Assssig th cost of Outsourcig: Efficicy, Effctivss ad Risk Todd Littl Ladark Graphics tlittl@lgc.co Abstract Offshor outsourcig is a popular approach for copais lookig to rduc softwar dvlopt costs. W hav foud that th full pictur of cost ad valu rquirs lookig at fficicy, ffctivss, ad risk. 1. Itroductio O of th challgig issus with outsourcig is dtriig how to asur succss. Ladark Graphics has b ivolvd i offshor dvlopt for 5 yars ad has wrstld with this issu for so ti. W hav co to th ralizatio that th full pictur of cost ad valu rquirs lookig at fficicy, ffctivss, ad risk. particularly wh lookig to offshor providrs, is dtriig which projcts to outsourc ad how to balac a ovrall projct portfolio. 2. Efficicy At first w wr focusd o th pur cooics of th dvlopt costs, i.. fficicy. Th sigly low costs for offshor dvlopt ad it look attractiv as a as to rduc costs. Tabl 1 idicats our xpric with th rlativ cost for a dvlopr for svral coutris. TABLE 1 Coutry Approx Cost rlativ to US US 1.00 Caada 0.85 Idia 0.40 Pakista 0.25 Lookig just at th rlativ costs, it is coo for th dia to spout out figurs such as outsourcig ca rduc dvlopt costs by 75%. Most aalyst groups such as Gartr or Forrstr ar far or ralistic ad a or coo figur quotd is that outsourcig could rduc dvlopt costs to 75%. Likwis, w ralizd that cost pr dvlopr was a rlativly aiglss tric o its ow. What is rally of itrst is th cost to dlivr th projct. Two additioal paratrs ifluc th projct cost: th fficicy of th dvloprs ad th itral aagt ovrhad rquird for th projct. Usig ths thr variabls w stablishd a first ordr idicatio of th outsourcig savigs (s appdix for a or dtaild drivatio). c + Savigs% = 1 Whr = OUTSOURCE fficicy = Equivalt INTERNAL days pr OUTSOURCE day = INTERNAL Maagt ovrhad = INTERNAL days to gt 1 OUTSOURCE day c = OUTSOURCE rlativ cost = cost pr OUTSOURCE day / Cost pr INTERNAL day As a forward lookig tric, this ratio has sigificat ucrtaity. W v s fficicy () rag fro 0.10 to as high as 1.0, but th fficicy ca oly rally b stiatd sic w do t rally kow how log this would hav tak had it b do itrally. To gt a aigful tric, it is iprativ that th fficicy () b asurd i a ar cosistt with th cost ratio (c). It is quit typical to copar cost ratios of xpricd itral dvloprs agaist quit juior outsourcd dvloprs. If that is how c is asurd th ust b asurd usig that sa copariso. It is also iportat that c b calculatd o a cosistt basis. If a ix of offshor ad oshor dvloprs is utilizd, th cost should b a fully burdd bldd rat ad th itral cost should b th icrtal cost of a dvlopr. I our xpric aagt ovrhad () tds to ru about 0.05 to 0.25. This aagt ovrhad should b cosidrd as th icrtal activity that would ot b rquird if th work wr to b do itrally. A high aagt ovrhad ca sigificatly rduc or wip out ay pottial savigs. O ight thik that or aagt ovrhad
would rsult i highr fficicy. What w hav foud is a bit of a ivrs highr fficicy allows a lowr aagt ovrhad. This happs bcaus wh th offshor ta is fuctioig fficitly thy do ot rquir uch aagt ovrsight. Agai, whil thr is ucrtaity i w hav foud that asurig for prior projcts is a usful idicator for futur projcts. I Tabl 2 w show a sall sapl of projcts fro so of our arly outsourcig projcts. Tabl 2 c Savig s Dvlopt 0.40 0.11 0.16 33% Tstig 0.27 0.04 0.18 16% Tstig 0.60 0.06 0.19 59% Tstig 0.60 0.05 0.19 60% Dvlopt 0.60 0.17 0.23 34% Dvlopt 0.64 0.17 0.23 38% Tstig 0.80 0.06 0.17 72% Dvlopt 0.56 0.13 0.30 23% Tstig 0.40 0.10 0.20 26% Tstig 0.60 0.06 0.21 55% Tstig 0.20 0.05 0.27-56% Avrag 33% 3. Effctivss Whil fficicy is lookig at th cost sid of th quatio, ffctivss is or focusd o th valu that th dvlopt dlivrs. Th valu is driv by th ability to dlivr th product with th faturs that ar dd at th ti that thy ar dd. W hav ot attptd to quatify a asur of ffctivss. Howvr, w hav idtifid svral drivrs that ca hav a ajor ipact o ovrall ffctivss ad valu gratio. 3.1 Projct Dlay A dlay or arly dlivry of th product could hav a sigificat ipact o th valu dlivrd. If th priary focus is o cost savigs, th thr is a vry ral possibility that th projct could hav dlays rsultig i a pottial valu loss which could b svral tis gratr tha ay cost savigs. O th othr had it is possibl that a wll fuctioig ad fficit outsourcr could produc rsults fastr tha could b dlivrd itrally. 3.2 Valu Cratio It is wll kow that th softwar faturs that provid axiu valu ar rarly wll kow at th bgiig of th projct. Faturs volv ovr th dvlopt cycl. Offshor dvlopt brigs two ajor challgs to th issu of scop chag aagt. First, th rot couicatio aks it or difficult to gt rapid ad tily fdback as chags ar idtifid. Th scod, prhaps or iportat issu, is that ofttis faturs ar discovrd via rich dialogu btw usrs of th syst ad th dvloprs. Th liitd couicatio chals availabl oft iss this opportuity ad th rsult is a dlivrd product with lss valu tha could hav b dvlopd itrally. 3.3 Valu Dlta du to Quality Poor quality is aothr as by which valu ca b rducd. So outsourcrs ar abl to hav vry high quality stadards ad as a rsult oft product rsults suprior to what is routily dvlopd itrally. 3.4 Valu Dlta du to Local Prsc So copais ar ralizig that thr is valu to b gaid fro havig a local prsc i a particular ara. This prsc ca srv to op up arkts which ar othrwis difficult to ptrat. Additioally, sotis local talt udrstads th local busiss ad as a rsult brigs valu by surfacig pottial opportuitis. O th othr had, thr is a pottial for valu loss if a outsourcr is idtifid as big fro a locatio which is viwd gativly by othr ajor arkts. 4.0 Risk Th savigs that ar obtaid by outsourcig ar ot fr of risk. Thr ar svral lts of risk that should b cosidrd ad th savigs asurd agaist th risk xposur. Risks could ipact ithr costs or thy could also ipact valu. Th t xposur is giv by th su of th probabilitis of ach risk ad th idividual xposur. Exposur = p E i i Th followig risks ar likly to b of cocr with a outsourcig projct, particularly with a offshor projct: 4.1 Tchical Risks Tchical risk is a asur of th fit btw th projct ad th skills ad capabilitis of th outsourcr.
It ca also b prst if thr is risk associatd with th ability of th custor to abl to dal with a outsourcr. To a crtai xtt th tchical risk is th priary drivr of th ucrtaity i th fficicy tiod arlir. So of th qustios to b askd iclud: Dos th outsourcig copay hav th tchical skills cssary to do th work? Dos th outsourcr udrstad th busiss doai? Ca th projct rquirts ad spcificatios b dfid to t th capabilitis of th outsourcr? Dos th outsourcig copay produc high quality rsults? 4.2 Political Risk May of today s outsourcrs ar i dvlopig atios. So of ths atios do ot hav th ost stabl of govrts. Ladark first startd workig with a Pakista outsourcr i 2000. Th trrorist attacks i Nw York had a hug ipact o our ability to cotiu busiss. Prior to that ti w had b abl to brig a ubr of popl fro Pakista to th US for traiig. For quit so ti aftr th attacks it was arly ipossibl to gt visas. Furthror, our copay placd a oratoriu o travl to Pakista du to trrorist attacks thr. Fortuatly w wr abl to gt th first group traid ad hav had rasoabl succss with this arragt, but it did liit th projcts ad activitis that w could outsourc. 4.3 Outsourcr Risk What is th cotigcy if th outsourcr gos out of busiss? Dos th outsourcr hav high ploy turovr? W hav had xpric with larg copais ad with sallr copais. Eploy turovr has b cosidrably highr at th largr copais. For our busiss this is a ajor cosidratio sic th larig ti is quit log. 4.5 Scurity ad Itllctual Proprty Risk Th cultur ad laws of ay outsourcig coutris as thy rlat to itllctual proprty ar quit diffrt fro that of wstr coutris. Ev wh th laws clai to hoor itllctual proprty thr ca b a ajor issu tryig to forc th laws. Host istaks ca also b ad by th outsourcr. Thr is a risk that th outsourcr will itroduc sothig ito th product which will xpos th copay to itllctual proprty challgs ad by a third party. Th rality is that thr is risk that itllctual proprty ca b coproisd ad a prudt copay will try to udrstad that risk. 5. Coclusio W hav had sufficit xpric with offshor outsourcig to kow that thr ar opportuitis for cost rductio. W hav had vry good luck with Caada whr w ar abl to sstially gt o-foro fficicy ad rap th cost bfit with alost o risk. W hav had varid succss with outsourcig to Idia ad Pakistai providrs. So projcts hav b gratly succssful whil othrs hav ot. Whil ach additioal projct tachs us sothig w, it is fair to say that th risk profil is ivrsly proportioal to th cost profil. Th challg is to fid thos projcts i our portfolio for which th cost savigs ar sufficit to ovrco th additioal risk xposur. Th odl i Figur 1 that Goffry Moor publishd i Dalig with Darwi is usful to charactriz projcts by thir product lifcycl. Thos projcts that ar ot particularly arkt diffrtiatig or issio critical ar ost aabl to outsourcig sic cost rductio is a dsird objctiv for thos projcts. 4.4 Fiacial Risk Ovr th log tr a global labor pool should rsult i a qualizatio of wags ad th cost diffrtial should largly disappar. Coutris such as Idia ar xpricig 15% aual salary iflatio. Currcy fluctuatios ca also hav a ipact o a global labor pool. I 2001 th Caadia dollar was about $0.60 USD. This ad Caada look lik a vry attractiv locatio. Today th Caadia dollar is about $0.85 USD so it has lost so if its cost advatag.
Figur 1 Ivt Dploy Markt Diffrtiatig Offload Maag Missio Critical A furthr tool for projct slctio is show i Figur 2 as a 4-quadrat graph showig probability of succss o th y-axis ad cost of failur o th x-axis. I gral w hav lookd to outsourc projcts that ar i th uppr lft quadrat whr w bliv that th probability of succss is high ad th cost of failur is low. Ths idas ar coo ss, but ot always coo practic. Figur 2 Outsourc Cosid Probability of Succss Cosid Avoid Riskd Cost of Failur
Appdix: Cost Savigs fro Outsourcig Noclatur: i Expctd Nubr of staff rquird if projct do Ihous c i Avrag burdd cost of Ihous staff f Nubr of Offshor staff rquird c f Avrag burdd cost of Offshor staff Nubr of Oshor Outsourc staff rquird c Avrag burdd cost of Oshor Outsourc staff Aout of Icrtal Maagt Ovrhad c Avrag burdd cost of Maagt Ovrhad Cost Savigs Savigs % = Cost Ihous Cost Savigs = Expctd Cost Ihous Cost Outsourc - Cost of Ovrhad Cost Outsourc = Cost Offshor + Cost Oshor Expctd Cost Ihous = i c i Cost Offshor = f c f Cost Oshor = c c Bldd Cost ratio = [f c f + (1-f) c ]/c i Outsourc Efficicy = i /( f + ) f Fractio of Outsourc staff Offshor = f /( f + ) Maagt Ovrhad factor = /( f + ) Cost of Ovrhad = c cii f Savigs% = f c i i c c + ci Savigs% = 1 if c c i, th c + Savigs% = 1