by Pam Baker

Is Outsourcing Cost-Effective?

Apr 07, 20098 mins

Efforts to reduce IT costs to meet budget reductions often include outsourcing, but in the current economy, will it actually help the bottom line?

For years now, companies have rushed to find cheap labor and increased profits in foreign lands. The move was a play to make bottom-lines blacker, company coffers deeper and corporations safer. The thinking was that global corporations would be more secure and more profitable if their operations were spread amongst many economies rather than anchored to one. But given the domino failures in economies worldwide, has offshore outsourcing helped or harmed enterprises in the final count?

“Globalization created so many hyper-competitive markets that many imploded,” says Dan Brown, adjunct professor in the Segal Design Institute, McCormick School of Engineering and Design at Northwestern University. He is also founder and president of Loggerhead Tools. “The continuous drive to lower prices is harmful to the company and the market.”

But therein lies the rub. Under severe economic pressures, consumers often demand unreasonably low prices which beleaguered companies most often achieve by outsourcing offshore. This leads to job loss which leads to more consumer demand for even lower prices. Margins then disappear and companies fold. The fear is that this chicken and the egg dilemma may leave everybody’s goose cooked.

Brain Freeze

For the moment, the dilemma is frozen in time. “Since September 2008, Canadian outsourcing transactions have not increased, but neither have they decreased,” says Mark Schrutt, director of Outsourcing Services at IDC Canada. “There is a lot of interest in increasing offshore outsourcing, but no movement, as companies are waiting to see what settles out.”

The situation is much the same worldwide, including in the U.S. As heads of state charge to battle, stoked by populist demands, and banks continue to hoard cash and credit, leaders of companies everywhere are frozen in confusion. “A lot of executives are stalled out and not making a decision,” says Frank J. Casale, founder and chief executive officer of the Outsourcing Institute (OI), a professional outsourcing association.

The Outsourcing Institute conducted a recent poll of 50 leading advisers, representing over 500 outsourcing deals. When asked the main reason why most outsourcing deals have become stuck over the past six months, the majority, 38 percent, said executives are not willing to make any major commitment at this time. Another 24 percent cited the economic situation while 14 percent said there were “too many distractions/too much going on to be able to focus.” In other words, chaos reigns.

Sooner or later though, the heat applied by so many outside forces will thaw corporate honchos and force them into action.

“Once business executives get out of analysis paralysis and decide to take action it usually works as follows: Action, i.e business decision, is always taken based on either (1) Fear (2) Pain or (3) Hope,” says Frances Karamouzis, vice president of Research at Gartner. “And in today’s environment, most executives are taking decisions because of either (1) or (2). And when people operate from a place of Fear or Pain—they usually think very short term and myopic. Thus Gartner does believe there will be a lot of ‘bad outsourcing’ deals that are signed during this time.”

Unfortunately, bad outsourcing deals are likely to worsen corporate standings as both new outsourcing deals and renegotiated existing deals tend to obligate companies for longer time periods than normal. “That’s because in order to renegotiate or drive a new deal for lowest possible costs, you have to give the vendor something and that something is almost always either an extension of terms or more services,” says Schrutt. “Vendors are very open to this to keep the business.”

New Deal, Raw Deal for India

All this renegotiating for even lower costs is driving many vendors in previously favored geographies, like India, to offshore outsource as well. “Solid, savvy vendors who once experienced 30 percent growth rates will struggle for 10 percent growth,” says Gartner’s Karamouzis. “Those who were experiencing much more modest growth rates and struggling to compete and differentiate themselves will really take a hard hit and there will be downsizing of the market in a very Darwinian way.”

According to a study released this week by the London School of Economics and Political Science (LSE), India is no longer the first choice for U.S. companies to offshore their technical services further pressuring vendors there to outsource. “The market has matured, employees are demanding higher pay and salary structures and India is now becoming attractive for its higher quality value-added services,” says Professor Leslie Willcocks, director of the London School of Economics (LSE) Outsourcing Unit. “Thus, creating the perfect storm of upward pressure on wages, combined with rising labor turnover rates. This has resulted in India and China increasing their own offshoring of IT and BPO work to other countries.”

The upshot: U.S. companies are getting better terms from existing offshore outsourcing vendors but at greater risks as chain-outsourcing can mean less control of data, product quality and intellectual property. It also likely means India’s recently developed middle class will suffer a downslide. While few U.S. companies will, or even can, untangle their current involvement with vendors in India, those vendors will shuffle work to other countries creating the same macro-economic effect in India as exists in the U.S. today.

As for China: the U.S. toy manufacturing industry, for one example, has largely moved from China to Vietnam and is unlikely to ever return. However, China is being considered by some companies looking to move out of India or to expand the global nature of their overall outsourcing strategy.

U.S. companies that have not previously gone the offshore outsourcing route, but are now looking to make the move due to current economic pressures, are not likely to select India or China. “This year we are seeing three global factors that are causing U.S. technology companies to pull back from traditional outsourcing locations, led by the recent boom and bust of the worldwide economy,” said Douglas Sirotta, a Partner in BDO Seidman’s Technology Practice, in a prepared statement. “Satyam’s fraud case and the terrorist attacks in Mumbai are causing a lot of companies to reconsider operating in India. And supply chain and shipping cost issues in China are negatively impacting the attractiveness of outsourcing technology operations to the Far East.”

Where Companies are Going

The Outsourcing Institute poll revealed 52 percent of respondents plan to decrease US outsourcing activity for 2009 as compared to 2008 while 34 percent plan an increase and 14 percent plan to hold tight. These are purely business, rather than political, decisions.

By all accounts, public policy has little to no effect on offshore outsourcing activity. “Outsourcing in general and offshore outsourcing in particular has not been significantly affected by government policy—neither that of the previous U.S. administration nor that of the current administration,” says Michael Corbett, chairman of the International Association of Outsourcing Professionals (IAOP), the global standard-setting organization and advocate for the outsourcing profession.

A recent survey of IAOP’s global membership found that the current economic and political climate is causing about 10 percent of organizations to look at curtailing offshore outsourcing, but 30 percent—or three times as many—are looking to expand their offshore outsourcing, says Corbett.

The 2009 BDO Seidman Technology Outlook Survey, which examined the opinions of 100 chief financial officers at leading technology companies located throughout the U.S., found the currently most common non-U.S. locations for outsourcing are India (50 percent), Southeast Asia, including the Philippines (31 percent, down from 50 percent in 2008), China (19 percent, down from 46 percent in 2008), and Western Europe (19 percent). But, future outsourcing plans show a different alignment in the same survey: the CFOs most frequently cite the United States (22 percent), followed by China (16 percent), India (13 percent), Southeast Asia, including the Philippines (7 percent), Latin America (7 percent), Western Europe (6 percent), Canada (5 percent) and Eastern Europe (3 percent).

The potential re-emergence of the U.S. as a prime sourcing geography is a savvy move reminiscent of the green movement that purportedly aims to save the environment. “While companies are quick to claim they are going green in order to rack up public approval and branding points, many are actually just reducing their power costs, a play often referred to as ‘green washing,'” says Brown. Similarly, if U.S. companies come to realize they must preserve the world’s largest consumer market in order to regain and maintain a solid customer base, they can easily score huge political and consumer points by appearing to bring jobs home in a patriotic move, when they are really stabilizing the market and re-capturing sales.

Such a move would be protectionism of companies rather than countries. “We have seen growing backlash to international outsourced call centers, resulting in companies demanding to bring call center agents back home,” says inContact CEO Paul Jarman. “A growing response has been homeshoring, or employing call center agents from their homes.” Contact centers comprised of at-home agents have much lower operating costs than traditional centers—as much as $25,000 per agent, per year, according to the International Telework Association and Council, he says.

While short-term profits are paramount; long-term profits and growth are equally crucial. Stabilizing the world’s largest consumer market would go far in rebuilding profits in companies worldwide. That does not mean, however, that offshore outsourcing is on its way out.

“The short term future of offshore outsourcing is certainly a rocky road filled with a lot politically incorrect headlines coupled with much more scrutiny on the business case and decision making approach,” says Gartner’s Karamouzis. “However, the business model is sound and given globalization is not a cyclical trend but rather a permanent fixture in new market realities—offshore outsourcing will once again prevail as a viable and acceptable business model to employ.”