The economics of offshore subcontracting

Basic forces

Companies want cost savings when they move their business to offshore countries. This is the first driving factor.

The second is supply and demand: if it is cheap to do some job, say, in Vietnam, then the companies that offshore to Vietnam will be more profitable and win market share or more companies will come to Vietnam. Either way, the demand for work in Vietnam will increase, raising wages. Eventually, some balance will be reached where offshoring is no longer a bargain. This may happen in several ways: In India, the wages have increased. Also, offshored people by definition can't be face-to-face with the customer, may speak lousier English, and have cultural differences, so there is a quality tradeoff: an offshored person is not as good as a local one.

Trust must be an important factor that inhibits offshoring, but I don't know much about it, since when the managers call my number they have already established basic trust between the two companies. However, the trip we do to India is the first transaction with the Indian customer. Establishing deeper levels of trust will happen if the customer perceives that Finnish subcontratees fulfilled expectations and provided good value for money.

Indianization

They say that India used to be cheap, and the cost per employee was about 1/10 of Finnish level 10 years ago. (These are extremely rough numeric estimates and based on hearsay.) Now the wage level is about 1/2 of Finnish levels. In this situation, it is in my case profitable to ship specific expertise from Finland to India. I'm sure that the Indian customer asked offers from several companies before deciding on us. Here's a new word to describe the phenomena:

Indianization: The process of dirt cheap offshoring countries moving up in the subcontracting chain. Characteristic features: Wages increase. The direction of subcontracting relative to Western countries is no longer one-directional but unbalanced bidirectional. New, cheaper countries take the same role which Indianized countries used to serve.

The direction is still mostly the other way around: work goes to India and Indians. I've heard recently about one testing department which started in India, and saw how people's work was moved there. New work was found for the Finnish emloyees. Also, I know several Indians who work for Finnish companies. The Indians get better wage and can enjoy Finnish freedom, safety and affluence.

Our company has a division in Bulgaria. The per-employee cost level is about 1/5 of Finland. They also say that when Indians want cheap programming labor, they subcontrant work to Vietnam/Thailand (don't remember which). Eastern Europe has done great economic progress after the fall of the iron curtain, so I hope and expect them to indianize quickly.

Here's what I've heard about the division of labor between offshore units and units which are local to customer. Basically, the communication-intensive and trust-intensive part of writing new software is done near the customer, where the subcontracting company(s) and the customers can sit around the same table and are immersed in the same culture. Testing and maintenance can be moved to offshore countries, because testing requires less communication and maintenance is less critical - after all, the is product by defintion "ready" when the maintenance part starts.

The politics of offshoring and the marginal employee

Basic microeconomics predicts that cheaper IT work means more IT work gets done. Customer companies get better systems for the same money, and they can afford to buy useful systems that would not have been implemented with first-world prices. Also, indianization is great for increasing the standard of living in less developed countries.

Offshoring is also a political threat, as the people in Western countries lose jobs as their work is moved to India. This also reduces the bargaining power and wages of the remaining emloyees.

By marginal employee I mean a Finnish emloyee who is just barely recruited to a company, because his or her skills are poor and/or track record is lacking. In the times of techno bubble in the 2000s, less was expected from the marginal employe. Many people studied a few years of computing science and then went to work. When the bubble burst, some of them got back to school to finish their degrees. A person in a student sauna commented that "sanity had been restored". This way, history has demonstrated the expectations for the marginal employee shift. Offshoring is a big threat for the marginal employee, because increasing the pool of workers means that more track record and skill can be expected from chosen workers.

Here are some predictions about political attitudes: Americans should be more concerned than Finns, because they have more to lose since the wage gap is wider. Seeing bidirectional subcontracting should reduce the fear of offshoring. Testers and less skilled programmers should be more concerned about offshoring and less sympathetic to the global advantages of indianization.