting portals and understanding all the underpinnings of IT, which you need to know to do a portal," he said.

Savings Game
Perhaps the biggest lure of offshore outsourcing is the perceived cost savings, especially in application development, because programmers offshore are paid far lower hourly wages than their U.S. counterparts.

But lower wages don't necessarily translate into savings, said Joseph Feiman, a vice president and research director at Gartner Group.

"The major problem we see in those decision-makers that look at outsourcing is they think if billing rates charged by, let's say an offshore Indian company, are three times lower than the cost of labor here, then the savings by outsourcing would be three times," he said.

Gartner advises enterprises to consider how other costs could eat into the savings generated by lower billing rates, said Feiman. Gartner developed a model to analyze the total cost of outsourcing based on billing rates, communication and effectiveness.

The communication parameter is a numerical measurement of the cultural difference and geographic distance between the customer and external service provider (ESP), whether the ESP is hundreds of miles away or thousands of miles away, Feiman said. The effectiveness parameter is a measure of the ESP's expertise in technology, project management and business domain.

"Once the ESP is offshore, in addition to the cultural distance, you have geographical distance, time zone differences and the necessity to collaborate only by electronic media," he said. "It's very difficult to build trust with someone you've never seen in your life. You cannot make a judgment whether to outsource just based on billing rates. You have to adjust any cost estimate by that communication factor and by effectiveness."

On the other hand, Indian ESPs can be highly qualified and knowledgeable, he added. Many of them have reached the highest rating -- level five -- in Carnegie Mellon University's Software Engineering Institute's Capability Maturity Model Integration (CMMI) measurement scale for IT service providers.

Texas Payoff
In Texas, the Texas Health and Human Services Commission's HIPAA Compliance Office was under the gun to meet a requirement that all health-care provider remittance claims be converted from paper forms to a specific electronic data interchange format.

To meet the scheduled deadline, a java application to serve approximately 2,500 pharmacies and eight service bureaus had to be designed, coded, tested and implemented in 10 weeks, according to Brad Ring, a product delivery manager in the Texas Department of Human Services' (DHS) project management office, which managed and implemented the project.

Texas selected Infinite Computer Solutions (ICS), which has offices in Dallas, to devise the application, Ring said. ICS won the contract for several reasons: The CMMI level-five certified vendor produced a bid that met the established evaluation criteria at a significantly lower cost than competing bidders, and it could meet the tight deadline.

"We felt because of the time frame, we would not be able to recruit people within this area or within central Texas who had the skills necessary and could pull it all together to make it work within this very aggressive time frame," Ring said. "This was a federally mandated deadline, and there's a federal sanction of $2,500 per day for every day that it [the application] wasn't put in. We were highly motivated to make sure it was done on time."

A Matter of Appearance
The Texas DHS Project Management Office confronted a worry familiar to a growing number of jurisdictions: Offshore outsourcing was a viable solution, but what fallout would it trigger?

"The discussions we had centered around the fact that in Austin, there are some people who are unemployed -- like in any other tech city," Ring said. "That was a real issue. It wasn't so much an issue of 'Should we use offshore?' We couldn't find anything wrong with that business model. We saw the benefits of it, and we had confidence it would work.

"We were concerned about the perception that it would create publicly if we did this for the first time," he said. "Now that it's been done, for almost three months there hasn't been any backlash at all."

He said project management staff worried the public would believe Texas was ignoring the local talent pool, despite the fact that the winning vendor offered the best combination of resources and skills, and could meet the agency's schedule and price.

"The bid from ICS came in at $180,000 for all the work," he said. "The next two lowest bids were $2.1 million and $2.4 million. This was about one-tenth of the cost, so how can I justify paying $2.1 million to get this job done? Actually that $2.1 million bid came from a large Fortune 500 company that may or may not use local resources -- and that's most likely since it's not headquartered here and it's not even headquartered in Texas.

"They would fly people in to manage this project, and we still would not be developing any local resources or providing any jobs if we went that direction," he said. "People need to be aware that most Fortune 500 companies are doing this either directly or indirectly to save costs. If a state is going to contract with a Fortune 500 company, there is no guarantee any jobs will be created."

ICS has offices in Dallas, he said. If that wasn't the case, it couldn't have won the contract because of legal issues involved with contracting directly with an Indian company lacking U.S. presence.

Opposite in Indiana
Kernan, of Indiana, took a completely different tack in November 2003. After a series of newspaper stories criticizing a state agency's $15 million contract with a company -- Tata Consultancy Services America (TCS America) -- that used offshore labor, Kernan canceled the contract.

In a statement, Kernan made no bones about the reason for pulling the plug. "As leaders, we have an obligation to build the capacity of our businesses here at home," he said. "The state has a responsibility to purchase a lot of goods and services on behalf of Hoosiers at a low cost, and we also have a responsibility to keep and create jobs here in Indiana. Those two things are not mutually exclusive. We have to marry these different responsibilities, work together across government and business, and take the whole effort to a new level."

That 'new level' is Kernan's Opportunity Indiana program -- announced at the time of the contract cancellation -- designed to examine and reform state government procurement with an eye toward giving Indiana businesses more chances to sell goods and services to the state.

Kernan singled out the contract between the Indiana Department of Workforce Development (DWD) and TCS America to upgrade the DWD's unemployment insurance computer system, saying the way the contract was created and put out for bid prevented Indiana companies from competing for the work.

Horse of a Different Color
From TCS America's perspective, being called an "offshore outsourcing" company misses the point.

"We get characterized as an 'offshore company,' and that's not actually correct," said Jim Thomas, TCS America's vice president of marketing North America. "We are a global company. We have clients in 55 countries around the world. We operate completely on a global model. Within the United States, we have almost 7,000 employees and our U.S. headquarters is in New York City."

TCS America has no qualms about going after business in state government and offering an offshore model for application development, Thomas said. But the company is sensitive to the PR issues facing government over situations like the Indiana DWD contract.

"Almost every one of our bids in state contracts are for on-site work," Thomas said. "The Indiana contract was going to be 100 percent done on-site in Indianapolis. Not a single piece of work was going to be done offshore."

He said TCS America likely would have brought in TCS employees onsite to do a big part of the work, and that 18 state workers would also have been involved in the project. Even with the structure of the contract stressing on-site development, Thomas said he's not surprised the DWD contract got so much bad press, given that this is an election year, but wishes the situation hadn't deteriorated to that point.

"In the process of signing the contract and the events that occurred leading up to the canceling of the contract, there was a great deal of misinformation published within the press," Thomas said. "Had more correct information been published, things might have turned out differently. If you go look at all the articles printed early on about the contract, all the opponents to the contract were talking about work going offshore to India. In this particular contract, not a single thing was going offshore.

"The election year certainly provides an opportunity for this to become a forum for a lot of people," he added. "Now will that forum still be there when the elections are over?"

Keeping IT in Indiana
Kernan's first step in kick-starting Opportunity Indiana was to create a work group to review Indiana's procurement. Chuck Martindale, commissioner of the Indiana Department of Administration, heads the task force.

Martindale said the DWD's RFP is a prime example of what could be changed.

"No companies that were domiciled in Indiana had the ability, from a size standpoint and a structural standpoint, to tackle the massive project," Martindale said. "We stepped back and said, 'Is there a better way to restructure this RFP, to where instead of buying the complete project, can we do it in increments? Can we do the tax system with one vendor, and employment services with another vendor?'"

In the disputed DWD contract, TCS America submitted a bid that was $8 million less than other bids, was ratified by a panel of subject-matter experts and met all the qualifications set out by the procurement process. Martindale said it's not yet known if a new procurement process that gives Indiana companies the chance to compete on big projects will save the state a comparable amount of money.

"You don't know if you don't try," he said.

The task force also is stressing that the state wants to see as many subcontracting opportunities for Indiana firms as possible, he said. If a company domiciled in Indiana can't be the prime contractor, the task force wants to make sure the prime contractor gives Indiana-based companies the chance to compete for subcontracting.

Given the public outrage over the DWD contract that forced Kernan to take action, one might think the state has a habit of ignoring Indiana firms in state procurement practices.

However, over the last five years, Martindale said, more than 90 percent of the state's contracts for construction activities and 85 percent of the contracts for professional services have been awarded to vendors with Indiana addresses. Indiana companies are clearly not being shut out of state business, but the coverage of the DWD contract still struck a chord with the public.

Martindale said talks with procurement professionals in other states revealed they faced the same issues because of the national recession.

"There's a tendency to want to try to help your own," he said. "There's a tendency to buy Indiana, buy Georgia, buy California or buy local. You have to weigh the public benefit versus being a good steward with the public dollar."
Shane Peterson Associate Editor