Managing offshore outsourcing contracts

Although IT directors are being tempted by offers of savings from offshore outsourcing, will the added complexities of managing a remote contract prove too costly?

The trend for UK companies to outsource IT and business functions gained renewed momentum last month when high street banks HSBC and Lloyds TSB announced offshore deals to India.

Analyst firm Gartner has predicted that the European market for offshore IT outsourcing will grow by more than 40% in 2003, and UK companies are lining up to take advantage of cheaper labour costs in countries such as India and Vietnam.

Estimates of the savings that offshore outsourcing can offer vary, but some experts believe offshore deals could cut costs by up to 40%.

Despite the obvious benefits, outsourcing experts have warned IT directors to consider the challenges of managing a contract from thousands of miles away in a different time zone.

The most dramatic risk to an offshore contract is geopolitical - potential military, political or economic instability could affect the country where the supplier is doing business.

The recent Iraqi war, for instance, sent shivers through the outsourcing business community even though most offshore outsourcing centres were relatively far away. Flare-ups in tension between India and Pakistan have also raised concerns.

Bob Aylott, principal consultant at outsourcing advisory company Orbys Consulting, said one way to manage geopolitical risk is to follow the example of manufacturing companies such as motor manufacturer BMW, which has factories in South Africa and South America. Outsourcing to different countries spreads the risk among suppliers, in the same way that companies in the UK often have more than one telecom supplier. "Having just one supplier is pretty unsafe," Aylott said.

Hidden increased costs

Another factor for companies to consider is the cost of managing the contract. The average offshore contract will cost significantly more to manage than the same contract in the UK.

Richard Sykes, chairman of outsourcing consultant Morgan Chambers, said that although companies could usually expect to spend between 3% and 5% of a contract's value on a UK-based outsourcing deal, the figure could rise to between 8% and 11% for an overseas contract over time. However, the cost of managing offshore deals should fall.

Other advisers, such as the National Outsourcing Association, believe the hidden cost of offshore deals could be far higher. It estimated that overseas telecom links, the need to have more managers to scrutinise the deal along with travel costs could reduce any savings, above that of employing someone in the UK, by up to 40%.

Ensuring that a less experienced overseas supplier is familiar with your business will also require a more prescriptive contract, which will take longer to draft and absorb more staff time.

"You cannot take any kind of tacit knowledge about your business or sector for granted," said Aylott. "In the UK, for example, everyone knows about the Bacs clearing system or the impact of Christmas on planning cycles - but not necessarily in the rest of the world." Experts also advise users to have a senior employee from the outsourcing provider stationed in the UK.

Regular travel to the offshore site, ideally every few months, will be another inevitable extra cost. Experts advise trips to check up on suppliers every two to three months.

"If you do not go every three months it is not enough," said Aylott. "Otherwise you are not seeing the people who are doing your work, only the front-end salespeople."

However much time and money is invested in managing a contract, there will inevitably be situations where a user wants to bring a service back in-house. One reason may be unhappiness with the supplier's performance, or the needs of the user could change, for example, following a merger. Bringing a contract back in-house can also be made more difficult if the staff who ran the service were transferred to the outsourcing supplier, as they may be reluctant to return to their original employer.

Some outsourcing advisers believe the logistical challenges of negotiating with managers thousands of miles away effectively makes reclaiming an offshore service impractical. To date, there have been few, if any, examples of a company bringing an offshore deal back in-house.

But for all the extra challenges of managing offshore outsourcing, there is no shortage of takers in the UK. The strong growth in the market is predicted to continue, at least for the next few years.


Offshore contract management team

Contract management needs to consist of three layers, said Stratos Sarissamlis, vice-president international at analyst firm Meta Group.

The lowest layer, comprising a small team of IT staff, monitors service levels to check they are being met. The team should meet twice weekly: once at the beginning to agree the week's work schedule, and at the end to sign off performance and delivery. It can identify areas for improvement or where there is need to update technology.

The second layer of staff should monitor finances, produce monthly reports, apply bonuses and penalties and assess any recommendations from layer one.

The third layer of staff should meet quarterly. Their focus is on business risk and resolving disputes and they should have the power to review and restructure the contract and approve recommendations for change.

Making an outsourcing contract work      

Enter the offshore market slowly. Test out suppliers with non-critical projects and add more work gradually. One-off development is very different from ongoing maintenance and support. 

Spread your risk among more than one supplier, preferably in more than one country, or with a supplier that can operate globally. 

There is a huge variety of experience and maturity among offshore suppliers, not just in systems development but in knowledge of how UK businesses work. Less experienced suppliers, although they may be cheaper, will require more management effort. 

You will need to invest more in contract management, around 10% to 11% of contract value, compared with only 3% to 5% for UK outsourcing. Over time this percentage should halve. 

The IT boom is creating a high churn among offshore IT professionals. Although you cannot bind your outsourcer's team contractually, encourage loyalty and belonging by making them feel part of your company and culture. 

Travel is inevitable. However good your UK-based account manager, you must visit your offshore team at least several times a year.