Also, the assumption that all the onshore work will be done by newly hired internal employees may not be the right one to make; customers almost always leverage contractors and existing employees. For the former, use the relevant contractor rates that are likely to get negotiated and the appropriate loading factor (you don't pay pensions, holiday allowances, and so on to them). For the latter, consider if they can be treated differently: it could be a sunk cost for a period of time or a partially apportioned cost.
Finally, internal employee costs are excessively padded by something called "an overloading factor" to account for pensions, holidays, desk space, corporate overheads, and other factors. A figure of anywhere between 20 percent and 50 percent is normally used here -- choose the figure that reflects reality, and take into account that you can't recover any of those costs anyway.
The straightforward costs are fairly easy to see -- costs related to personnel, communications, IT infrastructure, and tools and licences -- although sometimes the uplift required for converting single-site to multi-site licences can be hidden.
Many cost elements are not obvious. In their article Hidden Costs Impact Value in Outsourcing, authors Whitfield and Joslin state that potential outsourcers in all industries commonly assume that outsourcing can be plug and play, that the company will only have to absorb limited up-front costs before large savings can be realized, and that offshoring for labour arbitrage will ensure more than 60 percent cost savings.
In reality, 10 percent to 15 percent savings are more realistic for highly commoditized service areas, and 40 percent to 50 percent savings can be achieved only in optimal circumstances.
Travel of a customer's onshore staff first comes to mind as a hidden expense: a leading European software provider indicated that it takes 40 trips per annum to manage its offshore product testing program.
Equaterra, an outsourcing consultancy , points out a couple of interesting examples of hidden costs. One is the hidden cost of work retained onshore, internally. One retailer had outsourced the work of 1,100 employees, but held onto 50 percent of the work for 200 of those employees. As a result, the company overstated its business case by $24M (£15M).
Another overlooked expenditure is the hidden cost of internal, transitional headcount. Companies usually don't account for the costs of employees who help in the transition. For example, one pharmaceutical company kept about 20 percent of its staff for six months after the go-live date, which added $1.5M (£950,000) in cost. Over ambitious headcount estimates can cut projected savings by between 10 percent and 20 percent.
Other examples of hidden costs are set-up (initial knowledge transfer, training, retraining, for example) and managing the offshore outsourcing engagement (governance system, additional personnel, management time). A McKinsey study suggests a figure of 10 percent for additional transactional costs and 10 percent for additional monitoring costs, though particular cost elements were not specified.
A recent white paper by a leading offshore outsourcer in collaboration with a top-tier industry analyst reported that their return-on-outsourcing model takes into account benefits from cost savings, efficiency gains, and revenue improvement. But the bulk of the benefit actually comes from revenue improvement rather than tangible cost savings.
Assumptions on revenue impact are open to theoretical debate and as a result are seldom evidenced in financial statements. It's not that there is no revenue impact for offshore outsourcing, but customers should make the distinction between what benefits will actually hit the books versus benefits that are more theoretical in nature.
Statistics can prove just about anything. You need to exercise diligence and your own prudent judgment in the quantification process, otherwise you will end up building unrealistic, unseen, and unfeasible expectations of business value from offshore outsourcing.
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