Rethinking Offshore Outsourcing

By John Pallatto  |  Posted 07-15-2005

Offshore Outsource Savings Can Be Elusive, Survey Shows

Enterprises that expect to reap hefty savings simply as a result of assumed lower employee costs provided by offshore IT outsourcing services will be sadly disappointed, according to a survey of more than 5,000 corporate executives around the globe.

The 2005 Offshore Outsourcing Research Report, produced by Ventoro LLC, an outsourcing consulting and market research company based in Portland, Ore., found that only 9 percent of any cost shavings from offshore outsourcing was the result of lower overseas labor costs.

Overall, the report, which was publicly released this week, found that the cost savings from offshore outsourcing was not the 35 percent to 40 percent or even higher that many corporations assumed they would gain went they decided to go overseas, said Phillip Hatch, Ventoro president.

Hatch, who prior to founding Ventoro two years ago, worked as a market researcher and executive with Luxsoft, a Russia-based outsourcing company, said that one of the key reasons why outsourcing programs fail is because customers have absurdly unrealistic expectations about cost savings.

Click here to read about Indian IT services company Tata and Microsoft forming a joint outsourcing venture in China.

It was not unheard of, Hatch said, for customers to go into an offshore outsource engagement expecting to received 80 percent cost savings.

Instead, the Ventoro survey found that savings averaged slightly less than 10 percent for all the offshore outsourcing projects that Ventoro reviewed, Hatch said.

The average cost savings increased to 19 percent when Ventoro excluded offshore engagements that were deemed to be a failure by executives or engagements that didn't have a prior baseline to compare cost savings.

However, the report concluded that cost savings of 30 percent is a realistic target for well planned and managed offshore outsourcing projects.

"The big reason why people achieve cost savings is not because of low-cost hourly cost of labor," Hatch said.

Instead, the savings is coming from the quality of the systems that the offshore outsourcing and software development firms are producing, he said.

"The sophistication and execution of offshore firms is very good at this point," he said.

Both corporate executives and even the vendors have to get away from the notion that per-seat costs or overall employee costs are what is going to generate savings or return on investment from an offshore outsourcing program, said Hatch.

The survey found that 46 percent of the cost saving was generated from process improvement that resulted from the outsourcing project and 45 percent from the quality of the system or service provided, according to Hatch.

However, generating any cost savings proved difficult for more than 50 percent of the offshore engagements that Ventoro reviewed.

The survey found that 28 percent of the offshore outsourcing or offshore development project actually increased costs and 25 percent did not generate any significant savings.

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Rethinking Offshore Outsourcing

However, by the same token, 30 percent of the engagements generated savings between 1 percent and 20 percent, and the remainder generated savings of 21 percent to as high as 61 percent savings.

The survey also showed that a lot of companies weren't happy with their offshore strategy. Only 45 percent of the executive polled rated their offshore strategy as a success. While 36 percent stated that their offshore strategy had failed.

The results indicate "that we are starting to see that people are starting to move a little bit away" from offshore outsourcing, Hatch said. But that doesn't necessarily mean that corporations are not hiring offshore vendors.

Click here to read why some companies are becoming more selective about the kinds of IT operations they choose to outsource.

Instead, it may be an indication that companies are rethinking their strategies and doing more of a combination of offshore and onshore system development, he said.

Enterprises in the United States and Europe are looking more carefully now at what offshore projects and vendors are most likely to provide the best return investment or the more favorable total cost of ownership, Hatch said.

One in three of the executives who responded said they had to move overseas work back onshore because of problem with their offshore outsourcing strategy.

However, Hatch said that hasn't necessarily turned executives against the concept of offshore outsourcings.

Instead, 73 percent said they would continue to develop a long-term offshore strategy, while 17 percent said they had no plans "to pursue an offshore strategy in the future," and 10 percent were unsure whether they would continue their offshore plans.

The Ventoro report concludes by saying that the responsibility for success or failure of an offshore project rests with the corporate executives who are in charge of planning and implementing it, not the offshore vendor.

Click here to read about former Soviet leader Mikhail Gorbachev's efforts to promote outsourcing in Russia.

The enterprise has to have a clear idea of what it wants to achieve from the offshore project, and the goal shouldn't be just to reduce labor costs. Instead it should be something with the potential to generate a return on investment, improve business processes to lower operating costs, or serve customers better.

There has to be an organizational chart that clearly delineates roles and leadership responsibility between the offshore team and the onshore team, the report concluded. Without this, neither team will have a clear idea of how to meet project objectives.

Finally, enterprises have to recognize that achieving ROI from an offshore outsourcing project won't happen overnight, the report said; they have to be willing to set realistic goals for cost savings and expect that it will take time to realize potential cost savings and ROI.