Offshoring trends

Intheblack, Aug 2007

NEWS, OPINION AND MEMBER UPDATES

OFFSHORING PROCESSES FROM domestic Western labour to the cheaper alternatives available in China, India, Malaysia and Eastern Europe has been touted as not only logical but inevitable.

Yet companies that place too much emphasis on seeking cost reduction from offshoring could limit their performance improvement, according to a recently released study of multinational companies.

The study, Execution is Everything: The Keys to Offshore Success, was conducted by management consulting firm A.T. Kearney, and looked at why some companies gain major performance Improvements and cost savings from offshoring while others are less successful.

"Offshoring may be part of a broader profit improvement strategy," says Peter Munro, vice president of A.T. Kearney Australia. "But it is by no means a silver bullet for cutting costs."

The research looked at the post-offshoring change in operational performance reported by 42 companies across six measures: capacity, organisational flexibility, revenue performance, organisational capability, process maturity and service levels. It revealed the success of offshoring varied widely, with reported cost savings ranging from 0 to 75 per cent.

The study found that the majority (60 per cent) of companies that send operations offshore fail to meet their operation performance expectations, and 34 per cent fail to meet their savings expectations.

The study also revealed companies that focus on performance rather than cost were the biggest winners, saving 3.5 times more money than companies that offshore simply to cut costs.

"Placing too much emphasis on cost reduction serves to limit performance improvement," says Arjun Sethi, A.T. Kearney vice president and leader of the study. "Winning companies are viewing offshoring in a holistic fashion, and striving to achieve improvements across the entire organisation."

Companies that improved on at least three out of six operational performance areas experienced average savings of 44 per cent from offshoring, while companies that improved on two or fewer measures saved only an average of 30 per cent. The best-performing group averaged 64 per cent savings - more than 3.5 times the poorest performing group.

"These results clearly demonstrate that cost reduction strategies need to be about much more than going to India for cheap call centres," Munro says. "Cost savings, and therefore profit improvement, come from a complex range of factors such as strategic procurement, optimised supply chains and genuine cultural change within the organisation. So companies should fully explore these options before looking abroad."

The study found that low-complexity functions (such as call centres or transaction processing) that were sent offshore saved an average of 28 per cent in costs. Medium-complexify functions saved an average of 38 per cent.

The trend of focusing on the cost benefit of offshoring was also identified in Deloitte's fourth annual Global Financial Offshoring Report 2007, which underlines the growth of offshoring in recent times.

"In future, the best offshoring strategies cannot be based solely on financial gains from labour arbitrage," says Deloitte US managing partner Jack Ribeiro in the report. "Otherwise the legacy inefficiencies of older, onshore processes may simply be transferred offshore." Yet research undertaken by Deloitte Touche Tohmatsu shows that offshoring and sourcing decisions are too frequently based "purely on cost arbitrage grounds," says Ribeiro.

The Deloitte survey showed that offshoring has spread across nearly all business functions, with significant growth around transaction processing, finance and HR.

Although India remains the prime location for offshoring globally and in Australia, with about two-thirds of global offshored staff employed in the sub-continent, it could lose its crown.

China's share of offshored labour is already rising. The Deloitte survey found that one-third of financial institutions now have back-office processes, mainly IT, in China. Some 200 million Chinese people are currently learning English, providing a pool of skilled labour that may compete with India over the next 10 years.

Malaysia is also an attractive option as a shared services and outsourcing (SSO) hub. In its Offshore Location Attractiveness Index, which analyses people skills, availability, business environment and financial structure, A.T. Kearney ranked Malaysia as the world's third-most attractive location for SSO behind India and China.

The Deloitte survey found that more than 75 per cent of major financial institutions have operations offshore, compared to about 10 per cent in 2001.

"Many financial institutions require a wake-up call, as they lack a clear vision of their offshoring programs," the Deloitte report concludes. "Just a handful of financial institutions are setting the pace in offshoring. The test for the rest of the industry, both large and small players, is to rise to this challenge by optimising their ofshore operations."