Why Small Tech Companies Aren't Outsourcing

Many are focused on product innovation—and that's difficult to shift overseas

by Vivek Wadhwa

A common misconception is that today's outsourcing trend was driven by the tech industry. Even The Wall Street Journal ran a recent front-page article saying that Silicon Valley had helped power India's outsourcing boom by shifting sophisticated technology jobs there. While the industry does indeed outsource, it has had a minimal impact on the trend as a whole, according to new research. The leading outsourcers have actually been large corporations such as General Electric (GE), Citibank (C), and American Express (AXP). Many of them sent abroad their IT systems, which are different from the innovative software products that tech companies develop. In fact, few tech companies outsource core product development, because it just isn't practical to send this type of innovation offshore. Most are small or midsize businesses and can't achieve the economies of scale that larger businesses stand to gain from outsourcing.

The tech industry has never made up more than 15% of the outsourcing market, says Carnegie Mellon University professor Ashish Arora, who has researched outsourcing extensively. Banking, finance, and insurance account for about 40%, followed by telecom (17%), and manufacturing (12%). Arora includes the product development that companies such as Microsoft (MSFT), Adobe (ADBE.O), and Cisco (CSCO.O) perform in their offshore locations in his estimates.

New research by Columbia University professor Amar Bhide helps explain why tech companies don't outsource core product development. Bhide interviewed the CEOs of 106 tech companies and concluded that the problems with outsourcing innovation greatly outweigh the advantages. His report, set to be released on July 20 at the Kauffman-Planck Summit on Entrepreneurial Research in Dana Point, Calif., suggests fears of outsourcing in the tech industry are greatly exaggerated.

Bhide's research focused on venture-backed companies, which are usually better funded than most startups and which often receive encouragement from investors to go offshore. But the reasons most did not outsource apply to nearly all small and midsize tech companies.

Competitive Advantage

Of the 106 companies he interviewed, 19 performed some product-development-related functions in their offshore offices. Of these, 11 were developing a core product abroad, and the rest were developing ancillary subcomponents or doing other work. An additional 29 companies had some relationship with outsourcing companies, but only five of these were for core products. Most of the work done abroad was related todata entry, customer support, and testing/quality assurance. Companies had overseas operations for a variety of reasons. Some had no choice, and others saw opportunity.

A few companies that said they had to be abroad were developing products such as semiconductors, which have innovation embodied in physical goods. They explained they needed high volume, low-cost production to remain competitive. Others were reselling foreign-developed products and said they needed to use the specialized skills and assets of their offshore partners. Some companies were founded abroad and moved to the U.S. or acquired a foreign company. Most of these couldn't move their development to the U.S.; it was disruptive and expensive. And there were issues with obtaining U.S. visas (see BusinessWeek.com, 6/21/07, "One Easy Fix For Immigration"").

According to Bhide's research, the top reason tech companies chose to go offshore was for competitive advantage: They could get a wealth of highly educated workers at a fraction of the cost.