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global sourcing strategy and its relative success in implementing its global objectives.
Smart companies need to see measurable ¬nancial results or other strategic bene¬ts
and adjust the “How much” incrementally.




Leveraging offshore strategically: beyond cost savings

Leveraging offshore strategically applies to those companies in the fourth stage of the
offshore stage model (Figure 5.1). While relatively few companies have advanced into
this stage, such companies gain more from their offshore strategy than using offshore
locations simply as low-cost suppliers.
In particular, the spotlight in this section is on those strategic goals that are enhanced
or unique to offshoring. While there are many types of strategic advantages to out-
sourcing, to acquisitions, and to collaborations “ all of which can also be performed in
your home country “ this section separates what makes offshoring truly different.
Strategic offshoring may be even more important for companies that perform software
R&D than for “end-user” organizations like GE or Deutsche Bank. Hundreds of Western
high-tech companies, European, American, and Japanese, are doing software work off-
shore in either captive centers (subsidiaries) or via outsourcing, which in this case is also
labeled as “contract R&D.” For example, Indian-based Wipro provides offshore contract
R&D on a massive scale. It has 6500 engineers who supply services to many technology
¬rms including 9 of the 10 largest global telecommunication operators.2
Six strategic goals to leverage offshore are introduced here (and depicted in Figure 5.2).
Not all of these apply to both types of software work: end-user companies (such as banks)
and software R&D (product or embedded). Of the six strategic goals, one applies only to
end-user IT, two apply only to software R&D, while three apply to both types of work.

1 Speed, agility, and ¬‚exibility
The ¬rst strategic goal is illustrated with the case of the German airline Lufthansa:
In 1999, Lufthansa Cargo embarked on a massive IT project: to automate its
booking system. The company was hesitant to perform this project in-house
because it was not certain it had suf¬cient resources and suf¬cient know-how.
The project required expertise in middleware with speci¬c expertise in the
middleware software product BEA. On top of this, the air carrier, under
competitive pressure, wanted the project done very fast.

Lufthansa put the project out for bid. Two of the largest US-based IT service
firms each bid about 50 million USD, committing to a 2-year development
duration. The third bidder, Perot Systems, like the other two bidders, brought
expertise in airline systems to the table. But Perot relied on offshore resources to
staff some of the project. It won the bid for just 25 million USD with promised
97 Offshore strategy



4 Technological SW
1 Speed SW IT
diversification

5 Deeper SW IT
2 Talent SW
localization
ge
ta
an
v
ad 3 Knowledge
l SW IT
na
o
a ti networks
c
Lo
Capitalize on
6 New revenue IT
rapidly growing
generation
markets
Op
er
ati
on
al
s tra
teg
y

Reengineering processes
Legend
(Not unique to offshoring)
Applies to IT for end-user companies
IT
Applies to software R&D
SW

Figure 5.2 Leveraging offshore: strategic goals of offshoring.


delivery in only 9 months, which is less than half the duration of the other
bidders. Perot bid without some of these resources in-house, knowing that if they
win the contract they can “buy” the resources in the Bangalore cluster. They did.

Lufthansa Cargo became the ¬rst air cargo carrier in the world to offer its
customers an online-booking system.

The Lufthansa Cargo case illustrates the power of offshoring: the ability to draw from
a large labor supply to achieve quick ramp-up time (the time get the project started)
and reduced project duration (time-to-completion).
Certainly, speed is achievable in the US and Europe, but it is quite expensive.
Moreover, in Europe, quick ramp-up for large projects is more dif¬cult because labor
is in¬‚exible and largely immobile. Gathering engineers together from distant European
locations is unusual. In contrast, one of the attractions of offshoring is the ability to
build massive centers of hundreds, and sometimes thousands, of software profession-
als. In other words, offshoring is an opportunity for considerable consolidation in order
to achieve economies of scale.
Reducing time-to-market can also be achieved using follow-the-sun development
(introduced in Chapter 1). By taking advantage of time zone differences, the offshore
unit can accelerate a project: while the British workers sleep, the Asian offshore unit is
re¬ning the prototype and then passing it on for inspection, feedback, and re¬nement
98 Managerial competency


at the end of their day. If the company in question is a software product company, it
may be able to shave several months from the development cycle and release a product
earlier, giving it a competitive advantage. Some software companies have bene¬ted
from the speed advantages of follow-the-sun. For example, Portal Player, a maker of
multimedia chips and embedded software for Apple™s iPod, with R&D in India and
Silicon Valley, was able to perform rapid prototyping using follow-the-sun.
Offshoring organizations can be speedier and more agile due to the large, motivated
supply of labor. This is a labor force of young software engineers that are driven very hard
to succeed. They work long hours, often sleeping at the of¬ce to get more done. Thus, the
organizations offshoring to these destinations can afford to assign a large number of engi-
neers to a problem; and these engineers can be assigned to forge ahead in several direc-
tions instead of just one; they can ramp up and respond to a business need within days
instead of months. Infosys staf¬ng illustrates the depth of the labor pool. Infosys, as one
of the largest Indian providers, receives 900,000 job applications per year. When the com-
pany needs to staff more projects, it turns opens the labor pipeline a bit more. Murthy,
CEO of Infosys, asserts that his company is “always selling itself at twice its current size.”

2 Talent for innovation
Talent has a speci¬c meaning in the software business. Of the millions of software pro-
fessionals in the world, most are “blue-collar” programmers with commodity skills.
They are largely interchangeable with one another. A blue-collar programmer in
Bulgaria or the US or Brazil is undifferentiated (except for his price).
However, the top of the software labor pool is the talent. In software, as in music,
anyone can learn to play an instrument, but only the talented can compose a symphony.
The software talent are those who can innovate. They are the brilliant programmers
and software architects. They are not interchangeable. Nor are they easy to ¬nd. For
software R&D this talent is a key competitive factor.
In previous decades, software companies tapped talent locally, in their own nations.
In the 1990s, they began turning to Israel, India, and later still, to China. By the early
2000s, there were several hundred software R&D organizations in the leading offshore
nations.3 Intel, for example, has R&D organizations in India, China, Russia, Israel and
several other offshore destinations. While some of the offshore tasks are routine, and
some of the bene¬ts are in lower wages, Intel located and expanded in these locations
in order to access the local talent. Some of Intel™s leading chip sets are now designed
outside the US, by engineers in Israel and, more recently, in India. A measure of inno-
vation is the generation of patents: engineers within American technology ¬rms oper-
ating in India ¬led a cumulative one thousand (US) patents by the end of 2003.4
Software companies prefer to set up centers in locations that are a magnet for talent,
in technology clusters. And this becomes a virtuous circle: companies come because of
the talent; the talent comes because the best companies are there. A technology cluster is
an ecosystem that attracts key technology ingredients: the best technical and managerial
99 Offshore strategy


talent, as well as other ingredients, such as capital. In the 1990s, the undisputed global
technology cluster was Silicon Valley. Although it was expensive, the Valley attracted
technology ¬rms which were interested in access to its talent and access to critical
local (soft) knowledge that it had to offer. The up-and-coming technology clusters of
the 2000s are in India and China.

3 Building global networks for knowledge sharing
Successful companies encourage their various local and offshore centers to connect
and share in all kinds of ways. These locations collaborate, share knowledge, offer
ideas to each other, learn from practices in other countries, and solicit small problem-
solving solutions from each other. The importance of these networks applies to all
kinds of global companies: to non-technology multinationals, such as Unilever; to
pharmaceutical companies, such as Eli Lilly; to technology companies, such as Intel;
and to software companies, such as Microsoft.

4 Technological diversi¬cation
Large technology ¬rms can diversify their technology portfolio more effectively when
they spread their R&D facilities globally. Granstrand and colleagues5 studied global
technology ¬rms and found that the companies that attain long-run competitive advan-
tage are those that have expanded to many foreign locations and, in the process,
achieved technological diversi¬cation. These corporations are leveraging their off-
shore units to attain strategic diversi¬cation.
Companies need to have a diversi¬ed set of technological competencies not only in the
¬rms™ distinctive core competencies “ those that outsiders are likely to recognize “ but in
three others. The ¬rst of these competencies is in “niche” areas, which are intrinsically
small, and are those in which the ¬rm has less expertise, a lower pro¬le, and fewer
resources. The second competency is in background areas, dealing with processes and
coordination, allowing ¬rms to bene¬t from technical change. For example, the emer-
gence of India as a global center for applying mature quality processes in software
development is a strategic “background competency” for some companies. Third,
companies may also retain competencies in some marginal areas in which they have no
distinct advantages, although these generally tend to be outsourced.

5 Deeper localization
Almost all software has to be localized to local language and culture. The closer you
are to your customer, the deeper the localization. In strategic parlance this is called
local responsiveness. Many companies localize by hiring foreign language experts at
home. However, situating localization in the target market allows ¬rms to better cus-
tomize products to the local markets, particularly the large and more promising mar-
kets, such as India and China. This is the case with Microsoft™s signi¬cant presence in
China, with its development centers in Shanghai and Beijing which devote signi¬cant
resources to Chinese language scripts and other local needs.
100 Managerial competency


6 New revenue generation
Since the offshore markets are growing much faster than those in industrialized nations,
a company that is offshoring its IT functions has greater opportunities to generate new
revenue and new value from these operations. The path that many companies have
taken is to spin off their offshore center, create an independent offshore unit that can
sell IT services or products to third parties. A number of ¬rms have gone beyond that
point. Offshoring has given creative players greater opportunities to capture value from
their operations, particularly in India, by selling assets at a multiple of their original
investment. One offshore expert summarized it this way: “You take a look at your
assets, polish them in India where it is cheap, and sell them dear.”
Three examples illustrate this strategy:
— British Airways created its Indian-based WNS division in 1996 to reduce its operational

costs in IT and IT-enabled services. WNS was quite successful and grew dramatically.
British Airways recognized the strategic potential and began selling off pieces of WNS.
Its software assets were sold to Kale Consulting. What remained of WNS was a
successful IT-enabled services ¬rm. In 2002, a 70% stake was sold to Warburg Pincus.
Today WNS is the largest independent IT-enabled services ¬rm in India.
— US-based Citibank created its Indian-based CITIL division in 1989 with an initial

investment of about half a million USD. The division provided IT services to the
parent and, in parallel, began developing banking software products. In 2000,
Citibank renamed the division i-¬‚ex to capitalize on the brand recognition of its
Flexcube software product. i-¬‚ex became a public company in 2002 and later
reached an incredible market capitalization of 1 billion USD.
— UK-based ebookers, a large travel company, created its Indian-based Technovate

division in 2001 to support the parent in IT and IT-enabled services. By 2003,
ebookers recognized the potential strategic value in its successful division and
began selling Technovate piece by piece, with the ¬rst piece going for 10 million
USD based on an impressive market valuation of 160 million USD.

Operational strategy
Offshoring may also be used as a strategic opportunity to attain important operational
goals, such as re-engineering internal company processes. Corporations have tradi-
tionally used the occasion of building a new information system as an opportunity to
redesign wasteful, inef¬cient corporate processes, such as account processing and cus-
tomer approvals. Over the years these opportunities for organizational transformation
also coincided with outsourcing.
Does offshoring offer a unique advantage in this regard? No, because there are no
strategic locational advantages to the offshore geographic locations, the offshore
providers, nor the offshore labor. In particular, the offshore providers have no unique
advantages in organizational transformation. While the offshore ¬rms have been effec-
tive at delivering generic services, skills, and bright programmers, these ¬rms have no
101 Offshore strategy


advantages at re-engineering processes. Offshore providers have not developed advan-
tages in various vertical ¬elds and industries relative to the American or European
¬rms with which they compete. We should not confuse the high-quality processes
practiced by Indian providers (e.g. Capability Maturity Model (CMM) Level 5) with
the ability to innovate the client™s performance or system capabilities.
While there are many strategic advantages to outsourcing, we do not see evidence
that companies can attain better operational strategies offshore simply because it is off-
shore. We illustrate this point by examining the related area of outsourcing strategy
(not to be confused with offshoring strategy). The Outsourcing Journal gives out
annual awards to IT outsourcers that achieve such goals as “most transformational”
and “best process improvement.” These are strategic bene¬ts of outsourcing which can
be implemented by American, European, Indian, and other ¬rms. However, there is no
inherent advantage in offshoring to achieve transformational change unless that goal is
combined with other unique offshore advantages such as speed.
In conclusion, there are six strategic goals in leveraging offshoring that go beyond
cost reduction. The common denominator in ¬ve of the six goals is the ability to take
advantage of location-speci¬c factors. These locational advantages are in human
resources, easier links to various geographic locations, and proximity to markets.
These factors are called location-speci¬c because, by and large, they cannot be moved.
The offshoring company leverages these location-speci¬c factors using its own know-
how in order to create strategic value.



Strategic perils

Companies need to be cautious of strategic missteps in offshoring: losing their core
competencies, forgetting their strategic goals, and losing advantages in proprietary
knowledge and proprietary code. We cover each of these perils in this section.


Core competency is lost

“The distinction of core versus non-core activities does not hold in our case.”
Senior IT manager at a large
North American retailer on the ¬rm™s offshoring plans
“We have very few competitive technologies in our IT.”
Senior manager at a major Wall Street ¬rm
regarding the ¬rm™s offshoring plans
The ¬rm™s core competencies are those capabilities that are the source of its competitive
advantage over its rivals. These are capabilities that its competitors cannot imitate “ at
least not without great effort. Today, the conventional wisdom is that companies should
102 Managerial competency


hold tightly to their core competencies while trimming the rest “ becoming “virtual” or
“hollow” corporations via outsourcing, or more recently, via offshore outsourcing.
It is clear that smart companies should never outsource their core competencies, for
they will lose them. But what in IT is really a core competency? This is a question that
companies have been struggling with for years. Information systems that only a few
years ago were considered “strategic systems,” and therefore verboten to outsource,
are no longer considered vital as the quotes above illustrate. Companies are much more
liberal in outsourcing a variety of activities. Without doubt, some companies see IT as
a corporate function that has no core competencies (“IT doesn™t matter”).
The enthusiastic headlong plunge of some companies into offshoring may cause
decision-makers to overlook their core competencies in IT. We note Strassman™s studies
of outsourcing in this regard. In 1995, Strassman headed a study that led to the writing
of an in¬‚uential article called “Outsourcing is for losers.” He followed up on that article,
releasing a study in early 2004 titled “Most outsourcing is still for losers.”6 Strassman
calculated the value added of outsourcing using ¬nancial statements of two sets of data:
US ¬rms in general, and of US banks (who tend to be aggressive in their outsourcing
strategies). In both cases he found that the ¬rms that outsourced performed less well.
Strassman argues that his results suggest that “companies already failing for other rea-
sons tend to outsource increasing amounts of work, thus diminishing their value added.”
Some companies have examined offshoring vis-à-vis core competencies and deter-
mined that some competencies should not be offshored, drawing a line around a set of
technical and business competencies. For example, a major American health care sys-
tems ¬rm articulated the capabilities that it would not offshore: domain knowledge,
architecture, integration, and delivery. Companies can also approach this analysis by
conducting an inventory of their corporate-wide systems and determining which sys-
tems embed core competencies that the ¬rm should not outsource onshore or offshore.

Forgetting the broader strategic goals
Just as core competency is ignored, the plunge into offshoring may ignore a company™s
broader corporate strategic goals. We present two non-IT examples from the consumer
goods industry that illustrate how offshore cost reductions need to be balanced with
other strategic goals.
Many ¬rms in the athletic shoe industry outsource much, if not all, of their manufactur-
ing to low-wage nations (Nike, Reebok) in order to reduce costs. New Balance has taken
a different approach.7 New Balance maintains about 20% of its production in the USA. Its
costs in the US are somewhat higher, though its US productivity is also higher. Producing
domestically gives it the advantage of closer integration between design and production,
and greater quality control. The higher costs represent only 4% the costs of a typical shoe.
Many ¬rms in the apparel industry offshore to reduce production costs; yet Spanish
fashion chain, Zara, determined that time-to-market is more important than reduced
labor costs and kept most production at home in Spain. In the ¬ckle world of fashion
103 Offshore strategy


taste, being ¬‚exible and responsive is essential. By coordinating the production and
logistics process very tightly through its IT, Zara is able to restock its European stores
twice a week with completely new styles, with time-to-market that is 12 times faster
than its rivals.8
The lesson in these stories is that a focus solely on offshore cost reduction may
divert attention from the larger, more important strategic goals.


Losing advantages in proprietary knowledge and proprietary code
Software companies, in products and embedded code, face signi¬cant offshore risks
involving code theft or leakage of proprietary knowledge (as covered in the risk sec-
tion of Chapter 2). Stolen code that ends up in the hands of a competitor may be a
severe risk. Knowledge leakage is insidious. If a ¬rm is offshoring to a growing com-
petitor nation “ and many of the Asian destinations are in this category “ then it runs
the risk of transferring key know-how abroad, to its eventual rivals.
American technology ¬rms have staked out positions at all ends of this strategic
spectrum. “Competence will stay in US,” remarked one R&D manager in a conversa-
tion with us, meaning that at this ¬rm there will be tight control over what is offshored.
In 2004, Microsoft was quick to deny that core parts of its next Windows software
release will be offshored to India. However, in the same year a study found that 79%
of American software companies that were offshoring were performing some core
development tasks offshore.9 Often, it is the American technology giants such as Intel
and Motorola that have been moving core development tasks to China and India.



Strategic collaboration: offshore business models

Once the offshore vision is articulated, the offshore strategy needs to be developed,
de¬ned, and executed. This execution and implementation can travel down one of two
paths: “Buy versus Build.”
Certainly, “Buy versus Build” is not unique to offshoring: it is a generic business
decision that crosses all industries and all business types. Offshoring is no different:
variations on the offshore collaboration strategy diagram of Figure 5.3 have been used
in countless corporate meeting rooms and consultants™ presentations.
“Buy versus Build” represents a set of trade-offs. The “Buy” strategy encompasses
offshore outsourcing or offshore out-tasking (project contracting). From the point at
which the decision is made, “Buy” implies faster ramp-up time because the provider
already has operations in place. It is a less risky short-term strategy, particularly
because of the dif¬culties of international business; and it generates greater short-term
savings. Generally, the “Buy” strategy is chosen by ¬rms that are offshoring secondary
corporate functions, such as IT or IT-enabled services.
104 Managerial competency


Faster benefits
Less short-term risk
Less control
Buy t-task) Less strategic
u
ce, o
sour
(out



Slower benefits
Build
More short-term risk

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