In the past, it was the latest trend to outsource IT services with the hope that it would reduce costs and improve service. Many organizations that raced to implement the outsourcing or off-shoring model quickly realized that it did not save money and did not improve service. The companies then brought IT back in-house. This change in direction and the transition cost organizations a significant amount of money and a loss of IT credibility. As stated by one CIO interviewed, "Off-shoring is grossly overrated. Some claim a 70 percent savings when in actuality it is 20 percent savings, if that. Do not expect that type of savings."
There are many studies and opinions on the question if outsourcing and off-shoring actually lower costs. However, if done properly, you typically can save money with outsourcing and off-shoring. For example, one company found offshore rates of $22-$24 per hour, while on-shore the rate was $50 per hour and internal rates were $60 per hour. With pressures of cloud computing and software-as-a-service as well as increasing competition, the costs of outsourcing are declining. Outsourcing also supplies resources in a constrained market.
Top Tip 1: Get help for negotiating outsourcing
"To negotiate an outsourcing agreement, get industry expertise at the table with you. Even if you have negotiated contracts in the past, it is helpful to understand where the industry has gone since last time you negotiated and use industry best practices. We used an expert and the ROI was six months in a five-year contract."
—Lynn Willenbring
City of Minneapolis
City of Minneapolis
Top Tip 2: Off-shore savings
"The use of third party off-shoring has reduced our consulting costs overall, and in addition, it provides us flexibility to scale up or down as the business demands change. Although the off-shore hourly rates are approximately 60 to 75% less, the total project savings are more realistically between 25 to 50% due to increased management needed to support the off-shore model."
—Ursuline Foley
XL Global Services
XL Global Services
Outsourcing is not a panacea. In general, companies seem moderately successful with outsourcing, but you need to do it carefully and manage it well. Ongoing maintenance and management of supplier relationships are critical. The following are recommendations relative to outsourcing, off-shoring, and on-shoring from companies that have tried it and have learned many lessons:
- Do a complete and detailed cost-benefit analysis of outsourcing. Obtain external assistance to validate the model. Remove the emotion and determine if an outside party can truly do it cheaper or better. Do not assume outsourcing or off-shoring is less expensive. Be sure to consider all the costs in transitioning. Include the soft costs, such as quality, service improvements, and productivity, which can affect project costs and schedules.
- Expect costs savings from off-shoring or outsourcing to be longer term. The initial attraction of huge labor savings and hourly rates of off-shoring can be very attractive. However, when considering all costs, the cost savings are usually not huge and definitely not immediate. Although some projects eventually achieve savings through outsourcing, they may cost more in the first year or two of the transition. Typically, there is a significant investment in time and money to build and manage the outsourcing relationship.
- Have a single point of contact on both sides of the outsourcing relationship with a formal combined governance structure. Ensure you have a defined process for communication and escalation of issues. Make sure there is a good channel for honest feedback on both sides. Document all responsibilities, including ownership and clear role definition. When determining work processes, consider cultural issues, time differences, country demographics, quality, and maturity differences. Identify metrics that measure whether the relationship is working properly.
- Consider off-shoring services from expensive countries such as Europe and the United States to countries with cheaper labor such as India, the Philippines, and Indonesia.
- Consider in-sourcing to your own facilities in other countries with cheaper labor.
- Consider on-shoring using resources in less expensive areas within the same country. For example, one company in Silicon Valley established an on-shore programming facility in Portland, Oregon, and had 30 percent less labor costs and less turnover. A Minneapolis company obtained similar results by having an on-shore facility in rural Minnesota cities.
- Outsourcing does not make problems go away; it just removes them one level, which actually could make problems even worse. Do not take a bad process and try to outsource it. Improve the process, and when it is working, consider outsourcing as an option.
- Consider outsourcing targeted functions rather than the entire IT organization. For example, one company looked at outsourcing only the help desk. Many companies treat off-shore and local sourcing as either/or whether it is at a company-wide or project-wide level. You are most successful when you combine these two and use the strengths of one to offset the other's weaknesses. Some areas are terrific outsourcing candidates, while others are too high risk. For example, do not try to move the development of a unique mission-critical business system to an off-shore model as it can be high risk and maybe difficult to transfer the business knowledge necessary.
"We also looked at outsourcing to internal organizations, using locations of our company in other countries. This is more of an in-sourcing off-shoring model which was more palatable to some people."—Gail Farnsley
Purdue University
(former Cummins CIO)
- Make sure your project is large enough to warrant outsourcing. You need size and length of time to warrant the investment and effort of outsourcing.
- Consider outsourcing the entire business function, not just the IT portion. For example, outsource the payroll function and the supporting IT systems.
- Consider off-shore work in a staff-augmentation mode rather than full outsourcing. This can be particularly useful to test the model and reduce risk in a phased approach.
- Do not consider outsourcing for areas that are core to the business or mission critical. Do not consider outsourcing areas influenced by relationships or where high touch is necessary. For example, trying to outsource the business-analyst function would be challenging. Do not try to outsource or off-shore the development of a system with complex and evolving requirements as it can result in more waste and rework.
- Off-shoring works only if you put the controls and structures in place to make it work. If your plans and design are wrong, your system will be wrong.
"The key to using off-shoring successfully is knowing what projects and roles are good candidates for off-shoring and which are not. For example, we would not consider off-shoring projects that are affiliated to providing us a competitive advantage, such as business modeling techniques and projects associated with the revenue stream. Good projects for off-shoring include platform re-engineering, report creation, testing, maintenance releases or software upgrades. The roles we employ include project management, application architecture, design, and technical leadership. We use off-shoring for the roles of coding and quality assurance."—Ursuline Foley
XL Global Services
- Be aware of features that technically met the specification, but were not usable. Make sure your process does not just throw things over the fence but includes levels of oversight, reviews, and communication.
- Do training on both sides of the relationship. Train the outsourcing company in business, IT, and process functions. Train IT individuals in how to work with the outsourcer in areas of documentation and communication.
- Off-shore resources require more detailed specifications than what was needed previously. Make sure you account for these costs and times in project schedules and plans. The lack of business knowledge requires identifying the how, what, and why.
- Off-shoring can be a challenge with language and location differences. Make sure you have provisions and processes to accommodate the differences, risks, and communication challenges.
- An option to consider is to bring off-shore resources local. One manager was determined to make off-shore resources work and brought them locally for six months to manage them closely and train them in the business and IT. The manager treated them as part of the team, and the endeavor was very successful. Based on the number of off-shore resources, consider requiring at least one resource to stay onsite to interact and coordinate between both locations.
- Consider getting outside assistance when negotiating an outsourcing arrangement and contract. It typically involves large, very complex expenses, and terms and conditions are critical. For example, one firm specializes in negotiating outsourcing arrangements for government entities.
- Make sure the contract includes provisions for training and the necessary processes and procedures with which they must comply. Outline how and when problems will be fixed, any financial penalties for errors, and penalties for disruption of company operations. Outline security, compliance, insurance, and privacy requirements. Structure the contract for mergers and acquisitions on both sides. Include provisions for terminating the relationship and transitioning to in-house or another supplier at no cost.
"We had outsourced to a partner that was not a great fit for us economically. We went from complete outsourcing to more of a staff augmentation model with shorter term contracts, which was a better economic fit for us."—Steven John
H.B. Fuller
"With outsourcing arrangements, negotiate flexibility so you are not locked in for a fixed price amount. If you need to discontinue one service, you want to extract it without opening up the entire contract. Be aware of the inflationary increase rate. Hardware costs are stable or drop. If personnel costs stabilize you should not be tied to a predetermined inflationary rate."—Lynn Willenbring
City of Minneapolis
- Ensure you have executive support for outsourcing.
- Obtain multiple competitive bids. Have a cross-functional team assess options. Identify clear selection criteria, such as experience, cultural match, quality, scalability, and costs. Lowest price should not be the most important criteria. Include contract terms in the request for proposal.
- Watch out for hidden costs, both implementation and on-going.
- Evaluate various financing options.
- Include a clause in the contract for benchmarking costs on a regular basis with the right to evaluate and renegotiate based on current mar ket prices. In times of cost pressure, do not be afraid to ask your outsourcing partner for concessions and reductions. Prices in outsourcing contracts often drop because the outsourcer gets better at managing systems and requires less people once the systems and relationship is familiar. To get lower prices, you may need to be flexible in the terms of the contract or you can make other concessions.
"An off-shore model can be complex. You typically spend more for the first six to nine months. It is important to bring them on-shore to learn your business practices. Then, in six months or so, you start to see advantages as they go off-shore. You need to be willing to make the up-front investment to be successful."—Paul Kay
Long Term Care Group
- Re-evaluate your outsource partner on a regular basis and complete an updated cost benefit analysis and audit. Ensure the cost savings are continuously verifiable. Regularly visit off-shore or outsourcing locations to identify process improvements. Also, have off-shore resources come on-site on a regular basis. Obtain competitive bids to ensure prices remain attractive. Objective third-party audits of the processes and relationship can be useful.
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