INDUSTRY ANALYSIS
Congress and Protectionism: Outsourcing Your Job

One way or another, anti-outsourcing legislation seems likely to pass both houses of the U.S. Congress relatively soon. Whether this comes about through the House initiative led by Bernard Sanders or through other routes isn't important. What is important is that most of the proposals being discussed have bipartisan support and outlaw the use of government dollars to support foreign jobs at the expense of American workers.

From the long-run economic and military perspectives, this kind of reflex protectionism is counterproductive. In the long run, free trade produces balanced budgets and better jobs while ensuring that authoritarian regimes like Communist China's come to an end. The problem right now, however, is that the process is out of balance, with the negative consequences arriving a lot faster than the benefits.

What knocked the process off kilter is well known, too: Clinton made two deals with North Korea, one in 1994 and the other in 1999. In both cases, those arrangements were mediated by Communist China, which got provisional most favored nation (MFN) status for its help in the first round and permanent MFN status -- as well as WTO membership -- in the second.

Foreign-Sourced Services

With the controls attendant on conditional MFN lifted in 1999, Communist China made increased exports to the United States a national economic objective while continuing to block imports from the United States. In an environment where the government owns the country, that support for contract manufacturing quickly led to a disproportionate movement of manufacturing jobs from the United States to China, and consequently set off a frenzy of competitive bidding for American manufacturing jobs by other Asian governments trying to hold market share.

As a result, a lot of good people in both Canada and the United States are now either unemployed or underemployed. And politicians in both houses of Congress are reading polls telling them it's time to do something. No one yet knows in detail what that something will be, but it's a pretty good bet that the eventual compromise will attempt to slow the imbalance while providing political cover for those involved.

Thus, two elements seem almost certain to emerge as parts of the eventual consensus legislation. First, the new law likely will prevent the export of personal information for offshore processing. Second, it almost certainly will prohibit the expenditure of taxpayer dollars on foreign-sourced IT services -- if those services could be provided by Americans.

Both of these restrictions are vitally important to the IT industry. The prohibition against sending personal information out of the country for processing will stop the export of jobs -- and therefore the IT support for those jobs -- in areas such as personal financial planning and healthcare claims processing. That will kill the profitability of the financial management outsourcing services offered by companies like IBM (NYSE: IBM) and thus stop the targeting of those jobs and their IT support for offshore consolidation.

The Prepaid Infrastructure

More immediately, the requirement that federal dollars not be spent on foreign services where American equivalents are available will make foreign-sourced software support and development a thing of the past.

Federal dollars don't make up a big percentage of outsourced IT services dollars, but this tail will wag the much bigger dog of state and private-sector outsourced IT support because of the short-term impossibility of untangling the financial impact of different classes of outsourcing contracts.

For example, when a company like HP (NYSE: HPQ) offers Windows support as part of the purchase price of a PC, the service is internally priced on the basis of marginal cost plus a small contribution to overhead -- meaning that pricing assumes shared use of an existing infrastructure.

Thus the cost of adding support for another thousand PC users for a company that already supports a million or more is close to zero, because the only variable cost analysts need be concerned with is the pennies per hour paid to a foreign support worker.

Spreading Infrastructure Costs

Take away that prepaid infrastructure, however, and the picture changes. Now the cost of adding support for the next thousand users is about the same as adding it for the first thousand users, and companies like EDS, HP or IBM will have a much smaller cost advantage over the in-house IT department.

The legislation -- as currently proposed in both houses of Congress -- has provisions that will create this situation because the prohibition against spending federal dollars offshore makes commingling (spreading infrastructure costs across multiple clients) virtually impossible. Sorting out commingled costs on a pro rata or proportionate basis has a long history in military procurement, particularly for national offset programs, but would fly directly in the face of clear legislative intent and is therefore likely to be unacceptable.

As a result, a supplier like HP or IBM will need to prove that none of the cost associated with something like a leased PC reflects commingled services -- and doing so will require an internal "Chinese wall" that will take at least a year to set up.

It should be obvious that the biggest potential IT industry losers, at least in the short term, are Accenture -- which could be virtually wiped out in the United States -- EDS, IBM, HP and Oracle (Nasdaq: ORCL). Companies like Sun and PeopleSoft essentially will be unaffected. Dell, interestingly, has been putting its defenses in place for some time, with the probable ability now or very soon to sell a PC whose warranty support costs flow only from an investment in American workers.

Supporting Action

The other companies, of course, aren't sitting still either, but they appear to be focusing their efforts on lobbying for exceptions and special clauses to let them continue commingled support products -- and that's where you get your chance to play.

It doesn't matter which side of the political aisle you're on or whether you believe, as I do, that this legislation is fundamentally uninformed. A "fair trade act" requiring the United States to apply Communist China's own rules on imports from the United States to imports from Communist China would be fairer and more effective.

You should get to work and make sure your representatives in both houses know you support action on both kinds of restrictions.

In doing this, don't be discouraged by the fact that the lobbyists on the other side have more money and access than you do. Remember, elected representatives usually want the lobbyists' money only so they can use it to buy your vote -- which you can give or withhold directly.