Offshoring Benefits and Advantage, Still the Same in 2011 as they were in 2001?

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Following a decade of aggressive offshoring, many US companies have paused, reconsidering

their outsourcing strategies. Companies have transferred parts of their organization’s activities

from their company’s home country to captive centers offshore or to offshore service providers

in countries with lower labor rates. Although offshoring may provide a company with certain

benefits, most desirably cost savings, the advantages may not be as beneficial once the hidden

costs are revealed and business risks are considered.

Offshoring’s Current Reality

Globalization has inextricably linked the world’s major economies. The 2011 standard of

excellence is no longer “best-in-class” but rather “best-in-world”. In the global economy, every

company must compete against customer choices coming from everywhere and anywhere in the

world. Long before today’s internet existed, in 1979 Michael E. Porter wrote “How Competitive

Forces Shape Strategy” in the Harvard Business Review. Therein, he identified how the “Threat

of new Entrants” drives business strategy. Today, barriers to marketplaces are dropping quickly,

with new competitors just a mouse-click away from any customer.

Offshoring’s Implications

Since the mid-1990’s, U.S.-based businesses have looked overseas to locate their manufacturing,

business IT Applications Maintenance and Call Center and other operations in emerging

countries with strong labor forces, low wage rates and favorable business climates. This trend

was accelerated by Y2K and the IT industry’s need to rapidly build software maintenance

“factories” to research, correct and test the “millennium bug”.

The offshoring trend continued to evolve with the addition of Business Process Outsourcing

(BPO) and Knowledge Process Outsourcing (KPO) featuring functions of Accounts Payable

administration, medical X-Ray interpretation and Legal Activities. However, in recent years,

more and more companies are reversing course and moving Information Technology (IT)

operations back to the U.S., a phenomenon known as IT Onshoring.

Why Consider Re-Onshoring IT Outsourced Services?

Four key reasons include:

1. IT offshoring savings are often not realized as assumed by their initial business case

2. IT offshoring has placed corporate reputations in jeopardy

3. US Federal, State and Local Governmental actions now prohibit or have created barriers

to IT offshoring

4. IT offshoring business risks have arisen

1. IT Offshoring Savings Are Often Not Realized as Assumed by their Initial Business Case

A sharp increase in wage rates in countries, such as India, that have experienced tremendous

economic growth from years of job creation from multi-national companies, has occurred at a

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time when U.S. wages have risen at approximately the pace of inflation. Inflation in India, for

example, is more than double that in US. As offshore locations grow and westernize, prices and

wages increase. India’s CPI was 10.9% (2009 est.).1

Over the last three years, U.S. firms also had to contend with a weak dollar against foreign

currencies, resulting in higher-than-expected invoices paid in U.S. dollars. For example, the

Indian rupees (INR) per US dollar exchange has changed 13% in three years. (46.78 (2009),

43.319 (2008), 41.487 (2007))2.

In March 2010 Gartner reported: “India is also starting to face some challenges including wage

inflation, local attrition rates, geopolitical issues and financial irregularities, which are opening

opportunities for other countries that are also improving their capabilities to target local service

demands of more-mature regional Asian clients.”3

These same challenges are drivers to also re-consider IT Onshoring in 2011. These external

macroeconomic forces, combined with “hidden cost” industry averages of offshoring lost

productivity (2 – 4%) and cost of Governance (3-5%4) bring into question any business case’s

assumptions for outsourcing and offshoring that were written years ago.

What are the Real Savings of Offshoring?

On the surface, onshore vs. offshore general industry labor savings typically are 35 - 50%. The

offshoring add-on cost (lost productivity, travel, communications, audits, etc) averages 25 - 50%

offshore labor cost, often resulting in the average net savings of 0 -10%.

Once having made an IT outsource decision strategy, decisions on vendor location should not be

made solely on the basis of assumed cost savings. Sourcing decisions should be included in a

larger discussion on how the outsourcing IT supplier will enable the enterprise to meet its

business innovation, simplification, statutory, brand, growth and profitability objectives. That

discussion becomes a basis for finding the right supplier that can meet those goals and that

outsourcing supplier may very well be located onshore.

Factoids:

"...60 per cent of organizations that outsource parts of the customer-facing process will

encounter customer defections and hidden costs that outweigh any potential savings

they derive from outsourcing..."5

“The truth is, no one saves 80 percent by shipping IT work to India or any other

country.”6

1 https://www.cia.gov/library/publications/the-world-factbook/geos/in.html

2 https://www.cia.gov/library/publications/the-world-factbook/geos/in.html

3 http://www.gartner.com/it/page.jsp?id=1329213

4 International Association of Outsourcing Professionals, 2008

5 Gartner, March 2005, http://www.rttsweb.com/outsourcing/statistics/

6 “The Hidden Cost of Offshore Outsourcing”, CIO Magazine, June 16, 2009, Jagdish Dalal , International

Association of Outsourcing Professionals – previously a CIO at United Technologies

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“… 53 percent of customers have not realized business value/return on investment from

offshore outsourcing.”7

"...the number of buyers prematurely terminating an outsourcing relationship has doubled

to 51 percent while the number of buyers satisfied with their offshoring providers has

plummeted from 79 percent to 62 percent."8

2. IT Offshoring Has Placed Corporate Reputations in Jeopardy

In the opening scene of the new NBC comedy "Outsourced," lead character Todd Dempsy

arrives at work to find the call center he is supposed to manage has been moved to India.

Suddenly a brick flies through the window with an angry anti-outsourcing message attached.

Todd's boss laughs and adds it to a pile of bricks beside his desk.

Companies are re-examining the impact of offshoring on their corporation’s reputation. The

AFL-CIO created a searchable database of U.S. companies that have shipped jobs overseas. That

source of information influences customer sourcing decisions. “Entire communities are affected

negatively as tax revenues fall, dependency on public assistance increases, and incomes stagnate.

And as the offshoring and job loss spreads to sectors with higher technology and skills that drive

innovation and productivity, it puts the long-term competitiveness of the American economy at

risk.” 9

“Young workers’ optimism has slumped over the past 10 years along with their financial

circumstances. Today, just over half of young workers say they are more hopeful than worried

about their economic future - that’s a 22-point drop from 1999, when more than three-quarters of

young workers expressed more hope than concern about their economic futures.”10

These young

customers consider corporate brand reputations when making buying decisions.

Similarly, judicious financial services customers seek reassurance that their data is safe, even

though it is being maintained thousands of miles away in a nation that may be unstable at any

time. Stories such as Citibank’s are reality.

“Three former call centre workers at Indian firm Mphasis, which Citibank uses for customer

service support, were arrested by police this week after four U.S. Citibank customers discovered

$350,000 had been looted from their accounts. New reports in India today claim police have

identified that another $75,000 was stolen on top of that.”11

Incorporation of environmental, social and governance factors is considered a significant factor

in business success. Companies now think twice about employing workers in countries with

poor human rights records or overly lax labor standards. In the case of customer service call

centers, some companies are deciding it makes sense to pay more for U.S. workers who may be

better able to serve and communicate with customers. Some consumers simply prefer to do

7 CIO Magazine, November 2008, http://www.rttsweb.com/outsourcing/statistics/

8 DiamondCluster June 2005

9 http://www.aflcio.org/issues/jobseconomy/exportingamerica/outsourcing_problems.cfm

10 http://www.aflcio.org/aboutus/laborday/upload/laborday2009_report.pdf

11 http://www.silicon.com/legacy/research/specialreports/offshoring/0,3800003026,39129475,00.htm

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business with firms that commit to a domestic workforce. Add to this aforementioned example

that high quality, affordable labor is available in smaller U.S. markets, it is not surprising that re-

considering Onshoring is gaining currency.

3. USA Federal, State and Local Governmental Actions Now Prohibit or Have Created

Barriers to IT Offshoring

Hypothetical: US Federal Senate bill S. 3816 "Creating American Jobs and Ending Offshoring

Act"12

If this bill had been passed, if would have created a payroll tax holiday for companies that return

jobs to the United States from overseas, ended subsidies for plant closing costs, ended tax breaks

for plants that go overseas and had no penalty applied to moving jobs overseas, instead of

keeping jobs in onshore.

Reality: State of Ohio “Executive Order 2010-09S”

August 2010: Columbus, Ohio--Ohio Governor Ted Strickland today issued an executive order

that prohibits the expenditure of public funds for services provided offshore.

"Outsourcing jobs does not reflect Ohio values," Strickland said. "Ohioans have been among the

hardest hit by more than a decade of unfair trade agreements and the trickle-down economic

policies that promoted offshoring jobs at the expense of Ohioans who work for a living. We must

do everything within our power to prevent outsourcing jobs because it undermines our economic

development objectives, slows our recovery and deprives Ohioans and other Americans of

employment opportunities."

"Ohio's policy has been--and must continue to be--that public funds should not be spent on

services provided offshore," Strickland says in the order. "Throughout my Administration,

procurement procedures have been in place that restrict the purchase of offshore services.

Despite these requirements, federal stimulus funds were recently used to purchase services from

a domestic company which ultimately provided some of those services offshore. This incident

was unacceptable and has caused me to redouble my commitment to ensure that public funds are

not expended for offshore services."13

Two Examples:

1. State Level

The December 2010 State of Ohio Request for Proposal “ODJFS HATS II System –

0A1080” specifically states: “Data and work performed must remain within the

boundaries of the continental United States for this Project.”

12

http://dpc.senate.gov/dpcdoc.cfm?doc_name=lb-111-2-151 & http://www.youtube.com/watch?v=EvyIb8K1ju4 13

http://governor.ohio.gov/Default.aspx?tabid=1753

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2. Federal Level

“The Justice Department yesterday said that ITT will pay a total $100 million penalty,

one of the largest penalties ever in a criminal case. The company also becomes the first

major defense contractor convicted of criminal violation of the Arms Export Control Act,

the department said. ITT exported or caused to be exported defense-related technical data

to China, Singapore, and the United Kingdom without having first obtained a license or

written authorization from the State Department. The technical data included information

about a laser counter measure known as a "light interference filter" for military night

vision goggle systems.”14

Statutory barriers to offshoring are real and their political momentum is growing. Managements

must consider these factors when making or continuing offshore outsourcing decisions.

4. IT Offshoring Business Risks Have Arisen

In addition to cost, reputation and legal barriers there other new risks associated with offshore

initiatives which must be considered. These include:

Strategic Risks: such as, loss of control over future business decisions, the stability of the

provider, etc. JPMorgan Chase’s decision to first outsource IT and then bring it back in-house

stands as a cautionary tale for any CIO considering an outsourcing megadeal.15

A strategic risk

is accepted when outsourcing offshore. The “losses” are even harder to recapture unless an

onshore provider has a clear methodology for reversing and undoing the knowledge transfer that

has already taken place.

Operational Risks: such as, its impact on the organization’s people, integrating the offshore

provider’s processes into the business’s, risks from poor performance, security, data protection

and privacy, business disruption, etc. Companies whose own cultures embrace practices such as

Six Sigma, the Deming Prize, the Malcolm Baldridge National Quality Award, EFQM

excellence quality standards such as ISO 9001, or service management standards such as ITIL,

must integrate those with the culture and capability of the offshore supplier. Similarly,

challenges of security and information confidentiality become more complex due to ambiguous

privacy laws overseas which subject companies at risk of intellectual property theft.

Time zones and distance have proven this integration to be very difficult. Frequently, after

struggling for months “to make it work”, the offshore supplier’s labor is simply brought to work

onshore, as the customer’s initial outsourcing strategy devolves to become a simple labor cost

strategy.

Transactional Risks: such as, internal controls, termination clauses, dispute resolution, liability,

indemnity, warranties, and asset transfers are more complex when offshoring. Sarbanes-Oxley

compliance, HIPAA, and Basel II Accords, etc. must be satisfied. The offshore supplier must

meet these standards. One famous debacle was Satyam.

14

http://findarticles.com/p/articles/mi_6712/is_58_233/ai_n29340678/ 15

CIO Magazine, September 01, 2005.

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Forbes reported: “Satyam Systems, a global IT company based in India, has just been added to a

notorious list of companies involved in fraudulent financial activities, one that includes such

names as Enron, WorldCom, Societe General, Parmalat, Ahold, Allied Irish, Bearings and

Kidder Peabody. Satyam's CEO, Ramalingam Raju, took responsibility for broad accounting

improprieties that overstated the company's revenues and profits and reported a cash holding of

approximately $1.04 billion that simply did not exist.”16

As a result, some customers terminated their relationship with Satyam immediately and had to

find alternatives for their own business’ continuity.

Much has changed since the 1990s and Y2K. There are new and real drivers to Re-Consider IT

Outsource Onshoring. Management should re-inspect old decisions and test their continued

contribution to corporate results and new business strategies. Though offshoring may seem

appealing at first glance, make sure to dive deeply into the cons, along with the pros. While

offshoring may provide the company with financial benefits, hidden costs and business risks

often outweigh them. Now, more than ever, it is only under the right circumstance where

offshoring fully delivers upon the promised value proposition and the desired cost savings. If

cost savings is your primary driver, think carefully about engagement governance, ease of

communication and other potential inconveniences that will have to be managed on a daily basis.

Give consideration to domestic outsourcing as it may be the perfect fit for your outsourcing

strategy.

16

http://www.forbes.com/2009/01/07/satyam-raju-governance-oped-cx_sb_0107balachandran.html

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About the author:

H. Curtis Herge, Jr.

Director, Solutions Development

17177 Preston Road

Suite 300

Dallas, TX 75248-1243

www.cdi-its.com

(585) 260-3261 Mobile

(972) 728-8310 Dallas TX Office

Mr. Herge's career has focused on leading the planning, design, implementation and use of

complex information systems to enable and support the strategic evolution of business

organizations, products, markets and management processes.

He is a Certified Outsourcing Professional (COP) having passed the requirements established by

the IAOP. He is certified by APICS in Production and Inventory Management (CPIM).

Mr. Herge is responsible for delivering technology innovation and providing the backbone of

CDI's Consulting and Outsourcing group. Mr. Herge has also simultaneously performed as the

Acting Director of CDI IT Solution’s Application Lifecycle Management solutions delivery

organization.