Outsourcing and Offshoring
Last week, I was invited to speak on a panel at Stanford's Conference on Entrepreneurship to discuss "Leveraging Low Cost Locations."
This was not the most popular topic of the conference, but it seemed like a timely one. The day before the event, Cisco announced a big push into India, including relocating upto 20% of executives by 2010. (BTW, the HOT topic was Web 2.0 - of course! People like Mark Zuckerberg and Chad Hurley drew big crowds just as Larry Page did a few years ago).
Not long after the last bubble burst, VCs started pushing the idea of saving money by moving to offshore locations. One VC even claimed that "there isn't a board meeting that goes by that we don't ask, 'Why aren't you being more aggressive (with software development) in India and China?"
The funny thing is, I don't remember such discussions. What we have observed is that China and India are hot and US-based VCs have been launching overseas funds at a fast and furious rate (I guess it makes for a nice fund-raising pitch).
I have a different point of view - forget about costs. It's not that frugality or having a cost advantage doesn't matter, because it's DOES, but start-ups do NOT gain cost advantage by outsourcing or offshoring!
Why?
Start-ups don't compete on cost savings from outsourcing or offshoring (big companies do it with much more experience and management infrastructure). We compete based on the ingenuity and creativity of our people. If we deliver so little value that we must arbitrage labor rates, we will never make it in the long run. Any start-up's biggest challenge is lack of sales, which you get by solving problems for customers. But even that's not enough to WIN. We beat established competitors (like Cisco) by delivering more value. We can't be 10-20% better, we strive to make at least an order of magnitude leap or do something really special or remarkable. Such breakthroughs hinge on talent, not cost. (The paradox is that great talent and low-cost are tightly linked. Great people HATE waste and inefficiency! The brute force method - spending lots of money - is not how special companies get built. Great companies are capital efficient and profitable).
Last year, when one of our companies looked to hire developers with Peoplesoft experience, we found a great team in Argentina (they worked with the founders of our company years ago, when they worked for Peoplesoft). It's one of many, many examples which have convinced us that it does not matter where people come from - and cost is NOT the critical factor. It's all about getting access to the best people and fitting them together into winning (global) teams.
Some people believe that offshoring is bad for America. Even as a very small VC firm, our companies have over a thousand employees (and/or contractors) overseas. (In fact, 2007 will be the first year that our companies employ more people overseas). Perhaps that's an alarming fact. However, if we do not leverage the best talent, no matter where they are in the world, our companies could not be competitive. Then, sooner or later, we may lose all of our good jobs.
Some people also believe (or wish) that Americans have a lock on ingenuity, creativity, and craftsmanship. Perhaps our companies would always win - IF it weren't for those pesky, copy cat, low-cost competitors overseas - who don't respect IP rights, don't have to deal with XYZ regulations, don't have high healthcare costs, - or some other excuse of the day.
I just don't buy it.
I have an example from the Stanford conference. One of my fellow panelists was the founder/CEO of a company which manufactures goods in the USA and China - identical products produced in two locations. The quality of the products made in China is significantly better at a fraction of the cost.
The fact is, the rate of improvement at the Chinese factory is higher - creating a gap that will WIDEN over time. Perhaps, the Chinese workers are happier to have jobs or maybe they are more hungry - more motivated - to learn and improve. Whatever the reason, the advantages of the Chinese factory over the American one have little to do with cost. The American factory is not competitive - regardless of cost. The advantages of one location over the other have more to do with the creativity, passion and commitment of people.
A counter example is Harman International, a company which has remained competitive even while manufacturing in "high-cost" locations. Harley Davidson is another example of the triumphs of design AND manufacturing in America. In the case of Harman, labor as a percentage of costs has decreased from 20% to 5%. They've accomplished this by leveraging the talents of an inspired workforce who possess a relentless drive to learn and improve (I'd recommend Sidney Harman's book). Eventually, when labor gets down to 1%, what would be the point of squeezing labor costs?
In our portfolio companies, we have not seen material differences in productivity or quality across different countries or cultures. Output is more closely tied to the quality of input - by which we mean good management and leadership. Our managers put together winning companies by finding, nurturing, and developing great people.
You can't treat offshore employees differently than onshore employees. By this, I don't mean being insensitive to different cultures or backgrounds. We have tremendous diversity right here in our own back yard. We've seen Israeli engineers working side by side with Palestinian engineers at start-ups - this kind of stuff only happens here in Silicon Valley. This is a HUGE competitive advantage.
It's unrealistic to think that we can just give the low-cost, non-mission critical work (i.e. the "shit work") to offshore or outsourced workers and expect to be able to attract and retain great talent. In unproven locations, we may start with more boring, less risky projects (for example, a software company might start with Q&A rather than core development). But over time, we MUST give them more interesting work. If great people do not feel like they are learning or tackling meaningful work (some call it the "fun stuff" which keeps them on the leading edge) they will lose interest and look elsewhere.
As managers, if we treat employees as faceless resources useful only because they are cheap, sooner or later, we will get what we deserve - low productivity, zero loyalty, and high turnover. Don't treat workers like mercenaries! The most common reason people quit is not because of compensation, it's because they don't like their supervisors. Ultimately, the outcome hinges on management.
Some of our companies have experienced incredibly low turnover rates even in places like India (which has a terrible reputation for turnover) while other companies seem to have revolving doors. Even when we work with non-employees (i.e. with an outsource vendor), we treat them the way WE would want to be treated. We listen, care, communicate honestly, include people in decisions, share in the upside, etc. In certain cases, we've even given stock options to contractors.
It's a level playing field.
As Americans, we can be very competitive. But to keep jobs here, we have to deserve it! We have to stay hungry and be willing to work just as hard (if not harder) than our competitors abroad. That may be a scary (or depressing) proposition for some people - but it should be seen as a wonderful challenge. Silicon Valley was built on this competitive spirit.
Whether on-shore or offshore, it's comes down to management basics: first and foremost, attract and hire great people wherever you can find them - and then STOP doing dumb things to de-motivate already self-motivated people. Provide opportunities for them to learn and grow. Help them find fulfillment in their jobs. If we want to remain competitive on a global scale, there are no tricks or secrets. It takes great people, hard work, sound judgment and good management.
Bad managers fail on-shore as well as offshore (we've experienced this pain first hand).
Good managers succeed on-shore AND offshore, (in-source AND outsource).
The good news is that America (and especially Silicon Valley) has a tremendous wealth of creativity, experience, and talent. I believe, we will continue to attract some of the best and brightest from around the world (I doubt Chinese or Indian immigration policies will lead to a huge influx of talent from other cultures).
To conclude, Tom Peters has been reciting the following quote for several years:
"A focus on cost-cutting and efficiency has helped many organizations weather the downturn, but the approach will ultimately render them obsolete. Only the constant pursuit of innovation can leverage long-term success."
- Daniel Muzyka, Dean, Sauder School of Business, British Columbia
In our business - the start-up business - it's not about cost. The key to long term success is innovation, which comes from the hearts and minds of great people - bonded together - to form winning teams.
