In the last decade, IT offshoring has been a tremendous boom to high-tech companies and enterprises alike, as a way to keep innovation flowing without breaking the bank.

Highly-skilled workers in India, the Philippines and newer spots such as Eastern Europe have helped take the burden off US-based software companies and IT departments by providing low-cost application development, maintenance, and support. Silicon Valley companies, in particular, have been huge customers of these offshore providers. Yet offshoring, despite all its benefits, has suffered a few setbacks of late, raising questions among technology executives as to its future role in the U.S. market.

The overarching setback, of course, is the economy: CIOs and CTOs simply don’t have as many projects as they did a year ago to source, given budget cuts and the general climate of fiscal conservatism. Then there is the financial scandal concerning major Indian outsourcing company Satyam, in which the company founder and CEO admitted to overstating profits and reporting $1 billion in fictitious cash and assets. The scandal has rattled the nerves of companies outsourcing to that region.

The Obama Administration, accused of fostering protectionism, included a “buy America” incentive in the national economic stimulus package passed on February 17th. Finally, growing terrorism in several global outsourcing hot spots, particularly the large-scale attack in Mumbai in November 2008, is another reason for concern.

In Silicon Valley, traditionally a major purchaser of offshoring services, the outlook is a mixed bag, says Peter Bendor-Samuel, CEO of Everest Group, a Dallas-based outsourcing and research firm. “Discretionary spending is down,” he says. “Most offshore work is project work such as developing and customizing applications. As projects finish, there are no new projects coming along.

Generally speaking the environment is more risky and the attitude is wait and watch for outsourcing and offshoring, agrees Ashok Bardhan, Ph.D. and senior research associate at the UC Berkeley Haas School of Business.

Bardhan, co-author of a Berkeley research report, “The New Wave of Outsourcing,” which was published in 2003, says that while in the aftermath of the 2000-2001 dot-com bust, offshoring got a boost from companies needing to cut costs, the severity of this recession means that there is simply less IT work to do. “Existing offshoring arrangements have seen some cutbacks as a result of downsizing in parent operations,” he says. “This time around, the fact that there is major restructuring in addition to retrenchment means the picture is more complicated.”

Ultimately, though, offshoring still offers an enticing cost-benefits scenario that cash-strapped CIOs will need to consider for project work in 2009 and 2010. “You can save at least 50% on something like application development,” remarks Umair Memon, an Indian national who has been in the United States for 13 months, and works in operations at IT staffing firm Catalyst Systems, in Princeton, New Jersey. And, companies that can leverage relationships and volume are getting even better deals, from providers around the globe. “We are now seeing 5 to 20 percent discounting on IT offshoring,” says Bendor-Samuel, who notes that cheaper unit costs does not usually mean lower quality today, because of high unemployment. The Economic Times also reported that top Indian tech firms such as TCS, Infosys, Wipro, and HCL are discounting by up to 20 percent on offshoring.

Those services that have the best potential for growth include continuous projects such as application maintenance, which deliver a significant cost advantage through offshoring, according to Bendor-Samuel. Indian companies have a large pipeline for such work now, he says, and are merely waiting for US executives to pull the trigger.

The financial fraud news from Indian outsourcing firm Satyam dominated business headlines for weeks and is still playing out as buyout suitors and the Indian courts determine the outsourcing giant’s future. As of March 31st, the company was still in limbo, waiting for an investor. But outsourcing experts have a hard time seeing how the scandal will have much impact on demand for offshoring in Silicon Valley or elsewhere. “The Satyam incident looks like an isolated incident, at least for now, although corporate governance in India leaves a lot to be desired,” Bardhan says.

Adds Bendor-Samuel: “Satyam is a crisis of fraud not a crisis of delivery model, so it’s a huge cautionary warning around accountability. We have had Enron…and now India has Satyam.” He believes the fallout might be that top U.S. services firms including HP and IBM will get more offshoring dollars for their facilities in other countries.

It’s also likely that that the Satyam scandal will help other countries gain a stronger foothold in offshoring. The Philippines, for instance, has earned a reputation for quality work, competitive prices, and strong English-language abilities, says Bendor-Samuel. Diversifying beyond India is a smart strategy for American companies regardless, and is a trend happening now, he adds.

As well, while India will remain appealing to Valley tech firms because of its highly educated workforce and ability to provide the desired IT skill sets, prices in some cities like Bangalore are getting higher, which will also push demand to other locations, says Venk Krishnamoorthy, a Palo Alto-based IP patent attorney with Finnegan Henderson Farabow.

In the end, Satyam might have more benefits than risks for CIOs, as competition increases and US companies learn to become more vigilant when selecting and monitoring their offshore vendors.

America first?

Another undercurrent that could affect demand for offshoring is about protectionism: some companies simply want to help Americans stay employed, given the historic number of job losses that have occurred in the past 12 months. “There is a ‘buy America’ provision in the [federal] stimulus package,” concedes Bardhan, who says altruism will be a factor influencing US executives to reconsider domestic sourcing.

Rural Onshore America which provides low-cost contractors from the American heartland, is hoping to capitalize on that sentiment. The company, with offices in Ohio, Wisconsin, and Kentucky, employs 75 contractors in those states and also in North Carolina and Michigan-with plans to grow to 20 states by 2011. “We currently have more projects active, and in the project pipeline, than we have hired people,” says the company’s CEO Christopher Derrington. “Our best sales point is that we are 25-40 percent cheaper than USA urban labor, and provide the same time zones and communication skills of USA urban labor. I get a call once a week from a big company looking to relocate resources back from overseas.” Smaller companies that don’t want to hassle with the oversight staff needed for offshoring contracts are also knocking on his doors, he says.

A January 2009 survey of 100 tech firm CFOs in the United States, by the accounting and financial advisory firm BDO Seidman LLP, indeed indicates more interest in domestic than offshore outsourcing. The firm’s 2009 Technology Outlook survey found that 22% of participants plan to outsource to American companies this year, compared with 16% who plan to outsource to China, 14% who plan to outsource to India, and 19% have no additional outsourcing plans.

The decision to outsource or not, and to hire overseas or domestically, will depend on a variety of economic, business, and cultural factors. For Silicon Valley companies at least, the proven business strategy of using offshore companies to develop, support and maintain IT products and services on a 24/7 basis has become so entrenched over the years that it’s hard to imagine a future without this dynamic, says Krishnamoorthy, who often advises Valley technology firms and worked for many years as an engineer in the area.

“The trend for the long term will be growth driven by cost pressures and the culture of the Valley which is focused on startups and the push by VCs to have offshoring plans,” he says. And what Silicon Valley does, the rest of the country usually follows.