Sourcing and Vendor Relationships Vol. 5, No. 12 Proven...

Proven Practices for ITOffshore Outsourcing

by Joseph W. Rottman and Mary C. Lacity

As the global sourcing of IT development continues to increase, firms

struggle to maintain quality while pursing the labor arbitrage available

offshore. Based on more than 100 interviews with participants from US

firms, their offshore suppliers, and their legal and intermediary firms, this

Executive Report presents 28 lessons for shortening the offshore learning

curve and effectively engaging offshore vendors.

Sourcing and VendorRelationships

Vol. 5, No. 12

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Proven Practices for IT Offshore OutsourcingSOURCING AND VENDOR RELATIONSHIPSADVISORY SERVICEExecutive Report, Vol. 5, No. 12

Few IT management practiceshave sparked as much contro-versy as offshore outsourcing of ITwork. Front-page headlines con-sist of variations on the question“Will outsourcing hurt America’ssupremacy?”1 Meanwhile, otherarticles claim offshore outsourcingis stealing American IT jobs anddragging down US IT bonus pay.2

US companies that outsource off-shore are blacklisted on sometelevision shows, such as CNN’sLou Dobbs Tonight. Despite thecontroversy surrounding offshoreoutsourcing, the market is grow-ing faster than predicted, andmany consulting firms predict thatthe rate of offshore job transferwill continue to increase.

This growth is due to the positiveeffects of offshore outsourcing onUS IT jobs, IT productivity, IT

costs, and IT quality.3 The CatoInstitute — a conservative publicpolicy research foundation head-quartered in Washington, DC —argues that over the next eightyears, offshoring low-paying ITjobs will create newer and higher-paying IT jobs in the US. MichaelPerry, CEO of IndyMac Bank (interms of assets, the 10th largestthrift nationwide), attests to this;between 1993 and 2004, IndyMaccreated 5,000 new US-basedjobs as the company grew. Thisgrowth was fueled in part by low-cost offshore outsourcing, includ-ing the offshoring of 25% ofIndyMac’s IT staff.

Concerning IT productivity, globalproduction of IT hardwarereduced total hardware costs by30%, resulting in an additional US$230 billion in US gross domestic

product between 1995 and 2002.Some sources anticipate similareffects on productivity insoftware.4

Finally, an IBM Business ConsultingServices survey found that 82% ofIT managers reported cost savingsof 10%-50% from offshoring; fur-ther, 68% of respondents claimedsome or significant qualityimprovement.5

While such studies show thebenefits of offshoring IT work,detailed lessons based on actualcustomer and supplier experi-ences are still essential. For thepast 15 years, we have studieddomestic IT outsourcing (wherecustomers outsource to suppliersin their own country). A numberof our best practices, manage-ment frameworks, and relationship

models have been covered inprevious Cutter Consortiumreports.6 Our current researchidentifies the best, worst, andemerging practices for offshore IToutsourcing and compares thesepractices with our prior knowl-edge. Based on funded researchfrom the University of Missouri–St.Louis, we present findings frominterviews with 101 participants.This group comprised US cus-tomers, suppliers, and key inter-mediary consulting and legalfirms with substantial offshoreoutsourcing practices. Participantsshared their lessons learnedregarding the four followingoffshoring challenges:

1. How can US organizationsdevelop and implement aglobal sourcing portfolio?

2. How can US organizationsmitigate risks?

3. How can US organizationseffectively work with offshoresuppliers?

4. How can US organizationsachieve cost savings whileensuring quality?

The result was the identificationof 28 proven practices for address-ing offshore challenges. In thisExecutive Report, we discuss eachlesson and group the 28 practicesaccording to the four questionslisted above. As we discuss these

lessons, we’ll relay experiencesfrom some of the many Fortune500 and other companies weinterviewed. To ensure theanonymity of our participants andtheir companies, we use genericpseudonyms (i.e., Retail, Biotech,and Financial Services 1). A com-plete list and description of all theparticipants can be found inAppendix A. Although these 28practices have been distilled frommore than 100 interviews, to illus-trate the knowledge the majorityof these firms have gained, weconcentrate on the journeys offour major participants, which werefer to as the following: Retail,Biotech, Manufacturer 1, andManufacturer 2. Brief historiesof these four companies are pro-vided in Appendix B. Before wedetail each lesson, let’s look at abrief comparison of these findingscompared with domestic out-sourcing practices (see Table 1).

For CIOs, the good news is thatsome practices for managingdomestic outsourcing do indeedapply to offshore outsourcing.In particular, six best practicesare equally important for bothdomestic and offshore outsourc-ing, including (1) escalating thestrategic importance of newsourcing options (such as off-shore) after conquering thelearning curve; (2) creating acentralized program management

office (PMO); (3) selecting suppli-ers by considering 12 suppliercapabilities; (4) using pilot proj-ects to mitigate business risks;(5) developing meaningful careerpaths for inhouse staff; and (6)creating balanced scorecardmetrics.

Meanwhile, 13 of the 28 practicesapply to both domestic and off-shore outsourcing, but they aremore important for offshoringbecause the risks and transactioncosts are greater and the deliveryteams are more remote and cul-turally diverse. While Table 1shows all 28, this discussionpoints to the most important off-shoring practices: selecting asourcing model to balance costsand risks; openly communicatingthe sourcing strategy to minimizedomestic worker backlash; usingreal-time dashboards to verify,synchronize, and manage work-flows; and hiring an intermediaryconsulting firm to serve as abroker and guide to foreign coun-tries, cultures, and suppliers.

Finally, as Table 1 shows, nine ofthe practices are unique to off-shoring. One intriguing offshoringpractice is that of givingcustomers a choice betweendomestic and offshore outsourc-ing. PMOs can publish rates forsourcing locales and allowbusiness-unit managers to assess

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22 SOURCING AND VENDOR RELATIONSHIPS ADVISORY SERVICE

The Sourcing and Vendor Relationships Advisory Service Executive Report is published by Cutter Consortium, 37 Broadway, Suite 1, Arlington,MA 02474-5552, USA; Tel: +1 781 641 9876 or, within North America, +1 800 492 1650, Fax: +1 781 648 1950 or, within North America, +1 800 888 1816,E-mail: [email protected], Web site: www.cutter.com. Group Publisher: Kim Leonard, E-mail: [email protected]. Production Editor: PamelaShalit, E-mail: [email protected]. ©2004 by Cutter Consortium. All rights reserved. Unauthorized reproduction in any form, including photocopying,faxing, and image scanning, is against the law. Reprints make an excellent training tool. For information about reprints and/or back issues of CutterConsortium publications, call +1 781 648 8700, or e-mail [email protected].

the tradeoffs between lowercosts and greater risks. Otherpractices unique to offshore out-sourcing address the rigidCapability Maturity Model®(CMM®) requirements used byoffshore suppliers, bottleneckscaused by substantial time-zonedifferences, and establishingthe ideal inhouse/on-site/offshore ratio.

The companies we intervieweduse the 28 practices to success-fully exploit offshore resources.As mentioned previously,Appendix B presents illustrativecustomer experiences from fourUS firms that ventured throughseveral stages of offshore out-sourcing. These mini case studiesprovide rich descriptions of theunderlying challenges of offshoreoutsourcing and help to furtheranchor the discussion of bestpractices presented below. Thelessons are organized accordingto the four questions listed above.

PRACTICES FOR DEVELOPINGAND IMPLEMENTING AGLOBAL SOURCING PORTFOLIO

Most of our interview participantsare veterans of domestic USoutsourcing. They ventured off-shore primarily to seek lowercosts on short-term projects,such as Y2K during the late 1990s.Early adopters faced several chal-lenges, and the practices dis-cussed in this section can helpCIOs quickly ramp up to create aglobal sourcing portfolio.

©2004 CUTTER CONSORTIUM VOL. 5, NO. 12

EXECUTIVE REPORT 33

Sourcing Challenge

Practices to Overcome the Challenge

Equally Important

for Domestic

and Offshore

More Important

for Offshore

Unique to Offshore

1. Escalate the strategic importance of new sourcing options after conquering the learning curve.

X

2. Select an offshore outsourcing destination based on business objectives. X

3. Select an offshore outsourcing model that balances costs and risks. X

4. Create a centralized program management office to consolidate management. X

5. Hire an intermediary consulting firm to serve as offshore broker and guide to the hosting country, suppliers, and culture.

X

How can we develop

and implement

a global sourcing portfolio?

6. Select suppliers by considering 12 supplier capabilities. X

7. Use pilot projects to mitigate business risks. X

8. Give customers a choice of sourcing location to mitigate business risks. X

9. Hire a legal expert to mitigate legal risks. X

10. Openly communicate the outsourcing strategy to all stakeholders to mitigate political risks.

X

11. Use secure information links or redundant lines to mitigate infrastructure risks. X

How can we mitigate risks?

12. Use fixed-priced contracts to mitigate workforce risks. X

13. Design effective organizational interfaces. X

14. Elevate your own organization’s CMM certification to close the process gap between you and your supplier.

X

15. Bring in a CMM expert with no domain expertise to flush out ambiguities in requirements.

X

16. Negotiate the CMM documents for which you will and will not pay. X

17. Tactfully cross-examine, or even replace, the supplier’s employees to overcome cultural communication barriers.

X

18. Require the supplier to submit daily status reports. X

19. Let the project team members meet face-to-face to foster camaraderie. X

20. Consider innovative techniques, such as real-time dashboards, to improve workflow verification, synchronization, and management.

X

How can we effectively work with suppliers?

21. Manage bottlenecks to relieve the substantial time-zone differences. X

22. Consider both transaction and production costs to realistically calculate overall savings.

X

23. Size projects large enough to receive total cost savings. X

24. Establish the ideal inhouse/on-site/offshore ratio only after the relationship has stabilized.

X

25. Give offshore suppliers the domain-specific training to protect quality and lower development costs.

X

26. Overlap onshore presence to facilitate supplier-to-supplier training. X

27. Develop meaningful career paths for subject matter experts, project managers, governance experts, and technical experts to help ensure quality.

X

How can we ensure cost

savings while

protecting quality?

28. Create balanced scorecard metrics. X

Table 1 — Proven Offshore Management Practices

Lesson 1: Escalate the StrategicImportance of New SourcingOptions (Offshore) afterConquering the Learning Curve

Few US organizations we studiedapproach offshore outsourcingfrom a strategic perspective atthe outset. Most US organizationsinitially engage in offshoring fortactical reasons, such as seekinglower labor rates for staff aug-mentation on specific projects.During this early-adopter phase,offshoring PMOs are often erectedas separate entities from domesticoutsourcing offices to test theproof of concept. It isn’t until afterpilot tests are completed, supplierrelationships are established, andviability is proven that CIOs seekmore strategic uses of offshoreresources. This incrementalapproach is wise because USorganizations may first need togain experience with newoutsourcing options at an

operational level before seekingmore strategic objectives.

Figure 1 illustrates the typicalcustomer learning curve for off-shoring. During phase 1, CIOsbecome aware of offshoringthrough marketing hype (“You’llsave 60% on your IT costs”) orirrational propaganda (“Softwareoutsourcing will hurt America’ssupremacy”). CIOs quickly learnabout potential benefits, costs,and risks through discussion withpeers and consultants and byreading research. Most CIOs ini-tially engage in offshoring (phase2) to seek lower costs, primarilythrough the favorable labor arbi-trage. During pilot testing, CIOslearn about the immense amountof inhouse management requiredto work effectively with offshoresuppliers and achieve real costsavings (lessons 13-28, below). Aslearning accumulates, CIOs move

to phase 3, at which point theyexploit offshoring for quality aswell as cost reasons. During ourinterviews, participants repeatedlystated, “We went for the price; westayed for the quality.”

In phase 4, more mature adoptersuse offshore outsourcing to strate-gically enable corporate strate-gies, such as increasing businessagility, bringing products to mar-ket more quickly and cheaply,financing new product develop-ment, accessing new markets, orcreating new business. Ourresearch indicates that thesestrategic initiatives often evolveover time. Two examples belowillustrate the evolutionary natureof strategic offshore exploitation.

Agility, which offshore outsourcingenables, is a key strategy for com-panies that operate in cyclicalbusiness environments. Throughcreative sourcing arrangementsthat permit speedy commitmentto and divestiture of human capi-tal, business agility allows organi-zations to enable flexible staffingwhile continuing to nurture busi-ness innovation.7 FinancialServices 1, for example, usesoffshore resources primarily toenable strategic agility. It hascaptive centers in Manila, thePhilippines, and Mumbai, India,as well as various joint venturesand fee-for-service relationshipswith 14 Indian suppliers. Duringthe refinancing boom, the com-pany was able to beat competi-tors by quickly meeting theimmense surge in demand for IT



Phase 1:

The spread of

hype and fear

Phase 2:

Early adoption

Best and worst practices emerge

Focus on costs

Phase 3:

Market maturation

Richer practices emerge

Focus on quality

Phase 4:

Institutionalization

Focus on value added

Cu

sto

mer

learn

ing

Time

Figure 1 — The offshoring learning curve.

and business process services. Asthe refinancing bubble burst, thecompany was able to immediatelyscale back resources.

Financing new product develop-ment, which offshoring enables,is a key strategy for small compa-nies trying to compete with thedeep pockets of larger players. Asmall US-based healthcareservices organization wanted todevelop a software product toprovide information for a quickresponse to biological terrorism.Because the organization is shorton funds, it used an offshore sup-plier to finance the developmentof the new system. Under thisagreement, the supplier owns theintellectual property rights but thecustomer organization will marketthe application. Both parties willshare software licensing feeswhen the product goes to market.

Lesson 2: Select an OffshoreOutsourcing Destination Basedon Business Objectives

The majority of literature suggeststhat CIOs select offshore destina-tions by focusing solely on relativecountry advantages regarding ITcosts and risks. Consulting firmsare a major source of informationfor CIOs, providing comparativeanalyses of offshore IT destina-tions based on relative advantageof government support, IT laborpool characteristics, cultural com-patibility, and so forth. We lookedat several consulting firms’ data,and using any set of criteria, Indiaranks as a top locale becauseof government support, tax-free

technology parks, the presenceof an excellent labor pool (withan IT workforce of half a millionpeople and growing), low —though rising — hourly IT wages,high English proficiency, and high-quality suppliers as evidenced bythe largest number of CMMLevel 5–certified organizationson the planet. However, severalof our interview participants saidthat they are concerned aboutIndia’s rapid growth. Some partici-pants believe that India is becom-ing saturated (in particular, thecity of Bangalore), that salarieswill continue to rise and thuserode savings, and that theimmense turnover among Indianfirms, particularly for workers withtwo to five years of experience,will remain high. Those focusingsolely on IT costs and risks arelooking at Indian cities other thanBangalore or venues such as thePhilippines.

Most of our participants, however,selected destinations based onmore than IT-driven considera-tions. Instead, CIOs used broaderbusiness criteria by consideringthe company’s strategic objectivesand overall commitment to cer-tain destinations. For example,one aerospace company selectedMalaysia as its IT offshoring desti-nation because it hopes to sellplanes in that country. TheMalaysian government requiresthat some of the manufacturingbe done in Malaysia, and the ITpresence will certainly help tomeet that requirement. Anotherhardware company selected

China because it hopes to sellcomputers there. Other partici-pants selected offshore locationswhere they have existing manu-facturing or R&D facilities. Theexisting facilities serve as alaunchpad, with current employ-ees serving as guides to the coun-try, suppliers, and culture. One UScustomer chose Canada becauseit wants suppliers close by inorder to help it better service itsend customers.

Lesson 3: Select an OffshoreOutsourcing Model That BalancesCosts and Risks

CIOs need to access the variousmodels for leveraging offshoreresources. The four most preva-lent offshore sourcing modelsare captive, joint venture, build-operate-transfer (BOT), and feefor service (see Table 2).

With the captive model, the cus-tomer builds, owns, staffs, andoperates its own offshore facility.Captive centers provide the great-est amount of control but alsocarry the greatest amount of risk.For this reason, CIOs select thecaptive model only if they havea substantial commitment to acountry in terms of a large vol-ume of IT work over a long periodof time. EDS, Accenture, Dell,Intel, and IBM Global Servicesall have captive centers. Accord-ing to the CEO of an intermediaryoffshore consulting firm, mostUS IT suppliers need captivecenters to maintain competitiveservice rates.


EXECUTIVE REPORT 55

IBM created a captive center inIndia to reduce IT costs for oneof its large customers, AT&T. Atthe time, AT&T had a seven-yearcontract with IBM worth nearly$1 billion. The AT&T CIO pushedIBM to create a captive centerrather than build one himself. Hewas willing to trade off some ini-tial cost savings for greater opera-tional control and long-termfinancial gains. Today, nearly40% of AT&T’s application devel-opment is done offshore throughIBM’s captive center, with AT&Tallegedly receiving a cost savingsof 30%.8

With joint ventures, the customerand supplier share ownership inthe offshore facility. Customerssuch as CSC Corporation, PerotSystems, and TRW Automotive,Inc., chose this model over thecaptive model because they

wanted to sacrifice some controlin exchange for the supplier bear-ing most of the risk.

TRW, one of the world’s largestautomotive suppliers to originalequipment manufacturers(OEMs), created a joint venturewith India-based SatyamComputer Services, Ltd. Theventure will initially provide enter-prise resource planning (ERP),supply chain management, and e-business applications to TRWand then hopefully attract exter-nal customers as the venturedevelops automotive capabilities.9

TRW is the clear winner here;owning 24%10 in the venturegives Satyam some control, butthe company must deliverTRW’s IT requirements even ifit is never able to leverage theautomotive capabilities to attractmore customers.

With the BOT model, the supplierowns, builds, staffs, and operatesthe facility on behalf of the cus-tomer. Upon completion, the sup-plier transfers ownership and staffto the customer. From the US per-spective, this model helps bypasslegal obstacles because it is easierfor a supplier to create a newfacility in its own country than itis for a US organization to investdirectly. Also, this model enablesthe US organization to benefitfrom the supplier’s local expertiseon construction, utilities, andemployment.

PeopleSoft signed a three-yearBOT deal with Covansys andHexaware. The suppliers willbuild PeopleSoft’s India ServicesCenter and India DevelopmentCenter and hire and train theemployees. After three years,PeopleSoft will pay book value



Captive Model

Joint-Venture Model

Build-Operate-Transfer Model

Fee-for-Service Model

Description The customer builds, owns, staffs, and operates offshore facility.

The customer and supplier share ownership in offshore operations.

The supplier owns, builds, staffs, and operates the facility on behalf of the customer; ownership and employees transfer to the customer after completion.

The customer signs a contract for services in exchange for paying the supplier a fee.

Set-up cost, financial risk, operational risk

Highest High Medium Low

Ability to control Highest Depends on the amount of ownership

Medium Low

Example IBM TRW-Satyam PeopleSoft All 14 firms interviewed for this report

Table 2 — Offshore Sourcing Models

for the facilities and transfer theemployees to PeopleSoft at noadditional fee.

According to the CEO of an inter-mediary offshore consulting firm,none of his US customers actuallywent through with the transferphase of the BOT model. By then,his customers were comfortablewith the supplier and did not wantto take over the facilities. One par-ticipant said he backed out of thetransfer because he didn’t know“whom to call when the lights goout, and they do!”

With fee-for-service offshore out-sourcing, the customer signs acontract with a service providerthat has facilities and staff locatedoffshore. The supplier owns thefacilities, employs its own staff,and has its own infrastructure.Contracts are typically fixed priceor based on time and materials.By far, this is the most popular off-shore outsourcing model becauseit poses the least amount of risk.US organizations can readily alterthe volume of work sent offshoreto match fluctuating demandonshore. While the previous mod-els receive much greater expo-sure in the trade press due to theircollaborative and strategicnatures, the fee-for-service modelis the most widespread. All 14 ofthe firms in this study have uti-lized fee for service. For example,since 2001 Financial Services 3has used Wipro Technologies forstaff augmentation (time andmaterials) and delivery of selectprojects (fixed price). Although

the Wipro relationship representsonly about 5% of FinancialServices 3’s external IT spend, ithas allowed Financial Services 3to quickly ramp up or scale downwithout affecting the employmentof inhouse IT staff.

Some organizations use multiplemodels, as illustrated by FinancialServices 1. It uses captive centers,joint ventures, and fee-for-servicerelationships with 14 Indiansuppliers. Other organizationsswitch models after conqueringthe learning curve. One of ourparticipants from FinancialServices 6 began with a fee-for-service model. But as volume ofwork increased to 3,000 full-timeequivalents, the customer beganto consider moving to a captivecenter. According to the vice pres-ident of technologies at FinancialServices 6, “Once I have a verygood feeling about how the Indianmarket is progressing, I plan tomove to a captive center andrecoup the margin my vendor iscurrently gaining.”

Lesson 4: Create a CentralizedPMO to Consolidate Management

PMOs set up preferred supplierrelationships, negotiate contracts,assess overall performance,define best practices, and dissem-inate learning. This best practiceis not unique to offshoring. Theissue here is whether CIOs shouldcreate a separate PMO for off-shoring or integrate offshoringinto an existing PMO. Participantssuggest that CIOs should createa separate office if the offshore

initiative represents a significantdeparture from domestic out-sourcing practices or if theyintend to create a captive cen-ter or joint partnership thatwill require dedicated manage-ment. CIOs should create an integrated PMO if they want busi-ness requirements to drive thesupplier selection and if they wantthe onshore and offshore suppli-ers to aggressively compete.

Retail, a Fortune 100 company,used competition managed by theintegrated PMO to cut the domes-tic supplier rates by 10%-50%.When Retail decided to integrateits offshore PMO into its existingvendor management system, theresults were immediate and dra-matic. Prior to exploring offshorevendors as a solution to its con-siderable Y2K issues, Retail wasactively engaged with 35 domesticcontractors. The addition of off-shore providers to the supplierportfolio caused domesticproviders to lower their costs.According to Retail’s director ofcontract management:

We were paying about $100 forcommodity-type coding [withdomestic suppliers]. Thedomestic suppliers saw thewriting on the wall. We put outa bid to the approved list ofdomestic contractors, and thecurrent director of the PMOmade it very clear that we werenot going to pay those kinds ofprices anymore. Our domesticprices dropped from about $100per hour to $80, and some ofthe rates even dropped into the$50 range for some services.


EXECUTIVE REPORT 77

This integration also allowed avariety of vendors to competehead-to-head on capabilities andproject schedule in addition tocost. This allowed Retail tocompare the various value propo-sitions from the domestic contrac-tors with the offshore contractorsand expand their understanding ofthe offshore market.

Lesson 5: Hire an IntermediaryConsulting Firm to Serve as anOffshore Guide to the HostingCountry, Suppliers, and Culture

The intermediary consultingmarket is certainly growing fast,with players such as neoIT,SourceQuest, SoftAccess, Cincom,TPI, and Providio TechnologyGroup. Some experts estimatethat by 2005, intermediaries willbroker 64% of offshore contracts.11

Biotech, one of our case compa-nies, certainly found value in hir-ing an intermediary. A globalleadership team member said,

“I think it absolutely engaged usmore quickly with respect to theminforming the offshore vendors ofour situation and setting up thearrangements. We would havehad to spend a lot more of ourown time with all of that. SoI think it streamlined the initialprocess.”

The intermediary consulting firmsare also moving up the valuechain by offering offshore projectmanagement training to US cus-tomers, training joint teams oncultural compatibility, creatingtransition plans, and developingproject metrics.

Lesson 6: Select Suppliersby Considering 12 SupplierCapabilities

Concerning offshore suppliers,there are many choices. SomeUS CIOs move offshore via one oftheir domestic suppliers such asEDS, IBM, or Accenture. Certainly

AT&T preferred to move offshorethrough its existing partnershipwith IBM rather than try to builda new relationship with a newsupplier in a new country by itself.Some customers, such asFinancial Services 3, prefer toselect established offshore suppli-ers like Wipro because of theirmaturity and stability. Othercustomers, including Biotech, lookfor smaller niche suppliers withdomain expertise.

We should note, however, thatCIOs often make one major mis-take when assessing suppliers:they assess the supplier’sresources such as physical facili-ties, technology, and workforcecomposition rather than the sup-plier’s capabilities to effectivelymanage and deploy theseresources for the customer’s ben-efit. For example, many seniorexecutives ask for evidence ofexcellent supplier employees.This assessment does not distin-guish among suppliers; all credi-ble suppliers have excellentpeople. Instead, senior executivesneed to ask about the supplier’sbehavior management capability:how does the supplier motivateand manage people to deliverservice through a customer-focused culture?

A better way to assess the myriadsuppliers is to consider the 12supplier capabilities model cre-ated by David Feeny, Mary Lacity,and Leslie Willcocks (see Figure2).12 The 12 capabilities establishthe basis for the following threesupplier competencies:



Relationship

capabilities

Transformation

capabilities

Delivery

capabilities

Planning and

contracting

Organizational

design

GovernanceCustomer

development

Leadership

Business

management

Domain

expertise

Behavior

management Technology

exploitation

Process

improvement

Sourcing

Program

management

Figure 2 — The supplier capabilities model.

1. Relationship competency —the ability to create alignedincentives between thecustomer and the supplier

2. Delivery competency — theability to deliver daily opera-tions while still generating agood supplier margin

3. Transformation competency— the ability to meaningfullytransform the customer’soperations to decrease costsand improve service

High-level definitions of the12 capabilities are found in

Table 3. Although a detailedexplanation of the capabilitiesis beyond the scope of this report,a few examples illustrate how themodel can be used to comparesuppliers.

First, consider the leadershipcapability, defined as the abilityto identify, communicate, anddeliver the balance of delivery,transformation, and relationshipactivities to achieve present andfuture success for both client andprovider. After completing 76 casestudies of customer-supplier rela-tionships in IT outsourcing, we

have found that the main differen-tiator between success and failurewas the individuals who wereleaders of the supplier (andclient) account teams.13 Leadersmust operate as the CEOs ofrelationships rather than astraditional account managersnow delegated to the businessmanagement capability. Supplierleaders must also have significantclout within their parent organi-zation to mobilize resources onbehalf of their clients. For exam-ple, one US customer was initiallythrilled when the supplier hired ahigh-powered managing director


EXECUTIVE REPORT 99

Supplier Capability Definition

1. Leadership The capability to identify, communicate, and deliver the balance of delivery, transformation, and relationship activities to achieve present and future success for both the client and provider.

2. Planning and contracting The capability to develop and contract for business plans that deliver win-win results for customer and supplier over time.

3. Organizational design The capability to design and implement organizational arrangements to realize plans and contracts.

4. Governance The capability to define, track, assess, and fix performance. 5. Customer development The capability to transition users of an internally provided service to

customers who make informed decisions about service levels, functionality, and costs.

6. Process improvement The capability to design and implement changes to service processes to meet improvement targets.

7. Technology exploitation The capability to swiftly and effectively deploy technology in support of critical service improvement targets.

8. Program management The capability to prioritize, coordinate, ready the organization, and deliver across a series of interrelated projects.

9. Sourcing The capability to access whatever resources are required to deliver service targets.

10. Behavior management The capability to motivate and manage people to deliver service with a front-office mindset.

11. Domain expertise The capability to apply and retain sufficient professional knowledge of the process domain to meet user requirements.

12. Business management The capability to consistently deliver against both customer service-level agreements and suppliers’ own required business plans.

Table 3 — 12 Supplier Capabilities Defined

specifically to serve as accountleader. However, this outsidehire was ineffective in gainingresources and attention at sup-plier headquarters because noone knew him. The point is thatthe supplier leader must not onlybe an excellent CEO of the rela-tionship but must also have signif-icant clout within his or her ownorganization.

Second, consider the behavior-management capability, definedas the capability to motivate andmanage people to deliver servicewith a front-office mindset. Allmajor offshore or global suppliers,such as Infosys, Wipro, Tata,Accenture, EDS, IBM, CSC, Unisys,HP, CGI, and ACS have employeesto be proud of in terms of experi-ence, skills, and knowledge.While customers tend to ask sup-pliers for proof of workforce qual-ity such as résumés, average yearsof experience, turnover rate, andcertifications, this evidence willnot serve to differentiate suppli-ers. Customers should also askfor evidence that the workforceis empowered, satisfied, andcustomer-oriented. How do sup-pliers orient new employeestoward their culture? How do theyreward and encourage employeebehavior?

We found one small Indian off-shore supplier, S2Tech, with aninteresting behavior managementcapability. To overcome culturaldifferences, S2Tech’s founderand CEO hired Indians who havelived and worked in the US to

serve as project leaders. To over-come substantial time-zone differ-ences, he set work hours in Indiafrom 1:00 pm to 10:00 pm to cre-ate three hours of overlap with UScustomers for daily communica-tions. To reduce turnover, heinvolves entire extended familiesin frequent parties and outings.He has learned that if spouses,parents, and children are activelyinvolved in the company, then thefamily conspires to retain employ-ees. He provided several exam-ples of how this culture directlybenefits his US customers, includ-ing the following anecdote. OneUS customer needed an impor-tant deliverable by a Mondaythat coincided with an Indianholiday. To meet the deliverable,the S2Tech team members can-celled their holiday plans andworked through the weekend.Understanding the effect of thisovertime on both the teammembers and their families, theCEO financed an alternativeweekend trip to India’s versionof Disneyland.

To summarize, CIOs cannotmerely assess supplier resourcesand hope to achieve high perfor-mance. Instead, senior executivesmust assess suppliers based onthe 12 specific capabilities listedin Table 3.

PRACTICES TO MITIGATEOFFSHORE RISKS

All CIOs are aware of the risksassociated with offshoring includ-ing business, legal, political,

workforce, social, and logisticalrisks (see Table 4). We asked par-ticipants to provide specific exam-ples of successful risk mitigationpractices. They identified com-mon, but important, best practicessuch as using pilot projects, hiringlegal experts, and openly commu-nicating the offshore initiative toassuage fear. Some identifiedmore unique and intriguing prac-tices, such as giving the customera choice. Let’s look at lessonswe discovered.

Lesson 7: Use Pilot Projects toMitigate Business Risks

Biotech brought the concept ofpiloting to reduce risk to a newlevel. Biotech choose 17 pilotprojects that were mostly smallin size, required frequent deliveryof milestones, and gave piecesof the same project to two suppli-ers. For example, Biotech decidedthat before it would commit toone supplier for a PeopleSoft-to-SAP conversion, it would havetwo of the large Indian suppliersdo small pieces of the conversion.The company experienced muchbetter project leadership fromone of the suppliers in terms ofon-site coordination, project sta-tus reporting, technical fit withBiotech, and superior daily com-munications. Biotech selectedthis supplier to complete theentire conversion. Three monthslater, when Biotech went livewith SAP, the Indian supplierwas granted an ongoing mainte-nance contract for seven full-time



equivalents. The overall projectwas rated a great success.

Pilot projects must be largeenough to extract learning andmetrics, but small enough tominimize risk. But experts do notagree on the ideal size. Accordingto the CEO of an intermediaryconsulting firm, pilot projectsshould be sized at two person-years, representing a project costbetween $50,000 and $100,000.According to Biotech, the idealproject size is four full-timeequivalents for four months.

Lesson 8: Give Customers a Choiceof Sourcing Location to MitigateBusiness Risks

When a customer calls E-Loan,he or she is given a choice toprocess a loan within one dayusing an Indian-based supplier orto process the loan within twodays using a US-based supplier.Such choice allows the customerto determine the priority betweenspeed and location.

Similarly, the CIO of FinancialServices 4 allows strategic busi-ness units a choice for applicationdevelopment. The business unitscan source IT from three pre-ferred offshore suppliers managedthrough the offshore PMO or fromdomestic suppliers through thedomestic office. Rates are lowerwith the offshore suppliers, butrisks are lower with the domesticsuppliers. The CIO believes thebusiness-unit managers should bethe ones assessing the tradeoffs.

Lesson 9: Hire a Legal Expert toMitigate Legal Risks

Over the past 15 years, hiring alegal expert for domestic out-sourcing has been a standard bestpractice. Many legal firms special-ize in outsourcing, such as ShawPittman LLP and Milbank, Tweed,Hadley & McCloy LLP. The needfor legal expertise with offshor-ing is even more pronouncedbecause customers must abide by

different legal systems and moreregulatory requirements.

In conjunction with our research,we have spoken with ninelawyers that specialize in off-shoring. These lawyers help UScustomers with tax implications,protection of intellectual property,business continuity, regulatorycompliance, visa formalities, dis-pute resolution, and governing


EXECUTIVE REPORT 1111

Risk Category Sample Risks

Business • No overall cost savings. • Poor supplier in terms of capability, service,

financial stability, or cultural fit. • Wrong types of activities sent offshore. • Inability to manage the supplier relationship.

Legal • Inefficient or ineffective judicial system at offshore locale.

• Intellectual property rights infringement. • Export restrictions. • Inflexible labor laws. • Difficulty obtaining visas. • Changes in tax laws could significantly erode

savings. • Inflexible contracts. • Breech in security or privacy.

Political • Backlash from internal IT staff. • Perceived as unpatriotic. • Politicians threaten to tax US companies that

source offshore. • Political instability within offshore country. • Political instability between US and offshore

country.

Workforce • Supplier employee turnover. • Supplier employee burnout. • Inexperienced supplier employees. • Poor communication skills of supplier

employees.

Social • Cultural differences. • Holiday and religious calendar differences.

Logistical • Time-zone challenges. • Managing remote teams. • Coordinating travel.

Table 4 — Offshore Outsourcing Risks

law. Concerning dispute resolu-tion, all the participants focusedon the goal of reducing the risksof conflicts that could lead to liti-gation — and for good reason. Wewere told that litigation in theIndian court system is frequently a15-year process. Also, Indiancourts do not enforce legal judg-ments or awards made in the US.In contrast, India will enforce arbi-tration, so that has become thestandard clause for proposing tosolve customer/supplier disputes.Concerning tax implications,one participant said that hehelped a customer set up opera-tions in Mauritius because it is atax-free zone. He also determinedthe amount of ownership in ajoint venture required for favor-able taxation and negotiated howparties would bear the costs ofany tax law changes. Concerningthe protection of intellectual prop-erty rights, legal experts help bywriting further assurance clausesor by establishing a chain of titlefrom employees to the supplierto the customer.

Lesson 10: Openly Communicatethe Outourcing Strategy to AllStakeholders to Mitigate PoliticalRisks

At Financial Services 1, seniormanagement viewed offshoreoutsourcing as a potential wayto decrease the immense appli-cation backlog caused by therefinancing boom. But seniormanagement chose to keep thepilot project “low key rather thanpanic the IT staff while we weresimply testing the waters.”

Suddenly one day, the domestic ITstaff showed up for work to find11 people from India working incubicles. The domestic IT staffbegan to panic and question thefuture of their positions. TheIndian workers were isolated andtreated with suspicion, if not con-tempt. The IT staff found frequentreasons for complaining about theoffshoring projects. Eventually, theCTO held a town meeting andtold staff that no further layoffswould be caused by offshore out-sourcing. However, he wouldreplace fewer inhouse IT staff thatdeparted through natural attrition.

In contrast, Biotech was veryopen about the offshoring pilotsand told the internal IT staff thatoffshore outsourcing was about“doing more with a flat budget”and that no internal IT workerswould be fired as a result of off-shore outsourcing. Even withopen communication, there wassome backlash. When dealingwith the internal IT staff, aBiotech global leadership teammember noted that it is importantto separate emotional issues fromreal ones:

Different people perceive off-shore outsourcing in differentways. And I guarantee we havethe full spectrum. We wereaware of that and wanted to besure that it did not impact ourworkforce in a negative way. Sowe spent a great deal of time tokeep the communications astransparent as possible withouttrying to needlessly scarepeople. So it’s a tricky balance.I understand that there are

some companies that haveapproached this, and they’vesaid we’re just going to replaceeverybody this way. And theytell all of their people that andthen they say, now help usmake it happen. It’s a reallybad way to do things.

Lesson 11: Use Secure InformationLinks or Redundant Lines toMitigate Infrastructure Risks

Early articles on offshore out-sourcing focused on poor infra-structure quality in low-costcountries as a major risk factor.Our participants reported onlyminor problems — mostly withteleconferencing capabilities —because, at least in India, theinfrastructure has improved. First,many clients, such as FinancialServices 3, use secure communi-cations links between the cus-tomer and offshore supplier toenable easy and secure access.Second, many US customers optfor redundant lines so that down-time is not an issue. Third, theIndian government has replacedthe telecommunications monop-oly with competition. Accordingto the former president of MCI,India is in the process of layingfiber-optic cables in 100,000Indian buildings — as comparedwith 30,000 buildings wired in theUS. He further noted that atelecommunications company inIndia set a sales record by signingup 110,000 cell phone customersin a single day. All of these initia-tives will serve to increasetelecommunications servicequality and reduce costs.



The more common problem forUS customers is mobilizinginhouse resources to create theinfrastructure, such as setting up avirtual private network (VPN),cubicles, computers, accesscards, login IDs, and access tosystems. There is some level ofmanagerial disconnect betweenthe US project managers and theirsystems administrators. PMOs canhelp bridge the gap.

Lesson 12: Use Fixed-PriceContracts When Possible toMitigate Workforce Risks

Several participants complainedthat some of the suppliers’employees were inexperiencedand overworked, and employeeturnover was frequent. As oneBiotech participant noted, “CMMcertification is no substitute forexperience.” The customer ismost affected by workforce riskswhen using a time-and-materialscontract. Because the customer isbilled hourly, the customer subsi-dizes a new supplier employee’slearning curve. Also, supplieremployees who are unproductivetake more hours to completetasks, which, again, is reflected inthe customer’s bill. Some cus-tomers try to mitigate this risk bydemanding to see résumés ofsupplier employees or by settingminimum years of experience.These practices place the cus-tomer in the business of manag-ing the supplier’s resources,which can increase transactioncosts and create animositybetween customer and supplier.A better practice is to encourage

the supplier by using a fixed-pricecontract with clearly defineddeliverables. The supplier canbest decide how to staff the proj-ect to meet its contractual obliga-tions while maximizing its ownprofit margin. The supplieris incented to put its most pro-ductive people on the project toincrease its margin, or thesupplier may make a strategicdecision to finance its ownemployees’ learning curves. Let’snow turn to a discussion of thepractices to mitigate social andlogistical risks.

PRACTICES TO WORKEFFECTIVELY WITHOFFSHORE SUPPLIERS

Managing remote teams with proj-ect members from different coun-tries, cultures, and time-zoneswho speak different languages isone of the most difficult chal-lenges of offshoring. Fortunately,there are many practices that can

help customers work effectivelywith offshore suppliers.

Lesson 13: Design EffectiveOrganizational Interfaces

Our research has uncovered threemodels of organizational inter-faces, each with its own set ofbenefits and costs. As shown inFigure 3, both Retail andManufacturer 1 use the funneldesign, which provides the great-est constriction of the communi-cation pathways between thecustomer and its supplier. Sincecommunication from local busi-ness units and technical staff isfunneled through the project man-agers and then to the on-siteengagement manager, this modelplaces great importance on thevendor’s selection for an on-siteengagement manager. Thisreliance on a specific individualdoes pose risk to both parties.Retail, for example, experienced amajor failure with a large Indian



On-site

supplier

engagement

manager

Local

business

units

Architects,

database

architects (DBAs),

etc.

Project

managers

Offshore

supplier

delivery

team

Project

management

office (PMO)

Customer

Supplier

Offshore

supplier

delivery

team

Offshore

supplier

delivery

team

Figure 3 — The funnel design.

firm because the engagementmanager originally chosen to leadthe engagement didn’t have theskills or experience to work with aFortune 100 company. Once theshortcomings were brought to theattention of the vendor, actionwas quickly taken, and a moresenior engagement manager wasput in place. Time and confidencein the vendor, however, hadalready been lost.

Despite the risks associated withthis model, the benefits includebetter control over the engage-ment and a single point of contactthat will help mitigate the cultural,time zone–related, and communi-cation risks. This model alsorequires the engagement to belarge enough to warrant a dedi-cated on-site employee from thevendor.

In Figure 4, the network designoffers additional pathways ofcommunication between the ven-dor and the supplier. The networkdesign, used by Biotech, showscommunication taking placebetween all stakeholders at boththe vendor and the supplier.Particularly interesting is the directlink between local business unitsand the supplier. This linkageoffered mixed results for Biotech.One project that allowed localbusiness units to communicatedirectly with the supplier to definerequirements was successful. Inthis case, the local business unitwas very low on the priority list ofthe internal IT staff and feltneglected. Once connected with

the offshore delivery team, itsneeds were assessed, require-ments gathered, and the projectproceeded with a greater focus onthe user. This project came in ontime and under budget and withhigh customer satisfaction num-bers for the offshore vendor.

One project nearly failed due tothis linkage. The postmortemshowed that when the local busi-ness unit (whose needs are oftenboundless) was allowed to com-municate directly with the sup-plier (whose promises of deliveryare often boundless), scope, fea-ture, and budget creep proceededunchecked. While the projectwas completed, it was constantlydelayed and finished well overbudget.

The third model, which we call themirrored design, was actually stud-ied and documented by Kaiserand Hawk14 (see Figure 5). Theyreported on an eight-year relation-ship between a US financialinsurance company and an India-based supplier that evolved fromoutsourcing to cosourcing.(Cosourcing describes a closevendor/customer relationship inwhich the vendor augments oreven replaces the customer’s ITcompetencies. The supplier evenserves as team leader for sometypes of work.) To effectivelymanage the supplier’s increasedresponsibility, the two partnersrealized they needed multiple lev-els of formalized communication.They designed the dual projectmanagement hierarchy, or the

mirrored design. This model has asignificant onshore supplier pres-ence, including the supplier’s sys-tems analysts on the developmentstaff. This increases costs com-pared with the previous two mod-els, but is warranted by the highervalue work provided by the ven-dor.

Addressing CMM Challenges

Lessons 14 to 16 address theprocess gap between US cus-tomers and their offshore suppli-ers. Every interview participantraised the need to coordinatework processes, particularly withsuppliers who are committed tothe Software EngineeringInstitute’s CMM. While Indian sup-pliers were all certified at CMMLevel 4 or 5, US customers wereusually lower. At higher levelsof certification, an immenseamount of documentation isrequired. US project managershad never before been throughsuch a rigorous requirementsdefinition process.

At Biotech, for example, require-ments definition is an informalprocess when done onshore.Project managers speak fre-quently with users, who areusually located on campus head-quarters. The user feedback cycleis quick. In contrast, project man-agers working on the offshorepilots had to engage in many for-mal and planned communicationswith suppliers and users to createthe required documents. As oneBiotech global team membersaid, “The overhead costs of



documenting some of the projectsexceeded the value of thedeliverables.”

So what can be done to moreeffectively coordinate work withthe supplier’s CMM processes?The following practices were usedby participants.

Lesson 14: Elevate Your OwnOrganization’s CMM Certificationto Close the Process Gap BetweenYou and Your Supplier

Participants suggested that thebest way to extract value from thesupplier’s CMM processes is tobecome CMM-certified yourself.According to the director ofapplication development atTransportation: “A real problemwe had was our CMM Level 1.5guys talking to the vendor’s Level5 guys. So together, we haveworked out a plan with our ven-dor to help bring our CMM levelsup. When we do, it will be a ben-efit to both of us; our specifica-tions will be better, and so theycan use them more efficiently.”

The outstanding issue is the levelof certification required to effec-tively work with suppliers. The VPat Financial Services 4 believesthat customers need to reach onlyLevel 1.8 to extract value. The offi-cer of IT services at FinancialServices 3 set a more ambitiousgoal in pushing to bring his ownorganization up to at least a Level3. Still other US organizations seekhigher certification levels, as theUS federal government nowrequires for all government ITcontracts.

Lesson 15: Bring in a CMM Expertwith No Domain Expertise to FlushOut Ambiguities in Requirements

US customers often complain thatthe requirements process is longand requires a great deal ofexpensive iteration. This is usuallybecause the US customer doesn’t

understand how the supplier willinterpret the requirements. SomeUS customers, for example, weresurprised that supplier teammembers did not understand theconcept of a mortgage. In anotherinstance, US customers were sur-prised that the suppliers did notallow female name fields in the



Customer

Supplier

On-sitesupplierproject

manager

Localbusiness

units

Architects,DBAs, etc.

Projectmanagers

Offshoresupplierdelivery

team

PMO


team


team

On-sitesupplierproject

manager


team


team


team

Figure 4 — The network design.

VP IS

Team lead

Projectmanager

Director

Team lead

Relationshipmanager

Team lead

Anchor

Anchor

Developmentstaff

Team lead

Customer

Supplier

Developmentstaff

Developmentstaff

Developmentstaff

Figure 5 — The mirrored design.

software to be altered unlessrecently married (as is the rule inIndia). To reduce the cycles dur-ing the requirements definitionstage caused by misinterpreta-tions, one Indian supplier soughta unique solution. He brings in aCMM Level 5 expert to the clientsite who purposefully has nodomain knowledge. This enableshim to identify ambiguities in therequirements documents that theoffshore delivery team will likelyconfront, thus reducing the num-ber of iterations.

Lesson 16: Negotiate The CMMDocuments for Which You Willand Will Not Pay

The project manager at FinancialServices 1 noted, “You ask for onebutton to be moved, and the sup-plier has to first do a 20-pageimpact analysis; we are payingfor all this documentation wedon’t need.” This manager isnegotiating for exactly which doc-uments Financial Services 1 willand will not pay. This enables himto use only the CMM processes hebelieves add significant value.While this practice is unique, acustomized interface with eachcustomer could serve to increasethe supplier’s costs, which mayeventually result in higher prices.

Lesson 17: Tactfully Cross-Examine, or Even Replace, theSupplier’s Employees to OvercomeCultural Communication Barriers

Many interview participants saidthat Indian employees would notchallenge the customer even ifthey believe that the customer

was making a mistake. Indianemployees will not readily deliverbad news and won’t expressincomprehension. According toone frustrated participant, “Theplace could be on fire, and theywould say, ‘Oh it’s great — a littlewarm — but it is great!’”

While being anxious to satisfy acustomer is certainly a sought-after supplier quality, it can actu-ally be detrimental to effectivecommunication. Biotech’s globalleadership team member offersthe following anecdote:

You can sometimes be talkingwith someone, and across thetable they’ll be nodding theirhead as if they understand andagree with everything you’resaying. You find out later thatthey didn’t understand what youwere talking about. That’s oneof the interesting things to learn.Apparently the culture does notchallenge, so there is a “Thecustomer is always right” sort ofa feel to it. So you have to learn,when you’re in the dialogue,to ask the questions thatensure that understanding ishappening.

One American who works for amajor offshore supplier says helearned to cross-examine hisIndian counterparts to ensurethat they tell him bad news.Whereas in America he asks,“How is the project going?” inIndia he asks much more targetedquestions, to the point where heworries about being rude. Anotherparticipant solved the issue bycomplaining to the supplier’s

senior management that the sup-plier’s project manager was eva-sive about the project status. Thesupplier replaced that individualwith a woman who was muchmore forthcoming. Lesson 18 pro-vides another strategy to addressthis issue.

Lesson 18: Require Supplier toSubmit Daily Status Reports

At a US Midwestern regional bank,for example, the customer wasgetting increasingly frustrated withthe supplier’s inability to flagproblems or report delays in theweekly conference calls. Theproject manager for the bankdesigned a status report thatwould take the offshore teammembers only a few minuteseach day to complete. Initially,the supplier employees agreed,but ultimately the project man-ager could not get them to com-ply. After several iterations withthe supplier’s management team,the manager discovered that thesupplier’s delivery team did notunderstand how to fill in thereport and was afraid to ask.Once the instructions wereclear, the delivery team membersaccurately completed the dailystatus reports, which now serveas the major tool to identify andsolve problems. Manufacturer 2had an almost identical story —supplier team members did notverbally report bad news inweekly conference calls, butrather reported items on a dailyonline status report. This levelof micromanagement sometimesserves to frustrate US customers.



But at the same time, it was theonly tool these two customersfound to overcome cultural com-munication barriers.

Lesson 19: Let the Project TeamMembers Meet Face-to-Face toFoster Camaraderie

One project manager at FinancialServices 1 said he regretted neverbeing allowed to visit India. Hefelt he would have been a muchmore effective project managerhad he met the people face-to-face to get a better understandingof their work practices. The needfor the customer’s project man-ager to visit the supplier site isclearly emerging as a best, albeitexpensive, practice to get pastcultural communication barriers.It is much easier to switchto lower-cost media such as tele-conferences and e-mail afterpeople meet face-to-face. Biotechbore the cost of the team mem-bers meeting face-to-face. Aglobal leadership team membernoted: “Once you get good atspecking out what you need face-to-face, then an awful lot of thework happens by e-mail, and thenit’s just followup questions. Andlots of that happens by e-mail.”

While this lesson carries consider-able expense (a round-trip coachticket to Bangalore costs approxi-mately $2,000, and a business-class ticket is $6,500), the benefitsare clear and immediate. Afterhis first trip to see the vendor’soffshore delivery team, the man-ager of Manufacturer 1’s softwarecenter of excellence reported:

I can’t believe I waited twoyears to meet the people I havebeen only e-mailing and seeingin videoconferences! What adifference this trip has made.Now I know my team. I shouldhave done this at the verybeginning. I now have faces,and more importantly personali-ties, to go with names and titles.This trip was worth everypenny.

Lesson 20: Consider InnovativeTechniques, Such as Real-TimeDashboards, to Improve WorkflowVerification, Synchronization, andManagement

Project managers noted difficul-ties with transferring work, withkeeping track of programmingand database versions, and withwhen and how to verify supplierwork. At Biotech, most pilot proj-ects required the transfer of workevery two weeks. At FinancialServices 1, the customer takespossession of programming codeevery 15 days but needs to checkthe database architecture daily.Sometimes database schemashave discrepancies. A possiblesolution is a real-time dashboard.Dashboards are emerging toolsthat allow the customer toglimpse the supplier’s work inreal time. Although only one ofour participants (Manufacturer 1)has implemented a dashboard, allinterviewees saw a need for bet-ter workflow management. Thisdashboard allows for real-timegovernance of the engagement,with all projects color-codedbased on current status.

Lesson 21: Manage Bottlenecksto Relieve the Substantial Time-Zone Differences

Time-zone differences are oftenmarketed as a bonus of offshoringbecause operations can occuraround the clock. While that maybe true of call centers, time-zonedifferences do not typically facili-tate IT development projects. Forconcurrent tasks, like telephoneconferences, US developers haveto stay at work very late or thesupplier has to get up very early.For sequential tasks, if US devel-opers don’t stay late to completedeliverables, the consequence isthat the supplier sits idle for anentire day. For example, the proj-ect manager at Financial Services1 said he doesn’t have the powerto make the database administra-tor stay late to finish schemas,resulting in a bottleneck as thesupplier waits. At Biotech, theproject managers’ number onecomplaint about offshoring was itseffect on their work hours. WhileBiotech’s global leadership teamhas the power to enforce irregularhours within the IT department, itis more difficult to get business-unit managers and end users tocooperate. Biotech learned that abest practice to minimize bottle-necks was colocated people:have some Indian supplieremployees on-site in the US andsome Biotech staff on-site inIndia. As mentioned previously,S2Tech minimized the problemby setting the work hours in Indiafrom 1:00 pm to 10:00 pm to pro-vide a three-hour overlap withUS customers. Other practices



include flex time for US employ-ees working on offshore projects,even if it breaks formal companypolicy. Giving US employeesIndian holidays off to compen-sate for longer hours was alsoeffective.

PRACTICES TO ENSURECOST SAVINGS WHILEPROTECTING QUALITY

While participants did not expectto lose money during the pilot-testing phase, the main objectivewas testing the proof of concept.Substantial cost savings can beachieved only after employeelearning has accumulated and thesize of the projects increases. Inthis section, we discuss what par-ticipants learned about the neces-sary size of projects and QApractices to ensure cost savingswhile protecting quality.

Lesson 22: Consider BothTransaction and ProductionCosts to Realistically CalculateOverall Savings

For US companies, the initial off-shore driver is undoubtedly laborcost savings, a production cost.Although we know that in the USaverage labor cost per year per ITemployee is $63,331, comparedwith less than $12,000 in India,total production costs can bedifficult to assess. For example,Biotech estimates projects basedon an eight-hour workday butthe Indian offshore suppliers billnine and half hours per day. Themanagement challenge is extract-ing overall cost savings when bothtransaction and production costs

are considered. Transactioncosts are considerably higherwith offshoring.

Most CIOs find it difficult to calcu-late the transaction costs of off-shoring. As the Biotech head ofthe offshore PMO said:

It is clear that we saved moneyon a per-hour basis; there is noway to argue about that. But didthey [the offshore provider]save us money? Did they do itas fast as we would do it? Theother big complaint came fromthe project managers, [whosaid,], “Managing offshore proj-ects is really hard. … If I had tocount up how hard this is, thenwe lost money.”

Lesson 23: Size Projects LargeEnough to Receive Total CostSavings

Our research did not identify adefinitive benchmark for the sizeof IT project required to achievesignificant savings. We asked asenior researcher at a consultingfirm how big an IT software proj-ect has to be in order to achieve15%-20% in overall savings. Hequoted us between 80 and 100full-time equivalents, although headmonished that this number wasbased on his personal experience.Participants from Biotech agreethat larger-sized projects are thekey to getting overall cost savings.The head of Biotech’s offshorePMO, said: “We tended to pickwhat we perceived as low-riskprojects for the pilots. And insome cases, that meant that wepicked projects that were so

small, the overhead crushed anyvalue.” After pilot tests were com-plete, Biotech launched two verylarge application developmentprojects. These projects will betwo to three years in duration andrepresent more than $1 millioneach in IT spend, with significantcost savings anticipated.

Lesson 24: Establish the IdealInhouse/On-Site/Offshore RatioOnly after the Relationship HasStabilized

The CEO of an offshore intermedi-ary firm stated that the ideal ratiois 15% of client staff on-site tomaintain direction, 15% supplierstaff on-site to serve as liaisonsand project managers, and 70% ofthe supplier staff offshore. Whilecustomers are in the experimentalphase, the ratio is likely to bemuch higher. For example, whenFinancial Services 3 started off-shoring in 2001, the onshore/offshore ratio was 50/50. The sup-plier Wipro has a dedicated staffon-site, as well as a dedicatedoffshore delivery team. Thus far,the relationship has been success-ful in that Wipro delivered 115projects with an above-averagecustomer rating. As FinancialServices 3 has conquered thelearning curve and established agood supplier relationship, theofficer of IT services aims to shiftthe ratio to 30/70.

In other cases, the customerand supplier relationships havestabilized to such a point that thesupplier has no permanent staffon the customer premises. For



example, for some of the projectsat Retail and Manufacturer 2, no on-site supplier presence isneeded because the team mem-bers know the context andone another very well.

Lesson 25: Give OffshoreSuppliers Domain-Specific Trainingto Protect Quality and LowerDevelopment Costs

When Manufacturer 1 began toengage its Indian vendor, it real-ized that the need to carefullymanage and direct the knowledge-transfer processes was significant.The vendor did not initially havethe domain expertise in thedesign and maintenance ofembedded software, which differssubstantially from traditional soft-ware development. To bridge thisgap, Manufacturer 1 decided togive the vendor’s delivery teamthe same new employee orienta-tion sessions and training that isprovided to new internal employ-ees. The content of this trainingincluded tools, methodologies,and technologies used atManufacturer 1, as well as moretraditional orientation activitiessuch as facility tours, introduc-tions to peripheral departments,and human resources issues. Thetechnology and project training,which was conducted by thelead architects and project man-agers, dramatically increasesManufacturer 1’s transactionscosts. However, they hope to sig-nificantly reduce these costs asthe trained vendor employeesmove offshore and transfer theknowledge to the offshore teams.

Lesson 26: Overlap OnshorePresence to Facilitate Supplier-to-Supplier Training

This lesson is closely tied to theneed to provide the vendor withdomain-specific training. Sincethe overall goal of training thevendor’s staff is to ultimately pro-tect quality and reduce cost,Manufacturer 1 staged the trainingso the vendor’s on-site projectmanagers would overlap on-sitefor three to six months to facilitatethe knowledge transfer prior tothe original project manager mov-ing offshore to train the deliveryteam. This overlap and ultimatetransfer to offshore allows thevendor to center the deliveryeffort offshore where rates aretypically less than half of theonshore rates.

In addition to improving the trans-fer of knowledge, the overlap ofthe on-site project managers alsofacilitates the transfer of the rela-tionship. Both Manufacturer 1and its vendor mentioned thatthis overlap helps to maintain thecontinuity of the engagement.According to the engagementmanager:

The overlap allows us to helpease the transition. We canshare the stories and the historyat a personal level. For example,there are “inside jokes” thatonly the delivery teams wouldunderstand. We can transferthat “soft knowledge”along withtechnical lessons learnedabout the creation of embed-ded software.

Lesson 27: Develop MeaningfulCareer Paths for Subject MatterExperts, Project Managers,Governance Experts, and TechnicalExperts to Help Ensure Quality

Participants stressed the needfor subject matter experts (SMEs)and good project managers todefine and deliver businessrequirements and governanceexperts to manage external sup-pliers. But as US organizationsincreasingly outsource entry-levelpositions such as programming,how will future generations ofSMEs, project managers, and gov-ernance experts be groomed?

A global leadership team memberat Biotech said, “All of the bestproject managers I have everworked with all started as coders.If all the hard-core coding is beingdone offshore, where will we getour good project managers?”

At Manufacturer 2, the CIO hopesto swiftly groom future projectmanagers by putting all inhouseIT staff through project manage-ment training, even for low-levelgraphics designers. The vice presi-dent of technologies for FinancialServices 6 addressed this worryby partnering with local universi-ties to create “centers of excel-lence.” The centers’ mission isto develop skill sets aimed at“priming the pump” to ensurethe talent pipeline does not dryup. These centers work withFinancial Services 6 to understandthe changing landscape of ITwork and adapt their curriculumto create graduates with the



necessary combination of busi-ness, project management, andtechnical skills.

CIOs looking for an in-depthanswer to career paths of theresidual IT staff may refer to thecore IS capabilities model devel-oped by Feeny and Willcocks.15

Feeny and Willcocks defined ninecapabilities surrounding the elici-tation and delivery of businessrequirements, managing externalsupply, and ensuring technicalability. Global firms such asDuPont and Commonwealth BankGroup have adopted the model.

Lesson 28: Create BalancedScorecard Metrics

All participants identified the needfor measures that consider costs,quality, timeliness, and risks, butonly participants from one com-pany were fully satisfied with cur-rent assessment measures.Manufacturer 1 tracks inhouse,domestic, and offshore suppliers’costs, quality, and productivityusing a standardized activitymeasure. The data is capturedby an inhouse dashboard andanalyzed monthly by manage-ment to monitor real develop-ment costs and trends. It learnedthat real savings from offshore donot occur until after they haveinvested significant up-front train-ing of every offshore developerand team leader. They also sharethis data with vendors so that allparties understand the total costtrends.

In contrast, at Biotech, offshoremeasures are still in the formativestage. Traditionally, Biotech’s ITmanagers conduct subjectiveaudits on the back end of a sys-tem implementation. Critical feed-back from the customers and thesponsoring strategic business unitis deemed the most importantassessment factor. As the CIOnotes, “IT cannot make thisassessment alone, it has to bedone with the sponsoring anduser group.” The head of theoffshore PMO is developingmore quantitative metrics, butthe effort is not complete.

Some participants are pressuringsuppliers to develop a set of met-rics to serve as industry bench-marks. One participant said: “Ourvendor must have many cus-tomers who are all trying to dothe same thing. And maybe somehave already done it. If they couldjust come up with five to sevenkey measurements to help me, Icould better manage the projectand explain the process to myboss. But every time I ask for best-of-breed metrics, they tellme, ‘Metrics really need to becompany-specific and businessdriven, not vendor provided.’That does not help me!”

CONCLUSION

Most US CIOs are veterans ofdomestic outsourcing. While theymay have initially ventured off-shore primarily to seek lowercosts on short-term projects, theystay for the quality. Many CIOswill eventually escalate global

sourcing to enable strategic busi-ness objectives such as bringingproducts to market faster andcheaper, financing new productdevelopment, accessing new mar-kets, or creating new business.

In this report, we presented 28practices to help CIOs acceleratethe learning curve. Many of thesepractices require CIOs to equiptheir project managers with thethings they need to be successful,such as PMOs, CMM training, off-shore site visits, and techniques tomonitor the supplier’s work. Tohelp prevent internal panic amongIT employees, CIOs must openlycommunicate the objectives of anoffshore initiative to assuage irra-tional fears. CIOs also must rallysupport from stakeholders outsideof IT such as business-unit man-agers and end users to preventbottlenecks, scope creep, andpoor quality. We also believe thatCIOs have a social responsibilityto actively manage society’s per-ceptions of offshore sourcing.

ABOUT THE AUTHORS

Dr. Joseph Rottman is an AssistantProfessor of Information Systemsat the University of Missouri–St.Louis. He earned his doctor of sci-ence in information managementfrom Washington University in St.Louis. He has conducted researchand spoken internationally onglobal sourcing, innovation diffu-sion, and public sector IT. Dr.Rottman presented a keynoteaddress at the Michael CorbettOutsourcing World SummitConference in Bangalore, India.



He has conducted case studies inmore than 30 firms. His researchis being published and presentedto senior executives worldwide,including the Advanced PracticesCouncil of the Society forInformation Management, theOutsourcing World Summit inIndia, and in publication outletssuch as MIS Quarterly Executive,Information and Management,and CIO Insight.

Dr. Mary Lacity is a Professorof Information Systems at theUniversity of Missouri–St. Louis,Research Affiliate at TempletonCollege, Oxford University, andDoctoral Faculty Advisor atWashington University. Herresearch interests focus on ITmanagement practices in theareas of sourcing, IT privatization,relationship management, andproject management. She hasconducted case studies in morethan 100 organizations and hassurveyed both US and EuropeanIT managers on their manage-ment practices. She has givenexecutive seminars worldwideand has served as an expertwitness for the US Congress.She was the recipient of the2000 World OutsourcingAchievement Award sponsoredby PricewaterhouseCoopers andMichael Corbett and Associates.She has written five books:NetSourcing (coauthors ThomasKern and Leslie Willcocks);Global Information TechnologyOutsourcing: Search for BusinessAdvantage (coauthor LeslieWillcocks); Strategic Sourcing of

Information Systems (coauthorLeslie Willcocks); Beyond theInformation Systems OutsourcingBandwagon: The InsourcingResponse (coauthor RudyHirschheim), and InformationSystems Outsourcing: Myths,Metaphors, and Realities (coau-thor Rudy Hirschheim). Herarticles have appeared in theHarvard Business Review,Sloan Management Review,MIS Quarterly, IEEE Computer,Communications of the ACM,and many other academic andpractitioner outlets. She is SeniorEditor for MIS Quarterly Executiveand US Editor of the Journal ofInformation Technology. Shehas previously worked as a con-sultant for Technology PartnersInternational and as a systemsanalyst for Exxon Company, USA.

ENDNOTES

1Baker, Stephen, and ManjeetKripalani, with Robert D. Hofand Jim Kerstetter. “Software:Will Outsourcing Hurt America’sSupremacy?” BusinessWeek,1 March 2004, pp. 84-95.

2McGee, Marianne Kolbasuk.“Offshore OutsourcingDrags Down US Bonus Pay.”InformationWeek, 25 August2003.

3See, for example, Griswold,Daniel T. “Outsource, Outsource,and Outsource Some More: ABoon to the American Economy.”National Review, 3 May 2004,pp. 36-38.

4Lindsey, Brink. “Job Losses andTrade: A Reality Check.” CatoInstitute Trade Briefing Paper,No. 19, 17 March 2004.

5McCarthy, Jack, “RedefiningOffshore Outsourcing.”InfoWorld, 29 November 2002.

6See Lacity, Mary, LeslieWillcocks, and David Feeny.“Transforming IndirectProcurement Spend: A CaseStudy,” Cutter ConsortiumSourcing and VendorRelationships Executive Report,Vol. 5, No. 2, 2004; and Lacity,Mary, “Twenty Customer andSupplier Lessons on IT Sourcing,”Cutter Consortium Sourcing andVendor Relationships ExecutiveReport, Vol. 3, No. 3, 2002; andLacity, Mary, and LeslieWillcocks, “RelationshipManagement: A StakeholderPerspective,” Cutter ConsortiumSourcing and VendorRelationships Executive Report,Vol. 2, No. 3, 2001.

7Agarwal, Ritu, and V.Sambamurthy. “Principlesand Models for Organizing IT.”MIS Quarterly Executive, Vol. 1,No. 1, March 2002, pp. 1-16.

8May, Jeff. “Shipped Out: FromAT&T to IBM to Nowhere.”New Jersey Star-Ledger, 15August 2002.

9“TRW and Satyam to FormStrategic Alliance.” Press release,www.satyam.com, 8 June 2000.



10in India, this percentage ofownership is typical. WhereasUS ventures require only 51%ownership for complete controlof the enterprise, Indian lawrequires 76% ownership forequivalent rights.

11Field, Tom. “The Man in theMiddle,” CIO, 1 April 2002.

12Feeny, David, Mary Lacity, andLeslie Willcocks. “12 Capabilities

to Evaluate in your BusinessProcess Outsourcing Provider.”Oxford Institute of InformationManagement Working paper,2004.

13Lacity, Mary, and LeslieWillcocks. Global InformationTechnology Outsourcing InSearch of Business Advantage.John Wiley & Sons, 2001.

14Kaiser, K., and S. Hawk.“Evolution of Offshore SoftwareDevelopment: From Outsourcingto Cosourcing.” MIS QuarterlyExecutive, Vol. 3, No. 2, June2004, pp. 69-81.

15Feeny, David, and LeslieWillcocks. “Core IS Capabilitiesfor Exploiting InformationTechnology.” Sloan ManagementReview, Vol. 39, No. 3, Spring1998, pp. 9-21.



APPENDIX A: RESEARCHPARTICIPANTS

While several companies havebeen mentioned and quoted fromthroughout the report, AppendixA/Table 1 provides a completelist and description of all theparticipants.

APPENDIX B: CASE STUDIES

Our research included interviewswith 14 US firms that are activelyengaged in leveraging offshoremodels. While such a broadresearch base is essential to theapplicability of the 28 lessons,delving deeper into the journeyof four of these firms (Biotech,Retail, Manufacturer 1, andManufacturer 2) will enableCIOs to see perspectives, lessons,and strategies from four differentorganizations with very divergentstories.

Biotech

Biotech is a Fortune 500 companyand a leading provider of biotech-nology-based products. Over the

past four years, Biotech has expe-rienced moderate growth in rev-enues, earning billions of dollars ayear in sales but generating signifi-cant net losses in 2002. That year,the company reduced the IT bud-get by 5% partly to subsidize thenet losses from 2002. Doing morewith less became the CIO’s majorchallenge. A few members ofthe global leadership team, whoreport to the CIO, championed theinvestigation of offshoring. Thenumber one objective was toreduce IT costs by replacingsome of the expensive domesticcontract labor force with cheaperoffshore equivalents.

Three members of the globalleadership team began their off-shore investigation by visiting UScustomers onshore. Persuaded bythe cost savings they observed,they hired an intermediary toserve as a guide to India and toIndian suppliers. They selectedIndia as the offshore venuebecause Biotech already hadR&D facilities in Bangalore. In

that facility, Biotech had full-timeIT employees who ultimatelyplayed a significant role in man-aging offshore outsourcing.

Upon returning from India, theglobal leadership team began torally senior management supportfor offshore outsourcing. The CIOapproved and created a new off-shore PMO. The role of the officeis to transfer knowledge about off-shore contracting, negotiations,and management.

Members of the global leadershipteam started bringing pilot proj-ects to the offshore PMO. Theidea was not to generate costsavings immediately, but rather togain experience with the types ofapplications, suppliers, contracts,and work processes that areneeded to ensure offshore out-sourcing success. In all, 17 pilotprojects were undertaken withfour different Indian suppliers.They purposefully selected verydifferent types of applicationsincluding replatforming from

PeopleSoft to SAP, back-end sys-tems development, and end-to-end systems. They purposefullyselected new (wireless) and old(ERP) technologies. They pur-posefully selected different-sizedprojects ranging from a 20-person-per-day project to an800-person-per-day project (fourfull-time equivalents for eightmonths). They purposefullyselected two large Indian suppli-ers and two small Indian suppliersto compare vendor capabilities. Inseveral instances, Biotech gavesmall pieces of the same projectto two vendors so that the projectserved as a control group for bet-ter supplier comparison.

The offshore PMO negotiatedmaster service-level agreements(SLAs) with the four Indian suppli-ers. Statements of work (SOWs)were appended for each specificpilot. Two types of financialarrangements were used for thepilot projects: time and materialsand fixed price, although the time-and-materials contract has beenmore prevalent. Fixed-price con-tracts were only used for clearlydefined SOWs.

The offshore PMO also had toaddress major security concerns.Since 9/11, Biotech created theposition of information securityofficer. For the security officer,one of the concerns in offshoreoutsourcing was data security.To minimize the risk, Biotechrequired the supplier’s IT staff inBangalore to use Biotech’s secureR&D facilities for sensitive data

access and updates. Althoughthis arrangement met Biotech’ssecurity needs, the supplier’s ITstaff did not like commutingacross town to Biotech’s facility.(Apparently the trek is like aManhattan resident commutingto Queens.)

Seventeen pilots were launchedin 2003. The learning curve withthe offshore suppliers was signifi-cant. The top challenges identi-fied: working with the supplier’scapability CMM processes, time-zone differences, language differ-ences, and cultural differences, in



Organization Pseudonym (n=30)

Number of Participants Interviewed

(n=101)

Representative Titles of Participants

Customers

Aerospace 3 Vice president; system development managers

Biotech (Fortune 500) 7 Head of offshore program management; global leadership team members

Financial Services 1 (Fortune 100)

4 CTO; project manager

Financial Services 2 1 Vendor assistance manager

Financial Services 3 1 Office of IT services

Financial Services 4 (Fortune 100)

1 Vice president

Financial Services 5 1 Vice president, global delivery

Financial Services 6 1 Vice president of technologies

Financial Services 7 1 Program manager

Financial Services 8 1 CEO

Manufacturer 1 3 Manager, software center of excellence; program manager

Manufacturer 2 3 Program management office head; project managers

Retail 7 CIO; director of contract management; senior development director

Transportation 1 Director of outsourcing

Service Providers

Large Indian Supplier 1 16 Senior vice president (retail); vice president (outsourcing solutions); associate vice president, software development center; HR officer; general manager

Large Indian Supplier 2 11 Vice president (retail); general manager (quality); practice head

Large Global Supplier 1 11 CEO of India operations; partner; vice president of business engineering; HR director

Large Global Supplier 2 7 Deputy general manager; head of corporate quality; principal consultant

Large Global Supplier 3 1 Manager of products

Small Indian Supplier 1 3 CEO, HR executive

Small Indian Supplier 2 4 Managing director; vice president (quality)

Third Parties

Intermediary Consulting Firm 1 1 CEO

Intermediary Consulting Firm 2 3 CEO; vice president

7 Legal Firms 9 Lawyers; partners

Appendix A/Table 1 — Research Participants

particular the supplier’s reticenceto report bad news. The head ofthe offshore PMO described theproblem this way:

An iteration was due onMonday. On Friday, the guy [theIndian project manager] says,“It’s fine. A little bit of a stretch,but it is fine.” And on Tuesday,he’s asking for another twoweeks! So they missed it by100%. They didn’t feel like theycould tell us if they were goingto miss it. This seems to be themodus operandi: dig and digand spade and spade to getanybody to tell you that thingsare wrong. Because they justsimply won’t. They will tell youit is great.

Overall, the 17 pilot projectswere successful in that Biotechextracted the learning it wantedand demonstrated proof of con-cept. By accumulating all of thelearning from the pilot projects,Biotech’s IT management learnedwhich two suppliers it preferred(one large and one small sup-plier), the types of processesBiotech needed to developinhouse to facilitate offshore out-sourcing, and the types and sizeof projects best handled offshore.In September 2003, Biotech wasready to move from offshoreexperimenter to proactive costfocus.

During the second phase of off-shoring, Biotech aims to ensuresignificant cost savings. While thepilot projects experienced lowerhourly wages, overall cost savingswere not evident because of the

learning curve and risk-mitigationpractices, such as small projectsizes. In order to truly leverage off-shore savings, Biotech is embark-ing on larger projects, such as amultiyear, multimillion-dollardevelopment project with thelarge Indian supplier.

Retail

Retail is a Fortune 100, US-basedretailer with more than 1,000stores in North America thatemploys more than 125,000people. As with many large UScompanies, Retail began lookingoffshore in preparation for theY2K crisis. With six million lines ofCOBOL, it knew additional man-power was needed to tackle theproblem. In 1997, without anyformal request for proposal (RFP)process, it selected one of thelarge Indian suppliers to workon small, well-contained appli-cations in its major credit pur-chase management system.Retail took advantage of itsconsiderable experience withdomestic contractors and, follow-ing a staff augmentation model,simply added the Indian supplierto its list of more than 35 domes-tic contractors.

This addition of the Indian sup-plier to its portfolio of domesticsuppliers allowed Retail to ana-lyze the value proposition of allvendors simultaneously. Onemajor lesson learned by Retailwas the financial benefit in creat-ing an integrated PMO. Accordingto the director of the PMO, mostof the 35 domestic contractors

responded immediately to theinclusion of offshore vendors byreducing the rates of commodity-type coding by up to 50%.

The initial projects with the Indiansupplier progressed well, and thedirector of the PMO visited Indiaand the supplier in late 1997.Based on the success Retail hadwith the first pilot projects, theengagement steadily grew duringthe late 1990s. This expansionwas done on a project-by-projectbasis, with additional work beingappended to the master SLAcreated in 1997. Since 1997, Retailhas steadily increased its offshoreoutsourcing activities.

Retail’s offshore challenges havecentered on the vendor’s inabili-ties to effectively work with verylarge US firms. On two occasions,the size and complexity of Retail’soperations created obstacles forthe Indian firms. In the first occa-sion, a large vendor had selectedan inexperienced engagementmanager to interface with Retail’sproject managers. The CIO ofRetail attributes this challenge tothe rapid growth of the Indianvendors:

They [the vendors] only have somany A-team members. Theytried to send us a B-teamengagement manager. Almostimmediately, we realized thatthey expected the engagementmanager to learn how to workwith a Fortune 100 firm duringour engagement! Well, aftertwo or three mistakes, we toldthe vendor to fix the problem.To the vendor’s credit, they



replaced him almost immedi-ately, but we lost some timeand had to mediate with thebusiness units.

On the second occasion, a smallIndian firm overpromised andunderdelivered throughout theengagement. According to thevice president and director ofcorporate systems: “They were soanxious to engage with a Fortune100 firm, they consistently over-sold their capabilities and wereunable to meet the SLAs andquality standards. Eventually, weforced them to remediate at theircost, and we just discontinuedany future work with them.”

Currently, about 2% of its $200million annual IS budget is out-sourced to offshore providers. Thevast majority of this work has beenawarded to one large Indian sup-plier. However, recent initiatives bythe current CIO and his manage-ment team have begun to diversifyits offshore supplier portfolio.According to the vice presidentand director of corporate systems,Retail has been actively expandingits engagements with other firms.“Don’t get me wrong,” the VP said.“I’ve been extremely happy with[the large Indian supplier]. Everyproject they have done has beenbasically on time and on budget,and their quality is good. I justthink we need to use competitionto keep the vendors honest andkeep rates competitive.”

Retail is currently engaged withtwo of the top five Indianproviders and two Tier 2 vendors.

It has also formalized the RFPprocess to more accurately com-pare the responding vendors.

Retail estimates that the percent-age of work performed by off-shore vendors will increase overthe next few years as the amountof work done by internal staff anddomestic contractors decreases.

Retail plans the decrease in inter-nal staff to take place graduallyand through natural attrition, asshown in Appendix B/Table 1.

As Retail’s engagements withoffshore vendors continue tomature, it remains committedto outsourcing only noncoreactivities. It has no plans to movebeyond a staff-augmentationmodel and will perform all appli-cation development inhouse andcontinue to outsource primarilysystem maintenance. The staff-augmentation model offers manyadvantages to Retail. It maintainsthe company’s strong controlof management and applicationsdevelopment, and it offers theeasiest exit strategy and providesa stable level of offshoreresources. It also allows for

a quick ramp up and down ofavailable resources based oncurrent needs.

Manufacturer 1

Manufacturer 1 is a Fortune 100global manufacturer of industrialequipment with more than 75,000employees in more than 20 coun-tries. It has successfully trans-ferred its Six Sigma manufacturingmethodologies and experiencesinto the management of offshoreactivities. Of all the firms we havestudied, Manufacturer 1 shows thegreatest level of expertise in met-rics, human resources manage-ment, and governance. Theexperiences within a softwarecenter of excellence (SCE) withinManufacturer 1 are prime exam-ples of this proficiency.

Manufacturer 1 is currently on itssecond attempt to engage off-shore vendors. In the first attempt,it underestimated the knowledge-transfer challenges. During thisinitial period, the majority ofthe projects failed to deliver atacceptable levels of quality andcost. Manufacturer 1 used thelessons learned to better structure



2004 2005 2006 2007

Internal Staff 71% 70% 65% 59%

Domestic Contractors

10% 5% 3% 3%

Offshore Contractors

19% 25% 32% 38%

Appendix B/Table 1 — Retail’s Plans for Internal Staff Versus Contractors Through 2007

and detail the projects currentlyunderway. According to the man-ager of the SCE:

During our first try, we followeda “throw it over the ocean”model. We thought we couldjust send the vendor our specifi-cations and good code wouldcome back. We were verywrong. They didn’t understandembedded software or theequipment we manufacture.They didn’t even know whatour product looked like! Nowwe are spending considerabletime on domain knowledgetransfer and training.

The manager of the SCE, whichemploys about 150 people anddoes about $35 million per yearin development work, has nowactively used offshore outsourc-ing to reduce some of theburden placed on his staff. Forexample, recent changes tothe Environmental ProtectionAgency’s regulations of emissionsof diesel engines have forced theindustry to redesign many of thestandards and controls for thoseengines. According to the man-ager of the SCE, the new regula-tions created a significant backlogof new development and modifi-cations to existing applications:

You’re either going to get thesedone, or you’re not going to selldiesel engines; you’re going togo out of business. And they’revery challenging. Well, in themanagement of that program,we were going to do whateverit takes; we were going todeliver this product even if it

killed all of us, and we were alldead lying on the floor when itwas over. And that’s what wedid. And so we were ridingpeople hard to get the softwareand stuff done to be able todeliver that. And the only optionthat we had was, “Well, you’regoing to work harder until we’redone.” And so the softwaregroup that we have, for themost part, was ridden hard todeliver, and the only way thatwe can unload them is to haveresources. We were not goingto add a bunch of expensiveNorth American resources.We’ve got to find other waysof being able to add flexibilitybecause the other thing wedon’t want to do is we don’twant to hire a bunch of people,have a downturn, and lay abunch of people off. Culturallywe just don’t like doing that.

Manufacturer 1 is also aware ofthe cultural implications of usingan offshore vendor for staff aug-mentation and has factored thatinto its human resources prac-tices. Using a custom-designeddecision support system, it moni-tors how many offshore resourcesare currently being used as wellas future project estimations. Thisprovides the inputs for future hir-ing decisions, and it can estimatehow many project managers,architects, and project leaders itneeds based on how many off-shore resources are being utilized.That helps to determine howmany entry-level programmersthey need to hire to begin theprocess of training moreadvanced roles.

While technically using a staff augmentation model,Manufacturer 1 refers to itsoutsourcing as “out-tasking.”Approximately half of its outsourc-ing work consists of small “activi-ties” which are appended to themaster SLA. By cutting up largertasks into five to seven workdaysections, it can monitor cost,quality, and project schedulesclosely. This model also helpsManufacturer 1 to protect itshighly sensitive intellectual prop-erty. The SCE is primarily taskedwith the creation of embeddedsystems for use on the industrialequipment. These systems notonly have proprietary computercode but also have critical datafor the operation of the equip-ment itself. By segmenting theoutsourced work into such smallsections, Manufacturer 1 feelsit can outsource critical taskswithout revealing its intellectualproperty.

Currently, Manufacturer 1 is work-ing with two Indian vendors: onelarge and one boutique. It hasapproximately 50 offshore vendorresources (35 on-site, 15 offshore)working with its 150 internal staffmembers. While this 3-to-1 ratiois higher than Manufacturer 1would prefer, it is poised to greatlyreduce the number of onshorevendor resources. After an exten-sive knowledge-transfer move-ment, Manufacturer 1 is hoping togreatly reduce its costs by havingits vendors move their on-siteresources offshore, thus loweringthe billable rate. The innovative



knowledge-transfer procedureinvolved “indoctrination” ofthe vendor’s employees intoManufacturer 1’s culture,processes, applications, systemsdevelopment lifecycle, and devel-opment tools. During this process,all new employees (both externalvendors and internal employees)are given identical training. Oncetrained by Manufacturer 1onshore, the vendors’ employeestrain their colleagues and eventu-ally move offshore to train the off-shore development team.

Manufacturer 2

Manufacturer 2 is a US-basedglobal manufacturer with 24plants located worldwide; itemploys more than 12,000 people.The company, which grewthrough mergers and acquisitions,has six major strategic businessunits. In 2001, a senior VP at cor-porate headquarters was seekingto efficiently replatform the sixseparate ERP packages in thestrategic business units into aunified ERP system. After pricingthe large, US-based accountingfirms, he championed the off-shore journey in 2001 seekinglower rates. The senior VP hiredan intermediary offshore consult-ing firm to serve as a guide toIndia and the Indian suppliers. Hemade the trips to India andselected three offshore firms.After due diligence, the list pareddown to one large Indian supplierfor the ERP project and one small

Indian supplier for smaller, dis-crete IT projects.

Manufacturer 2 established VPNswith the two suppliers to ensuredata security. Although generallyhappy with infrastructure, thequality of the conference callscapability is still poor.

Manufacturer 2 experienced thesame startup challenges as ourother cases. The weekly confer-ence calls were not an adequatemethod for project status report-ing because the Indian supplierswould not willingly deliver badnews about project delays.Manufacturer 2 then requiredthe Indian suppliers to fill in dailystatus reports. This way, the cus-tomer was better able to tracksupplier work and to identifyproblems and delays. Accordingto the director of applications, thesupplier employees were morecomfortable reporting problemusing the reports than the weeklyconference calls.

Another issue was the lack ofinhouse project managementcapability. With the requiredCMM processes, the inhouseproject managers needed moretraining on formal developmentprocesses. They started puttingall the internal IT staff throughproject management training,even low-level graphics designers.The idea is not only to groommore project managers responsi-ble for needs analysis but also toincreasingly move low-level IT

jobs offshore to the cheapersuppliers, leaving more value-added project management workinhouse.

Manufacturer 2 does two mainassessment measures. For cost, ittracks actual time spent andhourly rates and compares thatwith onshore rates. For quality, ithires an outside consulting firmto do audits and code reviews,which have generally been ofexcellent quality.

After three years and 30 projects,offshore outsourcing has becomeinstitutionalized within the com-pany. The offshore resources haveevolved into a natural an exten-sion of the inhouse developmentteam. For smaller projects given tothe small Indian supplier, suppliermanagers no longer stay on-site atManufacturer 2 because all theteam members already knoweach other and have workedclosely together before.



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Personalized consulting help is available to enable you to manage sourcing projectsand relationships effectively, negotiate contracts, develop and implement a metricsprogram, write enforceable service-level agreements, create appropriate pricingschemes, choose an application service provider, and more.

Products and Services Available from the Sourcing and VendorRelationships Practice

• The Sourcing and Vendor Relationships Advisory Service• Consulting• Inhouse Workshops• Mentoring• Research Reports

Other Cutter Consortium PracticesCutter Consortium aligns its products and services into the nine practice areasbelow. Each of these practices includes a subscription-based periodical service,plus consulting and training services.

• Agile Software Development and Project Management• Business Intelligence• Business-IT Strategies• Business Technology Trends and Impacts• Enterprise Architecture• IT Management• Measurement and Benchmarking Strategies• Enterprise Risk Management and Governance• Sourcing and Vendor Relationships

Senior ConsultantTeamEach of the individuals on the CutterConsortium Sourcing and Vendor Relationshipsteam is an expert in outsourcing, offering theexpertise that comes from decades of hands-on, real-world experience. The team includes:

• Eric Buel• Bill Curtis• Carole Edrich• Michael J. Epner• Danny Ertel• Ian Hayes• David Herron• Jonathan Hughes• Wendell Jones• Stuart Kliman• Michael C. Mah• Marty McCaffrey• Eugene G. McGuire• Bart Perkins• William Ulrich• William A. Zucker

Sourcing and Vendor Relationships Vol. 5, No. 12 Proven...

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