How To Reduce Offshore Hidden Costs

According to a CIO article published in 2003, if you’re sending $10 million worth of work to India, selecting a vendor could cost you anywhere from .2% to 2% of the price each year — $20,000 to $200,000. Likewise, it stated that the transition costs could be the most expensive aspect of the offshoring endeavor. Should vendor selection be that expensive? What are the reasons for the high cost of transitioning work? In this article, we discuss some of the reasons for the high price tab for these phases of offshoring and provide you with some best practices for reducing the expense.

Common Vendor Selection Method #1: Do It Yourself

A common approach for companies new to offshoring is to task some manager with responsibility for the vendor selection. Frequently, it’s somebody chosen because he or she originated from one of the countries under consideration — not because that person has the ability to understand the dynamics of offshore outsourcing.

This presumably highly paid manager spends anywhere from three to nine months learning about the offshore industry, talking to 20 or 30 vendors, implementing a detailed vendor selection process with multiple short-listing phases, and finally in site visits, contract negotiations and selection of the vendor. This method is often filled with risks. There are many hundreds of offshore service providers spread across India, China, Russia and other parts of Eastern and Central Europe. Even though most of the vendors claim that they can do everything, the needed domain expertise typically only resides with a select few. There’s a high probability that the vendors that will quickly fall out of the running are those that have contacted the company directly or those the company heard about via the media.

Companies spend anywhere between $20,000 and $70,000 on the salary of the internal vendor selection manager. (That assumes that vendor selection is one of several projects handled by that person.) Travel, communication and the time-cost of senior management and engineering resources increases the price tag.

Common Vendor Selection Method #2: Onsite Consultant

Companies are increasingly starting to hire consultants to advise them in their offshore strategy and help them select the vendor. The high price of the consultants oftentimes offsets the advantage companies gained in reducing the internal management time and overall vendor selection time. Frequently, the consultants hired don’t have an offshore presence and lack timely knowledge of current offshore market realities.

Service Provider Selection Cost Reduction Strategies

Is there a better way? Here are two cost reduction strategies to consider.

1. Try peer-based vendor guidance. One way to reduce the cost is to make sure the vendor selection process is short and that only a few appropriate service providers are included in the selection process. Develop your initial list of vendors by talking to your peers in other companies with similar domain needs and who have mature offshore initiatives. You can find them at conferences and in the online discussion forum at Sourcingmag.com. If you’re with a software product company, you can use your investor network to find out what providers are being used by some of the portfolio companies.

2. Use specialist consultants. Another emerging option is the use of consultants that specialize in developing an offshore strategy and doing vendor selection. Offshore consultant costs are often only a fifth to a third of the expense of an onsite consultant. Due to their geographic proximity to the vendors, they often have current information about prospective vendors and can help companies make better choices.

Companies that follow these cost reduction strategies can effectively bring down the cost of service provider selection to $10,000 to $20,000 — a considerable reduction from the $20,000 to $200,000 quoted by CIO.

Next Area of Hidden Expense: Transition Costs

The success of the transition process often defines the success of the offshore initiative. To be on the safe side, companies are increasingly spending more during the transition process. Arranging for onsite or offshore team visits or a combination of both is a key transition mechanism that has proven to have a high success rate. However, the associated costs can sometimes be prohibitive.

Here’s a sample of the costs involved.

Assumption: This three-year project is worth $5 million/year and the number of offshore resources is around 120.

a. Offshore team visit to onsite
Team size = 12 engineers
Billing rate = $3,000/month
Onsite living expense = $3,000/month
Travel = $2,000/month
Total: 3 months of visits by 12 offshore engineers = ~$288,000

b. Onsite visit to offshore
Usually the number of client’s engineers needed to visit offshore during the knowledge transfer is smaller than the number required to visit onsite.
Team size = 5 engineers
Salary = $8,000/month
Offshore living expense = $2,000/month
Travel = $2,000/month
Total: 3 months of visits by 5 offshore engineers = ~$180,000

c. Combination of both
We estimate that the combination of both with shorter offshore and onsite visits will cost around $230,000.

The transition cost should be calculated as a percentage of the project cost over a period of three years due to the length of offshore engagement. The transition cost is approximately 1% to 2% of the project cost for a transition period of three months. Also, because the offshore team isn’t productive during this period, the cost of the rest of the offshore team (~$1 million for three months) should be added to the transition cost. That brings the transition cost to about 8% of the total project cost — with the client actually losing money during the initial months.

Best Practices To Reduce Transition Costs

1. Frequently, companies can find expert members of the client team that want to move back to the country to join the offshore team. Those people should be leveraged for knowledge transfer and to act as liaisons between the onsite and offshore teams.

2. Only a part of the offshore team should be hired during the transition phase. The rest of the team should be hired only after the knowledge transfer to the core offshore team is complete. This will save as much as 4% to 5% of the transition cost.

3. Use collaborative tools such as Webex, Microsoft Office Live Meeting, Windows NetMeeting and other video conferencing technologies to lessen the need for people to be present at the same location. These technologies can be used to conduct training sessions and code walkthroughs to help in the transition process.

4. A few members of the client’s team should be moved offshore for at least a year so that they can take ownership of the offshore projects and accelerate the knowledge transfer. The salary for the resources moving offshore should be structured competitively to the existing offshore salary, not to their onsite salary. If not, cost savings from going offshore will be reduced.

5. The offshore team should be involved in projects that will provide value add from the first day and still help them in the knowledge transfer. Some examples are architecture review, bug fixing, and source code and functional documentation.

6. Using online tutorials or webinars, you can devise a mechanism for the offshore team to become certified based on the requirements (technology, product familiarity, etc). This certification process can speed up the transition cycle and address a possible skills gap with offshore resources.

7. Service providers usually want the client to pay the transition costs against actuals. However, it’s possible to negotiate the contract with the vendor to achieve some of the following:

  • The transition cost should be added to the monthly billing rate and spread across the duration of the project.
  • Initially, the service provider should absorb the transition costs. The transition cost can then be factored into the contract as an incentive to the vendor, depending on the schedule and quality of its deliverables.
  • Some vendors that are keen on getting the project might be willing to absorb the entire transition expense.

These best practices can help reduce transition costs to 2% to 3% of the entire project cost and shrink the initial investment needed for those expenses.

Useful Links

Zinnov Research
http://www.zinnov.com/whyzinnov_research.html

Read more practical advice about working with offshore teams on the Zinnov Web site blog:
http://www.zinnov.com/blog/index.php

Webex
http://www.webex.com/

Microsoft Office Live Meeting
http://www.microsoft.com/office/rtc/livemeeting/default.mspx

Microsoft Windows NetMeeting
http://www.microsoft.com/windows/netmeeting/