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Putting a price on offshoring

Arpit Kaushik | Jan. 28, 2009
When quantifying the business value of offshore outsourcing, customers must consider three important aspects that are often ignored.

Finally, internal employee costs are excessively padded by something called "an overloading factor" to account for pensions, holidays, desk space, corporate overheads and other factors. A figure of anywhere between 20 per cent and 50 per cent is normally used here -- choose the figure that reflects reality, and take into account that you can't recover any of those costs anyway.

The straightforward costs are fairly easy to see -- costs related to personnel, communications, IT infrastructure and tools and licences -- although sometimes the uplift required for converting single-site to multi-site licences can be hidden.

Many cost elements are not obvious. In their article Hidden Costs Impact Value in Outsourcing, authors Whitfield and Joslin state that potential outsourcers in all industries commonly assume that outsourcing can be plug and play, that the company will only have to absorb limited up-front costs before large savings can be realised, and that offshoring for labour arbitrage will ensure more than 60 per cent cost savings.

In reality, 10 per cent to 15 per cent savings are more realistic for highly commoditised service areas, and 40 per cent to 50 per cent savings can be achieved only in optimal circumstances.

Hidden costs

Travel of a customer's onshore staff first comes to mind as a hidden expense: a leading European software provider indicated that it takes 40 trips per annum to manage its offshore product testing program.

Equaterra, an outsourcing consultancy, points out a couple of interesting examples of hidden costs. One is the hidden cost of work retained onshore, internally. One retailer had outsourced the work of 1,100 employees, but held onto 50 per cent of the work for 200 of those employees. As a result, the company overstated its business case by US$24m (£15m).

Another overlooked expenditure is the hidden cost of internal, transitional headcount. Companies usually don't account for the costs of employees who help in the transition. For example, one pharmaceutical company kept about 20 per cent of its staff for six months after the go-live date, which added $1.5m (£950,000) in cost. Over ambitious headcount estimates can cut projected savings by between 10 per cent and 20 per cent.

Other examples of hidden costs are set-up (initial knowledge transfer, training, retraining, for example) and managing the offshore outsourcing engagement (governance system, additional personnel, management time). A McKinsey study suggests a figure of 10 per cent for additional transactional costs and 10 per cent for additional monitoring costs, though particular cost elements were not specified.

A recent white paper by a leading offshore outsourcer in collaboration with a top-tier industry analyst reported that their return-on-outsourcing model takes into account benefits from cost savings, efficiency gains and revenue improvement. But the bulk of the benefit actually comes from revenue improvement rather than tangible cost savings.


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