Total Cost of Engagement

The unique value of Near Shore as an enabler for lower cost of offshore outsourcing

Executive Summary

The whole concept of Offshore

Outsourcing is created around the idea
that cost efficiencies can be attained by
shifting work from a high cost to lower
cost locations.

Although it is a fact that man/hour rates

are a fundamental driver to reduce costs,
offshore savings should not be
determined only by the man/hour rate
differentials. A holistic view of expenditure
measurement should be considered.
TCE or Total Cost of Engagement is an
approach that evaluates the total
expenditures of offshore engagements.

Contents: Despite the maturity level reached by the

offshore outsourcing programs in many
1. What is Total Cost of Fortune 500 corporations, the model
cannot be leveraged at its full potential.
Engagement (TCE)? There is still an important amount of work
that is done at the client’s site, thus
2. It‘s all about Offsite Leverage increasing the TCE. The reason is the
fact that time-zone differences and
distance with India, and other Asian
outsourcing destinations is a barrier.
3. Cost Components of the
Engagement Although Near Shore rates tend to be
higher, the overall cost of Near Shore
4. TCE – Softtek’s Near Shore® vs engagements is equivalent or less than
Offshore offshore, because of the efficiency gains that
working in close proximity to the US and in
the same time zones can bring. The Near
Shore model is much more efficient in
achieving higher percentages of work
performed at a lower cost location than
offshore.

The information contained in this document represents the current view of Softtek on the issues discussed as of the date of publication. Because Softtek must
respond to changing market conditions, it should not be interpreted to be a commitment on the part of Softtek, and Softtek cannot guarantee the accuracy of any
information presented after the date of publication.
This document is for informational purposes only. SOFTTEK MAKES NO WARRANTIES, EXPRESS OR IMPLIED, IN THIS DOCUMENT.
© 2005 Softtek. All rights reserved.

Product and company names mentioned herein may be the trademarks of their respective owners.
Softtek Document Number: NS-TCE200503-WP01.1
Total Cost of Engagement

1. What is Total Cost of Engagement (TCE)?

A few years ago, IT industry analysts introduced the concept of TCO (Total Cost of Ownership) to
measure the overall expenditure associated with a certain solution.
The TCO approach has helped IT and business managers evaluate solutions with a rational
model that encompasses all the costs related to a certain solution.
For instance, a TCO model for a corporate e-mail solution includes not just the license and
annual fees for the e-mail software, but also considers the direct cost of the hardware for servers
and clients, IT staff training, end user training, and external services fees. Furthermore, the TCO
model also considers the costs related to productivity losses or gains associated with ease of
use, performance and reliability, and could even embrace possible costs associated with vendor
risk and viability. Under this model, license cost, while important, becomes just another piece of
the puzzle.

The same way TCO provides a holistic view of expenditure measurement, proving that software
solution cost goes beyond licensing fees. TCE is an approach that should be considered to
evaluate the total expenditures for offshore engagements; these costs go beyond project team
costs (man/hour rate times project effort).
Considering the maturity level of off-shore vendors today as well as the Near Shore model, it is
imperative to broaden the evaluation criteria for Offshore services beyond project team costs and
man/hour rates.

2. It’s all about Offsite Leverage

The whole concept of Offshore Outsourcing is created on the idea that cost efficiencies can be
attained by shifting work from a high cost geography to a lower cost location. Professional
services man/hour rates are lower in Mexico, India or China, than those in US, UK or Japan.
Despite the maturity level reached by the offshore outsourcing programs in many Fortune 500
corporations, the model cannot be leveraged at its full potential; there is still an important amount
of work that is done at the client’s site, thus increasing the TCE. The reason for that is the fact
that time-zone differences and distance with India, and other Asian outsourcing destinations is a
barrier.
The percentage of work done at the offshore location is known as Offsite Leverage.

Typical Offsite Leverage for Asian vendors ranges between 60% and 65%, meaning that the
remaining 40-35% of work remains at the client’s site. Furthermore in some cases, vendors and
clients agree to add an overhead in the headcount to their projects, to have people dedicated to
minimize the impacts of distance and time-zone differences.

The Near Shore model is much more efficient in the Offsite Leverage metric. For US clients it is
much more convenient and feasible to have more worked performed in Mexico than in India.
Time-zone differences are non-existent or minimal. Air travel is easy and frequent, travel times
range from 1 to 5 hours. Communication infrastructure is similar, and so is the business culture.
The proximity component, inherent to the Near Shore Model, yields to an average Offsite
Leverage of 80% or higher.

The higher the Offsite Leverage, the higher the savings.

The Offsite Leverage impacts directly in the blended rate that the client will be paying. The higher
the leverage the vendor can have of its off-shore facility, the lower the blended rate. This blended
rate is called TCE Net Hourly Rate and is the ultimate rate that the client will pay for every
Man/Hour, it encompasses all the cost components of the engagement described below.

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The direct relation between Offsite leverage and TCE Net Hourly rate is represented in the
following graph:

3. Cost Components of the Engagement

Project Team Costs

The rate differential for IT services in the US and those of Off-Shore countries has certainly been
the most appealing argument for off-shoring. Offshore man hour rates can represent only a
fraction of the costs at hiring countries, primarily US, UK, Japan and Australia.
Project Team Costs which is calculated by multiplying the Man/Hour rate times the project effort,
has a very important specific weight in the cost evaluation of a solution, but is by no means the
only aspect that should be considered. TCE brings Project Team costs into a context where its
relative weight will be determined in conjunction with all the aspects that have an effect on the off-
shore engagement overall.
Use the following formula to calculate the Project Team Costs:
Project Team Costs = (On-Site Man/Hours * On-Site Rate)+(Off-Shore Man/Hours * Off-Shore
Rate)

Costs of Vendor’s Attrition

Every time a resource from the vendor resigns and leaves an engagement, there is a burden to
the project, caused by loss of productivity and a cost of knowledge transfer to the replacement.
This costs need to be considered as part of the TCE. To calculate these costs, two input values
are needed; the annual attrition rate in percentage and the average time to have a productive
replacement, with these values, the following formula can be used:
Costs of Vendor’s Attrition = Attrition Rate (%)* Number of Resources*Time to be
productive*Rate
Note: A good practice is to calculate separetly the on-site attrition costs from the offshore attrition
costs which tend to be much higher.

Project Overhead
Off Shore engagements tend to require people that is in charge of supervision and project
oversight, minimizing the effects of distance and time zone differences inherent to an Off-Shore
model. It’s a common practice of offshore vendors to have redundant project management roles,
one at the client’s site and the other offshore, and in some cases clients have to allocate internal
personnel. Thus increasing the cost in order to assure quality, on time delivery and avoid
communication flaws. This is considered as a Project Overhead and should be considered within
the TCE by using the following formula:

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Total Cost of Engagement

Project Overhead = (On-Site Man/Hours * On-Site Rate)+(Off-Shore Man/Hours * Off-Shore

Rate)

Allocation Costs at Client Site

This is the amount charged back from the organization to the project or IT area per person
working at the client's site. Generally includes power consumtion, office supplies, office space,
etc.
It is obtained by using the following formula:
Allocation Costs = On-Site Resources* Monthly Facility Use Cost per Resource* Number of
Months

Telecommunication Costs
This concept encompasses data and voice communication expenditures. In some cases the
highest portion of this cost is covered by the vendor, but there is always a client component in the
data portion, and in every case there is a cost for long distance phone calls.
Data Communication Costs = Monthly Data Link Costs * Duration of the Engagement in Months
Long Distance Costs = Number of LD Minutes * LD Rate

Transition and Knowledge Transfer

Includes labor costs and travel expenditures needed for knowledge acquisition. In most cases,
this is assumed to be a group of people from the vendor traveling to the client’s site and spending
as much time as needed to acquire the knowledge to carry-on the project. But a portion that is
generally overlooked is the time that client resources allocate to train vendor’s personnel, which
can represent a heavy burden to the cost of the engagement.
KT Costs = (Vendor’s resources on-site for KT * On-Site rate)+(Clients man/hours dedicated to
KT * Clients man/Hour cost)

Project Trips
Most off-shore engagements require some sort of traveling, either from the client’s side or the
vendor’s. The purpose of these trips can be project tracking and oversight, issue resolution or
scope change, among several reasons. Beyond the evident travel & living costs, project trips cost
should also consider the hourly costs of the resources that are traveling.
Project Trips Costs = Airfares + Hotel Fares + (man/hours spent in travel * hourly rate) + car
rental fees + perdiem

Relationship Management Trips

This is another concept that involves traveling expenses, and allocation of client’s personnel at
the vendor’s site. These relationship management trips are typically related to contract
compliance monitoring, service level agreements oversight, etc.
Relationship Management Trips Costs = Airfares + Hotel Fares + (man/hours spent in travel *
hourly rate) + car rental fees + perdiem

Engagement Staffing Costs

The costs incurred by the client in the process of selecting vendor’s personnel for the
engagement. This item refers only to the cost of man/hours invested in reviewing and interviewing
candidates. The invested time may vary depending on the type of engagement, typically Time &
Materials engagement will require a higher investment than those of Fixed Price.
Engagement Staffing Costs = Clients Man/Hours spent staffing * Client’s Man/Hour cost

Additional Considerations
In addition to the Project Costs, hiring managers should also consider additional costs inherent to
performing off-site projects. These costs are associated with possible losses in productivity due to
distance and time zone differences, in addition to a monetary value for risk mitigation, which
might be represented as a percentage of the Project Costs.

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Total Cost of Engagement
Productivity Losses
A trade-off for cost efficiency in off-shore engagements may be loss in productivity. Since
most part of the software project team is not at the client’s site, and in most cases in a
different time zone in a distant country, it is sane to assume that this factors can have an
impact in the team productivity, as opposed as having the same team on-site. The best
way to measure these productivity losses is as a percentage of the project cost.

Risk
This is a monetary value for the effects that Geographical and Political aspects can have
on the viability of the engagement. Risk factors include the following:
• Security Risks: Consider Information Security Standards, Vendor and Vendor's
country track record
• Privacy Protection: Consider the availability of Data privacy laws and the
enforcement of those laws. Also consider vendor's privacy protection policies.
• Government Interception Risks: Consider Foreign government capability to
access and intercept records, as well as available regulations for record
encription controls
• Intellectual Property Risks: Consider patent laws, trade secrets and copyright
enforcement in the Vendors country. As well as the sensibility of your
engagement for Intellectual Property.
• Employee & Labor Laws: Consider labor laws and possible liabilities of your
company in the vendor's country.
• Contractual and Legal Risks: Consider the availability of bilateral agreements
between you country and the vendors. Take into account contract enforcement
efforts.

These elements should have a monetary representation for the TCE. In some cases a
direct monetary value can be allocated for an instace of the risk, in others, it is good to
asume a percentage of the total cost of the engagement.

The complete picture of Total Cost of Engagement will include the following:

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Total Cost of Engagement

5. TCE – Softtek’s Near Shore® vs. Offshore

Man / Hour Rates

• While evaluating the difference of Man/Hour rates between Offshore, and Near Shore,
managers should consider the two components of a typical off-shore engagement; the
On-site rates and the Off-Shore / Near Shore rates.
• On-site rates tend to be very similar, because all Offshore vendors have to comply with
US regulations, and pay its employees a competitive wage while working in the United
States.
• It is a fact that cost-of-living in North American Near Shore countries (Mexico and
Canada) is typically higher than traditional offshore countries. Therefore in some cases,
Man/Hour rates tend to be 10-20% higher for the Near Shore component of the
engagement than those of Offshore.

Travel Expenses
Consider the following travel expenses for a trip of 3 full days at vendor’s facility:

Monterrey, Bangalore,
Concept
Mexico India
Airfare (JFK, 2 week advance, economy
$500 $4,000
class)
Hotel (Sheraton Hotel & Towers $180 / night) $720 (No Jetlag) $900
Total travel time 4 days 8 days
Cost of human resources (assuming an $80
$640 $1,280
/hour client cost and 8hrs per day)
Total Cost of Travel: $1,860 $6,180

From a conservative point of view, travel expenses to an Indian Off-shore facility are
330% higher than those of a travel to Softtek’s Near Shore facility.

Telecommunication Costs
• In most cases, the offshore vendor provides data links, and the biggest expenditure is
covered by the vendor. Nevertheless, there are some costs that should be considered,
mainly in two areas: hardware infrastructure in the clients end (routers, firewalls, etc.) and
Network Administration and Information Security personnel.
• Due to Business Continuity policies triggered by geo-political situations in central Asia,
most companies buying offshore services from India had to install redundant data
infrastructure, as part of their BCP, incurring in hardware and human resources costs.
• Long distance costs should also be considered. According to AT&T corporate rates
(published in AT&T web site), India Long Distance costs are 310% higher than those for
Mexico.
Consider a simple exercise for a 6 month engagement, where team members spend an
average of 60 minutes a day in long distance phone calls, the comparison of LD
expenditure is as follows:
Concept Mexico India
Per-Minute cost 19 cents 59 cents
6 month expenditure $1,368 $ 4,248
Softtek’s Near Shore engagement would offer additional savings of up to $2,880.

Engagement Management Overhead

• Distance and Time zone differences have a direct impact in the way an offshore
engagement is managed. For an offshore engagement in India, people on-site (client’s

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Total Cost of Engagement
and vendor’s personnel) have to accommodate odd schedules to have the necessary
communication like conference calls.
The impact in the Total Cost of the Engagement of this item, is that in some cases the
client has to pay overtime for it’s employees or local vendors, and in some Time and
Materials engagements, there are additional man/hour fees applied to this type of
activities.
• Most telephone communications for offshore engagements have to be planned and
agreed in advance, while Near Shore enables a more casual communication inherent to
software projects. Onsite managers can pick-up the phone, and be certain that they will
be able to talk with the Near Shore team any time of the work day, since Softtek’s Near
Shore Teams are working in the same time-zone.
Ease of communication has a direct impact on productivity, non-spontaneous
communication has a negative impact in the cost of the engagement.

Higher Near Shore Leverage Drivers

Near Shore contributes to a higher Near Shore leverage from the very beginning of the
engagement. Some examples that contribute to increase the leverage are the following:

• Trainer at the Near Shore Development Center Vs. all Team Onsite for training
• Full team Near Shore and fly as needed vs. having part of the team permanently onsite
• Two day review trips vs. one or two week when traveling to India
• $450 usd average cost of round trip flight
• UPS / Fedex Next day delivery
• Same time zone, including daylight saving
• Temporary import/export of equipment
• Same work calendar: In some cases there are more than 20 combined holidays of the US
and Asian offshore destinations

Geo-Political Risk
• Mexico is the second largest trading partner of the US, just behind Canada. Through this
relationship, strong foundations have been created, like telecommunications,
transportation, migration and legal.
• Mexico along with US and Canada are members of NAFTA (North America Free Trade
Agreement) valid since 1992. This agreement has effect in Near Shore engagements in
three ways:
o Mexico is Business-Friendly and culturally attuned to American Business
Practices
o Regulatory and legal issues of cross-border business dealings are significantly
less than those with countries not part of NAFTA.
o Availability of visas is not an issue, due to the availability of several types of visas
designed to facilitate exchange and transit as part of NAFTA

Attrition
• The fact that India based vendors have been growing so rapidly in the last few years, has
created market dynamics where talented individuals are always offered with attractive
opportunities. With so many large vendors concentrated in main India regions like
Bangalore or Chenai, attrition levels have been raising in recent times.
• Near Shore promotes higher retention levels due to better communication between the
onsite and offsite members of the team.

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Notes:

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