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What Is The Real Cost Of Outsourcing?


What Is The Real Cost Of Outsourcing?

CME CEO and co-founder, Wissam Youssef: I’ve been working for more than 17 years in the tech industry. I’ve had the chance to experience both sides of the equation as an outsourcing vendor, as well as a customer. Over the course of my career, I kept encountering the same questions over and over again, and I had to find the answers the hard way. How do we keep up with the ever-growing competition? Does outsourcing contribute to value creation beyond the cost savings opportunities?

In this article, I will try to summarize what I have learned throughout the years and demonstrate the real cost of outsourcing in order to achieve value creation.

Why do companies outsource?

Global research firm Gartner says global IT spending is expected to cross into $4 trillion territory by 2021. Enterprise software market is projected to be the fastest-growing segment. Of course, that was before the COVID-19 pandemic! Due to the negative economic impacts brought about by the coronavirus, global IT spending is now expected to decrease in 2020. However, the software development market is still set to grow 21% by 2028, while the enterprise software segment will be growing 10% year to year.
In order to attract talent, employers will need to invest heavily in brand improvement and boost employee benefits, which will inexorably increase costs. Talent shortage and cost pressures will pave the way for higher outsourcing adoption. As a result, recent studies have shown that the software outsourcing market will grow in double digits during 2020.

Hidden costs of outsourcing

Many outsourcing decisions are driven by spreadsheet analyses that focus on direct man-hour cost. However, decision-makers fail to consider the differences between a spreadsheet analysis and the real cost of outsourcing.
In the following section, I will unpack the main hidden cost drivers and share my recommendations to achieve the highest return on investment:

Communication and coordination cost: Requirements aren’t always bullet-proof, and developers will require clarifications and confirmations while designing or implementing a software feature. Due to time zone differences, developers might waste half a day before hearing back from the overseas lead. That detracts from developers’ ability to achieve domain expertise and to become capable of making the proper decisions quickly. Sometimes it is also a question of awareness of the target markets. In order to address this matter, customers often assign expensive dedicated onshore resources to handle communications with the offshore teams. In a typical team of 10 developers, the cost due to communication challenges is expected to add up to 25% of the total project cost.

Cost of employee turnover: Employee tenure is the length of time that a person spends with the same employer. Employee tenure in the tech industry is one of the lowest compared to all other industries. Tenure is affected by many demographic factors, such as age, economic status, and education. Employees tend to remain at the same job as they advance in age or during economic recessions. It is also notable that a higher education degree leads to higher retention. All tech companies, including Silicon Valley icons, suffer from the low tenure of their industry because it imposes costly losses on both financial and knowledge investments. Hiring and ramping up a replacement resource to become equally productive and knowledgeable is estimated to take 6–9 man-months on average. That leaves us with another 10 to 20% on top of the total cost for low-employee-tenure markets where the yearly employee turnover rate is up to 30%.

Quality cost: Issue tracking tools allow us to track and categorize the time spent on different types of tasks. These analyses have shown that a quality-driven team usually spends the majority of its time on developing new features and functionalities rather than fixing bugs. Typically, such a team spends 80% of its time on enhancements and new features versus 20% on bugs and technical debts. On the other hand, due to weak coding practices and lack of domain expertise, low-performance teams spend more than 50 to 60% of their time fixing bugs and addressing technical debts. That leads to at least a 30 to 40% decrease in efficiency.

The lack of domain-specific expertise can be a major drawback of using offshore resources. Productivity is usually hampered by a lack of domain expertise, which means companies need to dedicate in-house expensive resources to drive and maintain the complex quality assurance processes entailed. This leads to delays in deliveries and missing deadlines. The delay is around 30% in general, and it skyrockets up to 230% in more demanding industries such as insurance, banking, and healthcare, with a very low chance of co-creation opportunities.

Intangible costs due to missed opportunities and risks: Most of the common outsourcing destinations do not have rigid regulations and requirements when it comes to intellectual property ownership. Regardless of any contractually binding terms, background checks and trust remain the best options to mitigate the risk of intellectual property infringement.

Trust is established based on the time we spend with people, thus the importance of achieving a high employee tenure.

The points mentioned above often result in delays and missing business goals. The impact is beyond cost containment. These factors exacerbate the company’s challenges, jeopardize market share, and shrink revenue.
Finally, the moment of truth: What is the real cost of outsourcing when dealing with a low performance/ low-cost offshore partner? The answer depends on the industry’s domain-knowledge complexity. The real cost shockingly varies between two to three times the spreadsheet rates, and sometimes it severely hits a company’s market share and shrinks revenue.

A steady hand on the till

By now, one might be wondering whether outsourcing is a solution or a problem by itself. However, there are a plethora of outsourcing success stories. The benefits can be substantial in terms of speeding up product time-to-market and lowering costs. The key to success is finding the best-of-breed outsourcing partner. You can then leverage the vast potential of outsourcing to achieve at least a 30% cost reduction compared to in-house resources and reach business objectives on time without compromising the opportunities of value creation. Here is my recommended checklist to facilitate the selection of a high-quality offshore partner:

Domain expertise matters. Companies should work with offshore partners with a proven and well-recognized track-record in their industry domain knowledge.

Maximize the time zone overlap between in-house vs. offshore teams. Most offshore software companies are flexible in terms of late or early shift schedules; it is a matter of negotiation.

Avoid dispersed responsibilities and aim to build an end-to-end product management team within the same offshore location.

Establishing local leadership is a crucial element to optimize communication with overseas leads and improve employee tenure.

Assess the offshore partner’s ability to retain talent via brand investment, prudent career management, and employee benefits.

Quality output is usually correlated with soft skills and competencies such as awareness of design-patterns, critical thinking, problem-solving, and multi-disciplinary knowledge. Look for engineering minds rather than coders.

The daily life challenges we deal with shape our mindset and enable us to solve problems with non-conventional solutions. When considering outsourcing destinations, do not be afraid of uncharted waters. That is where companies should be building offshore development centers for the most efficient outsourcing journey. Companies might want to look for:

  • Countries in recession to reduce costs and maximize employee tenure
  • Day-to-day problem solvers by nature
  • An academic curriculum that embraces cross-domain knowledge education
  • Scrutinizing the offshore partner’s domain expertise

By applying these strategies, companies will be able to speed up value creation through technology innovation while meeting cost expectations.

This article was published in on Jun 22nd, 2021.

Expert Opinion

Wissam Youssef
Wissam Youssef


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