The *Real* Cost of Offshore Outsourcing

By Pam Baker, CIO.com |  IT Management, offshoring, outsourcing

One would think cash-strapped companies would find a heavenly match on foreign soils with plentiful, cheap labor. But that would be the romantic notion and not necessarily the reality. "Companies often 'plan for the wedding, but not for the marriage,''' says Dalip Raheja, chief executive officer and president of the Mpower Group. Now that offshore outsourcing is roughly a decade old, it's time to evaluate lessons learned and tally the real costs before renewing any vows.

The Honeymoon Is Over

"After a period of explosive growth in offshore outsourcing many companies are moving past the learning curve when it comes to the tangible costs of moving services and production offshore," explains Raheja. "Experience has built more certainty around what was once considered previously 'hidden costs,' or costs related to transition, development, selection, etc., which could easily cancel out any financial benefit of doing business offshore."

Now that time has told its tale, flaws are revealed and divorce becomes an option. One example, Delta's CEO, Richard Anderson, announced this month that the airline canceled its outsourcing to India because its customers were very vocal against foreign customer service agents. The struggling airline desperately needs happy customers so it responded to the complaints.

Often it is not simply the loss of disgruntled customers, a loss bad enough in a down economy, but loss in efficiencies and productivity as well that leads to the severing of offshore outsourcing relationships.

"We often find that outsourced agents are not trained as deeply as agents who work internally for an organization, and often lack the tools to do a thorough job for customers," says Dr. Miriam Nelson, senior vice president of Aon Consulting, a global HR/human capital firm. "We hear them rushing through calls, merely repeating the same troubleshooting steps, since they do not have that deeper understanding necessary to explain issues in a different way for the customer."

When call center work is outsourced to an offshore firm, service drops even further according to Nelson. "Offshore call centers are not only challenged by being in an outsourced position, but they also have to overcome language barriers and cultural disconnects," she explains. "When we benchmark offshore service against onshore service, offshore scores much lower."

The cost of poor service translates to hard currency losses for any corporation. One example: Aon recently observed an outsourcer in the Philippines and found the following, according to Nelson:

1. 41 percent of all calls are placed on hold. The average total hold time is 331 seconds. Agents are typically looking up information or speaking with other departments during these holds. Reducing the average hold time by 30 percent alone would result in an estimated annual savings of $384,000.

2. Agents are not speaking clearly on 56 percent of calls. The average talk time on these calls is 232 seconds longer than necessarily. This represents an estimated annual cost of $1,219,594 to the organization.

Problems Loom Large

However, problems with outsourcing are not contained to call centers; rather they cover the spread of business functions and business relationships.

One glaringly ugly example of a far-reaching problem: the Satyam Computer Services scandal which involved dual accounting books, mountains of forged invoices, faked bank statements and large numbers of unnecessary workers. Customers and investors alike were bilked and bamboozled by India's fourth largest outsourcing company.

"The Satyam situation dramatically weakens one of the fundamental pillars of the outsourcing model--that service corporations in emerging markets are fundamentally organized and monitored in the same ways as their client companies," explains Tim Carbery, principal of Axis Technology, a provider of IT and data security offerings for outsourcing with a client list that includes Bank of America, Wachovia, Fidelity and Citigroup.

This 'pillar' has been supported, according to Carbery, through specific contractual obligations (such as audited financials) between the BPO firms and their clients, which was considered the client firm's protection against local variations in business culture and regulations. "These client companies will now need to re-assess and audit their SOX and corporate policy compliance across all of their service providers to assure customers, and shareholders that they are not at risk," he says. "At this point only Satyam has been tarnished, but if irregularities surface at other providers through these assessments, even minor ones, then a significant portion of the industry could suffer lasting damage."

Paying the Tab

As the bills land in accounts receivables and checks flow out in payment, many think they have finally accounted for all the costs involved in outsourcing. But that may not be so. "Companies still have uncertainty around the intangible aspects of effectively managing and planning for a successful outsourcing relationship," says Raheja. "These hidden expenses include everything from the high rate of outsourcing relationship failures and the costs associated with a failed relationship, to underestimating the amount of time, resources and capital needed to ensure a successful outsourcing relationship."

There are other costs lurking in the shadows that are often overlooked. "Companies that outsource to China often ignore the big things like the potential loss of intellectual property and the legal costs involved in going to a foreign country," says Daniel P. Harris, attorney at HarrisMoure. "They also oftentimes fail to account for the little things as well, which can add up too. For example, I just finished working with a company that set up a software outsourcing operation in China and in doing their cost numbers, they initially completely failed to account for the fact that employers in China typically have to pay between 30 to 40 percent in taxes for every Yuan paid in wages."

Gutted and Gone

Perhaps the greatest unforeseen cost is how a now gutted company retains its shape after large portions of its inner workings move out.

"The most expensive long term cost is losing the expertise on how to do the 'simple things,'" says Alton Martin, COPC Inc. CEO and co-founder. "When you are outsourcing basics, such as IT, customer care, etc. the company looses insight to these departments to the third party, leaving the company at a loss when they need to fix more complicated issues."

Few companies realize this kind of loss applies to intellectual capital as well.

"Intellectual Capital (IC) includes the knowledge base--the expertise--your team develops solving problems," explains James C. Roberts III, Esq., attorney at Global Capital Law Group. "In this case, we see that the teams do not create the development toolkits they could use in the future. Conversely, the developer now has the toolkit to use for competitors. Intellectual Property (IP) loss arises when the U.S. company has to 'open up the kimono' to show the developers proprietary code in order to do the development."

"Losing the IP and IC is worse when the developed product or service actually requires on-going rights in certain underlying technologies or the developers' toolkit or even maintenance--especially if the offshoring partnership goes under," he added. "We find that much of this gets short shrift in negotiating the agreements."

The remaining elements contained in-house may mold a different vision than C-level management intended. "The greatest difficulty is in foreseeing what the organization will look like post-outsource,' says Dane Anderson, vice president of IT Services and Sourcing Technology & Service Provider Research at Gartner. "At first it was just a reduction in headcount. Now, holy cow, there's a vacuum where institutional knowledge used to be."

This story edited by Shawna McAlearney. Follow me on Twitter @ms_shawna

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