The Reliance On Labor Arbitrage Might Be Coming To End

The “Halting International Relocation of Employment” HIRE Act, if passed, will have dramatic implications on organizations’ outsourcing strategies and vendor agreements. It was introduced in the US Senate in early September and it is still in a very early legislative stage. It proposes a 25% excise tax on outsourcing and eliminates the foreign service provider tax deduction. The language is intentionally broad to discourage avoidance and the disguise of offshore delivery models. The penalties are excessive, making outsourcing arrangements cost prohibitive. Many organizations are seeking to understand what they should do now if, or when, this bill passes.

Quantify How Your Outsourcing Strategy Could Be Impacted

Results may vary, as not all outsourcing models are impacted equally. Offshore outsourcing appears to be the primary target, with IT back office and customer support burdened the most. A broad interpretation of the bill could include the internal offshore operations of US companies, including global capability centers. This puts internal fund transfer mechanism to cover salaries and operational expenses for these countries at risk. Even the freelance developers, contractors, and staff augmentation provider payments are scrutinized. They fall under the “foreign person” meaning of the bill. So, where’s the bright spot? Nearshore and onshore become more attractive cost-effective investments. Puerto Rico, as a stable US territory, is commonly highlighted as the next best option for strategic offshore market opportunities.

Just as important as the outsourcing models are the spend categories that would require a financial impact assessment. IT services, business process outsourcing, innovation, and R&D typically rely on large offshore teams. We can forecast with certainty that these categories will absorb dramatic cost increases.

We recommend quickly pulling together an enterprise checklist that helps you organize the outsourcing models and spending health that requires immediate attention.

Restructure Vendor Agreements

In addition to outsourcing models and spending categories, organizations must consider contractual agreements and financial structures. Most organizations do not have explicit terms and conditions that account for government mandates in their service agreements. So, at the risk of stating the obvious, review your contracts and vendor relationships. As a part of the contractual assessment, scrutinize fixed-price, time and material, force majeure, termination, and material adverse change clauses as your basis for renegotiation triggered by the potential government mandate.

Invest In Operational Efficiencies That Cannot Be Eliminated By Taxes

A “move up the value chain” or “shift left” are the guiding principles of operational excellence — rethinking strategies that compete on price and efficiency alone is the best guidance in response to this. Instead of focusing on labor arbitrage, measure provider model success against outcomes, differentiation, specialization — all value-based skills and insights. For those of you in the business long enough to remember, back in the early 2000s there was a “mandate” to end paper airline tickets for the airline industry. This was not just a simple change in procedure, it was a move to accelerate a value-based outcome by shifting focus from a commodity-driven transaction to a more strategic business model. It was less about hugging trees and saving paper — it was a foundational element of the digital transformation that has since redefined air travel. If you are currently experiencing flight delays, strategic use of digital platforms are still being addressed — that’s not my point. I’m sure the airlines appreciate your patience, and safe travels!

By Your Side To Get Ahead Of The Chaos

If you are a Forrester client, set up a guidance session with Bill Martorelli, Jeffrey Rajamani, Faram Medhora, Ashutosh Sharma, Greg Zorella, Linda Ivy-Rosser, Mark Moccia, Manuel Geitz, or Fred Giron. Review outsourcing strategies, vendor agreements, digital transformation services, and spend management components of your strategy portfolio.