In the last two decades, outsourcing overseas has been steadily on the rise with companies of all sizes jumping on board to help cut costs and make their operations more profitable. Reducing costs is the number one reason that companies choose to outsource overseas—factoring into 87% of the decision-making process for both IT and business sectors.
The myth is that outsourcing overseas can save companies up to 80%. The reality is that it is usually not even half that. In fact, a recent survey among IT companies that leveraged outsourcing overseas to lower overhead, found that 30% of companies said that it was effective in reducing costs, 55% said it was somewhat effective and 15% said it was not effective at all.
Ask an IT project leader in the “somewhat effective” group and one in the “not effective at all” group why outsourcing overseas did not deliver more of the cost savings they had expected, and it is probably a safe bet to say that hidden costs played a major role.
Hidden costs are one of the biggest risks associated with outsourcing overseas. And while it’s true that outsourcing overseas can provide bottom line benefits, it’s not a cakewalk to implement—requiring years of effort and substantial up-front investment with benefits not realized until many years down the road.
To get a better understanding of the TCO (total cost of ownership) of outsourcing overseas, let’s shed some light on some of the most common hidden costs.
Cost of Selecting a Provider
Choosing a service provider is anything but inexpensive, costing both time and money. You’ll need to dedicate resources to the bid, to sending RFPs and evaluating the responses, and to the actual writing of the contract. You’ll also need to carefully examine various outsourcing providers and determine which model aligns with your project objectives—all of which can take six months to a year and could possibly involve hefty legal fees.
The expense of selecting a service provider can cost from .2% to 2% in addition to the annual cost of the deal. For example, if you’re sending $5 million worth of work to India, selecting a vendor could cost between $10,000 and $100,000 each year.
The Cultural Cost
Outsourcing overseas involves solving cultural and organizational differences that can add anywhere from 3% to 27% to your outsourcing costs and can also lower productivity.
On average, an IT organization will experience a 20% decline in application development efficiency during the first two years of a contract due to cultural differences and experience levels.
According to Meta Group, a leading IT research and analyst consultation provider, productivity loss can add as much as 20% in additional costs to an overseas outsourcing contract.
The Cost of Transition
Typically, the transition period is the most expensive piece of the overseas outsourcing puzzle and can take from three months to a year—a period of time where there are no savings and significant expenses.
Beginning a relationship with a services provider requires training and explaining your business processes to your overseas team. This can involve bringing workers to the United States to learn the project skills needed; where they’ll work in tandem with your in-house employees and are paid U.S. wages. So technically, it’s costing you double—the overseas worker and your in-house trainer—with no work produced.
Additionally, during the transition, the overseas provider must put infrastructure in place that often results in long lead times in acquiring the necessary hardware. This can mean keeping their workers employed at your site for longer that you had budgeted.
The Cost of Lay-Offs
Lay-offs involve many—and often unanticipated—costs. For starters, you have to pay severance and retention bonuses to many of your employees—the ones needed onsite long enough to train the overseas workers who may be replacing them.
Lay-offs can also reduce morale, which can mean loss of productivity and a hostile environment. Often internal people will refuse to embrace or slowly embrace the transition to the offshore model because they don’t want a co-worker to lose their job. This can lead to delays as long as three years in building consensus and moving forward.
The Cost of Managing the Contract
Managing the overseas service provider involves significant costs—on average an additional 6% to 10%. Invoices, time sheets and contracts must all be managed correctly to make the process work.
Additionally, a project manager is necessary to manage the overall outsourcing process. A critical position that can set you back anywhere fro $50,000 to $100,000, duties include making sure that projects are moving ahead, auditing time sheets from the vendor, and developing and analyzing vendor proposals against the RFPs when bidding out work.