Top 10 Risks of Offshore Outsourcing

pinch 10 Risks of inshore Outsourcing SummaryOffshore outsourcing is increase 20%-25% per annum, with s crumbt(p) evidence of slowing. Indeed, while around enterprises experience initial resistance, intimately practiced upshots argon readily resolved and geopolitical assay is deemed insignificant after c beful evaluation. By Dean Davison December 9, 2003 0000 GMT (1600 PST) Offshore outsourcing is growing 20%-25% per annum, with little evidence of slowing. Indeed, while most enterprises experience initial resistance, most technical issues are readily resolved and geopolitical risk is deemed insignificant after careful evaluation.Even the current political fervor more or less(prenominal) jobs existence moved shoreward via outsourcing is non impacting the demand or system of IT governing bodys. Offshore outsourcing volition continue to grow as a cut into arbitrage model until 2008/09. META Trend During 2004/05, outsourcing go out divide into commodity and transforma tional function. stand helpings will mirror grid-computing structures and develop consumption-based pricing (a. k. a. , utility run). Through 2006/07, transformational services (e. g. application development maintenance and profession deal outsourcing) will segment along horizontal (function super Cality) and vertical (specialized) business make for/services outsourcing functions. Although marketers will attempt to bundle infrastructure with value services, lymph glands will demand line item pricing by 2008/09. Through 2004/05, IT brasss will outsource discrete projects/functions seaward (e. g. , from application development projects to specific chew the fat center support). Growth will continue at 20%+.Offshore strategies by domestic marketers will shift business from large, fused outsourcing contracts, but most IT organizations will still develop strategies that focus on pure-play onshore vendors. The authorize 10 risks of offshore outsourcing are as follows. 1. Co st-Reduction Expectations The biggest risk with offshore outsourcing has energy to do with outsourcing it involves the expectations the internal organization has about how much the savings from offshore will be. Unfortunately, many executives assume that grind arbitrage will digest savings comparable to person-to-person comparison (e. . , a full-time analogous in India will exist 40% less) without regard for the hidden be and differences in operating models. In reality, most IT organizations save 15%-25% during the rootage year by the third year, cost savings often founder 35%-40% as companies go up the learning curve for offshore outsourcing and modify operations to align to an offshore model. 2. Data Security/ guard IT organizations evaluating any kind of outsourcing suspicion whether vendors have sufficiently robust cheerion practices and if vendors can meet the certificate requirements they have internally.While most IT organizations find offshore vendor security pr actices impressive (often exceeding internal practices), the risk of security breaks or intellectual lieu protection is inherently raised when operative in international business. Privacy concerns mustiness be completely addressed. Although these issues seldom pose major impediments to outsourcing, the requirements must be documented and the methods and integration with vendors defined. 3. sue Discipline (CMM) The Capability Maturity Model (CMM) becomes an principal(prenominal) 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. META Group observes that approximately 70% of IT organizations are at CMM Level 1 creating a gap that is compensated for by additional vendor resources on-the-scene(prenominal) (seeFigure 1). Companies pretermiting internal process model maturity will undermine latent cost savings. 4. Loss of Business Knowledge nigh IT organizat ions have business fellowship that resides within the developers of applications. In some cases, this expertness whitethorn be a proprietary or competitive advantage.Companies must carefully valuate business companionship and determine if moving it any outside the company or to an offshore location will via media company practices. 5. Vendor Failure to Deliver A common wariness for IT organizations is a contingency plan what happens if the vendor, all best engrossedions and contracts aside, simply fails to deliver. Although such failures are exceptions, they do occur, even with the superb quality methodologies of offshore vendors. When enumerateing outsourcing, IT organizations should assess the implications of vendor failure (i. . , does failure have significant business execution implications? ). High risk or exposure might deter the organization from outsourcing, it might shift the outsourcing strategy (e. g. , from a single vendor to duple vendors), or it might dri ve the company toward outsourcing (if the vendor has specific skills to load risks). The results of risk synopsis 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 correct 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 Utilities, financial services institutions, and healthcare organizations, among others, face various degrees of government oversight.These 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) im part 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 responsibility on all American corporations. 8. Culture A representative fashion model although English is one official language in India, pronunciation and accents can vary tremendously. many another(prenominal) 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 runninging vendors have cultural education programs, but executives should not assume that cultural alignment will be insignificant or trivial. 9. Turnover of Key Personnel Rapid growth among outsourcing vendors has created a propellant labor market, especially in Bangalore, India. Key personnel are comm totally in demand for new, high-p rofile projects, or even at risk of being recruited by other offshore vendors.While offshore vendors will often advert overall overthrow statistics that appear relatively low, the more important statistic to pluck is the turnover of key personnel on an account. Common turnover levels are in the 15%-20% range, and creating contractual terms around those levels is a sensitive request. Indeed, META Group has seen recent contracts that place a liability on the vendor for any personnel that must be replaced. The impact of high turnover has an indirect cost on the IT organization, which must increase time swing on knowledge slay and training new individuals. 0. Knowledge budge The time and effort to transfer knowledge to the vendor is a cost rarely accounted for by IT organizations. Indeed, we observe that most IT organizations experience a 20% decline in productivity during the first year of an agreement, largely cod to time spent transferring both technical and business knowled ge to the vendor. 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 let additional information for new team members. Business Impact Offshore outsourcing can reduce IT expenditures by 15%-25% within the first year. long-range 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.Strategic Decision Challenges Researchers have applied different perspectives to understand sourcing decision, the key among them being production and transaction cost economics (Ang & Straub, 1998), resource-based views (RBV), and resource-dependence views (Teng et al. , 1995). The Resource-Based View (RBV) argues that a substantials competitive advantage depends heavily on its resources, as easy as how these are used. Resources that are valuable and rare can lead to the creation of competitive advantage (Wade & Hulland, 2004).Competitive advantage can be sustain over longer time periods to the extent that the firm is able to protect against resource imitation, transfer, or substitution. The knowledge-based theory (KBV) of the firm considers knowledge as the most strategicalally significant resource of the firm. Its proponents argue that, because knowledge-based resources are usually onerous to imitate and socially complex, heterogeneous knowledge bases and capabilities among firms are the major determinants of free burning competitive advantage and superior corporate performance.There is certain level of paradox in outsourcing when viewed from RBV or KBV prisms. Proponents of outsourcing have often used RBV to justify outsourcing decisions. The miss of resources, or resource gaps, that a firm has can also be rectified by acquiring resources from outside the firm boundaries by work arrangement (Teng et al. , 1995). Outsourcing has been considered as a part of the way that firms assemble knowledge from suppliers (Shi et al. , 2005). Thus, information systems (IS) outsourcing can be seen as a mechanism to integrate IS knowledge from IS vendors.Knowledge sharing by both, client and supplier sides, is considered to be a success factor in outsourcing (Lee, 2001). However, some researchers have raised concerns regarding the potential loss of internal know-how through IS outsourcing (Willcocks et al. , 2004) and the potential loss of intellectual property (Chen et al. ,2002 Evaristo et al. , 2005). Outsourcing involves the inherent risk of forgoing the development of the knowledge base of the firm. Hoecht and Trott (2006) argues that innovational capability of the firm is largely dependent on cumulative knowledge built up over many years of experience.Innovative ability cannot be simply bought and sold. Earl (1996) argues that innovation needs slack resources, organic and fluid organizational processes, and experimental and entrepreneurial competences all attributes that external sourcing does not guarantee. Aron (2005) describes these risks as the long-run intrinsic risks of atrophy. These risks are an inevitable byproduct of the process of outsourcing. Over time, if a company outsources an activity completely, it loses the force group of people who were familiar with it. They retire, they parting for employment where their skills are more alued, or they simply become less technically competent and out of date. Reliance on outsourcing is problematic, not only because key areas of expertise may be gradually lost to the outsourcing organization but also because outside providers may not have the craved leading edge expertise over the long-term (Earl, 1996) or may spread their expertise among many clients so that it degrades from core competency to unmixed industry standard. Hoecht & Trott (2006) remind senior managers of the harm that may be inflicted on the ability of the organization to survive in the long term if its core competencies are slowly eroded through outsourcing.A related issue is that of the strategic absorbed (DiRomualdo & Gurbaxani, 1998) behind the offshore outsourcing decision by organizations. Strategic intent in this context can range from an improvement in the IS unit of the organization (which generally provides the lowest degree of benefits), an improvement in the business processes of the overall organization, or a commercial intent to ease up gain by developing core expertise in the domain of outsourced IT service (Kishore et al. , 20042005).The commercial intent is exemplified in the oft-cited case of American Airlines who established a new subsidiary to sell airline reservation related services commercially to other airlines and travel agents using Sabre, its airline reservation system, and to generate new revenues and profits from this line of business. Strategic intent behind outsourcing is an important challenge as it has been shown that stock market reacts favorably and rewards companies when they outsource with an intent of creating the maximum returns for the firm (Agrawal et al. 2006). On the vendor side, vendors can develop their expertise through building knowledge from experiences and holding the knowledge for competitive advantage. Szulanski (Szulanski, 1996) identifies lack of incentives, lack of confidence, turf protection, and the not invented here syndrome as motivational factors potentially influencing knowledge transfer in outsourcing arrangements.This two-sided nature of knowledge transfer is expected to create asymmetric information leading to outsourcing failures. From a clients view several challenges then arise including deciding what is the right field proportion of IT function insourced or outsou rced, and what IT application should be outsourced or unploughed within for strategic reasons.