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The current stampede toward offshore outsourcing should come as no surprise. For months now, the business press has been regurgitating claims from offshore vendors that IT work costing US Dollar100 an hour in the United States can be done for US Dollar 20 an hour in Bangalore or Beijing. If those figures sound too good to be true, thats because they are. In fact, such bargain basement labor rates tell only a fraction of the story about offshore outsourcing costs. The truth is, no one saves 80 percent by shipping IT work to India or any other country. Few can say they save even half that. As just one example, United Technologies, an acknowledged leader in developing offshore best practices, is saving just over 20 percent by outsourcing to India.
Thats still substantial savings, to be sure. But it takes years of effort and a huge upfront investment. For many companies, it simply may not be worth it. Someone working for US Dollar10,000 a year in Hyderabad can end up costing an American company four to eight times that amount, says Hank Zupnick, CIO of GE Real Estate. Yet all too often, companies do not make the outlays required to make offshore outsourcing work. And then they are shocked when they wind up not saving a nickel.
In this article, we will explore a new TCO the total cost of offshoring. We will uncover all the hidden costs of outsourcing areas in which you will have to invest more up front than you might think, places where things such as productivity and poor processes can eat away at potential savings, and spots where, if you are not careful, you could wind up spending just as much as you would in the U.S. of A.
You cant expect dayone or even monthsix gains, Zupnick says. You have to look at offshore outsourcing as a longterm investment with longterm payback.
The Cost of Selecting a Vendor
With any outsourced service, the expense of selecting a service provider can cost from .2 percent to 2 percent in addition to the annual cost of the deal. In other words, if you are sending US Dollar 10 million worth of work to India, selecting a vendor could cost you anywhere from US Dollar 20,000 to US Dollar 200,000 each year.
These selection costs include documenting requirements, sending out RFPs and evaluating the responses, and negotiating a contract. A project leader may be working full time on this, with others chipping in, and all of this represents an opportunity cost. And then there are the legal fees. Some companies hire an outsourcing adviser for about the same cost as doing it themselves. To top it off, the entire process can take from six months to a year, depending on the nature of the relationship.
Vice President of Program Solutions and Management Ron Kifer spent several months on vendor selection before contracting with Bangalore, Indiabased Infosys to handle a whopping 90 percent of development and maintenance work for DHL Worldwide Express, a shipping company. There is a lot of money wrapped up in a contract this size, so its not something you take lightly or hurry with, Kifer says. There has to be a high degree of due diligence making sure that the offshore company can respond to your needs.
Even when there is an existing tie between customer and offshore vendors, the expensive and lengthy step of vendor selection is a mustdo for successful outsourcing. The chairman of Tata Consultancy Services TCS, a Mumbai, Indiabased outsourcer, sat on the international advisory board of Textron, a manufacturing company that owns such brands as Cessna Aircraft and EZGO Golf Carts, for several years. However, when David Raspallo, CIO of business unit Textron Financial, began exploring offshore outsourcing in 1999, he still spent five months doing what he calls the usual Betty Crocker BakeOff with service providers Covansys, ITS, TCS and Wipro. Ultimately, he went with U.S.based Covansys, which has three development centers in India. Selecting the vendor took 500 hours in total, involved Raspallo and three senior managers, and cost US Dollar20,000 in additional expenses.
At this stage, travel expenses enter the picture as well. A trip overseas helps CIOs get comfortable with their choice. After all, offshore vendors can send their best and brightest over for a dog and pony show, but checking out the company on its home turf provides more insight. John Dean, the CIO of Steelcase, an office furniture manufacturer, spent several thousand dollars to send one of his IT executives to Intelligroup Asia in Hyderabad, India, for a week before signing on the dotted line.
You can read everything you want to read and ask for advice as much as you want, but you have to make it a factbased decision, Dean says. So it was important to visit India to validate our thinking.
Bottom line: Expect to spend an additional 1 percent to 10 percent on vendor selection and initial travel costs.
The Cost of Transition
The transition period is perhaps the most expensive stage of an offshore endeavor. It takes from three months to a full year to completely hand the work over to an offshore partner. If company executives arent aware that there will be no savings,but rather significant expenses,during this period, they are in for a nasty surprise.
You have to bring people to America to learn your applications, and that takes time, particularly if you are doing it with a new vendor for the first time, explains GE Real Estates Zupnick, who maintains a handful of three year contracts with offshore vendors, including TCS and smaller vendor LSI Outsourcing. In GE Real Estates case, the transition time for each vendor was three months at the very least and up to a year in some cases, in addition to the money draining vendor selection period of several months.
Zupnick, who has seven years of offshore experience, says most of his peers dont appreciate the time and money it takes to get a relationship up and running. The vendors say you can throw it over the wall and start saving money right away. As a result, CIOs who have tried to go the India or China route, and nine months later they pulled the plug because they werent saving money, Zupnick says. You have to build in up to a year for knowledge transfer and ironing out cultural differences.
CIOs must bring a certain number of offshore developers to their U.S. headquarters to analyze the technology and architecture before those developers can head back to their home country to begin the actual work. And CIOs must pay the prevailing U.S. hourly rate to offshore employees on temporary visas, so obviously theres no savings during that period of time, which can take months. And the offshore employees have to work in parallel with similarly costly inhouse employees for much of this time. Basically, its costing the company double the price for each employee assigned to the outsourcing arrangement the offshore worker and the inhouse trainer. In addition, neither the offshore nor inhouse employee is producing anything during this training period.
During the transition, the offshore partner must put infrastructure in place. While the offshore partner incurs that expense, the customer should monitor the process carefully. Often it can take longer than expected. It took an awful lot of time to bridge the Pacific networking our company to the Indian vendor and getting that to work correctly, remembers Textron Financials Raspallo, who spent six months and US Dollar100,000 to set up a transoceanic data line with Infosys in 1998 for Y2K work. It also cost an extra US Dollar10,000 a month to keep that network functional. You have to know hands down that the technology infrastructure you put in place is fully functional and will operate at the same performance level as it would if you were connecting to someone on the next floor. Otherwise, you will have a lot of costly issues to deal with.
During the transition period, the ratio of offshore employees in the United States to offshore employees working at the vendor’s overseas headquarters is high. But after the transition is complete, CIOs have to get those employees out of the office if offshoring is to be a moneysaving move. It’s got to be 80 percent or 85 percent working offshore or the numbers just dont work, explains GE Real Estates Zupnick.
It makes sense for offshore service providers to place as many of their employees in the United States as possible. The providers margins,already quite decent for offshore work Indian companies charge U.S. companies US Dollar 20 an hour for an employee they pay around US Dollar10,really skyrocket when they are on American soil. They make more money and often the client feels better having them close, says Praba Manivasager, CEO of Minneapolisbased offshore adviser Renodis. But the customer immediately loses all of the billrate savings. If not included in the original contract, additional travel and visa costs also must be figured in. Tally it all up and you will pay as much as you would for one of your own employees.
Its a difficult area for CIOs to manage. Work is much easier to do with offshore workers onsite, but to cut costs they must push as much overseas as possible. Conversely, the more manpower based offshore, the more project problems and delays. BarryWehmillers Hergenroether says the amount of workers you can reasonably send offshore depends on the type of work being done. Industry or companyspecific system development requires more developers onsite. Legacy maintenance or simple upgrades may not require a soul.
On some of our projects, up to 50 percent of offshore workers are onshore, on others its closer to 10 percent, Hergenroether says. In some cases, where specific skills are the reason for offshoring, he may even bring in offshore talent over long term. But if youre going to do that, your cost savings diminish dramatically, he says. In fact, there may be no savings at all.
Bottom line: Expect to spend an additional 2 percent to 3 percent on transition costs.
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