Insurance companies today are battling a number of issues,including sinking margins, competitive pressures, globalization,sweeping regulatory changes, and product commoditization. To reactto the changing landscape, they have had to alter the risk-aversementality that has traditionally driven their business. As part ofa plan to break from the past, insurance executives must createleaner, more nimble organizations and be willing to take calculatedrisks.

In todays context, this plan often includes the use of offshorelabor for business process management and information technology.The advantages of using offshore labor are well documented andhighly compelling. Labor-related IT and back-office administrationcosts amount to a significant portion of an insurance companysoperating expenses. Programmers, claims processors, underwriters,and a slew of other re-source types generally are hired full-timeand paid prevailing U.S. wages. In an offshore country, not onlycan you find the skills required to perform these job functions inabundance, but also the wage rates will be significantly lower. Inmost cases, companies can realize a savings within a one-year timeframe of 30 percent to 50 percent by outsourcing to India. BecauseIT outsourcing is a mature industry in countries such as India,skilled resources and vendor choices are more abundant relative tothe newer areas of business process outsourcing (BPO) and callcenter outsourcing. However, this issue can easily be overcome withthe appropriate emphasis placed on training and processdevelopment.

The offshore outsourcing decision process generally focuses onfour key topics: cost, control, quality, and risks. Can I save onoperating expenses to the extent it will have a direct impact on mybottom line? Will I lose control of the processes that mayadversely impact my core business? Can I maintain or exceed currentquality levels by using offshore labor? What are the risksinvolved, and am I willing to take those risks? To address thesequestions, a structured road map to offshore outsourcing should bedeveloped. Broadly speaking, this roadmap should include threehigh-level components: country selection, delivery modeldefinition, and vendor selection.

Country Selection
Developing countries across the world are in a battle to become thepreferred destination for offshore outsourcing. Some countries haveemerged as early leaders, including the Philippines, Malaysia, andSouth Africa. Each country has its own particular strengths andweaknesses. Countries should be evaluated across several variables,including: cost, size of labor pool, political stability, culture,business environment, availability of vendors, andinfrastructure.

However, no single country has been more successful in theoutsourcing market than India, which currently owns about 80percent of the offshore IT outsourcing market and is positioned tocapture a majority of the BPO market as well.

Several key factors are responsible for the growth of theoutsourcing industry in India. First, India has a large, highlyskilled labor pool that is available at a relatively low laborcost. With over four million engineers, India ranks second only tothe United States as the country with the largest population ofEnglish-speaking technical personnel. This sizable pool of ITtalent in India is available to companies worldwide at relativelylow labor costs.

A second key factor driving the market is the educational systemin India. The origin of the present-day Indian educational systemcan be traced to the countrys roots as a British colony. TheBritish in-sisted on the establishment of education based onWestern standards and the use of English language. As a result, theIndian educational system today is a global leader in areas such asscience, technology, and management, and graduates from the IndianInstitutes of Management (IIMs), Indian Institutes of Technology(IITs), and the Indian Institute of Science (IIS) are highly soughtafter by corporations across the world.

A third key factor driving the Indian IT market is that ofquality. On a global basis, Indian IT firms own the majority of CMMlevel 4 and 5 certifications, with 51 and 27, respectively.Although the BPO and call center industries still are in theirearly stages, executives from the Customer Operations PerformanceCenter (COPC) have very positive comments about India. SeveralIndian delivery centers already have achieved COPC certification.In many respects, quality has become synonymous with India in theoffshore outsourcing marketplace.

Fourth, differences in time zones allow work to be carried on byIndian teams on a 24-hour basis, shortening cycle times andimproving productivity and service quality. The approximate 10- to12-hour time difference between India and the United States is aconsiderable advantage for India-based operations. For customercontact functions that require real-time interaction with customersduring U.S. business hours, Indian companies are more than happy toestablish nighttime shifts to accommodate the demands of U.S.clients.

Finally, the Indian government has recognized the importance ofthe outsourcing sector to the Indian economy. Government policy hascreated a favorable atmosphere for Indian businesses through taxrelief and infrastructure support for companies operating inGovern-ment Software Technology Parks. Gov-ernment policy towardthe industry also is being driven by the desire of the centralgovernment to encourage exports to generate foreign currencyreserves.

Because of the population and the established educationalsystem, India will keep its leadership position for the next fiveto 10 years. Skilled talent in the areas of IT and business alwayswill be readily available at lower costs than in the U.S. Andbecause of its early leadership position, other countries will findit hard to catch up, especially in the areas of quality,acclimation with U.S. business practices, and overall brandrecognition.

Delivery Model Definition
After a country has been selected, the next question for insuranceexecutives is how the offshore delivery center should bestructured. There are essentially five basic choices, all withtheir own benefits and risks:

Captive delivery center. This is the preferred model forcompanies that are completely committed to an offshore strategy andare willing to invest the necessary financial resources to buildtheir own subsidiary from the ground up. The key advantages of sucha model are long-term cost savings and control. Although thestrategy involves significant upfront capital commitments, in thelong run companies are able to maximize their cost savings as avendors profit margin does not need to be paid. From a controlperspective, the offshore delivery center will be committed to itsparent without competing interests. This model works well whenorganizations move from piecemeal outsourcing to a comprehensiveoutsourcing strategy. One disadvantage of this model is companiesare not able to learn processes from an offshore vendor, especiallyin the case of software development where process rigor isimportant. Another downside is companies must learn to build andoperate a business in a foreign country. The challenges of doingthis can be quite significant.

Build-Operate-Transfer (BOT). This is a model that is becomingpopular for U.S. companies because it takes on characteristics of acaptive center and, at the same time, mitigates a portion of thestart-up risks. Using this model, U.S. clients engage an offshorevendor to build a dedicated delivery facility and manage it for aspecific period of time, ranging from one to five years. After thistime period, the company has the option to buy the offshore centerfor a predetermined price. The vendor puts up the capital to buildthe center and assists with developing the operational pro-cesses.The advantages of this model for U.S. companies are it lessens theinitial capital requirements and it gives access to a vendorsprocesses. However, vendors are not inclined to make as much moneyunder this model relative to an outsourcing contract. Thus, thehourly offshore bill rates and eventual purchase price of theentity may be high. Some larger offshore vendors are not interestedin this model because they eventually lose the business once it istransferred.

Offshore Development Center (ODC). This model has gainedpopularity over the last three years, especially for largercompanies. ODCalong with captive center and BOTis not suitable forcompanies that wish to take a project-by-project approach. With theODC model, a U.S. company establishes a dedicated center separate(virtually and often physically) from a vendors main business. Thevendor manages the offshore center on behalf of the client. Thereis no buyout option of an ODC as is the case with BOT. The clienthas dedicated resources that cannot be moved to other parts of thevendors business. The benefits of an ODC are numerous: knowledgeretention, improved rate negotiation, increased productivity,faster ramp-up time, and consistency in delivery quality. Theoffshore workers often feel as if they are employees of the U.S.company and thus have a certain loyalty to the job. Thedisadvantages of such a model are that a company loses some of thebenefits of outsourcing, specifically those allowing it to havevariable costing instead of fixed costing. Regardless of resourceutilization under the ODC model, companies will pay the offshorevendor the same amount on a monthly basis.

Joint Venture (JV). This model has been used with limitedsuccess. Depend-ing on whom you ask, failure rates of offshorejoint ventures can range from 60 percent to 90 percent. In thismodel, a separate legal entity is structured in the offshorecountry, and equity is split between the offshore vendor and theU.S. client. The advantage of this model is the U.S. company andvendor can start with a clean slate and structure the JV in anyfashion that makes sense. Often, start-up capital comes from bothparties. However, the JV eventually will take on a life of its ownand often conflict with its parents interests. There are severaldocumented case studies that have shown this model to be lesseffective relative to other options.

Outsourcing. This model is best for companies that are new tooffshore outsourcing and those that want an ex-tremely quick pathto cost savings. There is minimal long-term commitment under thismodel for companies, and it is a good way to test the waters. Therelationship is defined contractually through service levels andhourly rates for offshore resources. With outsourcing, companiesoften complain they lose control of the outsourced work. Moreover,cost savings are not as high as with other models because thevendor needs to support its profit margin, which can range from 25percent to 50 percent.

Vendor Selection
The final phase of the offshore outsourcing process is selectingthe vendor. Selection strategies can be quite complex, as severalfactors need to be taken into consideration. Best practices invendor selection demonstrate the use of a weighting and scoringsystemcustomized for client-specific requirementsto create ashort-list of three to five vendors. The final selection of thevendor should be based on softer issues assessed during a series ofsite visits to the vendors facilities. These issues includecultural compatibility, alignment of goals and objectives, andcommitment from senior management.

For the more initial scoring system, however, the vendor shoulddemonstrate proven competence in its field. Breadth and depth ofcapabilities should be balanced by a commitment to quality,delivery, integrity, and innovation. Flexi-bility, efficiency, andcost savings also are important criteria. Overall, the vendorshould demonstrate a proactive and responsive management style thatsupports a customer-focused approach. In offshore context, reliableinformation about vendors is hard to come by, which furthercomplicates the process.

Once the vendor has been selected, key to success will be awell-managed relationship between the vendor and the clientorganization. Commitment to the relationship and development of ashared vision ultimately will create the greatest value for bothbusinesses. Risks and rewards need to be shared, and clearcommunication mechanisms need to be such that decision-making isbased on transparent information.

Conclusions
Like many companies facingshrinking profit margins, in-surers have to extract as muchefficiency as they can out of their operations. The industry as awhole has been relatively slow to adopt offshore outsourcing, butthe time for action may be now. The ad-vantages are many, and therisks can be properly controlled through a disciplined approach.Offshore outsourcing is here to stay and will eventually become anecessary element for survival.

Shailen Gupta is president of Renodis, which specializes inthe rapidly expanding offshore outsourcing market. He can bereached at [email protected].

The content of Inside Track is the responsibility of eachcolumns author. The views and opinions are those of the author anddo not necessarily represent those of Tech Decisions.

Worldwide IT Services Market Revenue Estimates by Region(Millions of U.S. Dollars)