The Second Decade Of Offshore Outsourcing: Where We're Headed
Offshore outsourcing of IT has changed everything about Scott McKay's job at Genworth Financial, right down to what time he gets to the office. McKay, CIO at the provider of life and mortgage insurance, now arrives between 6 and 6:30 a.m. so he can spend the first two hours of the day dealing with IT teams--employees and outsourcers--in India and Europe before the U.S. workday starts. The first thing McKay does is click on a feed customized to deliver summaries of major news stories in India, plus other happenings around the world directly related to Genworth's business.
In 10 years, Genworth has gone from offshoring just a few IT projects to having about half of all its IT work done outside the United States. But McKay avoids the word offshoring--he, like many a CIO, prefers the "g" word. "The concept of offshore outsourcing will continue to dissipate," he says, "and we'll focus on globalization."
OK, so what does that mean exactly? As companies head into this second decade of offshore IT outsourcing, globalization is starting to be more than a polite way to say "dirt cheap foreign coding." Cheaper is still important. But businesses in North America and Western Europe, at least those with any track record of success with their offshore providers, are getting closer than ever to those vendors--for example, trying to help them deal with employee retention, treating those problems as their own. Companies also are holding their offshore providers more accountable for costs and outcomes, with shorter contracts and more incentives tied to business results. And they're trusting their offshore providers with more-critical work.
Two-thirds of companies on the InformationWeek 500 list of business technology innovators say they do offshore IT outsourcing, up from 43% in 2004. Consulting firm NeoIT estimates that 75% of the world's 2,000 largest companies are engaged in offshore outsourcing, with 20% of their IT budgets spent on offshore contracts; it predicts that could rise to as much as 40% of budgets in the coming years.
Cost cutting is usually the main driver, but as companies rely ever more on foreign markets for revenue growth, they're rethinking where they want their employees, including those in IT. For Genworth's McKay, it makes sense that globalization of the IT workforce follows globalization of the business: About 30% of the company's revenue now comes from outside the United States, and that's projected to grow to 50% by 2010. About one-fourth of InformationWeek 500 companies say they're expanding their IT operations in China, India, or another part of Asia.
As offshore outsourcing heads into its second decade, it's bringing new risks. CIOs must figure out how they'll nurture the next generation of IT leaders if, with greater outsourcing, there isn't the same career ladder that gave today's IT architects and project leaders both hands-on system work and deep company knowledge. U.S. companies that are putting ever-more strategic projects and processes into the hands of offshore outsourcers must be even better at vendor management, or they'll repeat last decade's offshoring problems--unexpected costs, code that doesn't meet business needs, vendors without the skills to meet a contract, delays implementing critical new systems--on a bigger scale. With costs in India rising, and employee attrition rates of 12% or more common among IT service providers, they'll need to fight for top talent with every bit as much energy as they do at home.
LOSING THE SWEATSHOP MENTALITY
CIOs tend to say some variation of the following about offshoring today: It's not just about low-cost labor. Note the "just." Offshoring's still about pursuing cost savings, and companies still won't go offshore unless they save at least 20% to 30% compared with using their own staff, says NeoIT chairman Atul Vashistha. But the picture's gotten more complex, with more focus on factors such as accessing specific skills, weathering ups and downs of business cycles (what FedEx CIO Rob Carter refers to as "variable capacity"), and paying outsourcers in part based on a specific business result.
"The portfolio of IT work has changed dramatically, and we look to India as a source of the latest skills on the very latest of platforms," says Clive Selley, CIO of BT Group's BT Wholesale division, who has worked with Indian service providers for 15 years. BT Wholesale still places routine application maintenance work with Indian outsourcers, but it also has Infosys, Tata Consultancy Services, and Tech Mahindra working on customer-facing projects, such as running the processes and systems for the entire "lead-to-cash" process for its broadband business, from the time a would-be business customer expresses interest until it places an order, gets a bill, and pays. Selley predicts BT Wholesale will increasingly outsource such "holistic customer experiences that span people, processes, and technology."
More are getting comfortable with that idea. This year, 40% of InformationWeek 500 companies said they do business process outsourcing offshore, compared with just 17% in 2004. TCS says that last quarter, for the first time, its maintenance and application development revenue accounted for less than half of total revenue, with contracts to run business processes, manage infrastructure, and provide IT consulting now the majority revenue source.
Hidden costs were one of the hardest lessons of the past decade of offshoring. Many companies found they didn't realize the promised savings once management time and rework costs were factored in for products that, while coded to specification, didn't meet expectations. That's leading to outsourcing contracts based less on the input--number of engineer-hours worked--and more on the output, measured by the project's success in terms of generating revenue from new products, meeting system uptime requirements in an IT infrastructure support agreement, or the number of customer policies processed in an insurance company BPO contract.
Pankaj Vaish, a managing partner at Accenture who's based in India, is seeing more business process outsourcing contracts based on savings from lower-cost labor plus a performance measure. So if Accenture--which expects its Indian workforce to reach 35,000 this year and surpass the size of its U.S. staff--is collecting bills for a customer, the contract might include a percentage based on driving the typical accounts receivable cycle from 30 days to 25 days and on the resulting improved cash flow.
All this is a distinct shift from the past. Offshore outsourcing got its first big push in the late 1990s, as U.S. companies scrambled to fix the Y2K computer date field problem. When 2000 arrived without disaster, it convinced U.S. companies that "those guys in India can actually do good work," says NeoIT's Vashistha. When the U.S. economy sank two years later, and CIOs were asked to cut IT budgets, many looked again to offshore development work. As business investment slowed and outsourcing rose, IT unemployment shot up above 5.5%. Programmer jobs fell more than 20% in two years, according to Bureau of Labor Statistics surveys. Meanwhile, Indian outsourcing firms positively boomed: In 1996, annual sales at Tata Consultancy Services, now the nation's largest IT service provider, were $150 million. Last year, its revenue hit $4.3 billion--a compound annual growth rate of more than 100%.
Reports of failed offshore projects trickled in, but they tended to be small enough that companies could keep them quiet, often contracting for rework from another provider. Some companies, burned by the experience, brought the work back in-house. That still happens plenty today: 20% of InformationWeek 500 companies say they've taken back offshored work in the past year. Too often, companies got back code that didn't deliver the expected business benefit, because the developers didn't understand the company and IT teams weren't used to writing specs for an outsider. "No matter how good people program every day, if they're programming the wrong thing, it's not helping you," says Ralph Szygenda, CIO at General Motors, which has offshored IT work for more than 10 years.
These problems aren't causing companies to run from offshoring: 36% of InformationWeek 500 companies have sent additional work offshore in the past 12 months. The biggest risk these providers face is keeping up with growth, having enough trained people to deliver quality work without blowing the labor cost advantages. Some of their customers are lending a hand, crafting closer relationships with their offshore providers despite past problems they may have faced.
Judy Poirier was hired as VP of IT at Celestica, an $8.8 billion-a-year electronics manufacturer, in April 2006 after a failed project the prior year to outsource management and support of the company's IT infrastructure to an Indian supplier, which she declined to name. The Indian company didn't have sufficient talent, took too long to train staff, and suffered from high employee turnover, Poirier says. Celestica brought much of the work back to Canada, where the company is headquartered.
But here's the telling point: Celestica didn't bail out on offshoring. Poirier was brought in in part to help the company figure out how to do offshoring right. In late 2005, Celestica tapped HCL Technologies to do a one-time custom development project related to the company's SAP system. It was a relatively safe bet, considering the maturity of SAP application development skills in India. The project worked, and Poirier this year formalized a contract for more development work. Poirier says she's sending more work to HCL because she sees it as a vendor that can collaborate with Celestica and that has the right culture for retaining people in the volatile Indian labor market.
Talent and attrition are the biggest risks to India as an offshoring destination, and one of the top considerations for companies looking to send work offshore. Infosys hired 30,946 people in its fiscal year ended March 31, but lost about 11,000 throughout the year. TCS hired 12,523 employees just in its second quarter, while losing more than 3,200, and it plans to hire another 9,000 this quarter. Late last year, TCS launched a program to turn science graduates into software professionals through a seven-month intensive training program in technologies such as Java and .Net. The result was evident last quarter: About half of its new hires were "trainees," of which about 20% were science grads. IBM had about 53,000 Indian employees as of March, hiring about 10,000 in six months. Accenture's target of 35,000 Indian employees is up from 8,000 last year.
HCL has taken some pretty radical human resources steps to combat attrition. The company's motto is "employees first," a twist on the "customer first" mind-set. An employee who has a problem with the company or a manager can submit an electronic trouble ticket--like many IT help desks use--and the appropriate manager must respond within 24 hours. There's an internal Web page, open to all, where employees can provide feedback on any manager. "Their ability to retain resources in such a volatile market is a result of that program," says Celestica's Poirier, who now has HCL employees working "right alongside our employees in Mexico and Asia."
After two years of success with application development, Poirier now is looking at HCL to help with major upgrades of IT systems, doing higher-value development of technology road maps and system design, as well as software development and implementation. "They've done it 15 other times with 15 other customers, and we haven't done it before," she says.
THE TALENT PROBLEM
Though IT service providers are making major efforts to retain employees, businesses experienced at offshoring have learned the hard way they can't leave it up to the vendor to keep workers happy.
Much of Genworth Financial's IT work is done in India and handled by three outsourcers: Genpact, a spin-out from General Electric that used to be GE Capital's India-based business process service provider, plus Patni and Satyam. About five years ago, when staff turnover rates started rising in India, Genworth Financial discovered that the problem was the night shift. People quickly burned out working at night just to please U.S. customers, and in a hot job market they could bolt for daytime jobs. Between 2003 and 2006, Genworth launched "Project Daylight," which called for transitioning work previously done 80% during the night in India to 85% during the day. That meant pulling some jobs back to the United States, like call center work, and developing processes that required shifting work from one time zone to another as workdays end on one side of the globe and begin on another. In retrospect, "the night shift was designed for short-term cost savings, rather than designing your company to be a truly global business," McKay says.
Teradyne, a semiconductor testing equipment maker, started offshore outsourcing in the late 1990s with its Y2K remediation work. Last year, it cut a five-year, $70 million contract with HCL Technologies to outsource 80% of its IT work. About 70% of the outsourced workers--more than 200 workers--are in India and 30% in the United States, many of them on guest-worker visas from India. HCL handles infrastructure and desktop support and application development. Teradyne's remaining internal IT employees focus on architecture design, project management, data analysis, and leading and implementing new application projects, which they then turn over to the outsourcing team to run.
Teradyne decided that a large permanent IT staff didn't fit the cyclical nature of its business. CIO Chuck Ciali says outsourcing lets Teradyne ramp up for big projects and down during leaner times, and lets it draw on specialists it can't afford to hire. "We don't need a storage architect on our staff, as we don't leverage those skills that often," Ciali says. "HCL has greater skills in that space."
But with more than three-fourths of the people running IT not company employees, Ciali wants to make sure contractors are satisfied and motivated. "There's a lot of work we do to be sure they're feeling challenged," Ciali says. That includes working with HCL to make sure HCL employees have upward mobility and new opportunities while still staying on the Teradyne team, and having IT teams rotate between the United States and India. "It does wonders for making their jobs more real in terms of how critical IT is to the business," Ciali says. "They can put a face to a name, and that does a lot to create a team environment."
BT Wholesale's Selley may be the customer, but he sees himself as competing for talent at the top Indian firms. "The quality of the opportunity that we place with a supplier in large part dictates their ability to retain and develop talent," he says.
A BT Wholesale executive team recently gave a presentation in Bangalore called "Joining The Dots," intended to help contract workers from Infosys, TCS, and Tech Mahindra understand BT's strategy and the role IT and process engineers play in it. The team explained BT Wholesale's market segments, key competitors, new products, and what it plans to launch over the next few years. "It's about spending time with people and explaining our objectives rather than just describing a piece of software they need to deliver by Friday," Selley says. "We want those employees to bring ideas back to us, too. It's been far too unidirectional between the U.S. and U.K. and suppliers in India."
BT Wholesale pays close attention to attrition rates when choosing providers in India, but Selley says the raw numbers don't reveal much. What matters is whether they're keeping the experienced and skilled engineers. Selley insists that tapping the talent pool at big offshore companies like Infosys now outweighs the cost advantages. "Those guys are hardworking and ambitious, which fuels them to learn more and have an impact," he says.
GM CIO Szygenda also sees a role in helping outsourcers work through problems. Part of it is self-interest: He wants GM to be able to work with multiple outsourcers, so he has demanded that they use certain standard processes for common IT tasks. But he also sees that as a model for the broader industry to adopt. Carnegie Mellon University's Software Engineering Institute and General Motors this month will publish a set of standards for buying services such as IT--called the Capability Maturity Model for Acquisitions--that draws partly on GM's experience. Szygenda says 75% to 80% of the 15,000 contract IT workers GM uses worldwide follow its standard processes.
FEARS OF A BRAIN DRAIN
Offshoring didn't kill the U.S. IT market, which employs more people--more than 3.6 million--than any other time this decade. But offshoring creates another looming risk to IT organizations and to the profession.
As businesses shift more strategic projects offshore, Celestica's Poirier worries what will become of the "incubator for the big IT brain" within companies. As offshoring of both routine and high-end work grows, there will be fewer people who joined the company 10 years ago, developed core applications that are still in use, and understand the inner workings of the IT infrastructure that grew alongside their careers. "It's all those guys you turn to when you're doing something interesting or exciting, or are in a crisis," Poirier says. "We still have those people, but a lot of them have a lot of gray hair." How do you build those skills without entry jobs? Poirier doesn't have the answer, and she doubts other CIOs do either.
Selley acknowledges it's a problem, particularly at a company like British Telecom, which considers technology its core. "It's very easy to focus on shifting more of your IT work to a low-cost, highly competent outsourcing supplier and lose the plot on what you're trying to do with your internal capability," Selley says. The company constantly questions which core elements it must own and what it "can afford" to let a partner do. "It's a question you just have to keep asking and keep answering," he says.
BT Wholesale tries to address the problem by building teams of staff and outsourced workers at co-location sites in the United Kingdom and India, focused around a specific customer function. Its lead-to-cash customer center in Puna, India, is staffed by three or four BT people from the United Kingdom and a half dozen from BT India, alongside a majority of employees from an outsourcer. "One of my senior guys is out there right now," says Selley. "This is a long way from the '90s, when you sent over one piece of discrete work. It's become very collaborative, and the whole model now is coding it together."
One path CIOs may need to take more often is poaching from the provider. About 60% of Applied Materials' IT services is outsourced, and employees within the company tend to be IT leaders such as program managers or directors. "But there are lots of opportunities for people to cut their teeth in outsource organizations," says Ron Kifer, CIO at Applied Materials. "We simply recruit people later in their careers for opportunities in our organization. You still have people coming up through the ranks, but not necessarily having started here as an employee."
HIRE OR OUTSOURCE? As the lines blur between outsourced worker and employee, CIOs start to wonder: Would we be better off assembling our own offshore staff?
A tempting notion, and one that a list of top U.S. employers couldn't make work. Dubbed "captive" centers, they have a spotty record for IT work, especially in India. A number of banks and other businesses--including Apple, Citibank, and GE--have given up on their IT operations in India, deciding that offshore service providers could run such operations more efficiently.
Retention can be one problem: Ambitious tech talent often quickly decide their IT career opportunities at a U.S.-based company are small compared with places where IT services are the central business. Attrition rates can be as much as 30% higher, estimates Forrester Research analyst Sudin Apte.
Yet some companies with global operations are finding it effective to have employees at their own IT development centers around the world, especially if they have growing revenue from a region or a manufacturing presence there. That's driving IT centers in places such as China, Latin America, Eastern Europe, and India.
Genworth Financial's McKay calls his a "virtual captive model" in India. It relies on Genpact to hire people, since it can offer a better career path. Yet those who work for Genworth are required to think about and perform their jobs as if they were an offshore division of Genworth, working entirely on its projects. This structure provides Genworth with a "core of people who stay focused on your business and industry and have deep subject matter knowledge, and they grow with you over time," McKay says.
Avnet, a distributor of semiconductors and other electronic components in 73 countries, as well as a provider of supply chain services, has had an internal IT team in Bangalore for about five years. About 18 months ago, it began building a team in Shanghai, and several months ago it established an IT team in Bucharest, Romania. The company hires offshore outsourcers when it needs additional coders to ramp up a project, but the important customer-oriented work is handled by the internal IT team.
CIO Steve Phillips doesn't expect salaries in India and other developing countries to stay as low as they are, but he says it's never been just about cheap talent. "We're a global operation, and if we're going to provide follow-the-sun support, we need folks across the world," he says. Avnet recently took an SAP system live for a customer in Asia, and a problem arose that was initially handled by an employee in Bangalore. The employee left work for the day and handed off the project to a U.S. employee, allowing Avnet to resolve the issue within 24 hours, Phillips says.
Not many companies can pull off the coordination needed to "follow the sun." At Avnet, the global IT team worked together on common life-cycle development processes and common change processes. Phillips acknowledges that takes a lot of documentation and forces everyone to do that work in English. And it takes a lot of travel: Phillips' top 10 IT leaders from the different locations meets face to face every quarter, most recently at the Shanghai location.
For CIOs, "globalization" means a growing dependence on IT pros all over the world, whether staff or those contracted through offshore suppliers. Problems that have marked the first decade of IT offshoring will continue, thanks to talent shortages, communications failures, and rising costs. CIOs like to point out that offshoring isn't only about cost savings, but the savings look likely to stay well into the next 10 years. Even without the cost savings, many CIOs insist they need offshoring because they can't get enough qualified talent here. That's debatable. But even if they could, there's a sense that globalization is a goal in itself--as more companies see their success pivoting on non-U.S. sales, they see a solely U.S-based IT organization as a weakness. Look for more companies to offshore bigger projects with higher stakes.
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