Tuesday, February 11, 2014
Offshoring: Challenges and Solutions
The articles “Time to rethinking offshoring?” and “Rethinking the model for offshoring services” from McKinsey were very interesting in pointing out the challenges emerging in the outsourcing and offshoring industry. Right from application development to accounting to payroll, the industry has been addressing a range of business processes and technology services. As the IT services and BPO industry matures, however, challenges are emerging.
According to McKinsey more that 70 percent of offshore delivery centers, including both wholly owned captive operations as well as vendors, narrow their global operations to just three locations, often situated in only two countries (most frequently India, China or the Philippines). This reliance on a limited number of geographic regions—historically driven by the availability of highly skilled, low-cost labour in these areas—is exposing providers to a variety of location-specific risks. These include abrupt currency and wage fluctuations, intense competition for employees, and regulatory limits. The data shows that when a delivery center in a large Indian city grows beyond 3,000 employees, costs spiral and performance begins to deteriorate.
Oil prices, the cost of shipping, have skyrocketed. Since 2003, crude oil has soared from $28 to more than $100 a barrel. The economics research institution CIBC World Markets estimates that in 2000, when oil prices were near $20 a barrel, the costs embedded in shipping were equivalent to a 3 percent tariff on imports. Today, that figure is 11 percent—meaning that the cost of shipping a standard 40-foot container has tripled since 2000.
Offshore delivery centers can accomplish this goal by diversifying their operations in two ways: on a macrolevel, by expanding their global footprints to reduce overconcentration in any one region; and on a microlevel, by broadening the range and scale of activities conducted in any one center. The result is a network approach to offshore delivery management that features centralized global delivery hubs and decentralized local or specialized service spokes.
The following composite example illustrates how one company, based in Paris, used this strategy to its advantage (above). The company was looking to offshore 2,000 specialized, high-end IT jobs and initially planned on sourcing the entire project in India. It opted for an alternative scenario, however, after running the numbers as part of its due diligence. With a view to minimizing its exposure to geographic, currency, and labor issues, the company tiered the work across several locations, placing roughly two-thirds of the project in India and splitting the remaining third across three other regions. It kept 100 jobs in Lille, France, and nearshored 300 more in low-cost Romania, because of the proximity of these locations to European markets. A further 300 were placed in Egypt, where government programs have substantially broadened the talent base. The company then housed the remaining 1,300 roles in Bangalore. By diversifying in this way, the company significantly lowered its overall portfolio risk while incurring only marginally higher costs than it would have under the all-India approach.
Companies must search for new locations and set up new centers proactively, before the performance of existing centers deteriorates. As per a research when centers in Hyderabad and Bangalore grew to around 2,000 to 3,500 seats, for instance, their cost performance began to deteriorate. To counter this, companies should assess their own performance profiles and scout new locations before their existing centers grow too large. As below diagram shows, having multiple locations versus one or two megacenters not only maintains the right cost–performance balance, but also helps to foster network effects.
Thus, by using a diversified approach, companies can mitigate risks and reduce the challenges they face. As the industry matures, so too must its service model. To sustain future growth, providers need to create a network of offshore centers to diversify their risk and provide greater management flexibility.
Question: What will be the implications on cost-structure by having the back-end operations within US in areas with cheaper labour? Should they also focus on increasing the development centers at Mexico?