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The Politics of Outsourcing

Information Week – by Diane Rezendes Khirallah

Imagine being a business-technology manager charged with developing a network, and you have two bids from outsourcers: one for $1.5million and one for $85,000. Would you take a chance on the low bidder? And if the bargain-basement price came from a relatively new company based in Russia, would you still be interested in the less-expensive option?

That was the question Fubu faced more than a decade ago. At the urging of partner Samsung Electronics Co. Ltd., the specialty clothing maker decided to go with a fledgling Russian company called EPAM Systems LLC, which has offices in Princeton, N.J., but does most of its work in Moscow and Minsk, Belarus.

Fubu took a chance, and the work was "executed beautifully," managing partner Norman Weisfeld says. "We became a $400 million company using this system," with a network that supports 250 users. Since it was built, EPAM has provided a variety of applications. Everything except Fubu's general ledger is developed and maintained by EPAM in Minsk.

The fact that the majority of EPAM's employees live and work in Russia wasn't a major factor in the decision to select the company for the outsourcing deal, Weisfeld says. But he has been impressed with the quality of the work and the loyalty of the IT workers there. "Nobody can dispute the quality of the work in Russia," he says. "We haven't had two days' downtime in two years - and you can't beat the cost."

Like Fubu, business-technology managers thinking about outsourcing need a nup-to-date world atlas. A host of new companies - and countries - are trying to grab a piece of the U.S. IT outsourcing business, and picking the right partner has never been more complicated. Terrorism, religious strife, changing governments, the threat of nuclear war, and failing national economies all are issues that need to be considered when weighing whether to outsource overseas.

Many of these issues weren't even on the radar screen a year ago, much less major factors in outsourcing decisions. But in the past year, the world has seen the terrorist attacks of Sept. 11, the threat of nuclear war between India and Pakistan, continued violence in the Mideast, economic problems in South America, and many other developments that could affect outsourced IT work in other countries.

Business-technology managers are paying closer attention to world events as overseas outsourcing companies - still relatively minor players in the outsourcing market - compete for a larger share of the pie. The Aberdeen Group estimates that offshore outsourcing represents about 2% of the $400 billion market for global IT services. But most of the growth is taking place overseas. Most overseas outsourcing vendors report annual growth rates of 30% to 40%, while U.S. IT services firms struggle to meet last year's numbers. Aberdeen says that while 37% of the businesses it surveyed recently say they use more than one outsourcer, only 14% say they outsource to more than one country.

The trend of outsourcing to many places around the world is immature, but it's growing, Aberdeen analyst Stephen Lane says. "There are certain skills in certain places and differing rates - that's what it's about at the end of the day," he says. When shopping for vendors, he cautions businesses to concentrate on what's important. "Companies focus on the country first and the supplier second," he says. "But countries don't deliver services, suppliers do."

India is the clear leader, but its role is still small. All of India's IT work combined came to about $7.7 billion for 2001. In contrast, IT services firm Accenture billed $11 billion for the same period.

India's position as an IT outsourcing leader faced a big threat earlier this year when the border dispute between India and Pakistan grew heated and the specter of war between the two nuclear powers became a real possibility. India has sometimes jokingly been described as the back office for many of America's prominent businesses because of its many outsourcing companies. So the threat of war concerned many U.S. businesses that increasingly rely on Indian workers to develop applications, answer help-desk calls, and provide other types of IT services. War, or at least a serious threat that service could be disrupted, would have provided an opening to fledgling firms in other regions and countries emerging on the horizon of outsourcing – Eastern Europe, Russia and China are among them – that hope to duplicate India's success.

Indian firms were quick to reassure U.S. clients that there was no cause for alarm. Many pointed out that their development sites in Bangalore and Chennai were well out of range of a potential nuclear strike by Pakistan. Fortunately, tensions eased and the threat of war faded.

Northwestern Mutual was one of the businesses worried about the possibility of war. "Of course there was concern," says Phil Zwieg, VP of IS at the nation's leading provider of individual insurance policies. "But that's all in the past."

Northwestern uses Indian outsourcing firm Infosys Technologies Ltd. for a variety of tasks. At the time, Zwieg was in constant communications with executives at Infosys about backup, preparedness, and the political situation. Zwieg was assured that there would be no interruption of service, and it turned out those assurances were correct. Now, business is back to normal, and Zwieg says he isn't considering going elsewhere.

That's good news for Indian companies, which have attained a leadership position in offshore outsourcing based on a reputation for high quality, lowcost, and meeting deadlines.

Indian developers are highly meticulous in their documentation, release planning, and metrics, says Stephanie Moore, a Giga Information Group analyst. "Nobody tests better than the Indians," she says. And the legacy of British colonialism means widespread fluency in English and a rigorous Western-style education.

Another factor: U.S. outsourcing companies simply can't compete with the rates charged by Indian outsourcers, which average $22 to $35 an hour.

For many businesses, outsourcing overseas is a step-by-step process. Business-technology managers often test the waters with a small assignment or project. If that works out well, more work is sent overseas.

That's the way it worked at TV ratings company Nielsen Media Research. CIO Kim Ross first hired Cognizant Technology Solutions Corp. in 1995 to supplement his own staff with an offshore team. That approach provided the easiest entry and the most control, Ross says. Over time, Nielsen added projects - first maintenance and, eventually, new development - that gave Cognizant more project control. Now, Cognizant is "sort of an extension of our own organization," he says. "We'll look at a project that's more stable in its life cycle, or even a new project, and ask, 'Is this something Cognizant could do?'"

That comfort level took awhile to achieve, Ross says. But now, "we can know the fixed price of the whole life cycle." Nielsen negotiates a fixed price for the first phase of development and only then negotiates the next phase of staffing and maintenance. Today, the level of comfort with Cognizantis such that Nielsen outsources some of its most innovative projects that embrace the newest technologies.

For example, a project to manage data collection for all 13,000 U.S. local cable systems is being developed. For each system, Nielsen needs to know what ZIP codes are being served, what network is showing on which channel number, and other service information. "It's a huge data-management task," Ross says. Nielsen wants to store the information in a relational database that a Web browser can access. Like other projects Nielsen hands off to Cognizant, Nielsen creates the requirements, retains a supervisory role, and does quality assurance itself. But Cognizant takes on the bulk of the project, and Ross expects Nielsen will save 30% to 40% over doing it in-house.

When considering an overseas service provider, Ross' advice is to be cautious but not afraid. CIOs should "focus specifically on why this company would know your business well enough to serve you," he says.

But it doesn't have to be an all-or-nothing proposition, either. "There are good ways to sneak up on it," Ross says. "You can enter by mixing your staff and offshore staff on a project or by starting with a stable, well-run application." Once that's proven successful, consideration can be given to additional or more intensive projects.

Not every CIO is eager to embrace the idea. Jane Landon, VP and CIO at Prudential Insurance Co. of America, describes herself as a reluctant convert. Landon got into offshore outsourcing because she was given a project that had to be completed in seven months, and she faced penalties if it wasn't done on time. It also would have put her in front of the chairman of the board to explain the missed deadline. So she put six key staffers on the project and outsourced the rest. The results were good, and now offshore outsourcing is a regular part of her IT operations.

With the volatility in the financial-services industry, outsourcing is especially crucial now, she says. "I can take my offshore people down to zero on two weeks' notice," she says. "But I couldn't do that in the U.S." Another benefit: She expects a 55% savings as the company moves forward with other offshore projects.

Cost savings are one of the main reasons that businesses use offshore outsourcers. The Aberdeen Group says overseas labor rates can save a customer up to 65%, compared with using a U.S. company. But once project-management costs and other overhead are factored in, the savings typically amount to 45%.

As offshore outsourcing gains credibility, Landon and other business-technology managers may soon have more choices. While India has already made a name for itself as the gold standard in call centers, help desks, and application and network maintenance, Russian companies, whose IT pros enjoy an excellent reputation in math and engineering, want to do application development. There's a large talent pool of Russian engineers available to the commercial sector, more than 1 million, according to an estimate from the World Bank.

Luxoft, a Russian software development and outsourcing firm, saw a slowdown in business in the months after Sept. 11, CEO Dmitry Loshinin says. Luxoft, a member of the IBS Group, a large Russian IT holding company, employs more than 2,000 IT professionals. Many potential customers revised their IT plans following the terrorist attacks, and their new IT strategies included outsourcing, Loshinin says. And then after the India-Pakistan standoff, they wanted to ensure stability. "Large companies want several vendors in several different countries," Loshinin says. "Russia is just beginning to appear on the radar of these companies. We spend a lot of time to convince them to work with Russian programmers."

This year, Luxoft's largest outsourcing customers have been financial-services companies. Much of the work is in developing mission-critical applications where security is paramount, although work in other areas is picking up, too. A typical project costs around $1 million and takes between six months and one year, Loshinin says. "Ninety-five percent of our clients repeat the business. It can develop into a large deal."

While India and Russia are among the more prominent countries for outsourcing, they're by no means alone. Name a country and if it doesn't have an IT workforce already, it's working toward it. Perhaps inspired by successes in India, entrepreneurs and governments in places such as El Salvador, Fiji, Ghana, and Jordan are exploring the idea.

That may work out well for businesses looking to reduce their political and financial risk by spreading their offshore outsourcing among multiple countriesand regions. Cummins Inc., a maker of electrical power generators and other equipment, last year hired Indian outsourcer Tata Consultancy Services for mainframe application support and has since added application development.

Cummins plans to expand into other regions such as the Philippines and Eastern Europe. But the big prize is China, says Rob Neitzke, director of offshore development, where Cummins has been working with manufacturing partners for some 30 years. During the next three to five years, Cummins plans to diversify its IT suppliers. Neitzke is encouraging Tata to develop relationships in China and to do work there so Cummins doesn't have to manage the work and the relationship itself. Already, Tata is opening development centers in China.

While Neitzke acknowledges that language and culture can be hurdles in China, he's not particularly concerned. "They can code as well as anyone else," he says. "Conversational English is a problem, but that's improving as new generations" come along. Neitzke cautions other business-technology managers to be careful about sending their offshore outsourcing work to too many countries. He says it's important to have enough IT workers in one place to handle unexpected problems, last-minute changes, or additional projects. "If you start dividing your work among many countries, you may not have enough people to have critical mass."