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By Janet Rae-Dupree  |  Posted 04-01-2004

Offshore Winds: Outsourcing

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With more than 150 stores in airports, hotels and high-end resorts throughout North America, Asia and the Pacific Rim, DFS Group Ltd. knows how to peddle life's niceties to international travelers. But a policy of decentralized IT systems in far-flung locations had distracted the duty-free luxury-goods retailer's attention from the finer points of efficient global retailing and high-quality customer service. So by the end of 2000, the San Francisco-based company had a sprawling IT set-up with ten data centers, ten help desks and ten versions of roughly the same software running on 24 systems scattered across ten countries. "The code was brittle and difficult to maintain," says Ron Glickman, until recently senior vice president and CIO at DFS. "There was no documentation. All the details were stored inside people's heads."

Glickman's solution? Outsource everything to a firm able to consolidate systems, update and unify applications and keep the operation humming around the clock. But he'd have to figure out how to create this far-reaching IT solution for less money than he was already spending on 250 full-time staffers. And if DFS was going to do more for less money, it would have to do it somewhere a whole lot cheaper than San Francisco. As the summer of 2001 drew to a close, he and his managers were putting the finishing touches on a 36-month plan to consolidate DFS's servers and hardware operations in Singapore. DFS would then turn over the administrative system keys to Cognizant Technology Solutions, an IT consultant headquartered in Teaneck, N.J., with development centers in Chennai, Kolkata and Pune, India. The events of Sept. 11 made the cost efficiencies that much more imperative if DFS hoped to survive the deep plunge in international tourism that followed the terrorist attacks.

In the end, DFS managed to squeeze the highlights of its three-year plan into just nine months. Global IT expenses dropped 35 percent. The company's IT staff shrank 43 percent in the first year and 59 percent in the second. In six months, support for 7 million lines of code, located in ten countries, moved to a single development center in India, without any disruptions in business. Meanwhile, Glickman learned so much about the strategic management issues involved in offshore outsourcing that he decided to leave DFS this past December to become a change-management consultant. Does he recommend offshore outsourcing to every client? "Offshoring is a means to an end and not an end in itself," Glickman says. "I'm focusing on helping organizations transform, and if global outsourcing makes sense, certainly I can advise companies on offshore strategies."

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All Politics is Local

While lots of companies are actively pursuing offshoring, we found that few were willing to talk publicly about it. As the debate about offshoring's impact on domestic job losses has swelled, companies who had previously talked openly about their strategies began to clam up, thinking better of becoming the poster children for offshoring—particularly while the U.S. unemployment rate hovers stubbornly around 5.6 percent. In February, just after the Bush Administration predicted that the nation's economic recovery would bring an average of 300,000 new jobs each month in 2004, federal officials instead recorded only 21,000. And most of these jobs were government positions.

Meanwhile, the Bureau of Labor Statistics reports that fewer than 800,000 service-sector jobs have been sent overseas—less than 1 percent of the 140 million jobs in the U.S. economy. But those numbers, say observers, are growing rapidly. Forrester Research forecasts that between now and 2015, 3.3 million service-sector and IT jobs, a total of $136 billion in wages, will go overseas. And Gartner forecasts that 25 percent of traditional IT jobs will be located in emerging markets by 2008—indeed, roughly one in ten such jobs is already performed offshore, or will be by the end of this year, according to Gartner. Forrester's analysts believe the sectors with the most offshore activity will be IT and financial services. Speaking at the World Economic Forum in January, Nandan Nilekani, CEO of Infosys Technologies Ltd., an outsourcing firm based in Bangalore, India, noted that data will define what moves overseas. "Everything you can send down a wire is up for grabs," he said.

Despite the political fallout, however, the siren song of competition continues to lead CIOs down the offshoring path. "Outsourcing is an inevitable movement," says Jim Honerkamp, former CIO of building-services company Clopay Corp. in Mason, Ohio, and now an outsourcing consultant in Cincinnati. "Every CIO out there is faced with the same challenge I was faced with: Do more for less. There's no way to do it without leveraging these overseas capabilities. A lot of companies, Clopay included, do not like to advertise that they do a lot of [offshoring]. But you know that if a company isn't already doing it, they're going to be doing it. It's not just an economic decision. You have to have a good process, and a good partner. If you have all that in place, the economics are overpowering."

Yet it's a decision no company makes lightly. According to Forrester, more than 60 percent of the largest companies in the U.S. are "bystanders," with no offshore outsourcing relationships. Another 25 percent to 30 percent of Fortune 1,000 firms are considered "experimenters"—companies with multiple, small offshore relationships intended to augment internal IT staff or act only as lowcost contractors. Fewer than 10 percent of America's largest companies are either "committeds," employing offshore suppliers for more complex maintenance and development, or "full exploiters," outsourcing the bulk of their IT processes—and budgets—to offshore suppliers.

And there are those in the outsourcing industry who argue that without offshoring, the U.S. economy would be in even worse shape than it currently is. "We're helping companies to stay competitive," insists Bill Gargano, senior vice president of sales and marketing for EPAM Systems Inc., an IT outsourcing firm based in Lawrenceville, N.J. "If they can get the same or increased value at half the cost, [shareholders] would be screaming if they didn't try. You would fault them for not being prudent, not managing the business better."

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Manage, Manage, Manage

Meanwhile, behind the political hue and cry, CIOs must struggle daily with global outsourcing's unique management issues. While the business decision itself seems simple—why pay $85 an hour to a U.S. software developer to do what an Indian developer can do equally well for $40 an hour?—managing IT processes over thousands of miles can be daunting. That's why most businesses experimenting with offshoring for the first time don't head overseas themselves to recruit a workforce. Instead, they turn to an outsourcing company with a proven track record that has experienced staff available to handle larger projects, and can scale back just as fast when their client's needs are fewer. These outsourcing suppliers, particularly the half-dozen largest firms in India, are becoming increasingly sophisticated in the ways they help their U.S. clients manage the relationship. Worried about mitigating risk?

Many offshore outsourcing firms are expanding beyond their home countries to provide global alternatives in the event of political unrest or localized economic problems. Concerned about clear communication across thousands of miles and multiple time zones? Larger outsourcing contracts usually include provisions for the offshore partner to provide an on-site liaison in the U.S. to help coordinate projects and specifications. "It's our intention to insulate our customers from the complexities of managing global deployment," says Samuel Goldman, chief technology officer of Intra-sphere Technologies Inc., a New York-based life-sciences IT consulting firm with international operations in London and, come the middle of this year, India. "We can contribute to job creation by balancing the workforce, and the cost, between U.S. resources and offshore resources. That way a client company may go ahead with a project they might not otherwise have been able to afford."

Insulated or not, there are strategic issues that even the largest companies must resolve on their own. Figuring out how to mitigate the political, social and security risks can trip up even the most seasoned IT professional. While the existing political structure of an offshore partner's home country might be conducive to consulting, a new government could come to power that may seek to nationalize the industry. An emerging country might offer a low-cost, nonunion workforce today, but burgeoning affluence could change the economic picture tomorrow. And, as with any outsourcing relationship, it's difficult to control proprietary code or private records once they've left the relative security of a domestic network.

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Shailendra Palvia, a professor at Long Island University, and cofounder of the Center for Global Outsourcing, in Atlanta, suggests reversing the usual process for selecting an outside contractor: Choose a destination country before choosing which outsourcing supplier to use. "India is a prime destination because people there speak fluent English, both American English and British English. That removes one huge barrier—communication—immediately," Palvia says. "If you do not have that constraint—if your company already has a lot of Chinese workers, for instance—then you can consider China because their services cost a bit less than what you'd find in India. Or you might want to go to the Philippines for call-center outsourcing, because the Philippines offers a cost advantage some 20 percent less than India." There are, of course, other things to consider. India, with its long history as a British colony, has a highly evolved legal system based on the U.K.'s system. China, still new to free-market competition, has a legal system that Western companies find far more complex.

Attorney John Yates, head of the technology group for law firm Morris, Manning & Martin LLP in Atlanta, warns that while such "sleeper" issues as confidentiality, privacy and security aren't yet on the front burner for IT managers, they should be. "We can be assured that there will be massive litigation resulting from these issues," Yates says. "That will increase costs and make outsourcing less attractive." You think it's bad dealing with U.S. attorneys? Just wait until you need to hire attorneys in India, the Philippines and the United States. "We're going to see best practices emerge largely out of litigation in this area," he says.

Once you've chosen a region, select one or possibly two of the top competitors to complete a short-term pilot project. "Give them something that requires perhaps six months to a year," Palvia advises. "If the experience is good on a less mission-critical project, that lays a good foundation." Before work begins, Palvia suggests negotiating a detailed service-level agreement that spells out exactly what the outsourcing firm is meant to do.

Even with a clear-cut agreement, managing the relationship can become the next headache. Expectations about who completes what, and when, must be made absolutely clear, despite differences in language, culture and experience. "We tend to get involved when things have gone wrong," says Stuart Morstead, a cofounder of ISANI Group Inc., an offshore advisory consultancy based in Houston. "In a domestic environment, projects might be successful in spite of themselves. But offshore, no amount of luck will get you over a poor management hump."

A key problem for many companies, Morstead says, is the tendency to hand off an IT project to an outsourcer, then fail to check on progress until shortly before the entire package is scheduled to be done. "Your requirement specs have to be much more sophisticated," he says. "It's not like having IT on one floor and business units on another floor for whom you're building a new application. Domestic IT has a lot of access to the user community to validate design, but that's not going to happen 12,000 miles away. You have to be very, very clear from the start." Even then, he warns, an outsourcing firm's lack of familiarity with a given industry's needs can complicate matters.

Building regular checkpoints and goals into the contract, such as completing certain features within a given number of days, can help defuse disagreements before they gain traction. "The old rule of garbage in, garbage out still applies here," Morstead says. "If your provider is not accustomed to challenging the specs you've provided, even if they're gibberish, you're going to end up in trouble. Better to find that out early."

Putting experienced people in charge of the project on the domestic side can make all the difference. Don't jettison the entire in-house IT staff when the offshore partner is brought on board. There are still key management roles that experienced personnel should perform, including weaving together code generated overseas with domestic systems. When companies outsource a critical function like IT, says Rudy Puryear, a director at Bain & Co. in Chicago, they must retain key IT managers familiar both with what's happening overseas and with local technology issues.

While the cost savings are nice, many companies ultimately choose to outsource because of the flexibility inherent in the relationship. Rather than ramping up domestic full-time staff to handle larger IT projects, then paying them to sit idle during slower periods, outsourcing allows corporations to have the skills they need when they need them. Glickman, formerly of DFS Group, likens this to "just-in-time" manufacturing, in which the parts needed to assemble a product are created within hours of the finished item rolling off the line. "I didn't want to invest my fixed salary in specialized skills waiting for projects and problems to address," Glickman says. "This way I could come in on a just-in-time basis and have that as a variable expense."

The ability to mold more carefully the IT operation to a company's core business is key, says consultant Honerkamp. "If you've got a mechanism in place that allows you to flex up or down, or veer to the right or left on a dime, you can be responsive to the business," he notes. "If you try to do everything in-house with full-time employees, that flexibility goes away." That flexibility is even more valuable if you establish a long-term relationship with an outsourcing firm, he says. That firm's knowledge of your business, your infrastructure, your data and what you need to do with it allows the outsourcing firm to act more as a partner than an outside contractor. "We come to look at them as an extension of our in-house IT staff," Honerkamp says.

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Follow the Savings

Long Island University's Palvia characterizes globalization as "an irreversible phenomenon." Cheaper goods from China and cheaper services from India, he says, mean that in the end, U.S. consumers will save more money on the products and services they buy. According to Palvia, India will be exporting software worth $12 billion into the U.S. by the end of 2005. "All we can do is move forward rather than moving backward. We must remain globally competitive," he says. "There is no doubt that global outsourcing is here to stay."

Enacting new anti-offshoring policies wouldn't really help anyone, least of all U.S. workers fearful of losing their jobs, Palvia argues. "It's a similar situation to when manufacturing jobs, blue-collar jobs, were going overseas," he says. "I don't agree that we can go back to the old days of protectionism. If we do, other countries will do the same and we'll become isolated."

When First Index, a business-to-business marketplace for custom industrial manufacturing, decided to outsource its entire IT administration to EPAM Systems, which has development offices in Moscow and Minsk, Belarus, in the former Soviet Union, CEO Russ White knew he wouldn't have to place his critical systems in Eastern Europe. Instead, First Index consolidated the servers near the company's Whippany, N.J., headquarters. EPAM technicians maintain the company's software and services remotely over the Internet. "What would cost us $50,000 to $55,000 each month in the U.S. costs around $23,000 a month with EPAM," White says. "It's all about the money. I don't have the luxury of turning down those kinds of savings to maintain a handful of jobs in the U.S."

Janet Rae-Dupree, the technology editor for the Silicon Valley Business Journal, has covered technology and science in Silicon Valley for a number of publications, including BusinessWeek and the San Jose Mercury News.


Global Information Technology Outsourcing: In Search of Business Advantage
By Mary C. Lacity and Leslie P. Willcocks
John Wiley & Sons, 2001

"Offshore Management Challenges Spur IS Change in 2004"
By Diane Morello
Gartner Inc., Nov. 2003

"Offshoring: Is It a Win-Win Game?"
McKinsey Global Institute, Aug. 2003

"Users' Offshore Evolution and Its Governance Impact"
By John C. McCarthy
Forrester Research Inc., Dec. 2003

"Top 10 Offshore Outsourcing Trends of 2004: What They Are and How Service Providers Can Win More Business"
Ross Research, Jan. 2004