Offshoring ≠ illegal immigration

I have been closely following the current immigration debate and I was disturbed to see illegal immigration and offshore outsourcing discussed in the same breath by many commentators. Let us not confuse the two: the first is illegal, the second is not only legal but in fact any limitations on outsourcing would probably run afoul of international free-trade agreements and could ruin the US economy.

It is amazing how shortsighted these opponents of outsourcing are. The United States counts for 12.06% of total world exports while China counts for 5.33% and India a miniscule 1.14%! [Data from “The Economist Pocket World in Figures” 2007 Edition] If the US initiates a trade war and disrupts the global trade environment it stands to lose more than 10 times as much as India. As I have written before, the last time the US turned protectionist, it slid into the Great Depression. Let us not repeat the same mistake again.

All this vilification of outsourced may even be completely counterfactual. Take a look at Robert Samuelson’s “What Offshoring Wave?” article in The Washington Post. He explains that only 4% of mass layoffs stemmed from offshoring. I must admit that there is a flaw in his argument: he is only looking at layoffs of 50 or more and it would have been much more interesting to look at all layoffs. However, there is no reason to believe smaller layoffs would have significantly different causes. Here are a few select quotes from Samuelson’s article:

For the United States, Kirkegaard examined a survey on "mass layoffs" from the Bureau of Labor Statistics to see how many stemmed from offshoring. The answer: 4 percent. That included both manufacturing and service jobs.

In 2004 and 2005, the BLS counted almost 1 million workers fired in layoffs of 50 or more. That isn't a huge number in a labor force of about 150 million. Moreover, most causes were domestic. The largest reason (accounting for about 25 percent) was "contract completion" -- a public works job done, a movie finished. Other big categories included "downsizing" (16 percent) and the combination of bankruptcy and "financial difficulty" (10 percent). Only about 12 percent of layoffs stemmed from "movement of work" -- a category that would include offshoring. But two-thirds of those moves were domestic.

It's true that offshoring doesn't measure the full impact of globalization on U.S. labor markets. That effect would also include trade and investment by multinational firms. Still, with the unemployment rate at 4.5 percent, it's clear that globalization hasn't crippled the U.S. job machine.

Losing a job is a wrenching experience for anyone, but the lesson here is that most job loss has local causes. The offshoring obsession reflects its novelty and the potential threat to white-collar jobs that seemed inherently safe from foreign competition. In our mind's eye, globalization is so powerful that it's sweeping everything before it. The reality is that, though globalization is increasingly important, it's still a weakling compared with the domestic economy. The antidote to job loss is job creation, and that depends decisively on national economic policies and conditions.

It's easy to blame all our economic anxieties and problems on globalization, because that makes foreigners and multinational companies responsible. Though satisfying, it will also be self-defeating if it diverts attention from fostering a healthy economy at home.

Cartoon on salary inflation in India (also applies to China)

Another interesting cartoon from www.doubtsourcing.com which is somewhat rooted in truth. Take a look at this Hindu Business Line story on how Indian salaries grew fastest in the world. “IT sector salary is set to grow by about 13.7 per cent, and ITES and BPO growth may be by 15.5-16 per cent.” The Economist has a more interesting analysis that looks at “real pay” rather than just salary. This claims that Chinese real pay actually grew faster than Indian ones.

India vs. China: The other side of the story

I was asked by a reader, “so why do you think you will win your bet with Benny?” Most of India’s strengths are self-evident and have been widely written up. Here are a couple of thoughts on why I still believe I will win the bet:

• Be careful what you wish for, or in other words, how China may fall victim to its own success: The Chinese government tends to think big and right now it is trying to start 1000 BPOs by 2010. 1000 is a large enough number that it attracts attention (which by the way is what I think the government was trying to do) but it is too large a number of companies in too short a time for them to learn how to compete smart. If they can’t compete smart, they will compete hard which means they will undercut each other on price and overbid each other on paying workers. Pretty soon they will face the exact same problems India is facing: high employee churn rates, wage inflation and lower margins. The Chinese government has to help Chinese BPOs grow smart rather than just grow fast and that can’t be done by spending money alone.
  
• When it comes to quality, perception is as important as reality: While the Chinese BPO industry has existed for years, they have very little experience serving US and European customers and dealing with their quality expectations. The newer Chinese BPOs also tend to have less extensive quality management experience and technologies. [There are exceptions to every rule: I have met some Chinese BPOs who are investing quite heavily on their quality, while others seem to have very few if any quality experts on staff.] Furthermore, often the definition of quality in BPO engagements is quite subjective. If US customers believe that China has a quality problem, they will perceive lower quality in the processes run by Chinese vendors. Indian vendors addressed this quality perception problem by aggressively adopting CMM and reaching CMMI certification levels that were often higher than their customers’. [Look out for an upcoming post on why CMMI is not sufficient for BPO as opposed to IT outsourcing. But the reality is that the market broadly perceives it as a quality certification.] Chinese BPO vendors can’t follow that exact same strategy. The leading Indian BPO vendors have already invested years in reaching the highest levels of CMM. Even after spending years, the Chinese BPOs can at best match the Indian vendors in CMMI certification, not beat them at it.

No Entrance to Greenland (without English)

I took this picture when I visited Shanghai in 2002. I assume the Chinese text means “please don’t walk on the grass” or some variant thereof. The hilariously incorrect English translation may turn out to be prophetic though: can China gain entrance to the land of “green” (slang for money in America) without addressing their English problem? Probably not. However, there are three forces ameliorating China’s English problem:

• The Chinese Government: A story in fDimagazine.com [part of the Financial Times group] entitled Battle of the behemoths explored the question of: “Will China upstage India and become the epicentre of offshoring?” While the article does say “In terms of talent, India will continue to score above China” it also highlights what China is doing to address the talent gap. “The Chinese government is driving long-term improvements, recently announcing plans to spend more than $5bn on language training to target the BPO market.” As I have mentioned in previous posts, the Chinese government has a track record of successfully spending its way to success. Building ahead of demand can be very risky but it can pay off. Is $5 Billion a large enough investment for China to catch up to India? Assuming a BPO industry headcount target of 1 million operators, this is $5000 per operator of English training. In China, I am sure $5000 buys you a lot of English training.
  
  
• The Olympics: If you haven’t visited China recently, it will be very difficult for you to appreciate how important the Olympics are to the Chinese people. The Chinese are a very proud people, and they want to show off their country in the best light during the Olympics. As part of the preparations for the Olympics, they are investing heavily on English training for hotel staff, taxi drivers, and even shopkeepers. Previous Olympic hosts have ended up with excess hotels and sports arenas after the Olympics ended. China will probably end up with excess English-speaking citizens.
  
  
• Chinese entrepreneurs: Some entrepreneurs are adopting very interesting process innovations to address the English problem. One leading Chinese BPO splits up every document into its smallest component parts. Thus, one of their operators only processes the ‘Social Security number’ field of every loan application while another processes only the ‘employer’ field. At this level of granularity, the skill required is not really English language skill, but rather symbol identification and transcription skill. The Chinese written language contains more than 3500 characters and thus the Chinese are exceptionally good at symbol identification and transcription. Of course, this solution only works for low-end data entry work because higher-order tasks such as Knowledge Process Outsourcing or even advanced BPO activities such as insurance claims adjudication can not be easily broken into minute components. However, low-end data entry work constitutes the majority of Business Process Outsourcing work today and most Chinese entrepreneurs would be happy to capture a significant proportion of this market away from India. [For details on Chinese characters, see the website of the Chinese Language Program at Harvard University: “The Xiandai Hanyu Changyongzi Biao (Modern Chinese Commonly-Used Word List), compiled by the national language committee and national education committee in 1987, includes the most frequently-used 2,500 characters, as well as the second most frequently-used 1,000 characters. Thus it comprises 3,500 characters altogether. Those who have received a junior or senior high school education should know and utilize these 3,500 most commonly-used characters.”]

Overall, I don’t think China has adequately addressed its English Achilles’ heel yet, but both the government and the people are aggressively trying to address this shortcoming. Anyone who ignores the Chinese threat to the Indian BPO industry on the basis of English language gap alone does so at their own peril.
Note: I wrote this post because of comments from reader Greg Cruey and a visitor from the “China Law Blog.” Keep the questions coming; I will try to answer them as soon as possible.

The secret weapon of the Chinese BPO industry

I have an ongoing bet with my COO Benny who happens to be Chinese. He believes that the Chinese Business Process Outsourcing (BPO) industry will eat India’s lunch in the next few years. I on the other hand have always been confident that Indian entrepreneurship and innovation will help Indian BPOs beat all competitors including the Chinese. Till recently, I never worried that I may actually lose the bet. A recent conversation with Mr. Roc Yang (CEO of China Data Group, a leading Chinese BPO) forced me to acknowledge for the first time that perhaps Benny could win the bet after all.

Mr. Yang raised several reasons why China might beat India on the BPO arena. Some of these reasons I had heard before: lower employee churn rates, lower effective salary, and better infrastructure. While China may have these advantages today, either India will be able to address them over time (as in the case of better infrastructure) or China will face the same problems as its own BPO industry develops further (as in the case of employee churn).

Some of the competitive factors Mr. Yang raised (such as an ability to provide end-to-end services or more sophisticated operational procedures) are quite possibly valid for his specific company but I can’t imagine that they are true for all Chinese BPOs. Moreover, I can imagine conversations with CEOs of Indian BPOs who would raise the exact same factors as competitive advantages that the Indians enjoy. An analysis of who is right is beyond the scope of this blog. Most probably, only time will tell who is right on this issue.

One point that Mr. Yang highlighted however may turn out to be the secret weapon of the Chinese BPO industry. Contrary to popular perception, the Chinese BPO industry has existed for many years and quite possibly is as old as the Indian BPO industry. The reason that the Chinese have stayed under the radar is that they primarily serve the Chinese market. As Mr. Yang pointed out, because their customers are also Chinese they could never count on labor cost differentials as a critical factor in their business. Thus, out of necessity, they have had to be incredibly cost conscious. He believes that because the Indians have enjoyed a large labor cost differential relative to their customers, they have been much less labor efficient than the Chinese BPOs.

I must admit that many Indian BPOs often have an attitude that labor is cheap so we can always throw a lot of bodies at any problem. This has in many cases led to inefficient use of labor. If Chinese BPOs have truly figured out a way to be profitable in the absence of a labor cost advantage and are now shifting their attention to the US market then Indian BPOs may have cause for concern. An industry that is used to running lean and mean in their own country would have a huge advantage once they gain the additional advantage of the labor cost differential between China and the US. Look out India!

In reality, if the Chinese BPOs can truly bring labor-efficient solutions to the market, that would only spur Indian vendors to respond similarly. Due to the high employee churn rates and salary increases, Indian BPOs have already started to become more labor efficient. The entry of labor-efficient competitors from China would only accelerate the trend. I would expect to see even faster efficiency and accuracy improvements primarily via the adoption of new technologies and consistent processes across customers. This competition from China may just help spur the Indian vendors to the next stage in their evolution.

Interesting perspective on the Chinese BPO industry

William Dodson has a very interesting post entitled The Buddha and China Business Process Outsourcing on his “This Is China! Weblog.” Here are a few select quotes, but I would recommend you read the complete post.

The VC’s remote research had lead them to conclude there were still no pack leaders in the BPO market, no companies breaking away from the others and distinguishing themselves; especially for the North American and European marketplaces. They knew the Indians were coming to China, and that the Chinese government was promoting cities in China to become IT/BPO centers of excellence. They were confident and vested in the development of the China BPO market; but how long would it take to see an industry grow up that was as formidable as India’s?

China has no Y2K to finance or to educate its armies of fresh-eyed programmers in the hard-as-nails realities of Western business practices and operational processes. It does not have the troops of English-speaking, customer-focused go-getters that India does to kick-start an industry into the stars. Instead, China is going to have to boot-strap itself to become a world-beater in both the IT/BPO realms.

Certainly, the Chinese government has its heart in the right place and its intentions firmly set. Newly fielded economic development zones throughout China are flush with cash, already investing in platoons of engineers and hi-tech infra-structures. One partner in a venture to work with a local government to build its IT/BPO service base told me the governments are using the same approach they had in developing their manufacturing prowess: if you build it, they – the foreign companies - will come.

Problem is, the Chinese have no credibility when it comes to understanding and articulating the kinds of back-office applications that matter to knowledge-driven Western companies. Most Chinese IT companies cater to domestic customers; the vast majority support Japanese and Korean companies with relatively unsophiscticated programming that has been passed to them through highly detailed specifications; and the few BPO resources there are have made it this far performing rote activities that do not require much in the way of analysis or creativity: insurance claims processing, data entry and the like.

This is all not to say the Chinese will not develop a successful BPO industry, for I firmly believe they will, I told the VC on the conference call. And the VC, for their part, reiterated their long-term commitment to developing the BPO industry in China. However, we all agreed, it’s just going to take years longer than we would all prefer. And the industry will likely go through many incarnations before it makes as large an impact on the world scene as the Indian model has. But it would happen in this lifetime, we were confident.

I agree with several of the points raised by Mr. Dodson. I have previously expressed my concerns about China’s “build it and they will come” attitude in my China planning its way into Business Process Outsourcing? post. However, I have had similar concerns in the past, and have been proven wrong. When I first visited Shanghai, the Pudong area was full of beautiful new buildings, most of which were empty. The wide roads to the airport had so few cars that I was struck by the infrastructure overcapacity. China was clearly building ahead of demand and I felt it was a very risky gamble. However, today the buildings in Pudong are full and the roads are crammed. The gamble paid off for China. Will the BPO gamble pay off? Only time will tell.

The outsourcing bogeyman is the real threat to the US economy

It seems I managed to confuse some of my readers with my "Why a US ban on offshore outsourcing is the best possible thing for India!" post. I was using sarcasm to make a point, and am not really suggesting that the US ban outsourcing. Any ban on outsourcing would harm both countries overall, but would be especially harmful to the US. Let me make the same point using economic data rather than humor:

Right now the focus is on Business Process Outsourcing (BPO), however, during 1998 to 2002 everyone was convinced that IT outsourcing (ITO) to India would gut the American IT services industry. Let us consider the IT services most directly affected by offshore outsourcing, namely: “computer and data processing services” and “data base and other information services.” According to the “Digital Economy 2003” report published by the U.S. Department of Commerce, US imports of these services rose from $0.3 billion in 1995 to $1.2 billion in 2002 (with a peak of $1.6 billion in 2000). This seems to be clear proof of Ross Perot’s “giant sucking sound” and any number of Lou Dobbs’ tirades. However, in the same time period, US exports of these services rose from $2.4 billion in 1995 to $5.4 billion in 2002 (with a peak of $5.7 billion in 2000). Thus, the U.S. trade surplus in these services expanded from $2.1 billion to $4.2 billion over the same years when the US faced the greatest threat from Indian outsourcing firms due to the Y2K contracts and the Internet boom.

If the US had magically managed to “ban IT offshoring” and other countries had done the same, the US economy would have lost $26.2 billion over these 8 years. How many US jobs do you think that $26.2 billion translates to? I realize data provides cold comfort to people who have lost their jobs due to outsourcing. However, the above analysis highlights how overall global trade creates far more jobs in America than it destroys. If you don’t believe the analysis above, you should at least learn from US history. The following excerpt from the US Department of State website highlights how US protectionism contributed to and exacerbated the Great Depression.

The Smoot-Hawley Tariff Act of June 1930 raised U.S. tariffs to historically high levels. The original intention behind the legislation was to increase the protection afforded domestic farmers against foreign agricultural imports. … But once the tariff schedule revision process got started, it proved impossible to stop. Calls for increased protection flooded in from industrial sector special interest groups and soon a bill meant to provide relief for farmers became a means to raise tariffs in all sectors of the economy. When the dust had settled, Congress had agreed to tariff levels that exceeded the already high rates established by the 1922 Fordney-McCumber Act and represented among the most protectionist tariffs in U.S. history.

The Smoot-Hawley Tariff was more a consequence of the onset of the Great Depression than an initial cause. But while the tariff might not have caused the Depression, it certainly did not make it any better. It provoked a storm of foreign retaliatory measures and came to stand as a symbol of the ‘beggar-thy-neighbor’ policies (policies designed to improve one’s own lot at the expense of that of others) of the 1930s. Such policies contributed to a drastic decline in international trade. For example, U.S. imports from Europe declined from a 1929 high of $1,334 million to just $390 million in 1932, while U.S. exports to Europe fell from $2,341 million in 1929 to $784 million in 1932. Overall, world trade declined by some 66% between 1929 and 1934.

Thus, between 1929 and 1934, US imports were reduced by just $944 million while exports were reduced by $1,557 million and so the US economy lost hundreds of millions of dollars and more importantly tens of thousands of jobs due to US protectionism. Moreover, today due to the high growth rate of countries like India and China, the rest of the world counts for a significantly greater proportion of global economic growth than they did in the 1930s. As such, US protectionism would probably harm the US even more in the current environment because American companies would be locked out of the rapidly growing Asian economies while Asian and European companies would probably benefit from the vacuum created by the absence of American companies.

Daniel W. Drezner in his thought-provoking article titled “The Outsourcing Bogeyman” (Foreign Affairs, May/June 2004) provides two excellent examples on how US protectionism has already caused US job losses.

Consider the example of candy-cane manufacturers: despite the fact that 90 percent of the world's candy canes are consumed in the United States, manufacturers have sent much of their production south of the border in the past five years. The attraction of moving abroad, however, has little to do with low wages and much to do with protectionism. U.S. quotas on sugar imports have, in recent years, caused the domestic price of sugar to become 350 percent higher than world market prices. As candy makers have relocated production to countries where sugar is cheaper, between 7,500 and 10,000 workers in the Midwest have lost their jobs -- victims not of outsourcing but of the kind of protectionism called for by outsourcing's critics.

A similar story can be told of the steel tariffs that the Bush administration foolishly imposed from March 2002 until December 2003 (when a ruling by the World Trade Organization prompted their cancellation). The tariffs were allegedly meant to protect steelworkers. But in the United States, steel users employ roughly 40 times more people than do steel producers. Thus, according to estimates by the Institute for International Economics, between 45,000 and 75,000 jobs were lost because higher steel prices made U.S. steel-using industries less competitive.

Proponents of American protectionism should keep such recent misadventures in mind while pushing for higher tariffs.

US protectionism impacts more than just the economy. The previously quoted US Department of State article goes on to say: “More generally, Smoot-Hawley did nothing to foster trust and cooperation among nations in either the political or economic realm during a perilous era in international relations.” Does this sound eerily applicable in the current international relations context? George Santayana wrote: 'Those who cannot remember the past are condemned to repeat it.' Unfortunately, the cost of repeating this past mistake could be greater than the anti-globalization brigade can even imagine.

China planning its way into Business Process Outsourcing?

Sometimes it seems like everyone I know in India is either starting a BPO firm or working for one! Entrepreneurs all over the country have started BPO firms focusing on every conceivable business process. While the Indian government policies have helped somewhat, most Indian BPO entrepreneurs seem to see the Indian government more as a necessary evil than as a core promoter of BPO market growth.

Interestingly enough China seems to be taking a more planned approach. Ecommerce Times reports:

The China Development Bank (CDB) will issue 5 billion yuan (US$632.7 million) worth of credit to foster service outsourcing in five cities.

Chinese Minister of Commerce Bo Xilai said at the inauguration ceremony for the five cities, which are Chengdu, Xi'an, Shanghai, Shenzhen and Dalian, that the ministry will take measures to promote the fast growth of service outsourcing in the next five years.

Under the country's 6th Five-Year (2006-2010) plan, China aims to build service outsourcing bases in 10 cities, encourage 100 multinationals to outsource services from China, and foster 1,000 large and medium-sized service outsourcing enterprises.

It will be interesting to see whether China's planned approach will be more effective than India's unruly but entrepreneurial milieu. I admit I am biased, but my bet is on India.