Proximity and Software Programming: IT Outsourcing and the Local Market

Abstract

Prior interviews conducted by the Software Industry Center with service providers in the Indian software industry suggested the need for some face-to-face communication in coordination-intensive activities. That is, despite improvements in communication capabilities due to information technology (IT), some IT services may still be inherently nontradable. This observation motivates the present paper. We examine the question of which services are tradable within a concrete setting: the outsourcing of IT services across a broad cross-section of establishments in the United States. If markets for IT services are local, then we should expect the entry decisions of IT services firms will depend upon the size of the local market and conversely, increases in local supply should increase the likelihood of outsourcing by lowering cost of outsourcing. If markets are not local, then the composition of local demand should matter little to the entry decisions of suppliers, and local supply will not affect outsourcing. We analyze outsourcing decisions from 52,191 establishments with over 100 employees at the end of 2002, for two types of IT services: programming and design, and hosting. Programming and design projects require communication of detailed user requirements whereas hosting requires less coordination between client and service provider than programming and design. Our empirical results bear out this intuition: Supply of programming and design services are more sensitive to increases in local market demand than are providers of hosting services, and the probability of outsourcing programming and design is increasing the local supply of outsourcing, but the outsourcing of hosting is not. This suggests that hosting services are more tradable than programming and design, and there is some irreducible non-tradable or “local” component to programming and design services.