The Four Main Types of Offshore Outsourcing - Research Paper Example

?Risks and Challenges Faced by Developed Countries When Outsourcing their IT Some firms in developed countries have adopted offshore business model to help them cut costs of production through reduced wage expenses. Offshore outsourcing has enabled them reduced their domestic investment and high-waged employment. In this model, firms hire an external organization to carry out some of its business functions in another country. The four main types of offshore outsourcing are information technology outsourcing (ITO), offshore software development (software R and D), business process outsourcing (BPO) and knowledge process outsourcing (KPO). IT companies outsource their programming process. Despite being cost-effective, developed countries faces some risks and challenges outsourcing their IT. These also include hidden costs incurred during the outsourcing process. These factors have hindered the attainment of the desired wage rate savings. At times, companies adopt this labour arbitrage play with little or no regard of the risks, challenges or hidden costs involved leading to later regrets. These include distance, vendor selection, confidentiality, chain management, reduced wage gap, competition, compliance risks among others. India has benefited most from IT offshoring due to its technically proficient manpower and large pool of English speaking people. Risks and challenges Challenges of distance and transition According to Gonzalez et al (2010), great distance poses a challenge in vendor selection. This force IT companies in developed countries to rely on consultants in the foreign country hence making the initial process expensive. The long distance between the country of origin and the vendor leads to high travelling expenses. This is because the company management needs to make regular direct monitoring of the business process in the foreign country to ensure smooth operation and maintenance of quality standards. This leads to additional costs that threaten to wipe the anticipated savings. During the offshore outsourcing, transition has been found to be an expensive part of the business. Companies have to restructure their delivery pyramids in order to overcome the operational complications of offshore outsourcing. The need for restructuring gets some companies off guard. This leads to significant increase in project costs in ways that were not expected (Doh 2005). The importation of workers with foreign knowledge is necessary during the transition phase. These workers are usually imported from the mother country of the company making the offshore outsourcing. The imported workers are required to learn how applications work, create required documentation and query offshore staff. They smooth up the requirements process and reduce rework. Some of them are brought in as business analysts or project managers. However, this is not sustainable for long if at all the company has to cut down on labour costs. In some cases, the imported staff experience language and cultural barriers during their offshore business relationship. Communication difficulty makes it challenging for them to work with staff in the vendor country. This means that the workers of the vendor country may not be able to get all the directions they need for effective and quality operations (Herath and Kishore 2009). There have been concerns from some of the consumers concerning the technical support and levels customer care offered oversees workers due to language barrier. A serious damage to technical support and quality of customer care affects the market. Customers may loose confidence in the quality of products being offered to them. When the challenge of distance is compounded with language and cultural barriers, it makes it difficult for the onshore and offshore teams to function as a coherent team. It also leads to reduced effectiveness in task assignments, project delays and missed requirements (Falk and Wolfmayr 2008). According to Raisinghani et al (2008), the cumulative result of the challenges of distance and, language and cultural barriers is a 20% reduction in development efficiency during the first two years of the offshore contract. Some IT firms in developing countries which are adopting the offshore outsourcing business model do not have a good process for specifying their work. This challenges their offshore success. The CMM levels of the vendors have to be complimented by rigorous processes of the same level. Vendors on their part are allowed to operate at a maximum of two levels higher than their consumers. These restrictions result to lags in production leading to an overall increase in costs. The anticipated costs reduction is undermined as a result of this. An offshore project may require that a new joint management structures be put in place. Its main role is to define roles and responsibilities for all parties and, to control and direct outsourcing activities. Some companies lack these project management skills. This has hindered the anticipated success of offshore outsourcing of IT. On the other hand, those companies that have put in place these management skills have had to face increased costs of operation resulting to reduction in the expected profits. Narrowing Indian wage gap The main aim of offshore outsourcing of IT is to obtain substantial savings by cutting down on wage expenses. The narrowing of the Indian wage gap due to wage inflation is a challenge to such an endeavour. There was a 13-14% wage growth among Indian IT workers in 2003. Higher wage inflation levels are reported among the mid-level and senior-level workers. This is mainly resulting from the poaching of this group of key personnel. They are greatly required to offer quality service for quality operation of the IT company in their country. Though India has 4000 campuses that offer engineering, only 10% of these meet the minimum standards of countries like the USA, UK among other western countries (Tafti, 2005). According to Eischen (2004), there is high dependency on the small percentage of graduates from high quality engineering campuses in obtaining substantially qualified personnel. This means that the number of key personnel produced annually does not meet the demand hence the resultant poaching of the available key human resources. This has led to as high has 35% turnover among the mid-level and senior-level personnel. This has forced IT companies to pay a lot of premiums in order to be able to recruit senior-level Indian workers. Consequently, the payment of high premiums increases the costs of running the IT company in terms of wages. However, graduates from other campuses form a large percentage of workers in IT companies in the foreign country. All the workers need good sessions of orientation and training. This means that the company has to incur costs in terms of time required transfer of knowledge and training of personnel. A cummulation of these expenses on workers brings down the expected 50% wage savings by about 10-20% (Tafti, 2005). Vendor selection and hidden costs According to Tsuji et al (2007), poor vendor selection will lead to disastrous results. Some companies do not take their time to come up with clear definitions of the relationship they desire to have with the vendor. They do not enlist the standards and requirements that the vendor must poses before being given the contract. Any IT company wishing to enter into offshore outsourcing must decide on the type of relationship it wants to have with the vendor. This may force a company to make a decision outside the brackets of cost cutting to avoid waste of time (Raysman and Brown 1998). This means that the company will have to compromise on the level of savings it will make especially during its initial stages of operation. Knapp (2003) reveals that an exploration of the total cost of offshore outsourcing, (TCO), reveals some hidden costs. There are areas in which IT companies in developed countries should put more investments than it expects. These include productivity and upgrading poor processes. These additional investments end up eating away the potential savings that the company could have made through outsourcing. Selecting a vendor also presents some additional annual expenses to an IT company outsourcing its products. These costs include documentation requirements, negotiating a contract, evaluating the responses and sending out RFPs. Offshore outsourcing may require a company to have a project leader to work on the new business venture on full time basis. Such a person will definitely be on payroll. According to Tafti (2005), there might also be a need to hire an outsourcing advisor to guide the company on its outsourcing business. The company has to pay such individuals for their expertise. There are legal fees involved in creating a contract between the two companies. Time costs also are incurred in this process due to the long time that the entire process can take. This can range between six months to one year. More time is later spent coordinating the contract between the two companies. All these factors present additional costs to the IT offshore outsourcing process. The hidden and missed out costs are usually hard to predict. This causes the overall costs of offshoring to be underestimated (Knapp 2003). Later on, some companies realise that they have made insignificant on no savings out o the offshore outsourcing due to cumulative hidden costs. Managing the supply chain, competitive concerns and reliance on non-migrant Visas According to Herath and Kishore (2009), there is a loss of managerial control as a result of offshore outsourcing. Some companies tend to loose visibility and control across the stretched supply chain. This creates increased risks due to less control over some of their supply chain processes. Generally, it is more difficult to control the outsourcing service provider in a foreign country as compared to managing one’s own employees at home. Offshore outsourcing IT companies have to transfer knowledge to outside countries. There are high chances that such knowledge transferred to foreign countries will be tapped by individuals in the foreign countries for example the employees. Individuals who have tapped the company knowledge may use it to independently produce similar products. Such manufacturers sell their products directly to the consumers without going through the local intermediaries originally contracted for the service. This means that outsourcing creates competitors to the original companies (Knapp 2003). These disadvantages are also felt nationally. After outsourcing, a company is usually forced to make all its investments in the foreign country. However, when production increases, some domestic workers, who are experienced and qualified, quit or are forced to quit their jobs leading to fewer qualified workers. This makes the domestic market to be dependent on foreign market in order to obtain such products. This strategically weakens the domestic country. In a nut shell, offshoring creates and strengthens competitive firms in the foreign country while weakening the domestic country (Tafti 2005). In offshoring, it is difficult to obtain a real cost comparison based on quality compared to hourly rate. In some cases, the delivered output is less than the expected. Doh (2005) explains that even when operations are smooth, it is difficult to attain comparable innovation and creativity in the development process while operating in a foreign country as opposed to basing all business processes in the domestic country. According to Shao and David (2007), domestic employees, are denied the experience they would have gained by handling the entire process of manufacturing as compared to passing the work so an external party. The employees may feel that their growth is tampered with. This may lead to low worker motivation and an exodus of those workers seeking to experience full professional growth and satisfaction. This leads to the challenge of loss of internally generated talent. Whenever offshore outsourcing is adopted, employees may also feel that their jobs are insecure. This is especially true for cases in which the outsourcing may affect the continuity of some roles. Outsourcing may necessitate downsizing of the company employees. This greatly affects the employee motivations which in turn affect levels and rate of production in the company. Most of the foreign workers imported mainly rely on non-migrant component in form of H-1B or L-1 visas. Offshore companies rely on such individuals to complete work that requires an on-site presence. The L-1 visa lacks wage guidelines. When the US Congress realised such utilisation of the H-1B and L-1visas, it introduced of eight distinct legislation measures. These measures are aimed at restricting the use of H-1B and L-1visas. Some of the recommendation of the reform includes a permanent annual cap of 35, 000 on the present cap-less L-1 and imposing wage rates on L-1. The H-1B program received an annual cap of 65,000. This has forced some forms to rethink their business plans. Such restrictions could make some US companies to experience a collapse of their offshore business projects. It also threatens to reduce the cost-effectiveness of the offshore model (Tafti 2005). Confidentiality, compliance and legislation risks Offshore outsourcing can become a threat to the confidentiality and security of a company. This is because it involves the transiting of important information about the company across international boundaries. For example, in the process of outsourcing a payroll, the service provider will be able to know some confidential information such as salary (Lewis 2006). The Indian government acknowledges the growth of the offshore IT as a strategic priority. As a result, it has created a friendly environment for offshore IT. However, some companies especially those from the US face certain restrictions which they must comply to. The US companies face regulations like the Gramm-Leach-Billey act, Health Insurance Portability and Accountability Act and the California’s SB 1386. These require US companies with offshore operations and their offshore service recipients to ensure that data privacy. The risk resulting from a failure to do this is a severe financial penalty (Raisinghani et al 2008). Legislation risks include those legislations that limit the ability of state agencies from employing vendors whose composition of staff includes a large proportion of visa workers. For example in the US legislation Challenge to the IT work environment Outsourcing leads to creation of virtual organisations consisting of two virtual teams, one in the domestic country and another in the foreign country. The two geographically dispersed teams are supposed to co-operate in order to attain the company’s business goals. In order to achieve this, the two teams must constantly keep in touch. Offshore outsourcing IT companies in developed countries achieved this through constant technology mediated communication. This forms part of the hidden costs of offshore outsourcing. Cooperation through technology mediated models is not as effective as when all the workers could be in one place and offering direct support to each another. This has also limits the transfer of talents, knowledge and experiences among employees. Communications through e-mail is cumbersome as compared to face-to-face communication. This discourages frequent communication between the two virtual teams leading to little staff-to-staff support. Suggested solutions and frameworks to handle and resolve risks when outsourcing IT especially in developed countries. Mitigation measures that can be applied by developed countries on regular basis are required. These will help them to overcome the risks and challenges of offshore outsourcing of IT. The risks of distance and, language and cultural differences can be resolved by elevating offshore maturity levels. This can be achieved through the implementation of solid IT processes, methodologies and tools. In order to mitigate instability in the availability of key personnel and their high costs, offshore firms should come up with contractual terms that place the liability of replaced personnel on the vendor. The contractual terms should be based on the turnover rates. According to Erber and Sayed-Ahmed (2005), offshore firms should always retain a section of the analysis, development and management personnel. This will insure them against persistent and costly risks of knowledge transfer. An offshore outsourcing firm whose project management system is of high quality should be chosen. It should also have a tried-and-true process developing the company applications. Each company must also evaluate itself to determine if offshore outsourcing is necessary or it. This will avoid following the existing trends in the business world even when they are not bound to be beneficial to the company. If company has found it necessary to do an offshore outsourcing, it must put enough efforts in selecting the right vendor. The contract should be easy and flexible so as to ensure an easy and flexible outsourcing process. In order to deal with risks of security and confidentiality, the company must choose which business processes to outsource and those it cannot. The contractual terms must also include safeguards against data privacy abuse. Companies can also work with an offshore outsourcing consultancy firm. This will enable outsourcing IT companies to access and utilise local information, knowledge and best practices from the consultant (Fernandez et al 2003). According to Fernandez et al (2003), working with an outsourcing consultant will ensure that the company maintains the best possible relationship with its offshore clients while making sure that quality is maintained and its targets are reached within the time frames. Since security is a key issue in IT offshoring, companies should create a feedback mechanism. Its main function will be to control project overshoots and use them as a medium of maintaining a constant touch with the offshore partner. A company must analyse all its business processes to determine which work goes offshore and which work stays. This will enable it to maximise offshore savings while minimising hidden costs. Companies should acknowledge their employees in the domestic country in times of change. This will ensure that there is a maintained and even increased job satisfaction among the workers. In order to encourage collaboration and to boost job satisfaction among all its workers, outsourcing IT companies should ensure that the virtual team members in the domestic and foreign country communicate regularly. This is done through modern technologies like video conferencing and e-mail. Conclusion Offshore outsourcing presents the advantage of saving on costs and capturing the cheap foreign pool of expertise before other companies can do it. However, it can also be a good reason for a company to regret if it several factors are not put into consideration before arriving at the outsourcing decision. A company must therefore put into consideration the hidden costs, all risks and challenges before adopting this business model. For example vendor selection, confidentiality, chain management, reduced wage gap, competition, compliance risks and distance. There is need to do risk analysis so as to come up with an effective risk management plan. References Betz, S. and Makio, J (2008). Applying the OUTSHORE approach for risk minimization in offshore outsourcing of Software Development projects. Online. http://portal.acm.org/citation.cfm?id=1305004. Viewed. 21st March, 2011. Doh, P. (2005). “Offshore Outsourcing: Implications for International Business and Strategic Management Theory and Practice.” Journal of Management Studies (3) pp 695-704 Eischen, K. (2004). Working Through Outsourcing: Software Practice, Industry Organization and Industry Evolution in India. Online. http://www.compaid.com/caiinternet/ezine/offshorerisks.pdf. Viewed. 21st March, 2011. Erber, G. and Sayed-Ahmed, A. (2005). “Offshore Outsourcing - A Global Shift in the Present IT Industry .” Intereconomics, (2) pp100-112. Falk, M and Wolfmayr, Y. (2008). Services and materials outsourcing to low-wage countries and employment: Empirical evidence from EU countries. Online. http://ideas.repec.org/a/eee/streco/v19y2008i1p38-52.html. Viewed 21st march, 2011. Fernandez, D. Kemeny, D. and Bastani, B. (2003). “Intellectual Property Strategies in Security and Privacy.” Online. http://lp.findlaw.com/. Viewed. 21st March, 2011. Gonzalez, R. Gasco, J. and Llopis, J. 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(2007). “The impact of offshore outsourcing on IT workers in developed countries”. Communications of the ACM (CACM) (2) pp 89-94. Tafti, M. (2005). “Risks factors associated with offshore IT outsourcing.” Industrial Management and Data Systems (IMDS) (5) pp549-560. Tsuji, H. Sakurai, A. Yoshida, K. Tiwana, A. and Bush, A. (2007). “Questionnaire-Based Risk Assessment Scheme for Japanese Offshore Software Outsourcing.” SEAFOOD (1) pp114-127. Read More