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
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.
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.
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.
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.
Increased risk thanks to geopolitical problems and communications outages means that business continuity is a must.
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.
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.
This was first published in January 2004