Off-Shoring the Back Office Let’s face it, there’s hardly a business topic that’s more emotionally charged than off-shoring: the new trend of outsourcing business processes to foreign workers. It is much cheaper to pay people in other countries to do this routine work because they are paid only a small fraction of the salaries that American workers receive.
Few people noticed this trend in the low unemployment days of the Internet boom. However, when new jobs began to disappear, and companies felt the profit squeeze of high labor costs and global competition, off-shoring rose to central prominence.
The reason it’s a big story right nowis that it’s politically charged. People who have been laid off and feel vulnerable worry that their jobs might go to India or China soon. To many, it just doesn’t seem right for American companies to pay programmers or call-center operators in India to do jobs formerly done by Americans, especially when many Americans are looking for jobs.
However, many of these jobs are candidates for automation, so they don’t represent very secure jobs for Americans in the future. Eventually, computers will do much of the routine work, and so, even at subsistence Third World wage levels, there will be no justification for people to do them.
Also, for many businesses, offshoring seems like the only economically sensible approach for managing many non-core activities. Furthermore, GDP is essentially a product of the number of hours worked and productivity per hour. The shortfall implied by the skills gap discussed earlier means that our growth is going to grind almost to a halt in the next two decades ? unless we find a way around the demographic constraints imposed by the existing American population. And, the strong growth of the elderly population and other domestic burdens threaten to overwhelm our resources and diminish our standard of living.
Given these realities, let’s explore what’s driving the offshoring of low- to mediumskilled, information-handling work. These are the types of jobs that are found in call centers, insurance claim processing facilities, and the back offices of banks and insurance companies.
The confluence of two major forces has resulted in the rapid rise in the use of off-shoring by American businesses. In last September’s issue of Trends, we discussed the continued globalization of the economy. Globalization is reshaping our lives, careers and investments. We discussed how, whether you’re a globe-trotting Fortune 500 CEO or a small businessperson doing business in America’s heartland, globalization is heading your way ? and you’d better be ready for it.
Globalization, combined with the growing use of subcontracting arrangements, has led U.S. companies to develop global supply networks with suppliers in nearby NAFTA-member countries and with overseas trading partners, particularly in the Asia-Pacific basin. Due to the different distances, the former type of subcontracting deals are labeled near-shore supply arrangements, and the latter are called off-shore supply arrangements.
The rise of the Internet and improved communications links have enabled companies to expand their reach. Technology makes off-shoring possible through the availability of high-speed networks and massive computing power, together with software that makes it easy to manage systems from remote locations. Through off-shoring, companies can save money and avoid labor conflicts.
Although estimates of the size of the off-shoring market differ, the movement of IT-related work and of back-office processing from developed countries to vendors in emerging markets is an irreversible mega-trend. Consider the following:
? Companies have already offshored 2 percent of the 10 million computer-related jobs in the U.S., according to Information Technology Associates of America figures. Forrester Research estimates that American outsourcers have moved 400,000 back-office processing jobs overseas.? One-fifth of Fortune 1000 companies have already offshored some portion of their operations to India, according to McKinsey Global Institute. McKinsey estimates that $32 billion to $35 billion worth of outsourced business functions have already moved off-shore. ? India now has about 9 million college students, compared with 13 million in the U.S.1 Each year, India produces 2 million college graduates ? 80 percent of them English speakers who have no language barrier to working for U.S. companies.
The U.S. and India represent the majority of the world’s outsourcing industry ? both in terms of customers and suppliers. Two-thirds of India’s annual $13 billion in software and back-office revenues already come from U.S. companies. The Gartner Group has predicted that India will represent twothirds of the international “offshore market” for outsourcing services within three to four years.
The Indian off-shoring industry has been growing at a mindboggling 60 to 70 percent annually, according to McKinsey research. The Indian back-office services industry is currently worth $3.5 billion. A new research report from Morgan Stanley predicts that Indian firms will generate over $62 billion from off-shoring revenues by 2010.
According to Economic Intelligence Group research, call centers account for 65 to 70 percent of India’s revenues from off-shoring. Scores of American firms have relocated their call-center operations and other back-office tasks to India to save money.
And probably nowhere is this felt more than in the financial services industry. A report published by Deloitte Research estimates that $356 billion of costs for the global financial services industry will move off-shore, much of it to India.2 Chances are high that if you phone a customer service representative at Prudential or Citibank, you will reach an Indian call center.
Reduced costs are by far the greatest source of value for U.S. companies that off-shore. For every dollar of spending on business services that moves offshore, U.S. companies save 58 cents, mainly in wages. The easiest jobs to send abroad involve routine back-office record keeping that’s fairly labor-intensive, such as insurance claims, personnel forms, and billing records.
Wages for these jobs abroad are quite low compared to salaries in the U.S.3 Here are three examples:
1. While American workers are paid $10 an hour in call centers, Indians are paid $1.50.2. Insurance claim workers receive $1,500 a month in the U.S., versus $300 in India.3. U.S. accountants charge $75,000 a year for the same work that Indian accountants can do for $15,000.
Yet, off-shoring is only a shortterm solution. Call-center jobs going off-shore are unskilled. Such tasks can already be replaced by technology as some help desks have done. Such jobs may go to India now, but natural language voice recognition technology means they may not exist soon.
Also, experts say that U.S. companies often fail to anticipate how much money and energy they’ll spend dealing with cultural differences. Many of the offshoring success stories are big, IT-heavy companies like GE and Citigroup. They have been at it for years and have taken things slowly. They also enjoy huge economies of scale.
Merely managing a supply relationship will result in administrative costs for the client company of 3 to 10 percent of the value of a contract, as studies reveal. When these costs are factored in, many analysts put the real savings from off-shoring at 20 percent to 40 percent.
The big question for your organization is will these savings offset potential reductions in employee morale and weakening of customer relationships that are not currently virtual in nature?
By assuming that outsourcing is the answer rather than critically assessing its pros and cons, companies may be failing to do what really matters: improving a company’s performance and maximizing value. Outsourcing can be instrumental in realizing these goals ? but not always.
McKinsey consultants estimate that internal improvements alone can produce savings comparable to those of off-shoring ? for instance, 20 to 30 percent gains in direct labor productivity, improved purchasing practices, and reductions in required floor space. In most cases, a thorough make-versus-buy analysis will uncover total savings of 8 to 18 percent.
Today, many American managers believe in the value of outsourcing and off-shoring, and assume that it creates an advantage in every situation. But, based on the lack of evidence to the contrary, Michael Porter, the eminent Harvard Business School strategy professor, cautions that offshoring has become a fad.4
There are already cases of companies that used outsourcing and off-shoring, only to have it backfire. For example, both Lehman Brothers and Dell Computer offshored their call centers ? and then moved them back to the U.S. after customers complained about poor service.
However, many other companies have received satisfactory service at reduced costs ? and that is enough to power this trend into the next decade.
Based on the preceding discussion, we predict the following developments:
First, because of the significant benefits already being realized, the off-shoring market will grow by 30 to 40 percent annually over the next five years. This prospect may cause more job losses in the United States, but it will make off-shoring an industry with well over $100 billion in annual revenues by 2008.
Second, between 3 million and 6 million American jobs will be off-shored in the next 10 years. Forrester Research projects that 3.3 million U.S. jobs will shift from the U.S. to lowcost countries by 2015. This includes 1.7 million back-office positions and 473,000 IT positions, accounting for $136 billion in wages. Goldman Sachs Group estimates that even more jobs, as many as 6 million positions, will be sent abroad by 2013.
Third, all rules-based administrative functions will become candidates for offshoring. By the end of the decade, half of Fortune 500 firms will have off-shored the entire chain of the following back-office activities: accounts receivable, accounts payable, order placement, and account inquiry processes.
Fourth, companies will face growing dissatisfaction with poorly trained overseas operators and customer service representatives. We expect this will be a particularly acute problem for retail consumer products companies. To head off a potential backlash from consumer groups, we forecast most American retail fast-moving consumer goods companies will near-source their order placement and account inquiry processes to Canada and Mexico. Mexico will provide Spanishspeaking relationship managers to support the growing Hispanic population in the U.S.
Fifth, the controversy over off-shoring American backoffice jobs will disappear over the next few years. As the economy rebounds, there will be plenty of jobs for American workers, and those jobs will offer higher pay and more interesting work than the jobs that will be sent overseas.
Sixth, several global financial services companies will open their existing off-shored service centers to American firms. By the end of the decade, these overseas centers will process all of the non-strategic financial functions, including payroll and accounting, for a growing number of U.S. clients.
Seventh, one or two nonfinancial, corporate firms that have successfully off-shored their own back-office operations will create subsidiaries that will process transactions for other Fortune 1000 companies. These subsidiaries will compete directly with financial services providers and traditional outsourcers who are providing these services.
References List :
1. The Washington Post, January 14, 2004, "The Spector of Outsourcing," by Robert J. Samuelson. ⓒ Copyright 2004 by The Washington Post Co. All rights reserved. 2. The Times, April 12, 2003, "India Set for Flood of Jobs from the West," by Caroline Merrell. ⓒ Copyright 2003 by Times Newspapers Ltd. All rights reserved. 3. The Washington Post, January 14, 2004, "The Spector of Outsourcing," by Robert J. Samuelson. ⓒ Copyright 2004 by The Washington Post Co. All rights reserved. 4. Financial Times, October 14, 2003, "Unhappy with Outsourcing," by Michael Skapinker. ⓒ Copyright 2003 by The Financial Times, Ltd. All rights reserved.
