The Hidden Costs of IT Outsourcing

Keith Franklin, president of Empowered Software Solutions in Burr Ridge, Ill., loves offshore outsourcing.
Written by Olga Kharif, Contributor

Keith Franklin, president of Empowered Software Solutions in Burr Ridge, Ill., loves offshore outsourcing. It means more work for his 40-person company. Just last year, ESS, which specializes in developing applications for Microsoft's .Net platform for Web services, earned $500,000 in revenues from fixing buggy software written in India. It took ESS five months to repair a glitch-filled application for a Web portal. Most pages on the site weren't connected, turning updating into a nightmare. Some code was missing.

The shoddy work didn't come cheap, either: The Indian outsourcer went $1 million overbudget. Franklin says he could have done the project for less than $900,000 -- right here in the U.S.

Indeed, offshoring -- sending work overseas -- isn't always all it's made out to be. Particularly with information technology, which can be a lot more complicated than moving traditional manufacturing operations overseas. IT quality is much more difficult to gauge, says Atul Vashistha, chairman and CEO of info-tech offshoring consultancy neoIT in San Ramon, Calif. And since IT is an integral part of every business process, it requires more communication and management.

Offshore IT outsourcing started to soar during the economic downturn. With their companies' sales squeezed and shareholders screaming bloody murder, many CEOs began mandating that some IT work be sent overseas. They were following the lead of big companies, including chipmaker Intel and software giant Microsoft, that already do considerable software development in India and Russia. With the trend gaining momentum, more than 40% of U.S. companies will develop software or test it, offer tech support, or provide storage functions overseas by 2004, according to market consultancy Gartner.

"DIRTY LITTLE SECRET." On paper, it looks extremely attractive. A Russian programmer charges 80% less than an American. But when you parse it all out, the total cost of offshoring a given IT job is generally comparable to getting the work done domestically, says Tom Weakland, a partner at management consultancy DiamondCluster. It's just that few companies are aware of these real costs. "Most companies can't accurately measure their productivity and costs prior to and after outsourcing," says Weakland. "Most look just at wages."

A few companies have learned the lesson the hard way. A year ago, 100% of neoIT's business came from consulting companies wishing to go offshore. Today, about 25% to 30% of its business relates to fixing problems, says Vashistha. Most companies don't want to advertise the problems they've run into, of course. "It's a dirty little secret," says Michael Mah, managing partner at software consultancy QSM Associates, based in Pittsfield, Mass. "There could be more crashed projects in the next 6 to 12 months."

One weakness of moving support functions overseas is that it leaves no one on-site to help customers. Take publishing-software maker Quark. For the last year it has based its English-speaking tech-support staff -- people you call if your app keeps crashing -- in India. Kamar Aulakh, Quark's president, claims that the move hasn't affected service quality or caused any customers to flee. He says his support staff is able to resolve problems over the phone. But the trend leaves some customers worried.

BACKWARD PRIORITIES. As Empowered Software has discovered, programs developed by offshore outsourcers are also often buggier than software programmed domestically -- usually 35% to 40% more so, estimates Mah. "If a company makes software for flying airplanes, I wouldn't want [it] to be created with the priority of the deadline coming first and quality coming second," he says.

And if a financial application used by, say, a bank distorts crucial information such as trading data, a customer could sue or withdraw its business. Should such problems arise, the U.S. company can't easily turn around and sue its applications-development outsourcer overseas.

Fixing even small bugs can cost up to 10 times more after the software is written than at the design stages, Mah says. And some offshore-outsourcing companies charge extra for fixing bugs after delivery. In a worst-case scenario, a company could end up feeling like it's in that old Dilbert cartoon in which the pointy-haired boss promises $10 for every bug fix -- and a programmer decides to code himself a new minivan.

MIDNIGHT OIL. Costs add up even when offshoring is done right. Many companies tend to send expatriates to set up their operations abroad -- and their wages usually run high. Then there's the price of additional executive travel. And, ideally, offshore employees are also brought into the U.S. for several months for extensive training in language and culture.

More important is the cost and inconvenience of managing offshore crews. When privately held software maker Elance outsourced some of its development to India last October, its domestic engineers had to work past 10 p.m. every day to communicate with the Indian team. Even now, they have to work late a couple of nights a week, says Fabio Rosati, Elance's president and CEO.

Some companies also have to change their internal processes to accommodate offshore partners. Some decide to open branches abroad, where they have more control over how work is done. And others are diversifying their offshore outsourcing. Last November, Electronic Data Systems unveiled its Best Shore Initiative, designed to help clients pick the best offshore location. The locations have to pass tough guidelines for quality of work, infrastructure, and low cost.

One reason for the initiative, says Dan Zadorozny, EDS's vice-president for application-services delivery, is that labor costs in traditional outsourcing powerhouses such as India are escalating. Already, an entry-level programmer costs more there than in Argentina, he says -- which is where he's increasingly sending clients.

DOMESTIC SOURCES. Software companies that facilitate communication between customers and their offshore vendors are also prospering. Elance's software, already used by shipping giant FedEx, General Electric, and cell-phone maker Motorola, allows companies to track specifications, compile an audit trail of what was communicated to whom, and measure performance against hundreds of pages of contracts. The company declines to disclose its annual sales, but Rosati says they're doubling every year.

Other companies hope to lure disillusioned outsourcing customers back home to the U.S. In October, RTTS, a privately held test-automation consultant, unveiled a testing service that works just like one offshore -- only it's delivered out of New York. By doing the testing remotely, as Indian outfits do, rather than on-site, RTTS can match the price of Indian companies.

"It's the same model as India, but there are no time-zone and language issues to deal with," explains Bill Hayduk, director of professional services for RTTS, whose customers range from pharmaceutical to insurance companies. "Customers going offshore aren't happy with the quality they're getting. So we think there's a big opportunity for us."

The outsourcing trend is unlikely to reverse any time soon, however. Pressured by lower-cost competitors, U.S. companies like the instant gratification of savings on wages. But as the real costs of IT outsourcing become apparent over time, many companies may come to realize that it's no panacea.

BusinessWeek Online originally published this article on 27 October 2003.

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