The premise of offshoring is simple and straightforward: Reduce costs and gain a competitive edge by seeking out labor markets where skilled, well-educated workers are willing to be hired for a fraction of what comparable talent commands in the home market.
At some level, at least, the model seems to work. Companies that offshore – either directly or through a third-party service provider – have consistently achieved savings in the vicinity of 20 percent a year. But our data shows that there’s lots of money being left on the table, as projects are often poorly managed and could (and should) be reaping significantly greater benefits. Moreover, increasing wage rates and other factors suggest that many offshoring initiatives are headed for serious trouble over the long term.
Put simply, when it comes to offshoring, companies need to lose the complacency and seriously revisit their strategies.
The Price of Lift and Shift
The traditional approach to offshoring – commonly termed “lift and shift” – involves moving operations as quickly as possible to take advantage of lower wage rates. Transitional issues and process inefficiencies that exist onshore aren’t a major concern, the thinking goes, since additional personnel can be hired to the offshored operation without significant cost.
But lower individual labor rates in an offshore operation only take you so far. For one thing, lower individual productivity in offshored environments, even in so-called “mature” operations, quickly eats into your savings. While offshoring to a captive operation allows you the opportunity to improve productivity over time, our experience has shown that’s unrealistic in practice, particularly when the “lift and shift” approach involves a service provider. The challenge is compounded because problems must be managed through a third party.
Simply throwing bodies at problems has implications for service quality as well. In one case, we analyzed a mortgage processing operation that had failed to fully deploy workflow technology, resulting in 30 percent of effort being spent tracking down late documents, resulting in serious problems in terms of extended cycle times and increased errors.
Excessively high turnover rates in many offshore operations contribute further to reduced cost savings. Here’s a typical scenario: A problem is offshored and additional “lower-cost” (but highly educated) bodies are hired without any effort really made to find a solution. After a while, the highly-educated bodies grow frustrated and depart for more financially and intellectually rewarding employment, resulting in even more bodies being cast into the void. A vicious cycle is created, whereby service quality and efficiency suffer.
While the problem may be tolerable today, it’s one that won’t go away and will likely get worse. Upward salary pressure in India and elsewhere is forcing organizations to seek new destinations; but the low-cost/low-efficiency model will likely be replicated in these markets as well. Although the salary differential between onshore and offshore workers remains substantial, the combined effects of lower productivity, increasing salaries, hiring/training replacement staff, and managing problems associated with continuity will close the gap far sooner than originally anticipated.
Here’s another serious long-term implication of the lift and shift strategy as currently practiced: Substantial increases in processing volumes will drive increases in total costs over time. In other words, an inefficient offshore operation – by virtue of its inefficiency – will struggle mightily to keep up with increased work volumes and become even more inefficient. That, combined with the aforementioned salary increases offshore, will significantly offset offshoring’s competitive advantage over time. As the chart below indicates, the cost benefits of offshoring decrease substantially over a five-year period, relative to an onshore environment where an improvement initiative is implemented.
What’s more, the top-performing 10 percent of onshore organizations are able to achieve the cost savings of lift and shift offshoring and more than offset lower wage costs offshore solely by enhancing efficiency and refining processes. “ACME Prior” shows a bank’s performance prior to lift and shift offshoring. “ACME Offshore” shows the 16 percent improvement that results from “lift and shift” offshoring, with no process improvement initiative. “Onshore Best” shows what the top 10 percent of performers achieve, while “Offshore Best” shows top-performing offshore operations.
The Benefit of Fix and Mix
So, the question remains of how to achieve “offshore best” status – world-class performance levels in a low-cost offshore operation. The answer lies not in chasing cheaper talent all over the globe. Rather, the key to an effective offshoring strategy is to address performance issues before offshoring, and thereby reap the benefits of both lower salaries and an efficient organization. As such, the best alternative to “lift and shift” is “fix and mix” – optimizing the efficiency of processes within onshore operations, and then offshoring selectively to take advantage of more competitive wages.
Following a slight cost increase in year one (investments in training and transition), the fix and mix approach yields sustained cost savings. Once you establish the offshore operation, continued training and support programs are essential to reduce turnover, to make offshore staff feel like part of the business, and to improve service quality. Here again, a minimal investment upfront yields significant returns over the long term.
The days of cheap yet talented labor are numbered, and you must be more proactive than your competition. Offshoring process problems compounds issues of distance and culture. At a minimum, develop a performance improvement plan for the offshored operation. Better still, reengineer the operation before offshoring. Companies that invest in building solid processes and an onshore management framework in combination with staff training and orientation will win out.