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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications 3 Effects of Offshoring on Specific Industries The committee commissioned papers on offshoring in six economic sectors—automobiles, semiconductors, software, personal computer (PC) manufacturing, pharmaceuticals, and construction engineering and services—to gather information for the workshop (see Part 2). The six industrial sectors were selected based on (1) the size and importance of the industry to engineering and the overall economy and (2) the availability of expert authors. Table 3-1 provides a summary in graphic form of the six industries. The commissioned authors were given a list of questions to use as guidelines (Box 3-1) and were asked to submit abstracts, and then draft papers, in the run-up to the workshop. Following the workshop, the committee developed questions and suggestions for revisions, which the authors incorporated into the final papers. Table 3-2 provides a summary of answers based on the commissioned papers mapped onto the questions in Box 3-1. Summaries of the papers follow. SOFTWARE-DEVELOPMENT INDUSTRY The software-development industry was the first to engage in the offshoring of engineering for the purpose of reducing costs. In Chapter 2, we described the beginnings of software-development offshoring, particularly to India, as part of an overall picture of offshoring. In this summary, we describe the current status of software-development offshoring, trends, information gaps, and unanswered questions. Although offshoring of software development was the leading edge of the practice of engineering offshoring, it is still not clear whether offshoring in other industries will follow a similar pattern. The paper by Dossani and Kenney on offshoring in the software-development sector is focused on India. Although a few other countries, such as Ireland, which adapts software products developed by multinational companies for the European market, are also destinations for offshoring, the scale of activity in India is much greater than elsewhere. The number of workers employed in software development in India is increasing by 30 to 40 percent a year, from about 2 percent of U.S. employment in 1995 to almost 20 percent in 2005 (Table 3-3). India today specializes in software services, such as the development and maintenance of custom-application software for large clients in several industries, such as insurance and finance. From this base, multinational companies operating in India and Indian domestic firms have moved into other areas, such as product software and embedded software. The increasing technical sophistication of Indian workers and higher value added to products are being driven by investments by U.S.-based companies (Table 3-4). Dramatic increases in exports from India to countries all over the world indicate that software development there is now targeted at the global market. The first offshoring of software development by U.S. firms to India had one common characteristic—the work being offshored was modular and did not require regular contact with customers (Dossani and Kenney, this volume). Several U.S. companies began by contracting with a vendor to perform this non-integral work. After a period of time, they decided to set up Indian subsidiaries to perform more integral work. At first, although costs were lower in India, it was more difficult to hire an equivalent team there than in Silicon Valley. Nevertheless, as these companies gained experience in managing offshoring relationships, the barriers
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications TABLE 3-1 Data on Six Industries, 2002 (except where indicated) Computer Systems Design and Related Services NAICS: 5415 Software NAICS: 5112 Semiconductors NAICS: 3344 Automobiles NAICS: 3361-3363 Construction Engineering/ Services NAICS: 23, 3413 Pharmaceuticals NAICS: 3254 PC Manufacturing NAICS: 3341 Total for 6 Industriesa U.S. Total Value-added ($ billions) 173.5 103.5 110.4 469.8 1,358.4 140.6 73.7 2,429.9 10,469.6 Employment 1,107,613 356,708 437,906 1,078,271 8,459,885 248,947 150,751 11,840,081 114,135,000b R&D performed ($ billions) 11.9 12.9 11.9 16 (est.)c 10.7 10.1d 3 76.5 193.9 R&D scientists and engineerse 90,800 80,800 73,000 83,200 n/a 51,800 15,100 394,700 1,066,100 aThe software industry is represented by two NAICS codes, 5414 and 51112, which clearly do not map exactly onto the industry sectors covered in the commissioned papers, particularly for software (figures here understate the revenue, employment, and R&D of interest) and PC manufacturing (figures here overstate the revenue, employment, and R&D of interest). bTotal private sector employment. cIn recent years, the auto industry R&D total has not been reported by NSF because it would disclose the total for an individual firm. $16 billion is a rough estimate obtained by subtracting the R&D performed by the aerospace industry from the total R&D for the transportation equipment sector. d2001. eR&D scientists and engineers is not an ideal proxy for the population we are interested in, but this data is collected by NAICS code and allows an apples to apples comparison. Note that Moavenzadeh (this volume) gives an estimate of 189,000 engineers in the auto industry for the relevant NAICS codes. Sources: Bureau of the Census, 2004 (for value-added and employment); NSB, 2006 (for R&D performed); and Hecker, 2005 (for R&D scientists and engineers). began to come down. For example, Broadcom, a software-intensive semiconductor company, reports that its team in Bangalore is now as productive as its teams in San Jose and Irvine, with costs in India running about one-third of those in the United States. As the institutional infrastructure in India has improved, offshoring has become part of the normal way of doing business in the software industry. The diaspora of U.S.-educated Indian entrepreneurs has helped fuel the growth of the Indian tech sector, which is developing in a way that complements Silicon Valley (Saxenian, 2006). One example cited by Dossani and Kenney is Netscaler, a company that turned to offshoring when it was facing a funding crunch. The tactic enabled the firm not only to survive, but also to grow (both in India and the United States). Aspray et al. (2006) observe that offshoring has become essential to the globalization of the software industry and will undoubtedly continue and increase. In Dossani’s workshop presentation, he reported that today, in Indore, which is not a large IT center like Bangalore or Mumbai, wages for engineers who work 12 hours a day, six days a week are about $200 a month. However, in larger centers like Bangalore, salaries for experienced engineers are rising rapidly. For example, in a 2006 survey, “State of the Engineer,” published in EE Times, the mean salary for Indian respondents was $38,500. However, as the history of Silicon Valley shows, higher costs are not necessarily a barrier to innovation-fueled growth (Saxenian, 2006). Despite very high costs for skilled labor, Silicon Valley has remained a prime location for innovative start-ups. In a workshop presentation, Alfred Spector, a consultant and NAE member, outlined three possible scenarios for the future of software-development offshoring (Spector, this volume). In the first scenario, offshoring frees up U.S. talent and money, which can then be focused on higher value-added activities, such as testing, which then becomes much more efficient. In the second scenario, the rise of India and other offshoring destinations in certain sub-disciplines leads to a loss of U.S. jobs in those sub-disciplines, but, again, frees up talent and other resources for the creation of new sub-disciplines or super-disciplines that keep U.S. software innovation strong overall. In the third scenario, when U.S. students learn that certain activities are being moved offshore, they conclude that opportunities for software innovation in the United States are drying up and decide not to pursue careers in those areas; this leads to atrophy in the U.S. talent and skills base.1 The three scenarios are not mutually exclusive—the United States might maintain its leadership position in some aspects of software but lose it in others. Spector says that the 1 One reviewer of this report suggested tracking metrics related to software innovation over time to determine which of these scenarios is being realized.
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications TABLE 3-2 Comparison of the Industry Sectors Covered by the Commissioned Papers Software Semiconductors Automobiles Construction Engineering/ Services Pharmaceuticals PC Manufacturing 1. Nature of engineering work Scope of work that can be spatially disaggregated is growing. Disaggregated business models, functional integration in products. Increasing pressure to increase efficiency, more open innovation process. Supply of workers in the industry is a problem. Increasingly difficult environment for business models based on blockbuster drugs. Disaggregated business mode grew up in the 1990s. 2. Current status regarding globalization Strong capabilities in several countries, distributed development increasingly common. Globalization has complemented U.S. innovation/market leadership. Successive waves of globalization, “build where you sell,” emergence of global suppliers. Large project sector more globalized than building/ residential sector. Increasing consolidation, globalization of companies and markets. Engineering and manufacturing increasingly concentrated in China. 3. U.S. engineering workforce Increasing, expected to grow over the next decade. Sustained growth over time, less opportunity for older and less-skilled, increase in foreign-born. Total employment down over the long-term, same is true for engineers. Aging—low starting salaries discourage U.S. civil engineering grads. Appears to be growing, though life sciences may be growing faster than engineering. Fairly small 4. Countries where work is expanding India in particular, evidence of growth in other countries. India China, India, wherever the automotive market is expanding. Large range of offshoring destinations, in addition to India and China, Eastern Europe is attracting work. China, India, United States still attracts innovation investment. China, Taiwan 5. Offshoring occurring Yes, driven by cost reduction, extent of high-value job losses uncertain. Yes, cost reduction a primary motivator. Yes, both through global optimization of platform development and through offshoring of routine tasks; also onshoring. Yes, growth of global teams in the large project sector. Yes, began with clinical trials and is moving up the value chain, but limits on end-to-end; also significant onshoring. Yes, only limited engineering work remains in the United States. 6. Work that is more or less vulnerable More vulnerable: standardized service and maintenance; Less vulnerable: Interface with final customer. Product definition is less vulnerable. Less vulnerable: Work on vehicle types where the United States is the leading market (e.g. large pick-ups); work where high degree of domain knowledge is needed. Less vulnerable: Work where high degree of interaction with the customer is necessary. More vulnerable: clinical trials; Less vulnerable: the most sophisticated R&D. Less vulnerable; high level definition of product characteristics; most other engineering work is gone already. 7. Future outlook Diversification of destination countries, increase in value-added of offshored work. Continued globalization of engineering work. Fortunes of leading global OEMs diverging, U.S. engineering fortunes have more to do with competitive success of companies than offshoring per se. Will increase, although there are limitations on offshoring due to licensing, government procurement regulations, national/homeland security concerns. U.S. engineering employment not likely to be impacted by offshoring. Companies that can innovate will need at least some U.S. engineers; Taiwanese engineering will be offshored to China.
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications BOX 3-1 NAE Offshoring Project: Issues and Questions to be Addressed in the Commissioned Papers What is the nature of engineering worka in the industry, and how is it changing? Why is it changing? What are the typical entry level skills and credentials required of engineers? How do various countries compare in the production of qualified engineers, and in the institutions that provide skills and credentials? What is the current situation with regards to globalization of the industry? How globalized is the industry in terms of manufacturing, competition (e.g., do firms based in one or a few countries dominate certain market segments?), and capability (e.g., are certain engineering capabilities available in only one or a few countries)? What do we know about the U.S. engineering workforce in this industry from statistics and other data? Is the engineering workforce growing, shrinking, stable, aging, or we don’t know? Are wages rising at the same pace as the overall engineering workforce? Are there differences between those with graduate, 4-year, and 2-year degrees? In what countries and regions is engineering work expanding in this industry, and why? Is offshoring occurring? If so what are the primary sources and destinations? What roles have multinational corporations and start-ups played? Has government policy played a role? Has engineering work followed production? Are engineering workforces growing, and if so how fast? What are trends in wages? What are the current and projected capacities for educating and training engineers? Is it fair to say that engineering work previously performed in the United States is being offshored, or is there a positive net effect? Are there qualitative differences in the types of engineering jobs that are performed in the U.S. and those performed elsewhere? Are there types of engineering work in which the United States or other countries enjoy distinct advantages? Are there areas of engineering work that are more or less vulnerable to offshoring? What can individual engineers and U.S. institutions do to retain their competitiveness? Can you make projections regarding future offshoring trends? How concerned should U.S. engineers be about offshoring in this industry? Will wages in countries in offshoring destination countries rise to an equilibrium level? Are new destination countries likely to emerge? What factors will determine future outcomes? a“Engineering work” is defined as the full spectrum of research, product and process development, engineering management, manufacturing engineering, etc. growth of the open-source movement and other advances in underlying technologies will also affect how offshoring and regional capabilities evolve. As in other industries, the growth of offshoring in software development thus far has been led by U.S. companies. Japanese companies are much less inclined to offshore software work (Aspray et al., 2006). Western Europe-based firms fall somewhere in between; of these, U.K.-based companies account for the largest share of offshoring. One technological trend that will challenge software TABLE 3-3 Increases in Offshoring of Software Production in India Employment 1995 2005 United States 1.5 m 2.6 m India 27,500 513,000 Source: Dossani and Kenney, this volume. developers in the future, with uncertain implications for offshoring, is the growing popularity of multicore processors and multiple-processor systems. These technologies offer significant advantages in hardware design and more rapid processing, without the heat limitations of single processors. However, multicore designs require software designers who can deal with concurrency and develop new programs in which tasks can be broken into multiple parts that can be processed separately and reassembled later (Krazit, 2005). Because these skills may not be available in the usual offshoring destination countries, relatively more engineering work may become available in the United States. Some concerns have been raised about whether the globalization of software might be a serious threat to national security (Hamm and Kopecki, 2006). For example, accidental defects or maliciously placed code might compromise the security of U.S. Department of Defense networks. The Defense Science Board is currently completing a study on how the department should address these concerns.
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications TABLE 3-4 Rising Sophistication of Technical Work in India 2001 2002 2003 2004 2005 2006 (E) Computer-aided design (CAD) and computer-aided manufacturing (CAM) (CAD/CAM) ($B) 3.65 4.40 4.87 5.98 7.67 10.16 Total software exports ($billions) 5.30 6.16 7.10 9.80 13.10 17.10 Share of CAD/CAM (%) 68.90 71.40 68.60 61.00 58.50 59.60 Share of foreign firms’ revenue (%) 14.50 22.00 26.00 31.00 31.00 n/a Source: Dossani and Kenney, this volume. AUTOMOTIVE INDUSTRY The paper by John Moavenzadeh, executive director of the International Motor Vehicle Program, on engineering work in the automotive industry begins with a description of the two main categories of engineers—manufacturing engineers and product engineers (the majority). Manufacturing engineers typically work at production facilities, while product engineers typically work at corporate engineering and design facilities. Product engineering can be divided into several categories: product design, development, testing, and advanced engineering. A significant percentage of product engineers work for automotive suppliers rather than for original equipment manufacturers (OEMs), such as Ford, Toyota, and Volkswagen. Moavenzadeh describes the difficulty of estimating the size of the automotive engineering workforce in the United States based on official statistics, which are not specific to the engineering categories in the industry. By inference and extrapolation, he estimates that at least 160,000 engineers and technicians support OEMs and suppliers in the U.S. automotive industry (Tables 3-5a,b). The automotive industry ranks second among U.S. industries in terms of overall spending on R&D. Six of the top 20 companies that spend the most on global R&D are automotive OEMs. Engineering and product-development productivity levels differ for OEMs based in different parts of the world; Japanese OEMs are more productive, for example, than OEMs based in the United States and Europe. From its beginnings in the late nineteenth and early twentieth centuries, the automotive industry has been international. In the first half of the twentieth century, for example, Ford and General Motors both had a large number of overseas assembly plants. Over time, in some of the larger markets, subsidiaries, which operated almost as separate companies, were established to design and build cars specifically for those markets. Since the 1960s, the auto industry has “undergone a second wave of globalization,” fueled by changes in the U.S. market, which is still the largest and most open market in the world (Moavenzadeh, this volume). One of those changes was the growth of the Japanese auto industry. At first Japanese companies in the United States relied exclusively on exports from Japan. Gradually, however, they built manufacturing and then engineering capabilities in the United States and Europe. These so-called “transplants” now account for more than 30 percent of U.S. auto production. Today more than half of General Motors employees are outside the United States, and companies such as Volkswagen, Hyundai-Kia, and Honda assemble more than half of their vehicles outside their home countries. The supplier base is similarly distributed, especially tier-one suppliers, which provide interiors and other components that require R&D and production closely coordinated with OEMs. Automotive manufacturers manage their production and engineering “footprint” based on a number of factors, including customers (i.e., the location of the market); capability (i.e., the best way to leverage available talent); cost (i.e., labor costs and integration costs at various locations); and government (i.e., trade and investment policies). The most important factor, though, is market growth (Moavenzadeh, this volume). The United States, Japan, and Europe have large, but already mature markets that are not growing very rapidly, whereas large developing economies TABLE 3-5a BLS Data Showing Automotive Engineers in the United Statesa Occupational Code NAICS 3361: Motor Vehicle Manufacturing NAICS: Motor Vehicle Body and Trailer Manufacturing NAICS 3363: Motor Vehicle Parts Manufacturing Total of All Three NAICS Codes Engineering managers 610 570 3,960 5,140 Industrial engineers 3,390 1,240 14,460 19,090 Mechanical engineers 1,920 1,360 9,300 12,580 Electrical engineers 150 110 910 1,170 Engineers, all other n/a 180 7,200 7,380 Total 6,070 3,460 35,830 45,360 All Occupations 256,700 168,840 693,120 1,118,600 aDoes not include most product engineers.
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications TABLE 3-5b Bottom-Up Estimate of Engineers and Technicians Employed by OEMs Company Current Number of Engineers and Technicians Projection General Motors 11,500 Decreasing Ford Motor Company 12,000 Decreasing DaimlerChrysler 6,500 Steady Japanese companies 3,593 Increasing rapidly Korean companies (Hyundai-Kia) 200 Increasing rapidly German companies (BMW) 150 Increasing TOTAL About 34,000 such as China and India have markets that have grown rapidly in recent years and are expected to continue growing. Thus automakers from all over the world are trying to make inroads into those markets. Ford and General Motors have been particularly active, building manufacturing capacity as well as engineering capability in China, Latin America, and elsewhere. In addition to market factors, cost factors tend to encourage OEMs and automotive suppliers to locate engineering activities in the developing world, especially in China (Figure 3-1). Moavenzadeh estimates that, whereas a fully loaded, experienced engineer in the United States might cost $100,000 a year, an equivalent engineer in China might cost $15,000 a year. However, Chinese engineers are reportedly less productive, which may reflect their lack of domain knowledge (many Chinese have never driven a car). As the Chinese economy grows and automobiles become more common, however, we can expect Chinese engineers to become more competitive and more productive. Even with the current productivity gap, a number of engineering tasks can be offshored fairly easy. As was the case with software development, these are modular tasks that do not require customer contact, such as developing engineering bills of materials, performing failure modes effects analyses, performing routine stress analyses, developing heat-transfer calculations, and generating tool designs from part specifications. The cost incentives for developing automotive-engineering capabilities in developing economies such as China and India can work in two ways. The first, engineering connected with the manufacturing of parts exported to the United States and elsewhere, involves different motivations and impacts from offshore engineering not connected with manufacturing. The former is an important aspect of globalization in the automotive industry, particularly in the rise of China’s auto industry. The U.S. trade deficit with China in auto parts was $4.8 billion in 2005 and has increased rapidly since then (Moavenzadeh, this volume). Imports from China, whether manufactured by subsidiaries of suppliers based in Europe or the United States, China-based manufacturers, or joint ventures, tend to be less sophisticated products, such as radios, brake components, and after-market aluminum wheels. The second way cost differentials can provide incentives for offshoring is related to the offshoring of engineering services; companies either contract foreign firms or build their own subsidiaries to perform engineering tasks offshore. In addition to China, India is well positioned as a destination location for this sort of work. ValueNotes (2006), a research consultant company, predicts that offshoring of automotive engineering and design services will increase from the 2005 level of $270 to $300 million globally to more than $1 billion in 2010. Automotive engineering services in India at subsidiaries of global suppliers, such as Delphi, and subsidiaries of Indian OEMs, are expected to increase at an annual rate of 30 percent during this period. Because China has attracted so much attention from the global auto industry as a growth market and source of components, we now look more closely at the current state of China’s engineering capability and the potential effect of offshoring on China’s global competitiveness. First of all, the Chinese government has used a number of stratagems over the years to force or encourage the formation of joint FIGURE 3-1 Engineering labor rates vary widely, as shown by the annual cost of an automotive engineer with 5 to 10 years experience. Source: Moavenzadeh, this volume.
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications ventures, and subsequent technology transfer from global auto companies to domestic manufacturers (Zhao et al., 2005) However, so far these joint ventures have not led to the transfer of skills the Chinese government had anticipated, mostly because Chinese engineers, who were expected to rotate back to domestic parent companies, have not done so because of the large salary differentials. China’s automotive R&D capability is currently far behind that of countries that build cars for the most sophisticated global markets (Zhao et al., 2005), and it will probably take years for China to assimilate the management of automotive-development processes. R&D management is also in an early stage, and several Chinese auto companies have hired foreign executives at very senior levels to run them. R&D currently being done by joint venture firms mainly involves adapting, or “localizing,” foreign technology and designs for the Chinese market. Notwithstanding these barriers, China will continue to move toward the top tier of auto-manufacturing nations. China’s growing exports of automotive parts and the slow, but not insignificant, skills transfer occurring through joint ventures with foreign OEMs are providing an excellent foundation for the development of a world-class automotive technology base. In addition, the Chinese government funds three university centers that conduct applied automotive research for Chinese OEMs. China’s greatest asset is the continuing growth of its domestic auto market. Firms based in the United States, Japan, and Europe have adopted different approaches (some companies in different parts of the same region also differ) to entering the Chinese market. General Motors and Ford, as well as several major Europe-based OEMs, have been aggressively building engineering and manufacturing capability in emerging markets as a way to establish and build market share there. However, to date, most Japan-based OEMs have made efforts to enter the Chinese market through exports rather than through joint-venture manufacturing, although there are indications that this may be changing (Business Week, 2006). The effects of these differences on global automotive competition are topics for future studies. For U.S.-based OEMs, Ford and General Motors in particular, the most difficult problem today is not offshoring itself but coordinating and optimizing global R&D and engineering operations (Moavenzadeh, this volume). The current goal is to coordinate global programs to produce vehicles with similar fundamental architectures that can be easily modified to meet local customer demands and regulatory requirements. Reducing the number of vehicle architectures will reduce cost, improve speed-to-market, and hopefully enable OEMs to meet the demands of particular markets. At General Motors, for example, Korea is the center of expertise for small-car development, and the United States is the center for full-sized truck development (Cohoon, 2006). The overall picture of offshoring in the auto industry would not be complete without taking into account the phenomenon of “onshoring,” that is, foreign-based OEMs and suppliers building engineering capability in the United States (Table 3-6). Japanese OEMs employ more U.S. engineers than Europe-based automakers because of their much larger manufacturing presence in North America. Although long-term career prospects for U.S. auto engineers are highly correlated with the fortunes of U.S.-based OEMs, especially in southeastern Michigan and a few other areas, onshoring raises the possibility that, as long as the United States remains a leading auto market, OEMs, regardless of nationality, will maintain engineering capability here. THE PHARMACEUTICAL INDUSTRY The pharmaceutical industry, including the biotechnology sector, has several unique features, as does the nature of engineering work in pharmaceuticals. The value chain in this industry runs from discovery (including target identification, lead discovery, and optimization) through clinical development to manufacturing to marketing and distribution (Pore, Pu, Pernenkil, and Cooney, this volume). Pharmaceutical companies have very strong incentives for ensuring that the science-based discovery process is as efficient as possible. Bringing a drug from the concept stage to the marketing stage currently costs about $800 million, takes 8 to 12 years, and requires the testing of 5,000 compounds for every drug that is actually approved (McKinnon et al., 2004). Today’s “big pharma” companies are squeezed between a business model that emphasizes blockbuster TABLE 3-6 Employment in Foreign-Brand R&D and Design Facilities in the United States, 2006 Company Location(s) Established Employees BMW Spartanburg, NC; Woodcliff Lake, NJ; Oxnard, CA; Palo Alto, CA 1982 70 Honda Torrance, CA; Marysville, OH 1975 1300 Hyundai Ann Arbor, MI 1986 150 Isuzu Cerritos, CA; Plymouth, MI 1985 100 Mazda Irvine, CA; Ann Arbor, MI; Flat Rock, MI 1972 100 Mercedes-Benz Palo Alto, CA; Sacramento, CA; Portland, OR 1995 50 Mitsubishi Ann Arbor, MI 1983 130 Nissan Farmington Hills, MI 1983 980 Subaru Ann Arbor, MI; Lafayette, IN; Cypress, CA 1986 30 Toyota Gardena, CA; Berkeley, CA; Ann Arbor, MI; Plymouth, MI; Lexington, KY; Cambridge, MA; Wittmann, AZ; 1977 950 Source: Moavenzadeh, this volume.
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications products, which entail high risks and high fixed costs (i.e., R&D and marketing), and pricing pressure and competition in key product classes (Campbell et al., 2005). Some analysts predict that the industry will experience slower revenue and profit growth in the future because of a slowdown in the new-product pipeline. The industry is also very concentrated; in 2004, the top 10 global companies accounted for almost half of global sales (Gray, 2005). The fill, finish, formulation, and packaging processes have been globalized for some time and serve global markets. The expiration of patents and consequent competition from generics have increased incentives to control costs by moving manufacturing overseas, even for products manufactured for the U.S. market. However, the discovery of active pharmaceutical ingredients, the core innovative activity of pharmaceutical companies, has traditionally been centralized at a few research facilities in the home country and, perhaps, a very few other global centers of pharmaceutical innovation. Drug and process development, which involve more engineering than drug discovery, have been similarly concentrated. The commissioned paper on this industry focuses on China and India as offshoring destinations. Both countries have the advantages of market potential, low costs, multiple R&D shifts in a day, a large number of graduates in chemistry and biology, government research support, and tax incentives. In addition, they have large numbers of treatment-naïve patients, which is an advantage for conducting clinical trials. China and India also have significant disadvantages, including regulatory barriers (especially in India). In addition, as discussed in Chapter 2, only a fraction of the trained workers are qualified to work in the environment of a multinational company (10 percent in China and 25 percent in India). Another barrier is the uncertainty of protections of intellectual property. Evidence shows that no offshored R&D in emerging economies, in any industry, involves cutting-edge research (Thursby and Thursby, 2006). McKinsey Global Institute (2005) estimated that global pharmaceutical companies had offshored about 10,000 full-time employees by 2003, almost three-quarters of them working in R&D. As noted in Table 3-1, 51,800 R&D scientists and engineers were working in the U.S. pharmaceutical industry in 2002. Perhaps the most significant activity in emerging economies is clinical trials, with India the preferred destination. In a recent estimate, the value of the current outsourcing market for clinical trials was $158 million and was predicted to increase to more than $500 million in the next few years (O’Conner, 2006). In addition to cost savings for clinical trials, global pharmaceutical companies also save time because patients there can be recruited more quickly than in developed markets. China is the preferred location for R&D in advanced proteomics (the systematic, automated study of protein structure and function) and molecular biology, while India is the preferred location for lead optimization (the assessment of a family of candidates and the evolution of the ones with the greatest chance of success). Because these capabilities are fragmented across the value chain, however, no single location can provide end-to-end solutions. China and India have also become leading global locations for manufacturing of pharmaceuticals, which ultimately contributes to the innovative capabilities and engineering talent base in those countries. For example, China is the world’s largest producer of active pharmaceutical ingredients, with sales of $4.4 billion in 2005; India is the third largest producer, with sales of $2 billion. India has the second highest number of FDA-approved manufacturing facilities, after the United States. Overall, India’s production costs in pharmaceuticals are about half those of the United States, including labor, raw materials, capital costs, and regulatory costs. In general, the impacts of offshoring on U.S. engineering (and science) capabilities in the pharmaceutical industry have not been significant so far. Even with rapid growth, McKinsey’s projections of the number of jobs that will be offshored in the next few years is small compared to the number of U.S. engineers working in those areas. In addition, the trend toward R&D or engineering offshoring in the U.S. pharmaceutical industry may be more than offset by significant onshoring. For example, major European pharmaceutical companies such as Novartis and GlaxoSmithKline have shifted much of their R&D and manufacturing activities to the United States in recent years. The large U.S. talent base and the absence of price regulation are the major attractors. In addition, companies based in India that have emerged as global leaders in the generic drug market are beginning to form joint ventures with, and even acquire, U.S. companies, with the goal of building capabilities in marketing and innovation. These trends bear close watching. PERSONAL COMPUTER MANUFACTURING PC manufacturing is a $230 billion industry that includes desktops, notebooks, PC-based servers, and hand-held computing devices, such as personal digital assistants (PDAs), personal music players, and smart phones.2 PCs also drive the sale of PC software (a $225 billion market), IT services, and other hardware, such as peripherals, storage, and networking equipment (Dedrick and Kraemer, this volume). The United States, which is the leading market for PCs, is home to some of the top PC vendors, such as Dell and Hewlett-Packard. Companies from China (Lenovo, which acquired IBM’s PC business a few years ago), Taiwan (Acer), and Japan (Fujitsu, Toshiba, Sony) are also among top PC manufacturers. 2 Hand-held devices are grouped with PCs here because the design and development processes are very similar. However, the issues related to software development are very different from those related to PCs.
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications The value chain in the PC manufacturing industry is highly disaggregated and globalized. Two suppliers, Intel and Microsoft, set the most widely adopted standards for the microprocessor and operating system. Other components, including storage, displays, semiconductors, and wireless networking components, are core technologies of the PC manufacturing industry. Most of the manufacturing and physical engineering for notebooks and desktop machines is done by contract manufacturers and original design manufacturers (ODMs). U.S.-based firms originally turned to Taiwan-based companies to take advantage of lower costs and to avoid becoming dependent on Japanese companies that could become competitors. Since then, Taiwan-based ODMs have shifted almost all manufacturing to China; they are now shifting much of the engineering to China as well. The main tasks for PC firms are to define and anticipate the changing needs of customers, integrate innovations of suppliers into well designed product packages that meet those needs, and bring the packages to market quickly at an attractive price. Therefore, the focus of PC manufacturing companies is on product development rather than R&D. The engineering tasks for PC manufacturing vary with the product category. Desktops, for example, require the integration of components into the chassis. Although it may take as long as nine months to design a new chassis, it takes as little as two weeks to design specific models based on that chassis. Notebook PCs involve more complex engineering tasks, such as the optimization of design elements that require trade-offs in weight, sturdiness, heat generation, energy efficiency, and so forth to achieve an ideal mix. Newer product categories, such as smart hand-held devices and blade servers, present many engineering challenges, first because no dominant technology standards have been established for devices such as iPods and PDAs, and second, because some products are unique to particular companies. The disaggregated business model of the PC industry, in which significant aspects of engineering are offshored, has enabled Dell, Hewlett-Packard, and other leading companies to hold down costs and remain competitive in an industry that has rapid product cycles. Apple has even used a disaggregated business model to create the iPod, a new kind of product that straddles the line between IT and consumer electronics. The key to long-term success in the PC industry appears to be protecting the interface with customers and the resulting information flow. Knowledge gained from customers feeds into product definition, high-level design, and the most sophisticated engineering tasks. Thus the effective use of offshoring can enable firms to sustain their U.S. operations and employment levels with U.S. employees who work mainly in non-engineering jobs. As a result, not many engineering jobs in the United States remain in this industry, and the ones that do require high levels of skill and experience, as well as an ability to innovate. Overall employment in the U.S. computer manufacturing industry, of which the PC industry is a part, appears to have remained relatively stable in recent years, although the composition of the workforce has changed. Employment in electronics and electrical engineering has gone down; employment in applications-software engineering has gone up; and employment in other categories has remained more or less stable (Dedrick and Kraemer, this volume). Table 3-7 shows the distribution of engineering jobs in the computer industry as of 2005. Because of changes in classifications, it is difficult to track the events of the 1990s, when the trend toward offshoring in PC manufacturing and engineering developed. Table 3-8 shows engineering salaries in the computer industry. Table 3-9 shows the supply and demand for engineering skills at PC and related industry firms. As the employment numbers suggest, there is a growing need for engineers with software skills and knowledge of both hardware and software in the manufacturing processes still based in the United States. Also, U.S. firms are looking for experienced engineers who can be productive immediately. Thus only a few of the firms interviewed by Dedrick and Kraemer report making entry level hires. Management skills are also in high demand. Taken together, these trends indicate that employment in PC manufacturing could be difficult for young U.S. engineers with little or no job experience. Both U.S. and Taiwanese PC companies are now looking to China for engineering talent. According to Dedrick and Kraemer’s interviews with managers, Chinese engineers today do not have analytical skills and market knowledge comparable to those of experienced U.S. engineers. However, investments in training Chinese engineers have paid significant dividends, even though turnover remains high and salaries are rising rapidly. The largest Taiwanese ODMs have been focusing their efforts on training engineers in the Shanghai/Suzhou region, which is now the hub of notebook PC manufacturing. As in the auto industry, PC firms based in different countries have adopted different approaches to offshoring. For example, Japanese PC makers, whose efforts are focused mainly on satisfying the demand in their domestic market, do not offshore manufacturing or engineering jobs. CONSTRUCTION ENGINEERING AND SERVICES Construction is a $4 trillion industry, with about one-fourth of that in the United States. Conceptually, the industry can be divided into two sectors. Engineering, procurement, and construction (EPC), which involves the construction of industrial and infrastructure facilities, is made up of large firms that employ many engineers. Architecture, engineering, and construction (AEC), which involves construction of buildings and residential facilities, is made up mostly of smaller firms (Messner, this volume). The description that follows addresses offshoring in both sectors, although the companies (mostly very small) that make up the residential
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications TABLE 3-7 Engineering Jobs in the U.S. Computer Industry, 2005 2005 Computer software engineers—applications 12,800 Computer software engineers—systems software 18,240 Computer hardware engineers 12,940 Electrical engineers 2,900 Electronics engineers, except computer 3,710 Industrial engineers 3,430 Mechanical engineers 2,280 Engineering managers 5,630 Industrial designers 180 Total 62,110 Source: BLS, 2007. TABLE 3-8 Engineering Salaries in the U.S. Computer Industry, 2005 Computer software engineers—applications $94,760 Computer software engineers—systems software $92,030 Computer hardware engineers $94,690 Electrical engineers $84,820 Electronics engineers, except computer $86,330 Industrial engineers $77,710 Mechanical engineers $78,740 Engineering managers $130,020 Industrial designers $94,800 Source: BLS, 2007. TABLE 3-9 Survey Results for Jobs in PC and Related Industries Engineering Job Category Major Activity Where This Skill Is Used Demand for Engineers Availability in U.S. Availability in Other Locations Where Activity Takes Placea Cost and Quality Relative to U.S.a Engineering managers R&D, design, development Stable or growing Tight Tight or enough Lower cost, lower quality Engineering product managers Design, development Stable Tight or enough Tight or enough Lower cost, same quality Hardware engineers Design, development Stable Tight or enough Enough Lower cost, same or lower quality Electrical engineers R&D, design, development Falling or growing Tight or enough Enough Lower cost, same or lower quality Electronic engineers Development Falling Tight or enough Enough Lower cost, same or lower quality Mechanical engineers R&D, design, development Stable or growing Tight or enough Enough Lower cost, same or lower quality Software engineers R&D, design, development Growing Tight Tight or enough Lower cost, same or lower quality Industrial engineers Manufacturing n/ab n/ab Enough Lower cost, same quality Industrial designers Design Stable Enough Enough Lower cost, lower quality Note: Names of firms are confidential. Four were personal computing companies. One was a component supplier. aResponses regarding availability, cost, and quality of some skills in other locations vary by firm, depending on where they perform these activities. We report one response when there was general consensus, more than one if there were different responses. Other locations include Singapore, Taiwan, Malaysia, Ireland. bFirms interviewed had no manufacturing in the United States, so demand and availability of industrial engineers was not relevant. Source: Dedrick and Kraemer, this volume. portion of the AEC sector (about half of the U.S. construction market) do not engage in offshoring. In contrast to industries in which the top 20 global companies account for a large percentage of the market (e.g., pharmaceuticals and PC manufacturing), construction is highly decentralized. The 400 top U.S. contractors account for less than 20 percent of the market. Engineers in the construction industry are involved in all phases of the delivery and operation of facilities. Factors that influence offshoring include the uniqueness of projects, the extensive local knowledge necessary to meet local codes and conditions, the active involvement of owners in most projects, and the desire of owners to keep information about a project from being widely disseminated, particularly overseas. Like data for other industries, the data for the construction industry are not sufficient to provide a clear picture of the current status of offshoring. We can say that offshoring in construction engineering and services is occurring, but firms are also aggressively hiring civil engineers (the largest engineering discipline) and other design professionals (e.g., architects) in the United States. There is no evidence that offshoring has had a significant impact on the employment of engineers in the U.S. construction industry. The following discussion is based on available statistics supplemented by information from surveys and interviews.
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications The focus of this analysis is on civil engineers (although small numbers of other types of engineers also work in the construction field) and architects (design professionals whose work is subject to offshoring). The current demand for engineers and architects in the United States is high because the civil engineering workforce is aging, many engineers are retiring, and, until recently, the construction market was growing rapidly. Firms that were interviewed for this study in the EPC sector, the most active sector in offshoring, said that offshoring has had little impact on the size of their U.S. workforce (Messner, this volume). However, India and China are again the primary offshoring destinations, and the large wage differentials are shrinking rapidly as salaries in some places in developing countries rise, particularly in Mumbai, India, and other specific locations. EPC firms that are active in international markets have been offshoring engineering work for 15 years or more. The vast majority, however, indicate that they coordinate work among locations to meet the needs of specific projects (Figure 3-2). Several steps in the construction-engineering process have been subject to large-scale offshoring. These include the development of 3D models during the design process, the conversion of 2D sketches to CAD models, and the development of engineering shop drawings for mechanical and steel subcontractors; there is also some offshoring in the IT sector. Cost reduction was the reason cited most often (followed by better quality) for offshoring among the EPC firms surveyed (Table 3-10). There was some difference of opinion about whether offshoring also reduced engineering time. In 2004, the United States had an official trade surplus for AEC services of almost $3 billion, including a bilateral surplus with India. This number does not include interactions between a U.S. company and its Indian subsidiary, but does include outsourced work. Work that is offshored in FIGURE 3-2 Use of global teams by firms in the EPC sector. Source: Adapted from CII Project Team 211 Survey, 2004. TABLE 3-10 Impact of Offshoring on Projects in the EPC Sector Impact on: Percentage of Responses Opinion Engineering cost 48 More than 10% reduction Construction cost 75 No impact Engineering time 48 No impact Overall project delivery time 59 No impact Engineering quality 65 No impact Construction quality 72 No impact the AEC sector includes the transformation of hand-drafted documents into 2D CAD or 3D CAD models and some engineering tasks for building projects, such as engineering of the foundation, structure, and technical systems. Overall, however, offshoring in the AEC sector has been limited for several reasons, such as the small size of most AEC firms, the need to protect sensitive or secure information for some projects, the need for local knowledge or interaction with the owner for some projects, and a poorly developed institutional infrastructure for construction engineering and services in potential destination countries. Some tasks are being automated through new software tools rather than being offshored. More than 90 percent of survey respondents in the EPC sector said they thought offshoring would increase in the future (Figure 3-3). Some said they thought increasing offshoring would lead to lower quality designs, but others, in companies that have established operational low-cost engineering centers abroad, said they believe that with effective organization and management, they will be able to maintain quality and lower their costs. With lower costs, they said, they can produce more detailed designs than would be possible if the work were performed solely in the United States. FIGURE 3-3 EPC contractors’ perceptions. Source: Adapted from CII Project Team 211 Survey, 2004.
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications Concerns have been raised about potential security risks for U.S. buildings, particularly for critical infrastructure facilities, when detailed plans are developed and disseminated outside the United States (ASCE, 2005). Industry groups such as COFPAES and AIA continue to monitor this situation. SEMICONDUCTORS According to the authors of the paper on offshoring in the semiconductor industry, Clair Brown, director of the Center for Work, Technology, and Society at University of California Berkeley, and Greg Linden, a research associate at the center, the long-term trend of globalization of technology has had a significant impact on the nature of engineering work in the United States in this industry. Offshoring of engineering is increasing in all three major stages of semiconductor production—design, fabrication, and assembly and packaging. For more than three decades, the number of transistors per unit of area has increased exponentially. Along with these advances, the cost of fabrication facilities (fabs) has also increased steadily; today a 300-mm wafer fab of minimally efficient scale costs about $3 billion. The demands on designers have also increased as they must find ways of using available “real estate,” or space, on a device. In short, projects have become increasingly complex with significant implications for the engineering labor market and for offshoring. The need for the efficient integration of system-level components has led to a greater emphasis on system software, preferably generated in parallel with chip design. According to Brown and Linden, “Software can now account for as much as half the engineering hours involved in a large chip development project” (this volume). U.S.-based companies account for more than half of global industry revenues; Intel alone, the largest company, accounts for 15 percent. Texas Instruments is the only other U.S.-based firm in the global top 10, but a number of rapidly growing medium-sized companies are in the top 50. A number of these firms are “fabless,” meaning they do not manufacture their own devices but contract out fabrication and assembly/packaging to “foundries,” such as Taiwan Semiconductor Manufacturing Company (TSMC). In the 1970s, assembly and packaging were shifted to Southeast Asia. In the 1990s, with the emergence of the Korean and Taiwanese semiconductor industries, the number and dispersion of fabrication facilities was accelerated. U.S.-based companies have shown a willingness to locate new fabrication facilities in various countries, as well as in the United States, in response to the size and potential of the market, tax advantages, and other incentives. One recent, widely discussed example is Intel’s plan to build a $2.5 billion fabrication facility in China (which would not include Intel’s leading chip designs) (IHT, 2007). In contrast to software, for which work is often outsourced to other companies, most offshore design work for semiconductors is done by subsidiaries. Larger U.S. chip companies have established design centers around the world, mostly in Asia. Sometimes the goal is to capture specialized skills that are available at the offshore location, such as knowledge of wireless networking technology in Scandinavia. Sometimes the goal is to capitalize on government policies, such as in China, where the government encourages, sometimes requires, direct investment in return for market access. The motivation for offshoring design work to India, the most popular destination, has been primarily to reduce costs. Of the top 20 U.S. semiconductor companies, 18 have established design centers in India; nine of those have opened since 2004. The size of these design centers varies widely, from 100 or so engineers in the smaller centers to 3,000 engineers at Intel’s design center. The flood of investment has led to challenges, such as finding enough trained engineers, coping with the high turnover rate, and meeting demands for rapidly rising salaries. The semiconductor industry has shown that design offshoring arrangements can be managed effectively, even though the costs of coordination and communication tend to offset some of the cost reductions in other areas. In reality, savings may come to 25 to 50 percent, rather than the 80 to 90 percent suggested by salary comparisons alone (Brown and Linden, this volume). Nevertheless, offshoring of the design phase is now a fundamental, expected feature of the business model for new U.S. semiconductor companies, which are also likely to be fabless. U.S.-based semiconductor start-ups, especially those with a founder or co-founder born in India, increasingly include design offshoring as part of their business plans (Saxenian, 2006). The impact of offshoring on semiconductor engineers and engineering organizations in the United States is difficult to determine exactly because, once again, the data are not definitive. However, based on government statistics, the Semiconductor Industry Association annual survey, and other sources, the U.S. workforce in semiconductor engineering has recovered from a drop during the tech bust several years ago and is now growing. Overseas employment, however, is growing faster (see Table 3-11). Overall, we can say that the availability of offshore design and manufacturing capability has made it possible for the creation and growth of new, innovative, U.S. semiconductor firms. Whether offshoring has had a negative impact on wages or on certain segments of the engineering workforce are questions that remain to be answered. Brown and Linden document several disturbing trends to which offshoring may contribute but which have multiple causes, including rapid changes in technology in the semiconductor industry, the high reliance in recent years on H1-B visa holders, the lingering effects of the tech bust, and so forth. One of these trends is that a substantial number, perhaps 10 percent, of older engineers has experienced long periods of unemployment. A second trend is that many U.S. citizens and permanent residents appear to have decided that graduate engineering
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications TABLE 3-11 Engineers at U.S. Chip Firms by Location (in thousands) 1999 2000 2001 2002 2003 2004 2005 United States 61.9 76.1 72.6 72.9 72.0 66.6 83.2 Offshore 17.5 20.0 27.2 29.8 30.9 34.6 42.2 Percentage in the United States 77.9 79.2 72.7 70.9 69.9 65.8 66.3 Source: Brown and Linden, Table 11, this volume. degrees do not provide enough return on investment to justify the time and expense of pursuing them.3 Companies are still hiring foreign students who earn degrees from U.S. institutions, however, who can work at U.S. companies on H1-B visas. Interestingly, when the number of H-1B visas was cut recently, U.S. semiconductor companies reacted by sending their visa-holding Indian and Chinese employees back to their home countries to help manage and develop subsidiaries there. Although offshoring has had positive impacts on destination countries, India and China face challenges in upgrading their educational systems to produce more engineering graduates and making their infrastructure, such as electrical power, more reliable. Overall, however, experience in the semiconductor industry shows that offshoring is likely to become a trend for engineering work everywhere. For example, both Taiwan and India are now offshoring work to China. Because semiconductors are critical components of many modern weapons systems, the U.S. Department of Defense (DOD) is justifiably concerned about maintaining access to semiconductors and related capabilities in design and manufacturing. In 2005, a task force of the Defense Science Board released a report recommending that DOD not only take steps to track the military’s needs and ensure that “trusted microelectronics components” are available, but also spearhead a broad national effort to ensure that leading-edge microelectronics skills and capabilities remain in the United States (DSB, 2005). It should be noted that there has also been significant “onshoring” in semiconductor design. Foreign-based firms like Philips, Hitachi, and Toshiba, for example, maintain extensive design operations in the United States. REFERENCES ASCE (American Society of Civil Engineers). 2005. Offshoring of Engineering Services. Policy Statement. Available online at http://www.asce.org/pressroom/news/policy_details.cfm?hdlid=507. Aspray, W., F. Mayadas, and M.Y. Vardi, eds. 2006. Globalization and Offshoring of Software: A Report of the ACM Job Migration Task Force. New York: Association for Computing Machinery. 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Washington, D.C.: The National Academies Press. Available online at http://www.nap.edu/catalog/11675.html. ValueNotes. 2006. Offshoring of Automotive Design & Engineering Services to India. July. Zhao, Z., A. Jaideep, and W. Mitchell. 2005. A Dual Networks Perspective on Inter-Organizational Transfer of R&D Capabilities: International Joint Ventures in the Chinese Automotive Industry. Journal of Management Studies 42(:1): 127–160. 3 This perception that pursuing a graduate degree in engineering is not a great investment might well exist in other fields, but Brown and Linden were the only authors to address it in detail.