Look Who's Going Offshore

Tech startups are heading overseas even more eagerly than multinationals

Last December, Hilmi Ozguc, chief executive of Maven Networks Inc., began looking for venture capital to expand his 30-person startup. One of his first moves was to e-mail James W. Breyer, managing partner at venture firm Accel Partners, who had pocketed a hefty return on a company Ozguc had co-founded years earlier. Breyer immediately saw promise in Maven's software, which helps companies such as Virgin Records distribute interactive video over the Net.

But there was a catch: Breyer thought Ozguc should be using more developers outside the U.S. than he was planning on. While Ozguc had been eyeing South Korea and Japan, Breyer thought he should open an office in China, too. Ozguc agreed, and in March, Accel invested $10 million in Maven. Breyer, now a director at Maven, continues to urge Ozguc to think about the opportunities for sending work overseas. "There is not a board meeting that goes by in which outsourcing does not play a significant role," says Breyer.

A new trend is sweeping through Silicon Valley and other centers of U.S. innovation. Startups, spurred by their venture investors, are catching offshore fever, and not just a mild case -- like some big multinationals have. While 15% of the 145 large companies recently surveyed by Forrester Research Inc. (FORR ) say they have made offshore a permanent part of their strategy, an informal survey of venture capitalists suggests 20% to 25% of the companies they invest in have a comparable commitment. The fervor has gripped some of venture capital's biggest names. Kleiner Perkins Caufield & Byers, Sevin Rosen Funds, and Norwest Ventures say at least 30% of their companies have moved jobs overseas, and that figure is rising. "The venture guys are driving offshore as much as anyone," says Forrester Vice-President John C. McCarthy.

AN IRRESISTIBLE PUSH. Accel's Breyer is in the movement's vanguard. Nearly 40% of Accel's 45 investments have set up operations overseas, according to a recent Accel survey shared with BusinessWeek. By 2005, Breyer estimates 75% of its companies will be using offshore resources. And its companies are sending more than just a handful of jobs abroad: Within two to three years, Breyer says, Accel startups should have half of their workers based overseas. "If a company is not actively investing in China or India, they need to provide a very compelling case to board members as to why they are not," he says.

As the U.S. economy has struggled to create new jobs, giants such as IBM (IBM ) have taken most of the heat for sending work overseas. Yet the actions of Breyer and his venture compatriots suggest that the changes in the economy may be more far-reaching than even some experts have realized. If not only Big Blue but also startups such as Maven are sending work abroad, the tech industry may not be the engine of job growth that it has been in the past. Although the tech sector accounts for about 5% of U.S. payrolls, or 6.5 million workers, it generated 13% of the new jobs created from 1996 to 2001. Over the next five years, Mark M. Zandi, chief economist at Economy.com Inc., expects tech to contribute 7% of the country's new jobs. "Entire occupational groups can be outsourced at the flick of a computer key," says former U.S. Labor Secretary Robert B. Reich, now a professor at Brandeis University.

Breyer concedes the offshore trend hurts the U.S. job market in the short term. But his own experience has convinced him that technology companies, especially in software, need to hire globally if they are to be competitive. As early as the mid-1990s, he saw how bringing on developers overseas had helped Accel companies Agile Software Corp. (AGIL ) and Actuate Corp. (ACTU ) lower their costs. Breyer figures that, over the long haul, if U.S. companies have the talent, efficiency, and flexibility to compete worldwide will they be able to provide a large supply of good, steady jobs. "Economies and companies that don't pursue outsourcing will not succeed long-term," he says.

Lowering costs is just the most obvious reason for offshoring. Consider the case of DataSweep Inc., an Accel-backed company whose software helps manufacturers manage their factories more efficiently. Breyer helped convince CEO Vladimir Preysman to hire eight programmers in India and China to translate its product into Japanese and connect its programs with software from SAP (SAP ). Although the programmers cost 75% less than they would in the U.S., Preysman says what's even more important is that offshoring those tasks will let the company accelerate its development cycle. "We can devote our internal force to software that needs to get out," he says.

Talent is another motivating factor. Mark Fleury, CEO of Accel-funded open-source software maker JBoss Inc., says half of its 30 workers are based overseas -- in Ukraine, Brazil, and other countries. In April, JBoss hired Dimitris Andreadis, a coder based in Greece, because he wrote a program that's critical for managing the performance of computer networks. "I will scout for talent wherever it is," says Fleury. "If you are a superstar of open source, we will find you."

Still, offshoring can test the management skills of some startups. In 2001, at Breyer's urging, BrassRing LLC in Waltham, Mass., hired an Indian company to develop a major release of its software, which helps corporations manage recruiting. But because BrassRing did not give the Indians a complete set of product specifications, key features were left out, and some testing was never done. It took an extra nine months to rewrite the code, the expected cost savings vanished, and customers were irked by the delay. BrassRing continues to use offshore labor for testing and some other projects but not for core development. Offshoring "is really challenging for a small company," says BrassRing CEO Deborah Besemer.

For Breyer, meeting the offshore challenge requires nearly perpetual motion. He encourages senior execs at his portfolio companies to go overseas once or twice per quarter, and he travels abroad regularly. This March, he spent 10 days in China meeting with entrepreneurs, government agencies, and potential offshore partners for Accel companies. "We can't put our heads in the sand or hope that global protectionism is the answer," says Breyer. In the tech industry, such is the new reality for giant companies and startups alike.

By Spencer E. Ante in New York with Robert D. Hof in San Mateo, Calif.

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