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Risk and reward have always been major factors in offshore outsourcing. The trick, of course, is to mitigate the former while maximizing the latter.
Laton McCartney, CFO IT
March 17, 2003
Not long ago, after FBI agents raided a Massachusetts software company they suspected of having ties to terrorists, calls began pouring into Tata Consultancy Services, an offshore outsourcing firm. Clients, most of them large American companies and financial institutions, felt newly vulnerable: given global tensions — and the prospect of war — did it make sense to have mission-critical applications humming away on computers in India, China, Russia, and other far-off lands?
Arup Gupta, president of Tata's American operations, assured his clients that his company did thorough background checks on its programmers and that there had never been a security problem. Nonetheless, some corporate CFOs and CIOs are understandably edgy about the risks inherent in going offshore in today's increasingly dangerous post-9/11 world.
Some argue that offshore outsourcing poses an economic danger as well: Forrester Research Inc. estimates that over the next 12 years, 3.3 million jobs accounting for $100 billion in wages will move offshore. Such statistics have fueled a backlash: New Jersey recently banned offshore outsourcing of state government work, and labor organizations have begun to question the impact of offshore outsourcing on the American workforce.
At the same time, corporations are under enormous pressure to realize the savings provided by having their software development or applications management done in Bangalore or Beijing. "Current economic conditions mean that many companies are struggling to maintain, let alone increase, sales and profitability," says Atul Vashistha, CEO of San Ramon, California-based outsourcing consultancy neoIT Inc. "So there is a business imperative to decrease costs." Offshore outsourcing has changed in many ways since Y2K put it on the map, but its economic argument remains compelling.
"Achieving cost reductions is the big nut," says Kumar Mahadeva, chairman and CEO of Cognizant Technology Solutions Corp., an Indian custom software and services provider with U.S. headquarters in Teaneck, New Jersey. Clients typically expect to cut labor costs by more than 70 percent when they source out programming tasks, and bring in IT projects at 20 to 50 percent below the cost of undertaking the same initiative themselves. Taken together, these savings can add millions of dollars to the client's bottom line.
Risk and reward have traditionally been the key variables in evaluating offshore outsourcing, but today the stakes have risen substantially on both sides. With war in Iraq seemingly on the horizon, political unrest in the Philippines, and nuclear saber-rattling in North Korea, the "risk model has become larger today," says Mike Gerdes, research director for I-4, an organization made up of top corporate security officers and managed by RedSiren Inc., an information-security firm. "But there is also a much greater awareness and understanding of the risk factors."
Offshore outsourcing did slow down in the wake of 9/11, but has begun to grow again. Delta Airlines recently turned over a big chunk of its global reservations systems operation to Wipro Technologies, one of India's major players in the software and services area. Delta expects to save as much as $15 million, which is not unreasonable based on other companies' long-term experiences.
Working for the past four years with New Delhi-based HCL Technologies Inc., Priceline.com Inc. virtually bet its future on offshoring. Determined to cut capital costs, improve time to market, and ramp-up quickly to meet explosive growth, Priceline.com had, at one point, 166 HCL consultants working on projects across four continents, while 20 other consulting companies also did work for Priceline.com and 4 other affiliate companies, says CIO Ron Rose.
Given that "the business units were making 650 modifications to the Web site a month," recalls Rose, "keeping up with that velocity was very difficult." But offshoring worked — the quality of the work passed muster and so did the savings, which Rose will only say amounts to "tens of millions of dollars."
Yet as some CFOs have discovered, offshoring doesn't always live up to the promises highlighted in a vendor's marketing material. Sure, technology workers in China, Malaysia, or the Philippines are far less costly than their American counterparts, but mounting an ambitious outsourcing effort overseas often involves substantial upfront costs, including travel (flying teams of programmers and managers — theirs and yours — back and forth), training, and establishing the infrastructure and the management team needed to implement and supervise the project.
Gartner analyst Debashish Sinha says that, realistically, by the time you factor in transitional costs and add the management overhead needed to supervise a substantial overseas technology initiative, an offshore-outsourcing client can't expect major cost reductions until year two or later. "In the first year, you'll probably see a savings of 18 to 20 percent, and maybe 25 to 28 percent the second year," he asserts. That's well below the numbers being touted by some offshoring champions.
The good news is that offshoring's rewards often extend beyond immediate savings. "In India, there's an improved labor dollar, but the workforce is also highly skilled and highly motivated," notes Nick Santoro, CFO of Uniprise, a division of UnitedHealth Group Inc. in Minnetonka, Minnesota. In two previous senior-finance positions, at Nasdaq and Citicorp, Santoro was involved in offshoring. He says the approach can work well, as long as the outsourcer is SEI Level 5-compliant (that is, certified by the federally funded Software Engineering Institute), the governance model is strong, the client spends considerable time onsite, and communication flows freely.
Hot Spots vs. Hot Sites
To limit their exposure to a crisis, a number of companies are taking a multiple site, multicountry approach to offshoring. That way, if there's trouble in the Philippines, a company can promptly transfer its processing or programming work to another location. "You need two 'hot sites,' not merely a theoretical failover site," cautions Rose, so that processing can be transferred almost instantly. "You also need load balancing across both sites to ensure both sites are truly operational, and each site should be on a separate power and communications grid."
As part of its business-continuity preparation, IBM Global Services, which has major offshoring centers in India and several other countries, can move work around within the host country, move it to another country, or even bring it back to the United States if needed. "We have a transition methodology in place worldwide," says Mike Dawkins, general manager of global operations.
But often the risk issues that end up on a CFO's desk are far more prosaic than the frightening headlines heralding the threat of cyber terrorists or nuclear warheads. "The geopolitical factors are partly media hype," asserts Cognizant's Mahadeva. "The risk has always been there. As an example, the India-Pakistan dispute has been going on for 90 years."
One area of potential concern, says I-4's Gerdes, is what he calls "the inability to control the orientation and social incentives of the people who work for you." Put another way, often after the initial honeymoon year is over in an outsourcing relationship and the vendor is anxious to generate some profits from the deal, it may bring in third- or fourth-string programmers. Or, unbeknownst to you, it may subcontract your work elsewhere.
Before the red flags go up, understand that this is rare, but it has happened. In fact, in several instances the outsourcer's programmers actually dipped their hands into the electronic till. In one case, a European bank had its customers' credit-card numbers stolen, says Gerdes. The same thing happened to a U.S.-based software company, and when its customers discovered what had happened, the uproar was deafening. "That's the kind of issue that a CFO might have to deal with — a public relations and legal disaster."
There's no simple way to bulletproof an outsourcing relationship against this kind of thing, but two measures are mandatory from the client side. "You need a robust governance model in place to oversee the project," says Santoro. And, adds Gerdes, the governance model needs to not only address deadlines and budgetary issues but also see that the outsourcer complies with all the parameters and laws that govern the client company.
Laton McCartney is a New York-based writer and editor. His most recent book, Across the Great Divide: Robert Stuart and the Discovery of the Oregon Trail, will be published later this year.
Offshore Outsourcing: Choices, Choices
When choosing where to outsource, you first have to decide which country's capabilities best meet your needs. Among the factors that come into play here are political stability, the depth and availability of technology talent, cultural fit, and the status of the country's currency vis-à-vis the dollar. "Remember, most outsourcing relationships are from three to five years," cautions I-4's Mike Gerdes. "A country's technological capabilities aren't likely to shift significantly during that time, but you can see a major currency shift in 12 to 18 months." Such a shift could have a dramatic impact on the cost benefits of going offshore.
With Fortune 1,000 companies expected to spend about a quarter of their IT-services budgets in India this year, the Asian subcontinent has become the location of choice for offshore IT work. In part, this is due to its abundance of well-trained programming, software-developer, and systems-engineering talent. Another key factor is English-language proficiency. "I've tried Russia, China, and other countries, but the English support you receive in India is critical with deliverables and documentation," notes Ron Rose, CIO of Priceline.com.
Gerdes, however, points out that wages have increased in India to the point where some of the cost advantages are vanishing. "A software developer in the U.S. with an M.A. and several specialized certifications gets from $70,000 to $80,000 a year," he says. "In India, you used to be able to find someone with the same credentials or better for 15 to 20 percent of that, but now the equivalent job is paying $50,000 over there." And, he adds, if Indian salaries continue to rise, look for China and Russia, among others, to increase their share of the offshore market.
Next, of course, comes the selection of a specific provider. Certainly there's no shortage of options: India alone has a half-million IT outsourcing workers. Among the largest vendors are Tata Consultancy Services, Wipro Technologies, Infosys Technologies, Satyam Computer Services, and Cognizant Technology Solutions. In other countries, competition is often spread across a range of small and midsize firms.
One of the most important criteria in evaluating a supplier, adds Rose, is its bench strength. "The outsourcer has to have a large-enough bench so it can supply the expertise you need when you need it," he explains. "We wanted a supplier with 1,000 or more programmers. With that kind of depth, if you suddenly needed, say, someone with expertise in Oracle databases, or a firewall engineer, there's likely to be a good one available when you need them."
A vendor should also be able to accommodate clients that may want to expand the portfolio of services they outsource and establish a more-extensive, long-term relationship with the supplier. "More and more," says Gartner analyst Debashish Sinha, "there's a shift from viewing offshore outsourcing as a tactical, low-level method of saving money to seeing it as strategic." As a result, the outsourcer's capabilities and awareness of a client's total needs become paramount.
Even if you decide offshoring is not for you, you may be involved with it nonetheless. American IT services and consultancies — including Accenture, Hewlett-Packard, EDS, Computer Sciences, and IBM Global Services — are offshoring with a vengeance. Accenture, for instance, operates in the Philippines and India, while IBM has operations from Mexico to India, including Canada and China. "We started using offshore capabilities for our internal applications in the mid-1990s," says Mike Dawkins, general manager of global operations for IBM Global Services, "and three or four years ago we incorporated our commercial customers. We believe we can meet any of the price points of competitors, including Indian companies." —L.McC
A World of Differences
What are the major challenges your company will encounter in offshore outsourcing?
For those who don't want to venture far from home, there's yet one more option to consider: near-sourcing. With this approach, you send your software-development projects and related IT work over the border to Canada. The advantages? "The workforce is much closer to what you'd find in the U.S. in terms of skills, and their legal system is similar to ours, which is important in resolving any disputes," says I-4 research director Mike Gerdes, who notes that courts in other countries such as India can take years to deal with a civil case. Travel time is less, the time zones match, and Canadians are generally price-competitive with more-distant outsourcers. That is, as long as the Canadian dollar remains valued well below the American greenback. —L.McC.