The European market for outsourcing overseas is set to grow by 40% this year, but there are issues IT chiefs should know about before taking the plunge.
A growing number of UK blue chip companies, such as BT and supermarket chain Somerfield, have recently outsourced IT projects overseas.
The European market for offshore outsourcing is forecast to grow by more than 40% this year, according to analyst firm Gartner, even though unions have warned of strikes if the deals lead to redundancies in the UK.
With IT decision makers at risk of being caught in the crossfire, the need to understand the benefits and pitfalls of offshore outsourcing is more important than ever.
Although the market in offshore outsourcing is becoming more mature, it is still not a practical option for small companies or small-scale projects.
"You have to be fairly big to justify the risk and expense," said Bob Aylott, principal consultant at offshore outsourcing consultancy Orbys. "Otherwise it is not worth it. The threshold for the amount of people involved is around 40, and if it goes to over 100 people it makes sense to look at going offshore."
The main attraction of offshore outsourcing is the savings that can be achieved through using highly skilled IT professionals who are paid a vastly reduced salary. For example, Indian salaries are about one-seventh of their equivalent London posts.
Savings from offshore deals typically range from 20% to 50% but these can take five years to materialise. Savings have to be set against up-front costs such as telecommunications links and staff expenses.
"In due course you can save between 40% and 50%, which means you can't afford to ignore offshore outsourcing," said Aylott. "But it could take four or five years and the savings could be virtually nothing to start with. However, you could save about 30% on a one-off project."
Another problem is the likelihood of a hostile reaction by UK IT staff when they hear a deal will be going offshore. All outsourcing is a threat, but offshore outsourcing raises the added spectre that the UK IT industry itself is being eroded. Even domestic outsourcers are now using offshore skills to reduce their costs, and major corporate users have set up offshore IT departments.
Consultation costs, retraining programmes, redundancy, loss of morale, disaffection and potential hostile strike action have to be factored into the cost-benefit analysis of going offshore.
As with any outsourcing deal, it is absolutely critical to continue to invest in the relationship after the contract has been set up.
Phil Morris, director of outsourcing at consultancy Morgan Chambers, said, "We recommend that 5% to 8% of the annual spend on any contract should go on managing it. When it comes to offshore, the complications of distance and culture mean that it is going to be 8% rather than 5%, though some get away with less depending on the sector and the complexity of the work."
Considerable effort is invested in selecting a supplier and setting up a contract in any deal, but when the supplier is offshore that effort has to be greater. Travel is an inevitable problem, as are the cultural differences that will need to be understood and allowed for.
Choosing what type of work to outsource is critical, said Ian Marriott, research director at Gartner and author of Gartner's report on offshore outsourcing. He advised companies do a pilot or a self-contained application development, as such projects carry the least up-front costs and will be more justifiable on a smaller scale.
Offshore deals encompass a wide range of IT, including maintenance and support work, business process outsourcing (BPO), such as payroll or cheque processing and, most typically, call centres. However, BPO offshore carries a caveat. "Your brand and image are in the the hands of a third party who is thousands of miles away," warns Marriott. You have to be very sure, that those hands are safe.
Keeping a close eye on your supplier is easier if they have a UK or European office. However, regular visits to the offshore site are essential.
"There will inevitably be some travel costs," Marriott said. "You should go during the initial evaluation and when the contract is up and running. Do not just rely on your local contact. You need to connect at an executive level should things start to drift."
There is also the delicate question of cultural differences between managing UK employees as opposed to, for example, Chinese or Indian IT professionals.
"Cultural differences can be significant if you do not educate your organisation to tackle them in the initial set-up," Morris said.
Differences can include a reluctance by non-European cultures to say no to or challenge customers; the user's directives never being questioned - even if the supplier has a better way of approaching the task in hand; or a supplier not having the kind of sector or domain knowledge that is taken for granted in the UK, said Aylott.
"You need cultural training and awareness on both sides to build the relationship," he said. Moreover, if your own organisation has staff familiar with the offshore country or if there are family connections, it can be helpful to have them on the team.
The cultural differences could also be technical. UK users can definitely find themselves as the "junior partner," which can come as a shock.
When it comes to software development, Indian suppliers in particular have a very high level of maturity; most are at level five of the Capability Maturity Model of software development.
In contrast, "No organisation in Western Europe has a higher score than CMM level three," Morris said.
This can mean a UK user, familiar with a sloppier level of application development can find themselves stretched to meet the abilities of their offshore supplier.
- Up-front costs will be high because of travel costs and cultural training. Expected savings may not appear for several years, except on one-off projects
- Running costs will be higher than domestic outsourcing
- Telco costs could be higher, especially if the offshore site is accessing your mainframe
- Telecoms outside main offshore centres may not be as effective
- Outsourcing customer-facing processes offshore, such as call centres, can jeopardise your brand image
- Unless handled well, in-house staff anxiety about job security could lead to loss of morale and strike action. Even if this is handled well, there could still be redundancy and retraining costs.
- Labour costs are reducedby about 20% on domestic outsourcing
- The time difference can be advantageous; offshore suppliers can work at "night"
- Many offshore suppliers have more efficient software development process (some as high as CMM level five).
This was first published in May 2003