2008

How effective is
offshore
outsourcing and
what critical
factors should be
considered when
outsourcing
For: BE790.614.5D
Business, Government and the World Economy

Johns Hopkins University

Facilitator: Arefaine G. Yohannes
February 17, 2007

By Martye Karen Joyce

2/17/2007
 TABLE OF CONTENT

TABLE OF CONTENT..............................................................................................................2
ABSTRACT..................................................................................................................................3

GLOBALIZATION TRENDS AND THREATS: .....................................................................4

........................................................................................................................................................7

WHAT IS OFFSHORE OUTSOURCING? ..............................................................................8

DECIDING WHAT TO OUTSOURCE ....................................................................................9

WHY COMPANIES SHOULD CONSIDER RELOCATION STRATEGIES.....................10

NATION BUILDING THROUGH OUTSOURCING - THE IMPACT...............................12

EXTERNAL CONSIDERATIONS...........................................................................................15

ENERGY - A DRIVING FORCE TO OUTSOURCING........................................................16

CRITICAL FACTORS TO OUTSOURCING.........................................................................20

THE THREAT OF LOST WAGES AND BENEFITS ............................................................23

CORPORATE OUTSOURCING FINDINGS.........................................................................26

RECOMMENDATIONS / STEPS...........................................................................................................29
BIBLIOGRAPHY......................................................................................................................30

ALWAYS CUSTOMER DRIVEN............................................................................................33

APPENDIXES............................................................................................................................33
SERVICE OUTSOURCING QUESTIONNAIRE..........................................................................................33

2
 ABSTRACT

This paper will provide a synopsis on the topic of offshore outsourcing in the United States.

The arguments over offshore outsourcing have been prompted by sharp drops in manufacturing

jobs. Furthermore, as hi-tech advances allow service functions to transfer overseas, a larger

segment of the U.S. workforce is faced with global competition. The current level of offshore

outsourcing of services is benign compared to the remaining job creation here in the U.S.

According to Bloomberg.com, estimates suggest that in the U.S., as many as 14-16 million

service jobs are in danger. Most of these service jobs are in the technology arena. In

manufacturing, additional areas are being impinge on by international competition.

Transferring employment opportunities abroad and critical functions, however, often raises

productivity and has a propensity to increase demand for an improved labor force. It also

lowers prices of many products at the retail level particularly benefiting lower-income families.

On an aggregate basis, data provides the U.S. with a net increase. However, there is a rising

apprehension that offshore outsourcing does not only involve transitional costs as the economy

undergoes structural change, but that it creates downwards pressures on salaries for many

corporations and individuals in competition with cheaper employment abroad. This occurs

when the jobs are identical in scope. As a result, the U.S. must intensify its focus in higher

learning and training in engineering, science, and IT. Free world trade remains a prerequisite

for globalization and the development of international division of labor. At both the federal

and at the state level of government, the trend is shifting further towards protectionism. This is

contributed to China’s dowel to the dollar and the opening of overseas markets for U.S. goods

and services.

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GLOBALIZATION TRENDS AND THREATS:

What is globalization and what is its impact?

Globalization is the process of denationalization of markets, politics and legal systems, i.e., the

rise of the so-called global economy. Globalization is also where the world experiences

international paradigm shifts. Global economic integration is one such model and is a major

concern surrounding outsourcing. Because of globalization, businesses are now are faced with

an entirely different set of rules compared to a few years ago. Global economic integration is a

continuous process that moves at different speeds reacting to changes in available resources,

economic circumstances, technology, and infrastructure (World Bank, 2001).

Therefore, it’s easy to believe that millions of jobs will shift from the most advanced

industrialized countries to low-cost countries such as India and China, while millions of others

will be created in existing and new sectors. This assertion is validated by the National

Association of Software and Service Companies (Nasscom), which claim that the total market

size of knowledge process-outsourcing business in India may rise to a staggering $15.5 billion,

up from $1.2 billion currently. Additionally, Industry experts predict that by 2015, offshoring

by the US companies will represent $135 billion in wages and 3.3 million professional jobs.

And new countries like Czech Republic, Poland, Hungary and Mexico are likely to become new

offshoring destinations this year (RTTS, 2005).

Significant amounts of growth in world trade originate in the multinational firms in both goods

and service. According to (RTTS, 2005), only 19% of U.S. businesses have an offshore

outsourcing strategy. However, the percentage skyrockets to 95% if only Fortune 1000

4
companies are considered. Progressively more open markets have Fortune 1000 companies

seeking efficient use of technology to share information and control their supply chain to

fragment parts of their productions activities placing different parts of their operations in

unrelated geographically locations through the use of subsidiaries or third party suppliers.

Subcontracting permits large companies to be more flexible by transferring some of the risks

related with offshoring to their sub partners.

The consequences of this political and economic restructuring are the subject of constant and

vigorous debate amongst global organizations, governmental institutions and academic

institutions. The debate is whether this model is effective on local economies, human welfare

and the environment. At a business level, we talk of globalization when companies decide to

take part in the emerging global economy and establish themselves in foreign markets. First,

they will adapt their products or services to the final user's linguistic and cultural requirements.

Then, they might take advantage of the Internet revolution and establish a virtual presence on

the international marketplace with a multilingual corporate web site or even as an e-business.

The post-war era has seen a remarkable lowering of trade barriers, both through regional

arrangements like the European Union, CAFTA and NAFTA and through world trade

agreements within the GATT/WTO-framework. The collapse of communism as an economic

bloc has opened markets in Eastern Europe and in Asian countries like Vietnam. Latin

American countries have also embraced free trade while Western Europe has embarked on

implementing the single market with free movement of goods, services, capital and labor.

Many observers point to the 1994 introduction of the North American Free Trade Area, NAFTA,

linking the United States, Canada and Mexico, and to the Chinese joining of the WTO in 2001,
5
as two specific watershed events profoundly affecting American manufacturing. Additionally,

CAFTA and the anticipated entry of Russia into the WTO continue to affect American’s

manufacturing and offshoring strategies.

(OECD, 2004) contends that increasing competition, on the demand side, in global and budding

markets are driving companies to sharply focus increased cost-cutting rather than on revenue-

enhancing opportunities. Many underdeveloped countries on the supply side have made

education a major charter and, as a result, have created a huge skilled and educated workforce

of young professionals. The U.S. is concerned with China and India graduating well over three

times more engineers and scientist with bachelor’s degrees than our university system. In fact,

India educates more engineers than most developed countries combined. Moreover, the vast

majority of Americans seeking degrees in math, IT, science and engineering are American

immigrants who do not qualify for employment in drastically needed areas and agencies such as

in intelligence agencies and NASA where clearances require U.S. citizenship (Friedman, 2005).

The globalization of manufacturing has been boosted by repeated improvements in

infrastructure that have brought down transportation cost: railways, container ships, airfreight,

etc. However, until recently the service sector in general had been protected from outsourcing

for two reasons: 70 per cent of the service sector was based on direct customer contact (nursing,

retail, etc.) and the remainder was protected by the lack of infrastructure to make global

competition possible (Kroll, 2003).

The biggest threat to service employment was the increased use of technology, making often

tedious and repetitive service jobs as obsolete as corresponding jobs in the manufacturing

sector. With the competitive pressure from abroad being for the most part absent, productivity
6
gains in the services sector as a whole have been weaker than in the manufacturing sector. This

has resulted in prices for services increasing at a rate higher than for those products faced with

international competition.

The advances of broadband technology and the use of the Internet have sharply reduced the

technological barriers to trade in services and have, as a result, opened a new area to overseas

competition. This is true for both lower value-added services like call center support and more

demanding areas like back-office functions and medical analysis and testing.

7
WHAT IS OFFSHORE OUTSOURCING?

There is no official definition of what constitutes outsourcing, offshoring or offshore

outsourcing. The terms are used interchangeably to describe the way some American firms

relocate some of their domestic operations abroad or replace American production with foreign

imports. Webster's Universal Dictionary loosely defines "Outsourcing" as: A company or

person that provides information; to find a supplier or service, to identify a source". In lay

man’s terms, it is a pure contracting transaction whereby one company purchases services from

another while retaining ownership and responsibility for the underlying processes; the clients

tells the provider what they want and how they want the work performed. At this juncture, the

client authorizes the provider not only to own and operate, but also redesign underlying

processes, to reap even greater cost and efficiency benefits. Accordingly, moving along the

continuum from client to provider control of non-core processes can create distinctive value,

especially in a trusting, long-term relationship (OffshoreITOutsourcing.com, 2005).

To be more precise, outsourcing is the relocation of a function to a third party producer

domestic or abroad. A more complex explanation defines offshoring as the relocation to an own

affiliate abroad, whereas offshore outsourcing is the relocation to a third party abroad. In

manufacturing, the automobile industry is a prime example of offshore outsourcing, where

technology, parts, software, design, etc. come from a variety of countries, often making an

American car more of a global product than a domestic one, (WTO, 1999). In services, it can

be a software programming company moving to a subcontractor or an own subsidiary in India

or it can be the back-office functions in financial institutions.

8
The optimal strategy for any corporation should include well thought out plans combining trade

and investment. Many companies are currently outsourcing a function having substituted a

domestic supplier with an overseas supplier. When an overseas partner is selected for an

offshore joint venture or subsidiary instead of the U.S. parent fulfilling the product or service

need internally, the original investment choice has long-term implications for U.S. workers even

if the impact on jobs initially was small. Choosing a blended approach between transferring of

operational functions and locations to explore are critical corporate considerations.

DECIDING WHAT TO OUTSOURCE

Business Process Outsourcing (BPO) is a strategy that executives utilize to help them focus on

their core competencies and achieve more than just cost savings. BPO has today received high

accolades for enabling organizations to meet a diverse set of objectives ranging from tactical to

strategic, such as, enabling consistent management practices through global operations,

accessing new sources of revenue and catalyzing organizational changes (Janko, W. & Koch, S.,

2005).

The first step towards making this wonderful resource work for any organization is first

deciding what functions should be outsourced. For this, it should be remembered that all

functions are not alike. While certain core functions such as decision-making, are not the right

candidates for outsourcing, others such as HR administration, finance & accounting and

payment services provide strategic advantages when outsourced.

In short, Globalization is concerned with the application of business practices, processes and

resources to take a business or a product globally. Additionally, globalization refers to the

9
process of internationalization, which can be adapted to various languages and regions without

engineering changes and the localization of products and services.

WHY COMPANIES SHOULD CONSIDER RELOCATION STRATEGIES

Cost is a critical factor for companies’ considering to offshore or offshore outsourcing

production. A recent survey conducted by The Economist (2004) points to the reduction of

labor costs and direct material costs as the most important factor leading to offshore

outsourcing. Additionally, access to distinctive materials, services and R&D assets as well as

market presence and diversification play vital roles. This is chiefly significant for investments

in other industrial nations. Wages found in countries with lower earnings are frequently a mere

fraction compared to developed countries, (chart 1) even when factoring in a nominal salaries

expansion in these countries of 8 per cent compared to 2.5 percent in the U.S. (Bie, 2005).

While low wages is an important consideration, it is not enough of a factor for an attractive

investment destination; other factors such as a country’s infrastructure, security and availability

of skilled workers must be considered. If low wages were the only criterion for foreign

investment, Africa would be flooded with foreign direct investments. Over the last 30 years, the
10
countries in Southeast Asia have been successful in combining low wages with an aggressive

strategy of promoting stability, investment protection, rule of law and a generally hospitable

environment (e.g. through tax incentives). Together with high investments in education and

infrastructure, these elements of good governance have gained increasing attention in

assessments of successful development strategies (Bie, 2005).

Any cross-border outsourcing transaction raises a host of potential legal issues; in addition there

is an emerging body of "global sourcing" legislation in the U.S. It is important to note that

while there is considerable risk not reviewing and weighing all factors collectively for

determining an outsourcing function. For example, there exist a consensus both in China and

the West that rule of law is a good thing, however, this is not a universally accepted truth. Some

communist governments, including China have been at least partially negative toward the idea

of rule of law, arguing that it interferes with class struggle and their infrastructure. Furthermore,

the rule of law is opposed in many authoritarian and totalitarian governments. The explicit

policy of those governments, as evidenced in the Night and Fog decrees of Nazi Germany, is

that corporations should carefully review and weigh how they leverage themselves in the global

arena (Wikipedia 2006).

Additionally, cultural variations and personal preferences create huge and often miscalculated

problems. As a general rule, the less complex the function (e.g. phone service vs. network

design), the more labor costs will be in the overall evaluation. Many businesses will assess the

overall cost/benefit analysis incorrectly and make sub-optimal decisions, either through

overemphasizing the offshoring or by over-investing in capital at home as a result.

11
Another concern is that a race to relocate offshore could also lead to unanticipated expenses,

from issues such as liability laws and high training costs due to labor turnover.

(Arora & Gambardella, 2004) asserts that language is a vital requirement (but not an adequate

condition alone) for relocating to a country with re-exports of the service function. India,

Ireland and Israel have a huge labor pool of English-speaking professionals, while investments

in China and Brazil mainly are aimed at the local market. It is important to note that the

Philippines, Malaysia, South Africa and other countries with strong English-speaking traditions

are also seeking shares of the future stream of offshore outsourcing activities. For the identical

rationale, French investments in back-office/call-centre services are being directed towards

French-speaking North and West Africa. In the Nordic countries, customer support is often

pooled outside, but by default has to be manned by Nordic speakers. This results in having to

raise the relative cost of providing a service there considerably.

NATION BUILDING THROUGH OUTSOURCING - THE IMPACT

Many companies surveyed referenced that beyond merely IT outsourcing, offshoring and

inshoring infrastructure services is the next big thing. Inshoring is the process where foreign-

headquartered multinationals contribute to U.S. economic growth, security and raising U.S.

living standards through their operations that are insourced, thus, creating American jobs

(Slaughter, 2005). The complexity of such interdependent relationships stretches far beyond

cost saving and entering into new markets.

One example of how involved outsourcing and offshoring can be is exemplified by the

relationships between U.S. military forces, international allies and contractors on the battlefield

in Iraq. This example in nation building is a case in point of how many multinationals
12
coooperate with governments to produce opportunities to perform offshore services. Thus,

offshoring and outsourcing is often explored to create opportunities to expand abroad as well as

for national security and for creating cost reductions (Bartholomees, 2004).

Several other key drivers are shifting suppliers’ requirements from remote management to one

of introducing offshore outsourcing into the solution. Quite often, private contractors play a

huge role in basic government work—mostly out of public view. One such example is the

controversy over the U.S. outsourcing the management of six U.S. ports by the United Arab

Emirate. This example, at the forefront of the offshoring debate, challenges how far

outsourcing should go. Several congressmen have vowed to block the sale of British port

operator P&O to Dubai Ports World of the United Arab Emirates, a staunch U.S. Gulf ally,

citing security concerns. The U.S. Congress needs to debate this position in order to create

greater transparency in certain U.S. and global counterterrorist organizations such as The

Counterintelligence Field Activity Agency, which is buried deeply within the intelligence

community. With the U.S. Congress in the midst of an election year, public fear of Arab nations

could potentially threaten their reelection chances (FSSI, 2006).

What is difficult for the U.S. population to discern, through all of the white noise, is the critical

importance of nation building and dispelling the awful perception of intolerance towards all

Arab-speaking nations following the events of 911. This deal is about D.P. World, a holding

company, managing only the terminal operations – which schedules and unloads ships. Local

port authorities will still run the ports themselves. D.P. World responsible with terminal

operations will not address port security; they are simply accountable for writing the paychecks.

Customs and Border Protection (CBP) and the U.S. Coast Guard are responsible for all aspects

of security. This agreement is critical with the Middle East flow of money and points directly
13
back to the Iraqi Government’s banking procedures with managing oil revenues coming out of

the Iraq (FSSI, 2006).

Some of the rhetoric would have people believe that U.S. ports are being sold to foreign

governments; the ports are controlled by the local port authority and the security – the most

important part – is not going to be changed one bit by D.P. World taking over this contract

(Worthen, 2005).

Suggesting that U.S. ports outsourced being a security threat is a chance for the U.S. to view

this agreement as a significant opportunity to broaden our nations security and further

participate in the paradigm shift occurring with the global economy. This reallocate of

resources should be examined thoroughly addressing the impact on U.S. jobs, union

participation, emerging technologies, trucking operations, emerging supply-side constraints with

industrial nations as China, India and unrefined resources from such countries as Saudi Arabia,

Nigeria, and other mineral rich nations. These shifts will ultimately result in a chain of

renegotiated agreements that will influence relationships worldwide.

Furthermore, the threat of Russia’s infiltration within the Middle East by collaborating with Iran

to develop a facility for enriched uranium and talks with HAMAS potentially compromises the

U.S.’s position within the Middle East. The U.S. must also pay critical attention to our closest

allies in and around the Middle East such as Israel by urging calm, preserving trust, and not

permitting any distance between our two nations (FSSI, 2006).

Another example of how multinationals collaborate with government in creating outsourcing

initiatives is the recent development of nuclear energy cooperation agreement between the U.S.

and India. This agreement too will allow multinationals and subcontractors involved with the
14
Department of Energy and other energy sensitive agencies focused on research and development

of nuclear science to share and to explore emerging technologies. Additionally, this strategy is a

critical opportunity to further nation building in areas where China may be attempting to

develop similar back door relationships.

EXTERNAL CONSIDERATIONS

Beyond the factors and the potential impact of outsourcing addressed earlier are many other

external factors driving multinational corporations and nations here and abroad; (Powell, 2004)

describes them as:

Excessive Corporate Taxation –Despite the bush tax cuts of 2002, the U.S. continues to have

one of the highest corporate tax rates; however, numerous tax breaks and exemptions exist for

targeted sectors, which include large multinationals. The latest tax reform package from October

2004 was originally meant to benefit exporters of manufacturing goods, but it has also proven to

lavish tax breaks on numerous other businesses, including importers of Chinese ceiling fans.

Escalating Costs Of Health And Pension Benefits – U.S. businesses are more exposed to costs

of benefits like healthcare, workmen’s compensations and pensions than most of its major

competitors abroad. In 2003, employer’s expenditure on health insurance for employees alone

reached over 8 per cent for total compensation. Daily there are rising tensions concerning the

strains of supplying pensions benefits to U.S. workers in the transportation and manufacturing

industries suggesting that pensions will be obsolete due high cost and tough global competition.

Escalating Costs Of Actual Or Threatened Tort Litigation - In 2001, the costs of the U.S. tort

system reached $205 billion, over 2 percent of the GDP. Comparable international data are
15
limited, but estimates suggest that tort costs are much more common in the United States

compared to their largest trading partners.

Escalating compliance costs for regulatory mandates - This particularly true for regulations

related to workplace safety, pollution abatement, and corporate governance.

Additionally, according to The Office of Management and Budget’s, (OMB, 2004)

Report to Congress on the Costs and Benefits of Federal Regulation, real expenditure for

administering and enforcing regulations nearly doubled from $13.7 billion to $31.9 billion from

1990-2005 (in real terms). In terms of compliance, three areas of regulation are hit particularly

hard: consumer safety, workplace safety, and environmental protection. The manufacturing

compliance costs were 147 billion dollars in 1997 (OMB, 2005).

One interesting model to offset the challenges facing many multinationals is a nearshore

outsourcing solution. A nearshore solution is a model used in international waters or with

bordering countries that do not have the restricted burdens of regulations and compliance

experienced in the U.S. The U.S SeaCode, a nearshore outsourcing solution, is one such

creative approach to circumventing U.S. regulations and compliance issues. Seacode has

created a solution with hybrid outsourcing creating new high-end jobs for U.S. engineers - even

bringing back jobs that had already left the country. They have achieved this by combining the

skills and experience of our U.S.-based engineers and program managers with unique ship-

based offshore engineering capabilities. As a result, they are able to deliver to clients a

combination of American engineering talent and reduced blended cost (SeaCode, 2005).

ENERGY - A DRIVING FORCE TO OUTSOURCING

16
Rising Energy Costs, Particularly Natural Gas – While energy reserve estimates for oil,

natural gas, and coal are very difficult to develop, globally there is concern with the available

energy sources. The result is worldwide there has been a major spike in the cost of energy. One

such example of the impact of rising energy cost is where General Motors and Ford Motor and

its shareholders finally received the bad news On May 5, 2005, where Standard & Poor's

downgraded their debt of both carmakers to junk status (Welch, 2005).

This is due in part to US consumer’s steady march into Asian car companies' dealerships

seeking more fuel-efficient vehicles in the quake of escalating gas prices. The National

Association of Manufacturers introduces an effective cost index to measure the effects of the

burden of the above-mentioned problems. The overall additional or hidden costs faced by

American manufacturers are estimated to 22 per cent of the raw cost index (Davis, 2005).

Energy resources fall into two broad categories: renewable and non-renewable. Ultimately,

the planet’s energy comes from three sources: the sun, energy of radioactivity of Earth’s
17
 creation material, or momentum energy of objects in the solar system. In the very long term,

none of this energy is unlimited. Except for the purposes of human use, incident solar energy

in its various forms such as biomass, hydro, photovoltaic cells, wave power and wind power

can be considered sources of renewable energy, as can geothermal energy from hot

radioactive creation material and tidal energy from the momentum of the Earth/Moon/Sun

system. The major non-renewable energy sources are hydrocarbons – oil, natural gas and

coal – which can be regarded as stored solar energy from photosynthesis of millions of years

past, and nuclear materials such as uranium. At present, most of the world’s energy comes

from non-renewable sources. In 2001, according to the Department of Energy’s Information

Administration the global energy split is as follows:

Table 1 Sources of Global Energy – 2001

Source Percent
Oil 42
Natural Gas 23
Coal 23
Nuclear 6
Total Non-Renewable 92
Hydro 7
Other 1
Total Renewable 8
Source: US Energy Information Administration

OFFSHORING vs. OUTSOURCING?

Relocating functions offshore to an affiliate or outsourced to a third-party can have significant

implications. The advantage of outsourcing a function is that companies can focus on their core

businesses and exploit cost-cutting measures. Additionally, outsourcing provides the

18
originating firm with enormous flexibility should problems occur, lower risks from business

cycles and less burden with increasing costs on benefits such as healthcare and retirement

programs. Also, relocating involves little capital investment.

Some disadvantages from outsourcing are the loss of control and an increased level of effort

essential when integrating responsibilities from third parties in the internal operating structure.

The more complex and integrated various services or processes are, the greater the probability

that outsourcing will occur.

(Bie, 2005) asserts that in the early days of moving operations abroad most firms chose to

outsource the activities to other, often local, companies. It was easier, quicker and required less

investment capital (hence risk). (Mann, 2004) argues that a significant slowdown in American

manufacturing foreign direct investments in low-cost countries (down from 12 billion dollars in

1999 to 1.3 billion dollars in 2005) may be attributed to increased use of offshore outsourcing.

However, as foreign direct investments around 1999 were at an all-time high, the majority of the

decline in investments is most likely attributable to the 911, general weak economic growth and

global anxieties.

Offshoring and inshoring has now become a standard operation and a core component of the

financial services business model, an increasing number of businesses choose to offshore,

thereby retaining control. In this way, the initial commitment is greater, but the company has

the advantage of remaining in control and thus integrating sensitive services in core businesses.

This is perceived as the model for the future.

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Other options include joint ventures and acquisition of an existing firm. However, investment

decisions are often subject to specific restrictions depending on the country in question. In

addition to being alert to specific challenges, (Bie, 2005) advises manufacturers to keep

essential production technology at home in order to avoid copying of product or subassembly.

This is critical given the trend in countries such as China where Chinese businesses are

aggressively filing patents and claiming other intellectual property rights to the counterfeits

locally, in effect becoming the legal owners (Spurgeon, 2004).

CRITICAL FACTORS TO OUTSOURCING

For a company contemplating relocating production, the primary objective is to ensure that the

perceived benefits from a low-cost environment are achieved. This list highlights factual data

gathered from real-world experiences I have personally encountered working on client sites

developing and revising business processes and from published articles relating to this subject.

Besides the relative labor costs, other factors such a barriers to entry (regulatory access to

market) relocation costs, integration in production chain and the availability of quality labor are

among the factors that companies have to face. Following is a highlight of such factors for

consideration:

 Infrastructure (physical access to market) because many offshore countries lack the

network bandwidth for fast communication and many experience intermittent electrical

outages.

 Security - Not all foreign countries have the high-level concern or the laws, such as those

for privacy or intellectual property, to protect organizations or nations assets.

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 Skill Set/Quality - encountering poor or unacceptable quality of work in test automation,

regardless of the CMM level touted or other defined universal methodologies for S/W, H/W

or infrastructures.

 Competency& Objectivity is your offshore partner performing your development and your

testing? Will they keep your best interests at heart (and provide adherence to functional,

performance, reliability and usability testing standards) when it conflicts with meeting their

deliverable date?

 Geopolitical Climate -While recent events have proven that the US is not immune to

terrorism, Asia and other underdeveloped areas experience instability caused by unstable

government, political unrest, terrorism, etc.

 Culture Cultures are different - It is possible to insult offshore partners inadvertently or

simply experience miscommunications. Business conduct, greetings, forms of address,

gestures, value systems and punctuality vary widely around the globe.

 Language Barriers - Unquestionably many offshore resources provide communication

challenges, especially over a forum that does not allow you the ability to view facial

expressions - and e-mail can be worse.

 Time Zone Clash - Many of the firms in Asia have as much as a 10-hour time difference.

The outsourcing firms try to spin this as a "good thing" for you. Is it good to not be able to

have your team discuss issues with their team as they arise?

 Difficulty Visiting Their Site - Because of the cost and length of travel (as much as 20 hours

each way), visiting your partners with any frequency becomes much more unrealistic. Also,

foreign ground transportation is not like that in the US.

 Difficulty Bringing Resources Here - There are possible Visa issues and heavy expenses

with bringing your partners to where you do business.

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 Increasing Price Trends - Many offshore providers that have been successful are increasing

their prices due to fact that competition for local human resources is pushing up the cost of

labor.

 Labor Backlash - There is a groundswell of backlash against the current trend toward

exporting jobs outside the US. This backlash may cause negative publicity for your firm.

According to (Bie, 2005), risks associated with offshore outsourcing for financial entities fall

into four categories: operational, reputation, legal and country-specific. The operational risk is

the income loss resulting from an internal failure in the business model or from external events.

With regard to operational risk, the bank argues that the transfers of managerial responsibility to

a third party (as is the case with the outsourcing of a service) introduces uncertainties and lessen

control of the overall exposure.

The reputational risk arises when the way by which services are performed by third parties

reflects badly on the originating firm. Consequently, even if the originator is not legally

responsible for the event, the firm can incur a monetary loss from loss of credibility. Especially

for financial firms, the breach of confidentiality concerning customer financial information can

cause significant damage. The transfers of information itself as well as imperfections in the

service provider’s control environment are specific areas of risk.

The legal risks arise as offshore outsourcing is based on binding contractual arrangements.

Besides small print problems, risks can arise when specific contractual details become

detrimental to the financial firm’s business strategy, for example if the contract is of long

duration, but the service in question reflects outdated business realities.

22
The above-mentioned risks are common to all outsourcing arrangements, but moving the

service offshore, which tend to lessen direct influence or at least increase the supervisory

burden, exacerbates the risks. Additionally, moving functions offshore creates country-specific

risks, which might include changes in foreign policy as well as political, social, economic, and

legal conditions.

In response to the increasing use of outsourcing, the Joint Forum, established by the Basel

Committee of Banking Supervision and other international supervisory bodies, issued nine

principles for the financial sector with regard to outsourcing. According to the principles, firms

should have a number of policies in place before entering an agreement, for example regarding

the attainment of direct responsibility and the establishment of a comprehensive risk

management system. The specific outsourcing arrangements should be on clear legal footing,

identifying rights and responsibilities of all parties.

The financial institution should also be vigilant in assuring that the service provider protects

customer confidentiality. Furthermore, financial supervisors should take into account a firm’s

outsourcing arrangements and make it an integral part of the monitoring exercise. Additionally,

supervisors should be certain that an offshore outsourcing arrangement does not hamper the

supervisory work, for example by reducing access to relevant material (BIS, 2004).

THE THREAT OF LOST WAGES AND BENEFITS

While outsourcing is inevitable, the requirement to understand the underlying implications of

outsourcing is important. The threat of job loss, deleted benefits, and lower wages are at the

forefront of this debate. Provided is a short table from a variety of sources and reports
23
comparing job loss estimates and projections due to outsourcing. The disparity in the numbers

shows the uncertainty and the difficultly in measuring these numbers. The total size of the U.S.

Labor Force is 140 million jobs (Outsourcing Statistics in Perspective, 2004).

Jobs Lost to Date* Projected Job Loss Jobs at Risk

14.1 million
300,000-995,000 3.3 million-6 million
14.1 million
300,000-500,000 3.3 million over 15 years (UC Berkeley)
(Goldman Sachs) (Forrester Research)

400,000-500,000 6 million over 10 years

(Business Week) (Goldman Sachs)

995,000
(economy.com)

TRENDS IN OFFSHORE OUTSOURCING AND TRADE SUBSTITUTION

As trade barriers are removed and new technologies integrate the global community, firms have

the ability take advantage of relative strengths on the micro level and optimize manufacturing

operations. This development is also reflected on the macro level in the trade statistics.

Overall, exports have enjoyed stronger growth rates than most GDPs for a long period of the

postwar era, thereby increasing the overall economic interdependence, (WTO, 2005). For

America, the external balance and the relationship with the surrounding world has become a

major focus of attention as the trade balance has continued to deteriorate. For 2003, the deficit

reached nearly 550 billion dollars, and the deficit on 2004 is on track to become even larger.

24
The increasing shortfall combined with significant employment elimination in the

manufacturing sector has shifted focus on corporate decisions to move production abroad, and

hence the individual decision on offshore outsourcing. This shift has amplified the spotlight on

China and its fixed exchange rate with regard to the dollar, as the Chinese trade surplus with the

United States has increased significantly to 124 billion dollars in 2003, or 23 per cent of the

total U.S. trade deficit in 2004. One explanation for the increasing deficit could be that U.S.

multinationals increasingly use foreign affiliates rather than direct exports to satisfy foreign

demand. Profits from foreign affiliates of U.S. multinationals are much higher than in the U.S.

parent and contribute overall to half of the total profits of the multinationals, but only with one-

third of the sales. For this reason, capital inflows (royalties and repatriated profits) are

increasing more rapidly than direct exports (Bie, 2005).

Furthermore, according to the Bureau of Economic Analysis, outsourced jobs outnumber

insourced ones by 3.4 million and in 2005 alone, total 2005 exports of $1,271.1 billion and

imports of $1,996.9 billion resulted in a goods and services deficit of $725.8 billion (BEA,

2006).

From a general perspective, the most significant development of the direction of America trade

is the increasing trade with Canada and Mexico since the NAFTA-agreement came into force in

1994, chart 3.

25
CORPORATE OUTSOURCING FINDINGS

Most U.S. organizations will require some type of nearshore or offshore element in virtually
every large outsourcing contract during 2006.

 For an example, IBM Global Services reported that 100 percent of its requests for
outsourcing support include an economical international sourcing alternative. Additionally,
organizations that already use offshore partners or offshore resources, but have a large
number of vendor staff performing duties locally, will eventually move this staff offshore in
order to benefit from greater profits.

 As global outsourcing/ consulting firms, such as Accenture, BearingPoint, Northrop

Grumman and CSC increase their presence in India their strategy is to: (1) compete with the
primary Indian solutions providers and (2) accommodate organizations that are challenged
with their bottomline. With India as a primary offshore destination allows U.S. companies to
take full advantage of their strategy rather than merely focusing on a cost containment
strategy, resulting in quality and output benefits being realized. Organizations should apply
26
 quality a stringent quality improvement program as an integral part of all Indian outsourcing
activities.

 Large system integrators will continue to replace small local contractors with offshore or
nearshore vendor support. As organizations transfer to remote ADP programming models,
they usually replace external contractors before considering replacing internal staff.
Furthermore, company’s intention is not to eliminate their internal staff. Their objective is
to cut down on external contractor spending thus, freeing up internal resources to focus on
mission-critical work.

 India will dominate as the preferred offshore country for IT services and China continues to
dominate the electronic and manufacturing market. Their vendors will continue to lead the
offshore marketplace. While these countries remain the best option for North American
organizations, vendors are seeking to develop shops in other low-cost countries, in such
countries as Brazil, Czech Republic, Hungary, Indonesia, Malaysia, Mexico, Poland and
Pakistan.

Out of the 66% of the participants who

are currently outsourcing, 40% are
focused on Business Process
Outsourcing, 23% on Applications
Management, and 38% on IT
Operations.

27
 75% of the participants indicated that
an effective outsourcing relationship
could transform an enterprise on a
strategic level.

Out of the 70% of the participants

who are currently considering leveraging
offshore resources as a component of
their outsourcing decision, 34%
indicated they are making their decision
now, 34% in 6 months, 5% in 9 months,
and 27% in 12 months or more.

CONCLUSION AND RECOMMENDATIONS

Strategically, organizations must examine the structure of the agreement. Beyond examining

price, the assessment should include: maturity, business processes, deployment capability,

security, long-term maintenance costs, management costs, service levels and the value chain.

These critical processes of any effective outsourcing proposition can’t be performed merely

with a worksheet approach and requires options analysis and a business-case format. In

addition, there are a number of sequences to consider that are provided in the following steps:

28
Recommendations / Steps

 Evaluate all risks and quantifying them when measured with probability. Review
alternative options e.g. (near-shore, partial offshore) and other combinations of services.
 Review the value of the partnership and its critical importance to your organization.
Obtain the expertise of an independent organization have them assess, measure and
manage the process of outsourcing.
 Assess the readiness of the organization (requirement management processes, level of
engineering specification, etc) for all aspects of outsourcing and offshore specifically.
 Organizations who finally decide to explore global opportunities should at initially
decide the model they are most at ease with, and then set their strategic direction. Most
importantly, they should not allow outsiders to drive the model.

Finally, the analysis and process should be done by and independent and non-biased third-party

organization who offers the objectivity necessary in assessing organization capabilities, business

processes and those of outsourcing partners.

29
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 P.O. Box 16813
P. 703-338-7118
P/F: 703-579-6444
Always Customer Driven www.fssincorporated.com
APPENDIXES

Appendix A: Service Management

Service Outsourcing Questionnaire
Company Name: _

Address: ______

Reference Name:
Reference Activity:

SIN(s): _________________________________________________________________________

NAICS Code(s)___________________________________________________________________

Brief description of services/products provided:

____________________________________________________________________________________________
________________________________________________________________________________

1. If you outsourced a process, did you

incorporate a change management plan?
2. If you are a financial services provider,
would you consider outsourcing your
technology functions, such as Security,
S/W or H/W support or a portion of that
function?
3. If you are planning to outsource your
sales/services function, what is most
critical to your decision?
4. If you are a buyer, which of the following
has been the primary reason for
considering a sole source approach?
5. When considering a BPO versus an IT
agreement, is your organization more or
less likely to consider a sole source
approach?
6. Has your organization ever had an
unsuccessful outsourcing relationship?
7. Has your organization attempted to
outsource any of the following?
8. What type of outsourcing is your company
contemplating? Has your company
engaged offshore?
9. What organizations are you or have you
used as an out sourcing resource?
10. If you have implemented offshore
outsourcing, in which country is your
service provider located?
11. What is your perception of offshore
outsourcing?
12. Where are you from? Where does your
organization and its stakeholders originate?
13. What is your interest in outsourcing based
on?
14. If you are a foreign based company, where

33
 are planning to outsource this year?
15. If you are a foreign-based company, what
are you planning to outsource this year?
16. If you are a foreign-based company doing
business with the US federal government,
have you established a proxy board?
17. What are you planning to outsource this
year?
18. What is your title in the company?

Ratings: Please summarize the contractor’s performance and circle in the column on the right the letter that
corresponds to the performance rating for each rating category. Please see the attached rating guidelines for a
description of the rating scale.
Factors Rated Key Questions Comments: (continue on additional sheets Rating
if desired)
Timeliness of 1. How would you rate the contractor’s E A U
Performance: ability to deliver a particular service or
product on time?
2. How timely was the completion of the E A U
order according to the terms negotiated?
Quality: 3. How would you rate the quality of the E A U
contractor’s product or service?
4. How would you rate the contractor’s E A U
application of internal quality control or
review systems during order performance?
Value: 5. How would you rate the value of the E A U
products or services provided compared to
the price paid?
Business 6. How would you rate the contractor’s E A U
Conduct: ability to resolve problems without
extensive guidance from company
counterparts?
7. How would you rate the contractor’s E A U
professionalism in responding to and
completing your order?
Customer 8. How would you rate the responsiveness E A U
Satisfaction: and cooperation of the contractor’s
customer service organization?
9. How would you rate the contractor’s E A U
willingness to work with you to address
special requirements (e.g., changes to
requirements, urgency, etc.)?
10. How would you rate your level of E A U
satisfaction with the effectiveness of their
performance?
Overall 11. How would you rate the likelihood that E A U
Satisfaction: you would use the contractor again, and
why?

RATING GUIDELINES
Please summarize contractor performance in each of the rating areas. Assign each area a rating
of E (Exceptional), A (Acceptable), or U (Unacceptable).

34