Outsourcing Information Technology to India: Explaining Patterns of Foreign Direct Investment and Contracting in the Software Industry

Abstract

In the past decade, U.S. software firms have increasingly utilized the low-cost information technology (IT) labor force in India. Companies wishing to capture the benefits of outsourcing can engage in contracting (hiring an Indian contracting company to perform the service) or foreign direct investment (FDI, opening an Indian subsidiary and hiring Indian employees). Modern FDI theories predict that Indian software outsourcing should occur primarily in the form of FDI. Contrary to the FDI theories, however, many U.S. companies are hiring Indian software contracting companies in order to use the lower-cost Indian IT labor force. This paper analyzes Indian IT outsourcing firms in order to understand the prevalence of contracting. The paper then refines previous FDI theory by recognizing a Hybrid Model in which contracting companies provide their clients with a combination of the advantages of both FDI and contracting.

Keywords: India, outsourcing, software, high technology, foreign direct investment

JEL Classification: C93,D20,D43,D81,D92,F00,F12,F20,F21,F22,F43,K22