Offshore Outsourcing - The Hidden Costs of Selecting a Vendor

The current stampede toward offshore outsourcing should come as no surprise. For months now, the business press has been regurgitating claims from offshore vendors that IT work costing $100 an hour in the United States can be done for $20 an hour in Bangalore or Beijing.

If those figures sound too good to be true, that’s because they are.

In fact, such bargain-basement labor rates tell only a fraction of the story about offshore outsourcing costs. The truth is, no one saves 80 percent by shipping IT work to India or any other country. Few can say they save even half that. As just one example, United Technologies, an acknowledged leader in developing offshore best practices, is saving just over 20 percent by outsourcing to India. (For more, read "Inside Outsourcing in India," www.cio.com/printlinks.)

That's still substantial savings, to be sure. But it takes years of effort and a huge up-front investment. For many companies, it simply may not be worth it. "Someone working for $10,000 a year in Hyderabad can end up costing an American company four to eight times that amount," says Hank Zupnick, CIO of GE Real Estate. Yet all too often, companies do not make the outlays required to make offshore outsourcing work. And then they are shocked when they wind up not saving a nickel.

The Cost of Selecting a Vendor

With any outsourced service, the expense of selecting a service provider can cost from .2 percent to 2 percent in addition to the annual cost of the deal. In other words, if you’re sending $10 million worth of work to India, selecting a vendor could cost you anywhere from $20,000 to $200,000 each year.

These selection costs include documenting requirements, sending out RFPs and evaluating the responses, and negotiating a contract. A project leader may be working full time on this, with others chipping in, and all of this represents an opportunity cost. And then there are the legal fees. Some companies hire an outsourcing adviser for about the same cost as doing it themselves. To top it off, the entire process can take from six months to a year, depending on the nature of the relationship.

Vice President of Program Solutions and Management Ron Kifer spent several months on vendor selection before contracting with Bangalore, India-based Infosys to handle a whopping 90 percent of development and maintenance work for DHL Worldwide Express, a shipping company. "There’s a lot of money wrapped up in a contract this size, so it’s not something you take lightly or hurry with," Kifer says. "There has to be a high degree of due diligence making sure that the [offshore] company can respond to your needs."

Even when there is an existing tie between customer and offshore vendors, the expensive and lengthy step of vendor selection is a must-do for successful outsourcing. The chairman of Tata Consultancy Services (TCS), a Mumbai, India-based outsourcer, sat on the international advisory board of Textron, a manufacturing company that owns such brands as Cessna Aircraft and E-Z-GO Golf Carts, for several years. However, when David Raspallo, CIO of business unit Textron Financial, began exploring offshore outsourcing in 1999, he still spent five months doing what he calls "the usual Betty Crocker Bake-Off" with service providers Covansys, ITS, TCS and Wipro. Ultimately, he went with U.S.-based Covansys, which has three development centers in India. Selecting the vendor took 500 hours in total, involved Raspallo and three senior managers, and cost $20,000 in additional expenses.

Bottom line: Expect to spend an additional 1 percent to 10 percent on vendor selection and initial travel costs.

By Stephanie Overby cio.com

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