The Executive Question: Offshoring

Is there a more contentious subject than offshoring? In the first of a new series of articles for silicon.com, David Butler - an advisor to executives due to his understanding of the way various economies apply technology to business - explains why making tough decisions now is necessary.

“I’m saving £6m a year by moving jobs to India,” said one CEO I talked to. “If I turned my back on that, the shareholders ought to have my guts for garters.”

“My members have worked in this company for 20 years,” said a trade union official. “I’m not going to stand back and watch their jobs exported.”

Is that it? Do we have to choose between shameless greed and a sentimental attachment to past patterns of investment? As usual the truth is much more complex, involving risks which, while not immediately apparent, are very real. Let’s work it through step by step.

The key to economic prosperity, as anyone knows, is growth. When the economy is expanding we all earn more, we spend more, we invest more and we smile more. Raising taxes for schools and hospitals and social services is relatively painless when we’re all getting better off. It hurts like hell when the economy is stagnant or contracting, especially as the first consequence of a stagnant economy is stagnant or falling wages.

In the UK it looks as if we’re set for a period of sustained economic growth. The OECD, the watchdog of economic probity, thinks Chancellor Gordon Brown is doing a great job. (So does he, by the way.) The recent Evalueserve report points out the UK economy is estimated to expand at 2.49 per cent per annum in the period to 2010. Surprisingly enough, given our poor track record, during the same period labour productivity is set to grow by about 2 per cent per annum. Both these trends – a bigger economy and people doing more work in the same time – stimulate growth in the demand for labour, creating new vacancies and making it harder to fill old ones.

Here comes the nub of the matter. These forecasts are based on the work of half a dozen or so prestigious research bodies, not just the Treasury. The forecast is that between 2003 and 2010 the workforce in the UK needs to grow from 27.66 million to 28.63 million. Since employers are already reporting unfilled vacancies, it’s hard to see how we can do that.

What happens when the workforce is too small to achieve the available growth targets? Two things happen. First, in a free market economy, wages rise and thereby undermine the projected increase in productivity. Second and more important is a loss in the potential output. If the labour shortfall is as acute as some forecasters fear it could drain away nearly half a percentage point of our projected growth. Dear reader, are you sitting down? That half per cent we might so easily lose amounts to £113bn.

What can we do? One answer is immigration. The government expects about 100,000 people to migrate to the UK every year between now and 2010. Nearly half of them will join the workforce. Offshore development is another possibility. By the end of 2005 about 80,000 jobs will have moved from the UK to countries like India, Malaysia and Poland. By 2010 that total will have risen to 200,000.

But the plain truth is that we will need more immigration and more offshore development if we are to have any chance of meeting the growth target available to us. Some of us may hate the ideas of more migration and more offshoring so much that we’ll willingly limit both. But if we do, the economic consequences will be dire.

As between the two ways of meeting a labour shortage, there are obvious advantages and disadvantages to both. Migrants make a demand on housing, health, education and social services, so their contribution is not all gain. But it’s obviously easier to manage a worker in your own plant or office than one in Bangalore. It is also possible to predict that an increase in immigration will run the risk of provoking an adverse response in the indigenous population, benefiting only extreme racist political groups. That argument also strengthens the argument in favour of more offshore development but I don’t want to go there.

But something else is changing too. European and American companies have been using offshore services for years, some for decades. They are gradually realising that the name of the game is changing. Up to now labour has been regarded as a commodity. If I can hire a call centre worker in India for a tenth of what it costs here, I sign the contract and bank the savings. But that’s not the end of the story, and not the best way to benefit either.

Everyone recognises that we now live in a world of alliances, partnerships and joint ventures. Even the biggest companies now accept that they need to work with others to address global opportunities. The defence and aerospace businesses are cases in point.

Major players in Europe and the US are now realising that an Indian company may not just be a source of cheap labour but possible partners in global ventures. Now business process outsourcing (BPO) is the name of the game. The true global players of the next decade will emphasise the growth potential of a partnership strategy. And they’ll use the benefits of growth to mitigate any possible disadvantages to the indigenous workforce.

Those Indian companies that in the past were happy to be seen as just sources of cheap labour are now eager – nay, aching - to embrace a more ambitious future. It will be an exciting ride, with major prizes for corporations that can build and manage an imaginative and effective portfolio of domestic and overseas resources.

The most crucial point is that managers must learn to make and defend their investment decisions better, not just allow themselves to be categorised as greedy and uncaring bastards. There is important work to do.

David Butler was formerly chairman of Butler Cox Plc and is now chairman of the Executive Learning Alliance, a company that tracks developments in emerging markets. He can be contacted by emailing editorial@silicon.com.