Archive for the ‘Offshoring’ Tag

The dangers of outsourcing

Conventional wisdom says companies should outsource manufacturing and operations to take advantage of lower wages and faster operational scalability. Aside from the question of whether this strategy (particularly when it involves offshoring) always delivers the promised benefits, you may also wonder whether outsourcing makes long-term strategic sense. The demise of Kodak, the iconic U.S. photography company, suggests organizations need to be wary of outsourcing strategic business activities. Outsourcing has been occurring for decades, based on the idea that moving labour-intensive work offshore would significantly reduce cost, without jeopardizing a firm’s competitiveness.

Kodak’s fall shows this is a dangerous assumption. Companies can unknowingly reduce their competitiveness when strategic work such as manufacturing and product design is outsourced. In other words, they stand a good chance of loosing the secret sauce that drives meaningful differentiation. Moreover, outsourcing accelerates the diffusion of knowledge and talent to outsiders thereby lowering barriers to entry. The result is higher levels of competition and a lower return on invested capital.In addition, many operations that were once performed more economically offshore can now be in-sourced at a similar cost and much lower risk.

Founded in 1893, Kodak was the dominant player in the camera, film and processing business with a strong reputation for product and manufacturing innovation. Ironically, Kodak developed the world’s first digital camera in 1975, yet was never able to leverage that early success to take advantage of the market shift to digital photography. Instead, the way Kodak expanded its digital business sowed the seeds of its demise. In 2013 the firm declared bankruptcy.

Harvard Business School Professor Willy Shih had a front row seat, having served as president of Kodak’s Digital & Applied Imaging business through the turn of the 21st century. “Much of the camera technology was invented in the United States, but U.S. companies gave it all up,” Shih said. He contends that when Kodak moved pieces of their operations overseas many years before, they lost technical expertise, product innovation and manufacturing skills. When digital cameras became the rage, Kodak had lost the ability to put together a compelling digital camera solution. As a result, they were unable to compete in this rapidly growing market. Coincidentally or not, other companies such as Dell, Blackberry/RIM and HP saw their fortunes decline during the same time they aggressively offshored major parts of their value chain.

From a strategic perspective, manufacturing a product can trigger new ideas that lead to improved operational efficiencies and product innovation, especially when there is close contact between users and designers at the production level. Maintaining key operations also allows companies to retain vital research and development, support and manufacturing knowledge, which are key to producing next-generation products. These long-term spillover effects can explain why successful consumer technology companies such as Apple and Google limit outsourcing to manufacturing, and keep product design, branding and customer support in-house.

Outsourcing need not be a risky strategy. The following are three things leaders should consider in deciding which activities are performed internally and which can be left to others:

Focus on what’s important

Many of the managers we speak with do not know what makes their organizations tick. Leaders need to know the key capabilities (e.g., assets, brands, people, knowledge, and resources) that deliver their unique value proposition so they can safeguard them.

They also need to understand what new capabilities (e.g., digital competencies) are required to generate growth three to five years out.

Double down on the core

Continue or increase investment in your differentiating, core capabilities that drive your market position and return on assets. These areas would include innovation, brand building, customer service or employee training.

Take steps to in-source strategic activities (those that are needed for growth) from external vendors.

Optimize existing relationships

For the foreseeable future, outsourcing is here to stay. It is unrealistic for companies to do everything in-house. In other cases, it is essential to unwind outsourcing arrangements or build up internal capabilities.

For these ‘sticky’ deals, managers should review and optimize their existing relationships to: Insist on and enable providers to deliver continuous improvement in terms of innovation, service levels or cost savings; ensure the company has mechanisms to capture the same learnings in areas such as product manufacturability and process efficiencies as their outsourcer; consider a dual outsourcing and in-house strategy for some activities to maintain flexibility and knowledge accumulation.

For more information on our services and work, please visit the Quanta Consulting Inc. web site.

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Offshoring’s burn victims

RBC’s recent imbroglio over its Indian IT outsourcing practices illuminated the pitfalls of dealing with offshore providers.  Unfortunately, the Bank’s experience is not unique.  Contrary to conventional wisdom, IT offshoring has not been a boon for every North American firm pursuing that strategy.   Quality and service have struggled to meet stricter North American performance and service standards. Moreover, India’s labour cost advantage is declining for a variety of macro economic reasons. Finally, pervasive business and brand risks remain.  Leaders need to relook their existing offshore relationships to ensure they still make business sense and consider new compelling, ‘Made-in-Canada’ alternatives.

Offshoring IT operations have always been difficult and risky; the RBC/iGATE flap is merely the public tip of the iceberg.   Alex Rodov, CEO of a leading Canadian IT testing firm QA Consultants, has seen the damage of these arrangements first hand:  “Offshoring is no longer the bargain it once was.  It is not uncommon to see higher – not lower – costs, more hassles, delayed time to market and compromised quality.”

Our research uncovered the following example of an offshoring ‘burn victim:’

Financial Services project is “A Bridge Too Far”

A leading financial services company was looking to launch a major, new online offering.  The firm did not have the internal capabilities to build this platform themselves.  They chose to outsource the initiative to a large Indian IT services provider.  This is where the problems began. The Indian firm underpriced the project to get the deal.  They also took the client’s business and technical requirements ‘as is’ without vetting its feasibility.

Ultra low cost pricing is a common strategy for offshore providers to gain market share.  In this case, unfortunately, it did not leave them much margin room to validate the client requirements or assign enough experienced staff.  As a result, the provider missed gaps in the software architecture and did not fully understand the client’s needs and expectations.  Not surprisingly, each version of the delivered code did not meet quality expectations.  Furthermore, the cultural, time and language differences hampered alignment around expectations and trouble-shooting. The provider tried to redress the quality issues by throwing more staff at the problem – and then tried to get the client to pay for them.  Not only did this generate more friction in the relationship but it also failed to address the root cause of the problem namely misaligned goals, poor Indian staff quality and an unbridgeable cultural and linguistic divide.

This is not a case of a single deal gone bad but rather one example of the real difficulties commissioning knowledge-based work thousands of miles away.  This story did not end well.  The initiative had a target budget and delivery of $3.2 million and 7 months respectively.  It eventually was delivered in 22 months for a total cost exceeding $65 million.

Declining India…

Blaming one party or another is too simplistic.  Failure has many fathers.  Business conditions have fundamentally changed – and not in India’s favour.  For one thing, India is losing its luster as the lowest cost place to undertake IT activities. According to 2010 U.S. Bureau of Labour Statistics, India’s average per hour cost advantage has shrunk to only 6-7x U.S. rates (versus a 20x times advantage 10 years earlier).  Furthermore, the quality of the Indian workforce has never lived up to expectations.  The Wall Street Journal has reported that 75% of technical graduates are unemployable by their IT sector. Finally, bridging the relationship/cultural divide has proven to be more challenging and pervasive than anticipated.   In all its forms, distance really does matter.

…Emerging Canada

At the same time, Canadian IT service companies have become more competitive, taking advantage of moderating Canadian wage rates, a steadily increasing, educated (and stable) workforce and a growing sentiment that we need to cultivate strong local businesses. The emergence of globally competitive Canadian IT services firms is giving North American companies more choice, not to mention highlighting the value of good old fashion Canadian innovation and hard work.  To wit, QA Consultant’s roster of blue chip clients such as Loblaw, Bank of America, Praxair and Canadian Tire, demonstrates that leading North American firms recognize the business and reputational advantage of staying closer to home when outsourcing key processes.

Most likely, the optimal outsourcing strategy will include a mixture of local and offshore operations, with the ultimate decision based on an assessment of total delivered cost, the importance of local control and predictability and; a prudent evaluation of brand and intellectual property risk.  Managers should approach these decisions objectively and not be afraid to challenge conventional wisdom that lower cost and higher performance can only be found offshore.

For more information on our services and work, please visit the Quanta Consulting Inc. web site.

The perils of offshoring

For North American companies looking to stay competitive, outsourcing some or all of their back-office business operations to India has achieved the status of dogma. However, in the past couple of years poor outcomes, changing cost dynamics and continued cultural challenges have swung the value and performance advantage back to North American providers in many cases.

The times they are a-changin’

Firms migrated operations to India to save money, focus on their core competencies, and move way from a fixed cost structure.  Today, faith in offshoring must be tempered by reason.  In the last few years, India’s significant advantages have yielded to some harsh economic realities.   New cost dynamics and the reality of doing business halfway around the world with a very different culture have reduced the attraction of offshoring many operations, particularly those in knowledge intensive industries.

India’s fading appeal

Four key developments, unlikely to dim in the medium term, are contributing to offshoring’s declining appeal:

Shrinking wage differentials

India’s primary advantage, low labour costs, has been steadily declining.  According to the U.S. Bureau of Labor Statistics, India’s average per-hour cost advantage in 2010 had shrunk to only 6-7 times U.S. rates versus 11 times the rate in 2001. This shrinking differential traces to a combination of Indian wage inflation and North American wage moderation.   If present trends continue, this gap could shrink to five times the U.S. rate by 2014.

Pervasive cultural challenges

India remains a culturally challenging place to do business; a situation unlikely to change in the medium term.  The differences–language, cultural mores, business practices–generate high indirect costs by introducing complexity, miscommunication and risk.  Furthermore, persistently high labour turnover in all Indian firms complicates attempts to close this ‘cultural gap’.

Higher than expected administrative costs

When they began outsourcing, firms understood there would be transaction costs — travel, communication, compliance and relationship management.  What virtually every company has experienced are administrative costs typically three times higher than their estimates and all tracing back to geographic and cultural challenges.  In some cases, these costs can make up close to 20% of the total project cost.

Increased business risk

Today, effective risk management (e.g., protecting intellectual property and sensitive data, business continuity) is a strategic prerequisite for many companies.  Lingering doubts remain that sensitive data and intellectual property sent over to India (or any other emerging economy) is as secure as it would be in North America.  Not surprisingly, some government regulations continue to prevent certain types of IP and sensitive data from leaving North America.  Furthermore, India remains in the center of one of the world’s most dangerous regions, with instability on all of her borders and inside to boot.

Case in point: IT services

IT services provide a good illustration of the challenges of offshoring. For the past 10 years, CIOs and professional services firms have enthusiastically offshored to India large swathes of their IT work in order to reap the advantages of lower wages and round-the-clock development.

In many cases, however, the promise has not kept up with reality.  India no longer possesses the same IT cost advantage versus innovative Canadian firms.  Alex Rodov, managing partner of North America’s largest dedicated software testing firm, QA Consultants, contends that “Canadian IT labour rates on average are no more than 20% higher than India’s.  After you factor in the high administrative costs, lack of visibility and hassle of doing business around the world, then our delivered costs are roughly equivalent.”  Secondly, India’s workers continue to suffer from poor productivity.  Despite working in modern facilities, most Indian IT workers (including recent grads) lack basic technical skills and rudimentary English language proficiency.  In fact, the Wall Street Journal has reported that 75% of India’s technical graduates are unemployable by their IT sector.

Finally, the integrated structure favoured by most Indian software enterprises — firms develop and test their own code — poses real quality and delivery risks. “This [model] often leads to poor outcomes.  Testing should never be done by the same firm and people writing the code,” says Rodov, “as they lack objectivity and independence.  Furthermore, when a project runs late or is over-budget, the same Indian firm will prioritize development, often cutting corners with vital testing operations.”

For many business operations the pendulum is beginning to swing back to North America. Many companies have done the math and now realize that some local providers can deliver better value and lower risk versus an offshore Indian solution. A forthcoming article looks will look at how innovative North American firms are beating the offshorers at their own game.

For more information on our services and work, please visit the Quanta Consulting Inc. web site.