Nearshoring: A Smart Alternative to Offshore
It is time for the financial services industry to switch from offshoring to nearshoring. The panacea of outsourcing to nations such as India and China has proven illusory. Offshoring is laden with hidden management problems and subsequent costs that translate into headaches and sometimes nightmares for the customers of offshoring providers.
In fact, the oft-cited key benefit of offshoring-huge savings in labor costs-appears to be an elusive reward. An outsourcing consultancy in Portland, Ore., Ventoro polled 5,231 North American and European executives at firms that use offshoring services and found "the average cost savings to be slightly below 10 percent" for the use of less expensive overseas labor. The Ventoro report from 2005 also discovered that 28 percent of the offshoring engagements actually led to increased costs and 25 percent of them "did not generate any material savings." The best-case scenarios did not appear to live up to the dramatic expectations of offshoring either.
"If we remove all those engagements deemed to be a failure by the polled executives, and those engagements that had
no prior baseline to compare cost savings, we calculate an average savings of 19 percent ... If you are anticipating an offshore outsourcing or offshoring savings of 50 percent or more, you are not being realistic," according to the Ventoro report. For financial services firms, in particular, a 2007 report on offshoring from the global financial services group of Deloitte & Touche USA found that 75 percent of the major firms have offshore operations. Yet half of all firms surveyed report only a 40 percent savings for each offshored business process. Even more troubling, "the range of savings is polarizing, and is now between 20 and 70 percent per business process," according to Deloitte's researchers.
In actuality, offshoring costs are on the rise. The U.S. General Accounting Office (GAO) reported in 2005 that firms were finding that start-up costs and the wages of workers in developing countries were going up, all of which undercuts the cost-savings rationale behind offshoring. "Furthermore, offshoring carries potential risks, such as possible political instability in overseas locations, less reliable civil infrastructure, exchange rate volatility, less developed legal and regulatory systems, and risks to intellectual property," according to the GAO report.
Researchers at Ventoro and elsewhere have found that long-distance offshoring does take its toll on the control of projects. The time difference-which was so glibly relegated to a non-issue-has come back to haunt many offshoring clients. User firms are finding that the time zone problem-a lag time of up to 12 hours or hours in some cases-can erode program management and communication.
The lag time ties into the main concerns of executives: quality control, intellectual property theft and fraud. Only one-third of those executives that have abandoned offshoring would seriously reconsider it even "if both security and quality issues could be satisfactorily mitigated," according to the Ventoro researchers.
So it's not surprising that many executives are having second thoughts about offshoring and are beginning to consider the virtues of nearshoring.
In contrast to offshoring, nearshoring offers virtual development teams that have the ability to collaborate with internal staff in the same or similar time zones. This means that easy fixes do not have to wait for an isolated team to take a day-and-a-half to turn around a solution. By eliminating the time difference problem, nearshoring providers can offer optimum time-to-market schedules for new projects and new products. From the point of view of the clients, working in the same time zone also leads to more satisfied and stable workforces-including those of the outsourcers.
In particular, using a nearshoring partner could mean the end of night shifts for offshored developers, and that's a good thing. The night shift is often the primary cause for offshored staff burnout-the demands of the graveyard shift compel them to find work elsewhere with better schedules. Conversely, nearshoring customers will not have the added worry that the quality of code and services will suffer because of bleary-eyed developers on the graveyard shift. The much more manageable time schedules will also mean that nearshoring clients will not have work days that start at 5 or 6 AM--a frequent requirement for U.S.-based companies tied to far-flung offshoring providers.
Aside from the problems caused by the time difference, the geographical advantages of nearshoring can allow a company's internal staff and external developers to meet in person. The great distances between offshoring providers and their clients make frequent trips rare and expensive. Thus there is very little face-time between project managers and offshored staff, which often results in misunderstandings about the direction a project is taking.
In some extreme cases, offshoring customers decide to cut corners by not having face-to-face meetings, which is a perilous course, according to Ventoro. "We often find companies attempt to improve their offshore strategy cost model by opting not to make the international trips. We believe this approach to be a false economy and found most that take this approach will not succeed," the researchers say.
Studies-and common sense-bear out the truth that face-to-face meetings with nearshored staff help mitigate unexpected management costs that are directly related to project confusion and unhappy surprises in the eleventh hour. While more face time may not guarantee perfection, working closely with nearshored staff is likely to avoid less-than-desirable results and setbacks such as fixing or rewriting code entirely, revamping business processes or the worst outcome-taking projects back inhouse, which defeats the very premise of offshoring. Ventoro reports that more than one-third of the executives polled had to take offshoring projects in house because of performance problems.
If the project management costs and time lag concerns aren't enough, the turnover rate among developers working for Indian and Chinese offshoring companies is high and getting worse especially when salaries are on the rise, reports Ventoro. The high turnover rate is a sign that the competition among offshoring providers for good developers is heating up and is driving up the rates that the offshoring providers will charge.
The Deloitte report also cites concerns about the future of the pool of skilled workers in India. "Only 10 to 15 percent of Indian college graduates are considered suitable for direct employment in the offshoring industry. This may result in a shortfall of up to half a million professionals by 2010," according to the report.
Offshoring clients should also be concerned that the high turnover rate could put their projects in jeopardy as well as put a strain on the quality of the software and services that are delivered. Project continuity and follow-up are also threatened if there's a revolving door of offshored staff.
Thus, nearshoring promises the operational efficiencies of an on-site staff combined with the cost-savings of outsourcing. So, where should U.S. firms look to if they are considering the nearshoring option? One frequently overlooked destination is Mexico.
As far back as 2003, analysts at Forrester Research noticed that Mexico was a rising star among the destination spots for nearshore providers. In large part, this is because of the cost and quality benefits of the Mexican labor force as well as the aforementioned time zone and geographical advantages for American businesses. Some of the distinctive qualities of the Mexican nearshoring work force are its loyalty and high level of IT training and expertise. For ex., since the mid-1990s the Instituto de Estudios Superiores de Tamaulipasce in Tampico, Mexico has been on the cutting edge of OO technology, particularly Java-based programming.
While citing Mexico's strength as a nearshoring destination for call centers and accounts payable departments, the consultancy Business Insights predicted in its report, "The Offshore and Nearshore Outsourcing Outlook: Key Locations, Outsourcing Models and the Leading Players," that "Mexican nearshore outsourcing will undergo substantial growth through 2008 ... With an abundance of English-speaking agents, it is also a competitive alternative to Canada as a nearshore destination from which to serve US English-speakers."
The nearshoring companies in Mexico also maintain higher levels of data and intellectual property security when compared to the destination countries for offshoring, say Forrester's analysts. The support of the Mexican government as well as the country's sturdy infrastructure is also seen as very attractive to potential nearshoring clients.
Offshoring's days are numbered, so it should come as no surprise that household names have set up shop south of the border, nearer than any would have imagined when offshoring began in the 1980s. Look for those numbers to grow exponentially as more companies learn of the nearshoring option.
Sam Cinquegrani is CEO and founder of ObjectWave, a software engineering company based in Chicago.