SIDEBAR: Outsourcing Strategies

A three-part series about outsourcing strategies and success models, defined in original research by MIT's Centre for Information Systems Research and CIO.

Transaction relationships: simple successful outsourcing

CIOs who outsource discrete processes that have well-defined business rules are almost always happy with the outcome.

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Co-sourcing alliances: offshore allies

Working with offshore partners requires CIO oversight and strong capabilities on both sides.

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Strategic partnerships: big deals, big savings, big problems

Large-scale outsourcing deals promise big savings, but they fail half the time. Here's how to make them work for you.

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SIDEBAR: The Captive Option

Companies interested in long-term offshore outsourcing are increasingly opening their own operations overseas.

As problems with long-term offshore contracts, such as growing turnover and diminishing quality, become more pronounced, captive offshore operations - in which a company opens its own offshore subsidiary - are gaining favour. The captive model gives a company complete control over offshore operations and, by eliminating the middleman, can boost savings. In fact, Deloitte Touche Tohmatsu found that among financial services companies, captive operations appeared to be more capable than offshore contracts of improving savings and quality over time.

Some companies may choose to go the captive route from the get-go, but more often than not it's a model they develop after working with an offshore vendor for a few years. Some offshore vendors even offer a "build-operate-transfer" model that allows a company to purchase the offshore centre from the vendor after a specified period of time.

But the captive model isn't right for everyone. If your offshoring needs are small, it wouldn't make much financial sense to set up an offshore subsidiary. Similarly, if you want to outsource a particular technology that an offshore vendor has spent years building a practice around, you might get better performance from the vendor than you would from your own captive operation. But if you're going to have 2000 workers offshore or have specialized needs, a captive centre is often a better option.

Some companies, like Lehman Brothers, end up splitting the difference with a hybrid model, setting up their own offshore subsidiary and supplementing that with offshore vendor relationships. Last February, Lehman CIO Jonathan Beyman set up a captive centre in Mumbai, India, that is focused on very high-level work such as developing and maintaining Lehman's proprietary software. It's the kind of work Beyman isn't comfortable handing off to a third party, particularly when turnover is such an issue. "Hopefully we've set up an organization where that's not as much of a problem," Beyman says. And in the captive centre, "IT and industrial engineers can get together and figure out how to redesign business processes and solve things that are not purely technical problems, but social problems."

The captive centre currently employs 300 people and is scheduled to grow to 600 by the end of the year. But Lehman continues to maintain outsourcing relationships with Indian vendors Tata Consultancy Services and Wipro, which have a total of 400 workers attached to lower-end projects, such as QA testing and infrastructure support, for the financial services firm.

SIDEBAR: 7 Steps to a Successful Offshore Relationship

1.Don't assume the hard work is over during the ramp-up period. Healthy offshore relationships require continuous improvement throughout their life cycles and extensive re-examination every three years.

2.Hold quarterly meetings with senior-level representation from both customer and vendor.

3.Rotate people out of the relationship management position after a few years to prevent burnout. Or consider having some permanently onsite at the offshore location. The travel required to manage relationships offshore can take a toll on employees.

4.Keep close tabs on vendor staff turnover. Pay attention to all levels, from the executive ranks to middle managers to line workers; defections at any level can have a negative effect.

5.Work with your offshore provider to cushion against the sudden loss of key employees. For example, on an important project place an extra resource who can be ready to jump in if necessary.

6.Make sure performance metrics mesh with reality. If they don't, come up with new metrics that do.

7.Survey business users and internal IT staff about their experiences with offshored support or projects on a regular basis. They can be your best measure of how well or poorly the engagement is delivering.