Tuesday, January 1, 2008

Offshore Regulations: What to Worry About

Source: http://www.cio.com/

As the offshoring debate heats up, CIOs are scrambling to meet the demands of current and pending legislation. Here's what's real, what's not and how to cope.

THE SIMMERING DEBATE over offshore outsourcing boiled over on Feb. 9, when the chairman of the president's Council of Economic Advisers, N. Gregory Mankiw, blandly asserted that offshoring was good for the economy. And while Mankiw's statement may be defensible, or at the very least arguable, its timing and tone revealed a political ear of the purest tin. Not surprisingly, his quote landed on the front page of newspapers nationwide, along with charges that the Bush administration was advocating sending American jobs overseas.

Senate minority leader Tom Daschle, for example, citing Mankiw's remarks, suggested that the White House would have to explain its support of outsourcing to millions of unemployed Americans. And Republican Rep. Don Manzullo of Illinois—where a lot of manufacturing jobs were lost due to offshoring—even called for Mankiw to resign. (He didn't.)

In any event, offshoring in general, and the Mankiw quote specifically, will more than likely be central to most every campaign this fall—including the presidential, especially given that the media has been raising a hue and cry over the exportation of U.S. jobs offshore. (For more on how the media and companies are wrangling over outsourcing, see Trendlines.)

And the legislating and politicking have already begun. By the end of February, state legislatures had introduced 27 bills designed to restrict offshoring. Two bills giving preference to state contractors have recently become law. And while such measures may have a minimal impact on the general profile of offshoring as practiced today, they may be considered the opening salvos in a battle that will only heat up.

"My personal view is that [the debate] won't end until the day after the election," says Bruce Josten, executive vice president for government affairs at the U.S. Chamber of Commerce, by many accounts the most powerful pro-business lobby in the country. "It is hard to imagine this being kicked off the front page."

Cutting costs by hiring cheaper foreign labor may help the economy in the long run, but that's a hard position for elected officials to take. If voting for laws that restrict offshoring helps politicians win elections, overwhelmingly they will do so. However, as is often the case in politics, many of those votes are more about posturing than policy making. Richard Shell, a Wharton School professor of legal studies and management, suggests that offshoring is the type of issue where lawmakers vote in favor of a bill and then use parliamentary techniques to kill it after the fact. "To be able to say that they proposed or voted for [an antioffshoring bill] is a very responsive thing to do," he says. "Actually limiting outsourcing is very hard."

Groups on both sides of the issue are drawing lines in the sand. The business community has made preserving the right to offshore a top priority. On the labor side, activists are lobbying for measures that restrict offshoring (mostly at the state level) with hopes of establishing a precedent and foundation for national antioffshoring legislation.

And once again, CIOs are caught in the middle. Public-sector CIOs and those whose companies have state or federal contracts face the most immediate risk from legislation limiting how they can source their work. Health-care and financial services CIOs face some elevated risks because of the sensitive nature of the data they handle. The legislation that could affect most other CIOs, however, is in the form of disincentives and obstacles, not outright bans. The U.S. Chamber of Commerce, the Information Technology Association of America (ITAA) and other organizations that oppose antioffshoring legislation acknowledge that they cannot stop all antioffshoring efforts from materializing. Therefore, CIOs need to start preparing for the inevitable and thinking about how to mitigate (or possibly eliminate) the effects of the legislative highballing down the political road.

With Government Contracts Come Government Restrictions

To date, the most common antioffshoring bills prohibit companies with state and federal contracts from sending their work overseas. The only federal offshoring law in this category, cosponsored by Republican Sens. Craig Thomas (Wyo.) and George Voinovich (Ohio) and signed last January, restricts companies with federal contracts from outsourcing that work overseas. Indus Corp., a software development and IT support services company, signed a 10-year, $175 million contract with the Department of Transportation in May 2002 to provide IT support for the federal highway administration. And while the company has an operations center in Bangalore, Indus President and CEO Shiv Krishnan says his company no longer uses it for work on any federal contracts. IT support and software development are "fertile ground to offshore," he says. "But we have a contract with lots of restrictions."

Indus, like other companies with contracts covered by the Thomas-Voinovich provision, must be careful to keep its government work separate from its nongovernment work; and its workforce for government projects separate from its nongovernment workforce. Krishnan stresses that the background checks required for employees who work with government data make it next to impossible for his organization to send work offshore. And, in fact, he suspects that this is precisely what future legislation will do to offshoring.

An amendment, sponsored by Sen. Christopher Dodd (D-Conn.) and passed by the Senate in March, would expand Thomas-Voinovich to include state contracts funded with federal money. (It has yet to come up for a vote in the House.) Many state bills already prohibit the use of state funds for offshoring. George Newstrom, secretary of technology for the state of Virginia, which has four antioffshoring bills pending, says that the public sector is particularly vulnerable since it is funded by taxpayers, who feel that the state has an obligation both to preserve and create jobs.

Nowhere was this dynamic more apparent than in Indiana, which last year put out an RFP to upgrade the systems that run the state unemployment insurance program. The winning bid was $15.2 million from TCS America, the U.S. subsidiary of the Indian IT outsourcing giant Tata. (The next closest bid was $23.3 million.) Work on the contract was scheduled to begin last October. But the irony of a state outsourcing its unemployment benefits project didn't go unnoticed or unremarked, and within a few months Indiana lawmakers proposed legislation that would prohibit sending state contracts offshore. Meanwhile, faced with mounting pressure, the governor canceled the TCS contract in November. And in March 2004, Indiana enacted a law that would give a 1 percent to 5 percent preference to Indiana companies. (For example, a bid of $100,000 would be calculated as $95,000.)

The state's IT procurement process changed even more substantially. "The reason why Indiana companies could not bid [on the unemployment contract] was that they weren't large enough," says Chuck Martindale, the commissioner of the department of administration for Indiana and the head of procurement for the state. "We had put together a project that they couldn't bid on."

Now, the state will attempt to break large IT projects into smaller chunks that it can source separately. "We are doing what we can with policies and procedures to maximize the opportunities for companies that have a presence in Indiana," says Martindale.

Virginia is trying to avoid becoming the next Indiana. The state is facing a budget shortfall of more than $1 billion, and there is pressure for IT (and all state agencies) to cut costs. But Newstrom says he has already ruled out offshoring as a way to do that. "If we were in a private setting, we would offshore," he says. But he isn't. So he won't.

Health, Finance and Other Privacy Quagmires

Antioffshoring groups have targeted health-care and financial services companies. Rep. Edward Markey (D-Mass.) has spoken about the need to restrict where companies send consumers' data. Both California and Arizona have introduced bills that would make it illegal for health-care providers to send their patients' records outside of the United States for transcription, and California would also restrict companies from sending individuals' financial data offshore.

Partners HealthCare CIO John Glaser admits that he is "a little more wary" than ever before when it comes to offshoring, primarily because hospitals rely on the government for reimbursement. Therefore, he says, there's "a greater degree of political entanglement." Partners offshores about 1 percent of its work in the form of transcriptions, radiology reports and low-level IT work. "I'd be stunned if there was legislation that stopped this," he says. Nonetheless, he's mulling over changes he could make that would strip patient information from the data Partners sends offshore.

A major insurance company that asked not to be identified undertook such a project that played out over two years. The company's rate-calculating systems are developed and tested in part offshore. Because of concerns about privacy and identity theft, the IT group built a utility that masks personal information such as names, Social Security numbers and addresses. Offshore developers cannot match the financial information to individuals. At first, a supervisor offshore who has gone through a background check had the authority to turn off the utility if necessary; but a few months ago, even that exception was eliminated, as the company sought to further tighten control and make certain that no offshore workers could access personal data.

The fact that the system already masks personally identifiable data means the company won't have to undertake such a project in the future in response to regulation. In addition, the company is lucky its development work is offshore, while maintenance is performed in the United States. The development work requires a test environment, rather than live production data, so the company won't have to readjust its work processes to satisfy potential privacy legislation. Most companies, however, do the reverse. "Ninety-nine percent of offshore is support and maintenance, which means they are running production data," says the insurer's CIO. If the government restricts customer data from being sent offshore, "they could essentially cut down that entire tree."

How Offshoring Can Make Retailers Look Bad

Without an outright ban on outsourcing (which parties on both sides of the issue agree is unlikely), the government is powerless from prohibiting most companies from sending work offshore. But it can make it harder. There is one way for the federal government to directly impede the offshoring practices of companies that aren't government contractors or in already regulated industries: visas. The two existing programs used to bring technology workers into the country, the H-1B and the L-1, have recently come under scrutiny. Both facilitate offshoring by allowing overseas workers to come to the United States for training. (For more on the link between offshoring and high-tech visas, see "Backlash.") Both Democrats and Republicans have introduced legislation that would tighten the rules on granting these visas and close the loopholes that allow these workers to be contracted out.

However, it is more likely that the government will take indirect action to discourage the employment of foreign workers. Sixteen states have introduced "right-to-know" bills that would require help desk and call center employees to disclose their location to consumers before conducting business—essentially creating a public relations headache for companies that offshore such work. Senator and presidential candidate John Kerry has sponsored such a bill.

These bills and others, such as a Daschle bill that would require companies to give employees 90 days' notice before their jobs are offshored, are calculated to cast companies that offshore in a bad light with their customers. Steve Williams, CIO of Mattress Giant, says that they are blatant attempts to smear corporate reputations. And they're working. Williams, who says that his company doesn't offshore development, is afraid that if he did, his "competition may utilize the fact that I have outsourced 20,000 jobs overseas." While Williams is an avid supporter of free trade, he says that a CIO would be crazy to start offshoring between now and November.

Some states will probably pass right-to-know laws between now and the election. On the federal level, the most likely outcome is legislation that would provide job training, health benefits and income support to IT workers who have lost their jobs to foreign labor. Jay Gardner, CIO of BMC Software, says that he would support such a measure, even if his company had to pay for it. He considers that to be the right approach for the government to take.

"I am concerned that legislation might take the wrong approach that would be politically popular, but not in the best interest of America in a global corporate environment," Gardner says. Nonetheless, "if all [offshoring] had to be turned off tomorrow—if we couldn't do any offshoring anymore—I still have a base of people to do those same jobs," he adds.

The Sky Is Lowering, Not Falling

Despite all the attention offshoring has received of late, relatively little is likely to happen between now and the election that will put a serious crimp in the practice. The Communications Workers of America is the largest organized labor group specifically targeting offshoring, and even they know that they have to pick and choose their battles. "We're not going to stop offshoring; we know that," says Tony Daley, research economist for Communications Workers of America. "We're [just] trying to set some rules for the market."

The forces opposed to antioffshoring legislation are better organized, richer and more sophisticated in the ways of leveraging influence. And they have made blocking restrictions a top priority. The U.S. Chamber of Commerce's Josten, for example, says that if the Chamber has to sacrifice every item on its 2004 agenda in exchange for preserving the right to offshore, his organization would consider the year a success.

Ultimately, public opinion will be the main factor in determining whether any antioffshoring legislation will pass. A March USA Today/CNN/Gallup poll reported that of 1,000-plus adults surveyed 58 percent said that preventing jobs from going overseas would be a very important factor in deciding whom they would vote for this fall; 27 percent said that it would be fairly important.

In light of these numbers, Harris Miller, president of ITAA, acknowledges that some legislation is inevitable. "Congress is going to want to say they did something," he says. Miller hopes that "something" will be restricted to job retraining benefits for white-collar workers, similar to the benefits that manufacturing workers now get when their jobs are sent overseas. (See "Offshored IT Workers May Get Training Benefits.")

When these bills do, in fact, pass, business groups like ITAA will make an effort to blunt their impact. For example, the Dodd amendment that restricts how states can use federal funds was itself amended to exclude signatories to the World Trade Organization agreement on government procurement (including many European and some Asian countries, although not India and China), and makes the amendments subject to a review by the Secretary of Commerce.

"We're lobbying," says Miller. "That's what we get paid to do."

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