In the past decade, American companies saw offshoring and outsourcing work overseas as a magic bullet for guaranteed cost savings. Indeed for some companies, offshoring and outsourcing overseas has proved beneficial. In financial services, for example, a 2007 Deloitte Global Financial Service Offshoring study found that half the banks interviewed reported that sending a business process, such as payroll, to a cheaper labor market saved over 40% of bottom-line costs.

Offshore and outsourcing of all types, including manufacturing, IT, and back office operations, are an essential and growing part of many businesses. Yet supply chain experts at Emory University’s Goizueta Business School and other Atlanta-area outsourcing experts say companies have had to earn their savings by taking on a whole new set of risks and managerial challenges. For the losers of this gamble, kinks in the supply chain, lost intellectual property, and disgruntled customers are some of the consequences of offshore projects gone wrong.

Another hard learned lesson of offshoring is understanding the limits to this strategic tool. Some kinds of work will probably never be moved overseas – drywall, for instance, is too heavy to ship economically from abroad; and specialty goods that need to be produced on short notice aren’t going to be sent abroad, says Richard Metters, an associate professor of information systems and operations management at Emory’s Goizueta Business School.

Despite the risks and challenges of offshoring, companies are still embracing it as a necessary part of their business. The problem though, say experts at Goizueta, is that few companies have fully mastered the intricacies of managing a project successfully. The Deloitte study, for instance, found a wide range in the degree of savings financial services firms have achieved in their outsourcing projects – anywhere from 20% to 70% – which suggests that many companies still have a lot to learn when it comes to managing their offshore projects.

Fortunately, offshoring and outsourcing best practices are emerging that provide a guide for navigating and maximizing the process. Additionally, the academic research in the realm is steadily increasing. Saji K. Mathew, a Fulbright senior scholar from India at Goizueta Business School, along with Anandhi Bharadwaj, a professor of information systems and operations management at Goizueta, are analyzing the risks companies face when they offshore one particular kind of work, software development.

After conducting 22 interviews with IT executives, the researchers found that executives worried about three major risks:

• Shirking: the contractor delivers an inferior product. Contracting firms will sometimes take more experienced workers off a project and substitute them for younger, cheaper workers, without letting the client know about the switch.

• Misappropriation of assets: product knowledge gained by a contractor that is passed on to a competitor and also retained by the contractor, or source code developed by the contractor at the client’s behest is kept by the contractor.
• Service locking: the engagement grows too deep, and the scope of the work the contractor provides grows so much that the company loses its bargaining power with the contractor.

To avoid these problems, companies use a variety of strategies, according to Mathew.

To prevent shirking, the terms of the outsourcing deal need to be explicitly stated. Contracts can be written more clearly, making the composition of a team clearer. There also needs to be a remedy if a contract is less profitable than the vendor had initially believed—another driving force behind shirking.

Misappropriation tends to occur more frequently with less established vendors. Interestingly, time can help to decrease the risk of theft. Contractors build up an incentive over time to protect their reputation.

Finally, to avoid service locking, companies try several remedies. One is to choose different providers for particular kinds of work, such as IBM for infrastructure maintenance, ensuring that accounts stay somewhat divided. Changing the level of the contractor’s investment also helps. “Oftentimes the clients and service providers agree to equally invest in the assets required,” Mathew says. Some companies insist the contractor makes an investment in the project, such as bandwidth or communications equipment, to ensure that the contractor is sharing both the risks and rewards of the partnership. This helps prevent an asymmetry of power in the relationship, he says.

Other companies dodge some of these risks by getting out of the outsourcing business altogether – not by staying home, but by building or buying their own offshore facilities, according to Metters. Some of the biggest users of offshore help don’t actually outsource at all, these days, but have their own employees in a lower-cost labor market. IBM, for example, now has 78,000 employees in India, according to its 2007 annual report – about one in five of the company’s employees.

To diversify their risks still further, many companies maintain a portfolio of operations centers, Metters explains. American Express, for one, maintains call centers in the U.S., India, and the Philippines. The idea, he says, is to create backup capacity “so if things really fall apart overseas, you still have capacity at home.”

A portfolio approach also gives the company a way to differentiate service levels according to the importance of the customer’s account,  Metters adds.

Finally, a portfolio approach helps the company protect itself against the risk that it might lose its institutional memory if one overseas operation were to fail. “Remembering corporate procedures is a big deal,” Metters says. One case in point: a U.S. airline that kept a lot of its back office operations in Barbados ran into trouble when it shut its island operations down after 18 years. “Training didn’t go on, people didn’t write down procedures, then when the operation was moved from Barbados, nobody knew how to do anything,” he says.

Whether the offshore shop is inside the company or at an external contractor, managing people 6000 miles away is often a challenge. Tom Halaburt, an Atlanta-based outsourcing consultant with HighRoads Advisory Services, says that in the early days, the offshoring process sounded easy. In fact, his previous employer ended up requiring more supervisors be hired to monitor performance offshore. “You had to put some extra manpower on it to make sure that the group 6000 miles away was performing what they needed to do,” he says.

In addition, Halaburt learned that it’s vital to have a single person in charge of the process. “From a best-practice perspective, I think it’s important to have a champion on both sides, a key stakeholder who is going to be responsible and held accountable for making that relationship work. That was probably the most successful management oversight tool that we had,” suggests Halaburt.

Another important differentiator, he says, is planning. When a project goes wrong, in 80% of the cases there’s been a failure due to insufficient details about what the offshore team was supposed to do, he explains. To avoid this, it’s essential to compile a lot of detail about a process, so that when a project is sent offshore, it becomes much simpler to get it going. “Once you get that information documented and have that, it doesn’t matter where you want to send the work -- it’s a repeatable process that can be completed,” he explains.

Finally, understanding and dealing with cultural and language issues will ease the outsourcing and offshoring process. Halaburt counsels not to overlook the importance of training, particularly educating employees in the home office about their foreign colleagues. For example, many Indians say ‘yes,’ as an acknowledgement, the way Americans sometimes say ‘okay,’ without actually suggesting that they have agreed to do something, he says. For outsourcing and offsourcing projects, subtle and sometimes more obvious language and cultural differences can also impede this business relationship.