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Offshoring Gains Momentum, Sophistication: But Pitfalls Remain for Firms that Act Too Hastily

Offshoring in the financial services industry is expected to double by 2008, but firms that approach the strategy solely from a cost-savings perspective, or that fail to address quality control, turnover and compliance costs, run the risk of missing out on its greatest competitive advantages - and not realizing those cost savings.

"If you're just looking to play with the arbitrage on the salaries, you're leaving a lot on the table," said Thom Barrett, a partner with PricewaterhouseCoopers in Boston.

In other words, said Barrett, who recently collaborated with colleagues Jeremy Scott and Nigel Vooght on the study, "Offshoring in the Financial Services Industry: Risks and Rewards," a firm should wring every bit of efficiency out of an activity before shipping it overseas or outsourcing it to a third party.

"If it takes you 10 steps to complete a task, you can be sure that whoever you get to do it will be able to do it in eight steps. And they'll charge you for 10," he said.

Saving money, however, remains the No. 1 reason financial services firms offshore services, such as payroll and call center activities, to countries with low labor costs, like India and Ireland. For instance, a typical call center agent in India costs about $7,500 annually, which is half of what it would cost in the U.S. So most firms do realize a savings, but as Barrett noted, a growing number are failing to sufficiently prepare activities for offshoring and are realizing cost overruns as a result.

According to the study, nearly one-third of the 156 senior executives PwC surveyed reported an increase in costs in the first year after offshoring. Another 15% indicated that their firm had realized no cost savings after five years of offshoring. According to PwC research, quality control, the transition from old to new facilities and the demands of retraining people and meeting compliance yardsticks are areas where most cost overruns occur.

PwC research indicates that annual staff turnover at some offshore centers in India runs upwards of 60%. And while the best way to retain employees, survey respondents said, is to offer training, career development opportunities and performance-based incentives, Barrett admitted that a more knowledgeable workforce could eat away cost savings down the road.

"That could be as little as five or six years out, but that's not a bad window of opportunity either way," he said.

In fact, an Oct. 12 study on offshoring conducted by Duke University and Archstone Consulting indicates that the talent pool in India has improved so much in recent years that 71% of the Forbes 2000 companies it surveyed said access to qualified personnel is a major driver when considering offshoring. Industry expertise is the key driver behind site selection, the broader study said.

"We are seeing a shift in the types of offshore functions, which is a shift in the mindset of how top executives are looking at ways to generate new business," said Todd Lavieri, president and CEO of Stamford, Conn.-based Archstone. "New product engineering, research and development and additional administrative functions are being more fully integrated into strategic plans."

Breaking out financial services firms, the Archstone study reveals that the industry overwhelmingly prefers offshoring to a third party, rather than operating a captive site. Awareness surrounding disaster recovery is also rising rapidly. Archstone officials said that's likely a result of recent natural disasters, rather than threats of fraud or exposing confidential client data.

Compliance and governance, however, are two areas where corners cannot be cut. According to PwC, regulators expect firms to maintain exceptional levels of transparency and risk management as offshoring activities become more and more sophisticated. Beyond payroll and IT, customer contact activities, such as scripted sales calls, and knowledge-based activities, like research and modeling, are fully expected to be among the tasks firms will be offshoring by 2008.

"Regulators are watching to ensure that standards of compliance and governance are maintained, particularly as offshoring shifts into areas which are more critical to business continuity and where concerns over client confidentiality and data protection prevail," Vooght warned.

In fact, PwC's experts claim, if fraud or some other sort of high-profile malfeasance were to occur at a firm's offshore site, regulators could respond more severely than if it had occurred in the U.S.

Companies planning to offshore an activity should also be mindful of a persistent sentiment among consumers and lawmakers against the practice. Last year, Illinois and Tennessee passed laws aimed at limiting offshoring, while a number of other states are currently eying legislation that would curtail state aid and tax breaks to firms that offshore.

But unlike the manufacturing sector, where high-paying union jobs tend to be at stake, Barrett said the financial services industry simply doesn't have a pool of people in the U.S. that are willing to perform mundane tasks at low wages.