IT directors considering outsourcing development work offshore
are advised to look beyond the low labour rates. Danny Bradbury
uncovers the hidden costs that can accumulate and eat into the
potential savings
True panaceas in the IT industry are rare, nevertheless, offshore
outsourcing seems to have become the latest "silver bullet".
However, taking your IT development or services infrastructure
offshore will not necessarily solve all your financial or
production problems.
Providers of offshore outsourcing services are urging customers to
adopt realistic expectations. Although an IT director's first
instinct is to look at reduced labour costs in outsourcing
locations such as India, there seem to be additional, hidden
costs.
Consultancy firm Sapient has located 40% of its billable staff
in its New Delhi office, but chief operating officer Sheeroy Desai
says that customers who expect 50% savings at the start of their
outsourcing project can be disappointed when they only achieve
about 20% after a few years. "Clearly there is a cost to offshore
outsourcing that is not being recognised," he says.
What are these hidden costs? Alex Blues, head of offshore
outsourcing for outsourcing advisory company Orbys Consulting, says
clients often ask how much they will have to pay a call centre
operative in India compared to the UK.
"The answer is £14,000 in Milton Keynes and £1,400 in Delhi -
but why ask that question?" he says. Offshore salaries often
exclude bonuses paid in an attempt to reduce employee turnover,
along with employees' accommodation costs. These costs are also
likely to rise; Gartner predicts that skills shortages could
increase the cost of outsourcing application development in India
and China by 25%.
Another cost to consider is making sure that software developed
abroad works on your own system. If a supplier produces software
tested on a different system, it could break when it is tested
locally, as Tim Davis, senior vice-president of distribution and
e-commerce for hotel group Hilton International, experienced.
Sapient used its offshore services to help Hilton develop a
reservation system. The project ran smoothly, but problems appeared
when the system was tested. "Because they did not exactly replicate
what we had in the UK, when the software was given to us to go into
production, we found errors," he says.
Replication need not be too expensive, as long as the system can be
redeployed elsewhere or the offshore development company used for
further projects, says Davis. At the end of the 54-week project, he
had spent £2.3m on system development. Before Sapient decided to
use its offshore outsourcing operation, the original estimate was
£3m. The service provider had originally wanted to avoid shipping
work to India because the offshore team had not built a hotel
reservation system before.
Risks extend from the project-specific to the global, and yet a
surprising number of companies ignore business continuity costs,
says Duncan Aitcheson, international managing director for
outsourcing advisory firm, TPI. Business continuity is important
because of the added risk of doing business in a country with
potential political instability. India's history of ambivalence
toward Pakistan has brought the two countries close to war in
recent years, which creates uncertainty for companies relying on IT
staff to hit project deadlines.
Although data can be replicated, political upheaval and the effect
this can have on staff could mean a severe impact on project costs.
This is another risk that should be factored into a quantitative
analysis. Companies should consider whether they can bring offshore
staff onshore to guarantee the continuity of their work, says
Blues.
Some companies choose this route to try and create a closer working
relationship between the onshore and offshore team. Paul Kelsall,
head of technical development for e-business at Royal Mail, used
Sapient's offshore services to redevelop the online portal for
Royal Mail, Parcelforce and the Post Office. Sapient shipped 15
developers to the UK when the system was being tested so that they
could interact with end-users more effectively. "Ideally, if money
is your driver, you should make the local contact as thin as you
can - it is important it works," Kelsall says.
Similarly, IT directors should expect to send staff to the offshore
location to assess and guide the remote team. At an early stage in
his project, Davis was forced to send a project manager to India
for three weeks to resolve a development problem.
Such overheads should not be underestimated, says Andrew de Cleyn,
business development director for outsourcing at LogicaCMG. "If you
fly to India business class, that is six months of somebody's
salary," he says. "If you are popping out for reviews once in a
while, it will cut into your costs." LogicaCMG operates a hybrid
model where it delivers parts of a project using teams both in
India and the UK to ensure a level of contact with the
customer.
The cost of this hybrid model can range widely, depending on the
length of an offshore strategy. A single project commissioned to a
third party might create some short-term savings, although it makes
it more difficult to amortise costs across multiple projects. De
Cleyn says some companies operate a build-operate-transfer model,
where they use a third party to create a software development team,
run it with them for a while, and finally transfer the team to the
client's ownership; essentially creating a new offshore IT
department. The costs include not only relocation and travel
overheads, but potential legal costs for joint ventures.
The extent of the relationship between an onshore and offshore
development team will affect the flexibility of a development
process. Iterative development, where system builds are constantly
fed back to end-users for analysis, are ideal for many companies.
It can be more difficult to do this in an outsourced model because
of cultural barriers and difficulties in creating regular
communications between end-users and developers.
Davis was very strict about locking down his design before the
building process started. This meant that once the system
architecture had been drawn up, no additional functions were added
and users could not tweak the system throughout the development
process in the way enabled by iterative methodologies. "For me, the
risk profile of this project would have been unacceptable if we had
to rely on iterative design and development," he says, although he
acknowledges that other companies with more outsourcing experience
may do things differently. Kensall took a more fluid approach to
software development, but also brought in overseas staff to his
local offices, adding to the cost base.
One of the less tangible costs associated with offshore outsourcing
is ensuring that an organisation is ready to manage the process.
Blues says many Indian companies have already qualified to various
levels of the Capability Maturity Model, which is a benchmark used
to judge the maturity of development processes. Offshore firms have
been driven to do this to compete with service providers closer to
Western clients. Many companies in the UK are not certified to a
high level of CMM - if at all.
This can create a disparity when UK staff who are used to working
reactively attempt to do business with an organisation whose
economies of scale depend on a very repetitive, refined process. If
IT directors are not prepared to be that methodological, either
they have to refine the process, or think twice about offshore
outsourcing, says Blues. "We tell one in three organisations not to
go offshore because they are not culturally ready. More
importantly, they are trying to export the problem, not the
process."
Taking all these costs into account, Blues scoffs at cheerleaders
who cite a 60% to 80% saving through offshore outsourcing. He says
savings of 35% or 40% are more realistic, assuming the risks have
been addressed. Go into an offshore outsourcing project with guns
half-cocked, and you can expect the cost savings to dip even
further.
Hidden outsourcing costs
Transition
You cannot flick a switch and
watch your project workload transfer overseas. Think about initial
support for offshore developers. If you are setting up a joint
venture under the build-operate-transfer model, legal costs will
also have to be taken into account.
Communications charges
Whether you are videoconferencing or telephoning, your
communications costs will inevitably be higher than for a local
project, especially with a leased line.
Travel and accommodation
Due diligence, company interviews and developer meetings will
require travel. Expect this to eat into your bottom line.
Staff management
Depending on the nature of the work being outsourced, offshore
projects could leave local staff high and dry. Managing retraining
or redundancy will create costs for the personnel department.
Management and governance
Do not expect a “fire and forget” solution. You may find yourself
needing to pay more attention to offshore projects, leading to
increased demands on management time and training requirements.
Inflation risks
Labour rates for offshore staff will not stay the same forever. In
addition to the current salary rates in the emerging outsourcing
markets such as China, Vietnam or Mauritius, consider the rate of
inflation, especially in wages.
Business continuity
Increased risk thanks to geopolitical problems and communications
outages means that business continuity is a must.
Security changes
Sending sensitive intellectual property overseas creates dangers.
Due diligence and tightening up network security will lead to
increased communications and management costs.
Hidden labour costs
Look out for bonuses paid by Indian companies to combat staff
attrition, and employee accommodation costs.
Mirrored development
Ensuring that offshore testing and systems are identical to those
at home will create capital overheads.
Self-assessment and preparation
Are your own methodologies up to scratch? Expect some training and
re-engineering costs to avoid problems down the line.