Why the Fast Growing Domestic Sourcing Market is Changing How Economic Developers Attract New Business

By: Eric Hochstein

The following is a guest post Eric Hochstein. Eric is an Economic and Business Development Consultant at Highstone Associates.

Domestic sourcing providers, companies which provide technology services from United States operations centers, remain relatively unknown in the global outsourcing industry, but are among the fastest growing segments of the IT industry. As a result of that growth, and the highly desirable jobs these companies offer, economic development agencies across the U.S. are aggressively seeking to attract these companies to their communities.

A combination of well-paid, highly skilled jobs and a clean industry makes domestic service providers outstanding targets for economic developers today. However, without a more detailed understanding of the industry, many pursuits will end unsuccessfully as the companies in this industry are creating different business models and going in different directions. Economic developers need to focus their attention on the right companies for their locations.

Domestic Outsourcing is Growing While the Global Market Contracts

Since the Y2K crisis, CIOs in major companies in the United States, and around the world, have relied upon offshore outsourcing, mainly from India, to relieve cost burdens of managing the growing technology demands of their enterprises and the limited availability of qualified resources. The offshore model provided access to almost unlimited, highly educated resources at a fraction of the localcost.

However, due to dissatisfaction with increasing costs and lower quality over the past decade, and with business models changing, causing a shift in spending control from IT departments to operating business units, the outsourcing location pendulum has begun to swing from an offshore extreme to more of a balance between offshore and domestic-based delivery.

Companies have begun to appreciate the benefits of domestic delivery for key components of their outsourcing portfolios, especially in the era of digital innovation.

The global outsourcing market has declined from peaks reached in 2010 and the value of outsourcing deals signed in 2014 shrank 17% to $120.4 billion from $145.5 billion a year earlier according to KPMG. But the value of contracts being delivered from the United States is actually growing.

With U.S. headquartered buyers estimated to account for approximately 40% of global outsourcing contracts, there is almost a $50 billion market opportunity for domestic providers to serve. Today, it is likely that less than 1% of global contracts are being serviced by purely domestic providers in the United States.

Despite having such a small share of the global market for outsourcing services, the domestic sourcing industry has grown rapidly over the past five years. Although there are no reliable industry figures, company executives say their companies are growing in the 20-50% range annually.

They need to be able to open new locations to keep up with the demand.  With a growing demand for U.S. delivered services, the future for domestic sourcing providers looks quite good.

As a result, communities of all sizes across the United States are anxious to attract outsourcing companies and the jobs they create.

What’s Driving Domestic Outsourcing?

First known as “rural outsourcing”, and based on the premise that only rural locations in the U.S. could support the low-cost business models required to compete with the costs of offshore outsourcing to India and other distant countries, the model has matured over time as the market has changed and the playing field has broadened.  As a result, service providers have established delivery centers in the United States.

Companies are choosing to outsource from domestic locations for a number of reasons.  Some have to do with problems in the offshore model, while others are related to the advantages of being onshore.

The first driver was the escalation of labor, recruiting, and training costs that decreased the offshore labor arbitrage advantage, which had been the original driver of the growth of offshoring.

The spread of “offshore fatigue”- the added stress and strain on domestic project teams charged with managing offshore projects – compounded the concerns about offshore costs. The fatigue was caused by long distance travel pressures, late night conference calls, and frequent issues caused by cultural and language differences and it accelerated internal dissatisfaction with offshoring.

More recently, changes insoftware-writing methodologies from waterfall to agile development, which demands more frequent intra-team communication and quicker iterations, magnified the benefits of proximity, similar time zones and culture. Since domestic sourcing aligns project teams better and speeds up development and testing, early adopter companies are rebalancing their outsourcing portfolios, shifting some work from offshore to onshore and sending new strategic work to providers in the United States.

The new paradigmrequires smaller teams with in-depth knowledge of the business domains and practices that reflect the unique traits and competencies of the contracting companies.  Business analysts, architects, and developers create more strategic and innovative applications, often in the emerging areas of social, mobile, big-data analytics, and cloud.Todayskill becomes more important than scale.

In the original labor-arbitrage outsourcing model, large-scale offshore projects often involved hundreds of engineers, developers and systems specialists working on networks, maintaining infrastructure, and supporting legacy systems and generic services. That work continues to be done offshore.

Another recent change in the outsourcing industry is also shiftingwork from offshore. Intelligent automation, the use of smarter and more integrated technologies to further eliminate the need for human interactions, has reduced the need to send work offshore. The new technologies require fewer, but more skilled and business-savvy, employees who can be found domestically.

Finally, some types of companies prefer that work be done onshore.  In regulated industries, such as financial services and healthcare, privacy and data security concerns are also driving work to the U.S. rather than offshore. Government agencies are, in many cases, prohibited from sending work offshore while some companies, for “patriotic” or marketing-driven reasons, prefer to keep work in the United States.

What Does this Mean for Local Economic Developers?

From the largest global companies to small and emerging domestic outsourcers, providers are increasing their domestic capacity and will need new locations from which to deliver their services.

Major global providers are revisiting their domestic capabilities as they adapt their global delivery models, while little known domestic-only service providers, such as Onshore Outsourcing, Nexient, and Eagle Creek Software Services all claim that their businesses are growing rapidly and that they are rushing to keep up with client needs.

At the same time, leading offshore providers, including the major Indian-owned service providers and companies from Europe, Asia, and Latin America, have been expanding their domestic presence due to changing market conditions and client requirements.

While all types of companies have been looking for domestic locations, their requirements differ widely. The larger, global companies appear to have a dual-prong strategy. They locate small teams in major cities near their customers’ locations and create larger delivery centers in lower cost locations, often second or third tier cities, near major educational institutions.

Offshore suppliers, particularly Indian-heritage companies, have also tried to be closer to their clients, often locating centers near major client facilities. For example, TCS (Tata Consulting) opened a large center in Midland, Michigan, near the headquarters of its client, Dow Chemical.  Infosys, opened a center in Milwaukee, Wisconsin to serve Harley-Davidson, headquartered there.

These companies usually staff their offices with a combination of U.S. residents and foreign workers on H-1B (temporary work) and L-1 (specialized knowledge) visas. With those visas becoming harder to get, more American workers have been hired by Indian companies in recent years.

The “purely” domestic suppliers are focused on identifying lower costs locations in the United States where they have access to a sustainable supply of resources and are fairly protected from competition from other service providers.  Some have chosen to locate in second or third tier cities, with populations around 500,000, while others have built strategies around smaller, rural communities with fewer than 25,000 people.Other companies believe their sweet spots are in the middle, in communities with between 75,000 and 250,000 people.

For the established companies with existing delivery centers in smaller communities, growth generally means opening centers in new locations with fresh supplies of labor, rather than local expansion. Their centers in small, low-cost areasreach a saturation level for the type of workforce that they require when they reach 150 or 200 employees.

This forces them to expand elsewhere with similar attributes.Some of these companies have developed a competence in recruiting, hiring and training the right candidates for their positions allowing them to go into almost any location.

For other companies, with facilities in larger cities and a capacity to scale larger as needed, physical expansion to new locations may be driven more by proximity to customers and new market opportunities than by the need to expand their candidate pool. In these cases, one important element is the availability of college graduates.

This means that economic developers, to be successful, must carefully profile the companies in the market and understand the specific needs and strategies of the companies they choose to approach in relation to the assets in their communities.  They need to be able to target the right companies for their community and offer the appropriate incentive packages and workforce development tools.

Communities Need a Collaborative Approach to Attraction

The growth of domestic sourcing requires all types of technology services providers, from global leaders such as IBM, to the smaller upstarts, to identify viable locations for their businesses with the right combination of skilled workforce and competitive costs to sustain their growing businesses.

To respond, economic developers will do best with a community-wide approach to attraction incorporating innovative approaches to workforce development, alignment with higher education, and a strong financial proposition.

Local universities and community colleges generally play a major role in helping to attract these new employers, in training their initial workforce, and in sustaining the flow of skilled resources to the companies. Companies say they are looking for those communities with established tri-partite partnerships between government, economic development organizations, and educational institutions.

The incoming companies want to see strong cooperation in the local community and significant benefits available to them in the form of grants, incentives and other programs which will help them start up quickly and which require minimal front-end investment in infrastructure, strong support for recruiting and training their new work force, and future commitment to their growth and local expansion. At the same time, most companies want to work closely with the local institutions to assure that education and training of students is relevant to the needs of their businesses.

Whether the companies are information technology services companies (IT), providing application development, network management, or quality assurance, or business process outsourcing (BPO) providers, handling processes such as finance and accounting services, human resources, or customer service, communities desire their presence and make them generous offers because they attract professionals and offer above-average salaries who are likely to establish roots in the community.

These companies require a vibrant ecosystem around them to support their growth and satisfy the broad requirements of the new employees. In fact, some believe that for each dollar of a service provider’s payroll, another $4-5 of economic activity is generated locally.

It’s Not just Rural Outsourcing

Companies of all sizes are actively providing outsourcing and technology services from the United States, some of which is being brought back from offshore as clients rebalance their outsourcing portfolios. IBM, the largest global technology services company, has established new development and innovation centers in mid-sized cities with strong academic centers around the United States.

Some of IBM’s newer locations include Dubuque, Iowa; Columbia, Missouri; East Lansing, Michigan; and, most recently, Buffalo, New York.

In 2013, IBMannounced it would create about 800 jobs in Baton Rouge, Louisiana. A key part of that deal was an investment of more than $14 million in state funding designed to accelerate the growth of the computer science program at the Louisiana State University.  Also, as part of the same deal, a local developer announced a new $55 million mixed-use development downtown with offices for IBM and an 11-story residential building.

IBM, state officials, and LSU formed a statewide partnership which has embedded IBM employees in the University to advise on curriculum development, teaching strategies, internships and career placement, as well as the encouragement of STEM careers throughout the state’s educational system.  Enrollment at LSU in the computer sciences has already tripled.

This public-private-academia partnership has already been replicated in other areas of Louisiana.  A number of leading domestic outsourcing companies have established operations in and around New Orleans, Houma, Lafayette and Baton Rouge, making Louisiana one of the hotbeds of the domestic sourcing industry.
Other companies are working with similar models. CGI, a Montreal, Canada-based global technology services firm which claims to be “the sixth largest independent information technology and business process services firm in the world”, opened its newest onshore delivery center in Lafayette, Louisiana in late 2014. CGI has established operations centers in four other U.S. communities including Belton, Texas; Lebanon, Virginia; Athens, Ohio and Troy, Alabama.

Each location draws on the resources of local colleges and universities to assure a quality workforce and “gives college grads more opportunities to live locally, while giving businesses throughout the U.S. the ability to source more IT work in America’s heartland.”

CGI stresses that its onshore model creates quality IT jobs in the United States, invigorates local economies, and is an example of community investment, requiring collaboration between local communities, governments at all levels, academia, and the private sector.

Models Fit All Sizes of Cities

Global firms, like IBM and CGI , have different requirements than emerging providers such as Rural Sourcing, Inc., Onshore Outsourcing, Genesis10, and Eagle Creek Software Services, all of whom are rapidly growing, purely domestic outsourcing providers. But it would be mistaken to think that all domestic outsourcing companies had the same business models and location profiles.

Monty Hamilton, CEO of Rural Sourcing, Inc., an early domestic outsourcing player, says that his business is “all about workforce and accessibility to talent”. His company has centers in Augusta, Georgia, Mobile, Alabama, and Jonesboro, Arkansas. While these are not “Tier 1” cities, they are not “rural” towns.  He says “RSI’s mission is to create 3,000 IT jobs in tier-2 cities across the United States by bringing jobs that were lost due to offshore outsourcing back to America.”

At the other end of the spectrum, companies like Eagle Creek Software Services and Onshore Outsourcing, are truly taking outsourcing to rural America.  But they are doing it in different ways. Eagle Creek, with headquarters in the Minneapolis area, has technology centers in Valley City, N.D., Pierre, S.D. and Vermillion, S.D.  Vermillion, has a population of about 10,600 and is the home of the University of South Dakota. Eagle Creek partners with, and recruits from, the school, but also recruits professionals from out of state to move to Vermillion for the promise of a career in a place with a good quality of life.

Offshore Outsourcing, which has an office in Macon, Missouri, population 5,500, generally recruits locally and regionally and trains and develops it core staff. It prides itself on bringing positive change to the communities it invests in.From an economic development perspective, Onshore’s arrival in Macon has been a driver of rebirth and great change in the local economy.

Domestic outsourcing service providers are a good new target for economic development teams throughout the United States.  The companies are growing and there will be a continuing need for new locations where companies will create 100 or more new jobs at a time.

In this industry, however, one approach will not attract all companies.Companies with different profiles will have different requirements, while communities of different sizes will have different assets and benefits to offer.

To be successful, economic developers must understand the industry, the companies, and the specific requirements the companies have. They must sell to the specific requirements of the individual companies and they will need to have their red carpets ready, and their partners prepared, because the outsourcing companies move fast when they are motivated and won’t have to wait to find good offers.

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