See the complete list of trends that we analyze.

1. Introduction to the Outsourcing and Offshoring Industry

Outsourcing will be an approximately $500 billion global industry in 2009, with the largest portions created in three broad areas: 1) logistics, sourcing and distribution services; 2) information technology services, including the creation of software and the management of computer centers; and 3) business process outsourcing (BPO) areas such as call centers, financial transaction processing and human resources management.

As of mid-2009, outsourcing of BPO and other services was continuing to suffer a difficult adjustment due to the global recession. For example, the financial services industry was one of the largest industry sectors that had turned to outsourced call centers. The downsizing of the global banking and investment sector meant a significant reduction in the need for services. In other types of services, such as BPO and knowledge management, major providers of outsourced services reported that clients were delaying or cancelling projects in large numbers.

Offshoring, on the other hand, covers such a wide variety of nations, products and practices that it would be difficult to put a number on it. A significant share of offshoring revenue is created by contract manufacturing of electronics, laptop computers, cellular telephones and consumer electronics such as iPods. Another major sector in offshoring is contract manufacturing of shoes, apparel and accessories.

For many years, the offshoring of manufacturing and services of many types was one of the world’s hottest growth industries. Starting in 2007, growth slowed in many sectors. By 2008 through mid-2009, plummeting consumer purchases of personal electronics, apparel, home furnishings and other items resulted from the global financial crisis. Offshore manufacturing was hit hard by these developments. Large numbers of factories closed, and vast numbers of workers lost their jobs. In China, for example, where tens of millions of people had left rural towns to move to manufacturing centers, huge numbers of workers were forced to return to their villages and farms. A global recovery to pre-recession levels will take a long and difficult time.

Cost savings have become less advantageous as wages and operating costs have been rising rapidly in the offshoring centers of China, India and elsewhere. Leading offshore services providers, such as IT consulting giant Wipro, are opening large offices and making acquisitions in America and Europe—the locales of their leading customers, as earning profits from work performed purely offshore has become more challenging, and offshore firms become more global and mature in nature. Now, performance and customer satisfaction are as important as cost. Meanwhile, products manufactured offshore for corporations that are headquartered in the U.S., Canada, Japan and other developed nations are very often intended for sale in offshore markets—a clear indication of globalization at work.

In order to consider the outsourcing and offshoring industry, it is best to define the terms up front, since the words are often used in conjunction and are sometimes used incorrectly.

Outsourcing can be defined as the hiring of an outside company to perform a task that would otherwise be performed internally by a company, organization or government agency—generally with the goal of lowering costs and/or streamlining workflow. Outsourcing contracts are often several years in length. Companies that hire outsourced services providers often do so because they prefer to focus on their core strengths while sending more routine tasks outside for others to perform. Typical outsourced services include the operation of human resources departments, telephone call centers, distribution centers, research needs, computer departments or services and the design and/or engineering of components or end-products.

Offshoring refers to the rapidly growing tendency among U.S., Japanese and Western European firms to send both knowledge-based and manufacturing work to third-party firms in other nations. The intent is to take advantage of lower wages and operating costs in such nations as China, India, Hungary, the Philippines and Romania. The choice of a nation for offshore work may be influenced by factors such as the language and education of the local workforce, transportation systems or natural resources. For example, China and India are graduating high numbers of skilled technicians, engineers and scientists from their universities—thus enabling these nations to attract massive engineering, research and development contracts. In addition, some nations are noted for large numbers of workers skilled in the English language, such as the Philippines and India. In many cases, offshoring utilizes less-skilled labor working for low wages in plants that manufacture such items as shoes, apparel and generic computer components. In other cases, offshore manufacturing contracts go to firms in nations that have developed very advanced technology and industrial bases with highly-skilled and educated workers. For example, final manufacturing of laptop computers is frequently offshored to very high quality firms in Taiwan and South Korea.

Captive offshoring is a term used to describe a company-owned offshore operation. For example, Microsoft owns and operates significant captive research and development centers in China and elsewhere. The goals of captive offshoring include greater company control through direct ownership, along with lower operating costs and the ability to utilize highly educated local workforces.

Insourcing refers to situations where an outsourced services provider moves into, and sets up shop in or near a client company’s facility. It is common for major companies to sign agreements with IBM Global Services, HP, Perot Systems and other outsourcing firms whereby these firms take over and operate a client’s internal computer department. Here’s a non-technology insourcing example: ARAMARK Corporation will build and operate snack bars, employee cafeterias and executive dining rooms within a client company’s facilities. (Occasionally, the term “insourcing” has also been used to describe the creation of jobs in America by foreign firms.)

China, India and similar mature offshore work centers will remain low- to moderate-cost providers of services and manufacturing for the foreseeable future. At the same time, as their economies grow, their business structures and middle classes will grow, and they will offer lucrative markets for exported intellectual property, goods and services created in the U.S., Europe, Japan and elsewhere. Meanwhile, these developing nations face immense challenges, including the need to: build infrastructure such as dependable electricity networks, roads and highways; extend their education systems; control pollution; enhance access to basic health care services; and provide greater opportunities to residents in rural and remote areas. In fact, rapid growth in offshoring centers in China and India has created myriad shortages and problems.

Many Chinese cities are experiencing significant difficulties with pollution and road traffic. The most popular Indian business centers, such as Bangalore, are experiencing daunting shortages of infrastructure of all types, while competition for workers is driving wages higher and higher. Despite the recent construction of new highways in India, traffic delays and inefficiencies are an immense burden. Nonetheless, the offshoring boom does not touch all residents in India or China, despite impressive growth in the middle classes. Income inequality is a significant problem. For example, the Asian Development Bank estimated, in 2006, that 77% of Indians live on $2 U.S. daily or less, a vast number of them earning small livings from low-tech agriculture. Clearly, there is room for substantial investment in education, transportation and development of rural industries. India began a five-year, $150 billion plan to update its woefully inadequate roads, ports, airports and electric plants in 2005.

China, since its business/economic reforms began in 1978, has been a bigger beneficiary of foreign investment than has India. As a result, growth has been generally faster. China’s exports grew ten-fold to nearly $1 trillion annually in the years from 1978 through 2006. Nonetheless, China has hundreds of millions of low-income residents subsisting on low-tech agriculture, despite the creation of more than 135 million jobs in that 28-year period. At the same time, personal income has made great strides in China. World Bank figures show that more than 600 million people in China were living on less than $1 per day in 1981. By 2005, that number had dropped to about 150 million.

The biggest advances in developing nations are yet to come. Recent studies have forecast that, from 2007 through 2014, an estimated 1 billion people throughout Asia will enter the middle class for the first time, and middle class income levels may rise significantly. However, the global economic slowdown of 2008-2009 will put a damper on this progress, as outsourcing sectors and offshore employment centers suffer from a slow market.

One offshoring trend that has continued to be strong, despite the recession, is the hiring of thousands of high-quality engineers and researchers to work in the offshore offices (particularly in India and China) of major tech firms such as IBM and Microsoft. IBM opened a research lab in India in 1998. Today, IBM’s headcount in India has grown to approximately 80,000.

Fully developed nations such as the U.S. have been shifting to knowledge-based economies for decades, as automation takes over domestic factory floors (displacing factory workers) and much of manufacturing shifts overseas. The challenge for developed nations such as the U.S. and Japan is to maintain their leads in such areas as intellectual property, investment in R&D and higher education. There is fierce competition among nations to foster advanced education, develop well-trained and motivated workforces, boost productivity and create high incentives for entrepreneurship and investment. Nations that succeed in this regard will invent the new technologies, services, consumer goods and business processes that can be sold to businesses and consumers in other nations.