Sep. 1, 2003 Issue of CIO Magazine | Offshore Outsourcing

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Offshore Outsourcing
> The Money

The Hidden Costs of Offshore Outsourcing

Moving jobs overseas can be a much more expensive proposition than you may think.


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Offshore Outsourcing


The Radicalization of Mike Emmons

Offshore Outsourcing The Money


You can figure out your own best and worst case scenarios for going offshore when you calculate the costs for yourself. Use our online calculators.

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Talk to David Raspallo

Outsourcing is a tangled, more expensive web than you think. What are the real costs of going offshore? David Raspallo, CIO of Textron Financial, knows. Until Sept. 15, go to ASK THE SOURCE to query him on offshore issues—costly and otherwise.













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Indian I.T. vendors have an unmatched commitment to customer service, but that positive can turn to a negative when eager-to-please vendors ignore flaws in software specifications.

Inside Outsourcing in India
Outsourcing to India can provide a huge payback—if you're willing to work at it. Two offshore veterans share their hard-earned lessons to help you determine if Indian outsourcing is right for your company.

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Outsourcing Research Center

Staffing and Retention Research Center

From the Store
Offshore Outsourcing: Navigating the Opportunities and Risks
This CIO Focus guide looks at the pros and cons of offshore outsourcing, analyzes the trends, examines what the countries have to offer and provides insights for dealing with the vendors and brokers.

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Doing Your Offshore Homework

Offshore outsourcing may save you money; then again, it may not. Rather than accept offshore vendors' claims, you need to calculate your own ROI. Here are some tips to get started.

1. Know what your internal costs are. If you don't know what your own real labor rates are for accomplishing tasks you plan to send offshore, how can you know how much you'll really save?

2. Ask your peers. Organizations such as the Society for Information Management and CIO conferences are great places to get the real information from peers who are outsourcing offshore.

3. Contact vendor references. Ask these CIOs what unforeseen costs they've encountered in their offshore engagements.

4. Estimate potential soft costs. As much as possible, figure in factors such as lower morale and cultural changes.

5. Create a three- to five-year plan. Include your identified hidden costs as well as anticipated scope changes.



The current stampede toward offshore outsourcing should come as no surprise. For months now, the business press has been regurgitating claims from offshore vendors that IT work costing $100 an hour in the United States can be done for $20 an hour in Bangalore or Beijing.

If those figures sound too good to be true, that's because they are.

In fact, such bargain-basement labor rates tell only a fraction of the story about offshore outsourcing costs. The truth is, no one saves 80 percent by shipping IT work to India or any other country. Few can say they save even half that. As just one example, United Technologies, an acknowledged leader in developing offshore best practices, is saving just over 20 percent by outsourcing to India. (For more, read "Inside Outsourcing in India.")

Hank Zupnick, CIO of GE Real Estate, found that because of cultural differences you cannot simply replace one American worker with one offshore worker.

That's still substantial savings, to be sure. But it takes years of effort and a huge up-front investment. For many companies, it simply may not be worth it. "Someone working for $10,000 a year in Hyderabad can end up costing an American company four to eight times that amount," says Hank Zupnick, CIO of GE Real Estate. Yet all too often, companies do not make the outlays required to make offshore outsourcing work. And then they are shocked when they wind up not saving a nickel.

In this article, we will explore a new TCO—the total cost of offshoring. We will uncover all the hidden costs of outsourcing—areas in which you'll have to invest more up front than you might think, places where things such as productivity and poor processes can eat away at potential savings, and spots where, if you're not careful, you could wind up spending just as much as you would in the U.S. of A. (For more on how to calculate your own TCO, see the worksheet "Do the Math" on bottom of this page.)

"You can't expect day-one or even month-six gains," Zupnick says. "You have to look at offshore outsourcing as a long-term investment with long-term payback."

The Cost of Selecting a Vendor
With any outsourced service, the expense of selecting a service provider can cost from .2 percent to 2 percent in addition to the annual cost of the deal. In other words, if you're sending $10 million worth of work to India, selecting a vendor could cost you anywhere from $20,000 to $200,000 each year.

These selection costs include documenting requirements, sending out RFPs and evaluating the responses, and negotiating a contract. A project leader may be working full time on this, with others chipping in, and all of this represents an opportunity cost. And then there are the legal fees. Some companies hire an outsourcing adviser for about the same cost as doing it themselves. To top it off, the entire process can take from six months to a year, depending on the nature of the relationship.

Ron Kifer, VP of program solutions and management at DHL Worldwide Express, ran into delays and additional costs in shifting jobs offshore when it took longer than expected to install the necessary hardware in India.

Vice President of Program Solutions and Management Ron Kifer spent several months on vendor selection before contracting with Bangalore, India-based Infosys to handle a whopping 90 percent of development and maintenance work for DHL Worldwide Express, a shipping company. "There's a lot of money wrapped up in a contract this size, so it's not something you take lightly or hurry with," Kifer says. "There has to be a high degree of due diligence making sure that the [offshore] company can respond to your needs."

Even when there is an existing tie between customer and offshore vendors, the expensive and lengthy step of vendor selection is a must-do for successful outsourcing. The chairman of Tata Consultancy Services (TCS), a Mumbai, India-based outsourcer, sat on the international advisory board of Textron, a manufacturing company that owns such brands as Cessna Aircraft and E-Z-GO Golf Carts, for several years. However, when David Raspallo, CIO of business unit Textron Financial, began exploring offshore outsourcing in 1999, he still spent five months doing what he calls "the usual Betty Crocker Bake-Off" with service providers Covansys, ITS, TCS and Wipro. Ultimately, he went with U.S.-based Covansys, which has three development centers in India. Selecting the vendor took 500 hours in total, involved Raspallo and three senior managers, and cost $20,000 in additional expenses.

At this stage, travel expenses enter the picture as well. A trip overseas helps CIOs get comfortable with their choice. After all, offshore vendors can send their best and brightest over for a dog and pony show, but checking out the company on its home turf provides more insight. John Dean, the CIO of Steelcase, an office furniture manufacturer, spent several thousand dollars to send one of his IT executives to Intelligroup Asia in Hyderabad, India, for a week before signing on the dotted line.

"You can read everything you want to read and ask for advice as much as you want, but you have to make it a fact-based decision," Dean says. "So it was important to visit India to validate our thinking."

Bottom line: Expect to spend an additional 1 percent to 10 percent on vendor selection and initial travel costs.

The Cost of Transition
The transition period is perhaps the most expensive stage of an offshore endeavor. It takes from three months to a full year to completely hand the work over to an offshore partner. If company executives aren't aware that there will be no savings—but rather significant expenses—during this period, they are in for a nasty surprise.

"You have to bring people to America to learn your applications, and that takes time, particularly if you're doing it with a new vendor for the first time," explains GE Real Estate's Zupnick, who maintains a handful of three-year contracts with offshore vendors, including TCS and smaller vendor LSI Outsourcing. In GE Real Estate's case, the transition time for each vendor was three months at the very least and up to a year in some cases, in addition to the money-draining vendor selection period of several months.

"The vendors say you can throw offshore jobs over the wall and start saving money right away. You have to build in up to a year for ironing out cultural differences."


Zupnick, who has seven years of offshore experience, says most of his peers don't appreciate the time and money it takes to get a relationship up and running. "The vendors say you can throw it over the wall and start saving money right away. As a result, I've heard of CIOs who have tried to go the India or China route, and nine months later they pulled the plug because they weren't saving money," Zupnick says. "You have to build in up to a year for knowledge transfer and ironing out cultural differences."

CIOs must bring a certain number of offshore developers to their U.S. headquarters to analyze the technology and architecture before those developers can head back to their home country to begin the actual work. And CIOs must pay the prevailing U.S. hourly rate to offshore employees on temporary visas, so obviously there's no savings during that period of time, which can take months. And the offshore employees have to work in parallel with similarly costly in-house employees for much of this time. Basically, it's costing the company double the price for each employee assigned to the outsourcing arrangement (the offshore worker and the in-house trainer). In addition, neither the offshore nor in-house employee is producing anything during this training period.

But it has to be done. "We made a mistake in the beginning of just packing up the specs and shipping them over, looking at it from a pure cost standpoint," says Craig Hergenroether, CIO of Barry-Wehmiller, a packaging manufacturer that has its own development center, Barry-Wehmiller International Resources, in Chennai, India, and works with other offshore vendors. "Silly mistakes were made because we didn't take the time to have them come over. It's a false savings to keep costs down by communicating only by phone."

During the transition, the offshore partner must put infrastructure in place. While the offshore partner incurs that expense, the customer should monitor the process carefully. Often it can take longer than expected. "It took an awful lot of time to bridge the Pacific [networking our company to the Indian vendor] and getting that to work correctly," remembers Textron Financial's Raspallo, who spent six months and $100,000 to set up a transoceanic data line with Infosys in 1998 for Y2K work. It also cost an extra $10,000 a month to keep that network functional. "You have to know hands down that the technology infrastructure you put in place is fully functional and will operate at the same performance level as it would if you were connecting to someone on the next floor. Otherwise, you'll have a lot of costly issues to deal with."

DHL's Kifer had similar problems. Long lead times for acquiring the necessary hardware in India delayed development work, he says. The hardware holdup put off the start of offshore work for several months, requiring DHL to continue to keep vendor workers employed onsite at the more expensive rate.

During the transition period, the ratio of offshore employees in the United States to offshore employees working at the vendor's overseas headquarters is high. But after the transition is complete, CIOs have to get those employees out of the office if offshoring is to be a money-saving move. "It's got to be 80 percent or 85 percent working offshore or the numbers just don't work," explains GE Real Estate's Zupnick.

It makes sense for offshore service providers to place as many of their employees in the United States as possible. The provider's margins—already quite decent for offshore work (Indian companies charge U.S. companies $20 an hour for an employee they pay around $10)—really skyrocket when they're on American soil. "They make more money and often the client feels better having them close," says Praba Manivasager, CEO of Minneapolis-based offshore adviser Renodis. "But the customer immediately loses all of the bill-rate savings." If not included in the original contract, additional travel and visa costs also must be figured in. Tally it all up and you will pay as much as you would for one of your own employees.

It's a difficult area for CIOs to manage. Work is much easier to do with offshore workers onsite, but to cut costs they must push as much overseas as possible. Conversely, the more manpower based offshore, the more project problems and delays. Barry-Wehmiller's Hergenroether says the amount of workers you can reasonably send offshore depends on the type of work being done. Industry- or company-specific system development requires more developers onsite. Legacy maintenance or simple upgrades may not require a soul.

"On some of our projects, up to 50 percent of offshore workers are onshore; on others it's closer to 10 percent," Hergenroether says. In some cases—where specific skills are the reason for offshoring—he may even bring in offshore talent over long term. "But if you're going to do that, your cost savings diminish dramatically," he says. In fact, there may be no savings at all.

Bottom line: Expect to spend an additional 2 percent to 3 percent on transition costs.

The Cost of Layoffs
Laying off American employees as a result of your offshore contract poses other sometimes unanticipated costs. To begin with, you have to pay many of those workers severance and retention bonuses. "You need to keep employees there long enough to share their knowledge with their Indian replacements," Zupnick explains. "People think if they give generous retention bonuses it will destroy the business proposition. They cut corners because they want quick payback. But then they lose the people that can help with the transition and incur the even bigger cost of not doing the transition right."

Layoffs can also cause major morale problems among in-house "survivors," in some cases leading to disaffection and work slowdowns. Companies with experience in offshoring factor productivity dips and potential legal action from laid-off employees into the cost-benefit analysis.

"You can never underestimate the effect these issues will have on the success of [your offshore venture]," says Textron Financial's Raspallo. CIOs must take time to communicate with their staffs, being "brutally honest," he says. "If your intention is to lay off some workers and move work offshore, let them know. If you want to move legacy systems offshore and retrain staff for other systems, tell them that. And constantly reinforce what the vision is."

Raspallo sets aside time for a monthly meeting with all staff (offshore included) by video. "In the beginning, we spent the whole time talking about the offshore proposition," he says. "If you don't spend that time doing that, your staff is going to make up stories about what's happening themselves."

Without this kind of effort, offshore endeavors are doomed.

"Internal people will refuse to transition to the offshore model because they have a certain comfort level, or they don't want their buddy to lose his job," Renodis's Manivasager says. "There has to be a mandate. Trying to build consensus can take a very, very long time." Manivasager has seen some relationships take as long as three years to get off the ground because the strategy was neither shared with nor embraced by employees.

Bottom line: Expect to pay an extra 3 percent to 5 percent on layoffs and related costs.

The Cultural Cost
One of the biggest impediments to offshore savings is productivity. "You simply cannot take a person sitting here in America and replace them with one offshore worker," GE Real Estate's Zupnick says. "Whether they're in India or Ireland or Israel."

One reason for that is the American workers' comfort level with speaking up and offering suggestions. "A good American programmer will push back and say, What you're asking for doesn't make sense, you idiot," Zupnick says. "Indian programmers have been known to say, This doesn't make sense, but this is the way the client wants it." Thus, work takes more time and money to complete. And a project that's common sense for a U.S. worker—like creating an automation system for consumer credit cards—may be a foreign concept offshore. Additionally, offshore vendors often lack developer experience (the average experience of offshore developers is six years).

On average, IT organizations going offshore will experience a 20 percent decline in application development efficiency during the first two years of a contract as a result of such differences, Meta Group Vice President of Service Management Strategies Dean Davison says. According to Meta Group, lags in productivity can add as much as 20 percent in additional costs to the offshore contract.

Another productivity killer is high turnover at offshore vendors. Attrition rates climb as high as 35 percent in India, according to the National Association of Software and Service Companies. "Unless you can somehow address that in your contract, you're paying for someone to learn your product and then they're gone," Zupnick says. Turnover can cost an additional 1 percent to 2 percent.

Finally, communication issues can slow things to a halt. "We had to do a lot more face-to-face interaction than originally anticipated because [offshore workers] just didn't interpret things the same way," says DHL's Kifer. "That resulted in a lot more travel there or bringing them onshore to bridge that gap. We did that a lot more often than the model would have prescribed." Language and other cultural differences can cost an extra 2 percent to 5 percent, according to Meta Group.

Bottom line: Expect to spend an extra 3 percent to 27 percent on productivity lags.

The Cost of Ramping Up
Well-defined and accepted internal software development and maintenance processes are also key to making an offshore situation work. "If you're an organization that develops and maintains by the seat of your pants, or it's a case where Mary Jo and Fred have been here for 30 years and they know how to do everything, you are in trouble," says Raspallo, who currently sends 65,000 man-hours of work to India.

Raspallo spent five months and $80,000 in consulting fees to get ISO certified in 1998, which puts his company at about Level 3 in terms of his employees' "capability maturity" in developing software. He also invested in an automated Web-based system to support the new software development and labor management practices. Most of the Indian offshore companies are ISO certified and at Capability Maturity Model (CMM) Level 3 or 5. "If your own staff can't get used to working at that level, you're going to have a major disconnect," Raspallo says.

If a company doesn't create solid in-house processes, "the vendor will have to put more people onsite to compensate for your inadequacies, and they'll spend all of your savings," says Meta Group's Davison.

DHL America's IT department spent a full year to get to CMM Level 2 in 2002. Kifer is aiming to be at Level 3 in the United States this year, with the ultimate goal of achieving Level 3 across the entire global IS team. "It's a big project, and it entails a significant level of training and education," he says. "But if you're going to take full advantage of offshore outsourcing, you have to raise your own maturity level." Not everyone was gung ho about the new level of discipline required, but Kifer lit a fire under them with annual bonuses tied to certification.

The ability to write clear specifications is also critical to achieving offshore savings.

"When you're doing this stuff internally, you tend to be much more cavalier," says Hergenroether. "When you have to package specs to go outside the company, that has to be done exceptionally well." Creating a great spec package is costly and time-consuming. On a 1,000 man-hour project for example, Hergenroether's staff will spend 100 hours to create a spec package.

At the other end of the process is quality assurance (QA) testing, an area which must become more robust in an offshore arrangement. "We essentially picked up two shifts of people in India working while we slept. The work we sent out at 4 p.m. came back to us at 10 a.m., and we didn't have a QA funnel big enough to handle that," says Radio Shack CIO Evelyn Follitt, who now hires more temporary QA staffers during development time.

Bottom line: Expect to spend an extra 1 percent to 10 percent on improving software development processes.

The Cost of Managing an Offshore Contract
Managing the actual offshore relationship is also a major additional cost. "There's a significant amount of work in invoicing, in auditing, in ensuring cost centers are charged correctly, in making sure time is properly recorded," explains DHL's Kifer. "We have as many as 100 projects a year, all with an offshore component, so you can imagine the number of invoices and time sheets that have to be audited on any given day."

At DHL, each project manager oversees the effort. He audits the time sheets from the vendor and rolls the figure into an invoice, which then has to be audited against the overall project, which is then funneled to finance for payment. Kifer's staff has been a bit overwhelmed. "We knew there would be invoicing and auditing," he says. "But we didn't fully appreciate the due diligence and time it would require."

At GE Real Estate, managing the offshore vendor is such a big task that Zupnick assigned someone to handle it on a half-time basis at a $50,000 salary. The individual makes sure projects move forward, and develops and analyzes vendor proposals against the RFPs when it comes time to bid out new work.

"It's a critical job," Zupnick says. "That's the price you have to pay to make this work."

Bottom line: Expect to pay an additional 6 percent to 10 percent on managing your offshore contract. end

Share your offshore outsourcing stories with Senior Writer Stephanie Overby at




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There is a greater chance that your datacenter will be destroyed by a half a kiloton warhead thanks your friends, the ladens, than there is of it being destroyed by a 200 megaton warhead dropped on India for the simple reason that your datacenter itself has not been shifted offshore but just some people that help run it.

Thank you for writing such an informative article about the pitfalls and hidden costs of IT outsourcing. The IT industry could use more of this type of ?straight talk? and less puffery around the excellence of outsourcing. In the IT world of today, the major motive in the mind of corporate executives seems to be cost, not quality or value.

Almost every article I read on the subject points out that a programmer in India makes $5,000 - $6,000 per year while an "equivalent" American programmer earns $60,000+ per year. However, your article excepted, I have not seen a single objective article that indicates that work done at a lower cost offshore is equal or higher in quality, done as quickly and/or performed as correctly as the work performed by "overpaid" American programmers.

In fact, quite the opposite is likely true. Often times, given the complexity that exists in the IT world, it is very difficult for business users and IT workers residing in the same locale to work out software requirements and successfully execute a project. In fact, some statistics say that around 80% of IT projects fail to meet their goals.

Now imagine moving the technical team several thousand miles away, put them on a work schedule that is completely opposite that of their end-users, give them a different native language, and give them a completely different set of cultural mores and norms. With as much sarcasm as I can muster, I must say that none of this seems intuitively likely to increase the odds of success, but it does have the "advantage" of being really cheap.

Offshore IT outsourcing is not about obtaining greater value in the form of equal or higher quality services for less money?it is simply about the pursuit of lower IT costs at any cost. Unfortunately, many executives stand to learn the hard way the truth contained in the old adage, "You get what you pay for." For these executives, the bitterness of poor quality will linger in their mouths long after the sweetness of low price is forgotten. Tragically, if history is any guide, these executives will likely go on to enjoy "golden parachutes" while many of the workers displaced in their unrelenting pursuit "to drive the cost out of the business" go on to enjoy a lower standard of living and an uncertain employment future.

Managing IT is difficult enough in the U.S., the clear world leader in IT. Most offshore outsourcing arrangements are doomed to failure from the start for the reasons outlined above. Before you make an outsourcing decision, think carefully about the impact that poor execution on the part of your IT outsourcing vendor will have on your business.

Dev Null
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Don't forget the costs of having your coders know everything about your business and having zero loyality. Many compaines in India are now getting up to speed to help migrate management and full company business plans. They can take a compaines money to develop the IT systems needed to compete with them and then set up an offshore company that does everything. How many of the "service" compaines are now working competely out of India with a local 1-800 number?

Tim Hogard
Expert Automation
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ME >>>> Jo0 + BaG of Chips!!

Welcome to the real world, where one sells ones own mother to make a buck! Get real, if we can make people work for free, we would do it!And if you dont, you deserve to work sweeping floors. And Duh! there is always a high cost entering the market for the first time. Reading this article is like re-inventing the wheel. And they do it with a serious face too!

Here is a cookie for you.

1337 |-|/\k3r
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The blame for the increasing trend in Offshore outsourcing of IT jobs should not only be attributed to the greedy corporate leaders but also to the numbskull politicians and political advisors. I have heard Greenspan callously disregard, in public, the loss of IT jobs to overseas vendors claiming that the workers would be reabsorbed in new industries like biotechnology and nanotechnology! The guy is out of his mind!

The trend of sending valuable technologies overseas not only leads to job losses and have detrimental economic consequences, but also has a major implication on the security and competitive advantage the US has enjoyed that enabled to keep it ahead of the rest of the world and provide it markets to sell into. The transfer of technologies allows these vendor nations to leapfrog in their technological capabilities without having to absorb any of the costs of Research and Development etc and as more countries become technologically savvy, they not only pose and economic threat but also a potential security threat.

As more countries get technologically savvy, there is nothing to stop them from developing their own competitive products and from competing against the American companies that willingly taught them – no gave them – the technologies for free! I am surprised that President Bush needs to create another position to investigate the loss of jobs in this country. Trickle down economics does not work without adequate controls! In fact the very foundation of economics (competition) is being disregarded. The ridiculous fiscal policies, lack of immigration controls, corruption of the judiciary and unbridled liberalization in the US are nothing short of stupidity and perhaps treason. These guys are selling the country and its people in the name of globalization and progress. The needs of the many are being squelched by the greed of a few – and this is supposed to be a democracy. The current state of the economy, the large national debt and deficits point to a financial meltdown and the problems are beginning to accelerate. If the trend continues, a depression not unlike the Great Depression is inevitable!

However, there are ways to fight back and reverse the trend before it is too late. 1. Stop investing in American companies that practice outsourcing. The idea is to send a strong message to the management that their callousness and greed has been recognized and will be responded to by the American public. 2. Stop buying products from companies that practice outsourcing. Buy from American companies that preserve American jobs. 3. Get politically active and write to your elected political leaders strongly demanding that they take action or face recall. Yes it will probably make them sit up and take notice and perhaps even lose some sleep. 4. Run for political elections yourself and make sure you keep your promises to protect jobs. 5. If you are an IT leader, do your homework. Educate yourself and your superiors about the true cost and impact of sending jobs overseas. Your will find that there are no better IT workers in the world than the American IT worker. A careful ROA will reveal the true costs and opportunity costs of offshore outsourcing do not justify the practice! Develop plans to train and retrain your people. After all, if you were to outsource, you would end up spending money training your vendors personnel! Do it before you find that you are the next one on the chopping block. After all, this trend would not have begun without your complicity. 6. If you are not an IT worker take heed. This trend started with manufacturing and is now focused on IT. However it will not be long before your jobs are on the line. After all, if the bottom line is the only consideration, with the obfuscation of the tangible and intangible benefits of preserving American jobs, there is no job in America that can compete against the low wages, low exchange rates etc. Be aware that the future is now and your future is at stake as well.

Bee Gee
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