US offshorers enamoured of China

As dissatisfaction with the existing offshore vendors grow, US buyers of offshoring services are looking at China with growing favour, says global consulting firm, DiamondCluster International's latest research.

Increasing dissatisfaction among US buyers of outsourcing services is leading them to terminate their contracts prematurely with offshore service providers even as they struggle to harvest the full value of their outsourcing relationships — despite having planned to increase their level of outsourcing over the next 12 months, says the third annual 'global IT outsourcing report released early this month by global management consulting firm, DiamondCluster International (Nasdaq: DTPI).

According to DiamondCluster International's 2005 Global IT Outsourcing Study the number of buyers prematurely terminating an outsourcing relationship has doubled to 51 per cent while the number of buyers satisfied with their offshoring providers has plummeted from 79 per cent to 62 per cent.

The report relies on the responses and discussions with senior 210 IT executives at global 1,000 companies and with 242 senior executives at outsourcing service providers in the US, India and other countries. The research was conducted in late 2004 and early 2005.

"The blame cannot be heaped solely on the shoulders of providers," says Tom Weakland, partner at DiamondCluster who leads its Global Sourcing Practice. "Many buyers are now several years into at least one outsourcing relationship, but they still lack effective measures to gauge the success of their outsourcing initiatives, which are critical for knowing and getting what you want."

DiamondCluster's third-annual study was the first in which any buyers reported that they are planning to reduce their outsourcing spending. Seven per cent will decrease onshore outsourcing and five per cent will do the same with offshore outsourcing.

As for outsourcing's benefits, the re-allocation of internal resources to more critical functions was the benefit of outsourcing buyers most often cited (83 per cent). Cost savings, generally considered the primary driver of outsourcing decisions, was only second in the DiamondCluster study.

While India and the US are still the top locations for outsourcing services, interest in China is growing, which is bound to put downward pressure on rates. But while this evidence of a maturing market suggests challenges for outsourcing providers, the news appears better for the IT staffs at US companies. While senior executives still view outsourcing as a cost-cutting opportunity, they also recognise outsourcing's value as a means to manage variable demand from the rest of the business and to redeploy in-house IT personnel for more crucial purposes.

"This finding underscores several things we see going on in the market," Weakland said. "Companies are learning that the tremendous cost-savings outsourcers have been promising are actually very difficult to achieve. And they are learning more about the cost of losing good people and the value of their institutional knowledge."

Other key findings from DiamondCluster's 2005 study of companies that outsource and the vendors who provide IT outsourcing services, include:

• 40 per cent of buyers expect to outsource some IT functions to China over the next three to five years compared to eight per cent last year;
  
• 88 per cent of buyers remain concerned about employee backlash, but worries about anti-outsourcing legislation and political pressure have waned;
  
• Buyers report that the greatest risks of outsourcing include the increased complexity of managing relationships, reduced operational effectiveness, and lower quality of output from their outsourcing providers.

China rapidly emerging as next offshoring hot spot
In 2004, only six per cent of survey respondents said they planned to establish offshore operations in China. Today, that number has soared to 40 per cent. "China is starting to look like India did 10 years ago," Weakland said.

"As outsourcing capability in China takes off, it will put deflationary pressure on the traditional providers of commoditised outsourcing services and set an entirely new price point. The most aggressive providers are establishing operations in China now to grab market share. Taking a wait-and-see approach is not an option.

Countries that appear to have fallen out of favour, according to the data, are Israel and Russia.

Providers keep the "face of outsourcing" out of sight
While worries about anti-outsourcing legislation and political pressure have dropped dramatically from 85 per cent to 50 per cent, concerns about backlash from employees, customers and the public persists. Eight-eight per cent of buyers remain concerned about employee reactions to outsourcing, 67 per cent fret about employee severance costs, 66 per cent about customer reaction and 65 per cent about negative publicity. Sensitive to buyers' concerns, providers limit their onsite presence to keep the "face of outsourcing" out of sight from employees, according to the study.

"Interestingly, buyers are not overly worried about the impact of competitor criticism or union pressures on their outsourcing endeavours," said DiamondCluster's Weakland. "We feel that this shifting mindset shows outsourcing has become integral to today's business strategy."

Despite war, terrorism and mounting tensions in the Middle East, buyer perceptions of global stability have improved. In 2004, 78 per cent of buyers said that concerns about global stability were impacting their outsourcing decisions, but today that number has dropped to 68 per cent.

Larger world conflicts are concentrated in regions not typically known for outsourcing and concerns about reactions here at home are taking precedence, according to Weakland.

Providers get smart about pricing
Buyers offered conflicting viewpoints on pricing of providers. While the majority believes rates have remained consistent, 25 per cent believe they have increased and 22 per cent believe they have declined.

"Providers have worked hard to remove cost as a key differentiator and it appears to be working," said Weakland. "Traditional industry pricing benchmarks are becoming less reliable as an indicator, therefore, buyers must be willing to balance costs and value when negotiating price."

Summing up the major findings of the 2005 study, Weakland said, "The organisations we studied make it clear that outsourcing is here to stay, but they are still struggling to execute an optimal sourcing strategy. One-off, transactional outsourcing deals haven't yielded the expected results.

"The future of outsourcing is dependent upon the ability of buyers to think about sourcing IT talent strategically and in using the appropriate metrics to confirm that they are deploying the right resources — internal or external — for the right functions," said Weakland. "In turn, it will be up to providers to meet and exceed buyer expectations, or risk losing important contracts."