Market leaders, costs, cost savings and BPO offerings are identified

The Yankee Group Technology Management Strategies advisory service recently delivered an audioconference about offshore outsourcing. Following the conference, we received a number of questions from vendors and enterprises. Because the majority of the questions came from enterprises working through the process of evaluating offshore outsourcing (i.e., evaluating the benefits and risks for their industry or organization and options for implementing an offshore solution), we decided to compile these questions in the following Q & A analysis to provide insight and recommendations for enterprises considering offshore outsourcing.

Question
In the banking, financial services and insurance (BFSI) space, what are the leading offshore providers in India?

Answer
Overall, BFSI companies are the leading consumers of offshore outsourcing. On average, for Tier 1 offshore providers in India, between 40 to 60 percent of their total revenue comes from BFSI sales. For example, the revenue breakdown (as of September 30, 2003) for top-tier Indian provider Infosys indicates the majority of its revenue comes from BFSI services—38.9 percent from BFSI ($441 million), 15 percent from manufacturing ($170 million), 15.4 percent from telecommunications ($175 million), 11.7 percent from retail ($133 million), 7.1 percent from transportation and logistics ($81 million), 3 percent from energy and utilities ($34 million), and 8.9 percent from others ($101 million). ABN AMRO, ING Group and Aetna are key customers for Infosys in the BFSI space. i-flex, Polaris Software, Tata Infotech, TCS and Wipro are other Indian offshore providers that focus on delivering services to BFSI companies.

Question
What are the transition costs involved in offshore outsourcing (or what percent of the total cost of an offshore outsourcing project is related to the cost of transition)?

Answer
The transition period (also referred to as the knowledge transfer period) for offshore outsourcing ranges from three to 12 months and is typically the most capital-intensive period of the project. The length depends on variables such as the complexity of the project or application (i.e., custom development or legacy maintenance), or whether the vendor relationship is new or established. On average, 3 to 6 percent of a typical enterprise offshore outsourcing project is spent on transition costs.

The costs associated with the transition period include the costs of getting the project set up and the infrastructure in place. Labor costs are at their highest during the transition period when the ratio of onshore employees in the United States to offshore employees is high (during the transition period, expect 80 to 85 percent of the work to be done onshore). At the start of a project, offshore developers must travel to the United States to work side-by-side with onshore employees (getting paid at the U.S. hourly rate) before moving the project offshore. Onshore, or in-house, employees typically must also travel to the offshore location to facilitate the start of the project. Investing in the transition process and closely monitoring and managing it, however, is the key to achieving cost savings. For example, after the transition period, quickly flipping the onshore/offshore employee ratio by moving 80 to 85 percent of the project labor offshore is critical to achieving cost savings. When offshore workers are onshore, cost savings disappear.

In addition to transition costs, enterprises must account for the cost of project management, international travel, communications and handling of cultural issues in assessing the cost savings of going offshore. For example, in addition to transition costs, 5 to 7 percent of a typical enterprise offshore outsourcing project is spent on managing the relationship. In developing a cost structure for offshore project management, enterprises need to take the following steps:

• Identify the number of people that will manage the relationship and determine how much of their time will be spent doing it.
• Determine the cost of international travel by estimating how many and how often in-house employees will travel to the offshore site and how many and how often offshore developers will travel to your site (do this for each year of your contract).
• Assess communications costs by determining the channels you and your offshore provider will use to communicate (i.e., phone, fax, e-mail, portals, in-person meetings, etc.). These costs may seem nominal, but during the course of a three to five-year relationship, they add up.
• Determine the method of handling cultural differences with your offshore outsourcer. Cultural differences can lengthen delivery time and require time and money to resolve, so the cost of addressing them should be included in your offshore cost structure.

Answer
Offshore application development and maintenance (ADM) is currently one of the largest service segments of offshore outsourcing. For many top-tier offshore providers in India, more than 50 percent of annual revenue comes from development and maintenance services. ADM is an ideal chunk of IT spending to send offshore, because the risks of going offshore are low, while cost savings are high. On average, 30 percent of an enterprise’s total annual IT spend goes to ADM. In most cases, sending this segment of annual IT spend offshore slices this percentage in half—10 to 15 percent.

The cost savings for sending ADM offshore shore are high because U.S. labor rates for ADM—ranging from $80 to $120 per hour—cannot compete against offshore rates. In comparison, the labor rates for ADM in India range from $40 to $60 per hour. In China, an emerging hot bed of low-cost technical skills, the costs of labor are even lower—ranging from $20 to $30 per hour.

Question
What business process outsourcing (BPO) offerings are moving up the value chain in India?

Answer
Our assessment of offshore BPO offerings indicates that most are in nascent phases of development. The dynamics of offshore BPO are much different than the dynamics of the IT development work that India has grown up on. Traditional offshore work, including ADM, is different for BPO on many levels. ADM is an arm’s length away from enterprise operations, while BPO is close to the heart of operational structures. Our research indicates that horizontal, high-volume, transaction-intensive functions, such as customer relationship management (CRM) call center functions, and HR payroll and benefit administration functions, are currently more advanced in comparison to financial, IT consulting and strategy functions. Because BPO requires deep vertical rather than horizontal expertise, offshore providers in India are leveraging existing customer relationships in developing BPO solutions. Because BFSI companies are the leaders in offshore outsourcing, BPO solutions for finance and accounting are advancing more quickly.

The Yankee Group originally published this article on 29 October 2003.