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Moving jobs overseas can be a much more expensive proposition than you may think.

The current stampete towards offshore outsourcing should come as no surprise. For months now, the business press has been regurgitating claims from offshore vendors that IT work costing $100-$150 an hour in the US or Australia can be done for $US20 an hour in Bangalore or Beijing.

If those figures sound too good to be true, that's because they are.

In fact, such bargain-basement labour rates tell only a fraction of the story about offshore outsourcing costs. The truth is, no one saves 80 per cent by shipping IT work to India or any other country. Few can say they save even half that. As just one example, United Technologies, an acknowledged leader in developing offshore best practices, is saving just over 20 per cent by outsourcing to India (see "Inside Outsourcing in India", CIO July).

That's still substantial savings, to be sure. But it takes years of effort and a huge up-front investment. For many companies, it simply may not be worth it. "Someone working for $US10,000 a year in Hyderabad can end up costing a company four to eight times that amount," says Hank Zupnick, CIO of GE Real Estate. Yet all too often, companies do not make the outlays required to make offshore outsourcing work. And then they are shocked when they wind up not saving a nickel.

In this article, we will explore a new TCO - the total cost of offshoring. We will uncover all the hidden costs of outsourcing - areas in which you'll have to invest more up front than you might think, places where things such as productivity and poor processes can eat away at potential savings, and spots where, if you're not careful, you could wind up spending just as much as you would locally. (For more on how to calculate your own best and worst case scenarios, see "Do the Maths" page 94.)

"You can't expect day-one or even month-six gains," Zupnick says. "You have to look at offshore outsourcing as a long-term investment with long-term payback."

The Cost of Selecting a Vendor

With any outsourced service, the expense of selecting a service provider can cost from .2 per cent to 2 per cent in addition to the annual cost of the deal. In other words, if you're sending $10 million worth of work to India, selecting a vendor could cost you anywhere from $20,000 to $200,000 each year.

These selection costs include documenting requirements, sending out RFPs and evaluating the responses, and negotiating a contract. A project leader may be working full time on this, with others chipping in, and all of this represents an opportunity cost. And then there are the legal fees. Some companies hire an outsourcing adviser for about the same cost as doing it themselves. To top it off, the entire process can take from six months to a year, depending on the nature of the relationship.

Vice president of program solutions and management Ron Kifer spent several months on vendor selection before contracting with Bangalore, India-based Infosys to handle a whopping 90 per cent of development and maintenance work for DHL Worldwide Express, a shipping company. "There's a lot of money wrapped up in a contract this size, so it's not something you take lightly or hurry with," Kifer says. "There has to be a high degree of due diligence making sure that the [offshore] company can respond to your needs."

Even when there is an existing tie between customer and offshore vendors, the expensive and lengthy step of vendor selection is a must-do for successful outsourcing. The chairman of Tata Consultancy Services (TCS), a Mumbai, India-based outsourcer, sat on the international advisory board of Textron, a manufacturing company that owns such brands as Cessna Aircraft and E-Z-GO Golf Carts, for several years. However, when David Raspallo, CIO of business unit Textron Financial, began exploring offshore outsourcing in 1999, he still spent five months doing what he calls "the usual Betty Crocker Bake-Off" with service providers Covansys, ITS, TCS and Wipro. Ultimately, he went with US-based Covansys, which has three development centres in India. Selecting the vendor took 500 hours in total, involved Raspallo and three senior managers, and cost $US20,000 in additional expenses.

At this stage, travel expenses enter the picture as well. A trip overseas helps CIOs get comfortable with their choice. After all, offshore vendors can send their best and brightest over for a dog and pony show, but checking out the company on its home turf provides more insight. John Dean, the CIO of Steelcase, an office furniture manufacturer, spent several thousand dollars to send one of his IT executives to Intelligroup Asia in Hyderabad, India, for a week before signing on the dotted line.

"You can read everything you want to read and ask for advice as much as you want, but you have to make it a fact-based decision," Dean says. "So it was important to visit India to validate our thinking."

Bottom line: Expect to spend an additional 1 per cent to 10 per cent on vendor selection and initial travel costs.