LOSING THE SWEATSHOP MENTALITY
CIOs tend to say some variation of the following about offshoring today: It's not just about low-cost labor. Note the "just." Offshoring's still about pursuing cost savings, and companies still won't go offshore unless they save at least 20% to 30% compared with using their own staff, says NeoIT chairman Atul Vashistha. But the picture's gotten more complex, with more focus on factors such as accessing specific skills, weathering ups and downs of business cycles (what FedEx CIO Rob Carter refers to as "variable capacity"), and paying outsourcers in part based on a specific business result.

"The portfolio of IT work has changed dramatically, and we look to India as a source of the latest skills on the very latest of platforms," says Clive Selley, CIO of BT Group's BT Wholesale division, who has worked with Indian service providers for 15 years. BT Wholesale still places routine application maintenance work with Indian outsourcers, but it also has Infosys, Tata Consultancy Services, and Tech Mahindra working on customer-facing projects, such as running the processes and systems for the entire "lead-to-cash" process for its broadband business, from the time a would-be business customer expresses interest until it places an order, gets a bill, and pays. Selley predicts BT Wholesale will increasingly outsource such "holistic customer experiences that span people, processes, and technology."

More are getting comfortable with that idea. This year, 40% of InformationWeek 500 companies said they do business process outsourcing offshore, compared with just 17% in 2004. TCS says that last quarter, for the first time, its maintenance and application development revenue accounted for less than half of total revenue, with contracts to run business processes, manage infrastructure, and provide IT consulting now the majority revenue source.

Hidden costs were one of the hardest lessons of the past decade of offshoring. Many companies found they didn't realize the promised savings once management time and rework costs were factored in for products that, while coded to specification, didn't meet expectations. That's leading to outsourcing contracts based less on the input--number of engineer-hours worked--and more on the output, measured by the project's success in terms of generating revenue from new products, meeting system uptime requirements in an IT infrastructure support agreement, or the number of customer policies processed in an insurance company BPO contract.

Pankaj Vaish, a managing partner at Accenture who's based in India, is seeing more business process outsourcing contracts based on savings from lower-cost labor plus a performance measure. So if Accenture--which expects its Indian workforce to reach 35,000 this year and surpass the size of its U.S. staff--is collecting bills for a customer, the contract might include a percentage based on driving the typical accounts receivable cycle from 30 days to 25 days and on the resulting improved cash flow.

All this is a distinct shift from the past. Offshore outsourcing got its first big push in the late 1990s, as U.S. companies scrambled to fix the Y2K computer date field problem. When 2000 arrived without disaster, it convinced U.S. companies that "those guys in India can actually do good work," says NeoIT's Vashistha. When the U.S. economy sank two years later, and CIOs were asked to cut IT budgets, many looked again to offshore development work. As business investment slowed and outsourcing rose, IT unemployment shot up above 5.5%. Programmer jobs fell more than 20% in two years, according to Bureau of Labor Statistics surveys. Meanwhile, Indian outsourcing firms positively boomed: In 1996, annual sales at Tata Consultancy Services, now the nation's largest IT service provider, were $150 million. Last year, its revenue hit $4.3 billion--a compound annual growth rate of more than 100%.

Reports of failed offshore projects trickled in, but they tended to be small enough that companies could keep them quiet, often contracting for rework from another provider. Some companies, burned by the experience, brought the work back in-house. That still happens plenty today: 20% of InformationWeek 500 companies say they've taken back offshored work in the past year. Too often, companies got back code that didn't deliver the expected business benefit, because the developers didn't understand the company and IT teams weren't used to writing specs for an outsider. "No matter how good people program every day, if they're programming the wrong thing, it's not helping you," says Ralph Szygenda, CIO at General Motors, which has offshored IT work for more than 10 years.

These problems aren't causing companies to run from offshoring: 36% of InformationWeek 500 companies have sent additional work offshore in the past 12 months. The biggest risk these providers face is keeping up with growth, having enough trained people to deliver quality work without blowing the labor cost advantages. Some of their customers are lending a hand, crafting closer relationships with their offshore providers despite past problems they may have faced.

Judy Poirier was hired as VP of IT at Celestica, an $8.8 billion-a-year electronics manufacturer, in April 2006 after a failed project the prior year to outsource management and support of the company's IT infrastructure to an Indian supplier, which she declined to name. The Indian company didn't have sufficient talent, took too long to train staff, and suffered from high employee turnover, Poirier says. Celestica brought much of the work back to Canada, where the company is headquartered.

But here's the telling point: Celestica didn't bail out on offshoring. Poirier was brought in in part to help the company figure out how to do offshoring right. In late 2005, Celestica tapped HCL Technologies to do a one-time custom development project related to the company's SAP system. It was a relatively safe bet, considering the maturity of SAP application development skills in India. The project worked, and Poirier this year formalized a contract for more development work. Poirier says she's sending more work to HCL because she sees it as a vendor that can collaborate with Celestica and that has the right culture for retaining people in the volatile Indian labor market.

Talent and attrition are the biggest risks to India as an offshoring destination, and one of the top considerations for companies looking to send work offshore. Infosys hired 30,946 people in its fiscal year ended March 31, but lost about 11,000 throughout the year. TCS hired 12,523 employees just in its second quarter, while losing more than 3,200, and it plans to hire another 9,000 this quarter. Late last year, TCS launched a program to turn science graduates into software professionals through a seven-month intensive training program in technologies such as Java and .Net. The result was evident last quarter: About half of its new hires were "trainees," of which about 20% were science grads. IBM had about 53,000 Indian employees as of March, hiring about 10,000 in six months. Accenture's target of 35,000 Indian employees is up from 8,000 last year.

HCL has taken some pretty radical human resources steps to combat attrition. The company's motto is "employees first," a twist on the "customer first" mind-set. An employee who has a problem with the company or a manager can submit an electronic trouble ticket--like many IT help desks use--and the appropriate manager must respond within 24 hours. There's an internal Web page, open to all, where employees can provide feedback on any manager. "Their ability to retain resources in such a volatile market is a result of that program," says Celestica's Poirier, who now has HCL employees working "right alongside our employees in Mexico and Asia."

After two years of success with application development, Poirier now is looking at HCL to help with major upgrades of IT systems, doing higher-value development of technology road maps and system design, as well as software development and implementation. "They've done it 15 other times with 15 other customers, and we haven't done it before," she says.