OFFSHORING - WISH YOU WERE HERE? Stewart Crane and Bob Heath, Bluerock Consulting The traditional holiday season may be over, but many executives are now planning foreign adventures, although this time not to increase tans, but to reduce costs. Offshoring: a small word with immense implications and diametrically opposed crusaders and critics, as demonstrated in the recent controversies embroiling HSBC and Lloyds TSB. Those in favour cite reductions in skilled labour costs of up to 76%, whilst those against claim predicted job losses akin to those in the UK manufacturing sector in the 1980s, with research group Forrester predicting the loss of up to 750,000 jobs in the UK alone. Those in favour claim that the capital released from cost savings will be invested in innovative business areas and hence create new jobs. Those against claim that hidden costs and risks will mean little realised corporate gain. The argument goes on. Whatever your opinion, offshoring appears to be here to stay: already 30% of the top 100 financial firms have existing offshoring operations, a figure which Deloitte expects to increase to 75% within the next two years, giving an annual cost saving of £82 billion in the next five years. In light of the current gloomy economic conditions where competitive survival for many companies is seen to be dependant on costs being cut further without impairing capability, the promise of between 30% and 70% savings from quality-accredited offshoring companies appears to be far too good to pass up on, and the potential saviour of many companies" profits (and their executives" bonuses). But, whilst there have been many high profile successes such as Citigroup and GE Capital, offshoring is, quite literally, playing on someone else"s territory. Behind the glossy brochures, somewhat akin to the building site lurking just outside the scenic photo of your dream holiday hotel, there are many risks and issues that need to be addressed in order to achieve that success. Arguably the main potential pitfall is that many of the costs involved in the transition of a capability overseas are not immediately apparent, and these may result in the return on investment taking significantly longer to achieve than expected. Indeed, CIO magazine in the US claims that "hidden costs" can add between 15% and 57% on top of the basic contract cost. Of these costs, many are simply extensions of those in traditional outsourcing arrangements, for example vendor selection and redundancies (TUPE is often not an option when choosing an offshore outsourcing partner). Many more, however, are new to offshoring, such as import taxes and customs duties, or are additional costs required to mitigate for uncertainties in, for example, exchange rates. Although offshoring does not necessarily involve outsourcing to a third party, the basic offshoring cost framework can be derived from the application of standard outsourcing principles, the main challenges being unfamiliarity with local conditions hence increasing complexity and uncertainty. To reduce this, offshore vendors should be able to provide specific cost details and validate planning assumptions relating to their domicile, however the best option is to ensure that the vendor is responsible for all costs incurred outside of the "home" country. At a high level, the key costs and issues can be broken down into the following areas: 1. MANAGEMENT Management of a remote capability is always much more complex and hence expensive. However implemented, it is likely that the selected provider will be experienced in the process, whilst the buying company isn"t, resulting in an asymmetry of experience which requires the utilisation of more specialist resources who can bring to the table hands-on experience. The following lessons learnt demonstrate some of the typical complexities involved: 1.1 Don"t assume anything is common Even where the selected offshore company has staff with excellent spoken English, communication between individuals and project teams will undoubtedly prove to be the single hardest challenge. Meetings held by teleconference, and unfamiliarity with accents on both sides, can easily lead to misunderstandings and unproductive meetings. Similarly, what may be common terminology and processes (for example credit card processing) in the home country, or even the company seeking to offshore, may be unfamiliar or have a different meaning in the offshore vendor"s country. This must be addressed by ensuring that staff with appropriate language and / or listening skills are available on both sides of the phone line so that nuances in the conversation can, if required, be readily clarified following the call. 1.2 Yes doesn"t always mean yes Understanding the vendor country"s culture is key to successful management. This is particularly true of Asian and Far Eastern cultures where the immediate response may be "yes we can do it", whereas the appropriate response should have been "no we can"t do it" or "can you provide more information". This can cause particular problems where solutions are proposed for discussion, but instead are simply agreed to. In a Western culture, unrealistic proposals would be argued against and rejected by the provider, whereas some other cultures may simply agree, despite subsequent inability to deliver. 1.3 Any change is a potential cost This is a truism for any sourcing relationship, but is particularly true with offshoring where a "change" may be triggered as a result of a misunderstanding due to language and / or terminology. Thorough due diligence and careful specification of what is required of the vendor - ideally in face-to-face conversations and / or workshops - is the only way to reduce the risk of post-contractual changes being identified. 1.4 Communications is the single largest challenge A robust and reliable communications infrastructure is a prerequisite without which any offshoring of business process cannot operate. Unless the purchasing organisation wishes to duplicate its application infrastructure offshore, it is likely that the offshoring team will be given access to the organisation"s own host systems. Failure of this access can leave dozens of staff at the offshore locations twiddling their thumbs at your expense. Stringing communications within the UK together with inter-continental links and local networks in the offshore country can lead to a complex communications infrastructure with unclear ownership that makes problem resolution difficult, and requires dedicated communications planning. 1.5 There is no substitute for having people on the ground This is particularly true during implementation and the early days following go-live when it is essential that issues are rapidly addressed. Having people on the ground who are familiar with the client organisations" systems and processes can be invaluable in cutting through the language, culture, and political (no supplier likes to admit problems) barriers. Unchecked, these have the potential to bedevil the go-live period, and to sour relationships from early on. 1.6 Pragmatic, scheduled monitoring must be implemented at all levels Seen as a high-profile, high-risk venture, offshoring will require extensive monitoring and reporting to ensure stakeholder buy-in. Activities such as invoicing, auditing, monitoring against metrics, and requirements change management all require implementation across both "home" and offshore parts of the business, although care should be taken that these are not sufficiently intolerant that the offshore team manage to the metrics rather than business objectives, resulting in inflexibility. Additionally, many communications which would normally be handled informally must now be scheduled, and it is critical that regular meetings are booked right from the outset. These may result in inefficient communications, but will at least ensure that issues are correctly identified and resolved in a timely manner. 2. STRATEGY DEVELOPMENT Research by a number of organisations has indicated that the highest success rate for offshoring corresponds to those companies who spent longer developing a comprehensive strategy and implementation plan, including detailing what capabilities to offshore, and what business model to adopt. The majority of offshoring to date has involved either call centres switching some of their operations offshore or IT development and operations (Gartner predict that by 2008, a quarter of all technical IT jobs will be centred in low-cost, developing world countries like India). But that"s not where it stops. Practically any non-customer facing activity can be successfully offshored: data entry, finance and accounting, processing, administration, underwriting and many other functions have all been successfully offshored, with the list being limited primarily by the appetite for risk, the criticality of the capability and the level of end-customer interaction involved. Before a final decision can be made, IT systems implications must also be considered, as not all applications work well across long distance communications networks. Typically, traditional session-based applications may work less well than those written using newer, internet-based technologies, although systems offshored should ideally be wellestablished, and with few interfaces. The selected capability(s) can be offshored via a number of business models: it is a common misconception that offshoring always involves outsourcing, whereas the term equally relates to creation of captive business capabilities in a remote, lower-cost location, and various hybrid models in between. Invariably the most important factor in selecting the best business model, beyond simple price concerns, is the balance between understanding of the environment in which the capability is to operate, and consideration of the levels of control to be maintained over the offshored capability. However, other factors that must also be considered are the flexibility of the solution, and the speed with which initial set-up and subsequent changes can be implemented. 3. SELECT LOCATION AND/ OR VENDOR Often the starting point in the selection process, the country (and city) where the offshored capability is to be based must be chosen through a detailed analysis of candidate locations. Whilst the country predominating offshoring headlines has recently been India, many other countries such as China, Thailand, and Brazil are also heavily promoting their capabilities, whilst "nearshore" options which balance lower risk against higher wages, such as Ireland and Hungary, are yet another possibility. Factors which need to be considered in making this decision include IT and communications infrastructures, geopolitical and reputational risk, taxation, legislation, English proficiency, average wages, ongoing availability of staff, and economic stability (inflation, interest rates, exchange rates). Particularly for developing countries, predicting future conditions can be a high risk activity, and it is necessary to employ someone with an intimate local knowledge to minimise this. Where relevant, vendor selection is similar to any outsourcing arrangement, although typically more costly due to increased requirements such as remote infrastructure access, and greater due diligence being required to compensate for unfamiliarity in the vendors and local conditions. Due diligence must also be performed to ensure compliance with security and regulatory requirements. Where the vendor does not have a local presence, problems with remote communications and cultural differences, must be built into the time and cost allocated to the selection process. Irrespective of this, however, vendor selection plans must include visits to the vendor to examine their capabilities in action. 4. TRANSITION & OPERATION Transition of a business capability offshore usually takes longer than a standard outsourcing transfer. A typical transfer to an offshore vendor may take between three months and a year, a period which will require extensive travel by all parties to effect the required skill transfers, procedural development, resolve implementation issues, etc. In planning for such a transition, there are four main areas which must be addressed: 4.1 Systems A systems development strategy must be developed to cover those situations where existing applications are either inadequate to cope with remote teams, as discussed above, or require modification to meet the increased requirements. It may in fact be appropriate to make use of the timing of any systems rework to upgrade an existing system, or perhaps to replace a legacy bespoke system with a packaged solution. This is likely to have the added advantage of being more easily (and hence cheaply) supported by the offshoring vendor. Development tools and methodologies must be synchronised, as discussed below. 4.2 Processes Of great relevance to new outsourcing arrangements, there is an overhead inherent in interfacing to the vendor"s service delivery function, and ensuring synchronisation of the processes between the two organisations. In particular, many offshore vendors are accredited to ISO standards, and measured by the Capability Maturity Model (CMM) level, with many Indian vendor"s, for example, being at levels 3 or higher. Both of these standards, whilst laudable, involve strict adherence to rigorous documentation standards, resulting in additional workload, both in document production, and review and acceptance. As a result it may be necessary to upgrade processes within the parent company to handle this. 4.3 People Whilst many companies report that offshore workers are often very dedicated to providing a quality service, and will work very hard and offer great flexibility to achieve this, there are many management issues which must be addressed, not least those relating to culture. Add to this lack of face-to-face communications, time differences, differing public holidays, and the reported high attrition rates of certain offshore companies, and a significant additional management overhead is introduced. Benefits, however, can also be gained from the arrangement, particularly due to the injection of experience gained from other companies" implementations, and also the opportunities for shift working between locations, with a handover between, which may allow for external hours of operation eg. "follow the sun". 4.4 Risk Mitigation Wherever and however a capability is offshored, it represents an increase in risk, and this requires mitigation. Amongst the risks commonly introduced by offshoring, the most typical are around the introduction of a brand new service provider to the organisation, and the extension of the existing infrastructure. A strategy taken by many companies adopting offshoring is for higher risk processes to be split across multiple suppliers, situated in multiple locations. An approach commonly recommended is to split the service across a major supplier, a secondary smaller supplier who could be ramped up quickly were the key supplier to fail, and potentially to maintain some capability in house. This has the benefits of resilience and of providing realistic competition for any bids for additional work, hence keeping prices competitive. Technical resilience, particularly around extended infrastructure networks, which are more prone to failure in offshoring situations is another risk which must be planned for and costed. For example, a secondary intercontinental comms line may be essential to mitigate outages on the primary line. The Algerian earthquake of earlier this year led to outages of days, if not weeks in some cases, for those comms links passing through the Suez Canal. It is vital to plan how your organisation would deal with such a failure for this duration, and ensure that the risk of this happening is minimised. SUMMARY As stated at the start of this article, offshoring has farreaching impacts, and an article of this length can only hope to touch on some of the main issues which are specifically introduced as a result of adopting an offshoring strategy. As a final consideration, discussions are currently ongoing that suggest the benefits of offshoring may have a finite lifetime. It is argued that, as the available skilled staff become employed, so prices will increase, and hence the cost benefits of offshoring will reduce. This effect is already beginning to happen in certain areas of India, as reported by Nasscom, who believe there will be a shortfall of 250,000 people in India by 2008, and report that high-tech workers" average wage rose by 8% last year. Yet none of the potential issues are insurmountable, and, aided by careful planning, many companies have successfully used offshoring to reverse their fortunes, such as eBookers, who are reporting a quarterly cost saving of nearly £1m, without which it is questionable whether they would still exist. At the end of the day, offshoring is rather like a tan: given careful preparation and ongoing care, it will look fantastic and outlast the summer. But if you forget to pack the sun cream, all you can hope to be left with is a red face.