Outsourcing Evolution

Outsourcing is not necessarily a new way of doing trade. However, the recent globalization enabled U.S. companies to seek out new alternatives to fulfillment and as a result we have seen a recent redistribution of power.

In the beginning with what has been called “Outsourcing 1.0” large companies outsourced various tasks to countries where the cost of labor created efficiencies, such as India and China in the IT services space. The result was that companies moved business-process jobs, such as customer-service and human resource processing offshore.

Later, in the early 2000s, as the cost of labor in India and China began to rise, new territories were sought out. In what has been defined as IT “Outsourcing 2.0”, a new service set was established and referred to as Business Process Outsourcing (BPO). Not only large companies, but also SME’s were able to afford an outsourced model. New countries, such as Canada, Mexico, and others in Latin America and Eastern Europe appeared in the IT Services field. The selection became more difficult and the cost was not the main concern, IT companies began to analyze supply chains and outsourcing opportunities in more detail.

There are 3 key forces driving the shift to Outsourcing 2.0 :

1. Universal pain in all dimensions of outsourcing. Access to best practices and processes, peer networking and professional development. These problems of the marketplace have affected both large and small players alike.

2. Changes in who outsourcing and how it is done. Buyers need access to more specialized services, best practices information, case studies and tools to guide them to successful outsourcing contracts and relationships. Objective opinions are needed.

3. The evolution of Web 2.0 and the growing impact it´s having on communication, collaboration and knowledge sharing.

Thus, with its proximity to the USA and with potentially lower cost and time zone problems, Mexico can compete successfully against a country such as India, the market leader.

In the last months a new direction of outsourcing is accessing to the Information Technology Industry, Outsourcing 3.0. This is about Knowledge Process Outsourcing. This new era wants to make outsourcing sustainable. Global corporate bigwigs are beginning to eat entire departments of Companies, with the purpose of cover as much fields and presence as possible. Anyway, Outsourcing 2.0 stills predominating.

Failure to Recognize Time Zone Difference as a Challenge in Outsourcing

Every day people post articles about advantages or disadvantages of offshore software development. Companies seeking to outsource could go crazy sorting through the vast information, trying to figure out what is the best option for their business.

It seems even the biggest and best analysts fail to recognize some of the most important factors. A couple of days ago, one research piece called “The Shifting Geography of Offshoring” drew my attention, a study about the Top 50 countries worldwide as the best destinations for providing outsourcing activities, including IT services and support, contact centers, and back-office support.

This study ranked 1st India with 6.91 out of 10 followed by China, while Mexico was placed in the 11st position with 5.43 and Chile in the 8th place with 5.50. The 3 primary categories measured were: Financial Attractiveness, People skills and availability and business environment.


Yet, no where does the study mention the impact of time zone differences on outsourcing, particularly on productivity, which greatly affects total cost. India and China may be excellent outsourcing locations for large companies, but small and medium size companies should be working with teams in the same time zone.

Software development is difficult enough. Don’t make it more complicated by adding a new variable.

So how does India and China arrive 1st and 2nd respectively if time zone affects total cost, productivity and overall cost? When you outsource to an offshore location people needs to stay up late at night to complete the task, wake up early; or work double shifts, or additional management needs to be put in place on the client side, or additional visits are needed to the customer site or the vendor location; all these have a significant impact on productivity and cost.

Working behind schedule can trigger an unimaginable quantity of problems that in a short time may not be important and visible, but in the end will be a headache. When you are dealing with an overseas vendor, the time zone problem will surely arise - the difference between your Asian vendor and you may be twelve hours (and a half) or more. Just imagine that you arrive at the office at the same time when your vendor's employees are going to sleep.

Why are countries such as Chile or Mexico ranking under Asian countries if the nearshore model offers the same advantages as offshore, plus the alternative of having a developer of support team working in the same time zone. Time zone is a critical element in engagements where high collaboration is a must.

The Manpower Myth in the Software Industry

In the beginning, India’s attractiveness as an outsourcing destination was the cheap and vast manpower. Every year thousands of engineer graduate from Indian Universities creating an enormous talent pool.

However, in many cases, they have failed to produce world-class software products. Why? It´s true that many young people graduate with IT degrees in India, but the abundance of IT graduates doesn't guarantee quality work.

India’s booming software industry, which has maintained rapid growth over the last 15 years lacks well-trained and experienced resources which has a greater impact than some companies imagine.

A couple of years ago, for example, Google had some problems finding skilled development resources as many other American companies are also looking for the best software talent.

The company's Founder and Director Kavitark Ram Shriram admitted: “Google, which is considered to have a very low attrition rate even in the high-job-hopping Indian IT space, has found it more challenging to hire certain talent in India as compared to other parts of the world”.

Apple in April of 2006 commenced operations in India, but one month later they ceased activities. Some of the reasons were: India isn't as inexpensive as it used to be, the turnover is high, and the competition for good people is strong. In the end, Apple felt it could do it more efficiently elsewhere.

Today, a large company which wants to recruit people has to have in-house training facilities and extensive training programs. These training programs are expensive and sometimes companies use their experienced manpower for training. That implies a higher cost (expensive airplanes tickets, the long distance, the host, etc.) The trainer can be in more “productive” activities like projects and R&D, instead of teaching.

Perhaps American companies will seek software development outsourcing partners closer to home, such as Canada or Mexico to avoid the headaches of Asian offshoring. At least the training can be much easier and the cost is lower because of the close geographical proximity.

Total Cost of Engagement (TCE)

Undoubtedly, offshore outsourcing has reached a mature level. Countries as India and China have built huge IT hubs, and invested in education for young people to facilitate the acquisition of human resources to meet the growing demand.

The boom of offshoring has been primarily driven by the belief that lower wages decreases the expenditures of the companies. What have frequently been misunderstood have been the hidden costs.

Recent studies have found that despite the low rates per hour that countries like India or China are able to provide, the Total Cost of Engagement (TCE) is higher than outsourcing the same service to a nearshore location. If you compare the cost of labor in India vs. Mexico for example, you will find India is about 10-15% cheaper.

The total cost of engagement (TCE) evaluates the total expenditures of outsourcing projects. In addition to the hourly rates of engineering talent you must consider the cost of additional management overhead, travel costs, the painful cost of staff turnover, and a certain amount of productivity loss due to the distance and degraded communications. Most of these costs are directly related to the separation in time and distance between teams. Below is a detailed explanation of why in the end offshoring typically is more expensive than nearshoring.

1. There is still an important amount of work that needs to be done at the client´s site. No amount of technology can make up for the productivity achieved face to face. Typical offsite leverage for Asian vendors range between 60 -65%, which means 40-35% of the work remains at the client´s site. The percentage of work that can be done offsite when working with a nearshore provider fluctuates around 80%.

2. Overhead. Due to the addition of inexperienced resources halfway around the world and the poor communication that typically occurs, additional resources from the client side are needed to manage the relationship and the work. This creates additional overhead for the client.

3. Proximity. The long distance between the client and the offshore team, make more expensive and difficult the travels between the 2 destinations. Nowadays, close proximity is a key success factor in IT engagements. Close proximity offers an improved cost management, particularly when travel is required, and allows for better supervision and control.

4. Time zone difference. This can be a huge barrier because offshore and onsite teams need to accommodate schedules for call meetings, releases, etc. causing an overtime payment. Sharing requirements documents and communicating entirely by email greatly reduces the likelihood of getting the desired results.

5. Offshore training. Offshore resources need to be trained by onshore teams, so flight tickets, visas, accommodation, etc. become more expensive the offshore model.

6. High attrition. After all the training and learning curve is overcome a the expense of the client, developers return to the development center in India or China and, recognizing their new found skills and value in the marketplace, they seek higher paying jobs, causing a disruption in the project as new, inexperienced resources are added to the team.

As the result of the total sum of these costs plus the man/hour rates is the Total Cost of Engagement (TCE), which certainly is pretty much higher in India or China than Mexico or other LA Countries.

A good calculator for comparing the cost of development between in-house, and nearshore and offshore teams can be found here.

Engagement model calculator

More information supporting nearshore outsourcing can be found here.

Mexico nearshore

Nearshore vs. Offshore Total Cost of Engagement

GSC LOCATION SELECTION APPROACH