Latest News

Offshore IT Service Trends: Is a Foreign Affair in Your Future?

Driven by cost pressures and a desire for increased business agility, offshoring of IT services has seen consistent growth since the 90s that paused briefly during the global recession but is now rebounding. Both large and small organizations need to understand the environment that is driving this momentum, to better leverage its benefits and avoid its risks.

Copyright 1999-2010 Info-Tech Research Group

Executive Summary

After a brief pause during the global recession, offshoring of IT services has resumed its rapid historical growth in both large and small organizations. This note considers the following questions in light of these trends:

  • Who is buying offshore IT services?
  • Why are they buying?
  • What are the key offshore locations?
  • Who is selling?

Use this note to gain the insight required to make informed offshoring decisions.

Trend Point

Recent Info-Tech research found that the outsourcing of application development, maintenance, and support often leads to significant benefits; for example, faster delivery (62% of those polled) and increased user satisfaction (61%), especially when good governance and project management principles are applied. For more information, refer to the Impact Research Report, "Application Outsourcing: Achieving Success & Avoiding Risk."

If an organization decides to outsource to gain these benefits, the next consideration is whether to partner with an outsourcer whose delivery team is in the same country (onshore), or in another country, typically a low-wage destination (offshore or nearshore).

The offshore option has seen rapid growth, and now accounts for $80B US in economic activity per year (Source: McKinsey Quarterly). The global recession stalled this rapid growth, but offshore outsourcing is already seeing a strong rebound:

Globally, the total contract value of new deals was essentially the same for 2008 and 2009 at $56B US.

Q4 of 2009 saw $19B US in new deals, a 54% increase over the previous quarter and 32% over the same quarter last year (Source: TPI).

This note examines trends in outsourcing to low-wage destinations that are either offshore (far from your organization) or nearshore (close to your organization).

Situation Analysis

Who Is Buying?

Large organizations pioneered offshoring and now both large and small organization are involved:

50% of the Forbes 2000 has initiated some sort of offshore activity (Figure 1).

35% of small organizations also offshore.

38% of companies that offshored IT functions have aggressive plans for more offshoring (Source: Duke University " Offshoring Reaches the C-Suite").

These trends suggest that offshoring is becoming a common practice for both IT and business tasks (Figure 1). Although many companies are involved in some offshore IT activity, this activity represents only 6.5% of the global market for IT services, so there remains plenty of room for growth (Source: Kennedy, The Services Shift).

Figure 1. Offshoring Shows Rapid Growth in Organizations of All Sizes.

Source: Duke University "Next Generation Offshoring"

Offshoring optics. Despite the popularity of offshoring, some executives interviewed were reluctant to broadcast their use of offshore services, for fear of being perceived as unpatriotic, especially in times of economic difficulty. While on the surface it may appear that offshoring creates job losses onshore, an alternative explanation is that "outsourcing is not about 'exporting jobs'; it is about 'importing competitiveness'" (Source: Prahalad & Krishnan, The New Age of Innovation). In other words, offshoring improves a company's competitive position, and the net effect of that competitiveness is increased prosperity onshore. An economic analysis of the data supports this view with each dollar spent offshore returning $1.14 in reduced costs, increased exports, repatriated earnings, and reassignment of labor into higher value work (Source: Mckinsey Global Institute, Offshoring).

Why Are They Buying?

Outsourcing can have many motivators such as flexible resourcing and improved business processes, and these are often important to those who buy offshore. However, buyers of offshore outsourced services cite cost reduction and business agility as central motivations.

Cost reduction was cited by 53% of organizations as a main driver for outsourcing (Source: Brown & Wilson, The Black Book of Outsourcing), and lower costs are especially important for those that chose an offshore partner. Info-Tech's research found that 72% of those that chose an offshore partner said that cost reduction was very important, compared to 38% who went with an onshore provider. In addition, those that choose offshore outsourcing are more likely to reach their cost reduction targets (Figure 2).

Figure 2. Cost Reduction More Likely in Offshore Outsourcing than Onshore.
Source: Info-Tech Research Group

With offshore salaries as low as $10,000 US per year for entry level positions, some buyers make the mistake of assuming huge cost savings will accrue. However, wage arbitrage is offset by new costs such as contracting, travel, and relationship management. A typical breakdown is provided in Table 1. Although not all of these expenses apply to all contexts, the breakdown serves as a useful starting point.

Table 1. Cost Breakdown: Accounting for More than Labor.

Source: Vashistha, The Offshore Nation While a handful of those interviewed for this research saw cost reductions of 50% over what they had been spending internally, 20% was a more typical level of cost saving. Neither of these outcomes are the inevitable result of the decision to offshore. For cost reduction to succeed, a project must be carefully managed with cost savings in mind.

Business agility. Cost also impacts the scale and flexibility of resourcing. In the words of one IT leader:

"I like the ability, from a cost standpoint, to swarm a problem. I can put a lot of talented people on a

particular issue in India, and I can't afford to do that here." CIO, Engineering Services Organization

Offshore providers often have flexible access to significant numbers of skilled professionals, which in turn allows their clients to respond to a changing business environment with enhanced agility. When this advantage is leveraged, the real payout is not the 20% or 30% savings on development costs, but rather the new revenue opportunities seized by an organization agile enough to respond to a market opportunity in months, rather than years.

What Is Driving the Expanded Menu of Locations?

In the 90s, India emerged as the near exclusive source of low-cost IT and IT-enabled services. Today, more than 30 countries have IT service ecosystems at varying stages of maturity. This expansion of geographic choice has been driven by the confluence of the following trends:

  • Global technology access. The penetration of low-cost telecom, broadband Internet, and computer literacy into many new locations.
  • Provider push. India's export revenues in IT and IT enabled services grew from $128 million in 1991 to $40.8 billion in 2007, a compounded annual growth rate of more than 43% (Source: NASSCOM Strategic Review). Other developing countries are following India's example and are rolling out supportive service-export policies alongside trade liberalization to win a piece of the offshoring pie. Local entrepreneurs and multinationals are also scrambling to capture a share of this market which has only about 11% of its potential (Source: Kennedy, The Services Shift).
  • Global diversification. Both consumers and providers of offshore services are interested in reducing the risk of service disruption associated with geopolitical change by having delivery centers in several locations.

What Are Key Locations?

The offshore IT outsourcing market has seen rapid global growth and service buyers can now choose from many locations, all claiming to deliver quality service at discount prices. But not all geographies are ready for primetime, so Info-Tech has short listed ten key locations that meet the following criteria:

  • Low cost. Can provide IT services whose total cost is at least 20% less than the total cost of onshore delivery, with equivalent or better quality.
  • Basic maturity. Has a reasonably developed supplier network that provides diversity of selection and risk mitigation.

Table 2. Ten Key Outsourcing Locations.

Source: Info-Tech Research Group For an evaluation of key Asian outsourcing locations, refer to the ITA Premium research notes, "India for Outsourced IT Services," "The Philippines for Outsourced IT Services,"and "China for Outsourced IT Services."

Nearshore Alternatives

Each region listed in Table 2 has countries that are nearshore, or are in close proximity, to major Western markets. Nearshore locations are in similar time zones and reasonable travel distance from their clients.

One advantage of a nearshore location is reduced travel cost and travel fatigue. More important is that the near synchronized time zones allow meetings and other synchronous communication to occur during normal business hours for both parties. This improves staff motivation and retention, which is especially important for high-end tasks performed in a distributed collaborative environment, where top talent on either end of the relationship can become burned out by late night or early morning meetings.

Of course, some city combinations are "more nearshore" than others: Los Angles and Guadalajara, Mexico are only a three hour flight apart. New York and Rio De Janeiro, Brazil are separated by a ten hour flight. Therefore, consider the exact location of both your onshore and offshore teams.

Who Is Selling?

Buyers have several Tiers of vendors to choose from (based on vendor revenue):

  • Tier 1 vendors. Defined here as vendors with more than $200M US revenue. These may be companies headquartered onshore (e.g. IBM, Accenture) or offshore (e.g. Tata Consultancy, Infosys). Tier 1 vendors generally have a broad service offering, offshore locations in multiple cities and countries, and mature processes. However, they often cannot offer a high service level to small customers and may lack business agility.
  • Tier 2 vendors. Defined here as vendors with between $100M to $200M US in revenue. Tier 2 vendors generally have a narrower service offering, fewer locations, and more flexible business processes. They provide an appealing blend of stability and agility.
  • Tier 3 vendors. Defined here as vendors with less than $100M US revenue. Tier 3 vendors often have a narrow service offering, frequently focusing on a single niche, from a single location. They often provide a high service level to small customers and can be very flexible. However, their small size can make them vulnerable to financial strains and resource constraints.

Organization size and vendor size. A rule of thumb in vendor selection is for buyers to choose a vendor similar in size to their organization. So large organizations often prefer Tier 1 vendors, mid-sized organizations Tier 2, and small organizations Tier 3. In fact, small organizations have shown that they are adept at locating specialized vendors and inventing new organizational structures to work with them. However, there are exceptions to this general principle, for example a Tier 3 niche vendor working with a segment of a large enterprise, or a division of a Tier 1 vendor successfully supporting a small enterprise.

Info-Tech Predicts

Offshore growth will continue at a rapid rate. Growth of offshore outsourcing has been very high since it started in the early 1990s. India saw 43% compounded annual growth between 1991 and 2007 (Source: NASSCOM Strategic Review) and other countries have seen similar growth rates in recent years. Although growth stalled during the economic downturn, as the economy rebounds, growth has resumed: Q4 of 2009 saw $19B US in new deals, a 54% increase over the previous quarter and 32% over the same quarter last year (Source: TPI). Projects that had been shelved are being dusted off and new projects associated with mergers and consolidation are emerging. Additionally, conservative budgeting means that managers are looking for a low cost way to get their projects done, something offshore providers can offer.

Emerging locations will mature. Client side desire for location risk mitigation and avoidance of wage inflation and turnover, together with a push from new vendors will result in continued maturation of locations outside of India. This will include local companies setting up or expanding operations as well as multinational and Indian-based firms expanding into new regions.

SME market will continue to grow. As collaboration technology improves and vendors develop niche competencies, the financial overhead associated with offshoring will decline and more SMEs will leverage offshore resources.

Key Takeaways

An offshore relationship may be in your future. With offshore IT services increasing their penetration of the outsourcing market, expect new opportunities to emerge in the future, some of which may appeal to your organization.

Recognize that the benefits of offshoring extend beyond cost reduction. While cost reduction is typical motivation for offshoring, focusing exclusively on achieving the lowest cost option can result in a number of problems. Choosing a low cost vendor can mean sacrificing strong governance practices, service levels, and/or innovative business processes. Focus on the additional benefits of offshoring beyond cost savings, such as the ability to gain access to expertise and to improve business agility through flexible staffing arrangements.

Even smaller IT departments can leverage offshoring. The benefits of application outsourcing are not reserved for large enterprises. Projects beginning at ten resources can provide adequate scale if a project is well managed.

Bottom Line

Driven by cost pressures and a desire for increased business agility, offshoring of IT services has seen consistent growth since the 90s that paused briefly during the global recession but is now rebounding. Both large and small organizations need to understand the environment that is driving this momentum, to better leverage its benefits and avoid its risks.

Leave a comment

seks shop - izolasyon
basic theory test book basic theory test