a fine balance* 2397 fine bal white cover 4/7/04 10:32 … fine bal white cover 4/7/04 10:32 pm page...

A Fine Balance*The Impact of Offshore IT Services onCanada’s IT Landscape

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*connectedthinking

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These footprints in the sand were photographed in Rajasthan, India. Rajasthan, formed in 1948, in northwest India,borders Pakistan on the west and comprises 132,150 sq mi (342,269 sq km). Its capital is Jaipur. Rajasthan is dividedinto the hilly southeastern region and the dry northwestern Thar Desert, sparsely inhabited by pastoral nomads. Thesand dunes, stretching into Pakistan’s heartland, have been used frequently by trade caravans of silk and spicetravelling from the Indian subcontinent to Persia. The camel fairs of Pushkar and Tilwara among others are stillconducted through the Thar Desert. In 1974, the desert region was the site of the underground explosion of India’sfirst nuclear device.

© 2004 PricewaterhouseCoopers LLP, Canada. “PricewaterhouseCoopers” refers to PricewaterhouseCoopers LLP,Canada, an Ontario limited liability partnership, or, as the context requires, the network of member firms ofPricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity.*connectedthinking is a trademark of PricewaterhouseCoopers LLP.

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ForewordDespite being bombarded with opinion, rhetoric and news about the trend to outsource domestic IT jobsoffshore, there has been a frustrating lack of information about the impact this trend is having or will have onCanada. In order to help our clients, other Canadian business leaders and government policy-makers betterunderstand the issues of global sourcing of IT services, PricewaterhouseCoopers LLP (PwC), in associationwith author and IT strategist David Ticoll, initiated a research project under the working name A Fine Balance.

The decision to use offshore sources of IT services is an importance business issue affecting our employees,potentially our customers, and collectively the future of our country’s economy. Without further investigationand dialogue on the issue we will make these important decisions without all the facts. This report does notpretend to present all the facts, but it does uncover insights from those already in the offshore IT servicesbusiness, both providers and buyers. It also presents insights from, and makes recommendations for, variousstakeholders, including our governments, education, and trade associations.

To gather the data for this report, we undertook a four-part research program. The four stages of the researchwere:

• Background: Review of over 400 published reports, studies, articles and speeches in the public domain,and market analysis to which PwC subscribes

• Supply Side: Structured 90-minute interviews with leading IT services providers, both global and domestic,representing Canada, U.S., India, France, Russia, and China

• Demand Side: Structured 60-minute interviews with executives from leading companies who buy ITservices using a global sourcing approach

• Stakeholders and Experts: Roundtable discussions with industry stakeholders from education, IT tradeassociations, government, and PwC’s global network of Outsourcing Advisors

The results of the research have been discussed and validated with industry leaders and PwC subject matterexperts around the world. We recognize that, for many companies, offshore outsourcing raises some sensitiveissues. We thank those buyers and providers who had the foresight and courage to participate in our study.Without their candor and insights we would not have been able to provide this report.

It is our intention to create active dialogue about offshore and nearshore IT services. We welcome andencourage your feedback.

Robert Scott David TicollPartner, PricewaterhouseCoopers CEO, Convergent StrategiesToronto, Ontario, Canada Toronto, Ontario, Canada

44 A Fine Balance

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A Fine Balance 43

Notes


PricewaterhouseCoopers LLP (PwC) works with clients around theworld to understand, and manage costs and risks associated with IT.Coordinating and sharing its experiences around the world providesPwC with global perspective to aid in local assistance. Our workaddresses IT planning, IT sourcing, IT project risk management, ITeffectiveness and various other perspectives which matter in managingIT costs.

For more information, please contact:

Robert ScottPartner, IT Advisory ServicesPricewaterhouseCoopers416 [email protected]

Table of ContentsSection 1 Amazing Facts—The Context 1

Section 2 Should You Go Offshore? 8

Section 3 What are Some of the Other Costs to Consider? 16

Section 4 Risk Management 20

Section 5 Selecting the Right Model & Provider 24

Section 6 Making Offshore Outsourcing Work 26

Section 7 Managing the Offshore Arrangement 30

Section 8 The Fine Balance 34

About the Authors 40

Acknowledgements 41

42 A Fine Balance


AcknowledgementsBuyers:We wish to thank the executives of buyer organizations whoparticipated in the study. They represent companies from variousindustry sectors including financial services, manufacturing, telecom,media, and services. Their insights and experiences were invaluable toour education. To protect their privacy and competitive advantage, wehave agreed to keep the names of participating organizationsconfidential.

Providers: We wish to thank executives from the provider organizations whoparticipated in various interviews, discussions and telephone calls.Their contributions were critical in this research. While severalcompanies elected to decline to participate for reasons which willremain their own, the following companies provided candid andcollaborative support:

Aithent EDS Canada Inc.Bonasource Inc. Fujitsu ConsultingCap Gemini Ernst & Young Infosys Technologies LimitedCGI Satyam Computer Services Ltd.ChinaTech Source Tata Consulting ServicesCNC Global

Stakeholders: Various other stakeholders provided perspective and support for ourresearch. In particular, we would like to thank:

Jason Bremner, IDC CanadaBernard Courtois, Information Technology Association of CanadaDr. Darren Maister, Ivey School of Business, University of WesternOntario

PwC Partners and Staffs:PwC prides itself on the concept of Connected Thinking. For this studywe drew support and expertise from PwC’s varied experience andknowledge from around the world. In particular, we would like to thank:

Jerzy Chaba (Canada) Carolyn Morris (Canada)Dibyendu Dhar (Canada) Shyamal Mukherjee (India)Sherry Dickert (Canada) Rob Reimer (Canada)Linda Drysdale (Canada) Alan Ross (Canada)Stephen Durrant (U.K. and Global) Norma Row (Canada)Joydeep Data Gupta (India) Lesley Stubbs (Canada)Gopal Kuchibhotla (India) Christine Walters (Canada)Mark Lutchen (U.S.) Cathy Wraggett (Canada)

For a list of references and sources cited in this publication, please seewww.pwc.com/ca/afinebalance.

A Fine Balance 41


About the Authors Robert Scott

Rob is a partner and National Leader for thedevelopment and delivery of InformationTechnology Advisory at PwC in Canada. Rob hasover 18 years of experience advising clients in thefields of IT Planning, IT Sourcing, IT ProjectManagement, and IT Operations Effectiveness. Heapproaches his work from a balanced businessand technology perspective and is equallycomfortable in either field. He is a member ofPwC’s Global Network of subject matter expertson global sourcing of IT services.

Thomas Garner

Tom is a Senior Vice President and Director inPwC’s Toronto Infrastructure, Government andUtilities practice. Tom’s focus is infrastructure andpartnership transactions involving the public sector.Prior to joining PwC in 2000, Tom served inexecutive, M&A, and advisory roles with severalmultinational organizations. Tom has over 20 yearsof senior-level experience in Canadian, American,and European businesses and transactions.

David Ticoll, CEO, Convergent Strategies

David Ticoll is one of Canada’s leading visionarieson information technology and business strategy,with over 25 years experience in the global ITsector. He has co-authored several business best-sellers, including The Naked Corporation: How theAge of Transparency Will Revolutionize Businessand Digital Capital: Harnessing the Power ofBusiness Webs. David also writes a column ontechnology and business strategy for The Globe &Mail. David was founder and CEO, from 1994-2001, of the Toronto-based international think tankand strategy firm, Digital 4Sight. He has served onseveral task forces for the Canadian and Ontariogovernments. David is a director of the InformationTechnology Association of Canada and a memberof the Advisory Board of Dexit, Inc.

Section 1Amazing Facts—• The respondents to our interviews—IT services providers and large

Canadian corporate buyers of IT services—agreed unanimously thatoffshore outsourcing in Canada has lagged the U.S., but is poised fora dramatic take off.

• Canada’s reputation as a venue for nearshore outsourcing issomewhat exaggerated. Though the country may have approximately150,000 call centre workers servicing U.S. firms, it’s likely that thenumber of skilled IT workers engaged in outsourcing projects is wellunder 20,000, if not 15,000.

• Canadian companies currently employ approximately 550,000 ITprofessionals, according to a study for the Software HumanResources Council. Some 75,000 or more of these jobs, we believe,could move offshore by 2010.

• Employment in Canada’s software and computer services sectordeclined by 6.1% during the first three-quarters of 2003. From 1997to 2003, employment in the sector increased by nearly 100%.

• Salaries are not comparable amongst countries. Consider this: ascripted call centre worker in Mumbai, might earn US$1.50 per hour,compared to US$10 per hour in Kansas City; an insurance claimsadjuster in Bangalore might earn US$300 a month, versus US$1,500in Dallas; and the US$15,000 annual salary for a Certified PublicAccountant in New Delhi might translate to US$75,000 in Boston.

• Forrester Research estimated that 3.3 million U.S. services jobs willbe relocated abroad between 2003 and 2018, accounting for US$136billion in wages. Over 400,000 of these jobs will be IT related, withthe greatest level of outsourcing expected in software developmentand customer service/call centres.

• Gartner Inc. predicts one in 10 jobs at IT services firms will moveoffshore by the end of 2004, and a quarter of all U.S. IT jobs willfollow by 2010. Many of the job losses will be structural. Despite the short-term advantages of offshoring, it warns that companiesneed to consider the loss of seasoned IT professionals andintellectual assets, as well as the impact of offshoring on thefunctions of their organizations.

• A widely agreed rule of thumb is that, on average, 30% of IT staff mustbe onsite or close to the users; the remaining 70% can be offshore.

• India produces 2 million college graduates each year, more than 80%of them English-speaking. The Philippines produces 290,000graduates, all English speakers. China produces 850,000 graduates,with minimal but improving English skills.

• The U.S. is now third in the world ranking of software graduatenumbers, behind India, which is first, and China. China has the

40 A Fine Balance A Fine Balance 1

Section 1Amazing Facts—The Context


largest number of science graduates in the world, while Indiagraduates 260,000 engineers each year.

• From 1997/1998 to 2002/2003, India’s software and services exportsgrew from US$1.8 billion to US$9.9 billion, representing a growth inshare of the country’s exports from 5% to 20%.

• A study for the Indian government projects the country’s revenuesfrom IT and IT-enabled services will jump from US$12 billion in 2003to US$62 billion in 2009, translating into a manpower requirement of1.5 million more jobs.

• In the U.S., software and services industry employment grew thefastest between 1993 and 2000—more than 12% per year—addingover one million jobs. Since 2000, this IT sector has lost 166,000 jobs.

• Though India is the leading centre for offshore outsourcing ofknowledge work, many other countries are involved, including China,the Philippines, Russia, Spain, Ireland, Mexico, Argentina, and otheremerging locations such as Eastern Europe and South Africa.

Offshore Outsourcing is Not a FadOffshore outsourcing of IT work is not just a passing fad. And, of course,it is not just IT jobs that are moving offshore. Any knowledge-basedfunction that does not require direct personal interaction is a candidate.

It is also not just routine jobs that are being relocated. Some of theworld’s leading companies—like Apple, General Electric, IBM,Microsoft, and Morgan Stanley—have set up shop in India to conductresearch, development, and product innovation.

The fact is we are in the early days of a shift that will have profoundimplications for companies, their market offerings, competition, thecareers of millions, and the competitiveness of nations.

Thomas Friedman, author of The Lexus and the Olive Tree, describesthis change as nothing less than the third era of globalization. Hesuggests that the first era, driven by falling transportation costs, ranfrom the late 1800s to World War l. The second, from the 1980s to2000, was predicated on the spread of personal computers and fallingtelecom costs, and is what we usually think of as “our” globalization.This era is over. We have now entered “Globalization 3.0.”

Friedman suggests the third era is the result of three technologicalwaves. First is the massive installation of undersea fibre-optic cable thatprovides bandwidth to send data anywhere, almost free of cost.Second is the proliferation of personal computers. And third is the riseof a collection of software applications—email, Microsoft Office,Internet telephony, and specialized business process applications—thatprovide the mechanism, along with personal computers and bandwidth,for global collaboration and distribution of workflow.

The fact is we are in the early

days of a shift that will have

profound implications for

companies, their market

offerings, competition, the

careers of millions, and the

competitiveness of nations.

We have explored the need to balance the real benefits against the realand perceived risks. Buyers must look at their own unique situation andassess their readiness and willingness to go offshore, and then screenproject characteristics for those most suited for offshore delivery. Theyshould systematically assess and manage risks, particularly thoseunique to offshore.

The worldwide shift to global sourcing of IT services is, at the sametime, a great threat and an even greater opportunity for our domestic ITindustry. We are not at a crossroads, because we do not have tochoose a single path. We can actively embrace the best the world hasto offer in low-cost centres like India, China, and Russia, confident thatlost jobs will be replaced by new ones if we act quickly to define them.We must define our role on the global stage by building up andmarketing Canada’s unique and sustainable advantage as a globalsupplier of IT innovation.

As illustrated, the net effect of this could be major job loss or evengreater job creation. Whether we choose to passionately pursue theopportunity, or suffer silently while departing jobs are left unfilled, we,as Canadians, are today in a fine balance.

Whether we choose to

passionately pursue the

opportunity, or suffer silently

while departing jobs are left

unfilled, we, as Canadians, are

today in a fine balance.



sometimes continuously. Much of the work is high-touch—physicalproximity (including shared time zones) and cultural affinity are critical tosuccess.

Canadian IT educators should teach agile application developmenttechniques. This entails more than teaching technology skills. It alsorequires interpersonal communications, project management, andbusiness knowledge—capabilities that will be critical to a generation ofIT workers that need to appreciate and interact with real people. Thedays of the geek are coming to an end.

Regardless of the move to component-based architecture, global ITsourcing means that the skill sets that will be in demand in richcountries will change. Canadian IT professionals will do well to focustheir skills development on:

• IT/business strategy

• Program planning and management

• Business analysis, solution design, end-user requirements

• Global project management

• Rapid application development

- Rapid application development and collaborative engineering- User interface design- Specialized industry applications (see previous list)

• Application maintenance (where business user interaction is intense)

• Call centre operations

• Technology maintenance and support

• User help desks

IT services firms should work to develop and expand Canada’snearshore IT services industry. An industry association, modeled onIndia’s NASSCOM, should focus on creating the conditions for thisindustry’s success. This industry should capitalize on our proximity tothe U.S., shared time zones, cultural similarities, low geopolitical risk,tax incentives, and cost advantages. Combining the still competitivedollar and cheaper overall labour costs, Canada enjoys a 30-35% costadvantage as a nearshore venue for U.S. customers. Industry andgovernments should seek to ensure that Canadian IT services continueto be protected under NAFTA.

ConclusionWe began this report by indicating that this topic suffers from a lack ofinformation that is relevant to Canada. By sharing current real-worldexperiences that Canadians are having, and by drawing conclusionsabout our collective strengths and weaknesses, we hope to ignitedebate in boardrooms, on the shop floor, and at town halls across thecountry.

Canadian IT educators should

teach agile application

development techniques. This

entails more than teaching

technology skills. It also

requires interpersonal

communications, project

management, and business

knowledge—capabilities that

will be critical to a generation of

IT workers that need to

appreciate and interact with

real people.

We believe that if the first era of globalization revolved around politicsand trade, and the second around supply chains, then the third era iscentred on knowledge work.

As Friedman tells us, new networks, information technologies andmodes of communication are the fundamental driving forces at the rootof this change. But there are others. It is the convergence of businessreadiness with technological change that has made offshoreoutsourcing such a powerful force. As we have seen:

• Businesses in rich countries are now ready to outsource knowledgework. In the second wave of globalization, managers learned todisseminate production work across global supply chains. Throughthis, many acquired mindsets and techniques that prepared them todo the same with knowledge work.

• Knowledge work is becoming increasingly modular and subject toindustrial-style division of labour. Many knowledge-based professionsand business processes have become codified, thanks to computersoftware, quality standards, and process methodologies. Theseactivities can now be separated into increasingly minute pieces to bedistributed among workers regardless of location. In addition tosoftware development itself, areas affected include accounting andfinance (market analysis, tax preparation), customer service (callcentre), back office (HR services, forms processing), and a variety ofindustry-specific functions (insurance claims, radiology, productsupport). In a pilot project, Reuters News Wires recently hired sixreporters in Bangalore to write articles about small- and mid-cap U.S.companies for newspapers around the world.

• The world is ready. Emerging economies now have people andcompanies that offer competitive capabilities, and who understandhow to disseminate, manage, and deliver global knowledge work. InIndia, this is the result of deliberate, carefully conceived efforts tocreate an industry that began in the late 1980s. The effort included afocus on tax policy, education, skills development, business strategy,and marketing. But India is not the only offshore venue; one majorNorth American-based provider also offers services from Brazil,Argentina, Hungary, Ireland, and many other countries.

• The business infrastructure is ready. Leading India-based firms, forexample, have internalized the techniques and methodologies ofoutsourcing that have been developed by leading Westerncompanies, such as project capital finance, service level agreements(SLAs), flexible change management, and governance. They havedeveloped business practices and relationships that generate andsustain the trust that is essential to long term outsourcingrelationships. In addition, they have gained quality certificationlevels—notably the Capability Maturity Model for Software (CMM)—that place them ahead of their North American counterparts, serviceproviders and buyers alike.

Meta Group, an IT research firm, believes that outsourcing withinNorth America is growing at an average of 10-15% annually. Incontrast, outsourcing to offshore venues is growing at a rate of more

The world is ready. Emerging

economies now have people

and companies that offer

competitive capabilities, and

who understand how to

disseminate, manage, and

deliver global knowledge work.

In India, this is the result of

deliberate, carefully conceived

efforts to create an industry that

began in the late 1980s.



than 25%. Most of this growth has been in the U.S., where outsourcinghas been rapidly increasing over the past 10 years. Canadiancompanies have outsourced IT services for decades, but have tendedto rely on local delivery.

This difference, we believe, is about to disappear. Canadian companiesare waking up to the benefits of offshoring, while IT services providersknock on their doors with offshore proposals. And it is not justtraditional global vendors—companies with headquarters in India,Russia, and other offshore locations have also set up shop in Canadaand are using Canada as a nearshore delivery centre to serve U.S. and Canadian buyers.

Why Offshore?Some respondents, especially purchasers of offshore outsourcing, saythat cost savings is not the principal driver of their decision. However,they admit that without cost savings, other factors would not enter intoplay. As for providers, even those who tout other benefits have noillusion that cost savings are central to the rise of this market, and totheir ability to close just about every deal. Respondents estimated thatcost benefits for shifting a major set of IT activities from the U.S. toIndia range between 50 and 70%. Service providers also said that U.S.customers can save 20-30% by moving certain IT activities to Canada.

Low cost is a necessary condition, but it is not the only one. There is nopoint in buying a cheap service if it is of poor quality. Buyers and sellersunderstand that offshoring is about value for money—and when valuefails, the paradigm is at risk.

Quality, therefore, is a critical driving factor for offshore outsourcing.This factor is a bit controversial and, clearly, is central to the valueissue. Most of the large India-based firms have invested heavily inensuring quality.

Other reasons for considering moving offshore include:

• As the country’s most desirable IT employers, Indian IT services firmscan hire the cream of the crop. One Canadian IT executive said thathe met about 100 employees in a visit to India’s top four firms(Infosys, Satyam, Tata, and Wipro), and would have felt comfortablehiring any of them.

• They diligently apply quality management disciplines to projectcontracting, management, and delivery, such as SLAs, formal qualityassessments, reviews and governance mechanisms.

• India’s top firms have, as similarly noted earlier, attained CMM Level5—the leading standard in software quality methodologies. They leadtheir North American competitors, as well as most of their customers,in meeting standards.

Canadian companies are

waking up to the benefits of

offshoring, while IT services

providers knock on their doors

with offshore proposals. And it

is not just traditional global

vendors—companies with

headquarters in India, Russia,

and other offshore locations

have also set up shop in

Canada and are using Canada

as a nearshore delivery centre

to serve U.S. and Canadian

buyers.

Which IT services will Canadians deliver in the future: To differentiateCanada from low cost centres in India, China, Russia and thePhilippines, Canadian IT services companies must leverage industryknowledge, emerging technologies, and expertise in businessprocesses. We see the following niches as having potential in thisevolving environment:

Advanced & specialized technologies

• Animation• Bioinformatics• Content management, reporting and analytics• IT security, mobility, manageability• Software and technology tools• Nanotechnology

Industry applications

• Retail banking• Digital media distribution• Games• Health informatics• Homeland security and defence• Resource industries (mining, oil and gas, forestry)• Telecom

Business process outsourcing

• Accounting• Human resources• Procurement• Customer care• Claims processing

How will Canadians deliver IT services in the future? Just as today’scars consist of interchangeable components, software is moving to anew component-based approach called Services Based Architecture(SBA). Web services technologies and other evolving Internet standardslet applications exchange information more easily. Leading-edgecompanies use services-based architectures to redesign their legacyapplications. Standards facilitate the breakdown of large-scaledevelopment projects—the meat and potatoes for most offshore ITservices companies—into smaller, re-usable chunks. This new modelwill lead to an “IT parts” industry that develops specialized businessknowledge through close relationships with end users. Thesedevelopments are well suited for Canadian IT services companies thatoffer value-added industry or process knowledge, and are intimatelyfamiliar with European and North American business cultures.

Many leading organizations are migrating from a step-by-step waterfallapproach to iterative or collaborative development as seen inmethodologies like Sun’s XP (Extreme Programming), Cap Gemini Ernst& Young’s Accelerated Delivery Centres, and Bell Canada’s ExciteDevelopment Centres. Iterative development breaks large projects intosmall units of work. Developers and business users interact frequently,

To differentiate Canada from

low cost centres in India, China,

Russia and the Philippines,

Canadian IT services

companies must leverage

industry knowledge, emerging

technologies, and expertise in

business processes.



Assumptions• Net job loss is estimated at 13% of total Canadian IT jobs. Note that

this is less than 2.3% of the U.S. forecast of 3.3 million jobs by 2010(Forester)

• Increase in jobs estimated as Canada takes on 3% of the globaloffshore IT services market up for grabs (equivalent to 5% of the U.S.offshore market)

The difference between the passive and proactive scenarios is anopportunity worth over 240,000 jobs over the next seven years.Governments cannot ignore an opportunity to create 165,000 skilledjobs, nor can they stand by and watch 75,000 jobs migrate offshore orbe retrenched back into the U.S. Canada must confidently step up andclaim its share in the global marketplace for IT services.

What Should Canada and CanadianCompanies Do?Companies should make choices about outsourcing that will enablethem to grow and compete. Not all companies must outsource. Forsome, it makes business sense to retain a local work force and rely onloyal, engaged employees. For others, the costs and risks ofoutsourcing simply do not add up. But many will conclude thatoutsourcing is a good choice, and will make their business decisionsaccordingly. Those companies should pursue outsourcing in a plannedand thoughtful way to manage risks and impacts that affect theiremployees, shareholders and communities.

Companies and governments should work together to address the twokey issues associated with outsourcing—impact on laid off employees,and competitiveness of the Canadian economy. These two issues areinterlinked—the future competitiveness of the Canadian economydepends on its ability to create jobs that are marketable and have highvalue. Firms should behave in a transparent and trustworthy way withtheir employees. They should work with governments to cushion theimpact of employment loss and help provide training in skills andcapabilities that have value and potential in tomorrow’s economy.

Governments, business leaders, and the IT industry should focus onensuring that Canada will compete and win in tomorrow’s high-value ITservices, research and development, and innovation. In the past, allaspects of IT represented an opportunity for Canadians and domestic ITservices providers. In the future, a portfolio of niche market strategieswill be required. Quoting the Great One, hockey player Wayne Gretzsky,“You don’t go to where the puck is. You go to where the puck is goingto be”. To aid in determining where the puck is going to be, we look attwo aspects of the future of IT services:

1. Which IT services will Canadians deliver in the future2. How will Canadians deliver IT services in the future

Firms should behave in a

transparent and trustworthy

way with their employees. They

should work with governments

to cushion the impact of

employment loss and help

provide training in skills and

capabilities that have value and

potential in tomorrow’s

economy.

Some North American service providers argue that all this may seemimpressive, but it is not a substitute for deep, on-the-ground culturalaffinity. They acknowledge that offshore firms have an advantage inmaintenance of legacy systems and development of highly pre-specified technology tools, but where business knowledge is critical—such as for new applications or packaged software implementation—aWestern-based firm is the safe choice. Western companies can provideonshore resources to manage the design and business analysis, andthen use their Indian back office as a software factory. Indian firmscounter that they have the onshore resources in North America to dothe same or, if not, that this issue will soon be corrected.

One seasoned India-based executive described the pendulum swingover the past decade in this way: In 1994, on the heels of the recession,the main driver offshore was cost savings. Then, during the heyday ofthe Internet and Y2K, the drivers were time-to-market, quality and, still,cost. When the bubble burst, cost again was primary. “It’s swingingback once again,” according to the executive. “A huge driver today isavailability of skills.”

The Automobile Industry All Over Again?In the late 1970s, the North American automobile industry went intocrisis. Since World War ll, the car business, along with many others,had become lazy, fat, hierarchical and bureaucratic. They awoke to anoil price shock instigated by a Middle Eastern cartel and frighteningcompetition from Japanese manufacturers. Customers flocked toinnovative, reliable, cheaper, and more fuel-efficient products fromcompanies such as Datsun, Honda, and Toyota. In 1955, American-owned companies built 100% of the cars sold in the U.S. Thirty yearslater, their share had dropped below 70%. In 2003, Toyota became thenumber two car company in the U.S., with profits and marketcapitalization exceeding the combined totals of DaimlerChrysler, Fordand General Motors.

At the heart of the automobile revolution was the concept of TotalQuality Management (TQM). The Japanese companies did not inventTQM—they learned it from the U.S. and applied it with rigour anddiscipline. In doing so they not only improved the quality of theirproduct to the delight of the consumer, but they also reduced theirmanufacturing costs, allowing them to sell quality automobiles atcompetitive prices. The parallel to TQM in software development is theaforementioned CMM—another American innovation, developed byCarnegie Mellon University in 1987. Like TQM, CMM defines processdiscipline and ascribes standards to how software should be“manufactured”. As in the automobile industry, the new entrants appliedan American innovation to re-invent an industry. This was done byaddressing the mediocre quality prevalent in the domestic softwareapplication development marketplace.

In 1994, on the heels of the

recession, the main driver

offshore was cost savings.

Then, during the heyday of the

Internet and Y2K, the drivers

were time-to-market, quality

and, still, cost. When the

bubble burst, cost again was

primary. “It’s swinging back

once again,” according to the

executive. “A huge driver today

is availability of skills.”



It is entirely possible that

165,000 or more Canadian IT

jobs will move offshore or be

repatriated to the U.S. by 2010,

along with an equal number of

other knowledge-based

functions.

Like the Japanese automobile

manufacturers, India’s leading

IT services firms, including

Infosys, Satyam, Tata, and

Wipro, have emerged on the

scene to change the rules of

the game. They represent a

competitive threat to global

players like Accenture, CGEY,

EDS, HP, and IBM—as well as

to CGI, Canada’s leading

outsourcer.

• Canada has the depth and wherewithal to respond to this challenge.This is yet another round of competition, and we must step up tomeet it head-on.

The fact remains, though, that offshoring poses economic risks formany individual Canadians and, consequently, to the Canadianeconomy. It is entirely possible that 165,000 or more Canadian IT jobswill move offshore or be repatriated to the U.S. by 2010, along with anequal number of other knowledge-based functions. The Canadian wayis to face up to the social and economic risks, take steps to mitigatethem, and prepare to compete in the new environment.

To understand what is up for grabs, we have painted a pessimistic(passive) and an optimistic (proactive) scenario for what could happen.While debate can rage about the underlying assumptions, the scenariosillustrate what can be done.


Like the Japanese automobile manufacturers, India’s leading IT servicesfirms, including Infosys, Satyam, Tata, and Wipro, have emerged on thescene to change the rules of the game. They represent a competitivethreat to global players like Accenture, CGEY, EDS, HP, and IBM—aswell as to CGI, Canada’s leading outsourcer. The competitive strategiesof the Indian firms are similar to those of the Japanese car companiesin the following ways:

• They apply a quality- and process-based software manufacturingapproach to what is still often treated in North America as a personal,creative craft

• They achieve dramatic cost savings, letting their customers do morewith less

• They have a long-term approach, based on years of preparation,planning, and development of technique

All this bodes well for India-based firms. So are we likely to see SiliconValley, and parts of Houston, Denver, Ottawa, Waterloo, and Montreal,hollowed out as jobs flow to low-cost jurisdictions?

Again we look to the history of the automobile industry. After the initialshock of offshore manufacturing, Japanese companies soon createdmany North American jobs in their manufacturing plants, supply chains,dealer networks, repair shops, and the used car industry. Theproductivity bump led to incremental employment growth in the NorthAmerican sector. The significant difference this time around is that suchjobs are not likely to be created in the IT services industry. Here theproduct is digital, can be built and serviced anywhere and, due tointellectual property rights, is restricted from being resold by a licensee.While offshore-based IT firms are hiring in North America, their netcontribution to IT employment will inevitably be negative.

For a variety of good reasons, Japanese automotive companies haveset up huge modern manufacturing plants in North America. Initially,trade agreements and quotas played an important role in encouragingdomestic assembly. But rising costs, particularly in Japan, have alsobeen a major factor in moving more work off Japan’s shores. For ITservices companies, capital investment is minimal. Several years fromnow, when rising Indian wage rates erode the current gap with NorthAmerica, the work will move—as some of it already has—to places likeChina and the Philippines.

Lessons learned from the automobile industry clearly indicate thatglobal sourcing can shift fortunes and employment in significant ways.

Global and Canadian IT firms are not blind to this. Almost all have agrowing presence in India, from which they deliver offshore IT servicesto customers around the world. However, their employee numbers aresmall relative to the big four Indian companies. They have aggressivehiring plans, but it will take time for them to build organizational culturesand mechanisms that compare to their Indian counterparts. Untilrecently, global players were somewhat hesitant to promote their

Canadian dollar†

U.S.implementsprotectionistlegislation

Backlash

Studentenrollments in IT

Immigration

Taxation

Net job change

Passive

$0.75

Canadian IT servicesrestricted along withthose of other countries

Canada grouped withoffshore providers byU.S. media and anti-offshore campaigners

Negative press results indrop-off in IT trainingcourses in colleges anduniversities; currentcurriculum createsgraduates with skills forjobs which are migratingoffshore

Current levels continue

SR&D programs continueto fund creation oftechnologies, but not thecreation of IT servicescompetencies

Reduction of 75,000 by 2010

Proactive

$0.75

Canada ensures itsnearshore IT servicesindustry which supportsthe U.S. is protected byNAFTA

Canada low-key marketsits advantages and longterm trading partnership

Educators identify thenew skills required.

Canada takes aleadership role indefining the new ITcareer in a GlobalDelivery world; programsprovide internationalexperience

Highly targetedimmigration helps createcentres of excellence intargeted niche serviceareas

SR&D tax programsexpanded to fundentrepreneurship in theexport of IT services toworld markets

Increase of 165,000 by 2010

† Currency forecast TD Bankeconomist January 2003


Section 8The Fine BalanceWe interviewed an IT executive of a large Canadian corporation who had just returned from his first tour of India. He expressed boundlessenthusiasm about the quality of its people and the capabilities of its firms.He now believes that his company could, theoretically, keep only 30% ofits current IT staff—to do creative work and manage projects—and sendthe remaining jobs to India. Furthermore, he thinks many non-IT jobscould also be offshored. “I used to say we should consider the risks ofoffshoring,” he said. “Now I believe we should consider the risks of notoffshoring…we could easily become a brand-name company, with mostof the work done overseas.”

We asked this executive what these changes mean for his children. “I’mterrified. I don’t know what careers I should tell them to prepare for.”

This conversation sums up but one of the issues entailed in thephenomenon of offshore outsourcing. Sure, companies may reducecosts and improve IT productivity and quality, but employees will losejobs, and the entire job market for IT professionals may shrink. Wageswill decline. Individual lives will be damaged. Many IT graduates alreadyface unemployment.

Some argue that this is but a phase in capitalism’s cycle of creativedestruction. The same things happened when Montreal and Toronto lost their textile factories, and when the coal mines shut down inCape Breton. Then a new generation came along and created industriesbased on knowledge and creativity. Be confident that we are on the eveof another wave of economic innovation.

Skeptics respond that knowledge work is the end of the line. The nextcycle may well be a decline in the standard of living for millions ofNorth Americans—a race to the bottom.

Sounds scary. Is protectionism the answer? We don’t think so, forseveral reasons:

• It won’t work. Many of today’s corporations are global, and it ispractically impossible to prevent them from seeking workers wherethey choose to. Barring domestic firms from offshoring would forcethem to compete on an uneven playing field.

• It’s not the right thing to do. Workers and firms in emergingeconomies should also enjoy the fruits of innovation, growth, andglobalization. The alternative is a threat to global peace and security.

• Offshoring does reduce the costs, and improve the quality, ofproducts and services. This is beneficial to consumers, shareholders,and contributes to innovative development of the Canadian economy.

“I used to say we should

consider the risks of

offshoring,” he said. “Now I

believe we should consider the

risks of not offshoring…we

could easily become a brand-

name company, with most of

the work done overseas.”

offshore offerings. Barriers to doing so included internal transfer pricingchallenges, measurement systems tied to local geographies, andgeneral lack of awareness about their offshore capabilities within theirsales force. Domestic and global providers report that many of thosebarriers have now been overcome and they are ready to better servetheir clients interested in offshore solutions.

Domestic and India-based providers are converging. Both sides seek tobe global players with both high-touch onshore services and low-costoffshore services. Mergers, acquisitions, and strategic alliancesbetween domestic and offshore providers could quickly change thecompetitive landscape.

Domestic and India-based

providers are converging. Both

sides seek to be global players

with both high-touch onshore

services and low-cost offshore

services.


Section 8The Fine Balance


Section 2 Should Offshore? Powerful forces drive the growth of offshore IT outsourcing. But howdo individual buyer companies approach the decision to engage inoffshore outsourcing?

The Buyer’s Motivation toOutsource OffshoreCompanies engage in outsourcing—domestically or offshore—toachieve a few basic outcomes. These are:

• Cost savings compared to internal provision, due to differences inwage rates or improved efficiency and productivity

• Access to resources and capabilities not available internally

• Freeing up capital for strategic projects

• Transformation—using the capabilities of outsource providers tofundamentally reconfigure the company

Which of these are driving the offshore decision-making process inCanada? Our research indicates that two of the main outcomes arecentral in the offshore outsourcing decision: cost savings and accessto resources.

Cost savingsIn studies around the world, cost is the most important motivator forinitiating the move offshore. This is what gets the attention of Canadianbuyers, drives the initial engagement of offshore resources, and remainsan objective of offshore outsourcing.

While providers claim average cost savings in the range of 30 to 50%,the actual savings realized by Canadian buyers is reported to bebetween 20 and 30%. Savings may be smaller than advertised butCanadian buyers report that benefits are “in line with theirexpectations,” and that the benefits of improved quality and vendorresponsiveness over in-house operations or domestic providers offeradditional value.

With the rise of the Canadian dollar to its current level around US$0.75,we expect to see more interest in offshoring from Canadian companieswith significant IT labour expenditure. Activity in offshore sourcing hasrecently heated up in the manufacturing sector, which is negativelyimpacted by the rise of the Canadian dollar.

Our research indicates that

two of the main outcomes

are central in the offshore

outsourcing decision: cost

savings and access to

resources.


Section 2 Should You Go Offshore?


• The level of organizational readiness will likely increase, for individualcompanies and for the buyer market. In our research, both onshoreand offshore providers observed that, for the most part, Canadianbuyers were behind their U.S. counterparts in active consideration of the offshore option. However, they are observing an increase inreadiness to engage offshore resources as experience in individualcompanies, companies within industries, and the market as a wholebuilds over time.

• The need for organizational readiness will decrease, as onshore andoffshore providers become more similar. Offshore providers arebuilding their Canadian-based capability, to be “close to thecustomer”. At present, some buyers identified the ability to leverageoffshore resources as an important skill, while offshore providersindicated that they are moving to become more “client friendly” anddecrease the need for this skill. Meanwhile, onshore providers arebuilding their offshore resource base, so that they can offer theirbuyers the cost benefits of offshore provision in addition to theirexisting “close to the customer” capability.

• The need for careful examination of individual project suitability willremain. However as buyer understanding of offshore-related issuesand risks matures, risk management strategies will be built intoprocurement specifications for response by prospective providers.As providers—onshore and offshore—gain a better understanding ofthe unique requirements of the Canadian market they may improvetheir offshore offering to decrease the prospective risks and increasethe net attractiveness of projects.

As providers—onshore and

offshore—gain a better

understanding of the unique

requirements of the Canadian

market they may improve their

offshore offering to decrease

the prospective risks and

increase the net attractiveness

of projects.

Interestingly, despite costs advantages, not all Canadian experiencewith offshore is bound for India and China. One Canadian-basedmultinational moved some network support functions to Canada fromthe U.S. as part of a centralization initiative. In the process, thecompany realized a 50% savings due to a combination of the currencydifferential and lower labour costs. In another case, a Canadian buyerundertook its first offshore venture to a European provider to realize acost reduction, which it estimated at 20%.

Access to Resources andCapabilitiesAccording to our interviews with Canadian companies who havesuccessfully used offshore sources, another factor weighs almostequally with cost savings. That is: ready access to pools of qualifiedresources. Given the uproar in the U.S. over job loss to offshore, thismay seem odd. Nevertheless, respondents identified specific skillareas—such as familiarity with legacy IBM technologies—that are hardto find in Canada.

In one situation, a buyer required a large team of developers tocomplete reports and customizations as part of a sizeable SAPimplementation. The buyer was unable to source 40 SAP developersfrom the Canadian market quickly enough to meet its deadline so itsuccessfully engaged its preferred domestic system integrator to use itsdevelopment centre in Mumbai, India.

Resource availability links to another benefit: flexibility. In an arm’slength contract relationship, not only is it easy to add resources, but itis also easy to remove them when they become redundant. Indianstaffers are renowned for their willingness to work long hours. Also,Indian firms, along with some North American competitors, are knownfor business flexibility—willing to work to achieve stretch goals, and tobargain fairly when a change in scope is required. All these combine toenable faster time-to-market of IT systems—another touted benefit ofoffshore outsourcing. One Canadian buyer indicated that its primarymotivation was the need to engage “70 people for four months” onshort notice, in order to complete a critical project.

Domestic providers should note that several buyers commented thatpoor service quality and account management of domestic suppliershad facilitated the decision to go offshore.

Buyers reported a wide range of results from their first offshoreexperience in terms of the service quality of work, but satisfaction ratesincreased with experience. All agreed that use of an offshore providerpresented unique issues and that a learning curve exists.

One Canadian buyer indicated

that its primary motivation was

the need to engage “70 people

for four months” on short

notice, in order to complete a

critical project.



Freeing up CapitalA buyer organization may be constrained by its ability to raise capital tosupport upgrading of a business process. In no interviews did a buyeridentify access to capital as a reason to deploy offshore outsourcing.This is likely driven by the fact that most offshore outsourcing isdevelopment and application management services and notinfrastructure management. As such, it is more labour intensive thancapital intensive.

Providers identified access to capital as an important consideration inmaking global investment decisions. Differences in cost of capital canhave a significant impact on where global firms elect to build capacity.Most providers indicated that their investments in capacity have beendeal driven (they acquired people and infrastructure through transfer ofassets in an outsourcing deal). To gain economies of scale many ofthose providers are now going through a global review of capacity andinvestment decisions. The decisions about where to invest are basedupon supporting local markets, prevailing local costs (including labourrates), investment climate, and an ability to provide “follow-the-sun”support for services such as application maintenance. Recentannouncements by the Canadian federal government to offeraccelerated Capital Cost Allowance (CCA) write-offs for sometechnology purchases should help make Canada more attractive tothose making global investment decisions.

TransformationTransformation was not cited as a motivator by buyers or onshore-based providers. Offshore-based providers indicated that their mostsophisticated buyers are gaining a transformational advantage fromoffshore outsourcing, leveraging the lower offshore cost base toincrease capabilities in ways that would be impractical with an onshorecost base. Several companies in the U.S. and U.K. are leveraging low-cost services to undertake initiatives which they could nototherwise afford. British Airways, for example, is collecting previouslyunrecoverable fee revenues from travel agents. Using U.K. or U.S.based resources made it unprofitable to collect change fees less thanUS$30, but using India-based resources makes those collectionsworthwhile. The impact is recovery of revenues previously written-off.

The Decision ProcessHow do buyer organizations make the decision to invest in anoutsourcing transaction? Our discussions with both buyers andproviders, as well as our review of published reports, paint the followingpicture:

• One or more triggering events give the buyer a reason to believe thatoffshore delivery may deliver a benefit

To gain economies of scale

many of those providers are

now going through a global

review of capacity and

investment decisions. The

decisions about where to invest

are based upon supporting

local markets, prevailing local

costs (including labour rates),

investment climate, and an

ability to provide “follow-the-

sun” support for services such

as application maintenance.

- Extra care in defining the project and deliverables and“deconstructing them into buckets” so they can be managedeffectively

- Reporting and project management tools, such as scorecards,project meetings and updates at the leadership level

- Using the performance-based risk/reward provisions built intothe SLAs—“the money is not important, but the incentive toperform as expected is”

- Dispute resolution mechanisms—one buyer indicated that itexpected issues and disagreements to arise, but tries to“learn what works and what doesn’t” to resolve conflictswithout having to use formal dispute resolution tools

• Insurance. One buyer indicated that it was using insurance tomanage some of its risks

Who is Really Responsible?It is common for buyers to leave the operational details of an offshoreproject to an onshore (often incumbent) provider. However, buyersrealize that the final accountability for the success of any project,whether in-house, onshore outsourced, or offshore, rests with thebuyers’ management.

To summarize, our research indicates that offshore outsourcing is—atthis stage of its evolution—still different enough from traditional onshoreoutsourcing to warrant special attention from buyer management, andcorresponding participation from onshore or offshore-based providers.

Why is this important? Recent studies, validated qualitatively by ourresearch, indicate that while the number of contract-ending incidents is down for offshore development and outsourcing contracts, in 2003about one in five buyers still ended their contract prematurely. While an 80% success rate may be acceptable to early adopters, it leaves agreat deal of room for improvement for the general masses. Those mostsatisfied with their relationships manage them proactively.

What Might the Future Hold?Our interviews with buyers and providers suggest several trends in thedecision environment for offshore provision in Canada:

• Factors affecting organization willingness to engage offshoreresources will continue to be event-driven. Offshore-based providersobserved (in our interviews and published reports) that while offshoreprovision has been a market reality for many years, only recently hasit attracted the attention of the mainstream news media, government,and the public. This level of attention—for the most part negative—may be permanent, long- or short-lived, but will likely be driven byevents such as political elections and broadly publicized, large-scaleinitiatives from well-known companies.

…buyers realize that the final

accountability for the success

of any project, whether in-

house, onshore outsourced, or

offshore, rests with the buyers’

management.



IDC Canada reports that, in

2003, 16% of clients reported

being offered an offshore

option. With the greater

awareness of the offshore

trend, the rise of the Canadian

dollar and the continued

investment of local resources in

Canada by offshore firms, we

expect this to increase

significantly in 2004 and

beyond.

Building the human side of a

relationship requires investment

on both sides. Experienced

buyers make site visits to their

offshore providers in order to

accomplish this, as well as to

satisfy themselves of delivery

capability.

• The potential benefit is weighed at a high level against a screen offeasibility, cost, and risk considerations

• If the balance of prospective reward versus feasibility, cost, and riskis favourable, the buyer will invest further time and money to pursuethe offshore option

The Triggering EventThe initial consideration of offshore provision for a given initiative canbe triggered by the following types of events:

• Sales calls by providers. IDC Canada reports that, in 2003, 16% ofclients reported being offered an offshore option. With the greaterawareness of the offshore trend, the rise of the Canadian dollar andthe continued investment of local resources in Canada by offshorefirms, we expect this to increase significantly in 2004 and beyond.

• Attendance at industry conferences at which the offshore option isdiscussed, or published reports are reviewed.

• Competitor or sister organization known to be engaging offshoreresources for delivery of processes or projects.

• A critical need to improve a business process.

• IT budget pressure (mentioned by most respondents).

• Dissatisfaction with one or more existing domestic IT providers (anobservation of several buyers).

• For buyers experienced in outsourcing, and offshore provision inparticular, consideration of the offshore option is a matter of coursefor all IT projects, or all projects of pre-determined types.

• Receipt of a proposal unexpectedly involving offshore provision,related to an initiative for which the offshore option was notconsidered.

• Discovery that an existing outsourced relationship involves offshoreresources.


Section 7ArrangementOnce an offshore outsourcing transaction is complete, it must bemanaged for success. This is equally true for a single discrete project, aseries of projects, or a longer-term business process outsourcing (BPO)program. Our respondents employed outsourcing management andgovernance leading practices including:

• Organizing for successful management of the outsourcingrelationship. This includes organizing internally within the buyer andprovider, with clear lines for accountability, authority, andcommunication. It also requires that these two organizations get toknow each other during the negotiation, startup, and earlyoperational phases.

• Developing and building the habits of effective outsourcingmanagement, which should include holding disciplined projectmeetings, referencing the original project plan as necessary,developing a comprehensive SLA, and keeping a balancedscorecard. This also means nurturing the “soft” side of a successfulrelationship between buyer and provider staff at the operational andmanagement levels where appropriate.

• Managing change. In a shorter relationship aimed at completion of adiscrete project, change is generally minimized by defining clearexpectations. However, in a longer term relationship (a series ofprojects or an ongoing BPO service relationship), change is to beexpected, as buyer needs and provider capabilities evolve.

• Preparing for the expiry or renewal of the relationship, which are,again, more common in longer-term contracts.

Best Practices Have GreatImportance Both buyer and provider respondents (onshore and offshore) stressedthe importance of strong governance practices, highlighting thefollowing:

• Building the human side of a relationship requires investment on bothsides. Experienced buyers make site visits to their offshore providersin order to accomplish this, as well as to satisfy themselves ofdelivery capability.

• The importance of structure. For many respondents, particularlyexperienced buyers, necessary structure included:

Organizationalreadinessscreen

Triggeringevent

Organizationalwillingnessscreen

Organizationalcharacteristicsscreen

Decision:invest inoffshoreinitiative?

Section 7Managing the Offshore Arrangement


The Three-Part ScreenGiven the difference in wage rates between offshore and onshoreresources, and the multitude of possible triggering events, why is not all IT work done offshore? The answer lies in opposing factors that ourresearch suggests fall into three categories—two related to the buyerorganization, and one related to the nature of the specific work beingconsidered for offshore provision.

1. Buyer organization willingness: In today’s environment, public relations and political factors canweigh heavily on the offshore decision. Some highly visibleorganizations have decided not to consider the offshore option at all.However, in our study, buyers of offshore services said they wereaware of these issues but were not dissuaded from considering theoffshore option because of them.

2. Buyer organization readiness: Buyer organizations can be at very different levels of readiness toundertake an offshore initiative. Readiness is related to two primaryfactors:

• Level of relevant experience: Organizations with previousoutsourcing experience (particularly successful) are more readythan those who lack it. Even if previous experience is withoutsourcing to domestic providers, the abilities to define andpackage work for successful outsourced implementation, andmanage complex vendor/partner relationships, are importantcontributors to readiness. Offshore providers identified lack ofbuyer confidence and experience is one reason Canada lags theU.S. in using offshore resources.

• Organizational IT capacity and resilience: It is no coincidence thatthe leading buyers of offshore outsourcing are large companieswith substantial internal IT capability in the areas of managementand execution. These companies have the ability to discern andmitigate the risks of an outsourced project going wrong in a waythat a smaller company—or one with a relatively lower level of ITcapability—cannot. Our buyer respondents were all largeorganizations with substantial IT capability; providers indicatedthat such buyers are much more likely to go offshore.

3. Project characteristics: The characteristics of specific projects strongly influences theoffshore decision. Both our own research and published reportsindicate that “impulsive” choices of offshore provision is,appropriately, very much the exception. At a high level, critical project characteristics fall into three main categories:

• Project complexity: The more complex the project, the higher therisk and the greater the management overhead cost. Overall,project complexity is a major factor in what one provider named

Offshore providers identified

lack of buyer confidence and

experience is one reason

Canada lags the U.S. in using

offshore resources.

with measures required by internal policies, customer expectationsand legislation. Steps should include reviewing the provider’smethods of handling personal information, how data istransmitted, accessed, used, stored, destroyed and shared, aswell as employee screening practices.

North American companies need to ensure that their offshoreservice providers are maintaining a high level of informationsecurity. The “paperless environment” is one response to meetthis need—where employees are not permitted to bring any bagsor papers in or out of the data processing facility. Systems that areused to access the data must have some functions disabled toprevent unauthorized copying or downloading of data. Thereshould be no printers, hard drives, CD-ROM or floppy disk drives,and source material should be read-only.

Once an organization is convinced that the service provider’sbusiness practices support personal information privacy, a cleardescription of responsibilities in the contractual agreement isrecommended. Specific requirements regarding data handling andprocessing procedures should be outlined in a comprehensiveSLA, including restriction on use and disclosure. The SLA shouldalso include a right-to-audit clause.

A final consideration is whether and how to inform customers thattheir personal information is being shipped and processedoverseas. Many consumers will be reluctant to share information ifthey know that it is being sent across borders, especially withrespect to sensitive information related to health or financialpositions. However, if organizations do not disclose that informationis being outsourced and a privacy breach occurs, it is likely thatcustomers will sever their relationships with the organization.

There are several responses to

the threat to privacy posed by

offshore outsourcing, including

calls for a legislative or

regulatory response both here

and abroad, as well as more

scrutiny and enhancement to

the control over outsourcing

partners.



In most cases, the single greatest operational risk from offshoreoutsourcing is the impact on internal staff. Even when handledeffectively, the use of lower cost offshore resources can be a seriousthreat to career progression, trust in management, and job security. Werecommend a proactive and open process that engages the existingstaff. Additional coaching and skills-upgrade support may be requiredto mitigate fears of job loss. Where jobs are lost, management must beprepared with a communication strategy that lays out the businessrationale for the decision and, ideally, a broader framework againstwhich other cost saving opportunities will be assessed.

PrivacyOffshore outsourcing is increasingly in the spotlight of activitiescausing consumers and advocates concern regarding personalinformation privacy. The protection of personal information is achallenge for most organizations, and outsourcing only adds tothat challenge. Risks of identity theft and other abuses of personalinformation are increased and difficult to detect and, withoutlegislative jurisdiction, laws and protections that North Americanconsumers are coming to expect cannot be adequately enforced.Add to these risks the fact that most consumers are not awarethat their personal information is being transferred offshore, andthe impact of any breach is amplified, with the consequent loss ofcustomer trust and business.

There are several responses to the threat to privacy posed byoffshore outsourcing, including calls for a legislative or regulatoryresponse both here and abroad, as well as more scrutiny andenhancement to the control over outsourcing partners.

The global legislative environment for privacy is complex andevolving. Canada has comprehensive privacy legislation (theaforementioned PIPEDA), which requires that organizationsprovide protection of personal information in their possession orcustody, including information that has been transferred to a thirdparty for processing. The European Union (E.U.) Privacy Directiveprohibits data transfers outright to any country lacking an"adequate level of protection," as determined by the E.U. Severalnon-E.U. countries have privacy legislation either proposed orenacted in response to this directive. The U.S. is taking a differentlegislative tact regarding offshore outsourcing, with some groupsadvocating legislation that would make it easy for individuals whohave had their privacy violated by an offshore contractor to suethe American outsourcer. Other groups, such as financial services,are threatening an outright ban on outsourcing for specific typesof services. The bottom line is that organizations need tounderstand privacy legislation in the countries where they aredoing business.

Organizations need to make certain that the provider they selecthas taken measures to ensure data privacy, which are consistent

In most cases, the single

greatest operational risk from

offshore outsourcing is the

impact on internal staff. Even

when handled effectively, the

use of lower cost offshore

resources can be a serious

threat to career progression,

trust in management, and job

security.

“the biggest risk—that it doesn’t work.” Specifically, projectcomplexity encompasses:

- The challenge of defining the project in such a way that it canbe successfully implemented offshore, and the cost (moneyand time) of creating this specification. One onshore-basedprovider said projects that can be “defined, with no changes,”are best suited to offshore provision. Another notes the riskthat the outcome could be “letter right and spirit wrong.”

- The frequency and depth of interaction and iterativedevelopment between the buyer and the provider. (Ourresearch and published reports indicate this is generally donelocally even by offshore-based providers. Ratios of onshoreand offshore resources differed greatly by provider.)

• Project criticality: Defines the business risk that a buyer takes byopting for offshore provision. One buyer referred to this as the“back office versus mission-critical” risk assessment. Specifically,project criticality includes risks related to:

- Privacy, protection of intellectual property, data security, andcompliance with regulatory and legislative requirements suchas the Personal Information Protection and ElectronicDocuments Act (PIPEDA). PIPEDA defines the obligations ofcompanies operating in Canada but is not binding for offshoreorganizations. However it does bind their onshore contractingagents. Security and privacy were cited by an offshoreprovider as a major issue being addressed by the Indianindustry, but another provider claimed it was “not a big deal,”or an issue that should deter a buyer. The importance of thisconsideration was reinforced by onshore-based providers,one of which pointed out that these concerns affect anyoutsourcing relationship. IDC Canada affirms that prospectivebuyers list security as the number one perceived risk inoffshore sourcing.

- Impairment of critical customer relationships, either via poorperformance or customer unwillingness to accept an offshorepoint of contact. When Dell repatriated back to the U.S. someof its offshore customer service provision it cited concernswith customer service.

• Project impact on the buyer may vary considerably from contractto contract. Projects involving significant reductions in onshoreemployment may run the risk of losing valuable employeeswhose skills are not used during the project. In an onshoreoutsourcing initiative, the blow of losing employees is oftensoftened by the assumption of some or all of the buyeremployees by the provider. For buyers, the work sent offshorewas largely work that had already been outsourced. In fact, onebuyer indicated that the work sent for offshore provision was “not that interesting for our people.”

Security and privacy were cited

by an offshore provider as a

major issue being addressed by

the Indian industry, but another

provider claimed it was “not a

big deal,” or an issue that

should deter a buyer.



Development Methodology andOffshore/NearshoreProviders and buyers agree that rigorous and consistentmethods are critical to delivering successful softwaredevelopment projects. It is important to align needs andexpectations with the methods used by the outsourced provider.

Software development methodologies fall into two maincategories: predictive and adaptive. Each category encompassesa variety of methodologies. Every methodology has pros andcons, with some better suited for remote development thanothers. The key factors are the level of specification required andthe level of interaction between those who define the functionalrequirements and those who write code.

There are various types of predictive delivery models (i.e.waterfall, spiral, and incremental), all focus on development ofan application based upon a well-defined specification and assuch are well suited for remote development. Prototyping is oneof the implementation techniques that results in a workingreplica of a system. It allows the developer to provide earlyfunctionality to the users, establishes the process to perfect therequirements definition, provides risk control, and effectivelycreates a de facto specification in the form of the prototype.

The alternative to the predictive model is the adaptive model.Many new adaptive software development and projectmanagement methodologies converged recently under the agilemethodologies banner. They evolved conceptually from thespiral model with prototyping, and focus on collaboration (peer-to-peer and group-to-group, including business-to-development, collaborative decision making, knowledge-sharingand collaborative project management). Business functions aresegments and development is repetitive in nature. The processof gathering requirements becomes more and more informal,cumulative, and experimental. These agile methodologies arebetter suited for close working arrangements between businessusers and developers, and work most effectively when bothparties are in the same time zone.

One Canadian buyer cited agile methodologies as a way todramatically improve application development cycles. Aftersuccessful trials, the company has repatriated several offshoreapplication development contracts. It is now setting up severalrapid development centres in Eastern Canada. Its businesscase demonstrates that the use of rapid developmenttechniques in low-cost Canadian centres competes well withoffshore, and the company’s intellectual capital remains withintheir organization.

One Canadian buyer cited agile

methodologies as a way to

dramatically improve

application development cycles.

After successful trials, the

company has repatriated

several offshore application

development contracts. It is

now setting up several rapid

development centres in Eastern

Canada.

Managing an offshore outsourcing contract adds complexity to thegovernance and management of your IT program. All six IT risk driversoutlined in the lens are impacted. Below is a brief summary of some of theunique impacts your offshore program may have on your IT operations:

To provide a broad framework

for IT management, we borrow

from the book Managing IT as a

Business: A Survival Guide for

CEOs, written by PwC partner,

Mark Lutchen, in 2003.


Risk Driver

Alignment

Resiliency

Futures

Support

Leverage

Operations

Risks

• Which governance model is appropriate to ensure your business sponsors are engaged in the evaluation and management of your provider?

• Which performance measurement metrics are appropriatefor managing your offshore provider?

• What assurance do you have that your provider takesinformation security as seriously as you do?

• Do you have the right to have a third party audit yourprovider’s security?

• Does your provider adhere to Canadian privacy legislationin protecting your customer and employee data?

• Geographic, political, socio-economic and infrastructurefactors impact your risk profile. For example, wherepotential business continuity planning/disaster recovery(BCP/DR) spans multiple cities and countries, riskassessment must include those other countries andfacilities that will support any major BCP/DR incident.

• What is your provider’s roadmap to adopt emergingtechnologies and standards that are outlined in yourarchitecture?

• What is your plan for training your staff to effectivelyengage and manage the offshore vendor?

• How do you manage the contract with the offshoreprovider? How are disputes settled?

• What is your company’s official line on the use of offshoreproviders? What do you tell clients, the press,prospective recruits?

• Does HR need to be involved to help secure work visasand ensure that your provider and staff are properlydocumented for international travel?

• Does your use of offshore providers have a negativeimpact on tax programs including SR&D tax credits?

• What is the longer-term career track for your employees ifdevelopment work is to be done offshore?

• How do day-to-day roles change with an offshoreprovider?

• What authorities, access rights, data management issues,and policies need to be amended?

• How will testing be scheduled and managed?


Section 6Outsourcing WorkMany lessons can be learned from those with experience managing anoffshore IT services relationship. These lessons help us provide aframework to systematically manage IT operations under an offshorearrangement.

It is interesting to note that experience with offshore outsourcing differsfrom year to year and market to market. We have reviewed marketstudies over a period of several years and from various markets aroundthe world. The following are a few of our observations:

• As companies gain more experience with offshore outsourcing, theirawareness of proximity to resources goes up significantly.Anecdotally, buyers have explained that in their first experiences withan offshore model they struggled with the right balance of offshoreand nearshore resources on a project and have since trended towarddedicated on-site staffing to remotely support offshore workers.

• In the selection process, buyers are increasingly weighing referencesand reputation as essential criteria over size of the resource pool.This may be evidence of the maturation of the marketplace as buyerslook for specialized resources.

• While provider and buyer perceptions are aligned on risk issues—including legislative, political, and employee backlash—they are outof step on the importance of negative publicity and internationalstability. Almost 80% of buyers identified international stability as arisk factor, compared to less than 70% of providers.

To provide a broad framework for ITmanagement, we borrow from thebook Managing IT as a Business: ASurvival Guide for CEOs, written byPwC partner, Mark Lutchen, in 2003.It provides a lens through which thevarious aspects of risk in IToperations can be viewed andmanaged. It identifies six areas whichmust be managed in unison toensure success. Using the lens, amanager can see how the manydimensions of IT operations must betaken into account when managingan offshore outsourcing engagement.

As companies gain more

experience with offshore

outsourcing, their awareness of

proximity to resources goes up

significantly.

The Decision to ProceedMoving to the decision and implementation phase of anoffshore project can be expensive and disruptive, even whenonly taken to the detailed business case stage. Seniormanagers must carefully weigh the prospective benefits againsttheir willingness and readiness to undertake an offshoreinitiative (either by directly engaging offshore resources, directingtheir onshore providers to do so, or merely consideringproposals with offshore content). No buyers made a fastdecision to engage offshore resources, even in the face ofurgent cost or resource pressure. Providers similarly encouragebuyers to carefully consider the risks as well as motivatingfactors. One provider indicated that it assisted buyers to“purchase prudently,” and that they have a “review process tomanage [the] risks.”

Experienced organizations rely on all the facts to make adecision:

• Resisting the temptation to take individual issues as a“knockout factor”—including potential public relationschallenges or one bad outsourcing experience.

• Assessing their organizational readiness in the context of theproject decision at hand.

• Carefully examining the characteristics—complexity,criticality, and impact—of each project and making abalanced judgment of the potential net benefit compared tothe potential risk.

Once an organization is ready and willing to proceed withoutsourcing, the final decision depends on finding the providerwho best helps balance cost savings against the inherent risks.

Once an organization is ready

and willing to proceed with

outsourcing, the final decision

depends on finding the provider

who best helps balance cost

savings against the inherent

risks.


Section 6Making Offshore Outsourcing Work

ContextFilter

OPE

RATI

ON

S

LEVERAGE

ALIGNMENT

RESILIENCY

FUTU

RES

SUPPORT

Business ManagementLiaison/SLAs

Governance &Leadership

PerformanceMeasurement/

Analysis/Reporting

Organization/People Skills

EmergingTechnologies

UserTechnology

Competencies& Skills

Marketing/Communications

Finance/Budgeting

SourcingManagement &Legal/Contract

Issues

Data Quality & Management

SecurityConfidentiality/

Privacy

BusinessContinuity/

Disaster Recovery

Service Delivery(Operations &

Initiatives)

EnterpriseCore System


Section 3Other Costs to

Consider?

Transaction CostsA 2001 study of 50 IT outsourcing deals by Jerome Barthelemy foundthat, while every company differs in how it sources its services, industrynorms indicate that the average company will spend about 3% of thevalue of a traditional domestic outsourcing contract on choosing theright provider and creating and reaching the agreement. These numbersexclude the internal effort for change management, communication andthe ongoing contract management costs.

While no definitive research is available to show how this will differ onoffshore deals, our experience leads us to believe that the transactioncost for an offshore contract can be significantly higher due to:

• Increased complexity on legal and tax implications

• Increased travel costs for site visits and contract start-up

• Network provisioning

• Security assurance

• Severance costs for employees made redundant—in domesticoutsourcing, the provider often assumes buyer staff as part of thedeal; this is less likely when the provider is offshore

• Retention programs for key staff who may be threatened

The same study suggests that ongoing contract management costsaverage approximately US$300,000 per year for most large IToutsourcing projects.

Tax Implications:It is important to ensure that anticipated cost savings from IToutsourcing are not eroded or eliminated by unintended,adverse tax consequences. We have explored several potentialtax implications from offshore outsourcing of IT services andfound that, while migration of functions to lower cost locationssuch as India or the Philippines may well offer significant costsavings, these locations are also high tax regimes. Althoughcertain jurisdictions do provide tax incentives to promoterevenues from export of IT and IT enabled services, theseregimes are often administered with zeal by their revenue

…industry norms indicate that

the average company will

spend about 3% of the value of

a traditional domestic

outsourcing contract on

choosing the right provider and

creating and reaching the

agreement.

• Perform reference checks (preferably face-to-face) with companieswho have recently used your bidders for similar work. The DiamondCluster study previously mentioned also found that reputation andreferences jumped to the top of the list of vendor selection criteria.This indicates that as buyers gain more experience with offshore IT,the more they value the experience of their provider.

• Engage your procurement expertise or legal counsel at an early stage to ensure that the ownership of identified risk areas are clearlydocumented.

• If you are using a trusted provider that you have worked with before,test their knowledge of their own processes and procedures, as thesecan differ broadly across borders, internal organization boundariesand country organizations.

• If possible, travel to the proposed location and speak directly to thepeople who will be performing your work. Buyers who reportedsuccess with offshore outsourcing identify site visits as a key factor intheir success.

• Meet and assess the on-site people who will be working locally withyour team. Most providers place members of the project team at theirsite to interact with their people. The ratio of the team members aton-site versus offshore ranges, but a number of buyers and providersidentified 1:7 as the right balance for application development work.

• To secure a contract which meets your needs you should maintaincompetitive tension throughout the selection process by having atleast two qualified bidders compete for the work.

Every transaction is different, and each requires significant businessplanning and preparation. A trusted business advisor, who has experiencewith multinational outsourcing, can be a good source of information.

If possible, travel to the

proposed location and speak

directly to the people who will

be performing your work.

Buyers who reported success

with offshore outsourcing

identify site visits as a key

factor in their success.


Section 3What are Some of the Other Costs to Consider?


Section 5Model

Doing business offshore does not require that you outsource the workoutside of your own organization. Many of the largest users of ITservices in India and China are in wholly owned divisions of Americanand European based companies. Many have been there for over tenyears. Several of the large Indian-based IT outsourcers got their start asin-house operations for foreign companies.

At a high level, there are four models through which to employ offshoreIT services:

• Do-it-Yourself: Create a wholly owned subsidiary or operatingcompany in a low-cost jurisdiction

• Outsource: Contract a third party, either

– An offshore provider based in a low-cost jurisdiction, or

– A domestic provider which has offshore operations

• Strategic Alliance: Form a joint venture with a service provider or withother business alliances to share costs, risks and experience

• Acquisition: Acquire a service provider in a low-cost jurisdiction toprovide your services

Choosing the best model or models for your needs requires detailedassessment of the costs, benefits and risks, including the taximplication laid out in the previous section. The remainder of thissection addresses the implications of the Outsource model.

During the transaction or decision phase, we propose the followingactions to identify and quantify potential risks while selecting youroutsource provider:

• Treat the selection of an offshore or nearshore provider as animportant business decision. The use of a formal selection process(i.e. Request for Information, Request for Proposal) is recommended,because it forces you to document your requirements andexpectations, and the providers are required to submit their offers in writing.

• Consider doing a pilot engagement with a manageable piece of workto test the waters before you jump in. Be sure to select a piece ofwork that will serve as a fair test for the provider and you to assess.

• The RFP should ask the bidders to create risk mitigation strategies toaddress your identified risk areas.

Choosing the best model or

models for your needs requires

detailed assessment of the

costs, benefits and risks,

including the tax implication…

officials who want to ensure that the service provider earns areasonable level of profits, in line with the functions it performs,the risks assumed and the capital it employs. Tax may not bean issue when the outsourcing service provider is a third partyas the corporate tax cost is rarely passed on to the buyer of theservices.

Intellectual PropertyWhen the offshore provider is a third party negotiating with thebuyer at arm’s length, intellectual property is not usually anissue. But when the provider is affiliated with the buyer, it islikely to be a consideration (e.g. in India, China, etc.). In thesesituations it will be important to ensure that the contractualarrangements are drawn up in such a way that the providerdoes not retain any rights to, or an interest in, the intellectualproperty created from its efforts. Ownership of the intellectualproperty created should typically be retained and managedoutside of the country where the provider is based. Otherwisethe revenue authorities in that location would have furtherjustification to demand a higher allocation of profits and makepricing adjustments accordingly.

The more significant tax risks associated with outsourcing canbe categorized between direct income tax and indirect taxissues, and are summarized below.

Direct Taxation (of Income)When activities are outsourced to another country, will theperformance of those activities create a taxable presence inthat country for the Canadian company? If so, how will thecompany be taxed, and at what rates?

A company will typically have a taxable presence in anoverseas country if it carries on its business there through apermanent establishment (PE). A PE can include an agency thathas authority to conduct business on behalf of the overseascompany. The risk of finding an agency PE may be exacerbatedwhen the provider is a related company.

For example, in India, the Central Board of Direct Taxes (CBDT)recently issued a circular which noted that an overseas entity’sprofits should generally not be subject to Indian income tax,provided that the tasks outsourced to India are regarded asnon-core activities and that the Indian unit is compensated onan arm’s length basis. If the tasks are considered core activitiesof the overseas entity, and if the Indian operations are deemedto constitute a PE of the overseas entity, then its profits couldbe subject to Indian income tax. However, use of anindependent third party service provider usually insulatesoverseas companies from PE exposure.

Ownership of the intellectual

property created should

typically be retained and

managed outside of the country

where the provider is based.

Otherwise the revenue

authorities in that location

would have further justification

to demand a higher allocation

of profits and make pricing

adjustments accordingly.


Section 5Selecting the Right Model & Provider


Further clarification on the circular is awaited from the Indiangovernment, but with an Indian corporate tax rate for overseascompanies of 41%, there is obvious concern.

Withholding TaxAnother point on the tax checklist should be to ensure that thepayments to the service provider are not subject to anyCanadian withholding taxes. This requires consideration of thelegal characterization of the payments, the location where theservice provider carries out the services, and the terms of therelevant Double Tax Convention in place between the payer andpayee countries.

For example, the India-Canada Double Tax Convention restrictsthe application of withholding tax to payments for serviceswhich could be characterized as “Royalty or Fees for IncludedServices (technical service fee).” Most of the services that arebeing outsourced may not fall within the Treaty classification of“Royalty or Fees for Included Services” and thereby not besubject to any withholding tax in the payer country.

Inter-Company PricingOutsourcing IT tasks to a related offshore company raises thespecter of the taxman challenging the inter-company pricing ofthe services, and ultimately making an adjustment to the inter-company price. For example, this challenge could come from theCanada Revenue Agency (CRA) if they consider the fees chargedby the service provider to be excessive. Alternatively, the revenueauthorities in the service provider’s jurisdiction might challengethe level of fees if their profits were considered inadequate for thework performed, risks assumed or capital employed.

In the context of India, PwC has encountered situations whereIT-related inter-company services have been priced (usually ona cost plus basis) within an acceptable arm’s length rangefrom a Canadian or U.S. perspective. Yet, the Indianauthorities have tried to deem a higher margin for the Indianunit’s services. What needs to be considered is that the arm’slength pricing is done keeping the acceptable range from Indiain mind. India has recently introduced Transfer PricingLegislation primarily based on the OECD guidelines. Thissituation creates tension between the outsourcer’s countryand the related service provider.

Indirect TaxationAs with direct taxation issues, it will be important to ensure thatthe savings are not eroded by unexpected imposts, such as aGoods and Services Tax (GST), Value Added Tax (VAT), or othertypes of sales, business and excise taxes.

Outsourcing IT tasks to a

related offshore company raises

the specter of the taxman

challenging the inter-company

pricing of the services, and

ultimately making an adjustment

to the inter-company price.

Offshore50TM

Working with buyers around the world, PwC has gatheredextensive insight into the risks which are unique to offshoresourcing. We have combined that global knowledge in aproprietary tool we call Offshore50TM. This tool assists PwCadvisors to perform a comprehensive risk assessment of abuyer’s business case for offshoring IT or business processes.It covers over 50 risk areas, including strategic, financial,technology, process (including facilities), regulatory and legal. Itis further supported by references to country-specific risks andissues in over 30 offshore locations, as well as key regulationssuch as privacy (PIPEDA), Sarbanes-Oxley, anti-moneylaundering and employment legislation.

There is significant and growing buyer interest in combiningoffshoring with other cost reduction programs, in order toachieve dramatic improvement in the cost of operations to meetcompetitive pressures.

Offshore50TM provides buyers with a rapid assessment of therisks inherent in offshoring IT and business processes, as theyapply to their own offshore base of operations or to a third-party service provider’s facility.

The risk assessment is designed for use by an experiencedadvisor with a specialization in outsourcing or shared services.It is further supported by industry, regulatory and other case-specific knowledge.

By systematically identifying

and planning for potential risks,

buyers can reduce their

exposure by creating

contingency plans, staffing

appropriately, transferring risk to

the provider, working with

stakeholders, and even hedging

currency fluctuations if

appropriate.



outsourcing being imposed, and 84% fear backlash from their ownemployees.

• Immigration and Work Visa Issues: One of our offshore providerscomplained that entering Canada is becoming very difficult for“visiting” offshore resources, although the immigration situation ismuch more favourable than in the U.S. it is widely expected thatlimits on the number of requisite H1 visas for the U.S. in 2004 wouldbecome a potential risk for offshore providers. Citizens of somecountries have an easier time getting the appropriate visas to enterCanada—something to keep in mind when selecting a provider.

Risk Sharing From our interviews we found the most active risk managementstrategy was for buyers to transfer some project and/or business riskto the provider. These risks can include time and cost over-run, as wellas penalties should the project impact the customer’s business. Todifferentiate project risk from business risk, we use an example wherea buyer engages a provider to build a new order management system.Project risk sharing may tie a bonus to meeting a project milestone,like delivery of the specified application on time. Business risk sharingwould pay a bonus only when the buyer starts to receive revenuesfrom the new order management system.

It appears that providers were prepared to assume significant projectrisk, but were unable or unwilling to accept business risk. Qualitatively,we observed providers taking on greater project risk for offshoreoutsourcing than has been traditionally assumed in domesticoutsourcing. This may be the result of providers aggressively seeking to grow market share or simply having confidence in their ability tomitigate risk.

Despite our perception of low price for offshore services, offshoreproviders have enjoyed good margins that have afforded them theability to underwrite significant project risk. We believe that as themarket matures, and as providers increase their industry and processknowledge, we will see conflicting forces impact risk sharing. On onehand, thinner margins will reduce providers’ ability to assume significantrisk. On the other, the entrance of global players with experienceproviding project and business risk sharing arrangements will forceoffshore providers to offer similar options.

By systematically identifying and planning for potential risks, buyers canreduce their exposure by creating contingency plans, staffingappropriately, transferring risk to the provider, working withstakeholders, and even hedging currency fluctuations if appropriate.

Citizens of some countries have

an easier time getting the

appropriate visas to enter

Canada—something to keep in

mind when selecting a provider.

For example, companies outsourcing certain activities will want tosource from the most efficient locations—locations that do notrequire the imposition of a service tax or a VAT charge on top ofthe fees charged by the service provider.

This is not always a clear issue. Under India’s service tax laws,services exported from India are tax-exempt if consideration isreceived in convertible foreign exchange in India. It has beenrecently clarified by the Indian tax authorities that any service forwhich consideration is received in convertible foreign exchange inIndia would not be subject to any service tax.

Tax IncentivesWhen comparing potential sourcing locations, the business caseshould include consideration of any tax incentives. For example,India offers various tax holiday benefits to businesses engaged inexport of IT services including software development. The benefitis available equally to Indian-owned service providers and foreign-owned Indian incorporated subsidiary/branches.

Canada offers a number of incentives for particular types ofactivities. One of the most relevant in the IT sector is theavailability of Scientific Research and Experimental Development(SR&ED) investment tax credits and related provincial incentives.Software development performed in Canada by a taxpayer that iscarrying on business in Canada (or in some cases a relatedtaxpayer) may be eligible for SR&ED incentives if the developmentwork relates to the business of the taxpayer and a number of testsare satisfied.

Depending on the province in which the development work isperformed, SR&ED tax incentives for software development workperformed in Canada could reduce development costs by asmuch as 37% (63% for certain CCPCs). Therefore, the availabilityof SR&ED incentives could significantly impact the comparativecalculations and even marginalize the operational cost savingsbetween the locations of choice. For example, a U.S. companymight consider whether it should outsource certain softwaredevelopmental work to India. While India may appear to be thelogical choice to minimize costs, SR&ED incentives in Canadamay reduce India’s comparative advantage. When coupled withthe advantages of proximity and ease of communication, thescales could easily be tipped in Canada’s favour.

Depending on the province in

which the development work is

performed, SR&ED tax

incentives for software

development work performed in

Canada could reduce

development costs by as much

as 37%.

When coupled with the

advantages of proximity and

ease of communication, the

scales could easily be tipped in

Canada’s favour.



Section 4 Risk ManagementAs we have determined, providers generally do a good job ofhighlighting the cost savings of offshore outsourcing. Market leaders areproactively addressing perceived risks through carefully scriptedmarketing and selling. In India, NASCOM, the powerful IT serviceslobby group, works effectively with the Indian government and even theU.S. government to influence pro-offshore legislation and taxation.Faced with this highly organized selling machine, what can aprospective buyer do to identify and quantify the risks before enteringinto an offshore IT contract?

Are the risks any different when offshore resources are engaged?According to IDC Canada, the top five risks buyers identified in offshoreIT outsourcing are:

• Security

• Quality

• Service

• Knowledge transfer

• Risk that cost savings will not materialize

Our research identified additional risks specific to the engagement ofoffshore resources. We recommend that buyers consider drilling downbeyond general service and quality risks to consider:

• Proximity

• Currency

• Regulatory compliance

• Tax issues

• Political, employee, public relations and geopolitical risk

• Immigration and work visa issues

• Proximity: The “far-away” nature of offshore resources—inability toengage in face-to-face dialogue, differences in time zones, and lowerlevels of mutual familiarity—mattered, and was worthy of explicitmanagement. This can also be a determining factor in companiesestablishing their own captive sites within offshore locations toensure local management oversight. However, one buyer indicatedthat they would be willing to pay a price premium of “up to 10%” foronshore provision, recognizing the additional cost and inherent risk.Buyers with extensive offshore experience also undertook site visitsto their offshore providers, to close the “proximity gap.”

Faced with this highly organized

selling machine, what can a

prospective buyer do to identify

and quantify the risks before

entering into an offshore IT

contract?

A 2004 survey by Diamond Cluster found a significant increase inproximity as a top five risk issue to be managed. Notably, it hasincreased substantially for those who have experience with offshore.The finding is consistent with the interviews we conducted: The moreexperience buyers have with offshore services, the more they valueproximity to their supplier or supplier representative. Buyers andproviders have responded by adjusting the mix of on-site versus off-siterepresentation.

The difference in time zones was acknowledged by our respondents asbeing a potential asset or liability depending on the nature of the workand the level of interaction required between people in the various timezones. None of our respondents cited “calls in the middle of the night”as an operational problem, but several noted that arrangements did needto be made to assure that time zone differences were accounted for. Thebenefit of “having others work while you sleep” is diminished if theirquestions must wait until you wake.

• Currency: Most offshore outsourcing contracts are done in the localcurrency of the buyer. In longer-term contracts there are often terms toaddress currency fluctuation outside of a stated range, and, for most ofthe contracts we discussed, the provider bore the sole responsibility forcurrency fluctuations. In 2003, when the Canadian dollar rose 20%against the U.S. dollar, it was a difficult year for Canadian firmsexporting services to the U.S., but a very good year for those offCanada’s shore to be paid in Canadian dollars. For providers, currencyrisk is managed at the corporate (global) level, and has not been a deal-specific consideration in the past.

• Regulatory Compliance - Security and Privacy: Particularly with theintroduction of privacy legislation in Canada in recent years, securityand privacy are top-of-mind issues with both buyers and providers. Oneexperienced buyer indicated that it is important, but that they are ableto manage it—the security architecture is specified by their own ITorganization, and implemented by their providers (onshore or offshore).An onshore-based provider indicated that buyer requirements for datasecurity, and in particular Disaster Recovery Planning (DRP), arebecoming increasingly demanding. An offshore provider indicated thatbuyers, when doing site visits, realize that the security provisions in theoffshore environment can be as stringent as those onshore.

• Political: This risk is manifested in two ways. First, the risk of onshorepolitical and public relations backlash against offshore sourcing wasacknowledged by all respondents as a feature on the landscape.However, none of our respondents cited this as a reason for havingdeclined to enter into an offshore arrangement (for buyers), or for failingto secure a Canadian assignment with offshore resources (forproviders). The second part of this risk is geopolitical risk affectingproject delivery. Only one respondent (an onshore-based provider withglobal sourcing capability) cited this as a risk which would affect theallocation of work. However, awareness of these risks is high on theminds of buyers. A recent study of 180 buyers of offshore service foundthat 85% were worried about legislative or policy barriers to offshore

In 2003, when the Canadian

dollar rose 20% against the

U.S. dollar, it was a difficult year

for Canadian firms exporting

services to the U.S., but a very

good year for those off

Canada’s shore to be paid in

Canadian dollars.


Section 4 Risk Management
