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3 Effects of Offshoring on Specific Industries The committee commissioned papers on offshoring in six software-development sector is focused on India. Although economic sectorsâautomobiles, semiconductors, software, a few other countries, such as Ireland, which adapts soft- personal computer (PC) manufacturing, pharmaceuticals, ware products developed by multinational companies for and construction engineering and servicesâto gather in- the European market, are also destinations for offshoring, formation for the workshop (see Part 2). The six industrial the scale of activity in India is much greater than elsewhere. sectors were selected based on (1) the size and importance The number of workers employed in software development of the industry to engineering and the overall economy and in India is increasing by 30 to 40 percent a year, from about (2) the availability of expert authors. Table 3-1 provides a 2 percent of U.S. employment in 1995 to almost 20 percent summary in graphic form of the six industries. in 2005 (Table 3-3). The commissioned authors were given a list of questions India today specializes in software services, such as to use as guidelines (Box 3-1) and were asked to submit ab- the development and maintenance of custom-application stracts, and then draft papers, in the run-up to the workshop. software for large clients in several industries, such as insur- Following the workshop, the committee developed questions ance and finance. From this base, multinational companies and suggestions for revisions, which the authors incorporated operating in India and Indian domestic firms have moved into the final papers. Table 3-2 provides a summary of an- into other areas, such as product software and embedded swers based on the commissioned papers mapped onto the software. The increasing technical sophistication of Indian questions in Box 3-1. Summaries of the papers follow. workers and higher value added to products are being driven by investments by U.S.-based companies (Table 3-4). Dra- matic increases in exports from India to countries all over SOFTWARE-DEVELOPMENT INDUSTRY the world indicate that software development there is now The software-development industry was the first to en- targeted at the global market. gage in the offshoring of engineering for the purpose of The first offshoring of software development by U.S. reducing costs. In Chapter 2, we described the beginnings firms to India had one common characteristicâthe work of software-development offshoring, particularly to India, as being offshored was modular and did not require regular part of an overall picture of offshoring. In this summary, we contact with customers (Dossani and Kenney, this volume). describe the current status of software-development offshor- Several U.S. companies began by contracting with a vendor ing, trends, information gaps, and unanswered questions. to perform this non-integral work. After a period of time, Although offshoring of software development was the lead- they decided to set up Indian subsidiaries to perform more ing edge of the practice of engineering offshoring, it is still integral work. At first, although costs were lower in India, not clear whether offshoring in other industries will follow it was more difficult to hire an equivalent team there than a similar pattern. in Silicon Valley. Nevertheless, as these companies gained The paper by Dossani and Kenney on offshoring in the experience in managing offshoring relationships, the barriers 20
EFFECTS OF OFFSHORING ON SPECIFIC INDUSTRIES 21 TABLE 3-1â Data on Six Industries, 2002 (except where indicated) Computer Systems Design and Construction Related Engineering/ Services Software Automobiles Services PC NAICS: NAICS: Semiconductors NAICS: NAICS: Pharmaceuticals Manufacturing Total for 6 5415 5112 NAICS: 3344 3361-3363 23, 3413 NAICS: 3254 NAICS: 3341 Industriesa U.S. Total Value-added 173.5 103.5 110.4 469.8 1,358.4 140.6 73.7 2,429.9 10,469.6 ($ billions) 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 11.9 12.9 11.9 16 (est.)c 10.7 10.1d 3 76.5 193.9 ($ billions) R&D scientists 90,800 80,800 73,000 83,200 n/a 51,800 15,100 394,700 1,066,100 and engineerse aThesoftware 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- growth (Saxenian, 2006). Despite very high costs for skilled intensive semiconductor company, reports that its team in labor, Silicon Valley has remained a prime location for in- Bangalore is now as productive as its teams in San Jose and novative start-ups. Irvine, with costs in India running about one-third of those In a workshop presentation, Alfred Spector, a consultant in the United States. and NAE member, outlined three possible scenarios for As the institutional infrastructure in India has improved, the future of software-development offshoring (Spector, offshoring has become part of the normal way of doing busi- this volume). In the first scenario, offshoring frees up U.S. ness in the software industry. The diaspora of U.S.-educated talent and money, which can then be focused on higher Indian entrepreneurs has helped fuel the growth of the Indian value-added activities, such as testing, which then becomes tech sector, which is developing in a way that complements much more efficient. In the second scenario, the rise of India Silicon Valley (Saxenian, 2006). One example cited by and other offshoring destinations in certain sub-disciplines Dossani and Kenney is Netscaler, a company that turned to leads to a loss of U.S. jobs in those sub-disciplines, but, offshoring when it was facing a funding crunch. The tactic again, frees up talent and other resources for the creation of enabled the firm not only to survive, but also to grow (both new sub-disciplines or super-disciplines that keep U.S. soft- in India and the United States). ware innovation strong overall. In the third scenario, when Aspray et al. (2006) observe that offshoring has become U.S. students learn that certain activities are being moved essential to the globalization of the software industry and will offshore, they conclude that opportunities for software in- undoubtedly continue and increase. In Dossaniâs workshop novation in the United States are drying up and decide not presentation, he reported that today, in Indore, which is not to pursue careers in those areas; this leads to atrophy in the a large IT center like Bangalore or Mumbai, wages for en- U.S. talent and skills base. gineers who work 12 hours a day, six days a week are about The three scenarios are not mutually exclusiveâthe $200 a month. However, in larger centers like Bangalore, United States might maintain its leadership position in some salaries for experienced engineers are rising rapidly. For ex- aspects of software but lose it in others. Spector says that the ample, in a 2006 survey, âState of the Engineer,â published in EE Times, the mean salary for Indian respondents was â One reviewer of this report suggested tracking metrics related to soft- $38,500. However, as the history of Silicon Valley shows, ware innovation over time to determine which of these scenarios is being higher costs are not necessarily a barrier to innovation-fueled realized.
22 THE OFFSHORING OF ENGINEERING TABLE 3-2â Comparison of the Industry Sectors Covered by the Commissioned Papers Construction Engineering/ Software Semiconductors Automobiles Services Pharmaceuticals PC Manufacturing 1. Nature of Scope of work that Disaggregated Increasing pressure Supply of workers Increasingly difficult Disaggregated engineering can be spatially business models, to increase in the industry is a environment business mode grew work disaggregated is functional efficiency, more problem. for business up in the 1990s. growing. integration in open innovation models based on products. process. blockbuster drugs. 2. Current Strong capabilities Globalization has Successive waves of Large project sector Increasing Engineering and status in several countries, complemented U.S. globalization, âbuild more globalized consolidation, manufacturing regarding distributed innovation/market where you sell,â than building/ globalization of increasingly globalization development leadership. emergence of global residential sector. companies and concentrated in China. increasingly suppliers. markets. common. 3. U.S. Increasing, expected Sustained growth Total employment Agingâlow starting Appears to be Fairly small engineering to grow over the over time, less down over the long- salaries discourage growing, though workforce next decade. opportunity for term, same is true U.S. civil life sciences may be older and less- for engineers. engineering grads. growing faster than skilled, increase in engineering. foreign-born. 4. Countries India in particular, India China, India, Large range China, India, China, Taiwan where work is evidence of growth wherever the of offshoring United States still expanding in other countries. automotive market destinations, in attracts innovation is expanding. addition to India investment. and China, Eastern Europe is attracting work. 5. Offshoring Yes, driven by cost Yes, cost reduction Yes, both through Yes, growth of Yes, began with Yes, only limited occurring reduction, extent a primary motivator. global optimization global teams in the clinical trials and engineering work of high-value job of platform large project sector. is moving up the remains in the United losses uncertain. development and value chain, but States. through offshoring limits on end-to- of routine tasks; end; also significant also onshoring. onshoring. 6. Work More vulnerable: Product definition is Less vulnerable: Less vulnerable: More vulnerable: Less vulnerable; high that is more standardized service less vulnerable. Work on vehicle Work where high clinical trials; Less level definition of or less and maintenance; types where the degree of interaction vulnerable: the most product characteristics; vulnerable Less vulnerable: United States is the with the customer is sophisticated R&D. most other engineering Interface with final leading market (e.g. necessary. work is gone already. customer. large pick-ups); work where high degree of domain knowledge is needed. 7. Future Diversification Continued Fortunes of Will increase, U.S. engineering Companies that can outlook of destination globalization of leading global although there employment innovate will need countries, increase engineering work. OEMs diverging, are limitations not likely to be at least some U.S. in value-added of U.S. engineering on offshoring impacted by engineers; Taiwanese offshored work. fortunes have due to licensing, offshoring. engineering will be more to do with government offshored to China. competitive success procurement of companies than regulations, offshoring per se. national/homeland security concerns.
EFFECTS OF OFFSHORING ON SPECIFIC INDUSTRIES 23 BOX 3-1 NAE Offshoring Project: Issues and Questions to be Addressed in the Commissioned Papers 1. 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? 2. What is the current situation with regards to globalization of the industry? How globalized is the industry in terms of manufactur- ing, 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)? 3. 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 donât 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? 4. 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? 5. 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? 6. Are there areas of engineering work that are more or less vulnerable to offshoring? What can individual engineers and U.S. institu- tions do to retain their competitiveness? 7. 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? aâEngineering workâ 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 developers in the future, with uncertain implications for underlying technologies will also affect how offshoring and offshoring, is the growing popularity of multicore processors regional capabilities evolve. and multiple-processor systems. These technologies offer As in other industries, the growth of offshoring in soft- significant advantages in hardware design and more rapid ware development thus far has been led by U.S. companies. processing, without the heat limitations of single proces- Japanese companies are much less inclined to offshore soft- sors. However, multicore designs require software designers ware work (Aspray et al., 2006). Western Europe-based firms who can deal with concurrency and develop new programs fall somewhere in between; of these, U.K.-based companies in which tasks can be broken into multiple parts that can be account for the largest share of offshoring. processed separately and reassembled later (Krazit, 2005). One technological trend that will challenge software Because these skills may not be available in the usual off- shoring destination countries, relatively more engineering work may become available in the United States. TABLE 3-3â Increases in Offshoring of Software Some concerns have been raised about whether the glo- Production in India balization of software might be a serious threat to national security (Hamm and Kopecki, 2006). For example, acciden- Employment 1995 2005 tal defects or maliciously placed code might compromise United States 1.5 m 2.6 m the security of U.S. Department of Defense networks. The India 27,500 513,000 Defense Science Board is currently completing a study on Source: Dossani and Kenney, this volume. how the department should address these concerns.
24 THE OFFSHORING OF ENGINEERING TABLE 3-4â 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 firmsâ revenue (%) 14.50 22.00 26.00 31.00 31.00 n/a Source: Dossani and Kenney, this volume. AUTOMOTIVE INDUSTRY and General Motors both had a large number of overseas assembly plants. Over time, in some of the larger markets, The paper by John Moavenzadeh, executive director of subsidiaries, which operated almost as separate companies, the International Motor Vehicle Program, on engineering were established to design and build cars specifically for work in the automotive industry begins with a description those markets. of the two main categories of engineersâmanufacturing Since the 1960s, the auto industry has âundergone a sec- engineers and product engineers (the majority). Manufactur- ond wave of globalization,â fueled by changes in the U.S. ing engineers typically work at production facilities, while market, which is still the largest and most open market in product engineers typically work at corporate engineering the world (Moavenzadeh, this volume). One of those changes and design facilities. Product engineering can be divided was the growth of the Japanese auto industry. At first Japa- into several categories: product design, development, test- nese companies in the United States relied exclusively on ing, and advanced engineering. A significant percentage of exports from Japan. Gradually, however, they built manufac- product engineers work for automotive suppliers rather than turing and then engineering capabilities in the United States for original equipment manufacturers (OEMs), such as Ford, and Europe. These so-called âtransplantsâ now account for Toyota, and Volkswagen. more than 30 percent of U.S. auto production. Moavenzadeh describes the difficulty of estimating the Today more than half of General Motors employees are size of the automotive engineering workforce in the United outside the United States, and companies such as Volkswa- States based on official statistics, which are not specific to gen, Hyundai-Kia, and Honda assemble more than half of the engineering categories in the industry. By inference and their vehicles outside their home countries. The supplier base extrapolation, he estimates that at least 160,000 engineers is similarly distributed, especially tier-one suppliers, which and technicians support OEMs and suppliers in the U.S. provide interiors and other components that require R&D automotive industry (Tables 3-5a,b). and production closely coordinated with OEMs. The automotive industry ranks second among U.S. in- Automotive manufacturers manage their production and dustries in terms of overall spending on R&D. Six of the engineering âfootprintâ based on a number of factors, includ- top 20 companies that spend the most on global R&D are ing customers (i.e., the location of the market); capability automotive OEMs. Engineering and product-development (i.e., the best way to leverage available talent); cost (i.e., productivity levels differ for OEMs based in different parts labor costs and integration costs at various locations); and of the world; Japanese OEMs are more productive, for ex- government (i.e., trade and investment policies). ample, than OEMs based in the United States and Europe. The most important factor, though, is market growth From its beginnings in the late nineteenth and early twen- (Moavenzadeh, this volume). The United States, Japan, and tieth centuries, the automotive industry has been internation- Europe have large, but already mature markets that are not al. In the first half of the twentieth century, for example, Ford growing very rapidly, whereas large developing economies TABLE 3-5aâ BLS Data Showing Automotive Engineers in the United Statesa NAICS 3361: Motor Vehicle NAICS: Motor Vehicle Body and NAICS 3363: Motor Vehicle Parts Total of All Three Occupational Code Manufacturing Trailer Manufacturing Manufacturing 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.
EFFECTS OF OFFSHORING ON SPECIFIC INDUSTRIES 25 TABLE 3-5bâ Bottom-Up Estimate of Engineers and ing bills of materials, performing failure modes effects Technicians Employed by OEMs analyses, performing routine stress analyses, developing Current heat-transfer calculations, and generating tool designs from Number of part specifications. Engineers and The cost incentives for developing automotive- Company Technicians Projection engineering capabilities in developing economies such as General Motors 11,500 Decreasing China and India can work in two ways. The first, engineer- Ford Motor Company 12,000 Decreasing ing connected with the manufacturing of parts exported to DaimlerChrysler 6,500 Steady the United States and elsewhere, involves different motiva- Japanese companies 3,593 Increasing rapidly Korean companies (Hyundai-Kia) 200 Increasing rapidly tions and impacts from offshore engineering not connected German companies (BMW) 150 Increasing with manufacturing. The former is an important aspect of globalization in the automotive industry, particularly in TOTAL About 34,000 the rise of Chinaâs 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- such as China and India have markets that have grown rap- based manufacturers, or joint ventures, tend to be less so- idly in recent years and are expected to continue growing. phisticated products, such as radios, brake components, and Thus automakers from all over the world are trying to make after-market aluminum wheels. inroads into those markets. Ford and General Motors have The second way cost differentials can provide incentives been particularly active, building manufacturing capacity as for offshoring is related to the offshoring of engineering ser- well as engineering capability in China, Latin America, and vices; companies either contract foreign firms or build their elsewhere. own subsidiaries to perform engineering tasks offshore. In In addition to market factors, cost factors tend to encour- addition to China, India is well positioned as a destination age OEMs and automotive suppliers to locate engineering location for this sort of work. ValueNotes (2006), a research activities in the developing world, especially in China consultant company, predicts that offshoring of automotive (Figure 3-1). Moavenzadeh estimates that, whereas a fully engineering and design services will increase from the 2005 loaded, experienced engineer in the United States might cost level of $270 to $300 million globally to more than $1 billion $100,000 a year, an equivalent engineer in China might cost in 2010. Automotive engineering services in India at subsid- $15,000 a year. However, Chinese engineers are reportedly iaries of global suppliers, such as Delphi, and subsidiaries of less productive, which may reflect their lack of domain Indian OEMs, are expected to increase at an annual rate of knowledge (many Chinese have never driven a car). As the 30 percent during this period. Chinese economy grows and automobiles become more Because China has attracted so much attention from common, however, we can expect Chinese engineers to the global auto industry as a growth market and source of become more competitive and more productive. components, we now look more closely at the current state Even with the current productivity gap, a number of en- of Chinaâs engineering capability and the potential effect of gineering tasks can be offshored fairly easy. As was the case offshoring on Chinaâs global competitiveness. First of all, with software development, these are modular tasks that do the Chinese government has used a number of stratagems not require customer contact, such as developing engineer- over the years to force or encourage the formation of joint China India Eastern Europe Mexico Western Europe United States 0 20 40 60 80 100 120 $ thousands FIGURE 3-1â 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. fig 23
26 THE OFFSHORING OF ENGINEERING ventures, and subsequent technology transfer from global phenomenon of âonshoring,â that is, foreign-based OEMs auto companies to domestic manufacturers (Zhao et al., and suppliers building engineering capability in the United 2005) However, so far these joint ventures have not led to States (Table 3-6). Japanese OEMs employ more U.S. engi- the transfer of skills the Chinese government had anticipated, neers than Europe-based automakers because of their much mostly because Chinese engineers, who were expected to larger manufacturing presence in North America. Although rotate back to domestic parent companies, have not done so long-term career prospects for U.S. auto engineers are because of the large salary differentials. highly correlated with the fortunes of U.S.-based OEMs, Chinaâs automotive R&D capability is currently far especially in southeastern Michigan and a few other areas, behind that of countries that build cars for the most sophis- onshoring raises the possibility that, as long as the United ticated global markets (Zhao et al., 2005), and it will prob- States remains a leading auto market, OEMs, regardless of ably take years for China to assimilate the management of nationality, will maintain engineering capability here. automotive-development processes. R&D management is also in an early stage, and several Chinese auto companies THE PHARMACEUTICAL INDUSTRY have hired foreign executives at very senior levels to run them. R&D currently being done by joint venture firms The pharmaceutical industry, including the biotechnol- mainly involves adapting, or âlocalizing,â foreign technol- ogy sector, has several unique features, as does the nature of ogy and designs for the Chinese market. engineering work in pharmaceuticals. The value chain in this Notwithstanding these barriers, China will continue to industry runs from discovery (including target identification, move toward the top tier of auto-manufacturing nations. lead discovery, and optimization) through clinical develop- Chinaâs growing exports of automotive parts and the slow, ment to manufacturing to marketing and distribution (Pore, but not insignificant, skills transfer occurring through joint Pu, Pernenkil, and Cooney, this volume). ventures with foreign OEMs are providing an excellent Pharmaceutical companies have very strong incentives foundation for the development of a world-class automotive for ensuring that the science-based discovery process is as technology base. In addition, the Chinese government funds efficient as possible. Bringing a drug from the concept stage three university centers that conduct applied automotive to the marketing stage currently costs about $800 million, research for Chinese OEMs. takes 8 to 12 years, and requires the testing of 5,000 com- Chinaâs greatest asset is the continuing growth of its do- pounds for every drug that is actually approved (McKinnon mestic auto market. Firms based in the United States, Japan, et al., 2004). Todayâs âbig pharmaâ companies are squeezed and Europe have adopted different approaches (some compa- between a business model that emphasizes blockbuster nies in different parts of the same region also differ) to enter- ing the Chinese market. General Motors and Ford, as well as several major Europe-based OEMs, have been aggressively building engineering and manufacturing capability in emerg- TABLE 3-6â Employment in Foreign-Brand R&D and ing markets as a way to establish and build market share Design Facilities in the United States, 2006 there. However, to date, most Japan-based OEMs have made efforts to enter the Chinese market through exports rather Company Location(s) Established Employees than through joint-venture manufacturing, although there BMW Spartanburg, NC; Woodcliff 1982 70 are indications that this may be changing (Business Week, Lake, NJ; Oxnard, CA; 2006). The effects of these differences on global automotive Palo Alto, CA Honda Torrance, CA; Marysville, 1975 1300 competition are topics for future studies. OH For U.S.-based OEMs, Ford and General Motors in par- Hyundai Ann Arbor, MI 1986 150 ticular, the most difficult problem today is not offshoring Isuzu Cerritos, CA; Plymouth, MI 1985 100 itself but coordinating and optimizing global R&D and engi- Mazda Irvine, CA; Ann Arbor, MI; 1972 100 neering operations (Moavenzadeh, this volume). The current Flat Rock, MI Mercedes-Benz Palo Alto, CA; Sacramento, 1995 50 goal is to coordinate global programs to produce vehicles CA; Portland, OR with similar fundamental architectures that can be easily Mitsubishi Ann Arbor, MI 1983 130 modified to meet local customer demands and regulatory Nissan Farmington Hills, MI 1983 980 requirements. Reducing the number of vehicle architectures Subaru Ann Arbor, MI; Lafayette, 1986 30 will reduce cost, improve speed-to-market, and hopefully IN; Cypress, CA Toyota Gardena, CA; Berkeley, 1977 950 enable OEMs to meet the demands of particular markets. At CA; Ann Arbor, General Motors, for example, Korea is the center of expertise MI; Plymouth, MI; for small-car development, and the United States is the center Lexington, KY; for full-sized truck development (Cohoon, 2006). Cambridge, MA; The overall picture of offshoring in the auto industry Wittmann, AZ; would not be complete without taking into account the Source: Moavenzadeh, this volume.
EFFECTS OF OFFSHORING ON SPECIFIC INDUSTRIES 27 products, which entail high risks and high fixed costs (i.e., the preferred location for lead optimization (the assessment R&D and marketing), and pricing pressure and competition of a family of candidates and the evolution of the ones with in key product classes (Campbell et al., 2005). Some analysts the greatest chance of success). Because these capabilities predict that the industry will experience slower revenue and are fragmented across the value chain, however, no single profit growth in the future because of a slowdown in the new- location can provide end-to-end solutions. product pipeline. The industry is also very concentrated; in China and India have also become leading global loca- 2004, the top 10 global companies accounted for almost half tions for manufacturing of pharmaceuticals, which ultimately of global sales (Gray, 2005). contributes to the innovative capabilities and engineering tal- The fill, finish, formulation, and packaging processes have ent base in those countries. For example, China is the worldâs been globalized for some time and serve global markets. The largest producer of active pharmaceutical ingredients, with expiration of patents and consequent competition from ge- sales of $4.4 billion in 2005; India is the third largest pro- nerics have increased incentives to control costs by moving ducer, with sales of $2 billion. India has the second highest manufacturing overseas, even for products manufactured for number of FDA-approved manufacturing facilities, after the the U.S. market. United States. Overall, Indiaâs production costs in pharma- However, the discovery of active pharmaceutical ingre- ceuticals are about half those of the United States, including dients, the core innovative activity of pharmaceutical com- labor, raw materials, capital costs, and regulatory costs. panies, has traditionally been centralized at a few research In general, the impacts of offshoring on U.S. engineering facilities in the home country and, perhaps, a very few other (and science) capabilities in the pharmaceutical industry global centers of pharmaceutical innovation. Drug and pro- have not been significant so far. Even with rapid growth, cess development, which involve more engineering than McKinseyâs projections of the number of jobs that will be drug discovery, have been similarly concentrated. offshored in the next few years is small compared to the The commissioned paper on this industry focuses on China number of U.S. engineers working in those areas. and India as offshoring destinations. Both countries have the In addition, the trend toward R&D or engineering off- advantages of market potential, low costs, multiple R&D shifts shoring in the U.S. pharmaceutical industry may be more in a day, a large number of graduates in chemistry and biology, than offset by significant onshoring. For example, major government research support, and tax incentives. In addition, European pharmaceutical companies such as Novartis and they have large numbers of treatment-naÃ¯ve patients, which is GlaxoSmithKline have shifted much of their R&D and an advantage for conducting clinical trials. manufacturing activities to the United States in recent years. China and India also have significant disadvantages, The large U.S. talent base and the absence of price regula- including regulatory barriers (especially in India). In addi- tion are the major attractors. In addition, companies based tion, as discussed in Chapter 2, only a fraction of the trained in India that have emerged as global leaders in the generic workers are qualified to work in the environment of a mul- drug market are beginning to form joint ventures with, and tinational company (10 percent in China and 25 percent in even acquire, U.S. companies, with the goal of building India). Another barrier is the uncertainty of protections of capabilities in marketing and innovation. These trends bear intellectual property. Evidence shows that no offshored R&D close watching. in emerging economies, in any industry, involves cutting- edge research (Thursby and Thursby, 2006). PERSONAL COMPUTER MANUFACTURING McKinsey Global Institute (2005) estimated that global pharmaceutical companies had offshored about 10,000 PC manufacturing is a $230 billion industry that includes full-time employees by 2003, almost three-quarters of them desktops, notebooks, PC-based servers, and hand-held com- working in R&D. As noted in Table 3-1, 51,800 R&D scien- puting devices, such as personal digital assistants (PDAs), tists and engineers were working in the U.S. pharmaceutical personal music players, and smart phones. PCs also drive industry in 2002. the sale of PC software (a $225 billion market), IT services, Perhaps the most significant activity in emerging econo- and other hardware, such as peripherals, storage, and net- mies is clinical trials, with India the preferred destination. working equipment (Dedrick and Kraemer, this volume). In a recent estimate, the value of the current outsourcing The United States, which is the leading market for PCs, market for clinical trials was $158 million and was predicted is home to some of the top PC vendors, such as Dell and to increase to more than $500 million in the next few years Hewlett-Packard. Companies from China (Lenovo, which (OâConner, 2006). In addition to cost savings for clinical acquired IBMâs PC business a few years ago), Taiwan trials, global pharmaceutical companies also save time be- (Acer), and Japan (Fujitsu, Toshiba, Sony) are also among cause patients there can be recruited more quickly than in top PC manufacturers. developed markets. China is the preferred location for R&D in advanced â Hand-held devices are grouped with PCs here because the design and proteomics (the systematic, automated study of protein development processes are very similar. However, the issues related to soft- structure and function) and molecular biology, while India is ware development are very different from those related to PCs.
28 THE OFFSHORING OF ENGINEERING The value chain in the PC manufacturing industry is ing industry, of which the PC industry is a part, appears to highly disaggregated and globalized. Two suppliers, Intel have remained relatively stable in recent years, although the and Microsoft, set the most widely adopted standards for the composition of the workforce has changed. Employment in microprocessor and operating system. Other components, electronics and electrical engineering has gone down; em- including storage, displays, semiconductors, and wireless ployment in applications-software engineering has gone up; networking components, are core technologies of the PC and employment in other categories has remained more or manufacturing industry. Most of the manufacturing and less stable (Dedrick and Kraemer, this volume). Table 3-7 physical engineering for notebooks and desktop machines shows the distribution of engineering jobs in the computer is done by contract manufacturers and original design industry as of 2005. manufacturers (ODMs). U.S.-based firms originally turned Because of changes in classifications, it is difficult to track to Taiwan-based companies to take advantage of lower costs the events of the 1990s, when the trend toward offshoring and to avoid becoming dependent on Japanese companies in PC manufacturing and engineering developed. Table 3-8 that could become competitors. Since then, Taiwan-based shows engineering salaries in the computer industry. Table ODMs have shifted almost all manufacturing to China; they 3-9 shows the supply and demand for engineering skills at are now shifting much of the engineering to China as well. PC and related industry firms. The main tasks for PC firms are to define and anticipate As the employment numbers suggest, there is a growing the changing needs of customers, integrate innovations of need for engineers with software skills and knowledge of suppliers into well designed product packages that meet both hardware and software in the manufacturing processes those needs, and bring the packages to market quickly at an still based in the United States. Also, U.S. firms are looking attractive price. Therefore, the focus of PC manufacturing for experienced engineers who can be productive immediate- companies is on product development rather than R&D. ly. Thus only a few of the firms interviewed by Dedrick and The engineering tasks for PC manufacturing vary with Kraemer report making entry level hires. Management skills the product category. Desktops, for example, require the are also in high demand. Taken together, these trends indi- integration of components into the chassis. Although it may cate that employment in PC manufacturing could be difficult take as long as nine months to design a new chassis, it takes for young U.S. engineers with little or no job experience. as little as two weeks to design specific models based on that Both U.S. and Taiwanese PC companies are now looking chassis. Notebook PCs involve more complex engineering to China for engineering talent. According to Dedrick and tasks, such as the optimization of design elements that re- Kraemerâs interviews with managers, Chinese engineers quire trade-offs in weight, sturdiness, heat generation, energy today do not have analytical skills and market knowledge efficiency, and so forth to achieve an ideal mix. Newer prod- comparable to those of experienced U.S. engineers. How- uct categories, such as smart hand-held devices and blade ever, investments in training Chinese engineers have paid servers, present many engineering challenges, first because significant dividends, even though turnover remains high no dominant technology standards have been established for and salaries are rising rapidly. The largest Taiwanese ODMs devices such as iPods and PDAs, and second, because some have been focusing their efforts on training engineers in the products are unique to particular companies. Shanghai/Suzhou region, which is now the hub of notebook The disaggregated business model of the PC industry, in PC manufacturing. which significant aspects of engineering are offshored, has As in the auto industry, PC firms based in different coun- enabled Dell, Hewlett-Packard, and other leading companies tries have adopted different approaches to offshoring. For to hold down costs and remain competitive in an industry example, Japanese PC makers, whose efforts are focused that has rapid product cycles. Apple has even used a disag- mainly on satisfying the demand in their domestic market, gregated business model to create the iPod, a new kind of do not offshore manufacturing or engineering jobs. product that straddles the line between IT and consumer electronics. CONSTRUCTION ENGINEERING AND SERVICES The key to long-term success in the PC industry appears to be protecting the interface with customers and the result- Construction is a $4 trillion industry, with about one- ing information flow. Knowledge gained from customers fourth of that in the United States. Conceptually, the industry feeds into product definition, high-level design, and the most can be divided into two sectors. Engineering, procurement, sophisticated engineering tasks. Thus the effective use of off- and construction (EPC), which involves the construction of shoring can enable firms to sustain their U.S. operations and industrial and infrastructure facilities, is made up of large employment levels with U.S. employees who work mainly in firms that employ many engineers. Architecture, engineer- non-engineering jobs. As a result, not many engineering jobs ing, and construction (AEC), which involves construction in the United States remain in this industry, and the ones that of buildings and residential facilities, is made up mostly of do require high levels of skill and experience, as well as an smaller firms (Messner, this volume). The description that ability to innovate. follows addresses offshoring in both sectors, although the Overall employment in the U.S. computer manufactur- companies (mostly very small) that make up the residential
EFFECTS OF OFFSHORING ON SPECIFIC INDUSTRIES 29 TABLE 3-7â Engineering Jobs in the U.S. Computer TABLE 3-8â Engineering Salaries in the U.S. Computer Industry, 2005 Industry, 2005 2005 Computer software engineersâapplications $94,760 Computer software engineersâsystems software $92,030 Computer software engineersâapplications 12,800 Computer hardware engineers $94,690 Computer software engineersâsystems software 18,240 Electrical engineers $84,820 Computer hardware engineers 12,940 Electronics engineers, except computer $86,330 Electrical engineers 2,900 Industrial engineers $77,710 Electronics engineers, except computer 3,710 Mechanical engineers $78,740 Industrial engineers 3,430 Engineering managers $130,020 Mechanical engineers 2,280 Industrial designers $94,800 Engineering managers 5,630 Industrial designers 180 Source: BLS, 2007. Total 62,110 Source: BLS, 2007. TABLE 3-9â Survey Results for Jobs in PC and Related Industries Major Activity Where Demand for Availability Availability in Other Locations Cost and Quality Engineering Job Category This Skill Is Used Engineers in U.S. Where Activity Takes Placea Relative to U.S.a Engineering managers R&D, design, development Stable or Tight Tight or enough Lower cost, lower quality growing 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 Tight or enough Enough Lower cost, same or growing lower quality Electronic engineers Development Falling Tight or enough Enough Lower cost, same or lower quality Mechanical engineers R&D, design, development Stable or Tight or enough Enough Lower cost, same or growing 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. construc- about a project from being widely disseminated, particularly tion market) do not engage in offshoring. In contrast to overseas. industries in which the top 20 global companies account for Like data for other industries, the data for the construc- a large percentage of the market (e.g., pharmaceuticals and tion industry are not sufficient to provide a clear picture of PC manufacturing), construction is highly decentralized. The the current status of offshoring. We can say that offshoring 400 top U.S. contractors account for less than 20 percent of in construction engineering and services is occurring, but the market. firms are also aggressively hiring civil engineers (the largest Engineers in the construction industry are involved in all engineering discipline) and other design professionals (e.g., phases of the delivery and operation of facilities. Factors architects) in the United States. There is no evidence that that influence offshoring include the uniqueness of proj- offshoring has had a significant impact on the employment ects, the extensive local knowledge necessary to meet local of engineers in the U.S. construction industry. codes and conditions, the active involvement of owners in The following discussion is based on available statistics most projects, and the desire of owners to keep information supplemented by information from surveys and interviews.
30 THE OFFSHORING OF ENGINEERING The focus of this analysis is on civil engineers (although TABLE 3-10â Impact of Offshoring on Projects in the small numbers of other types of engineers also work in EPC Sector the construction field) and architects (design professionals Percentage of whose work is subject to offshoring). The current demand for Impact on: Responses Opinion engineers and architects in the United States is high because Engineering cost 48 More than 10% reduction the civil engineering workforce is aging, many engineers Construction cost 75 No impact are retiring, and, until recently, the construction market was Engineering time 48 No impact growing rapidly. Overall project delivery time 59 No impact Firms that were interviewed for this study in the EPC Engineering quality 65 No impact Construction quality 72 No impact sector, the most active sector in offshoring, said that offshor- ing 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 dif- ferentials are shrinking rapidly as salaries in some places in the AEC sector includes the transformation of hand-drafted developing countries rise, particularly in Mumbai, India, and documents into 2D CAD or 3D CAD models and some en- other specific locations. gineering tasks for building projects, such as engineering of EPC firms that are active in international markets have the foundation, structure, and technical systems. been offshoring engineering work for 15 years or more. Overall, however, offshoring in the AEC sector has been The vast majority, however, indicate that they coordinate limited for several reasons, such as the small size of most work among locations to meet the needs of specific projects AEC firms, the need to protect sensitive or secure informa- (Figure 3-2). Several steps in the construction-engineering tion for some projects, the need for local knowledge or process have been subject to large-scale offshoring. These interaction with the owner for some projects, and a poorly include the development of 3D models during the design developed institutional infrastructure for construction engi- process, the conversion of 2D sketches to CAD models, neering and services in potential destination countries. Some and the development of engineering shop drawings for tasks are being automated through new software tools rather mechanical and steel subcontractors; there is also some than being offshored. offshoring in the IT sector. Cost reduction was the reason More than 90 percent of survey respondents in the EPC cited most often Â(followed by better quality) for offshoring sector said they thought offshoring would increase in the among the EPC firms surveyed (Table 3-10). There was some future (Figure 3-3). Some said they thought increasing off- d Â ifference of opinion about whether offshoring also reduced shoring would lead to lower quality designs, but others, in engineeringÂ time. companies that have established operational low-cost engi- In 2004, the United States had an official trade surplus neering centers abroad, said they believe that with effective for AEC services of almost $3 billion, including a bilateral organization and management, they will be able to maintain surplus with India. This number does not include interac- quality and lower their costs. With lower costs, they said, they tions between a U.S. company and its Indian subsidiary, can produce more detailed designs than would be possible if but does include outsourced work. Work that is offshored in the work were performed solely in the United States. Do you plan to increase, maintain or decrease Use for all projects 6% your use of global virtual teaming? Do not use 17 % Decrease Maintain 0% 7.5 % Use for the Increase first time 92.5 % 15 % Use for many projects 62% FIGURE 3-2â Use of global teams by firms in the EPC sector. FIGURE 3-3â EPC contractorsâ perceptions. Source: Adapted from Source: Adapted from CII Project Team 211 Survey, 2004. CII Project Team 211 Survey, 2004. Committee Figure 3 -3
EFFECTS OF OFFSHORING ON SPECIFIC INDUSTRIES 31 Concerns have been raised about potential security risks ductors is done by subsidiaries. Larger U.S. chip companies for U.S. buildings, particularly for critical infrastructure have established design centers around the world, mostly in facilities, when detailed plans are developed and dissemi- Asia. Sometimes the goal is to capture specialized skills that nated outside the United States (ASCE, 2005). Industry are available at the offshore location, such as knowledge of groups such as COFPAES and AIA continue to monitor this wireless networking technology in Scandinavia. Sometimes situation. the goal is to capitalize on government policies, such as in China, where the government encourages, sometimes re- quires, direct investment in return for market access. SEMICONDUCTORS The motivation for offshoring design work to India, the According to the authors of the paper on offshoring in the most popular destination, has been primarily to reduce costs. semiconductor industry, Clair Brown, director of the Center Of the top 20 U.S. semiconductor companies, 18 have es- for Work, Technology, and Society at University of Califor- tablished design centers in India; nine of those have opened nia Berkeley, and Greg Linden, a research associate at the since 2004. The size of these design centers varies widely, center, the long-term trend of globalization of technology has from 100 or so engineers in the smaller centers to 3,000 en- had a significant impact on the nature of engineering work in gineers at Intelâs design center. The flood of investment has the United States in this industry. Offshoring of engineering led to challenges, such as finding enough trained engineers, is increasing in all three major stages of semiconductor pro- coping with the high turnover rate, and meeting demands for ductionâdesign, fabrication, and assembly and packaging. rapidly rising salaries. For more than three decades, the number of transistors per The semiconductor industry has shown that design off- unit of area has increased exponentially. Along with these shoring arrangements can be managed effectively, even advances, the cost of fabrication facilities (fabs) has also though the costs of coordination and communication tend to increased steadily; today a 300-mm wafer fab of minimally offset some of the cost reductions in other areas. In reality, efficient scale costs about $3 billion. The demands on de- savings may come to 25 to 50 percent, rather than the 80 to signers have also increased as they must find ways of using 90 percent suggested by salary comparisons alone (Brown available âreal estate,â or space, on a device. and Linden, this volume). Nevertheless, offshoring of the In short, projects have become increasingly complex with design phase is now a fundamental, expected feature of the significant implications for the engineering labor market business model for new U.S. semiconductor companies, and for offshoring. The need for the efficient integration of which are also likely to be fabless. U.S.-based semiconduc- system-level components has led to a greater emphasis on tor start-ups, especially those with a founder or co-founder system software, preferably generated in parallel with chip born in India, increasingly include design offshoring as part design. According to Brown and Linden, âSoftware can now of their business plans (Saxenian, 2006). account for as much as half the engineering hours involved The impact of offshoring on semiconductor engineers and in a large chip development projectâ (this volume). engineering organizations in the United States is difficult to U.S.-based companies account for more than half of determine exactly because, once again, the data are not de- global industry revenues; Intel alone, the largest company, finitive. However, based on government statistics, the Semi- accounts for 15 percent. Texas Instruments is the only other conductor Industry Association annual survey, and other U.S.-based firm in the global top 10, but a number of rap- sources, the U.S. workforce in semiconductor engineering idly growing medium-sized companies are in the top 50. A has recovered from a drop during the tech bust several years number of these firms are âfabless,â meaning they do not ago and is now growing. Overseas employment, however, is manufacture their own devices but contract out fabrication growing faster (see Table 3-11). Overall, we can say that the and assembly/packaging to âfoundries,â such as Taiwan availability of offshore design and manufacturing capability Semiconductor Manufacturing Company (TSMC). has made it possible for the creation and growth of new, in- In the 1970s, assembly and packaging were shifted to novative, U.S. semiconductor firms. Southeast Asia. In the 1990s, with the emergence of the Whether offshoring has had a negative impact on wages Korean and Taiwanese semiconductor industries, the num- or on certain segments of the engineering workforce are ber and dispersion of fabrication facilities was accelerated. questions that remain to be answered. Brown and Linden U.S.-based companies have shown a willingness to locate document several disturbing trends to which offshoring may new fabrication facilities in various countries, as well as in contribute but which have multiple causes, including rapid the United States, in response to the size and potential of the changes in technology in the semiconductor industry, the market, tax advantages, and other incentives. One recent, high reliance in recent years on H1-B visa holders, the linger- widely discussed example is Intelâs plan to build a $2.5 bil- ing effects of the tech bust, and so forth. One of these trends lion fabrication facility in China (which would not include is that a substantial number, perhaps 10 percent, of older Intelâs leading chip designs) (IHT, 2007). engineers has experienced long periods of unemployment. In contrast to software, for which work is often outsourced A second trend is that many U.S. citizens and permanent to other companies, most offshore design work for semicon- residents appear to have decided that graduate engineering
32 THE OFFSHORING OF ENGINEERING TABLE 3-11â Engineers at U.S. Chip Firms by Location Aspray, W., F. Mayadas, and M.Y. Vardi, eds. 2006. Globalization and Off- (in thousands) shoring of Software: A Report of the ACM Job Migration Task Force. New York: Association for Computing Machinery. Available online at 1999 2000 2001 2002 2003 2004 2005 http://www.acm.org/globalizationreport/. United States 61.9 76.1 72.6 72.9 72.0 66.6 83.2 BLS (Bureau of Labor Statistics). 2007. Occupational Employment Statis- Offshore 17.5 20.0 27.2 29.8 30.9 34.6 42.2 tics, 2007. Available online at http://www.bls.gov/oes/home.htm. Percentage in the 77.9 79.2 72.7 70.9 69.9 65.8 66.3 Bureau of the Census. 2004. Economic Census 2002. Available online at United States http://www.census.gov/econ/census02/. BusinessWeek. 2006. Toyota in China: Full Speed Ahead. BusinessWeek, Source: Brown and Linden, Table 11, this volume. March 9. Campbell, A., G. Rotz, and K. Worzel. 2005. Getting Fit in Pharma: From Periodic Cost-Cutting to Continuous Productivity Improvement. New York: Marakon Associates. Available online at http://www.marakon. com/ideas_pdf/id_051205_campbell.pdf. degrees do not provide enough return on investment to CII (Construction Industry Institute). 2004. Planning a Global Virtual En- justify the time and expense of pursuing them. Companies gineering Team: A Tool for Success. Research Summary 211-1. Austin, Tex.: CII. are still hiring foreign students who earn degrees from U.S. Cohoon, J.D. 2006. Remarks at the Workshop on the Offshoring of Engi- institutions, however, who can work at U.S. companies on neering. National Academy of Engineering, Washington, D.C., October H1-B visas. Interestingly, when the number of H-1B visas 24, 2006. was cut recently, U.S. semiconductor companies reacted by DSB (Defense Science Board). 2005. High Performance Microchip Supply. sending their visa-holding Indian and Chinese employees February. Available online at http://www.acq.osd.mil/dsb/reports/2005- 02-HPMS_Report_Final.pdf. back to their home countries to help manage and develop Gray, N. 2005. PharmExec 50: Untying the Gordian Knot. Special Report. subsidiaries there. Pharmaceutical Executive (May): 84â100. Although offshoring has had positive impacts on destina- Hamm, S., and D. Kopecki. 2006. Techâs Threat to National Secu- tion countries, India and China face challenges in upgrad- rity. BusinessWeek.com. November 2. Available online at http://www. ing their educational systems to produce more engineering businessweek.com/technology/content/nov2006/tc20061102_797312. htm?campaign_id=rss_tech. graduates and making their infrastructure, such as electrical Hecker, D.E. 2005. High-technology employment: a NAICS-based update. power, more reliable. Overall, however, experience in the Monthly Labor Review 128(7): 57â72. semiconductor industry shows that offshoring is likely to be- IHT (International Herald Tribune). 2007. China approves $2.5 billion Intel come a trend for engineering work everywhere. For example, Corp. chip plant amid booming demand in country. IHT, March 13. both Taiwan and India are now offshoring work to China. Krazit, T. 2005. Microsoft: Multicore Chips Changing PC Software. InfoWorld, October 26. Available online at http://www.infoworld.com/ Because semiconductors are critical components of many article/05/10/26/HNmicrosoftchips_1.html. modern weapons systems, the U.S. Department of Defense McKinnon, R., K. Worzel, G. Rotz, and H. Williams. 2004. Crisis? What (DOD) is justifiably concerned about maintaining access Crisis? A Fresh Diagnosis of Big Pharmaâs R&D Productivity Crunch. to semiconductors and related capabilities in design and New York: Marakon Associates. Available online at http://www. manufacturing. In 2005, a task force of the Defense Sci- marakon.com//ideas_ pdf/id_041104_mckinnon.pdf. McKinsey Global Institute. 2005. 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A Dual Networks Perspective on Inter-Organizational Transfer of R&D Capabilities: International Joint Ventures in the Chinese Automotive Industry. Journal of Manage- ment Studies 42(:1): 127â160. â 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.