The Insider's Guide to Outsourcing Risks And Rewards

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ISBN: 9780849370175 | 0849370175
Cover: Hardcover
Copyright: 5/3/2006

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It is essential for a corporation to not only survive but thrive in today's global outsourcing environment. The Insider's Guide to Outsourcing Risks and Rewards is a comprehensive and accessible resource that assists an organization in deciding whether it will benefit from pursuing-or not pursuing-such an endeavor.The author, an 18-year veteran of the IT industry, is an experienced consultant, software developer, manager, and entrepreneur. Providing an authoritative and unbiased view, he helps the reader navigate through a number of offshore outsourcing issues related to software management and international business. He examines the potential benefits derived from offshore outsourcing, as well as the possible pitfalls and how to avoid them as they apply to an organization's particular situation.Offering a unique combination of technical and political insight, The Insider's Guide to Outsourcing Risks and Rewards is the one resource to have when trying to figure out your organization's next step.

1 Introduction

(18)

This introductory chapter includes sections about best practices, myths, and risks, along with a checklist and a glossary.

It provides many entry points and references to other chapters of the book where specific issues are analyzed in more detail.

1.1 Myths about Offshore Outsourcing

(2)

First-timers in offshore business have much to learn.

This section lists some myths that are commonly believed by inexperienced buyers and that have even appeared in some published articles.

1.2 Best Practices

(3)

Some best practices have been successful in a number of projects and according to the experience of the author.

Notice, however; that best practices are guidelines — not a panacea.

More important than understanding the "how-to-do-it" is understanding the "what-can-go-wrong" when dealing with best practices.

1.3 Risks and Hazards

(3)

Many hazards exist in offshore outsourcing.

That is what the entire hook is about: making responsible managers aware of what can go wrong and what steps could he considered to mitigate these risks.

This section highlights some particularly frequent challenges and references the reader to the chapters and sections where the issues are analyzed in more detail.

1.4 Checklist for Strategic Successful Offshore Outsourcing

(2)

The following checklist provides a number of questions that can help a customer evaluate the maturity of its offshore outsourcing plans and assess the chances of success.

1.5 Opinions and Hard Numbers about Global Sourcing

(4)

At the time when this book was written, widely accepted hard numbers were difficult to find.

Many organizations that submitted such numbers had vested interests to influence the public opinion about global sourcing in one or the other direction.

This might explain why even numbers submitted by governmental statistical institutions exhibited huge differences, depending on which government controlled the respective institution.

Another reason for not including extensive surveys and studies in this book is that the numbers from these studies become outdated rather quickly.

In particular, "expert prognoses" that refer to the future are prone to require "corrections" soon after they are published.

Thus, only a few selected numbers and expert opinions that are currently under discussion are presented here.

1.6 Definitions of Terms

(4)

Offshore outsourcing has developed its own vocabulary.

This section provides a concise overview of the terms used and includes references to the chapters where these concepts are explained in more detail.

2 Drivers

(10)

The potential cost reduction is a compelling argument in favor of offshore scenarios for many companies.

Due to its dominant role in a considerable a number of offshore projects, an entire chapter of this book, Chapter 3, is dedicated to cost aspects.

In addition to the obvious financial motivation of cost reduction, commercial (strategic) or technological issues might be taken into consideration, such as:

Efforts to acquire and maintain IT know-how

Access to scarce talent

Additional flexibility

Focus on core activities

2.1 Technological Drivers

(5)

Gaining access to leading-edge technology may be an important reason for considering an outsourcing scenario.

In many cases the customer wants to outsource the IT-specific know-how, although the domain expertise and business know-bow should remain in house.

A technologically strong vendor specialized in IT offers attractive advantages including economies of scale and access to top talent.

The outsourcing step, however, may lead to strategic risks for the buyer in the long run, such as loss of direct control over technical staff and restriction of free access to intellectual property and business know,-how.

2.2 Commercial and Strategic Drivers

(2)

An advantage of outsourcing is that the buyer gains a certain degree of flexibility: staff must be paid only as long as needed.

To some extent fixed costs are turned into variable costs.

The validity of this outsourcing advantage must be questioned, however, and assessed in the particular scenario at hand, the customer is frequently keen on staff stability on the vendor's side.

Continuity of staff in the context of cost efficiency requires a certain degree of continuity of orders.

The outsourcing relationship allows the customer to focus on its core activities.

The other side of the coin is a higher dependency on the external vendor providing crucial IT services.

Many of the published success stories of offshore outsourcing refer to rather large organizations — say, those with at least 50 in-house IT staff Small organizations have access to offshore outsourcing as well, but they need more creative solutions.

2.3 Allotting Driver Priority

(3)

Technological, commercial, or financial drivers may play a role when designing offshore plans.

Depending on the degree of priority assigned to each of these factors, the outsourcing scenario will look completely different.

For this reason it is of foremost importance that the customer fully understand its motivations and establish its priorities.

3 Costs

(184)

American and Western European companies receive offers for software development from emerging countries such as China, India, and Eastern European nations almost every day.

Sometimes the prices put forward are as low as 25 percent of the price offered by onshore providers for the same services — in extreme cases, even below this rate.

These numbers suggest that cost reductions of at least three quarters should be expected if software projects are outsourced to offshore vendors.

Nevertheless, most case studies report savings of only 15 to 30 percent.

Even these considerably smaller savings are achieved only after the offshore relationship has been established and the cooperation has found its rhythm; the first few projects frequently involve no savings at all and sometimes entail even higher costs than in the case of onshore workers.

This raises the issue of the reasons why this could happen.

Offshore projects include a number of hidden costs of which first-time customers are frequently not aware — e.g., costs for governance and communication.

In failed offshore scenarios, adequate governance often was lacking.

In other cases high communication costs led to reduced communication and consequently to compromised management quality.

3.1 Realistic Estimation of Costs

(4)

An offshore cooperation implies a number of hidden costs that blunt the cost advantages.

Managers who are new to the business are not always aware of the costs of establishing the relationship, transferring the know-how to the vendor, managing the relationship and — one of the most important factors—communication.

Cultural differences can cause more problems than expected.

Failing projects may, in turn, lead to consequential damages.

Last but not least, the customer has to work out a realistic plan of business continuity if the relationship with the vendor is to be ended.

3.2 Cost Dynamics

(6)

Initial costs are only one component of the calculation.

The prognosis of cost evolution is no less important.

The rather high costs of establishing the offshore scenario are present only during the first few projects.

Thus, later projects will not be affected by these initial costs.

However, the salaries for developers in emerging countries have been steadily growing over the years; thus, it can be expected that the differences will not last forever.

The last variable in the equation is the vendor's pricing policy: some of the largest and most mature vendors in India have already started asking why the price has to be lower if the quality is higher

3.3 Communication Cost

(3)

Long distances between service provider and buyer make communication more expensive.

If the two firms are separated by many time zones and have only few common office hours, apparently commonplace things such as phone calls can become a real issue.

Unless the partners on both shores speak the same native language, at least one of them has to communicate in a foreign language.

Depending on language proficiency, the quality of communication may suffer.

Expensive and difficult communication can result in simply less communication, which may in turn lead to a breakdown of management quality.

(See also Section 7.4.)

Due to the hazards of communication cost, the customer is well advised to consider communication costs carefully in the very first outline of the offshore scenario.

This applies especially if the projects are prone to having extensive communication needs —e.g., innovative products.

(See Chapter 8.)

3.4 Business Continuity in Case of War or Disaster

(3)

Once the offshore scenario is established, it has growing importance for the buyer.

Thus war or disaster in the emerging country can have a serious impact on the customer's business continuity.

Some countries are more prone to political instabilities or disasters and others are less vulnerable.

If emergency situations are likely to occur, the customer might want to establish a disaster recovery plan.

4 Countries: Deciding on an Offshore Location

(18)

Partners from at least two countries contribute to the offshore scenario.

The responsible managers should have some basic knowledge about these countries.

This information has to come from reliable sources; otherwise, it is useless or even harmful.

The governments of the developing country or institutions closely related to the government are not necessarily the best sources in this instance because they are likely to make biased statements; most governments throughout the world are vying for foreign investors because such investors are highly attractive for their countries' economy.

For obvious reasons, a government might be tempted to paint its country's image in exaggeratedly bright colors.

Thus it might be better to enlist the help and common-sense expertise of independent sources.

Foreigners who have who have worked in the country's software industry could be reliable advisers.

Organizations that provide ratings of the investment climate in various countries are another source of information.

This chapter provides a checklist of what should be known about the countries and companies involved.

Some items might not be answered, but others might have limited relevance for the offshore scenario at hand.

Some of the questions could have an obvious answer for some managers but not for other members of the offshore relationship.

The questions offer some guidance for further investigation and may help prospective participants in an offshore relationship avoid potentially costly information deficiencies.

The checklist identifies items that may qualify as truisms in industrialized countries but are not to be taken for granted when it comes to developing nations — e.g., continuous supply of electricity, telecommunication, and Internet access.

4.1 Importance of Background Information about the Contributing Countries

(31)

When preparing for setting up an offshore relationship, the management of all contributing companies should be in possession of at least some basic knowledge about the situation in the respective countries.

In addition, they should know as much as possible about their future partners.

This background information is necessary to cross-check the calculation made on an offer.

It helps executives anticipate risks that might arise in future projects and find possible mitigations.

It may even provide some essential information that might lead to the cancellation of future cooperation before it has actually started.

One reason for canceling the cooperation might be that there is no acceptable solution for the anticipated risks: sometimes it is better not to start cooperation at all rather than to have it end in a fiasco.

4.2 Investment Climate

(8)

The political situation in the offshore country can greatly influence the long-term success of the offshore scenario.

Political instability or territorial conflicts might lead to war, which makes business virtually impossible.

Potential natural disasters are other reasons for an emergency plan.

There are huge differences in the way foreign managers perceive the level of security in everyday life in emerging countries.

If personal freedom or human rights are overly restricted, a smooth work flow may become impossible.

4.3 Economic Facts in the Offshore Country

(2)

Cost efficiency is a prime issue in most offshore scenarios.

This is why potential investors should know some basic economic facts about the emerging country, including average income, cost of living, and prices for office space and other real estate.

Taxes are important, and the prognosis for labor cost influences the long-term feasibility of the offshore relationship.

4.4 Legal Systems

(6)

The executives of all contributing companies need a basic understanding of the legal systems in the other countries involved.

There are huge differences in the practical aspects of legal systems in emerging countries and in industrialized countries.

In practice, the differences are even larger than the study of the published laws may suggest.

5 Partners: Customer—Vendor Relationship

(30)

It's all about relationships in outsourcing business.

The first decisions for the emerging relationship are already made before its actual onset at the time when the customer selects a vendor and the two parties negotiate the outsourcing contract.

This preparation task constitutes a significant part of the investment in establishing the offshore scenario, but a carefully structured process of vendor selection can greatly diminish the costs of establishing the relationship.

The customer's first step is defining the vendor selection criteria and clarifying the motivations for the outsourcing decision: financial, technical, or commercial.

After both sides have elicited reliable information, the exact stipulations of the contract can be negotiated.

Once the outsourcing scenario is established, the customer must manage the vendor and oversee the work of the offshore team.

When the cooperation gains speed, it is quite likely that sooner or later disputes about technical or contractual issues will appear.

Litigation is almost always the worst solution.

Therefore, many outsourcing contracts include a dispute resolution procedure, which usually starts with forwarding the conflict in a predefined way to higher management.

If the issue remains unsolved, the partner can apply mediation or arbitration in an attempt to find a mutually acceptable settlement before taking the ultimate step of going to court.

One widely applied method of government and vendor management is benchmark audits; an independent third party provider of benchmarking services helps to analyze the relationship and evaluates the vendor's performance by comparing it to that of peer companies.

The benchmark study should determine whether the service level still matches the state of the art and whether the prices are appropriate and the contractual provisions are fair.

The benchmark report may conclude that the vendor has to solve any identified problems within a reasonable time period or that the fees need adaptation. Benchmark clauses are adopted in many outsourcing contracts.

For the customer, they are a way to keep the vendor honest.

A successful benchmark audit can increase customer satisfaction and thus improve the customer–vendor relationship.

In scenarios where the customer works with a single provider, this vendor can gain undue influence because of its monopoly position.

Some customers try to avoid these problems by working with more than one vendor in parallel.

Such so-called "multisourcing" scenarios can have a number of advantages because they introduce a competitive element.

However, coordinating multiple vendors who are competitors on the market creates other challenges and requires advanced skills in project management and information technology (IT) politics: the work atmosphere might become tense, and the project can reach a crisis because the various service providers do not cooperate smoothly but try to undermine each other's reputation in front of the customer.

5.1 Vendor Selection and Contract Negotiation

(9)

Vendor selection and negotiation of the outsourcing contract are major items on the list of costs in the process of establishing the outsourcing relationship.

However, it is possible to save costs by applying a well-defined, carefully considered, and structured process evolving from the first informal discussion to the signed contract in a systematic way.

5.2 Due Diligence: Eliciting Information about Vendors

(6)

Any outsourcing relationship (not only offshore) is based on trust.

Before the customer can enter this relationship, it has to do some due diligence and collect some basic data about the partner

Cost reductions are a strong motivation in many offshore scenarios.

If the vendor is overly cheap, this may be an indication of economic instability, which is against the best interests of the customer.

Because the vendor's team is part of the customer's extended enterprise, the buyer has to validate the qualifications of the offshore workers.

A particular problem of teams in emerging software industries is the worryingly high attrition numbers.

Many customers ask jar references from the vendor to evaluate its reputation in the market.

However, reading and interpreting recommendations requires experience and a good deal of skepticism.

Most offshore scenarios are designed for long periods of time.

For this reason, many analysts suggest that synergy of strategic goals is necessary.

Security is a particularly important issue in offshore scenarios.

The customer needs to ensure that the fixture partner's security measures reach the necessary standards.

In many scenarios it can prove difficult to elicit reliable and complete information regarding the listed items.

The vendors might have good reasons to disclose only part of the required information or give misleading or even false information.

5.3 Vendor's Need to Garner Information Regarding the Customer

(2)

Like customers, vendors need information about their prospective partners.

The offshore team should have a profound understanding of the client's business culture and the values promoted by the buyer's organization — i.e., how things are done at the customer's site.

The differences in labor costs are a key motivation jar many offshore scenarios.

For this reason, the offshore team has to be aware that protection of the onshore working time is of high priority.

Most buyers are fair and serious, but there are a few exceptions involving somewhat nasty customers.

To avoid future problems, the vendor will want to assess the "rating" of the customer as early as possible.

5.4 Governance: Managing the Relationship with the Vendor

(5)

The buyer is well advised to implement strong and cautious management, carried out by people who fully understand the content and strategic goal of the outsourcing deal, oversee the work of the offshore team, and manage the relationship.

This steering committee constitutes an interface to the offshore team, facilitates dispute resolution, and serves as an internal advocate of the offshore scenario.

In many practical cases, it turns out that overseeing the work of an offshore team is no easier than developing the software in house.

The customer's team usually needs additional training to deal with the challenges of remote project management.

5.5 Dispute Resolution

(2)

During the long term of an offshore cooperation, it is quite likely that disputes about technical and contractual issues will appear.

Frequently, litigation is the last and least desirable option.

For this reason, many offshore contracts provide for a set of procedures for conflict resolution that defines a way in which the partners can express their concerns and search for a mutually accepted solution without resorting to costly litigation.

This so-called escalation procedure includes alternative dispute resolution (ADR) and a reasonable number of preliminary levels before the ultimate step of legal action.

5.6 Benchmark Audits

(5)

During a benchmark study the service levels and prices of the deal are compared to the conditions of the vendor's peer companies.

Usually an independent third party, the benchmark provider, carries out the audit.

A successful benchmark requires careful preparation, which starts with defining the scope of the audit and eliciting the necessary raw data during a monitoring period.

Some contracts provide an automatic adaptation of the prices as a consequence of the audit.

In other relationships, the results are used as a basis for discussion without immediate legally binding consequences.

Not all analysts agree on the methodological reliability of a benchmark audit.

Some object that most IT projects are unique and not really amenable to a like-to-like comparison.

Another objection is that the quality of the relationship can hardly be measured by means of normalized comparison.

6 Stakeholders: Interest Groups in the Offshore Relationship

(40)

The offshore relationship has quite a number of different groups with an interest in the relationship ("stakeholders").

Obviously, both companies (onshore and offshore) and their executives are important.

However, other viewpoints should be considered as well, including those of:

The developers in the emerging country — who are working for relatively low pay

Onshore technical staff — many of whom will probably lose their jobs

Offshore managers and entrepreneurs — who might face conflicting interests

Envoys of Western companies — who have to work temporarily or permanently in emerging countries

Offshore liaisons — who are visiting the customer's office in the industrialized country

All these groups have a say in and an important contribution to the success of the offshore cooperation.

These stakeholders can have secret plans for the future, which may not necessarily be in line with the contract.

Only rarely do the other parties involved consider these plans "fair."

6.1 Conflicting Viewpoints: An Introductory Case Study

(2)

Offshore relationships usually involve numerous interest groups with divergent interests, some of which are disclosed, although others are kept secret.

The following case study offers an illustration of how the secret interests of various stakeholders may turn a potentially successful offshore scenario into a failure.

6.2 Customers and Vendors

(2)

It has been said that an offshore scenario has to be a win-win situation.

To some extent this is true; if the deal is overly unbalanced the relationship becomes unstable, and it is quite likely to end in a lose-lose situation — i.e., in a way that is unsatisfactory for both sides.

Skepticism regarding a long-term successful offshore relationship is especially justified if the prices are unrealistically low and not sustainable for the vendor in the long run.

Unfortunately, the harsh reality is that outsourcing is not an inherent win-win scenario.

In many respects, customers' and vendors" interests are poles apart.

The balance of prices is one obstacle against a win-win strategy.

Another obstacle is that the business models are prone to change with time: vendors become better qualified and accumulate additional capital for more ambitious plans.

Customers, on the other side, shift their focus to their core competencies while losing power and control in the IT field.

It is difficult to predict where this dynamic will lead to in, say, ten years.

Both shores will make long-term strategic and commercial plans— which are to their own advantage, of course, and not necessarily to the advantage of their current business partners.

This section will outline some areas where customers' and vendors' interests are diametrically opposed.

6.3 Staff in Developing Countries

(7)

Employing and organizing employees in emerging countries is quite different from managing an onshore software team.

These differences are particularly important for customers who want to establish their own foreign subsidiary and not merely work with an independent vendor

6.4 Management of Human Resources in Emerging Software Industries

105

(6)

To some extent, management of staff in an emerging country is similar to leading a software team in an industrialized country. However, important differences exist.

High attrition of staff is a serious problem in emerging software industries.

Because most software projects require a certain degree of continuity, the offshore management has to pay particular attention to controlling the retention rate.

A specific part of the attrition problem is represented by emigrating software engineers, who constitute a significant fraction of the young graduates.

If someone decides to leave the country, the offshore company usually cannot make a competitive offer to keep this person on the job.

In some offshore countries, there are excellent top talents at a high professional level.

For IT companies, it is very attractive to hire these young stars.

However, even in emerging countries these talents are a scarce resource.

Thus finding, hiring, and retaining outstanding talents requires specific management skills and a lot of background information.

6.5 The Customer's In-House Team

111

(4)

The customer's in-house team is vital when offshore plans are evaluated.

On the one hand, the offshore scenario will need the active support of as many members of the onshore team as possible to train the replacement workers.

On the other hand, most of the members of the in-house team will lose their jobs once the offshore cooperation is established.

Those who will contribute to the offshore cooperation will he needing new skills and significant training.

6.6 Offshore Manager

115

(2)

Emerging countries enjoy high economic growth, but qualified managers are few and far between.

For this reason, some offshore vendors encounter problems with finding and holding onto experienced leaders, as managers with the necessary business experience have many options both in the emerging country and abroad.

6.7 Envoys from Western Companies

117

(2)

Some offshore business models require that managers and technical staff temporarily or permanently relocate to the developing country — e.g., as customer's representatives.

These so-called envoys take an important role in the communication mechanisms of the offshore relationship.

In developing countries, costs of living are usually lower.

However, if the envoy wants to keep up Western living standards, the cost of living might be even higher than in industrialized countries.

As compared to the low per capita income in the developing country, the envoy is considered rather well-off such individuals are attractive targets for crimes with economic motivations.

6.8 Offshore Staff Working in Industrialized Countries

119

(3)

Liaisons are employees of the offshore vendor who work for a certain time at the customer's site (see also Section 7.4).

In many offshore scenarios, liaisons facilitate international communication and narrow cultural gaps.

The liaison usually bears a lot of responsibility within the project.

For this reason, these people are very qualified and carefully selected — which makes them particularly attractive to headhunters.

A possible conflict of interest arises if the offshore worker wants to use the liaison role as a base 'Or starting a software business.

Due to the liaison's large influence in the project, the customer might be tempted to corrupt the liaison to gain undue advantages, apart from the "officially" negotiated ones.

6.9 Offshore Advisers

122

(1)

Establishing an offshore scenario requires much background information about the contributing countries and about IT outsourcing management.

Some specialized consulting companies offer this know-how and can help the customer find a qualified vendor and establish the relationship.

Some offshore scenarios enlist the help of specialized companies consisting of offshore professionals to establish the cooperation.

The advisers working for these companies are experts in the offshore outsourcing of IT projects.

They are well acquainted with the state of affairs in both countries, they are sufficiently knowledgeable on software technology and contracts, and they maintain excellent contacts, both onshore and offshore.

These offshore advisers are frequently rather small organizations; sometimes they are in fact one person companies where the offshore agent is self-employed.

The agency can play various roles in an offshore scenario.

6.10 Shady Business Agents

123

(3)

Selecting a proper, suitable agency implies a certain degree of care and suspicion because not all offshore agents are creditable enough.

The case study gives an example.

6.11 Public Opinion in Industrialized Countries: Globalism

126

(7)

It is not only one company that goes offshore; the entire software industry in leading economies is on its way to foreign soil.

This fact introduces a political dimension to the discussion.

7 Business Architectures

133

(22)

Analysis of offshore scenarios has shown that only a limited number of business architectures turn out to be successful in practice.

Some business models that are successful on domestic markets may fail in an offshore scenario.

Two aspects should be considered when establishing which business model is reasonable in a given offshore scenario: the projects' characteristics and the consequential damages if the project fails.

Costs for communication can be high in offshore scenarios, and management quality can seriously suffer as a consequence of lack of quality communication.

Many analysts consider these facts among the prime reasons for failing offshore scenarios.

For this reason, the business architecture has to address communication cost from the very onset.

Following is a Business Models Overview.

7.1 Business Architecture Adequate to Projects at Hand

133

(2)

The projects that should be carried out in an envisioned offshore scenario have a strong hearing on the business architecture.

A scenario that includes many, short, and easy projects requires a completely different business model than a single large and technologically challenging project does.

Consequential damages are of particular interest in case the project fails: if high damages are to he expected, the client will need additional means of control over the vendor's processes.

7.2 Options for Business Models

135

(11)

When designing the blueprint for the business architecture, the customer has to decide whether it wants to work with an independent vendor or start its own foreign subsidiary.

A subsidiary requires more know-bow but provides the customer with strong control instruments.

In offshore business, several types of one-to-one relations are frequently applied — joint ventures, strategic alliances, etc.

In practice, many of these business architectures are somewhere in between an independent vendor and a foreign subsidiary.

Another factor that influences the business model is the size of the contributing units: although most published case studies refer to large customers, small clients often have to find more creative solutions.

Important business models that are frequently applied in offshore outsourcing are onsite offshoring, body leasing, agencies, and subcontracting (daisy chains). The so-called follow-the-sun model is used in help desk management where 24/7 availability is required.

7.3 Constraints for Business Models

146

(2)

Some specific factors have to be considered when designing the business architecture of an offshore scenario.

The business architecture should take into account the high startup cost of the offshore relationship and the precious know-how that needs protection.

Some business models, such as foreign subsidiaries, require much information on the countries involved and professional background on software projects.

For the customer, it is wise to carefully analyze whether this know-how is available in its organization.

7.4 Communication and Cultural Distance

148

(3)

A major challenge for offshore software projects is the unavoidable long-distance communication.

If this problem is not solved in a satisfactory manner, the communication costs are likely to take up most of the potential cost savings.

For this reason the business architecture should be designed so that communication is minimized.

(See Section 3.3.)

In general it is more cost efficient to outsource an entire project — not parts of a project, i.e., modules.

In addition outsourcing only some phases (like implementation or test) causes higher costs than outsourcing the entire life cycle of the project.

The staff at the offshore site should have enough competence and ownership to assume responsibility for the entire product — i.e., for the final result.

Otherwise, the project may fail because noone is truly responsible for the outcome, i.e., for the success of the project in its entirety.

A rule of thumb says: Outsource entire things (not parts) for their entire life span and make the offshore site accountable for the overall result.

In many offshore scenarios this rule leads to acceptable costs of communication.

The following tactical approaches can help reduce the cost of communication as well as the cultural distance.

7.5 Multi-Sourcing

151

(4)

The customer can try to avoid dependency on a single vendor by working with multiple vendors in parallel — so-called multi-sourcing.

In this way the unduly strong monopoly position of the sole vendor is broken, and competition can put the outsourcing scenario in motion.

Multi-sourcing, however, requires advanced skills in both management of the multiple vendors and IT politics.

8 Selecting Suitable Projects

155

(14)

Certain types of projects can be transferred offshore more easily than others can.

For this reason, the selection of suitable projects is a crucial success factor for an offshore scenario.

The category of projects that can be outsourced advantageously includes short projects and routine work–based projects.

In projects that require very specific know-how, outsourcing can lead to considerable advantages.

It is generally easier to outsource entire projects than parts.

Highly iterative processes such as "Extreme Programming" require specific business architectures to be accessible for offshore outsourcing.

More obstacles have been reported within projects that fall into one of these categories:

Projects with high risks of consequential damages in case of failure

Projects that include confidential intellectual property or technologies that are covered by export restrictions —e.g., military projects

Innovative products that require much interaction between the software team and domain experts or management

Projects that require a high degree of security

8.1 Less Challenging Projects

155

(2)

Less challenging projects, routine work, and short projects are easily accessible to offshore outsourcing.

Thus, these projects are a frequent entry point into an offshore relationship.

8.2 Projects Requiring Very Specific Technological Know-How

157

(1)

Some specific technical problems can be very easy to solve for someone who already did this work but extremely time-consuming for someone who is green in the field and has who must first learn the technology.

Therefore, outsourcing the solution to specific technological problems can be a major advantage.

8.3 Virtual Teams

158

(5)

In some scenarios there might be compelling reasons to outsource only a part of a project or only certain phases of the development.

In many cases, however, outsourcing an entire project for its entire life cycle is more cost efficient.

8.4 Highly Iterative Development Processes

163

(1)

In some projects where time-to-market is extremely critical— e.g., Web applications — eXtreme Programming and other highly iterative software processes have reported impressive successes.

In such software management processes no (or very few) requirements are written in advance.

Instead, one or more user-representatives are permanently working with the software team and specify new requirements just as the project is being implemented.

Integrating highly iterative processes into the widely used outsourcing frameworks—like the fixed-price contract—is difficult.

For this reason eXtreme Programming requires a specific business architecture to be successfully outsourced.

The anecdote is an example of such a situation.

8.5 Unsuitable Projects

164

(5)

Some projects are less accessible to offshore outsourcing.

This class includes:

Projects with high consequential damages due to project failure

Projects that include valuable intellectual property, confidential data, or technologies subject to export regulations

Projects that lack clear 'written specifications

Innovative projects for which complete requirements are hard to specify in advance

In some organizations, anticipated cost savings arc limited and do not justify the investments and risks of the transition period

9 Contracts: Project Contracts and Service Agreements

169

(44)

The contracts used in outsourcing business can be roughly grouped in three categories.

1. Fixed-price contracts. An estimate of the workload is prepared in advance, and the contract partners agree on a fixed amount of money for the entire project.

2. Unit-price contracts. The contract sets a certain sum to he paid per hour of actual working time.

3. Service agreements. The provider substitutes for the customer's internal IT department for a certain period of time.

The contract specifies the vendor's duties and the monthly fees.

Project contracts involve more-or-less detailed written requirements determined before the implementation can start.

When the implementation is finished, the product must be officially accepted by the customer.

In most projects, the implementation is followed by a guarantee period during which reported failures must be repaired without additional payment.

9.1 Requirements

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Requirements are usually developed in several steps that provide an increasing level of detail: the Product Vision Statement, the Concept of Operations (CONOPS), and one or more detailed Software Requirements Specifications (SRS).

Before the CONOPS is agreed upon, the project is considered to be in the "brainstorming phase."

In this phase many projects are likely to undergo fundamental changes regarding the feature set and the volume of investments.

Quite a number of projects are cancelled before they reach the phase of detailed specification.

Frequently, the vendor has to contribute in one way or another to the requirements phase.

In some outsourcing scenarios, the partners start discussing technical aspects even before the contract is completely negotiated and signed.

This practice raises two important issues:

1. How is the vendor's precontractual investment protected?

2. How is the confidentiality of the requirements ensured?

9.2 Fixed-Price Contracts

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In a fixed-price contract, the partners agree in advance on a certain price for a specified project.

The requirements must be rather well specified in advance and in written form because they form the basis of cost estimation.

For customers, the fixed-price contract has the advantage that it provides prior information on bow much the project will cost.

In practice, however, this apparently firm base of calculation must be questioned because most software projects require changes and extensions even before the first version is delivered.

These changes add to the price.

In extreme cases the final price can be double the initially agreed-on fixed price — or even higher.

The "acceptance" is an important milestone in the life cycle of a software project because it triggers the start of the guarantee period.

In addition, the payment for the project must be made at this stage at least a significant part of it.

A specific problem that might arise in fixed-price contracts is cancellation.

Unless the contract includes a carefully drafted clause, the customer can only cancel the project with high losses.

9.3 Unit-Price Contracts

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In a unit-price contract, the working time that has been spent developing the project is accounted and paid for at a rate on which the partners have agreed in advance — e.g., payment per hour.

Notice, however, that a unit-price contract (in its pure form) does not limit the budget for the contract.

Because a limited project budget is of vital importance for most buyers, unit-price contracts frequently include upper limits, ensuring that the project will be finished within this budget.

Unless the contract provides something else, the maintenance of a unit-price project is paid for separately.

This is at the very least a nuisance for the customer because it has to pay the vendor for repairing its own faults.

In some cases the maintenance can significantly increase the costs of the project.

Because the customer has to pay for each working hour, it has an interest in making sure that the reported hours have really been used for its project.

Verification of the reported hours is a particular issue if the vendor is offshore.

9.4 Guarantee Period

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The purpose of the guarantee period is to provide the customer with the right to free-of-charge repair of defects discovered after the project has been delivered.

Although the guarantee period is an important part of most contracts, some issues require further in-depth consideration.

There will usually be a delay between the error report and the corrected version.

The customer would like to obtain the corrections as fast as possible.

In practice, however, this is not always possible.

Some defects require that a service engineer come to the user's site and analyze the problem there.

The costs for travel are usually much higher than the few working hours spent correcting the error.

If this is an issue, the contract should provide how such costs are handled.

Repairing reported faults is much more efficient if the failure is reproducible on the developer's computer— i.e., if the developer has a known procedure that always shows the reported wrong behavior.

Mature defect reports, however, require additional efforts on the side of the user.

A particularly challenging class of defects is "transient defects" — i.e. failures that occur only sporadically, even if the same sequence of operations is performed on the same computer.

Resolving defects of this class can be very costly.

Thus, the contract should include stipulations in case the project is prone to this class of errors.

In some cases it may be debatable whether a reported behavior is in fact a failure or if it is a desirable feature.

Many of these potential disputes are clarified in style guides, which specify in detail the "look and feel" of the applications of a certain operating system.

In practice, however, it may prove costly, for the vendor to stick to each tiny detail of the style guide that is being implemented.

For this reason, some service providers hesitate to sign contracts that include references to style guides.

Repairing the defect is only one step. Delivery of the corrected version causes additional costs. In general, not each fixed problem justifies a new version.

Software does not wear out over time.

All failures that are identified afterwards are already present in the software at the time of delivery.

In some countries, legislation does not cover this case adequately, and it might be necessary to make clear that these are not "latent defects" — otherwise, the guarantee period for software would never end.

9.5 Transferring Responsibility for Source Code

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In many software projects the responsibility for source code (in jargon called "ownership) is transferred during the life cycle of a software project.

Prior to a certain date, a certain team "owns" the source code; after that date, another team is responsible for it.

Notice that in this context "ownership" is equivalent to responsibility and does not hint at the notion of ownership in a legal sense.

One example where transfer of ownership is necessary is the guarantee period: before the guarantee period ends, the vendor is accountable; afterward the customer is responsible (unless the contract provides otherwise). Transfer of ownership can entail difficult defect responsibility issues.

9.6 Service Agreements: Outsourcing the IT for a Certain Time

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A service level agreement usually includes the following parts (among others):

Contract terms — flow long is the contract valid?

Scope of services. What exactly are the vendor's duties?

Service Level Agreement (SLA).

A detailed specification of the quality of provider services (e.g., response time).

10 Industrial Espionage

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Confidential assets benefit from little legal protection in emerging countries.

In this chapter, an introductory case study shows how easy it was for a Pakistani clerical worker to threaten a prestigious American hospital with publishing their confidential patient files on the Internet.

Ultimately, the Pakistani worker could not even be sentenced for what she had done.

Potential targets of industrial espionage include data, source code, and business secrets, each of which has different dynamics and is thus analyzed separately in this chapter.

There are a number of ways that confidential material can fall into the wrong hands, including server access, test data, access of the offshore liaison to the customer's networks, an unreliable subcontractor of the vendor, professional industrial spies, criminal attacks against the vendor (e.g., forced entry into the office building), and vendors who are also working for the customer's competitors.

Protection against espionage includes tight monitoring of human resources and understanding of the legal systems of the countries involved — to provide the necessary deterrence of adequate punishment in case the attacker is caught.

Despite all precautions, watertight protection of confidential material in developing countries has been difficult, at least so far.

For this reason, the customer has to assess carefully which risks its organization can afford and whether the cost advantage justifies the risk.

10.1 Espionage: An Introductory Case Study

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This case study outlines the situation of a clerical worker from Pakistan who had been transcribing confidential patient data from a prestigious hospital in California.

The Pakistani woman claimed that her client owed her money and threatened to make the patients' files public through the Internet unless she was paid the money she believed was due to her

10.2 Targets of Espionage

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In this section three targets of espionage are addressed: confidential data, source code, and business secrets.

Data is the most systemized and easiest item to protect.

Source code and the related technical documentation are more difficult to protect because they have to be handed over to offshore staff who need to work with them.

Business know-how has a rather unstructured meaning; even a handwritten page of paper on which an executive outlined a new business idea can be top secret.

Background information about the business is usually not considered "secret."

Nevertheless, on some narrow markets it can constitute a precious resource that is managed like a secret.

10.3 Potential Security Vulnerabilities in Offshore Scenarios

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There are a number of ways for potentially unreliable offshore workers to access confidential information:

The protected data is placed on a server that can be accessed by offshore staff, either, foreign engineers who gain access to the server password in an unauthorized way or developers who have legitimate access to the server because they have to carry through maintenance tasks.

Test data frequently contains information that can be traced back to real persons or real customers.

This is true especially if the test data is used in the context of analyzing a reported defect that only occurs in very specific conditions.

Workers in emerging countries are rather poor and thus more tempted to take up unserious offers.

Although many customers have some lines of defense in place against external attacks, the defense against attacks from inside is frequently rather poor.

Throughout the offshore cooperation, foreign staff can gain the status of insiders.

In this case it may be ridiculously easy for the offshore developer to break the lines of defense that were supposed to protect against "attacks from inside."

Some offshore vendors subcontract part of the work to other countries where the salaries are even lower— and so is the reliability of workers.

Another category of unreliable workers is spies in software teams who get employed from the very beginning .for the main purpose of stealing confidential information.

A special kind of espionage strategy is that of "intentional security vulnerabilities" — fragments of code that are included in legitimate software allowing unauthorized access to classified information (e.g., "backdoors" and "Trojan horses").

Security in emerging countries frequently fails to meet the standards of industrialized nations. Unless the vendor's office building is under permanent surveillance, it is quite likely that sooner or later forced entries will be reported.

Other potential security gaps include the vendor's networks.

Vendors who are also working for competitors constitute a particular danger for confidential information.

In extreme cases, the competitor could even buy the vendor's organization.

10.4 Defense against Espionage

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Careful preparation of lines of defense and tight monitoring of human resources can greatly improve the security of confidential material.

Another important solution is severe punishment if the attacker is captured.

Nevertheless, the protection of confidential material in emerging countries does not reach the high standards level that it does in industrialized countries.

For this reason, the customer has to assess carefully which risks to take.

11 Termination of the Outsourcing Relationship

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Only a few outsourcing scenarios continue indefinitely.

All others end sooner or later; they are limited to one or more projects, or they are designed for a certain period of cooperation.

The customer should retain the ability to terminate the relationship with the vendor and continue its business with another provider or bring the services back in house.

This step requires access to key personnel and to technical material such as source code and documentation.

Contractual provisions are important, of course.

Experience shows, however, that contractual provisions alone are not enough to meet the requirement of business continuity after finishing the outsourcing relationship.

The exit plan must also include careful management of in-house know-how and practical business decisions, e.g., maintaining leadership in essential business relationships.

These conditions seem obvious; nevertheless, they cannot always be taken for granted in practice.

In many outsourcing relationships, the customer's dependency on the vendor constantly grows until it reaches an extent where the customer cannot go on anymore without the vendor.

In this case the customer cannot easily escape this binding relationship — even if it is not necessarily legally binding and the contract includes provisions for termination of the cooperation.

If the buyer is not really in a position to end the relationship, this vulnerability might turn to its disadvantage in time; the vendor might change its pricing strategy or decrease its service level.

A recent poll shows that it is anything but rare that IT services have to be brought back in house (see Figure 11.1).

11.1 Contractual Stipulations

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Most contracts allow termination due to breach of material obligation.

Termination for convenience allows the customer to end the contract without any reason whatsoever, paying a fee agreed upon in advance.

Some contracts include other reasons for termination — e.g., in case of insolvency or if the vendor leaves the business.

Contractual provisions are important if the customer wants to terminate the contract.

Additional practical preparations, however, are necessary to provide business continuity.

11.2 Vendors Forestall the Departure of a Customer

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The vendor has good reasons to build up a strong position with the customer and thus increase the customer's dependency on its services:

The vendor wants to receive additional orders from that customer in the future.

The vendor tries to keep the client away from potential competitors.

During the time of the contract, the vendor will take measures so that the customer can switch to another provider after the contract is finished only with considerable difficulty.

The outsourcer might want to increase the margins of the services provided for that customer.

The buyer, on the other hand, faces a number of obstacles when it wants to switch from one vendor to a competitor.

These obstacles help the provider consolidate its position with this client.

11.3 Issues of the Posttermination Transition

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A customer who wants to switch from one vendor to another will encounter a transition problem that includes:

The necessary transfer of know-how from the old vendor's staff to the new vendor's staff

Access to technical documentation, intellectual property, source code, and other deliverables

Leadership in business relationships

The posttermination assistance might turn out to be inefficient because the relationship is strained and the vendor is uncooperative.

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The Insider's Guide to Outsourcing Risks And Rewards

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Table of Contents

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