IT Offshoring Savings Declined for Past 5 Years

The average savings achieved by IT offshoring has declined for the past five years, even as companies expanded their offshore initiatives, Duke University's sixth annual corporate offshoring study found.

If there's been one constant during the years that Dr. Arie Lewin has studied the corporate offshoring experience, it's this: Very few companies understand the strategic value of global sourcing. Even today, just five percent of companies that offshore IT services do it really well, says Levin, professor of strategy and international business at Duke University's Fuqua School of Business and director of its Center for International Business Education and Research (CIBER).

According to results from the sixth annual offshoring survey conducted by CIBER in conjunction with The Conference Board, average cost savings achieved by offshoring (both third-party outsourcing and captive center operations) has declined consistently during the last five years, in part because just a handful of companies have an optimized enterprise-wide sourcing strategy. And despite all the knowledge readily available about offshoring management requirements, companies continue to get tripped up by the so-called "hidden" costs of global sourcing.

Nonetheless, more than half of the companies surveyed expect to expand their offshoring initiatives during the next 18 to 36 months, the study found. Nearly a third have already moved up the value chain to offshore innovation-related services.

CIO.com talked to Dr. Lewin about eroding offshore labor arbitrage advantage, the effect of offshoring on domestic IT job opportunities, how companies who succeed at offshoring look beyond cost cutting, and why executives continue to be surprised by the management overhead required to make offshoring work.

CIO.com: You found that the average savings yielded by offshoring IT services has decreased from around 38 percent a decade ago to 27 percent today. To what do you attribute that decline?

Dr. Arie Y. Lewin: First there is the fact that the labor arbitrage effect is eroding, and there's nothing you can do about it. There are inflationary cost pressures in offshoring across most countries and especially at hot spots like Bangalore. For most locations labor arbitrage dissipates over three years. If you are only counting on labor arbitrage you will be disappointed.

The second factor is whether you are doing captive or third party outsourcing. Most large IT services offshoring is done via a third party. On the external provider side of the equation, [many] are getting better at what they do, which allows the most efficient to charge at market rates but make higher profits. An important source of savings is excelling in process optimization. One company that is at the state of the art with process optimization and process reengineering is the Penske truck rental company. Penske lives by and breathes process optimization. They're perhaps the only example that [offshore outsourcing provider] Genpact can brag about. They understand that process reengineering means steep jump in savings.

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