The offshore outsourcing model was first successful in India, and therefore, it wouldn’t be wrong to call India the birthplace of offshore outsourcing. Indian companies have provided application development services to overseas firms for more than a decade. In addition to a vast pool of talent and fluency in the English language, India has two other traits that are needed to be a successful offshore region—rapidly-growing infrastructure, and a proven experience of doing business with Western companies.

India’s popularity as an offshore region of choice has grown in recent years. Between 1998 and 1999, the number of IT projects sent by companies based in the United States to India grew by almost 60%. With such strong demand for Indian IT services expected to continue, the IT services market has become a major driver for India’s present and future economic growth.

Recognizing the tremendous value of this market, India is working to maintain its status as a dominant offshore region. To that extent, the Indian government has shown strong support for the software industry, encouraging advances in software development through tax breaks for companies and educational incentives for students and IT workers.

Others are emerging stronger

Although it is by far the most dominant region in the offshore outsourcing market, India is not alone in the provision of offshore IT services to US-based firms. A number of other emerging offshore regions, including Canada, Mexico and the Caribbean (both are as ‘nearshore’ regions due to their proximity to the United States), South Africa, Israel, Ireland and Eastern Europe, are also in the race.

Each of these emerging regions has the potential to develop into a lucrative offshore outsourcing market. But so far, only India has the four characteristics required of a successful offshore region—fluency in the English language, a vast pool of IT talent, solid infrastructure and experience of doing business with Western companies.

Talking to users of offshore outsourcing, India is clearly the region of choice, though Mexico, Russia and Ireland are also emerging as preferred destinations. Most customers are currently satisfied with their offshore providers and are not looking to establish relationships with firms in other regions or countries. This finding emphasizes the importance of established  successful relationships between vendors and end users in the outsourcing market.

As is often the case in outsourcing engagements, an end-user with a successful current or prior relationship with an outsourcing vendor is likely to award new projects to the same vendor without putting the projects out for competitive bids. In the offshore outsourcing market, end-users with successful offshore relationships are likely to continue using the same offshore providers for additional projects.

Those companies that have opened global offices staffed with their own personnel—the global operations model of offshore outsourcing—are more likely to look beyond India to meet their offshore needs. For example, PriceWaterhouseCoopers has an office in India and is looking to expand operations in India and in Eastern Europe. Companies leveraging the global operations model of offshore outsourcing may be primarily attracted by the significant cost savings in regions such as Eastern Europe.

Of contracts and services

Offshore outsourcing contracts are typically lower in value and shorter in length than broader IT outsourcing engagements. Whereas the typical infrastructure support deal will range in length from five to ten years, offshore outsourcing contracts average one year in length.

The legacy of application development services in the offshore model remains strong. A majority of the IT projects sent offshore in 2000 included application development services, including traditional mainframe-based application development, e-commerce-based application development, and enterprise platform application development.

It is important to keep in mind that the end-user here comprises large, high-technology companies. These companies are currently sending a great deal of application development work offshore, but expect their offshore portfolios to expand beyond application development over the next five years.

Application development services will continue to account for a majority of spending on offshore IT services. However, with the proliferation of Internet and wireless expertise among offshore firms, one does expect to see a shift in the mix of IT projects sent offshore over the next few years.

Future of offshore outsourcing

In a validation of the offshore model, current end-users of offshore outsourcing services plan to continue their use of offshore IT service firms in the near future. Users responded that their offshore outsourcing needs will change. In addition to application development work, current end users plan to outsource other services, including remote network management and customer care and help desk functions (e.g. expansion to Web-based chat).

Cost-savings are the primary driver of offshore outsourcing. However, cost-savings are difficult to quantify. Offshore outsourcing users estimate savings of 20-40% of a project’s total cost. Exact estimates vary, from 30-40% of the total outsourcing budget of a firm to 40% of the total labor costs on all outsourced projects done offshore.

Ishan Ranjan is VP, projects, CMIL.