Offshoring: How far, how deep?

The question on the lips of most CIOs is no longer whether to send work offshore. It's a question of how much to send.

The offshoring of IT jobs is now an everyday business reality. Every Australian bank does it; and if you believe the whispers, even our federal government departments are strongly considering it.

The question today is how far you go -- how deep do you build a partnership with your offshoring partner, and how much of the high-risk or sensitive operations you keep in-house.

ZDNet Australia's Brett Winterford travelled to Delhi in India to talk with some CIOs at a customer meet to learn from their efforts.

Motivations
It's often assumed that those Australian companies that opt to push their business processing or application development offshore do so purely to drive down costs.

While there can be no doubt that the average IT knowledge worker in India earns far less than his Australian counterpart, the reality is that from a business perspective, cost is rarely the sole driver.

Ask an Australian CIO, and they report that it's simply a matter of having little choice -- there is just not enough IT students graduating from our universities to hire.

Those workers with in-demand skills can afford to pick and choose between employers with little regard for loyalty.

John Loebenstein, former CIO of St George Bank, said that while originally executives like him approached the Indian outsourcers with a view to conducting basic labour arbitrage for cost savings, those days are over.

"It's evolved from there," he said. "These days, if you are purely going for cost you won't find the cost differentiation isn't that much. You only save money after you reach a certain scale, and even when you do it might be 10 percent, not 20 or 30."

In application development, for example, he sees little savings. "For every three or four developers you hire in India, you have to hire another at home. Offshoring development is an extraordinary expense, when you consider the dedicated line for security, the travelling costs, the set-up calls and firewalls and servers. That soon eats away at the pure wage arbitrage."

Rather than cost, it's the scale and flexibility of the resource pool the Indian outsourcers provide which is more attractive than cost: the ranks of the bigger outsourcers -- Wipro, Infosys, HCL, Satyam et al -- have tens of thousands of young, skilled staff ready to deploy on projects.

Loebenstein said it is the intellect, the flexibility of resource and discipline of certain offshore providers that make them attractive.

"There is incredible brilliance and innovation in Australia," he said. "But today the world is your oyster. We are fortunate that we can now look across borders to get the best resources. Whether or not they are in India is almost immaterial. It could be The Philippines, Ireland, Melbourne or Delhi: geography doesn't matter anymore."

Global trend: Deeper relationships
Australian companies tend to be a little more nervous about sending work offshore than their American or British peers. Most of the application development local banks have outsourced to Indian companies, for example, occurs 'onshore', where an outsourcer brings staff over to Australia temporarily from India to complete a project.

More advanced nations in the outsourcing game, said Pradeep Bindal, vice president and infrastructure services global director for Indian outsourcer HCL, took their initial forays into outsourcing in a similar fashion.

"Australia tends to be behind the US and the UK in terms of being comfortable with sending work offshore," said Bindal. "When outsourcing first started in the US and Europe, it was mostly done onshore too."

Globally, the direction tends to be sending more work offshore -- and more to a single partner or handful of partners with which the client is asked to place greater levels of trust.

"Trusted relationships will be of the most importance in the next few years," is the catch-cry of Vineet Nayar, CEO of HCL, a US$6 billion Indian-based outsourcer whose clients include AMD, Boeing, Cisco, IBM and Microsoft. "We want to do business with fewer customers, but be more strategic to them."

Financial services conglomerate Deutsche Bank and networking giant Cisco are two very large companies that have gone with this mantra.

Over the last decade, said Tony McCarthy, managing director of IT at Deutsche Bank's Investment Banking group DB, has made India the "single largest resource pool for Deutsche Bank in the world".

Cisco has gone even further -- making India its "second head office".

Wim Elfrink, chief globalisation officer at Cisco Systems, moved his family to the Indian city of Bangalore in January.

Elfrink doesn't believe that globalisation is about where things are cheapest anymore. "It's not about cost and labour arbitrage," he said. "It is not about call centres. It is about how you can globalise the brains of the world. It's about picking up on the innovation of different players and making something out of that."

While a cost advantage is a bonus, Elfrink said, it's not a "sustainable differentiator" from your competition. That can only come when you derive real value from your partners.

Elfrink said that Cisco, like many of its global peers, is consolidating the number of partners it works with and is building deeper relationships with those remaining by using virtualisation and collaboration tools.

He sees offshoring providers becoming offshoring "partners": "adding value, providing thought leadership, and exchanging best practices".

It's necessary, Elfrink said, to leverage the resources of global players in order to develop new products at the breakneck speed the market demands.

"I think at the moment, being a CIO is one of the most complex jobs," he said. "You have to dare to make bets. You have to dare to make a choice."

"You need to make investments in trusted relationships," agrees Peter Bendor-Samuel, founder and CEO of outsourcing consultancy Everest. "Naturally that means you have to cut down on the number of suppliers. Fundamentally, it requires a change in your trust barriers."

How close is too close?
Cisco is not shy about letting down its trust barriers, especially in the area of offshoring application development. After kicking off a basic offshoring relationship with HCL around "time and materials" to develop a new product line a few years ago, Cisco recently took its marriage to new extremes. HCL now shares a revenue stream with the networking vendor from the sale of the Cisco-branded product.

"We wanted everyone, from the CEO down to the developers, be it at Cisco or HCL, to feel ownership of the project," said Clive Foreman, vice president of the network management product group at Cisco.

"We bring HCL into customer engagements and share customer satisfaction data and even our results around that product line. We actively encourage the HCL team to bring new ideas to the product line. There's already been a lot of patentable IP created."

In light of the close relationship, Cisco has removed any SLAs (service level agreements) out of the deal.

"Generally an SLA is a penalty applied when the performance of an outsourcing partner continually falls below an agreed threshold," Foreman said. "There are zero SLAs between Cisco and HCL. While we have a sufficient array of metrics around quality, around productivity and hitting dates, the reality is that if any of these go south, we're both in trouble."

Foreman said that such a strategy involves a greater amount of risk. "It comes down to choosing the right partner," he said. "You don't do a deep partnership with somebody that doesn't share a strong sense of mutual commitment and trust."

Other CIOs are a little more conservative, even if they are engaging in deeper relationships with their outsourcing partners.

A recurring theme among CIOs attending a conference on outsourcing in India earlier this month was that while closer relationships are desired, one needs to remember who the client and who the customer is.

Outsourcing partners need to understand, said Deutsche Bank's McCarthy, that even if they move to a more equitable "partner model" they won't just be getting the high quality, visible work -- but will have to continue to perform tasks that aren't so glamorous.

McCarthy said that DB offshores to "take off our plates some of the huge burden we face managing literally thousands of applications on a day in day out basis".

"We often see with third party strategic partners, they want to go into the deep change space, the development space. They would always come to me telling me what they wanted to do for me rather than listening to what my problems were. And my problem is a big application environment that needs to be supported."

McCarthy said he had to sit down and explain to the outsourcer that while new application development represents 10 percent of the bank's application spend, ongoing application management is 90 percent. "I had to ask, why were you pursuing the 10 percent rather than the 90 percent?"

McCarthy's comments were echoed by several other high profile customers, Boeing included. A representative from Boeing commented at the conference that perhaps its outsourcing partner needs to take a reality check as to who is better placed to integrate complex technologies -- the company that builds the "Dreamliner" or the outsourcer.

Why your partner wants commitment
A quick analysis of the financial performance of Indian outsourcers and their push towards "valued partner" becomes clearer.

Nearly all are experiencing strong revenues as more companies send work offshore. But the strong development of the Indian outsourcing market is a double-edged sword -- with it has come wage increases for skilled Indian IT workers. Coupled with a poorly performing US dollar, these companies will struggle to maintain profit margins at their current levels.

For the first quarter of 2008, for example, HCL Technologies continued to grow its revenues significantly, and to a lesser degree its profits. In that same quarter however, it raised salaries by around 15 percent for its offshore workers and four percent for its onshore workers, while the Indian rupee appreciated by 13 percent against the US dollar.

Deeper relationships with less customers can help the outsourcer buffer these margin-eroding pressures, as it will lower the cost of sale and could ideally result in recurring revenue from shared IP.

Understanding these motivations may help CIOs structure a better deal for their company should they decide to send work offshore.

The prevailing theme among CIOs speaking to ZDNet Australia, is that at a high level you certainly can consider moving to a "partner" model rather than a "provider" model should the shoe fit. But as one speaker so eloquently put it, "keep strategy and control close to your heart. Share execution."