High Oil Prices and its Impact on Offshoring of IT

Recently, we've been swamped with project bids. I am unsure if other offshore firms are in the same boat or not, but it could just be "referrals" at work due to our higher than usual marketing effort in the previous quarter. However of late I have been excessively concerned with the future of the offshored IT services given the rapidly changing dynamics of the world with astronomical oil prices.

Just to give a glimpse of the impact on a developing country, the cost of inelastic price goods such as food, fuel, electricity etc have appreciated well over 30% and rising. In a developing country, the vast majority of the population is just hanging by a thread around the poverty line. With monthly inflation heading towards 30% I dont even want to imagine its impact on the society.

In contrast, in a developed nation inflation has a limited impact due to appropriate market forces already in play. The cost of fuel will make a dent, but the substitutes to commodities impacted will be made readily available and unless the economy hits stagnation, by and large the majority will pull through. Examples include availability of generics in medicines, tax incentives for fuel efficient cars/appliances, entrepreneurs betting on disruptive technologies etc.



Being in a developing country ie Pakistan, has had the selling point of lower labor costs, which has been instrumental for "wave 2" offshoring, ie inline with concepts of labor arbitrage. But with the cost of living rising significantly, and market inefficiencies that hamper the availability of cheaper substitutes (read corrupt and inefficient/non-innovative governments/private sectors), the labor arbitrage may not hold for much longer. The salaries will need to rise, and in doing so will impact the arbitrage. And with offshore productivity generally considered to be lower, the honeymoon may come to a screeching halt. This arbitrage is key for "wave 2" specific offshore countries in sustaining the lifestyles they've quickly gotten used to.

I fear a reversal of offshoring where possible, lets face it, no firm is going to track back on billions of dollars of investment in offshore office overnight. But if the oil prices remain high, the reversal may happen and catch up pace unless the "3rd wave" is quickly achieved.

My view of the positives and negatives stacked up on the offshore market are given below.

Positives

1. Still cheaper to do business in developing nations by around 30% to 60%
2. Access to large pool of technical resources (most developing nations have had a sustained high population growth rate - in simple terms, population average age is young and entering job market)
3. Over time, offshoring has become more straight forward and the unknowns and risks have come down. Hiring US based managers with experience in dealing with offshore engineers too has improved, thereby reducing barriers to offshore

Negatives

1. Offshore productivity is slightly lower. Thats both because onsite managers cant manage as efficiently and the typical offshore engineer is not as versed with the problem being resolved. A typical US based engineer is better able to relate to the concerns/problems as the target market is generally the US population for products
2. US engineering costs may come down. An employers market in the US quickly forces engineers to reduce their salaries. They are able to take advantage of work from home opportunities as well (See my previous post) with a high degree of reliability, thereby reducing their gas bills and cost of living. This will further reduce the arbitrage.
   
3. US businesses may cut down on IT budgets and initiatives as corporations feel the oil pinch. This will speed up the previous point
4. Political unrest in the developing world due to hyper inflationary pressures. This is probably consequence, and I do hope it never comes around to this!