Outsourcing Trend Faces Challenges

Mounting political risks and the Trump administration’s “made in America” rhetoric could discourage companies from shifting services work overseas.

Over the past few decades, U.S.-based companies have shifted more and more chores previously performed in-house—from IT work and answering customer calls to finance and accounting tasks—to lower-cost locations around the world. That trend toward services outsourcing has now run up against two potential threats: increasing political risk around the globe and, here in the United States, the Trump administration’s emphasis on keeping jobs at home.

In just the last year, markers of the mounting risk have included the U.K. vote for Brexit and the U.S. election of Donald Trump. U.K. consultancy Verisk Maplecroft predicts that all regions of the world will see a decline in the stability of governments over the next three years. While the hazard is greatest in developing nations in the Middle East and Africa, European countries are also at risk, the firm said.

The Philippines, one of the world’s most popular outsourcing locations, is a high-profile example. The nation has had a hectic six months since Rodrigo Duterte became president last summer. Duterte has made combative comments about the United States, including announcing the Philippines’ “separation” from the U.S. last fall along with his preference for an alliance with Russia and China. Duterte also has supported extrajudicial killings of drug dealers and addicts in an attempt to control the nation’s drug problem, with Amnesty International estimating that 7,000 people have been killed since July.

H. Karthik, a partner at management consulting company Everest Group and leader of its global sourcing practice, said Duterte’s comments about a separation from the United States altered risk perceptions.

“No companies have publicly stated any significant changes in their Philippines strategy, but many of them are adopting a wait-and-watch approach,” he said.

Karthik compared that wariness about the Philippines to developments in other outsourcing locations, such as the political unrest in the Ukraine, Egypt, and Tunisia, and recent widespread public protests in Romania.

“There are many instances around the world of increasing geopolitical risk,” he said, and added that in the Ukraine, Egypt, and Tunisia, the local unrest has had an effect on the demand for outsourcing services. “There are examples where things haven’t made a material impact yet, like the Philippines, and other examples where people have chosen to look at locations that are more stable and less risky.”

Companies that are making decisions about outsourcing locations differentiate between different types of political risk, Karthik said. The instability of a government “doesn’t mean much as far as the industry is concerned,” he said. “But if it’s anything about investment attraction laws, violence, or security issues, then companies tend to be more concerned.”

David Rutchik, executive managing director at the consulting firm Pace Harmon, agreed that while companies are keeping an eye on the situation in the Philippines, they aren’t at the point where they’re considering moving to other locations.


Trump Administration’s Push on Jobs

U.S.-based companies that send services work to offshore locations are more concerned about the Trump administration’s push to keep jobs in the United States, Rutchik said.

Although the president’s comments to date have generally seemed aimed at manufacturing rather than services jobs, it’s far from clear how his rhetoric will translate into government policy. But Rutchik and others noted a couple of recent developments in the U.S. with implications for services jobs.

Legislation introduced last month by Rep. Zoe Lofgren, D-Calif., would tighten the requirements for the H-1B visas that allow skilled foreign workers to come to this country. Both Indian outsourcing companies and U.S. corporations use the visas to bring workers to the U.S. Among other things, the law would boost the minimum annual salary for workers using the visas to $130,000, more than double the current $60,000.

And a tax plan put forward by Speaker of the House Paul Ryan, R-Wis., would remake the U.S. tax system by exempting income from exports from taxation but levying a border adjustment tax on goods and services that are made overseas and sold in the United States.

While it’s highly uncertain whether the proposals will survive the legislative process, either would have a big impact on companies’ decisions about what work is done in the U.S. and what work is done offshore.

If imports of goods and services were taxed, “there would be clear tax advantages to operating in the U.S. rather than operating overseas,” said Johan Gott, a principal at A.T. Kearney, a strategy and management consulting firm. “That could certainly lead to a new equation.”

Rutchik said a tax on services delivered from offshore “could change and potentially really cripple the offshore portion of the outsourcing industry.”

Moreover, the possibility of such a tax on services or other changes that would discourage offshoring pose “operational concerns” for companies that rely on offshore providers, he said. “Companies are concerned as far as business continuity. If there was to be some radical shift, service delivery can’t change that quickly.”

And in the wake of incidents in which Trump has targeted companies that were planning to move jobs out of the U.S., companies that outsource services work are wary of attracting that kind of presidential attention, Rutchik said. “No one wants to be in the Twitter crosshairs and called out.”


Trade War-Gaming

Gott is heading A.T. Kearney’s development of what it terms “trade war-gaming,” a process that helps companies think through the outcomes that are possible, given the considerable uncertainty around how various proposals will develop into actual policy.

“Under different scenarios, what will the impact be, and what levers do you have to respond to that?” he said. “Nobody can tell you what the future will look like, but what you need to do now is sit down and think through the options.”

While many of the companies worrying about these questions are manufacturers, Gott said he’s also getting questions from companies that outsource services work.

At first glance, the prospect of a border tax might seem to encourage the recent onshoring trend in which companies bring some work that was being handled overseas back to the United States.

But Gott said companies bringing work back generally aren’t doing so because of cost considerations, but because certain jobs have become more important to them and are therefore better handled closer to home. He cited the example of IT application development, which “is now in certain aspects your customer interface, so it’s critically important.”

Instead, U.S. moves to discourage offshoring could end up fueling another trend, that of automating service work.

“I think the back office is about to be revolutionized in many ways,” Gott said. “Raising the minimum wage of H-1B workers will accelerate that. Companies operating in the U.S. will invest at a more rapid pace in technology solutions.”

Everest Group’s Karthik said that overall, the various proposals, while surrounded by an enormous amount of uncertainty, are likely to produce “a more cautious approach to offshoring.”

But over the long term, companies may respond by transforming the way they do the work, he said. “Let’s say you take an extreme scenario where the president does impose some taxes when it comes to imported services. If labor arbitrage is going to be less attractive, you would then think about: Can the work itself be automated?

“It’s something we expect will happen over a period of time, but the political uncertainty may force this to happen,” Karthik added. “If these proposals are made into formal policies, it may actually create some new, innovative ways of service delivery that may help the global industry in the long run.”

 

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