Outsourcing: Thriving at Home and Abroad

In spite of the troubled global economy—or more likely, because of it—one of the few business sectors that continues to thrive is outsourcing. No wonder: Companies looking to cut expenses in the face of soft demand are keener than ever to hand off parts of their operations to lower-cost providers. As a result, outfits providing everything from third-party customer support and information technology services to back-office processing saw revenues grow last year by an average of 13% and expanded their workforces by 18%, according to the International Association of Outsourcing Professionals.

Of course, that's no comfort to the millions of people in developed countries who are out of work. But it does mean that major outsourcing providers, from IBM (IBM) and Capgemini (CAPP.PA) to Indian giants like Wipro (WIT) and Infosys (INFY), are surviving the recession better than many companies.

The economic situation also is reshaping outsourcing itself. Widespread layoffs in the West—especially in the U.S.—have flooded the labor market with highly skilled workers who are eager for jobs and often willing to accept lower pay. That's prompting global outsourcing providers to beef up their presence in the U.S., where they can scoop up local talent and offer services for far less than they could have two years ago.

politically explosive

Also driving U.S. growth in outsourcing services: Rising costs in traditional Indian destinations such as Bangalore and Mumbai make second-tier U.S. cities like Indianapolis and Boise, Idaho, relatively more price-competitive than in the past. "Many countries and cities are trying to get on the Indian [outsourcing] bandwagon," says Graham Pascoe, an advisory partner at consultants PricewaterhouseCoopers (PWC) in London.

The net effect, Pascoe says, will be broader choices among outsourcing locales and a move to more—and smaller—contracts. In the past 12 months, he notes, outsourcing deals already have fallen on average by 5% to 10% in value. "The credit crunch will accelerate outsourcing, but the economics of deals will be structured in a different way," Pascoe concludes.

There's another factor, too, that's altering decision-making about outsourcing. Sending work overseas already was controversial when times were good; now, in the face of widespread unemployment, it has the potential to be explosive. "Offshoring can be an emotive and fractious topic," says Shashank Tripathi, director of the outsourcing advisory service at consultancy Deloitte in London. "Locally focused companies without past [outsourcing] knowledge don't want to experiment when the economy isn't at its best."

Tata in Indianapolis

As a result, Tripathi says, companies lacking experience with outsourcing will likely steer clear of it for now, even if that means swallowing higher costs in the short term. And even firms with established offshore operations are taking a more nuanced approach. That often includes relocating customer-focused operations back home, while maintaining back-office services in cheaper countries.

Which locales may benefit from the latest trends in outsourcing? Consultants KPMG say some of the winners could be in unexpected places. One city getting a lot of attention is Boise. The longtime home of Hewlett-Packard's (HPQ) printer division boasts a tech-savvy workforce and burgeoning startup scene, yet the cost of living in the Idaho capital is far lower than in other western cities such as San Francisco or Denver. That has already prompted both HP and Microsoft (MSFT) to set up IT service centers there.

Another U.S. contender in outsourcing is Indianapolis. The Indiana capital is home to a thriving life sciences industry, as well as a growing tech sector that even has led Indian giant Tata Consultancy Services (TCS.BO) to set up shop there. "Indianapolis is a hub of entrepreneurial activity," says a recent KPMG report. (Click here to download it.)

Farther afield, cities in countries from Argentina to Australia are vying to entice outsourcing business through a variety of tax breaks, infrastructure upgrades, and government subsidies. In the Americas, that raises the prospects for places such as Chilean capital Santiago and Brazil's Campinas, which combine well-trained, multilingual graduate pools with closer proximity to the U.S.

Central and Eastern Europe Benefit

A similar story has played out in Central and Eastern Europe. Looking for cheaper places to house their European IT and manufacturing support operations, companies such as Sony (SNE) and German airline Lufthansa (LHAG.DE) have moved operations to cities such as Poland's Gdansk and the Bulgarian capital, Sofia. PWC's Pascoe says the decision makes business sense. "The region's second-tier cities offer an abundantly skilled workforce at a significantly lower cost [than Western Europe]," he says.

Outsourcing boosts the bottom line for most clients, but in the current economic climate, the practice is undergoing dramatic shifts. Aside from the rise of alternative locales on every continent, today's political culture requires companies to be more careful than ever about where they site their work—especially if they're receiving financial aid from national governments. These changes likely will mean more work is outsourced locally and less offshore. But one way or another, concludes Deloitte's Tripathi, "In the long run, outsourcing is here to stay."

See our slide show for a look at 31 cities around the world vying to become outsourcing hot spots.

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