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\u2019d be hard pressed to find someone who\u2019s 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."\n\n Sure, there\u2019s anecdotal evidence of what\u2019s worked for some and what hasn\u2019t 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\u2019ve developed what they believe to be one of the first rigorous, peer reviewed examinations of offshoring best practices. To date, they\u2019ve interviewed more than 165 individuals from 40 companies\u2014and not just the usual suspects. Certainly, they\u2019ve 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\u2019s early examinations focused on the offshore outsourcing learning curve and best practices for accelerating it while maintaining quality and cost savings. Now they\u2019re focused on the delicate process of transferring knowledge offshore while still protecting intellectual property. The basic thrust of their findings\u2014that offshore outsourcing takes a lot more work than its domestic counterpart\u2014comes 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\u2014and worst\u2014ways to do just that.\n\nCIO: 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. \n\nYet 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\u2019ve got an operation with about 100 headcount in Hyderabad, and they\u2019re getting ready to shut it all down. They\u2019re 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\u2019s spinning out of control. LACITY: It\u2019s 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. \n\nHow long does it take to move up the learning curve with offshore outsourcing? LACITY: It depends. Sometimes it\u2019s six months. Sometimes it\u2019s two years. Sometimes you just abandon offshore and never go back again. \n\nYou 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\u2019s what we see now for offshoring\u2014up to 69 percent of the value of the contract. But those costs will drop over time. They\u2019re 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. \n\nYou say one investment worth making is bringing an engagement manager over from the vendor. ROTTMAN: For many engagements it\u2019s a necessity. [The engagement manager] is the primary point of contact for the client\u2019s 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\u2019s 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\u2019t want to throw in that onsite engagement manager. \n\n Just the physical act of bringing the offshore suppliers\u2019 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\u2019t do it exactly right. So, code that would run in Bangalore wouldn\u2019t run in the United States. I\u2019m still seeing infrastructure and onboarding and security issues.\n\nWhat 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\u2019re just focusing on cost. LACITY: When you\u2019re 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\u2014what is idiosyncratic about their business processes\u2014becomes more critical. We\u2019re 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\u2019s a very delicate balance. \n\nSounds 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\u2014software 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.\n\n We talked to the director of the offshore development center and the customer\u2019s Six Sigma black belt. They realized that the supplier didn\u2019t even know what the machinery looked like for which they were writing the code. They didn\u2019t comprehend the concept of embedded software. And they didn\u2019t understand the company\u2019s 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. \n\nHow 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\u2019t 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\u2019d hear a U.S. manager complain, "You really have to give the offshore development teams very specific instructions. They really don\u2019t 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\u2019t give us all the information that we need. They don\u2019t direct us. We\u2019re kind of left on our own."\n\n What\u2019s the biggest mistake customers make when selecting an offshore location?LACITY: If you\u2019re setting up a captive center offshore, then we would suggest you pick a location because you\u2019re in that country for another reason. You\u2019re in that country because you\u2019re going to sell products there. You\u2019re in that country because you already have R&D facilities there, and you can use that as a launch pad. Don\u2019t select a country just because they have the lowest costs or something else that\u2019s going to change. You\u2019ll have to move every couple of years.\n\nIs 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\u2019t prescribe it for everybody. It depends on the kind of work you\u2019re 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\u2019re 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\u2019ve seen some U.S. clients that can\u2019t 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\u2019ve also seen single supplier models work well, too. There\u2019s 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. \n\nDoes the same hold true for pricing models\u2014fixed price contracts work well for some clients while others do better with a time-and-materials (T&M) arrangement? ROTTMAN: It depends. We\u2019ve seen T&M contracts work well. We\u2019ve seen fixed price contracts work well. And we\u2019ve seen both of those work very poorly. \n\nAre 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\u2019re doing. If you\u2019re doing call center work, you can do fixed price. You know exactly how much it\u2019s going to cost per call. ROTTMAN: And on the development side, if you\u2019re 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. \n\nDoes owning your own offshore supplier help to mitigate risk? LACITY: Anyone who sets up a captive center wants control. In many ways, it\u2019s easier. In other ways, it\u2019s more difficult. The problem they\u2019re having is, you might be able to understand a government, the Indian federal government, for example. But when you\u2019re trying to actually buy a building, wire a building, get fire permits, hire people, it\u2019s a considerable challenge. \n\nAnd they\u2019re trying from the get-go to set up a captive center? They didn\u2019t opt for the build-operate-transfer model with a third party? LACITY: Yes. And what\u2019s interesting is that they think they\u2019re able to get better talent in India because it\u2019s prestigious for [the Indian applicants] to come work for this large, well-known U.K.-based company. Still, the HR issues in India are quite challenging. \n\nHaving traveled to India, did you see any evidence of the increased turnover problems we\u2019ve been hearing about? ROTTMAN: Absolutely. I spent a couple hours with the gentleman who runs the technology park in Hyderabad. He predicted that the demand for freshman college graduates out of the Indian schools would exceed the supply by 2008. And with the demand increasing, you\u2019re going to see a lot of turnover, just as it happened during our own dotcom boom with people jumping jobs. Turnover affects the knowledge transfer. It affects the protection of the capital expenditure for training. Turnover continues to be mentioned over and over again by the clients we talk to. \n\nWere you able to tease out any best practices for dealing with the turnover issue specifically? ROTTMAN: The industrial manufacturing firm, in order to mitigate some of that risk, required the supplier to shadow employees, so that knowledge transfer actually was overlapping between two people. The clients would have a key training session over a few months to transfer knowledge from its architects and the lead project managers to the supplier\u2019s project manager. Once that project manager was up to speed, he was shadowed by another colleague on the supplier side. So there were two people essentially doing the same job for an overlap period of three to six months. After that happened, then the initially trained employee went offshore and transferred the knowledge to the offshore development team, while the shadowing employee stayed. They would do this over and over again with a three- to six-month overlap to ensure that if one of those people did leave then the knowledge was contained in another person. LACITY: And the other thing is, these Indian employees wanted to go home. They don\u2019t want to stay in America for five years. \n\n Indian software development companies value the software quality processes and procedures as laid out by the Software Engineering Institute\u2019s Capability Maturity Model (CMM). The leading Indian vendors are usually assessed at CMM Level-5 status, yet their customers may not understand it all. Can that create problems?LACITY: Yes. We found a lot of that. CMM is what this offshore supplier delivery team is trained in. They are expecting requirements to come over in that form. That\u2019s the start of their work processes. We talked to one Indian CEO who found an interesting solution. You bring over to the U.S. a CMM expert from the vendor who doesn\u2019t know anything about the specifics of your business. Then that person can flesh out all the ambiguities and ask all those questions here when they\u2019re sitting right next to the client, rather than throwing it offshore and waiting for a whole team to ask the same set of questions. [See "Bridging the CMM Gap"]\n\nAll those CMM processes can frustrate clients who are used to walking down the hall to ask a developer to make a change. You say there might be some middle ground between the rigid processes of the offshore developer and the way a client is used to working, called "flexible CMM." ROTTMAN: There was a retailer who had an engagement with a supplier that was robust enough that they could say, "You do whatever you have to do to maintain your CMM processes, but I\u2019m not going to pay for all of that. If I just need a button moved, I want the button moved. I\u2019m not going to pay for a 20-page impact analysis of the movement of the button." That customer had enough clout and a strong enough relationship with the vendor to impose a flexibility on them.\n\n Are most offshore providers willing to be that flexible with their CMM processes? ROTTMAN: It depends on the relationship and the vendor\u2019s size. If those processes are not billable, then the engagement has to be large enough that the vendor can absorb those costs. LACITY: If you look at some of the key process indicators and CMM, they\u2019re really geared towards the benefit of the supplier organization. For example, there\u2019s all kinds of processes that deal with tracking defects. Well, those reports aren\u2019t going over to the customer. The supplier is using them internally to fix the software as best they can before it goes over to the client. So, CMM is really about the internal processes primarily used within the organization that\u2019s adopted it. That\u2019s why I think some of the customers say, "I\u2019m paying for all your processes, and I really only want the ones that are customer-facing and adding value to me." \n\nIs it still important for the client to improve its own CMM capabilities if it wants to source work offshore? ROTTMAN: CMM capability is necessary but not sufficient for knowledge transfer. You have to have that framework in which to work. But that structure by itself is no substitute for experience. It does help in requirements definition and process mapping. But it\u2019s no substitute for knowing the people offshore and how they work. It\u2019s no substitute for real experience or social capital.\n\nWhat do you mean by social capital? LACITY: Work gets done by people. It doesn\u2019t get done by processes. It doesn\u2019t get done by documentation. If you want to put an umbrella over all the things that we\u2019ve talked about\u2014an onsite engagement manager, job shadowing, bringing over a CMM expert from overseas\u2014it\u2019s really about building the social capital between the customer and the supplier. It\u2019s not only about knowing the business. It\u2019s knowing who in the business does things. How do they do it? And once that social capital is developed, then knowledge transfer occurs. You develop better relationships with your supplier. Your quality goes up. And you have more satisfied supplier employees who want to stay on the account, so turnover goes down. It\u2019s so simple. Of course, everybody needs to meet face to face. Of course, everybody needs to develop a personal relationship. But it\u2019s expensive to bring people over from India here. It\u2019s expensive to send people here over to India. And so customers don\u2019t start doing it until they let up on costs and say, "I\u2019ve got to make an investment in this social capital that\u2019s going to let me finally achieve what I\u2019m expecting to get from offshoring."\n\n Has anyone figured out the best metrics for measuring the success of an offshore relationship? LACITY: I think the best you\u2019re going to get is if you try to do some kind of Balanced Scorecard\u2014a bunch of measures that will help you capture the big picture.\n\n The biggest problem practitioners have is trying to figure out at a fundamental level how much money they\u2019re saving. And it\u2019s very difficult to know, because you\u2019re not doing this in a lab. You don\u2019t say, "OK, you go develop this software onsite, you go develop it offshore, and we\u2019ll compare the cost." So, they try to guess: how many hours would this have taken me onshore versus doing it offshore? Or they go ask their internal staff, "If you were to do it, how many hours would it take?" Well, is that number valid? It\u2019s very difficult to know how much you\u2019re really saving. \n\nDespite all the work, you talked to some offshore outsourcing customers that were at a point where they were happy with the arrangement. LACITY: Those are some of our companies that have been doing it the longest, have conquered the learning curve, and have a significant global presence and substantial supplier relationships. But that\u2019s like the prize after the end of a very, very long marathon. ROTTMAN: A good example is the industrial manufacturer who failed at first. When you talk to them now, they can\u2019t find enough projects to send offshore. Their internal staff is happy. They\u2019re back to working 50-hour weeks instead of 70-hour weeks. Their project backlog is down. Their costs are down. Their quality is up. LACITY: We work in a global economy, and IT work needs to be done globally. Even if you\u2019re talking about domestic outsourcing, most of that IT work is sourced globally. So I think eventually we\u2019re going to stop talking about domestic outsourcing versus offshore outsourcing and just talk about global sourcing.Senior Editor Stephanie Overby can be reached at email@example.com.