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When to Outsource and When to Offshore

The subject of outsourcing is in the news a lot lately, particularly when the outsourcing is done to a location outside your country. Based on my experience, a company should consider outsourcing when one of the following criteria is met:

  1. The vendor can do the job better than your company, at a reasonable cost.
  2. The vendor can do the job just as well as your company, but the vendor is less expensive.
  3. The vendor can’t do the job as well as your company, but the vendor is less expensive, and the vendor does a “good enough” job.
  4. The vendor may not do the job as well as your company, but the need for the job is uneven, cyclical, or unpredictable. As a result, it would be easier and less expensive to have a vendor do the job than to maintain a workforce in your business to deal with the uneven demand.

When shouldn’t you outsource?
Here are some outsourcing disadvantages:

  1. You increase risk because you create a dependency on a single point of failure over which you have very little control. Risk is even higher if the vendor is dealing with your customers (like outsourced customer support), or if the vendor is handling an aspect of your business that differentiates your company from its competition.
  2. The process becomes more rigid, and is more difficult to change. An outsourcing business can only be profitable if the vendor has set up extremely well-defined processes. You may have to conform to the vendor’s processes, follow the vendor’s rules, and give up the flexibility that you had with your own resource.
  3. You have to invest in a one-time expense to negotiate the outsourcing contract, work out all of the processes that you will use in relating to the vendor, determine the details of how the vendor will be measured and compensated, and handle the transition to the vendor’s services. In a large outsourcing deal, this is a huge undertaking.

Most outsourcing starts out as a financial decision, but it’s important that you go beyond finance to evaluate risk and return. Outsourcing your cleaning service may have very low risk, but outsourcing the development of a key company product is a whole different story. It’s important to put together a risk mitigation plan as part of the early investigation into outsourcing, including the answers to questions like:

  1. What are the risks? Specifically what could go wrong?
  2. What are the consequences if each of those things happens?
  3. What could you do to minimize the probability of those things happening?
  4. What would you do if they happen anyway?
  5. If things don’t work out with this vendor, what options do you have? How difficult would it be to move the job to another vendor? To bring the job back in-house?

If the risks are too high, or you’re not prepared to handle the consequences of things going wrong, then you shouldn’t be looking at outsourcing.

Why Offshore?
I’ll define offshoring as outsourcing work to a vendor outside your own country. I can think of only three reasons why you might want to outsource your work to an “offshore” vendor:

  1. It’s less expensive. This is the primary reason for offshoring in the IT world. Outsourcing to a country with a low cost of living or with a favorable exchange rate can be considerably less expensive than outsourcing to someone local.
  2. The vendor may offer better quality. I don’t hear this reason so much any more, although it was common in the electronics industry at one time. Some offshore software vendors claim to have better quality, but I haven’t seen any statistics about actual work done by these vendors.
  3. You can take advantage of time zone differences. For example, to provide customer support in off hours, or to have programmers implement your designs during the night to be ready the next morning.

Note that these three reasons don’t replace the initial four outsourcing criteria—they just add another dimension to the decision. First you should look at whether you want to outsource, then you should look at whether you want to outsource to an offshore vendor. If it’s too risky to outsource in the first place, then an offshore vendor won’t change the situation. If an outside vendor can’t do a job as well as your own people, then you either say “no” to outsourcing or you figure out whether the vendor can do a “good enough” job. What’s “good enough”? That depends on the situation. Dell recently changed one of its offshore vendors because customers complained about service from offshore workers. In Dell’s case, it wasn’t good enough.

Additional Disadvantages of Offshoring
All of the disadvantages of outsourcing apply to offshoring, but offshoring introduces a few more things to watch out for:

  1. Language barriers can cripple an offshoring relationship. If you thought it was tough for a business user to work out the details of a process with an IT person, wait until they try to do it with an IT person who speaks English as a second language. Be sure that any offshoring agreement makes it clear who will be talking to whom, and that language proficiency requirements are spelled out.
  2. Currency fluctuation can change your costs unless you make sure your pricing is defined in your own country’s currency. And even if your price is protected, that just shifts the currency fluctuation risk to the vendor, who has to absorb the cost. If your vendor becomes unprofitable, then the vendor may try to change the contract, or even go out of business.
  3. Your agreement is at the mercy of international politics. Things we take for granted, like safe locations for work, are not as guaranteed in certain countries. Trade embargoes and wars between nations could impact your offshore vendor, or even cut off your access to the vendor. One offshore vendor I worked with had a “disaster recovery plan” that called for all of the workers to get in their cars and drive to a neighboring country when their government collapsed. Problems like this make power outages appear trivial in comparison.
  4. Legal agreements may be difficult to enforce. You can go after the local representative, but they probably don’t keep very much capital in your country. So be very careful to avoid paying in advance for work unless money is held in a trustworthy in-country escrow account.

Conclusion
Think of offshoring as an extreme form of outsourcing. All of the same outsourcing rules apply, and there are a lot more risks. But the much lower cost of offshoring has fundamentally altered the mathematics of the outsourcing decision, tipping the balance of the equation away from keeping work in-house. That’s why offshoring is in the news: it’s very attractive to consider cutting some of your costs by 50 – 90%, even if it means eliminating local jobs.

Note: This post was incorporated into my book, Boiling the IT Frog, as Chapter 15. For more about the book, click here.

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