Pulling the Plug

Since day one the issue of offshoring has been a scratchy one, raising both eyebrows and hackles. And now, with some organizations chafing three-to-four years into their offshore contracts, apparently there's a real itch to scratch.

Reader ROI

• Why the value of offshoring often dips after three years
• What to do to keep the relationship fresh and productive
• How to know when it's time to bow out

There's a sense of relief in Scott Testa's voice as he talks about terminating the last of his company's offshore outsourcing contracts this northern summer.

As COO and CIO of Mindbridge, an intranet software provider, Testa has overseen engagements with a handful of Indian IT service providers since 1999. In the beginning, the lure of lower costs from offshore outsourcing was hard to resist. And indeed, through 2002, Testa couldn't have been happier with the results. He was saving his company 30 percent on the application development and maintenance work he otherwise would have sourced domestically.

But by 2003, Testa began to see the benefits slip away. Staff turnover at the Indian vendors increased. The quality of work on offshored projects decreased. And Testa's internal staff was growing weary of the time and travel required to keep the relationships on track.

Things finally reached a breaking point last year. "[Offshore outsourcing] made a lot of sense for us at one time," says Testa, who will sever ties with the last remaining Indian vendor in June. "But it made a lot less sense for us in 2003. And by the end of 2004, it was right there in our face. It just wasn't nearly as cost-effective - or effective - for us any more. We'd get better quality and lower costs by doing the work domestically."

Testa's experience is a sign of the outsourcing times. In the late 90s and early part of this decade, many CIOs jumped on the offshore outsourcing bandwagon. They were either feeling the lure of potential savings or being pushed by CEOs or boards with similar dollar signs in their eyes. A surprising number of companies ended up going offshore first and figuring out a strategy later.

Now, as marriages arranged during the heyday of offshore outsourcing have matured, offshore outsourcing satisfaction rates have dropped. Last year, IT consultancy DiamondCluster International reported that the number of buyers satisfied with their offshoring providers fell from 79 percent to 62 percent, and the number of buyers prematurely terminating an outsourcing relationship doubled to 51 percent. Also in 2005, PricewaterhouseCoopers found that half of the financial services executives it surveyed were dissatisfied with offshoring.

Several years into the craze, expectations about offshoring have come crashing down to earth. In a recent study of offshore outsourcing results among financial services companies, Deloitte Touche Tohmatsu discovered that although offshore performance during the first few years was consistent with expectations, many companies encountered an alarming drop-off in both cost savings and quality after three years. "It is a lot of work to manage these relationships. If you don't put the resources and the work into managing this relationship well long term, you are destined to have issues," says Testa. "That, quite frankly, is what happened to us."

Philip Hatch, founder of offshore outsourcing consultancy Ventoro, has also found a maximum ROI point occurs sometime before the first three years are up. "After you hit that [three-year mark], unless there is some additional external force, things get stale," says Hatch, who worked for Russian outsourcer Luxoft from 2000 to 2003. "Turnover rates on the outsourcing team pick up. The methodologies and tools that worked well in the beginning become obsolete. And other soft costs creep in," he says.

CIOs who are just beginning to evaluate the offshore option could benefit from the lessons learned by those who have gone before them. Even before they make the decision to offshore, CIOs should factor in the costs involved in keeping a long-term offshoring relationship from becoming stale. Smart CIOs have figured out that continuous tweaking and constant attention, as well as developing the right metrics for judging performance, are keys to long-term offshore success.

"Unless an outsourcing engagement goes through some kind of reinvention, by five to seven years out you're going to see no material cost savings over what you would pay to do the work yourself," Hatch predicts. "The outsourcing engagement will be obsolete."

Join the CIO Australia group on LinkedIn. The group is open to CIOs, IT Directors, COOs, CTOs and senior IT managers.

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