Particularly IT, Software Firms
Why Small Business Must Hire Offshore

By James E. Challenger, President
Challenger, Gray & Christmas, Inc.

Will the small business sector -- the nation's largest creator of new jobs over the last decade -- become the largest outsourcer to foreign countries?

They may be left with little choice, according to an analysis of outsourcing issues and interviews with venture capital executives by Challenger, Gray & Christmas, Inc., researchers.

It is a matter of survival for these firms, especially those in the information technology sector where the company's highest costs can be payroll. One venture capitalist even told our researchers that it would be virtually impossible to start a new IT or software company in Silicon Valley without offshore outsourcing.

Small business could lobby to gain an exemption from the proposed Federal legislation seeking to curb American companies from shipping work overseas.

Small business, defined as those with 500 or fewer employees, could argue that as they are the No. 1 creator of jobs, and as they too are competing in the global marketplace, an exemption to the proposed law would also gain domestic jobs as they out-compete foreign firms on the basis of superior American-made product quality, service and price.

The movement toward increased offshore outsourcing perhaps can best be seen in Silicon Valley where companies and start-ups of all sizes are containing costs through increased outsourcing.

In fact, Warren Weiss, general partner at Menlo Park-based Foundation Capital, said in a recent interview, "There's no way you can have a Silicon Valley company without outsourcing. You simply cannot make the numbers work."

That sentiment was echoed by Venetia Kontogouris, managing director for Trident Capital, based in Westport, Conn., with offices in Palo Alto, Calif.

"It is far too expensive today to start a technology business in Silicon Valley without outsourcing. The economies of salary simply do not make it possible. Companies can go to India and get highly skilled workers with PhDs for the equivalent of $15,000 to $20,000 per year. You can have a team of five to six programmers in India for about the same cost as having one or two in Silicon Valley," Kontogouris noted in an interview with Challenger researchers.

The need for cost containment has increased in recent years as venture capital firms become more frugal with their investment dollars.

Before the dot.com collapse it was common for new firms to receive as much as $15 million in the initial round of venture capital funding. Today, most ventures receive $3.0 million or less for the first year, which means they can only spend about $250,000 per month.

A cost analysis by one Silicon Valley employer, Solidcore Systems, supports the view that it is becoming increasingly difficult to operate a tech firm without outsourcing.

Solidcore calculated the cost of keeping one tech employee in Silicon Valley at $15,000 per month, which includes salary and benefits, hardware, software, taxes and real estate costs. In New Delhi, India, a worker with same skills and responsibilities costs the employer $2,500 per month represents a savings of $12,500 every month or $150,000 per year. By sending 10 jobs to India, a start-up can slash $1.5 million from its payroll expenses.

Cost savings is not the only factor that makes offshore outsourcing so attractive, according to Trident Capital's Kontogouris.

"Off shoring is extremely valuable in terms of its ability to expedite product development, particularly in information technology and back office software production. A company based in Palo Alto, Calif., for instance, has access to a 24-7 workforce," she said.

Mark Heesen, president of the National Venture Capital Association, Washington, D.C., noted in a conversation with Challenger researchers that a company incorporating offshore outsourcing into its business plan is inevitably going to be more attractive to a venture capital firm, because they figure to see a faster return on their investment.

If a company can bring its product to market faster and cheaper through outsourcing, it is naturally going to win out in the competition for limited funding dollars.

Trident's Kontogouris expects that more and more investment will be directed to American firms that outsource services to Asia. In addition, she predicted that the next major area of investment will be in companies that plan to develop and sell products and services to the Asian markets, China and India in particular.

"The creation of these information technology jobs in India is forging a new consumer class, one that wants and needs all types of products, from software to kitchen appliances. There are a lot of opportunities. The investment money is likely to flow to the companies that plan to tap these opportunities."

It is only going to get easier for companies of all sizes to send business operations and functions overseas. Kontogouris said the cost structure of establishing and maintaining Internet connectivity between the United States and Asia used to be very expensive, but has fallen dramatically. In fact, costs have dropped 40 percent in just the last 12 months.

As prices drop, more companies will join the ranks of offshore outsourcers. One group estimates that the value of business process outsourcing will rise to $243 billion by 2007, up from $1.3 billion in 2002. By 2015, 3.3 million white-collar jobs are expected to be sent to foreign lands, according to research firm Forrester Inc.

As more money and jobs migrate overseas, there is increased worry within the United States that jobs here are being permanently destroyed.

The trend of increased outsourcing among small businesses is especially troubling since these firms, up until now, have been responsible for 73 percent of the job creation in this country.

Some are attempting to slow the tide of offshore outsourcing, but to do so is futile. However, as certain kinds of jobs dry up here, there is no reason to think that our talented workforce will not redeploy its skills in new directions and endeavors.

The cost savings and efficiency gains achieved through outsourcing will in fact free up resources that can be used for innovation and to expand other areas of business, thus creating new opportunities and jobs in America.

For such a workforce shift to be successful, an entirely new approach to education will be required -- one that promotes lifelong learning with a strong emphasis on technology.

We should be developing programs that encourage companies, schools and other government entities to offer skills training and tuition reimbursement to adults throughout their lives.

Challenger also urged that education embrace the diversity that globalization will bring with it by focusing on international studies, including foreign language and cultures.

In the new New Economy, the biggest winners in the job market will be the New Americans, highly educated, with roots in Asia, Africa, the Middle East and Latin America, matching the diversity of the increasingly global marketplace. They will stand out and offer leadership and exceptional skills, such as the ability to speak and write a second, third or even fourth language.

Tomorrow¹s workforce may be getting the message, at least on the importance of languages. The number of college students learning foreign languages is at a record high. The biggest increase was in Arabic classes, which saw enrollment jump 92.5 percent in 2002, according to the Modern Language Association.

James E. Challenger, president of Challenger, Gray & Christmas, Inc., pioneered outplacement as an employer-paid benefit. His third book, The Challenger Guide, (Contemporary Books) is available in paperback.