It is a trickle that has become a flood – from the early days of Y2K when global companies hesitantly started outsourcing their non-core work to offshore locations such as India, the concept of outsourcing has come full circle, and has now rapidly moved to a stage where organizations are even outsourcing core services such as R&D. While initially, the focus was only on cost, the sustained focus on quality has meant that the growth of outsourcing has continued unabated.

However, as history has shown us, not every global organization has managed to achieve the full potential of an outsourcing initiative despite the obvious advantages of cost, quality, and resource flexibility. The most typical mistake made by organizations is to base their assumptions on labor arbitrage alone. For example, a wage difference of say, 50%, will not directly translate into cost savings of 50% as there are other cost elements involved. In reality, the total cost savings of an outsourcing engagement will differ based on the staffing costs, costs related to infrastructure and related support costs, governance and program management costs, and transition related costs.

Hence, to take advantage of the full potential of an outsourcing initiative, organizations must look beyond the temptation of short term staff augmentation and project-based approaches, and look at forming a strategic and long term relationship.

A proven and time tested model adopted by organizations who venture first into the world of outsourcing is the staff augmentation based approach. Here, the client typically pays for the resources on a T&M (Time and Material) model. Once the organization is confident of the technical capability of the vendor staff, it scales up the quantum of work by increasing the number of resources. However, even as this arrangement gives organizations the flexibility to ramp up resources, it still leaves a lot to be desired.

Further, as the customer and vendor relationship is directly based on the man-hours of work, the vendor has no incentive to be motivated to contribute towards techniques or methodologies that can improve the efficiencies.

Project-based approaches for the generic projects are faced with other challenges. A typical fixed-price project execution starts optimizing delivered functionality (granular, holistic functionality) whenever the interaction effort between onsite and offshore locations becomes complex and starts costing more than budgeted. As a result, the efficiency levels and the utilization ratios are far below expectations and while, contractual functionality gets delivered, the holistic delivery leaves a lot to be desired. This is because individual projects require high levels of project management, and the learnings from challenging situations do not necessarily get captured.

An offshore development center or ODC is a dedicated development center located in locations such as India, for carrying out software development, testing or related support and maintenance activities. Organizations can choose from setting up an ODC on their own, or give the mandate to setup an ODC to an experienced offshore service provider. The latter model is far more beneficial as offshore providers share infrastructure components among many clients – and hence the total cost incurred per client comes down drastically.

In a project-based model, a new team is formed for every project. Hence, knowledge retention and the benefits of reusability cannot be availed. This issue is effectively tackled by the ODC model, where the responsibility of staffing and quality is on the vendor. As the vendor has an incentive to improve productivity on a year to year basis, it deploys the best frameworks and methodologies to achieve the best possible efficiencies. To further the productivity gains, vendor also starts focusing on the interface points with the client organization, propagating best practices onto these interface points. This results in the standardized processes percolating through to the client side of organization, a desirable value-add from outsourcing perspective.

Additionally, once a basic foundation for an ODC is established, the model is flexible and easily scalable. This can enable a quicker launch of new projects for a particular client, as processes are standardized and customized, and past knowledge is captured for reuse. For example, a database of known errors for say, an SAP application in North America, can be used in another project of the same nature in say, Europe. This enables faster resolution, and allows maximization of savings.

Moreover, experienced service providers have the benefit of working with hundreds of clients, which helps them in fine tuning the technical, functional, and governance skills required in managing an ODC.

Service providers also bring to the table specially developed tools and methodologies, that can enable an organization to quickly set up an ODC. With fine-tuned processes and proven experience in establishing ODCs, offshore service providers can enable organizations quickly establish their ODCs. Additionally, service providers completely understand the different cost components and time required for setting up a development center. They also better understand the local dynamics involved in the hiring process, and the complexities involved in the legal and administration areas. Offshore service providers are also well versed in the planning and execution effort required for setting up the infrastructure and choosing appropriate locations.

As many global organizations are relatively less experienced in running a captive center and are first-time outsourcers, the results of setting up a captive center can often be disastrous. The challenges of running a captive center efficiently by global organizations was highlighted in a Forrester Research study last year, which said that more than 60% of captive centers were struggling with escalating attrition and costs. Captive centers are driven mostly as a cost center and not as a profit center with robust transfer pricing set-up. Due to the expense focus, captive centers often do not have adequate incentives either to expand their footprint across the parent organization or keeping costs under tight control. Additionally, keeping rare-skill staff on the rolls is a bigger challenge for captive centers due to the small numbers. Loss of one such staff member can be a large loss to the entire team.

Experienced service providers can tackle these issues effectively; foremost factor being that they service large number of customers and attrition is planned for in a more meaningful manner since the impact is directly on bottomline. They also tend to leverage earlier learnings passing some of the cost benefit to the client and retaining the balance to boost bottomline. The end result is that the start-up costs are kept under control resulting in better stability, quality and profitability.

Most offshore service providers have a distributed presence across many locations – which can help organizations to quickly set up ODCs for leveraging large talent pools with round-the-clock delivery capability. Additionally, service providers usually have well documented and defined security policies in place, which are regularly audited by internal and external agencies.

To reap the full benefits of an offshore outsourcing initiative, it is imperative that organizations plan for a long term engagement in the form of an ODC. By adopting this approach, organizations can reduce the fixed costs over a long term period. For example, change management, transition, governance and project management costs will gradually keep reducing over a three-to-four year period. As the relationship matures and the service provider continues to introduce new techniques to boost productivity in an ODC, the costs of managing the ODC will go down - while efficiencies continue to go up.