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Offshore software development market


“Offshoring”, or “offshore outsourcing”, generally means moving the physical location of

information technology (IT) services delivery from a developed nation with high wage rates
to a developing country with lower wage rates.

The offshoring of IT services began in the mid-1990s when companies outsourced their Y2K
and euro conversion initiatives. The IT labor market in the developed countries was very
tight at that time and offshoring was often their only option. The work performed proved to be
very successful. India, in particular, has become well known for its high-quality application
development and maintenance work. “Y2K legitimized the offshore marketplace and gave
the Indian providers traction,” according to Rita Terdiman, vice president of Industry Services
at Gartner. [1]

Since the beginning of the global economic downturn in 2000, offshore outsourcing has
become one of the major sources of IT cost savings. Although legacy application
development and maintenance projects still represent the majority of work moved offshore,
companies are increasingly relying on offshore suppliers for custom application
development, call center, and business process outsourcing services as well.

Market Size

In 2000, the annual total global IT services market was estimated to be roughly $400 billion.
North American companies spent approximately $114 billion on in-house software
development, contracting, and purchases. [2] The global offshore IT services market is
valued at between $9 billion and $10 billion annually, and therefore, represents about 2 to
2.5 percent of the global IT services total.

The United States, which accounts for about 45 percent of worldwide IT services spending,
is the largest customer of offshore software services. U.S. companies accounted for roughly
60 to 65 percent of the total, European companies account for about 25 percent, and
companies in the Asia Pacific region account for 10 to 15 percent. [3]

According to a recent report published by IDC, a Framingham, MA-based market research

firm, offshore outsourcing is the dominant trend in the IT services industry. IDC states that
42 percent of the application management contracts have some offshore component and
that the main reason for moving offshore has been lower cost. [4] Incoda, believes that the
demand for offshore outsourcing of IT and IT-enabled services will continue to increase due
to continued cost pressures, the anticipated global economic recovery, and to the trend of
globalization of services.

Type of Service Offerings

The offshore outsourcing market has evolved over the last decade. In the mid and late
1990s, it was used almost exclusively for delivering highly commoditized, technical staff
augmentation. Today, companies are relying on offshore software developers for a much
broader range of IT services. The service offerings of offshore suppliers cover the entire
spectrum of IT activity—from support and maintenance of legacy applications to complex
custom applications and a variety of other higher value IT and IT-enabled services. Gartner
Group places the types of offshore service offerings into three categories, based on the
suppliers’ level of experience with those service offerings. [5]

- Most mature: application maintenance and management, application migration, and legacy
application development.

- Medium maturity: new custom application development, enterprise application integration,

implementation of application packages (e.g., ERP, CRM, SCM), and business integration.

- Least mature: call centers, business process outsourcing (BPO), infrastructure outsourcing,
ERP services, remote network management, product engineering, embedded software, and
technical services.

The two fastest growing segments of the offshore services market are application
management and business process outsourcing (BPO). BPO is capturing the attention of
many executives as a way to reduce the costs of business processes such as customer
care, billing, collections, claims processing, and various other back office functions. Gartner
points out that call center and transaction processing markets are more mature than the
outsourcing of more complex, back-office processes.

Offshore providers will strive to create or extend differentiated capabilities and continue to
expand their services portfolio offerings to include higher value add project-based services.
Given the growing level of competition in the services outsourcing market, companies that
don’t have unique capabilities will be subject to downward pressure on billing rates.

Large multinational enterprises have been the largest users of offshore software services
suppliers. In 1999, more than 185 of the Fortune 500 companies outsourced at least part of
their software needs to India [6]. Today, the majority of the Fortune 500 use offshore
development services through third-party suppliers or have wholly-owned development
centers established offshore. Some well-known companies utilizing offshore software
development include General Motors, American Express, 3M, Cigna, DuPont,
Weyerhaeuser, ING Group, Motorola, Accenture, British Airways, Intel, Deloitte Consulting,
British Telecom,, Home Depot, Shell, Sprint, Nortel Networks, EDS, Aetna,
and MasterCard. Major hardware and software giants like Microsoft, IBM, Apple, Oracle,
Novel, Sun, IBM, Compaq and Texas Instruments all have extensive offshore operations.
Not surprisingly, the largest industry sectors using offshore software development are those
that are heavily dependent on information technology, including banking, insurance, and
other financial services, communications, media, and software.

The successes of large multinational companies have generated strong interest in offshoring
by small and medium sized companies, including an increasing number of technology start-
ups. More than eighty percent of the software companies surveyed are shipping work
offshore today or will do so in the next year, according to the Sand Hill Group, an investment
and research firm based in San Francisco, California, who published the findings of survey
of 51 software companies in July 2003. The study found that 63 percent of the responding
companies are currently involved in offshore initiatives and an additional 21 percent are in
the process of sending work offshore and will have such processes in place within a year. [7]


Three primary drivers have produced the rapid growth in offshore outsourcing. They are:

1. Difficult economic conditions around the globe. Companies are being forced to investigate
any and all opportunities to reduce their cost structures.

2. The large, wage-rate differences for similar skills that exist around the globe. The larger
the differential between domestic wage rates and offshore rates translates directly into larger
cost savings in both direct and indirect labor costs.
3. Demonstrated outsourcing successes by well-regarded companies. Numerous articles
and case studies have been published that document the benefits achieved from offshoring
by respected global corporations.

Incoda believes that businesses will continue to focus their attention on core business
priorities and will increase their offshore outsourcing of non-core IT systems and processes.
Potential customers for offshore services will continue to look for cost savings and are
gaining a level of confidence with the delivery capabilities of offshore suppliers. Many of the
today’s offshore projects will expand from discrete assignments to multi-year outsourcing


Three enablers support the move to offshore outsourcing.

1. The increasing capabilities and falling costs of telecommunications worldwide, including

high-speed Internet, instant messaging, web conferencing, and VoIP. These
telecommunications advances, along with numerous productivity tools, such as collaborative
project management software and knowledge management applications, enable businesses
to leverage highly qualified workforces anywhere in the world.

2. Tax and other financial incentives offered by governments to nurture the growth of the IT
services sector. For example, in India, the government plays an active role in promoting the
software export industry, with initiatives such as the Software Technology Parks of India
(STPI) and the Special Economic Zones (SEZ), which offer income tax exemptions until
2010. Other developing countries are also supporting their domestic software export industry
through specific policies and tax incentives.

3. Availability of educated, technically skilled, and motivated workers in countries around the
world. Long-term trends predict a shortage of IT talent in the world’s developed economies.
In many countries, open technical positions remain unfilled because of a lack of applicants
with the requisite technical and non-technical skills. On the supply side, India alone
graduates roughly 110,000 computer professionals annually from its more than 1,800
educational institutions.

By Dr. Bernard L. Palowitch, Jr., President & CEO of Incoda Corporation.