Outsourcing vs. Offshoring

Aug 20, 2008 / By Paul Vallee

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I tripped over an old oracle-l exchange (not that old, from March of this year) and I thought it would make good content for a blog post on the critical difference between outsourcing and offshoring.

It started when Ethan Post posted a link to this fascinating story at the Ludwig von Mises Institute about how the U.S. dollar’s collapse affects the outsourcing industry. As many of these posts do, the idea of outsourcing gets conflated with that of offshoring. What the author really means to say is that the “downward dollar delivers a blow to offshoring“, not outsourcing.

Let me explain further. I am now cribbing shamelessly from my oracle-l post and so if you read this already this spring, my apologies.

Ethan had posed the following question:

Interesting article on the effects of the dollar’s fall on outsourcing. Would be interesting to hear a few of you who are perhaps feeling these effects to comment.

To which I replied:

Our margins were definitely squeezed painfully from April 07 until late last year (follow that link to see a 20% or so decline in the USD/CAD exchange, and remember that a substantial chunk of Pythian’s costs are in CAD and about 70% of our income is in USD). So it hasn’t been really that much fun adjusting to our new currency realities. That being said, I think there is a meaningful difference between offshorers and outsourcers and that these different ideas get conflated a lot, including in this case.

If your company’s entire business model is simply shifting work from a country where wages are high to a country where wages are lower, you have two problems. First, you are very vulnerable to this type of currency shift because it is at the core of your profit model. This is called labour arbitrage. Second, as time marches on and we continue our trend to a global rate for any given IT service, your company will cease to have any reason to exist. This article from the Economist covers general India inflation, trust me focus on labour inflation in the information technology sector and the situation is much, much worse.

However, outsourcing properly conceived can be highly successful even when the resources are hired locally to the market being targeted; meaning without relying on exchange rate differences nor differences in global payscales. These companies are successful because by concentrating expertise, adopting best practices, innovating and reusing work they have found efficiencies that add up to more than their direct costs of services delivery + overhead (meaning, that profit model has nothing to do with currency or wage geography).

I would count Pythian among companies conceived along those lines, we are far from alone, certainly our direct competitors based only in the U.S. dbaDirect, Contemporary and DCC (hi guys! well done!) do not rely to any degree on wage differences or exchange rates as parts of their profit models. To put things into perspective, although Pythian has a presence in 10 countries now (including four U.S. cities), our profit model also has innovation, expertise, scale and re-use as it’s heart and soul, not labour arbitrage.

So anyway, we’ve successfully adjusted over here and I think offshoring will lose a lot from the collapse of the USD, but these companies that are offshorers only will be forced to morph into something better to survive, which is good for everyone.

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