Exerpt from An Overview of Offshore Software Development, by Dr. Bernard L. Palowitch, Jr., President & CEO of Incoda Corporation.

While there are benefits and risks in incorporating offshore suppliers in a sourcing strategy, in most cases, companies find that the advantages outweigh the risks.

Benefits

The primary business rationale for offshoring has been to reduce IT operating and infrastructure costs. The cost savings from offshore outsourcing increase with the percentage of total development effort outsourced and the percentage of work performed offshore. They are maximized when the entire development is outsourced and all the work is performed overseas.

Since the predominant component of IT costs is direct and indirect labor, sizable cost reductions can be achieved by moving these functions to lower wage rate locations. Based on recent average wage rates for IT professionals, net savings from offshore outsourcing generally range between 25 to 40 percent for U.S. and European companies. Cost savings has been the primary business rationale for offshoring across all industry sectors. The Sand Hill Group Study found that even technology companies were moving work offshore, driven, in part, by lower labor costs.

After wage rate differentials, the level of cost savings also depends on the amount of work that is moved offshore. While an analysis of offshore projects shows that the optimal ratio of offshore to onshore work ranges between 70:30 to 80:20, some companies only reach a 50:50 split because they desire to have a greater number of people onsite, which reduces the overall savings.

Offshore outsourcing has been used to achieve a variety of other financial and non-financial benefits, including:

• Faster time-to-market for new products and services
• Increased focus on core competencies
• Staff augmentation for work load balancing and/or access to skilled IT labor on an as-needed basis
• Access to skilled IT labor to augment existing (internal) skill sets
• Access to leading technologies
• Ability to have work performed nearly 24/7 by augmenting local activities with development centers on other continents.

Other reasons for offshore outsourcing include a scaleable business model that can be ramped up or down very quickly without incurring long-term costs such as unemployment insurance and employee benefits, and implementing the software development and quality assurance processes and practices of the offshore suppliers as a way to quickly improve the customer’s own internal processes.

While labor cost savings have been the primary rationale, additional value can be achieved over time from enhanced and streamlined business processes. For example, creating a single shared services environment can generate sizable efficiencies if the current processes are done in different locations or done by different business units. Business process reengineering, i.e., removing inefficiencies and bottlenecks and enhancing workflow using automation and other information technologies, can add additional cost savings as well as faster cycle times and other business benefits.

Challenges

Before launching an offshore development initiative, senior management needs to thoroughly understand the challenges to successful offshoring. Major risks and issues include differences in language, culture, politics, regulations, and work practices—all of which can disrupt a collaborative customer-supplier relationship. Specifically, some of the key challenges include:

Internal Organizational Issues

• “Loss of control” of projects and processes
• Increased management attention
• Concerns over retaining intellectual property and other proprietary information
• Concerns over potential legal issues with foreign companies
• Uncertainty about achieving the financial and nonfinancial objectives
• Sensitivity around moving certain types of applications overseas
• Security risks
• Customer preference for suppliers in close physical proximity
• Internal IT departments may not welcome outsourcing due to concerns about job security.

Offshore Market and Supplier Issues

• Formative offshore market
• Dependence on supplier-provided information
• Limited understanding of suppliers’ true reputation and track record
• Socio-cultural barriers and business compatibility
• Infrastructure issues
• Supplier may have little or no experience in the industry or business function/process
• Uncertain political climate.

Project and Process Management Issues

• Communication, language, and cultural issues
• Time zone and holiday schedule issues
• Increased travel costs.

The importance of the risks listed above varies widely from company to company. Some of the risks presented could be quite costly and damaging to the business, and therefore, mitigation strategies should be developed before getting underway.

* * *

To learn more about Incoda's perspectives on offshore software development, please see:

• Overview of the Offshore Software Development (OSD) Market for IT and IT-enabled services
• OSD Delivery Models
• Key Differences Between Local and Offshore Software Development
• Comparison of the Leading OSD Countries

To download the entire Incoda white paper, An Overview of Offshore Software Development, please visit the Resources Section of this website. Registration is required.

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This page lists the primary financial and non-financial benefits and common organizational challenges of offshore outsourcing custom application and web software development.