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The Hidden Costs of Offshore Outsourcing

March 17, 2022

Offshore outsourcing has steadily risen in popularity over the last two decades. Companies of all sizes have jumped on board to seemingly help reduce employee expenses and make their operations more profitable.

However, there are a few myths around offshore outsourcing that should be addressed. For example, there is a myth that by moving certain functions overseas, companies can save as much as 80% of their IT costs. The reality is that it is typically not even half that. In fact, a recent survey among IT companies that leveraged offshore outsourcing to lower overhead, found that only 30% of companies said that it was effective in reducing costs. In addition, 55% said it was somewhat effective and 15% said it was not effective at all.

Ask an IT project leader in the “somewhat effective” group and one in the “not effective at all” group why offshore outsourcing did not deliver more of the expected cost savings, and the likely answer you’ll receive is that hidden costs played a major role.

Hidden costs are one of the biggest risks associated with offshore outsourcing. And while it’s true that offshore outsourcing can provide bottom line benefits, it’s not an immediate result and often requires years of effort and substantial up-front investment.

We’ve outlined some of the most common hidden costs to help give you a better understanding  the total cost of ownership (TCO) of outsourcing your IT efforts to offshore resources.

Understanding the Total Costs

Choosing an offshore outsourcing service provider can be costly with the amount of time and resources needed to vet each potential partner.  

The Evaluation Cost: You’ll need to dedicate resources to create and send RFPs, to evaluate the responses, and to the contracting phase. You’ll also need to carefully examine the various outsourcing providers strengths and weaknesses and determine which of their model aligns best with your project objectives. The due diligence, interviewing, reviewing, and contracting can take as much as six months to a year and could involve substantial legal fees.

The Cultural Cost: Offshore outsourcing also involves the careful blending of cultural, language and organizational differences that can add anywhere from 3% to 27% to your outsourcing costs and lower productivity. According to Meta Group, a leading IT research and analyst, productivity loss can add as much as 20% in additional costs to an offshore outsourcing contract. And, on average, an IT organization will experience a 20% decline in application development efficiency during the first two years of a contract due to time spend overcoming work environment/cultural differences and experience levels.

The Transition Cost: The transition period is typically the most expensive overseas aspect of offshore outsourcing and can take from three months to a year—a period where there are little to no savings and significant expenses.

Beginning a relationship with an offshore outsourcing services provider requires training and explaining your business processes to your new overseas team. This can involve bringing workers to the United States to learn the project skills needed to work in tandem with your in-house employees and are paid U.S. wages while they are in country. This means you are paying your overseas worker and in-house trainer and no revenue producing work is being accomplished.

Additionally, during the transition, the offshore provider must put the infrastructure in place to replicate your environment, which can result in long lead times to acquire the necessary hardware. This means keeping their workers employed at your site for longer that you had budgeted.

The Internal Workforce Costs: While a strategy for reducing costs, lay-offs involve many costs. For example, you may have to pay severance and retention bonuses to many of your employees—the ones needed onsite long enough to train the offshore workers who may be replacing them.

Lay-offs also affect morale, which means loss of productivity and a hostile environment. It is not unusual for internal staff to refuse to embrace or begrudgingly  embrace the transition to the offshore model. This can lead to delays that take as long as three years to build the needed consensus to really move forward with an offshore model.

The Contract Management Cost: Managing offshore service providers involve on average an additional 6% to 10% in costs to your organization. Internal staff must correctly manage invoices, time sheets and contracts to make the process work. Additionally, you will need a project manager oversee the overall outsourcing process. A critical position that cost anywhere from $75,000 – $150,000, depending on the duties, which could include auditing time sheets, and developing and analyzing vendor proposals against the RFPs when bidding out the initial work.

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