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Ever since offshore outsourcing became the norm of the modern world, experts have been warning industries not to follow the general trend and jump into the outsourcing bandwagon. Their advice is to determine whether the outsourcing exercise will really benefit your company before making the decision.
The inescapable global competition has led to a conventional wisdom that any business activity that can be moved offshore will be moved offshore. This cutthroat zeitgeist often compels small and medium-sized enterprises to jump into an outsourcing decision without fully considering the consequences.
Let's first make the distinction between outsourcing and offshoring, because they are often used interchangeably. Outsourcing refers to the practice of taking certain internal company business processes or functions and contracting them out to a third party. Outsourcing focuses on the identification of specific business activities---the what---regardless of where and by whom they are performed. Offshoring simply is the relocation of a business activity to an overseas location.
Mutually Exclusive
Theoretically offshoring and outsourcing are mutually exclusive; the two concepts are often conjoined in the modern lexicon because they are commonly linked in practice. One of the primary motivations for outsourcing is cost reduction and one of the easiest ways to reduce costs of labor-intensive activities is to move them to low-wage countries.
The trick for SMEs in this globalized environment is to identify processes and services in one's own business most appropriate for outsourcing and to find the right balance between internal and external service providers, an activity Gartner terms "multisourcing."
To assist in isolating those activities ripe for outsourcing, Gartner has developed a chart to categorize processes or services based on a company's level of internal competence in each and their value in differentiating the company from competitors. Tasks ranking low in both areas are targets for outsourcing, while those high in each should be kept in-house (see the "Gartner Multisourcing Decision Model" chart below).
Identifying Strategic Rationales
Successful outsourcing focuses on addressing strategic reasons for disinvestment. Companies making an outsourcing decision need to use a disciplined process, such as Gartner's multisourcing, to reveal strategic business issues and answer the key questions of "why" and "what" you are outsourcing.
According to Kurt Potter, research director for IT services and outsourcing at Gartner, such a formal approach "allows you to get management buy-in and create a governance structure" for outsourcing activities. And when it comes to governance, Forrester Research Vice President Stephanie Moore recommends that every offshore outsourcing effort be centrally managed by an offshore program management office or team.
Survey data compiled by Gartner's Potter shows the primary reasons SMEs outsource are to lower costs, improve service, provide more predictable costs, reduce capital investment, or develop new systems. While cost reduction is a common motivation for outsourcing, according to Potter, "if you do it just for cost, you're likely to fail" because outsourcing introduces work and costs not obvious to the newcomer.
Gartner's data closely matches that from the Duke University CIBER/Archstone Consulting Second Biannual Offshore Survey, which polled primarily Fortune 1000 companies on their offshoring activities. The Duke study covered both captive and outsourced activity, and it reveals that large companies are moving processes offshore primarily to reduce costs (97% of respondents listed it as "important").
With businesses desperate to remain competitive, the explosion of Internet infrastructure capacity around the world and a ready labor pool of technical professionals has proved a fortuitous combination, making business IT functions the easiest to offshore. According to the Duke CIBER survey, 22% of large companies offshore some or all of their IT, while Gartner's survey puts that number at 49% for SMEs (see the "SMB Use Of Offshore IT Outsourcing" chart below). Other commonly offshored functions include call or contact centers, product development (engineering and R&D), and finance or accounting.
While the imperative to lower costs may be driving functions offshore, the savings can be elusive. The Duke survey found that large enterprises' average savings of 41% for offshored activities compared with baseline inhouse, domestic costs. Similarly, Gartner's survey of SMEs finds expected savings of only 19% across a spectrum of IT functions. Gartner's Potter states these modest results are caused by a number of factors, including overseas wage inflation (averaging 15% per year in India), high employee turnover (also 15% per year), and high gross margins (about 60%) by offshore service providers.
Hidden Costs & Risks
According to work by Forrester's Moore, engaging in offshore contracts brings a number of new responsibilities and costs to any business, including:
- Vendor and contract management
- Retraining of existing staff for new roles and responsibilities
- Transition costs for existing functions or services
- International travel
- Greater telecom and security expenses
- Severance pay for workforce reduction
- Productivity loss because of lower employee morale, new process overhead, and cross-cultural communication difficulties
Offshore outsourcing also carries a number of business risks and inhibitors to achieving anticipated results. Chief among these is the loss of control over critical functions and the likelihood of process changes to accommodate standards and methods used by a third-party provider. Additional concerns include greater risk to data security, potential reductions in service quality, lack of acceptance by customers, and increased employee turnover because of decreased morale. According to Forrester's Moore, "to do offshore outsourcing right... companies have to perform a tremendous amount of research. In many cases, this includes hiring consultants and analysts to support the effort."
Competitive Weapon
Outsourcing has become a significant competitive weapon in a company's arsenal, however it is not a panacea for a habitually underperforming business and its indiscriminate use has led many to disappointment. When coupled with a careful business analysis, offshore outsourcing has the potential to lower costs 20% to 40% in functions such as IT, but these savings are not risk-free and often are accompanied by increased staff stress. Outsourcing can also be successfully used to augment staff for short-term development projects and to fill skill gaps.
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