Secrets of Offshoring Success

Even as offshore outsourcing has matured, best practices have been few. Now two top academics reveal the principles that should guide CIOs.

Mary C. Lacity probably knows as much about IT outsourcing as anyone in the industry. Currently professor of information systems at the University of Missouri-St. Louis, Lacity has studied the industry since its genesis nearly 20 years ago. And you’d be hard pressed to find someone who’s talked to more CIOs about their outsourcing coups and catastrophes.Yet just a few years ago when CIOs would call Lacity up and ask her if she could send them any good offshoring research, even she had to say, "No."

Sure, there’s anecdotal evidence of what’s worked for some and what hasn’t for others when sourcing IT work overseas. But definitive best practices have been hard to come by.

So three years ago, Lacity and Joseph W. Rottman, assistant professor of information systems at the University of Missouri-St. Louis, set out to rectify that by conducting interviews with offshore outsourcing practitioners and their suppliers. Using that research, they’ve developed what they believe to be one of the first rigorous, peer reviewed examinations of offshoring best practices.

To date, they’ve interviewed more than 165 individuals from 40 companies—and not just the usual suspects. Certainly, they’ve talked to IT executives and project managers at client organizations. But Rottman also spent three weeks in Bangalore, Mumbai and Hyderabad interviewing members of offshore development teams from managing directors down to programmers. Cumulatively, these one-on-one talks have provided a gold mine of data. The duo has produced no less than eight published articles and reports from their research, gobbled up by information hungry offshoring customers and suppliers. And they plan a book to be published by early 2008.

Lacity and Rottman’s early examinations focused on the offshore outsourcing learning curve and best practices for accelerating it while maintaining quality and cost savings. Now they’re focused on the delicate process of transferring knowledge offshore while still protecting intellectual property.

The basic thrust of their findings—that offshore outsourcing takes a lot more work than its domestic counterpart—comes as no surprise. But their research crystallizes just where that micromanagement proves most effective and sheds light on some novel tricks of the trade. Although most advice about how to do offshore outsourcing right focuses on processes, requirements, and the like, Lacity puts forth an interesting thesis. Successful offshore outsourcing ultimately is not about processes or requirements. Rather, it is the result of a continuous build up of "social capital" between customer and supplier. Recently, Lacity and Rottman sat down with Senior Editor Stephanie Overby to discuss some of the best—and worst—ways to do just that.

CIO: So, the bottom line appears to be that a relationship with an offshore outsourcer requires a lot of hands-on involvement.

MARY LACITY: More, more, more.

JOSEPH ROTTMAN: Better, better, better. Yet the level of management required still catches offshore customers by surprise.

LACITY: It really does seem like each company starts afresh. Even though we have some research out there and consultants, so many companies make the same stumbles in their initial efforts to go offshore.

ROTTMAN: I got a call this week from a consultant for a very large company. They’ve got an operation with about 100 headcount in Hyderabad, and they’re getting ready to shut it all down. They’re really stumbling because they underestimated the knowledge transfer issues, the cultural differences, even the time zone issues. And this is a very large company that you would think would have done the due diligence and put some governance into the engagement before ramping up. Now it’s spinning out of control.

LACITY: It’s like every new sourcing market that I have seen. The initial push is for cost savings. Senior management tends to look at IT as a commodity. People go into it with that cost focus. But by the time you get to studying the companies that are pleased with their global sourcing model, their first sound bites are always about quality, agility and flexibility.

How long does it take to move up the learning curve with offshore outsourcing?

LACITY: It depends. Sometimes it’s six months. Sometimes it’s two years. Sometimes you just abandon offshore and never go back again.

You say the management costs associated with a successful offshore outsourcing arrangement can run upwards of 50 percent of the total contract value, versus 5 percent to 10 percent for a typical domestic outsourcing relationship.

LACITY: When I was looking at domestic outsourcing 17 years ago, the transaction costs were tremendously high too. And that’s what we see now for offshoring—up to 69 percent of the value of the contract. But those costs will drop over time. They’re bigger during the learning curve when you have to do all the training, developing these deep relationships with suppliers. Eventually you start to institutionalize it and you start reaping the rewards of that initial investment.

You say one investment worth making is bringing an engagement manager over from the vendor.

ROTTMAN: For many engagements it’s a necessity. [The engagement manager] is the primary point of contact for the client’s project managers. That person will work with both the onshore and offshore development teams. They can help mitigate some of the time zone risks, the knowledge transfer risks, the cultural risks. That person is a key piece to all of this.

But an engagement manager is an expensive employee to have onsite. It’s usually a person with four to six years of experience managing projects and a lot of customer-facing duties. When managers are looking only at labor arbitrage and the delta between onshore and offshore rates, they don’t want to throw in that onsite engagement manager.

Just the physical act of bringing the offshore suppliers’ employees on board and working can be difficult.

ROTTMAN: One Fortune 100 biotech firm we looked at kept tripping over onboarding. The Indian resources do not have Social Security numbers, yet all the systems are keyed on that figure. They underestimated the effect of having to modify those systems to use passport numbers instead.

We had one case where the offshore suppliers were forced to re-create the development environment in India, because throughput through the Citrix servers was always an issue. But when they duplicated the offshore environment, they couldn’t do it exactly right. So, code that would run in Bangalore wouldn’t run in the United States. I’m still seeing infrastructure and onboarding and security issues.

What about knowledge transfer?

ROTTMAN: Knowledge transfer is a fairly significant stumbling block. To move out of the initial phases of offshoring to focus on value-add and quality, you need to manage the knowledge transfer effort with greater rigor than if you’re just focusing on cost.

LACITY: When you’re in the early stages of a learning curve, you tend to do more pilot projects. You pick things for which you already know your requirements. But as you try to use suppliers more strategically and do more value-added kinds of work, the issue of customer-specific knowledge—what is idiosyncratic about their business processes—becomes more critical. We’re looking at practices for how the client can explain and transfer knowledge about their idiosyncratic needs to a supplier. How do you do that cost effectively and not give away all your intellectual property? It’s a very delicate balance. Sounds like quite a trick.

ROTTMAN: Let me give you an example. There was a Fortune 100 industrial manufacturing firm that had significant knowledge transfer issues. They were offshoring the development of embedded GPS software—software that controls the operation of a piece of industrial equipment. It has greater memory constraints, speed concerns, et cetera, than software written in C++, or Java, or anything like that. Their first attempt at offshoring followed a throw-it-over-the-ocean model because they really thought they had their requirements down and could do it with very little onshore presence. That resulted in zero deliverables. Projects were just shelved or brought back in house.

We talked to the director of the offshore development center and the customer’s Six Sigma black belt. They realized that the supplier didn’t even know what the machinery looked like for which they were writing the code. They didn’t comprehend the concept of embedded software. And they didn’t understand the company’s business.

So they took that learning and developed extensive training and job shadowing and integration practices to make sure that the development teams were integrated as tightly into the U.S. teams as their internal employees.

How did they transfer that knowledge while protecting their intellectual property?

ROTTMAN: They broke up the projects into three- or five-day tasks that could be wrapped up and sent to an offshore development team. Then they separated those tasks among various vendors with the idea that one vendor wouldn’t have enough pieces of the IP puzzle to put it all back together. Even with the increased transaction costs, they were able to obtain between 10 percent and 15 percent cost savings on the offshored projects.

You talked to offshore customers and vendors. Did you notice a big difference in how they viewed the relationships?

ROTTMAN: There were considerable differences. A good example of the difference is that you’d hear a U.S. manager complain, "You really have to give the offshore development teams very specific instructions. They really don’t show much initiative in going out and investigating a new solution to a problem." And when you talk to someone on the supplier side, they would say, "The U.S. managers don’t give us all the information that we need. They don’t direct us. We’re kind of left on our own." What’s the biggest mistake customers make when selecting an offshore location?

LACITY:

If you’re setting up a captive center offshore, then we would suggest you pick a location because you’re in that country for another reason. You’re in that country because you’re going to sell products there. You’re in that country because you already have R&D facilities there, and you can use that as a launch pad. Don’t select a country just because they have the lowest costs or something else that’s going to change. You’ll have to move every couple of years. Is it best to use at least two offshore providers rather than putting all your eggs in one basket?

LACITY: It is a risk mitigation strategy that some client companies we talked to are happy with. I certainly wouldn’t prescribe it for everybody. It depends on the kind of work you’re doing, the volume of work and how happy you are with your initial selection of the supplier.

ROTTMAN: It also has to do with the business that you’re in and whether or not the top three or four Indian suppliers have a specialized vertical within your domain. You could add multiple suppliers, as long as they had the domain expertise.

We’ve seen some U.S. clients that can’t find their niche vertical within the larger firms, and so they go with much smaller firms because of their domain expertise. And then they have those two competing against each other for contracts and for projects. So, we have seen multiple supplier models work well for some.

LACITY: We’ve also seen single supplier models work well, too. There’s a couple of customers that are more mature that had started with a single supplier way back in the Y2K days and have continued to transfer more work, more headcount, to their sole supplier. And that supplier continues to give the customer very good attention because of the volume of the account. Does the same hold true for pricing models—fixed price contracts work well for some clients while others do better with a time-and-materials (T&M) arrangement?

ROTTMAN: It depends. We’ve seen T&M contracts work well. We’ve seen fixed price contracts work well. And we’ve seen both of those work very poorly.

Are there rules for when one pricing model works better than the other?

ROTTMAN: Fixed price carries with it considerable risk for both the client and supplier. You really have to nail down your requirements. On the other side, with time and materials, you have real issues there with scope and budget creep. And the only people talking to each other are accounts payable and accounts receivable. And the project just goes on and on and on.

LACITY: It all depends on the type of work you’re doing. If you’re doing call center work, you can do fixed price. You know exactly how much it’s going to cost per call.

ROTTMAN: And on the development side, if you’re doing something like re-platforming without increasing the requirements or capabilities of the system, both the client and the supplier are able to nail those requirements down fairly well. That might work well for a fixed price. But ongoing development with considerable analysis would really be risky.

Does owning your own offshore supplier help to mitigate risk?

Related:
1 2 Page 1
Page 1 of 2
Survey says! Share your insights in our 19th annual State of the CIO study