More and more midmarket companies are opting to outsource part of their business to offshore partners, but the practice can become a nightmare if done in the wrong fashion. Dissatisfaction runs high: In one survey of 130 CIOs last year, New York-based consultants EquaTerra found that 42% were dissatisfied with their outsourcing relationships.
And in April, a Gartner Inc. survey of 200 European executives found that 55% renegotiated outsourcing arrangements -- both onshore and offshore -- before the contracts ended. The main reason: lack of flexibility, followed by higher than expected costs.
Yet despite the difficulty of managing international relationships, expectations and workflows, companies today are looking to partners in India, Russia and elsewhere not just for piecemeal development work, but for strategic business projects. Whether it's taking over a full product line or building half of an entirely new product, offshore partners are becoming intrinsically engaged in the real business of U.S. firms. With labor costs rising in India and elsewhere, it is business enhancement, not cost savings, that is now driving the migration of work.
"It's not just large multinational companies but also startups and midsize companies that are aggressively working with offshore partners," says T.M. Ravi, CEO of Mimosa Systems Inc. in Santa Clara, Calif., a 2003 startup that recently released its first product constructed with Indian help. "Our outsourcing operation is addressing the entire end-to-end product cycle. That's a major new trend. It used to be just tech service or support. Now you see that a lot of intellectual property development is happening offshore."
Yet empowering partners with more critical pieces of business means greater risk should the relationship go south. There are clearly lessons to be learned, and many CIOs are learning them the hard way. Defining goals, choosing partners, selecting metrics and building in effective governance seem like obvious steps yet still incredibly challenging in the real world. Even those who have worked with offshore partners in the past aren't immune to pitfalls with new ones.
Throughout Harold Williams' long career in the insurance business, he spearheaded outsourced projects at both Nationwide and Montana State Fund. Then last fall he became a vice president at Western Computer Services Inc. in Sandy, Utah. Western Computer Services, a subsidiary of four insurance companies under the umbrella of Farm Bureau Financial Services, had kept all its development in-house since its founding in 1972, and Williams saw an opportunity to outsource a job to India.
To develop the project and deploy a new interface required a fast turnaround -- six months -- and he didn't want to hire more staff or make room for consultants.
"This is the first time we've ever outsourced anything," he says. "I brought in some different ideas about getting to market sooner. I wanted a quick-strike approach. But my organization has fallen into some of the basic gotchas." These included problems in the quality assurance process at Western Computer Services. "We felt some pain. There's no substitute for experience."
Of course, there are success stories, too. Mimosa Systems used Symphony Services, a Palo Alto, Calif., firm with development centers in Bangalore, Mumbai and Pune, India, for half the development work on its first product, an e-mail archiving and recovery solution for Microsoft Exchange called NearPoint. "We were surprised with how extensively we used offshore operations," CEO Ravi says. "We expected that the efficiencies would be different between one person here and one in India. We expected maybe 75% efficiency, but we find it 100% or better. With the right planning, the offshore-onshore hybrid is very scalable, cost effective and robust for companies of any size."
Here are some of the ways to make that happen.
1. Define the offshore outsourcing goal
Determine the outsource goal, whether it's a strategic reinvention of the company or a cost-saving task being sent out of house. "The first principle is to understand the end objective of what you're trying to do," says Symphony Services CEO Gordon Brooks. Some outsource to cut cost, while others want to do something strategic. How you evaluate them is different. "Is this a project or a long-term extension of your own team?" Brooks says.
Atul Vashistha, CEO of consulting firm NeoIT in San Ramon, Calif., cites the examples of Dell, Capital One and Lehman Brothers as big firms that embraced offshore outsourcing -- for instance, Dell outsourced call centers -- and then had to retreat when quality suffered. "They took processes offshore that were not right for their organization, not well integrated or too complex," he says.
2. Design an offshore outsourcing road map
Cliff Justice, EquaTerra's multi-shore practice lead, says that many companies underestimate just how much work outsourcing in general involves. Removing part of the business means that the rest of the business needs to be reinvented as well. "Transformational outsourcing really requires a redesigned organization," he says. "Some companies will take a direct labor cost difference and some generic assumptions about the transition. But in reality there's a lot more to consider, such as the maturity of the process, the ability to document it and transfer that knowledge."
Vashistha says that a company has to start with a deep assessment of its applications and business processes in order to map out an outsourcing plan. What can be outsourced and in what order? He suggests developing a three- to five-year strategy. If the outsourcing objective is to transform the enterprise, then the commitment has to equal the goal and the right resources have to be allocated to achieve success.
The problem is magnified with offshore outsourcing, where companies hedge their bets. "A pilot [offshore] outsource is lower risk, but it doesn't actually make any difference. It doesn't move the needle," says Symphony's Brooks. "It has to make a difference. It's about making an impact, or it's not worth going offshore. The days of putting your toe into the water are over."
3. Select the best partner for the job
Performing due diligence on prospective partners means more than just examining the company's financials and client references. Increasingly, it means taking nontraditional measurements of a company's suitability, such as investigating whether the corporate cultures will mesh together well. "Being able to relate with the customer and establish a bond is very important," says Justice.
But the first crucial decision to make, Justice says, is between multiple best-of-breed partners or one-stop vendors that can provide a range of services under a single umbrella. He says it pays to consider second-tier providers as well as geographically dispersed centers of excellence. India remains the premier center for software development, but customer-facing applications such as call centers are thriving in the Philippines, which has a closer cultural connection to the U.S. And Eastern Europe and Russia have large talent pools of science labor.
There are also tradeoffs in cost versus quality. Medical transcription work, for example, might be cheaper in China than in India, but it could also require greater expenditures in training and quality control. "The maturity of the service providers varies tremendously even with the big U.S. players," Justice says. "Usually the countries are managed separately. The same company may have tremendous variations in quality."
Quality of service isn't the only measurement when evaluating offshore outsourcers. Geopolitical issues such as labor inflation (and conditions) and currency volatility play pivotal roles when choosing an offshore outsourcer.
India's labor inflation, for instance, has been in double digits in recent years, making long-term assignments there a little more daunting. Second-tier cities such as Pune instead of Bangalore or different countries like Cambodia or Vietnam may be better choices in the long run, Justice says. Meanwhile, China continues to face a stigma of being a haven for intellectual property theft. And poor IT infrastructure in developing countries may make it harder for offshore outsourcers there to deliver the goods.
4. Measure success in a meaningful fashion
Success doesn't mean just cost savings anymore. EquaTerra's Justice notes that companies that use offshore partners often have a difficult time accurately determining cost savings, overstating results by up to 100% or understating by as much as 40%. "The onetime labor arbitrage is not competitive," he says. "The aim should be lower cost, better performance and ongoing productivity."
Today, better measures are customer satisfaction rather than labor savings, performance targets pegged to business goals rather than service-level agreements. Midterm reviews of contracts are becoming more standard, to ensure flexibility. Brooks notes that one of his company's onshore partners has turned over management of a nonstrategic product line to the offshore enterprise, which receives a percentage of revenue in return. "The client has us completely aligned with their interests," he says. "If your service levels are too cumbersome, you have trouble adapting to the customer if it wants to change."
There's a tradeoff between having enough skin in the game and having the motivation to do whatever the client wants you to do, Brooks says. "The old metrics may not mean anything. One hundred out of a hundred times the metrics we set are not the same a year later. It evolves month to month, year to year."
5. Structure the relationship for good governance
EquaTerra's survey of 130 CIOs last year found that a chief complaint among those dissatisfied with their outsourcing relationships was poor governance. "Where risk is high and you're scaling rapidly, you need more rules so you know how levels of performance are measured," says NeoIT's Vashistha. "Companies often put a lot of time and effort into governance at first, and then let the supplier handle it. Then things fall apart. You need attention and ongoing management to get the suppliers' attention."
EquaTerra's Justice says that 4% to 6% of the contract cost should be dedicated to creating a governance board to manage the relationship. Procter & Gamble, for example, needed to build a 100-person governance structure to deal with all its outsourcers. Often vendor score cards and dashboard reporting are used as a part of the process to monitor performance. And increasingly companies are trying to ensure cooperation among outsourcers by drafting contract provisions requiring different providers to work together. "Once you move something out of your organization, you have to redesign how you do things," Justice says.
Western Computer Services learned the hard way about governance, or the lack thereof. While the six-month interface development project stayed on track for deployment this summer, Williams says he learned some valuable lessons about managing an offshore relationship. "The company that outsources still has the overall project management responsibility," he says. "Plan for as much involvement, if not more, than with an in-house development project."
6. Build bridges between the enterprise and its offshore partners
Vashistha notes that executive sponsorship and participation is key to a successful offshore outsourcing project. "Put the best team members in charge of running outsourcing efforts, not ones who have nothing better to do," he says. "You need the leadership in the company to help people understand the link between outsourcing and business strategy and lead the charge by making it an important part of the process."
Symphony's Brooks says that giving the offshore enterprise an ownership stake instead of mere tasks to perform will increase productivity. In the past, offshore centers used to be given little isolated tasks without a view of the big picture, and it was hard to see the outsourcer's contribution. Some companies simply defined a project, threw it over the pond and waited for it to come back. "Now [offshore outsourcers] are owning product lines or analytical models, and it's motivating," Brooks says. "You want a lot of good ideas flowing back and forth."
To this end, Mimosa encourages frequent travel in both directions and treats offshore and onshore teams the same, such as recently giving iPods to workers in Pune and Silicon Valley. "If you treat them as second class, the work that comes out will be second class," he says.