Top 10 Risks of Offshore Outsourcing

Offshore outsourcing is on a steady growth path, growing about 20%-25% per annum, with little evidence of slowing. Though enterprises experience initial resistance, most technical issues are readily resolved and geopolitical risk is deemed insignificant after careful evaluation. Even the current political fervor about jobs being moved offshore via outsourcing is not impacting the demand or strategy of IT organizations.
No matter which country you choose as your outsourcing destination, be sure to analyse its statistics in depth, as choosing the right outsourcing destination and partner can go a long way in ensuring that you reap huge benefits.
Outsourcing is not bereft of risks. The risks in outsourcing need to be successfully addressed to ensure your companys productivity. The top 10 risks of offshore outsourcing are as follows:

1. Cost-Reduction Expectations

The biggest risk with offshore outsourcing is that of cost reduction expectations. Companies that outsource their business functions assume that labor arbitrage will yield savings comparable to person-to-person comparison (e.g., a full-time equivalent in India will cost 40% less) without regard for the hidden costs and differences in operating models. In reality, most IT organizations save only about 15%-25% during the first year; by the third year, cost savings often reach 35%-40% as companies "go up the learning curve" for offshore outsourcing and modify operations to align to an offshore model.

2. Data Security/Protection

This is another risk that IT organizations evaluating any kind of outsourcing need to successfully tackle. Before deciding on an outsourcing supplier, be sure to check if they have sufficiently robust security practices and if they can meet the security requirements they have internally. While most IT organizations find offshore vendor security practices impressive (often exceeding internal practices), the risk of security breaks or intellectual property protection is inherently raised when working in international business. Privacy concerns must be completely addressed. Although these issues rarely pose major impediments to outsourcing, the requirements must be documented and the methods and integration with vendors defined.

3. Process Discipline (CMM)

The Capability Maturity Model (CMM) becomes an important measure of a companys readiness to adopt an offshore model. Offshore vendors require a standardized and repeatable model, which is why CMM Level 5 is a common characteristic. Companies lacking internal process model maturity will undermine potential cost savings.

4. Loss of Business Knowledge

Most IT organizations have business knowledge that resides within the developers of applications that may be of a proprietary nature or competitive advantage. Companies must carefully assess business knowledge and determine if moving it either outside the company or to an offshore location will compromise company practices.

5. Vendor Failure to Deliver

Even with the superb quality methodologies of offshore vendors, they may sometimes fail to deliver. When considering outsourcing, IT organizations should assess the implications of vendor failure and should have a contingency plan ready. If such a situation arises, the organization must be ready to shift the outsourcing strategy (e.g., from a single vendor to multiple vendors). The results of risk analysis vary between companies; it is the process of risk analysis that is paramount.

6. Scope Creep

There is no such thing as a fixed-price contract. All outsourcing contracts contain baselines and assumptions. If the actual work varies from estimates, the client will pay the difference. This simple fact has become a major obstacle for IT organizations that are surprised that the price was not "fixed" or that the vendor expects to be paid for incremental scope changes. Most projects change by 10%-15% during the development cycle.

7. Government Oversight/Regulation

IT organizations must ensure that the offshore vendor is sensitive to industry-specific requirements and the vendors ability to: 1) comply with government regulations; and 2) provide sufficient "transparency" showing that it does comply and is thus accountable during audits. The issue of transparency is becoming more significant as requirements such as the USA PATRIOT Act and the Sarbanes-Oxley Act place greater burdens of accountability on all American corporations.

8. Culture

Cultural differences are a sensitive issue in outsourcing. Though English is spoken throughout India, pronunciation and accents can vary tremendously. Therefore, many vendors put call center employees through accent training. In addition, cultural differences include religions, modes of dress, social activities, and even the way a question is answered. Most leading vendors have cultural education programs, but organisations should not assume that cultural alignment will be insignificant or trivial.

9. Turnover of Key Personnel

Rapid growth among outsourcing vendors has created a dynamic labor market, especially in Bangalore, India. Key personnel are usually in demand for new, high-profile projects, or even at risk of being recruited by other offshore vendors. While offshore vendors will often quote overall turnover statistics that appear relatively low, the more important statistic to manage is the turnover of key personnel on an account. The impact of high turnover has an indirect cost on the IT organization, which must increase time spend on knowledge transfer and training new individuals.

10. Knowledge Transfer

Most IT organizations experience a 20% decline in productivity during the first year of an agreement, largely due to time spent transferring both technical and business knowledge to the vendor. The time and effort to transfer knowledge to the vendor is a cost rarely accounted for by IT organizations. Many offshore vendors are deploying video conferencing (avoiding travel) and classroom settings (creating one-to-many transfer) to improve the efficacy of knowledge transfer. In addition, employee turnover often places a burden on the IT organization to provide additional information for new team members.
Business Impact: Offshore outsourcing can reduce IT expenditures by 15%-25% within the first year. Longer term, process improvements often make great impacts on both cost savings and the quality of IT services delivered.
Bottom Line: As IT organizations consider the vast benefits and allure of offshore outsourcing, they must balance the risks and uncertainties with the potential for labor arbitrage.