News and New Products

Offshoring’s Mixed Appeal

By Ed Sperling -- Electronic News, 6/11/2004

Electronic News sat down to discuss offshoring with Rahm Shastry, president and CEO of Tharas Systems; Barry Hoberman, chairman and president and CEO of Virtual Silicon; Sujata Milick, policy analyst for the U.S. Department of Commerce’s Office of Technology Policy; and Bernard Smith, VP of the Ireland Investment and Development Agency.

Electronic News: What works and what doesn’t in offshoring?
Hoberman: What has raised so much interest is the migration of jobs out of the U.S. or other Western industrialized countries to lower cost areas. What is different is that the shift is now starting to include the white-collar, professional, highly trained college graduate, PhD, and technician-level jobs, in addition to what has been historically manufacturing or low-value added manufacturing. Any sense of alarm is they’re concerned there is a new source of competition that may have effects on people who for a long time felt immune to being touched. You’ve hit a raw nerve, and that’s the source of controversy.
Milick: We’re currently looking at the larger phenomenon of global workers. It’s not just work leaving the United States. It’s also work coming in. There’s concern at all levels about the nature of work. There is a high level of interest in what’s happening to work, how is it changing, what are some strategies for American companies, what are the incentives that drive these strategies.
Shastry: This is part of the free trade. Free trade means free movement of products and personnel. In order for a company to be viable, they have to get the best source. It just keeps moving. From Taiwan it went to China. From Europe it went to Eastern Europe. This is a productivity issue -- how do I get the most value out of the least investment. Now, because we have gone through this terrible recession, with the stock market dropping we have the phenomenon of jobs leaving the states. In 1985 to 1986, we were worried about the DRAM business going out of the Valley. Intel was about to go out as a DRAM company. Now they are the No. 1 semiconductor company. They figured out where they can add value. DRAM was becoming commodity. The mundane tasks tend to go. It’s not only mundane tasks, but this is the ebb and flow of the world economy.

Electronic News: Are only the value-added or differentiated tasks going?
Hoberman: The source for manufacturing or service is going to go to the lowest cost source in a free economy. In the opening of the world economy, the improvement in the communications infrastructure and the reduction in cost in global transportation is making it possible for what historically has been intellectually related goods and services to be sourced at lower cost. To the extent I can find an engineer who can design advanced circuits at less cost than I can do in San Jose, I’m going to that. The higher-paying rewards are going to go to the individuals or sources that can provide a value add than what someone else can provide.
Shastry: If you don’t do it, your competition will, and that’s the biggest driver. People have to get the best value or service or you will lose. That’s why it feels like a herd mentality in the United States. It’s also happening in Europe, but less so in Japan because of the language barriers. It’s a global phenomenon.

Electronic News: Does it always work as planned, though?
Hoberman: As the manager of a company, I’ve had four offshore locations in the past 10 years -- two in India, one in Singapore and one in Eastern Europe. You need the right skill base and the local infrastructure, but from a management perspective, you need for your offshore location to be working the same mission as your company. There’s a choice managers face in pursuing an offshore location, whether they want an owned subsidiary or a contracted outsource arrangement with another company. The decision to do either is a function of the level of cooperation you get from the team you’re going to work with. Second, the leadership of that offshore team needs to be fully integrated with the relevant management team that’s doing the outsourcing. With those ‘soft’ facets in alignment and the logistics in place, you can make it work pretty well. If you’re missing those, you can have a catastrophe.
Shastry: Just like any project, whether it’s domestic or offshore, you have to manage. The difference here is you have immediate communication, local access, so the management becomes easier. I have heard of some horror stories in the Valley. It just needs to be managed better and make sure everyone is synchronized in what you’re trying to accomplish. We don’t do offshoring at Tharas because we are too small. There is an infrastructure up-front cost that needs to be amortized over a larger R&D budget. If you have five people, their labor costs may be one-third to one-fourth of what they cost in the Valley. But if you add up all the other expenses, such as travel, communication, the infrastructure, you’re not that far off. And then you have a 24-hour workday. Bigger companies have the muscle and they can do it.
Smith: We recently did a study on offshoring in India and China. The costs of software developers in India and China are about 20 percent of the costs in Ireland. But when it came down to the fully loaded costs, which include managing it properly and sending people over for training, interaction between the parent company and the company overseas, the cost rolls up to be 50 percent to 60 percent. And when you add in the difficulty of finding people to go out and manage it and soft factors like schooling for kids, it came up to 60 percent to 70 percent. When companies are investing in India and China they need to have operations of at least 200 to 250 people before it starts making sense to go over there. There is a critical mass that’s necessary.

Electronic News: Is work being broken down into different pieces because of offshoring?
Hoberman: I suspect every business is a little different. What we’re doing at Virtual Silicon is not atypical. We’ve recently opened a semiconductor design operation in Russia. A good portion of the engineering in our business is service-related as opposed to new science. That service-related engineering, which doesn’t have quite the degree of innovation in it that our new science does, needs to be done at the lowest possible cost. Our competitors perform those functions in remote locations, as well. Being able to perform those services, which are not our value-added services, at the lowest possible cost is critical to what we do. We’ve taken a close look at what are the bottom two quartiles of the engineering work that we do, and we’ve been able to move them to a much lower cost.

Electronic News: Is there a stigma to offshoring and how does that affect a company’s image?
Shastry: I am measured on the performance of the company -- what’s the revenue, am I profitable. It all depends on how you do it. There is a question in the market of, ‘What are we going to do for our children?’ Are all the jobs going away? This concern was there 15 to 20 years ago in the manufacturing segment. Silicon Valley has always turned around and the Valley is the most energetic place in the world. In the transition phase, people don’t know what’s going to end up there because this is a transition phase. We will figure out or develop processes that leverage the talent we have here in the Valley. We have great schools -- Stanford and Berkeley -- and they produce great engineers and management people. We are in a change and it’s tough to look further.
Hoberman: If you break away from the context of outsourcing, no one is saying the technology world in Silicon Valley is out of ideas and has nowhere else to grow. Wireless, networking, advanced consumer and media, the conversion of all of our media to digital electronics -- there are so many areas exploding in new technology. The impact of outsourcing is that it’s forcing engineers and managers who haven’t had to ask the question, ‘How do I make sure my career stays on line so I can continue enjoying the fruits of those opportunities as they develop in the market?’ In our move to Russia, it displaced some jobs in the company, and it has our employees here questioning what they need to do to remain a viable Silicon Valley worker. I think that’s the right question for them to ask.
Smith: What we’ve seen in Ireland in the last 50 years is the economy come from a low-cost producing economy to an economy that is trying to be one of the leaders in research and development. We’re putting money into higher value products and services, we’re putting money into education. Global companies will seek the resources they need at the lowest cost that they can. But what also will happen is that economies like China and India will create more affluent societies, create huge marketplaces for the companies that are investing there, and they will require more innovation and technology. Silicon Valley needs to invest in the area of technology and innovation and infrastructure. Economies go through cycles of three to five years, and then you can look back and say you’ve come a long way.

Electronic News: Because of all these changes, do companies have to re-evaluate their business models more frequently than in the past?
Shastry: We look at our business model every quarter. We are driven on a quarterly basis. But do we act on changing it, no. But we do look at trends and see what will affect us. We do see more work going offshore, but the core design and the core development still happens in the Valley. There are some exceptions, but most of the key innovations are still happening in the Valley at this time.
Hoberman: I think we probably look at our business every hour that we’re awake. It’s the nature of managing our business. But what has raised all of the attention level for managers is the cost of doing business. Costs have to be optimized, and that extends to pockets of our business where previously it didn’t.
Smith: More and more companies are focusing in on their core competency, and anything outside of that core competency is a subject for potential outsourcing.

Electronic News: Will we ever see a virtual corporation?
Shastry: I don’t believe so. In order for a company to be successful, it has to be close to its customers. If our customers are here, we have to invest here. If our customers move somewhere else, such as Japan or China or India, then we have to have investments there. You have to have nerve endings where your customers are. Otherwise, you don’t have a product that is sustainable in the long run.

Electronic News: Does offshoring raise the competitiveness of other geographies?
Smith: Yes. In the case of Ireland, we benefited from offshoring and outsourcing over the past two decades. Companies came to us 15 years ago because we were a low-cost producing country. They wanted products that could be screwed together and then distributed. Now it’s moved on. We’re more into high-tech and software. It has continuously brought us one step up the ladder. Last year the government invested $1 billion into groundbreaking research at the university level, also in conjunction with large corporations. Companies have to compete to get some of this money. There’s no question that without the investments from overseas, Ireland wouldn’t be where it is today. Last year, Ireland got two and a half times the investment from the United States than China. It has created a stronger economy in Ireland and it has brought the standard up in Ireland. We now compete for higher-value activities from U.S. companies. A rising tide raises all boats, and we’ve certainly benefited from a global economy.
Hoberman: Global outsourcing creates higher paying jobs and better skills and services in the regions that are being outsourced to.
Shastry: They become the consumers and then you are expanding the global market. They can afford to buy the latest fads and DVDs and cell phones. You expand the total market.
Milick: Sometimes there’s an implication that if it raises the competitiveness of other countries, it reduces the competitiveness of the United States. I don’t think that’s as clear cut. Raising the standard of living has implications of its own. You can go to Brazil and everyone has a TV in their slum, but that doesn’t mean that raising the standard of living equates to increased competition and competitiveness. Ireland, and possibly India and China are different. There’s always a direct link being made, and it’s not clear that a link exists that if one nation becomes competitive, the United States becomes less competitive
Smith: It also works two ways. Last year Ireland invested $2.6 billion in the U.S. There’s no question about it, if we hadn’t received all the investment and all the offshoring over the last two decades, there’s no way the companies in Ireland would have risen up to such a level that they are now investing into the U.S. That’s proof it is a virtual cycle and it will come back to reap awards for the U.S. The companies investing in the U.S. are coming here to find the expertise they need.