Parlez-vous software development?

More and more companies are going offshore to develop and maintain their software.

General Electric, Bank of America, Target and American Express, for example, have formed partnerships with Indian firms such as Tata Consultancy Services, Wipro, and Infosys. A recent survey by the Indian National Association of Software and Service Companies found that almost two out of five Fortune 500 companies currently outsource some of their software requirements to India.

The reason is simple: this approach saves time and money. Moreover, it is growing steadily more attractive: last year, North American companies alone spent $114 billion on in-house software development, contracting, and purchases--and costs will only go higher as additional basic business processes are conducted over the Internet.

Nonetheless, the benefits of going offshore can be hard to capture. The development of custom software is different from most other business activities, since it requires a detailed understanding of business processes and the way IT supports them. Building an offshore partnership therefore requires much effort and delicate handling by senior managers. What is more, the field of software engineering is relatively new, and procedures for quality control and project management, though developing fast, have yet to evolve fully.

Without discipline in managing offshore relationships, a company can not only squander the cost and time savings it had hoped to gain through them but can also face other problems, such as late deliveries, escalating costs, mismatches between expectations and deliverables, and even outright failure.

Despite these problems, successful offshore partnerships can be forged. Through our work with clients and interviews, we have created a diagnostic approach that helps companies to segment their software development and maintenance projects and thus to pinpoint good candidates for offshore outsourcing.

Charting the waters
In the 1970s and 1980s, manufacturing companies around the globe began to move large parts of their operations to places such as Mexico, the Philippines, and Puerto Rico, where lower labor costs made them more cost competitive. For the same reason, some companies attempted to outsource their software development efforts offshore in the 1980s, but it took the enormous amount of reprogramming required by the Y2K transition to catalyze the process. In the course of carrying out those projects, the poor reputation that most offshore firms had in the early 1990s was transformed: many of them did high-quality work and used sophisticated application-management processes to do it.

As a result, over the past five years, companies have begun to outsource many of their internal IT services, such as help desks, software support, and software development. The most popular offshore location is India, which combines high quality with low costs. Other possibilities, involving a variety of trade-offs, include China, Ireland, and Israel. Companies in the most popular offshore locations have excellent capabilities and are now in an ideal position to provide more sophisticated value-added software development services.

And that is a very good thing. Labor accounts for more than 75 percent of the cost of developing software, and the market for highly skilled IT professionals is very tight in the United States. Recruiting, hiring, and training people to meet the constantly changing needs of the IT environment not only costs a great deal of money but can also delay the completion of projects. Gartner reports that because of high turnover--the average stay of a programmer in any one job is only 11 months--companies spend more than 10 percent of their IT budgets recruiting and training new staff.

Although local outsourcing to software firms in the United States (or other developed countries) may be possible, companies can gain a strategic advantage from the lower wages and benefits prevailing in countries such as India, where hourly, fully loaded programming rates can be 40 to 60 percent below those in the United States. Companies that use offshore partners to do their non-discretionary programming (maintenance and enhancements of legacy systems, for example) also find that lower offshore costs free up capital for new development efforts--say, on mobile-commerce applications.

What is required?
Only companies with fairly large IT staffs--more than 50 in-house employees focusing on software development or maintenance--should consider offshore software partnerships, since much time and substantial resources are required to negotiate them and to oversee the work and the integration of development teams. Furthermore, a company that outsources software development shouldn't have a taste for "bleeding-edge" technology, which ought to be created in-house since it requires a high number of design-code test-redesign feedback loops.

Once a company decides that it is suited to outsourcing, it should establish formal processes for its make-or-buy decisions. To reap the greatest global economies of scale, an outsourcing deal must serve the needs of the company as a whole; divisions shouldn't be allowed to act independently. A senior IT leader--preferably the chief information officer--ought to head up the process, and senior business leaders whose applications will be affected by offshore relationships ought to be involved as well. If the partnership addresses the software development and maintenance needs of most of the company, the chief executive officer too might participate in the decision making.

Software development typically progresses through six steps: project initiation, analysis, logic design, physical design, implementation, and maintenance. The early phases tend to be poor candidates for offshore work because they call for a lot of collaborative communication and involve more business logic than technology. Good candidates for outsourcing require limited interaction between business units and the IT department; they should also be large enough for the potential savings to justify the necessary management attention. Relatively big projects are particularly attractive to an offshore vendor, for they allow it to spread its resources more smoothly and give it a greater opportunity to gain useful knowledge for future projects.

Strong candidates for offshore outsourcing include rewrites of core systems, re-architecturing efforts, the maintenance of legacy systems, data cleansing, and release updates. Offshore outsourcing is a particularly important option for maintaining legacy systems--often a large and onerous part of an IT organization's workload and one that is getting harder to accomplish given the relative rarity of legacy skills and the unattractiveness of the work. As a leading developer of software for automated teller machines said of his legacy systems, "Developers in the United States do not find these projects exciting."

Offshore partners may have difficulty maintaining application designs for projects such as e-commerce applications, which have short time frames or call for feedback from users. But once these projects enter the later stages of development, even they can benefit from outsourcing. A developer of business-to-business software who regards speed to market as critical remarked, "With our new overseas operation, our team is working round the clock, and I now have access to a larger pool of IT resources than I did in the United States alone."

Companies have generally developed their software in-house, so they have not yet fully worked out their approach to development partnerships. But the advent of high-quality outsourcing makes it essential for client companies to apply to this area their expertise in writing contracts and in managing vendor relationships. In software development as in other fields, forging a successful offshore partnership requires a high degree of due diligence and commitment on both sides.