By guest author Tony Scott
The Phases of Outsourcing: Cost Arbitrage and Process Efficiency
Tony: Anand, what you are doing is primarily outsourced product development – isn’t that unique to Persistent and a couple of other companies?
Anand: Yes it’s more rare. If you look at the amount of outsourcing that is being done by banks or some of the larger non-tech enterprises for their internal IT projects, by comparison, Microsoft, IBM, and Oracle do very little outsourcing for product development.
Tony: Is that because they have large captive Indian organizations?
Anand: No, even if you count those offshore captive organizations, it’s still a fairly small fraction of their total business. For example, Oracle probably has 5,000 to 10,000 people at best in India, including everybody. Its R&D group shouldn’t be fewer than 50,000 people.
Tony: So given the fact that historically, tech companies have not outsourced product development, how has that impacted Persistent’s business model, and have you seen this change over the years?
Anand: I’ve been selling outsourcing for 19 years now, and I believe that there are four distinct phases of how outsourcing has happened. These phases are true not just for the outsourcing of IT and software development but for any outsourcing whatsoever, whether it is cars or semiconductors. You can go through any industry and you can see these four phases.
Tony: Can you describe the four phases?
Anand: The first phase is purely cost driven. What happens here is that it’s a cost efficiency equation for companies. If there is anything you can do somewhere else at, say, one-fifth or one-sixth the price, people are willing to try it out. So what they do is move the factory to some lower cost place. The U.S. auto industry took their factories and pushed into Mexico and other regions, and used local labor to make the product since those labor rates are at a significantly lower cost. If the labor component on a product is reasonably high, this works out well, and you get a significant savings. So in the first stage, you are essentially using the arbitrage on the cost of labor as the main point of entry into the concept of outsourcing.
Anand: The next phase is when companies start to focus on process efficiencies. To do that, they not only put a factory in a new location, but also ask all their suppliers to put their factories there. To further use the auto industry example, instead of having a process that is based in Detroit, they follow a local process that is more optimized to the local environment and get the local people to improve the process of how the product is delivered. Now it’s not just cost arbitrage, but you are achieving process efficiencies as well.
Creating more efficient processes is where you get the next turn of efficiency of money. So once you have low-cost labor, the next thing you do is try to improve processes. And you can reap some benefits if you are very smart about how you are using the optimal resources.
If you are looking at manufacturing, you know you should try to optimize the supply chain, but do you really look at what exactly is going on inside your process? We’ve had situations where a company shut down an office in a particular area and moved that work to India or somewhere else where they are working across time zones, and then they don’t do certain things to make that work to the best advantage. There are all kinds of things you can do to improve efficiency, and there is value that you can bring in locally by evaluating what you have been doing in certain ways historically and seeing if you can do it some other, more efficient way. Many times what happens is that when you’re working from a process that was created in the U.S. context, and there were traditional reasons why people would not have looked at any other way to do it. When part of the process is outsourced or off-shored, it gives the company a chance to clean up the process and make it more efficient – that’s the second phase.