Offshore transfers and related outsourcing topics rank at the top of business issues for a wide variety of companies, according to a joint PRTM/World Trade magazine survey of 180 CXO respondents from many industries. No longer the sole prerogative of Fortune 100 companies, many small- and medium-size organizations are actively pursuing offshore opportunities. In fact, they often are able to move from the evaluation to the implementation phase more rapidly than large organizations.

Our survey shows that decisions to move numerous operational processes offshore are not limited to manufacturing companies, but instead apply to a broad range of industries, from consumer services to high tech. For over 60 percent of respondents, offshore-related matters rank as the most strategic decisions that management is expected to take in the next 12 months. Consequently, over 55 percent of companies surveyed involve their most senior leadership in such decisions.

Why go offshore?

We fashioned the survey to provide insights about the key drivers. The spectrum of reasons varies significantly, based on the type of business activity being moved offshore and the competitive dynamics of a particular industry. The offshore decision is typically related to a broader "make or buy" review.

Partnerships. If an organization does not achieve best-in-class performance in a non-strategic business area, it tends to consider going offshore with an outsourcing partner for that activity. In that case, achieving overall cost savings (as much as a 30 percent to 40 percent reduction) is the primary driver. These companies also expect to see improvements in their service levels from outsourcing. Another key motivation is to gain flexibility: 35 percent of the companies surveyed expect to develop the nature of the partner relationship over time (e.g., volume of business, terms and conditions, exclusivity) to effectively align with their business cycles. Eighty-four percent of the companies we surveyed see themselves moving to offshore sources in the near term in a multitude of areas.

Owning facilities offshore. The majority of companies (59 percent) are exploring, or have implemented in parallel, the launch of fully-owned facilities in select offshore locations. Beyond specific regulatory reasons requiring some part of their product to be locally produced, companies will open facilities offshore (beyond sales and marketing offices) mostly to benefit from an attractively priced talent pool. Additionally, this option mitigates the overall business risk by reducing dependency on one or a few locations. In reality, it is larger businesses that can afford such acquisitions or build-outs, taking advantages of economies of scale to offset the investment.

What is outsourced?

By far, manufacturing is the most often outsourced activity. Many companies surveyed (47 percent) are comfortable dealing with a large number of established vendors. In fact, over 35 percent of the companies we surveyed have moved the majority of their manufacturing activities offshore. And most companies (65 percent) are extremely satisfied with their outsourcing relationships.

Outsourcing product development. When the talent pool was in short supply in some U.S. locations in the late 1990s, numerous companies sent part of their development infrastructure offshore to locations with an emerging and abundant talent pool. Respondents reported that once an offshore development center was operational, net savings ranged from 25 percent to 40 percent. This explains why nearly one-third of those interviewed have implemented at least one product development effort involving a significant portion of offshore resources. These companies, on average, are sending 15 percent to 20 percent of their R&D activity offshore. The benefits include substantial cost savings and a better ability to handle the variations in product pipeline activities.

For most pioneers in outsourcing R&D activity, cost savings initially came at a cost: The complex coordination required between local and offshore development teams had a negative impact on time to market. Over time, these pioneers were able to adopt the appropriate collaboration tools and infrastructure to compensate for distance and time-zone differences.

Collaboration remains a delicate activity; we expect this competency to become a true differentiator between companies excelling at collaborative development-including offshore components-and those simply experimenting with offshore development for elements of low criticality to their future offers. Nearly 50 percent of the companies that are pursuing offshore development programs have achieved a net gain in time to market and consider the launch of offshore product development as valuable for the organization.

The most significant issue remains the risk of losing critical intellectual property, especially if development efforts are outsourced to third-party vendors. The most common practice adopted to mitigate this significant risk involves "slicing" a new product development program in connected-but separate-building blocks that, taken individually, do not allow the offshore facility to commercialize the entire end product.

Outsourcing information technology services. Large companies adopted the practice several years ago, but just a minority of small- and medium-size businesses send a significant portion of their IT service needs (infrastructure, applications, etc.) offshore. Many companies (42 percent) do not maintain all IT service activities in-house, and 21 percent are outsourcing IT services to an offshore partner. Over 50 percent expect the trend toward offshore IT services to increase over time. Several survey participants are expecting their U.S.-based IT partners (system integrators) to continue to shift their own activities offshore, although some of this activity may be invisible to the end user.

Offshore transfer of other business processes. This category includes a broad range of business activities and processes, some horizontal in nature and common to most industries (e.g., payroll, customer support, IT help desk) and others specific to an industry (e.g., claim processing, financial analysis/audit). It includes operational activities that must be executed as part of being in business, but that are not seen as a critical source of competitive advantage. Of those companies interviewed, 29 percent already outsource some business processes to an offshore partner. Clearly, the main driver for this type of decision is cost, although increased service levels provide an attractive factor as well. Over 85 percent of those surveyed are satisfied with sending business processes offshore, and most expect an increase in scope and scale of this type of offshore transfer in the near future. When they do outsource such activities offshore, they want to be able to track key performance indicators with their partners and they expect to have a seamless integration between their own and their partners' IT systems.

Rules for successful outsourcing

Although most survey respondents are generally satisfied with the level of performance their companies achieve through offshore outsourcing, they frequently admit that the early phases of the process have been challenging-especially the first offshore implementation. There is a consensus, however, that the ability to master offshore operations-either as owned or outsourced facilities-is becoming a key core competency. Organizations will need to learn how to develop, manufacture, and support products by effectively working with offshore facilities.

Some key learnings that have emerged from this recent survey and from our experience with clients include:

1. Look at your decision "holistically." As the number of enterprise functions affected by offshore transfers increases, management should not make offshore-related decisions in isolation and treat these decisions as point solutions to reduce costs in a functional area. Offshore transfers-either outsourced or insourced-should be thoroughly reviewed by the entire senior team; cross-functional impacts of each element of the decision require careful review and planning. In some cases, it may be relevant to involve the board of directors in the decision.

2. Don't forget to look beyond cost savings. Improving a company's cost position remains the major underlying driver for most offshore transfer decisions. However, other business and political elements should be reviewed. Time to market, availability and stability of talent, prior experience in outsourcing, the overall collaboration infrastructure, geopolitical risk, and governmental support are important elements to consider.

3. Don't outsource broken processes. Companies deciding to outsource specific processes offshore should ensure that these processes are stable and operate at a competitive performance level prior to initiating the transition. Offshore transfers are not the answer to solving internal process deficiencies. Instead, they should be viewed as an approach to achieve the next level of performance after reaching process management maturity and best-in-class performance. Transferring an unstable process with sub-par performance often leads to massive disruptions and a further deterioration of overall performance.

4. Conduct a detailed, objective due diligence of what should go offshore. When pursuing an outsourcing strategy, long-term success hinges on a company's ability to carefully define core competencies, carving out those work elements that provide little or no differentiation while focusing on those that provide a sustainable, competitive advantage. Usually, this involves breaking up tasks within a function, not the wholesale outsourcing of that function. Often, this is an especially delicate task because it requires a deep, objective dive in a particular operational area.

5. Use "experience-based" logic. The more transfers that are implemented successfully, the lower the risk, and the shorter the expected time to results. A company with no prior experience in transferring operations offshore will have, all other things being equal, a more difficult time making the transition compared to an organization with several offshore contracts already in place. That said, management should be realistic in its expectations; payback is not immediate, and significant financial and personnel investment is necessary prior to harvesting the full benefits of an offshore transfer.

6. Think of offshore transfers as a beachhead to international market expansion. Successfully opening and operating your own offshore location(s) is expected to yield invaluable insights and a base for relationships that can be used later as a commercial beachhead in that market.

Sidebar: What Small Companies Need to Consider When They Go Off-Shore

"Of the approximately 600 companies we surveyed, a significant portion was small (less than 100 employees). Such companies understandably approach global sourcing and supply chains from a different perspective than large companies.

But they're still obliged, more than ever, to ask 'what should we do as a small company' to compete in the global economy? We saw clearly in the survey a vast majority of small companies pondering this question.

Small companies have to overcome two essential hurdles to be successful in global trade. The first bucket is 'talent and people'. Typically they lack sufficient management bandwidth to go overseas and do the lengthy due diligence necessary to pick the appropriate partners. Then there is the matter of resources and existing infrastructure. Companies above $100 million, which seems to be the 'sound barrier', can scale much easier because they tend to have the appropriate systems and processes in place to support an off-shore relationship.

For a small company with higher risks, the answer to the question 'whether we should we be overseas' depends on who they serve and what they do. There's no 'one-size fits all' solution. Decision-makers have to do a holistic analysis. Companies with highly customized products or solutions, where the responsiveness of the supply chain is critical because what they are ultimately selling is service, could survive by not going outside the United States or by keeping their core operations in the most competitive states for their business. On the other hand, in an undifferentiated market where price is critical, it's not an option not to go world-wide.

In manufacturing, particularly of a commodity-type where the main differentiation is price, the fundamental game of outsourcing is to achieve lower cost position. But even in this area, where price is the game and there's no real alternative, our survey showed that off-shore sourcing poses perils. A lot of small companies have tried and got burned, at least initially.

The biggest reason is that they weren't properly prepared. This is particularly true when something is not working internally in the first place and the na•ve belief is that it can be fixed less expensively by somebody else overseas.

79% of the companies we surveyed had tried some form of outsourcing. The level of satisfaction was highest with ones that had been doing it longest, typically longer than 5 years. The reason probably has to do with getting better, over time, in breaking down the different elements in the manufacturing process so that they're contained and very quantifiable and have tight specifications.

Typically most newcomers under-estimate the length of that learning curve. So you don't want to go overseas with the 'crown jewels'. Better to start off with something more peripheral and less sophisticated where you have specific tools and specific guidelines. You always need a contingency plan for redundant processes and resources in case there's a breakdown off-shore. This has to be stressed; you need to have a Plan B which too many companies don't have.

Intellectual property is always very much at risk when an activity is sent overseas. Small companies tend to be na•ve about how fast industrial design, technology solution or entire products get copied. You need to keep critical elements in the United States and then slice the different off-shore modules thin enough so that, by themselves, they don't present much value. Final assembly requires the most labor but if you give your off-shore partner the whole thing, the risks of intellectual theft are the highest.

And then there's another lesson a lot of U.S. companies have learned the hard way: 'don't go with what appears to be the ultra-low-cost partner.' There's a reason they're cheap. Again there is not a single rule, but some companies have been successful in in establishing relationships in more mature markets, like the Philippines or Taiwan, where business practices are more developed; they end-up incurring 10-15% cost premiums up-front that they are able to transform in a long term advantage because of the stability and quality of the relationship they have established." -Roger Wery