Offshore Outsourcing - The Hidden Costs of Selecting
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," www.cio.com/printlinks.)
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 offshore outsourcing.
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
"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.
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.
By Stephanie Overby cio.com
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