As offshore wages rise, is offshoring still a no-brainer?

* Consider the high turnover and wage hikes at India outsourcing firms

I recently had several interesting discussions with middle and senior corporate IT managers about offshore resources. A couple of these companies had their own India-based staff and a couple of them were outsourcing to India-based resources. Three common themes emerged from these discussions.

First, was the growing problem of turnover of staff based in India. Second, several of the companies could not get a new IT resource requisition approved in the U.S.; they had to be offshore resources to get approved. It was just assumed this was the best alternative. Third, every one of these folks believes that some time in the next several years the labor rate arbitrage opportunities will have passed and offshoring will become less of a factor.

A recent report by the Everest Research Institute analyzed the rising wages in India with the following conclusion: The wage differences between the U.S. and key offshoring locations (re: India) are enough that offshoring will continue to offer enough savings to be viable for at least the next 20 years. This is far longer than the expectations of most of the people I have talked with.

A recent article in the East Bay Business Times titled "Higher costs, old woes erode offshoring savings" highlighted the changing landscape for India-based offshoring. This article makes the following points:

* Rising wages over the life span of a project shrink the initial savings estimates.

* More managers and other resources are required to do the same work in India because of distance and training.

* Smaller companies do not have the resources to effectively set up their own offshore operations and must rely on outsourcers.

* Turnover is a problem.

* Supply of technical people with sufficient skills has not kept up with demand.

* Quality can be more difficult to manage and correct long distance.

So at what price point do offshore wages become too high to make offshoring the seriously compelling decision it seems to be today for so many companies? I think the differences in Everest's 20 years, and those who see a shorter time horizon, root to looking past the hard dollar costs for resources.

Direct wage costs are not the only costs to personnel. When you consider the entire cycle of finding new resources, training them, dealing with the inevitable percentage of poor hiring choices, and dealing with turnover and all of the lost time and lost knowledge caused by turnover, you start to develop the whole picture. Then consider project management costs, which can be higher for offshore projects. Quality problems can be more prevalent and more difficult to resolve when teams are separated by an ocean and a 12-hour time difference, further increasing the total cost picture. I'm not sure the Everest study fully captured the indirect costs related to offshoring.

A real world example comes from a conversation with a middle manager in a Fortune 500 financial company. He told me, "I've got to work 24 hours a day. I work all day at my job and spend significant time on the phone at night with India." What is happening to his productivity as he has to deal with the time zone differences? He also said, "I spoon feed these Indian kids, teach them procedures and then they leave for more money...and you can't blame them. They are good workers, but they don't stay around very long." While he has gotten good results from the people he has worked with in India, turnover has been a significant drain on getting consistency out of the offshore team.

Offshoring can still make sense at current wage rates, but it certainly points out that wages do not have to approach U.S. levels before the value of offshoring declines. Eighty percent wage savings can mean only 30% total project savings when all things are considered. Offshoring is here to stay and will continue to be a significant part of IT work done globally. But as wage rates rise, it is no longer an obvious choice without proper analysis. Be sure to validate each decision after fully considering indirect costs and factoring in appropriate wage increases into longer term offshore projects.


Copyright © 2006 IDG Communications, Inc.

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