The offshore option is here to stay

As enterprises look for new ways to cut IT costs, there has been a great deal of speculation about the future of the offshore outsourcing business. Earlier this month, however, research firm McKinsey & Co. put that speculation to rest: the IT outsourcing market is alive and well and living overseas.

McKinsey, a company well known for its survey research, recently interviewed CIOs at many major companies about their attitudes toward outsourcing. The survey covered a great deal of ground, but one of the most interesting results was that although attitudes toward outsourcing in the U.S. have cooled, offshore outsourcing opportunities are heating up.

According to a summary of the survey research published in McKinsey Quarterly, about 21% of CIOs reported that they already have tried outsourcing IT projects to offshore outsourcers, particularly the well-known shops in India and China. Users of these services have saved an average of 50% to 70% over the cost of outsourcing the same projects in the U.S. Very few reported any problems with the work that was done or the service they received.

An additional 45% of CIOs are planning to use offshore IT outsourcing or are thinking about doing so, McKinsey reported. “We believe that by 2005, more than half of all Fortune 500 enterprises will have some experience with offshore providers, whose domestic competitors will thus increasingly be in the unenviable position of having to match offshore prices that don’t even cover all of their present labor costs,” the research firm said.

Of course, most U.S. enterprises will not do all of their outsourcing overseas – in situations where onsite work is required, U.S. outsourcing firms offer local resources that are difficult for an offshore company to cost-effectively match. Therefore, many U.S. enterprises will maintain a mix of domestic and offshore outsourcers, crossing the ocean for low-cost application development resources while keeping their onsite services at home.

According to McKinsey, however, the percentage of projects that can legitimately be done offshore is increasing. The research firm estimates that about 80% of custom applications development work – and about the same percentage of applications management work – can be done offshore. As much as half of the effort to install packaged software on desktops in the U.S. could viably be done by overseas outsourcers, the McKinsey report said.

Of course, U.S. outsourcing companies are not standing still for this emerging competition. U.S. outsourcers have lowered the cost of a typical systems integration project by 20% to 30% over the last 18 months, and that figure could drop even further, McKinsey said. But to stay competitive, many of those outsourcing firms will have to find lower labor costs for their services – perhaps by subcontracting with or acquiring their own offshore development teams.

What does all of this mean for U.S. enterprises? For one thing, the process of choosing an IT outsourcing partner for any given project is becoming significantly more complex. In addition to evaluating the costs and services offered by an outsourcer, enterprises will now have to consider whether some or all of the project might be done less expensively by an offshore provider. That sort of evaluation can become very complicated, especially when the enterprise must divide up the project between offshore and onshore outsourcers.

Even more importantly, the offshore outsourcing opportunity raises some questions about the relationship between the enterprise and its outsourcing providers. In the past, many large enterprises have aligned themselves with one or two major outsourcers in an effort to build a true partnership. Will the offshore opportunity lead to a “hired gun” mentality, in which outsourcers are contracted only on a per-project basis, without regard for past relationships?

Only time will tell. In the near term, however, the industry should get used to the offshore outsourcing alternative – the value proposition is too good for most enterprises to pass up.