Note: Most recruiters and search firms will never confront the question of whether opening an owned, off-shore operation makes sense. They are just too small for that to be an issue. However, many will use off-shore services for sourcing, name generation, even candidate qualifying. In this article, the authors address the economics and efficiencies of "offshore" work versus "offshore, in-housing," which is an issue – or may become one soon – for large- and mid-sized staffing firms. Even if you never expect to go offshore, the article raises many interesting points to consider should you ever decide to open up a remote branch office.
As offshore outsourcing of recruiting functions – and other business activities – has become more and more ubiquitous some companies are beginning to wonder if they can leave these functions offshore, but bring them in-house to lower costs or increase quality, or both. Executives interested in testing the idea of work offshore used outsourcers to prove the concept. Satisfied with the results, the next logical thought was "Could I do this better myself?"
However, companies dramatically underestimate the difficulty and cost of setting up and running operations offshore. As a result, most find their costs are higher than using an outsourcer and/or quality is lower – precisely the opposite of what they were hoping for. Several high-profile companies even did serious damage to their brands during the process of in-sourcing. As a result, many companies who tried bringing work in-house have abandoned these efforts. According to a recent CIO Magazine article, Citibank, Dell and Prudential, which had previously set up their own in-house operations offshore have all returned to outsourcing and sold their captive offshore operations back to outsourcers.1
Because in-sourcing offshore is more difficult than most realize, with the potential for savings modest and the potential for an adverse effect on quality real, we suggest that only very specific functions are good candidates for bringing in-house. This article lays out a framework to help executives think through whether in-sourcing is right for their business.
The following key take-aways are discussed in more detail:
Key challenges for bringing offshore work in-house include process issues associated with setting up a remote location, such as formalizing institutional knowledge and appropriately investing in overhead and management time, as well as offshore-specific challenges such as a sub-optimal labor pool and lack of middle management talent.
Scale is a key criterion in deciding whether to in-source. Programs under 50-75 employees will be significantly less expensive to keep outsourced. At the 75- to 100-employee level in-sourcing and outsourcing are roughly equal, and at greater than 100 employees, savings of approximately 1-5% are possible if in-sourcing is done successfully.
Given the challenges of bringing offshore work in-house, we propose a framework considering the risk/sensitivity of the work and the complexity/ difficulty of the work be used to determine which functions are the best candidates. Broadly speaking, low risk work is outsourced and high risk work is a candidate for bringing in-house, especially if that work is not difficult. Difficult functions, even those with high risk, may still be better suited for outsourcing.
In-Sourcing Is Difficult
Companies find that setting up remote operations offshore is difficult in two main ways: process challenges, and offshore-specific challenges.
What’s the Workflow Process?
The first area has nothing really to do with being offshore. It is simply that setting up a new and remote operation is challenging. Most companies operate using an informal system of processes combined with institutional knowledge. It is only when a company attempts to set up a remote operation that it realizes there are no formal processes to speak of. "Betty learned her job because she sits next to Joe who showed her the ropes," and "We don’t have a formal training program, or the one we do have is outdated, because new people learn on the job from the existing people," are common statements from executives in the process of setting up a remote operation. Outsourcers are familiar with this issue, and as a result have set up formal processes for recruiting, training, and quality. The good ones also understand how to work with their clients to ferret out institutional knowledge and formalize it.
Additionally, there are a wide variety of overhead processes that are often overlooked. Recruiting, training, accounting, payroll, human resources, etc. are all needed for the new offshore location. These are costs that are usually neglected in the cost/benefit analysis.
And finally, one of the major benefits of using an outsourcer – flexibility — must be considered. Companies using outsourcers are able to ramp-up or downsize their outsourced provider for seasonal or economic reasons. This is more difficult when the work is brought back in-house and can result in excess capacity and corresponding low levels of utilization.
The second area consists of challenges directly related to being offshore. The most obvious of these is the difference in the talent pool. Differences in education, culture, and language manifest themselves in a young and intelligent labor pool, but one that is significantly different than in the U.S. when it comes to problem solving (especially "thinking on your feet"), being proactive (rather than simply "doing what you are told") and communication (especially communicating bad news). U.S. managers are ill equipped to deal with these offshore issues, which require different ways of profiling, recruiting, training, and managing.
Issues with middle management talent are even more pronounced than with the frontline. The United States has been developing managers for the past 100 years, whereas India, the Philippines, and other offshore locations have only had 10 to 12 years to create a sizable middle management talent pool. The result is that good managers are extremely rare and cost as much as their U.S. counterparts. Even worse, bad managers are almost as expensive.
Salaries in the Philippines have increased more than 50% since 2004 and are "increasing at 10% per year," according to Benedict Hernandez, President of the Contact Center Association of the Philippines (CCAP).2
As the chart shows, the labor arbitrage is large for frontline staff, but approaches zero by the middle management level.3 For frontline and team leader positions, U.S. salaries can be two- to three-times as expensive as offshore resources. However, by the director level, U.S. salaries are only about 15% higher than offshore salaries. And for high quality personnel (those in the top quartile), offshore salaries can actually be 15-20% higher than in the U.S.
Savings Aren’t There
As a result, savings are often not realized. In addition to the costs and challenges, companies are often forced to invest significantly in management time to achieve the level of quality desired. This includes travel, lodging and the opportunity costs of diverting U.S. personnel to the offshore location to aid in recruiting, training, and ongoing floor management. As David Rutchik, a partner with outsourcing consultancy Pace Harmon, has stated, "These captive centers are difficult to manage and quite a distraction from a company’s core business."4
In some cases, quality is also impacted. Because of the challenges involved, quality is often worse in-house. This seems counterintuitive because in-house operations onshore are almost always of a higher quality than using an outsourcer. The difference is that the process and offshore-specific challenges mentioned above are sufficiently large to reduce quality below outsourced levels. According to CIO Magazine, the costs and effort involved in running captive offshore operations haven’t justified the results, which according to several executives at Dell and Citibank "rarely exceed those of a high quality outsourcer."5
Work To Bring In-house
Despite the fact that offshore in-sourcing is more difficult and expensive than expected, it still may be a good idea. We propose three main criteria to consider when making the decision: scale, risk/sensitivity of the work, and difficulty of the work.
Scale: This is the most straightforward criterion. If the scale of the offshore operation is less than 75-100 people, it does not make sense to do the work in-house. This is just simple economics. Due to the overhead investment required and economies of scale, most outsourcers do not break even on an operating basis until the 75- to 100-employee level. It therefore follows that for operations under this level an outsourcer will be less expensive. Of course an in-house operation will not have some of the overhead that an outsourcer has (such as a sales department), but the 75-employee level is just to reach operational break even, it does not include recouping capital investment, so we believe the range is appropriate. And for very small ograms, in the 10- to 20-employee range, performing the work in-house is significantly more expensive (up to 70% more expensive) than outsourcing.
Once scale has been achieved, it is possible to achieve savings of 1-5%. This, not coincidentally, is the profit margin for most offshore outsourcers. The average net income margin for a basket of public BPO companies was 1.7% between 2008 and 2011.6
Interestingly, once a scale of approximately 100 employees has been achieved additional scale does not improve cost savings. As the chart shows, programs in the 10- to 50-employee range will be as much as 70% more expensive to perform in-house. At the 75-employee range in-house and outsourced costs will be roughly equivalent. And at the 100- to 400-employee level, savings of 4-5% can be achieved.7
However, just because cost savings are possible, it does not mean that they will be achieved. According to a Dell executive who worked closely with Dell’s Philippine operations, "Costs are always higher when you have an in-house operation, due to a variety of factors including greater involvement of U.S. personnel and lower efficiencies because all work is from one company."8
Transactional Work: Given the overall thesis of this paper, that in-sourcing offshore is more difficult than most realize with the potential for savings modest and the potential for an adverse effect on quality real, we suggest that any function which is of low risk is not worth the time and effort to bring in-house. Transactional work, therefore, is best left outsourced.
Consultative: Traditionally, this would be a good candidate for in-sourcing. Certainly onshore, this type of work is usually done in-house. High-end, important and difficult knowledge work such as financial analysis would be worth the time, money and management focus for a company to do themselves. And, historically, the lack of high-end premium or specialized providers offshore meant that in-house may have been the only option for this type of work.
Recent trends, however, indicate that this type of work may best be out-sourced, even offshore. First, higher quality may not be possible inhouse. One reason U.S. companies don’t see the anticipated performance gains when they open their own offshore operations, in spite of investing more in those operations, is that professionals in these emerging market nations prefer working for the outsourcers. According to CIO Magazine, "Western companies that set up shop [offshore] have struggled to hire the best and brightest; many [offshore] professionals prefer to work for vendors that can offer a greater variety of work experiences and more opportunities for career advancement."9
And second, a new generation of specialized outsourcers is emerging offshore. Knowledge Process Outsourcing (KPO) is the latest wave and the next logical step in the evolution of offshore outsourcing. Premium offshore outsourcers, including those that are specialists in a certain function such as sourcing, name generation, even candidate qualifying, are becoming more established and represent a real alternative to doing the work in-house.
Because of the level of difficulty and risk of this work, we suggest a partnership model when working with outsourcers for these functions. Select one provider, be willing to pay a premium for the specialized expertise, and invest significant management time to ensure a successful program. Ideas such as placing one of your managers permanently at the outsourcer location or bringing outsourcer employees to the U.S. for specialized training are good ways to ensure quality.
Bringing offshore work in-house may be a good option for some companies, depending on the scale, type of work and risk. The framework outlined in this paper suggests that higher risk work pertaining to sensitive information is the best candidate for bringing in-house, especially if that work is not difficult and has sufficient scale.
However, there is substantial evidence that setting up an offshore operation is more difficult and more costly than most U.S. companies realize. As a result, the sought-after savings and quality are not realized. Leading companies, such as Citibank, Dell, and Prudential set up in-house operations offshore, only to find that their costs were higher than outsourcing with no improvement in quality.
1. "Outsourcing: the Demise of the Offshore Captive Center?" Stephanie Overby, CIO Magazine, June 30, 2009
2. "Salary Hikes in Call Centers Becoming Unsustainable," ABS4CBN News, July 15, 2009
3. Philippine and U.S. salaries are all for call center positions; Source for Philippine salaries: Kittleson & Carpo Consulting (kittlesoncarpo.com), interviews with local Philippine staffing consulting firms, and analysis by Professional Staffing Group Global Solutions; Source for U.S. salaries: glassdoor.com, salary.com, and Professional Staffing Group Global Solutions analysis.
4. Op. cit., Overby
6. Google Finance, Average Net Income Margin between 2008 and 2011 for: Convergys, Teletech, Stream, Sykes, Star Tek, and ExlService
7. Professional Staffing Group Global Solutions analysis
8. Interview with former Dell Computer executive, 2012
9. Op. cit., Overby