Anticipated Cost Savings From OffShore Systems Development:

Evidence from the Field

Gerald DeHondtKent State University

• Background– 10 Years Industry Experience

• Programmer / Analyst

• Quality Assurance Manager

• Network Architect

• Enterprise Architect

• Project Manager

– Provided consulting services to Fortune 500 companies and each of the Big Three Auto Makers.

Introduction

Outline of the Presentation• Overview

• Trends

• Current and Projected Implementations

• Research Perspective– Factors Impacting Offshoring– Proposed Model– Results and Analysis– Lessons Learned

Offshoring Trends• Offshore IT services will continue to grow by 20% until 2010.

• Offshore development will comprise 28% of IT budgets in the US and Europe by 2008.

• By 2008, Forrester expects that 70% of the world’s computer programming will take place in offshore countries.

• According to Gartner, the wage arbitrage in India will be eliminated by steady salary increases.

• Non traditional regions and countries other than India are being considered for outsourcing such as Eastern Europe, Latin America, China, Vietnam, and the Philippines.

Outsourcing Trends (Continued)• Business Process Outsourcing (BPO) is expected to grow at

79% annually until 2010.

• McKinsey Consulting projects a BPO potential of approximately $1 trillion. In 2005, the actual BPO volume is $30 billion.

• American-Express outsourced their entire Application Development and Maintenance (ADM) environment.

• GE has outsourced all of its back office operations.

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Outsource Model

Gartner Group, 2007

DealerCore Systems

Service Delivery

Dealer/FieldSupport

Dealer/FieldHosting

PortalApplications

BusinessIntelligence

DealerRelations

RiteSourceB

RitesourceA

RiteSourceA

RitesourceA

DealerOperations

Academy

RiteSourceB

SupplementalWorker

SupplementalWorker

SupplementalWorker

SupplementalWorker

SupplementalWorker

SupplementalWorker

SupplementalWorker

SupplementalWorker

3rd PartyVendor

Current On-shoreOutsource Structure

Application Service Desk

Outsource Off-shore Concept

DealerCore Systems

Service Delivery

Dealer/FieldSupport

Dealer/FieldHosting

PortalApplications

BusinessIntelligence

DealerRelations

DealerOperations

Academy

SupplementalWorker

SupplementalWorker

SupplementalWorker

3rd PartyVendor

1 or 2 Off-Shore Companies

Cost Drivers• One of the most costly areas to maintain in today’s

corporations is the Information Technology function (Barthelemy, 2001), a significant portion of which is systems development.

• Companies may contract this function with another company in order to reduce costs.– Utilize knowledge workers to perform a specific task

outside of the main revenue generating function of the customer, allowing them to focus on their core competencies. (Domberger, et al., 2000)

Anticipated Cost Savings

• The primary reason companies will offshore systems development activities is cost savings (Ang and Cummings, 1997; Ang and Straub, 1998; Casale, 2001; Loh and Venkatraman,1992a, 1992b; Slaughter and Ang, 1996; Gopal et al., 2002).– Obtain knowledge capital from the vendor at

less expense than maintaining in-house.

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Purpose of this Research

• Investigate the Total Cost of Ownership (TCO) proposition of offshoring systems development and determine whether unanticipated costs offset anticipated savings leading to project costs above initial expectations.

Challenges• Quality Control• Increased Time to Market• Overall Costs (Matloff, 2004; Misra, 2004)• Reliability Concerns (Weinstein, 2004)

A growing body of anecdotal evidence suggests that offshoring is often the worst possible solution and that the management challenges of these initiatives far outweigh its benefits (Sharma and Seshagiri, 2006).

Project Studied• The project being analyzed is the migration

of four legacy applications from outdated technology into a corporate standard architecture.

• The current application environment was being sundowned and the applications would have to be re-architected and rewritten.

• Corporate direction is to offshore a target percentage of systems development.

Methodology

• This research utilizes a Case Study approach to review the largest offshoring systems development project of a large manufacturing company ($200 billion in revenues).– Surveys and follow-up interviews with client

project personnel serve as the basis for the study.

Factors Affecting Offshoring• Cost

– 44 percent of corporate IT managers identified cost savings as the primary reason most global companies outsource IT needs beyond their domestic borders (King, 2003).

– Only 54 percent of the offshore agreements realized the expected cost savings (Caldwell, 2002).

– Transition and management costs can amount to much as 5 - 7% of the value of an outsourcing contract (Scheier, 1996).

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Factors Affecting Offshoring• Quality

– Defect rates on software developed by offshore firms may be as high as 35% – 45% greater than that of domestically produced code (Kharif, 2003).

– The lower per-hour wages are also offset by much lower overall productivity (Sharma, Seshagiri, 2006).

– This environment is now shrinking the advantages of offshoring particularly in the area of cost savings (King, 2006).

Factors Affecting Offshoring• Vendor Personnel

– Lack of trained software engineers is a major problem for most software companies (Nidomolu and Goodman, 1993).

– The quality of programmers or project personnel has been shown to have a positive effect on project performance (Gopal et al., 2003; Krishnan, 2000; Guinan et al., 2000).

Factors Affecting Offshoring• Distance

– Lack of proximity may pose significant challenges due to hampering the client’s ability to effectively monitor vendors and coordinate development activities closely (Gopal et al., 2003).

– Each time zone difference represents a potential loss in collaboration activities crucial for project success (King, 2003).

– No documented evidence that the 24 / 7 work touted by proponents reduces software development cycle time (Sharma, Seshagiri, 2006).

– WiPro and Tata Consultancy have recognized the need for personal interaction and have offices and staff in North America (King, 2005).

Proposed Model

Client Project Cost

DistanceVendor

Infrastructure

Quality

Vendor Personnel

Hypothesis 1

Hypothesis 3

Hypothesis4

ResultsAnticipated cost savings were not achieved.

• Hypothesis 1: Lower quality of the software product will lead to higher project costs. (Supported)– The quality of the delivered system was below

client expectations and below what could have been delivered using in-house personnel.

– The original system team was still required during development to serve as technical and subject matter experts.

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Results• Hypothesis 2: Less experienced Vendor

Personnel will produce lower quality software, thus increasing project costs. (Supported)– Project team assigned by the vendor was young

and appeared to have little experience developing systems of this magnitude.

– One respondent indicated the vendor team appeared to be on their first assignment after training.

Results• Hypothesis 3: Greater geographic distance

between the client and vendor will lower software quality, thus increasing project costs. (Supported)– “Friction of distance” was difficult to

overcome.– Client was heavily dependent upon the

reporting structure implemented by the vendor.– Impacted the client’s ability to monitor project

progress and they relied solely on unreliable status reports from the vendor. The client was unable to independently verify project progress.

Results• Hypothesis 4: Availability of the local vendor

offices and project support infrastructure will mitigate the distance factor and allow development of higher quality software. This higher quality software will lower project costs. (Not supported)– Presence of local vendor infrastructure did not

appear to enhance the quality of the delivered system.

Lessons Learned• The least expensive solution is not always

the best solution.• Truth lies somewhere in the middle.• Experienced project personnel bring a level

of insight to a project that can only be obtained with time.

• Clients need to be aware of particular challenges that may be inherent in the relationship unique with the vendor chosen to complete the project.

Questions ?