Finding Success Offshore: An Interview with Mary LacityBy CIOinsight | Posted 03-17-2005
Finding Success Offshore: An Interview with Mary Lacity
Fifteen years of research, five books and countless articles have earned Mary Lacity, a professor of information systems at the University of Missouri-St. Louis, a reputation as one of the world's foremost experts on IT outsourcing.
"Mary Lacity has a historian's view of IT outsourcing," says Jeanne Ross, the chief research scientist at MIT's Center for Information Systems Research. "She has carefully tracked the costs and benefits, the best practices and the pitfalls, the strategic partnerships and the failed contracts-all of which has given her extraordinary insight into how companies can generate value from their outsourcing arrangements." Lacity is also a research affiliate at Oxford University's Templeton College, and a faculty advisor at Washington University, in St. Louis.
Together with her colleague, Assistant Professor Joseph Rottman, Lacity recently studied over 25 companies that have outsourced IT to India, the Philippines, Malaysia, China and other countries. Lacity is also co-author, along with Professor Leslie Willcocks of the University of Warwick, of Global Information Technology Outsourcing: In Search of Business Advantage (Wiley, 2001). CIO Insight executive editor Allan Alter spoke with Lacity to discuss the value these companies are finding in offshoring, and the strategies they have followed.
What is the value of offshore outsourcing?
I think most customers initially get excited about going offshore because of the favorable labor arbitrage. The Fortune 500 customers we interviewed were using offshore outsourcing for two main areas: developing new applications, and re-platforming old ones, such as changing from PeopleSoft to SAP. They primarily go offshore to save on costs. Then they discover there are a lot of challenges in managing offshore teams-your transaction costs are very high in the beginning, while you're conquering your learning curve-and they tend to shift their focus from just cost-saving to the quality of the code they get, and how fast the work can be done. It's not until they have some significant experience with offshoring that we see some more strategic uses of it.
Click here to read how opposition to offshoring could impact your plans and your business.
How many companies make this transition from focusing on costs to focusing on quality and strategy?
Almost all of them. Most of them were primarily using offshoring not to replace their existing IT staff, but to address backlog and new projects that they wouldn't be able to handle with their existing head count. Rather than adding IT professionals to their internal staff, they were looking at ways that they could ramp up a big, perhaps one-time project, and then ramp down again once the project was completed.
Can you provide examples from your research?
A Fortune 500 financial services company originally went offshore because of Y2K. At that time, the IT executives there said, "Oh my goodness, I'm going to need X number of programmers for this one-time big task. How can I do this cheap and fast? How can I ramp down when I'm done?"
So they went offshore and developed a relationship with a large Tier 1 Indian supplier. Then the U.S. company decided not to cut the supplier loose, because, as they delivered on the Y2K project, the Indian firm started to establish a better relationship, and came to understand their client's main expectations. That same financial services company continues to have a lot of work done with this offshore supplier, and it has started looking at sourcing more strategically.
They now have relationships with 16 suppliers in Asia for IT and other functions. Because they started offshoring early on, they were able to ramp up very quickly when the mortgage-refinancing boom came, and then ramp down when refinancing diminished, without affecting their internal head count very much. So they went into offshoring to save on Y2K costs, and they saved money later because it enabled them to keep their flexibility. Another good Fortune 500 example that we came across is an industrial equipment manufacturing company that is using offshore suppliers to build embedded software for their equipment. That software is now part of the product, and the manufacturer continues to have a relationship with that supplier.
We also had some smaller companies in our study. One had the idea to develop a software package to help respond to a biological attack. They hired a small Indian supplier to develop the application for them. The contract entails having the supplier develop the software on their dime, in exchange for intellectual-property rights. Once the product is finished, the customer will market the software through their channels and share in the revenues from the software license fees. It's an interesting use of offshoring, but the outcome is still unproven.
Shying Away From Offshore
Why are some companies reluctant to go offshore?
Well, there's more risk going offshore than onshore. It takes a tremendous amount of internal management to make this work. And because visa requirements are such a headache now, it's very difficult to bring your Indian suppliers on- and offshore. A lot of business people are afraid to go offshore because of privacy and intellectual-property rights. Also, some of the people that we've talked to are worried that the labor arbitrage won't be as favorable anymore, because Indian salaries are going up.
You mentioned that internal management issues could be holding people back. What are the main ones?
It takes a lot of coordination. Software development is hard enough when you do it in-house. It's hard when you outsource it to a domestic supplier, and it's even harder when you outsource it to an offshore supplier. The differences in time zones, culture, travel and communication can be conquered, but it requires internal management coordination to make all this work.
Despite these risks and difficulties, do you still think more companies should be trying to outsource offshore?
I think it's a viable option, and certainly, if I were in a Fortune 500 company, it would be an option that I would want to explore. This is still a very immature market. If you look back 15 years, we had the same issues when companies started outsourcing to domestic suppliers. There's a lot to learn at the beginning of an emerging market. The nice thing is that early adopters conquer that learning curve pretty quickly.
If you're interested in going offshore, how do you select an approach that provides the value your company is seeking, while also balancing costs and risks?
There are a couple of decisions you have to make up front. First of all, what do you want? Where are you going to go? Which supplier are you going to pick? But there are four main approaches for providing value: captive centers, joint ventures, build-operate-transfer and fee-for-service.
What are these four approaches, and how do they differ?
The first model that U.S. customers usually try is the fee-for-service model, because it has the lowest risk, and it doesn't require much up-front investment. In "fee for service," the customer pays a fee to a supplier in exchange for services. The fee may be based on a fixed price, time and materials, or even a retainer model. It's a low-risk approach; you're just testing the waters with that kind of a model. It's easy to disengage if it doesn't work out. The disadvantage is that in order to get the cost-saving, you have to get enough volume of work.
Click here to read a survey on how well CIOs handle outsourcing arrangements. So companies seeking to save money by using the most common model might not actually find it.
Not unless they conquer their learning curve and get their volumes up.
Can you give me examples of companies that have pursued the fee-for-service model?
We know a lot of customers that are satisfied with the fee-for-service model, but they might try out different suppliers before they find the right supplier. One Fortune 500 company we studied engaged four Indian suppliers, and had 17 pilot projects, in order to test proof-of-concept and who they really wanted as a partner. At the end of the day, they ended up selecting one large Indian supplier for a certain type of work and one small Indian supplier for another, and they're finally at the point now where they're achieving the cost-savings at the level of quality that they want.
How much are they saving, and how much has quality improved?
We've asked that question over and over again, and the savings are very difficult to calculate. Most of the time, all you're going to get from a program management officer is the differences in hourly costs. If you stand back and try to say what the total cost-savings are-well, it's very difficult to say there are any total cost-savings. The only people that give us any kind of benchmark are the research firms.
It sounds like there's a reason that smaller companies are reluctant to go offshore: You need a lot of volume to save any money. How much work do you need to give to the offshore firms?
If you want total cost-savings of 20 percent, and you're talking about application development, then between 50 and 100 full-time equivalents in the long run. I'm talking only about software development. Savings on call centers require a much smaller volume of work. Sometimes you get savings almost immediately. The easiest one to get savings on is call centers. If you do it domestically, it costs $25 per call. If you do it offshore, it costs $15 per call.
Let's talk about the other models.
The other models are also interesting. For example, there's the build-operate-transfer model. Here, what companies want to do, ultimately, is to have their own captive center, but they're afraid to do this themselves. They may not understand the culture or the politics or, for example, the graft they might have to pay to, say, the fire inspectors. So they hire the supplier to erect the facilities, wire the building and hire the employees; later, the supplier transfers both the ownership of the facility and the employees to the customer. We don't have any examples in our data of companies that have actually gone through the transfer; they said, "I don't know who to call when the lights go out, and the Indian supplier does."
The other two strategies are joint ventures and captive centers. We saw a lot of joint venture activity in the early nineties with domestic suppliers. The idea here is to take the customer's main expertise and combine it with the supplier's IT expertise and then service a vertical market. Those didn't do well in the nineties, so we'll see if it works with Indian suppliers.
Click here to read about Google experience outsourcing its billing.
What's the difficulty?
I think the customer becomes schizophrenic in these kinds of joint ventures. Let's say I'm a customer, and I create a joint venture with an Indian supplier. The first thing is, I'm their first customer. I have engaged the supplier because they're going to do some massive amount of work for me. But as a joint venture, I also expect the supplier to be able to turn around and get more customers outside of this relationship. Here's where it becomes schizophrenic: As soon as the supplier turns its attention outside, I'm likely to say, "Hey! What about us? You've got to deliver to us." It's very hard to play this game well.
What about captive centers, where a U.S. company owns the facility and all the employees there work for that company? Is that something that only very big companies could do?
It's something where you have to have a large commitment, a volume of work over the long haul. We know a lot of large IT suppliers are creating captive centers. We also see some organizations creating captive centers in places such as China, but their reason for going to China is that they ultimately want to sell their end product to the Chinese market. We know of an aerospace company that's setting up a captive center in Kuala Lumpur because they want to sell fighter planes to Malaysia, and one of the requirements of the Malaysian government is that you have to source in that country. So that's an example of selecting a location based on a business reason.
Choosing an Indian Outsourcer
How do you choose an offshore outsourcing supplier in India? How do you decide which of these four approaches, or combination of approaches, will best align with your business strategy?
It depends on the context. The companies that created captive centers were doing it because they wanted to sell airplanes in that country, or products to the Chinese market, or they were going to commit to a large volume of work. Most companies, if you're just looking for cost savings, start off with the fee-for-service model, because that's the least amount of commitment. But there's a lot of fluidity. For example, one of the financial services firms in our study, with a fee-for-service model, engaged one of the large Indian suppliers. After five years they said, "We have so much work here; why are we giving this supplier this margin?" They're creating their own captive center now. We've also seen a company that had a captive center and then sold it.
So it seems that most companies will start with fee-for-service, and then afterward begin thinking about other models that they might want to move to. At what point should you think about the other options?
I wish I could tell you that the people we talk to have this great master vision, but a lot of it is just dipping their toes in the water and more strategic things came up. We like to think that all of this was so planned, but usually some opportunity arises and they see the opportunity.
What should you be thinking about strategically when you decide where to go?
Everybody assumes that chief information officers are going to pick up one of the Gartner or IDC reports and look at the country comparisons. But most of the customers we talked to went to a destination where they had existing manufacturing capabilities. Because they had a launch pad, they did not pick their destinations based on looking at IT criteria but, instead, where they already were globally, and where they wanted to go globally. They want to colocate their IT with that. That's great, because they can send the people who are already living there to do things. They can visit suppliers, and have the suppliers come on their premises. It's great to already have the visas and everybody established on your launching pad.
Besides India, what other countries do you believe U.S. CIOs will be turning to?
I think the Philippines are going to be one of the next big locations, because they have 300,000 IT professionals. I wouldn't discount Central and South America to provide Spanish-speaking call centers and other kinds of business processes, since governments in that part of the world are trying to stimulate higher-value work. I think our main interest in China is that we want to sell products there. We've got a huge language barrier there, as far as IT, but in other business processes I see much more activity in China.
Can a company that wants to get going on strategic IT offshoring dive into this whole hog, or do they need to ramp up slowly?
I believe that every company has to go through their own learning curve. They have to develop their own experience to do it. Now, they could go up that learning curve quickly by looking at best practices and what other people have already learned, but essentially they're going to have to learn how to do it themselves.
Do you see any change in how executives think about offshore outsourcing as they learn more about it?
I see so many parallels between the development of the offshore outsourcing market today and the domestic outsourcing market 15 years ago. I really believe that ten years from now this is going to be as much of a nonissue as domestic outsourcing. We live in a global economy, and we're going to source IT and other business processes globally. This is not going to be front-page news anymore.
Basically, if you're looking at India, you're either talking about a Tier 1 supplier-the companies you've probably heard of, such as Infosys or Tata-or smaller, lesser-known Tier 2 suppliers. Each has their strengths and weaknesses. [Oxford University Professor] David Feeny, [University of Warwick Professor] Leslie Willcocks and I just developed something called the "Supplier Capability Model." The model gives customers a way to assess what the suppliers are able to deliver in terms of their capabilities. That's very different than looking at supplier resources. Customers look at the suppliers' facilities, and at their employees' resumes, and they think that's going to translate to delivering what they want. Our model says: Don't look at the suppliers' resources; look at their capability to deploy those resources for the customer's benefit.
What would be examples of such capabilities?
A good example is behavior-management capability. Behavior management has to do with how a supplier retains, motivates and rewards employees. So instead of looking at resumes, you're looking at the culture that the supplier has been able to create to motivate, retain and reward their internal employees. Tier 2 suppliers typically have had a much stronger behavior-management capability than Tier 1 suppliers.
What are they doing differently?
Because they are smaller companies, their chief executive officer knows all the employees personally; they know their own personal strengths and weaknesses, their commitment to that company. They socialize together. The employees receive a lot of personal recognition, which is very important in Indian culture. However, they are weak on other things.
Sourcing capability, the ability to globally access and mobilize resources, including people with scarce skills, on behalf of a client. And the large Tier 1 suppliers have broader technology skills.
|Dr. Mary C. Lacity: A Brief Reading List|
Netsourcing: Renting Business Applications and Services Over a Network
By T. Kern, M. Lacity and L. Willcocks
Prentice Hall, 2002
Global Information Technology Outsourcing: In Search of Business Advantage
Articles "Twenty Practices for Offshore Sourcing"
"Twenty Practices for Offshore Sourcing"
Well, many of the Tier 1 companies have now gone public. They're in a different game now. They're like an EDS or an IBM: They want big contracts and large customers. So they're going to be less interested in servicing a small customer. A smaller U.S. customer might get better attention with a Tier 2 supplier.
So if you're a smaller U.S. company, should you usually look at Tier 2 suppliers first?
I'm reluctant to state a platitude; you might be able to attract a Tier 1 vendor if you're in a business line they haven't entered yet. But I would definitely look at the Tier 2 suppliers.
How do you go about finding the right Tier 2 of Indian provider?
That's where these intermediaries are great, because they tend to have relationships with up to 250 suppliers in India. They can introduce these suppliers to U.S. customers very well.
Who are these intermediaries?
They're usually Indians who have set up American businesses. Probably the most famous ones are neoIT, SourceQuest and Technology Partners International. They're the three I know best.
A complete list of publications by Dr. Mary C. Lacity can be found at www.umsl.edu/~lacity/vita.html