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Guidelines For IT Management: Planning for Offshore Outsourcing

As major corporations continue to leverage offshoring to save money and create value, it is important that they avoid the decisions that have prevented other organizations from maximizing those savings. In our last two articles we defined the variables that impact net savings and the five key decisions that companies make that limit savings. In this article we share four governing principles to help a company achieve full value from offshoring.

Four Principles to Best Leverage Offshore Savings

The four key principles cover the entire life cycle of offshoring, starting with formulating the offshoring strategy through contract execution and extending through the ongoing governance of the relationship:

1. Build and design for flexibility
2. Exploit additional sources of value
3. Plan for a practical transition effort that increases momentum
4. Design and contract for on-going continuous improvement post transition

Each of these design principles helps maximize value and avoids the decisions that most often lead to sub-optimal offshore relationships. They come from Everest's experience as an advisor in structuring and executing offshore outsourcing deals and from the insights resulting from Everest's ongoing research in the offshore space

1. Build and design for flexibility

One of the key reasons that companies often achieve limited savings through offshoring is that the design and the contract often only allow offshoring of those sub-processes that senior management feels comfortable offshoring prior to contract signing. There are two main issues with this approach. First, both the market and suppliers' capabilities change over time. Secondly, it can be difficult setting the correct scope of work to offshore prior to contract signing given the nascence of the market and the buyers' generally limited prior exposure to offshoring and resulting high degree of risk averseness.

Given that it is difficult to set the right scope prior to contract signing, best practices include designing a contract structure with clear commercial terms on how the buyer and supplier should approach probable scope changes and share the resulting value creation. Since moving additional work offshore can often decrease the supplier's future revenue stream it is critical to set up a mechanism that motivates the supplier to move work offshore before the buyer's leverage is reduced by signing of the contract. Developing this mechanism up-front creates a natural way for the governance team to effectively capture this value without having to revisit or restructure the contract. It also creates a process and framework to obtain senior management approval within the buyer's organization.

For example, Everest assisted a client in dividing its processes into three categories of complexity (Category 1 activities included transactions that could be moved offshore immediately while Category 2 and 3 activities were more complex, required greater industry insight, or were simply more risky to offshore). Each category had clearly defined milestones for moving offshore. Movement was linked to performance of the previous category as well as market developments. This delineation allowed the team to obtain sign-off on the initial plan for offshoring, enabled the company to design what-if scenarios around different timings for Category 2 and 3, and created a framework for decision making, execution and value creation and sharing. Equally important, the categorization defined how pricing would change as work moved offshore while the supplier discussions were still competitive.

2. Exploit additional sources of value

Buyers often consider offshore nothing more than a labor arbitrage opportunity and ignore potential additional sources of value. In fact, the movement of work offshore is often an opportunity for transformation that companies fail to fully appreciate or leverage. Potential sources of additional value include:

• Process re-engineering
• Improved utilization of fixed assets
• Leveraging time differences

Exhibit 1 shows that buyers who leverage these additional sources of value have significantly higher reported median savings than those that do not.

Exhibit 1

Process re-engineering. There are three fundamental enablers of process re-engineering resulting from transition of work to an offshore location. The first is the intensity of the effort required to document the processes. The resulting knowledge can be leveraged to identify current process band-aids and inefficiencies that can be fixed as part of the transition itself. The second enabler is the much lower cost of the investments required to make the technology or systems changes to improve the process as offshore development projects can be 40-50 percent lower cost than onshore. The third enabler is the increased process discipline that comes with use of offshore resources. When offshore resources are integrated into a process flow, it becomes imperative to use technologies such as imaging and workflow. The resulting automation and process rigor generally more than offset the required investment to implement the technologies.

Utilization. Fixed overhead costs for offshore centers are 40 percent+ compared to those in developed economies that are between 15-20 percent (assuming single shift operations). Improving utilization of these assets through two or three shift operations fundamentally improves the cost structure between 20 - 30 percent.

Exhibit 2 identifies these key cost items and how these can be leveraged through better utilization.

Exhibit 2

Shortening cycle times (business impact). A third lever that companies do not fully exploit is the reduced cycle times that leveraging offshore can create.

3. Plan for a practical transition effort that increases momentum

The key value driver here is not to be over-aggressive in the estimation of the investment and learning curve it will take to get your offshore strategy executed. Instead plan a cohesive strategy that establishes strong quality processes, defines robust transition plans and redundancy, and accounts for the early investments required, so that savings expectations are realistic (Note: suppliers are also willing to adapt their savings profile to provide clients earlier savings). In particular be aware and plan for cultural differences in work style and design the governance system or governance structure to manage explicitly for this. Key factors include differences in processes to deal with conflict, nature of hierarchies, extent of flexibility expected in deadlines, approach to resolving mistakes and issues, among others.

4. Design for on-going continuous improvement post transition

Clients often do not include this factor into their design of off\shore. Similar to the potential for up-front process improvements as part of the transition, the scope for productivity improvements in an offshore environment are usually much higher, especially due to learning curve effects, increases in scale over time, and a lower cost required to introduce new innovations. For example, while it is not trivial to measure and manage productivity in applications development and maintenance, suppliers are consistently willing to contractually commit to 5 percent year-on-year productivity improvements. These can offset or reverse the effects of cost of living adjustments that are also often part of multi-year contracts.

* * *

Buyers often capture only the tip of the iceberg when offshoring and are then faced with a mismatch in terms of actual and expected savings. To avoid this "post-offshoring dissonance," they need to recognize the true nature of savings, learn from the mistakes that others have made, and adopt the flexible performance driven principles described above to maximize their offshore related savings.

Publish Date: December 2004

Copyright © 2004 - Everest Partners, L.P.

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