IT Outsourcing: Definition, Types, Pricing Structures, and More

Posted by KMS Solutions on Dec 12, 2021 6:11:51 PM

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At some point, businesses often find they would need to build new IT systems, which require more staff. But it makes no sense to payroll new employees for a one-time project. This is where IT outsourcing comes in. By providing temporary professionals, IT outsourcing helps companies save costs and scale their teams immediately to kick-start projects.

This article discusses all things IT Outsourcing: definition, pros & cons, typical types of IT outsourcing models, pricing, and where best to outsource your IT functions.

Table of Contents

1. IT Outsourcing Definition

2. Types of IT Outsourcing

3. IT Outsourcing Models

4. IT Outsourcing Pricing

5. Most Commonly IT Outsourcing Services

6. Best IT Outsourcing Locations

7. IT Outsourcing Advantages & Disadvantages

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IT Outsourcing Definition

IT Outsourcing means handing over your IT projects (software development, testing, maintenance, ...) to external providers. 

There are several reasons why a company engages in IT outsourcing services. The most popular one is to save costs. Another is the need to scale IT resources immediately to get the project started. 

Otherwise, businesses outsource when they lack critical expertise for the project at hand. And that expertise is available in external IT outsourcing vendors.

Types of IT Outsourcing

IT outsourcing is divided into three types: offshoring, onshoring, and nearshoring. They are only different in how far the providers are to your team.

Many people use IT outsourcing interchangeably with IT offshoring, which is not true. The former includes the latter, together with onshoring and nearshoring.

1. Offshoring

Offshoring is when a company outsources its IT activities to an external provider in an overseas country. 

You may also have heard of offshore outsourcing, it’s the same as offshoring.

Many choose offshoring as their preferred IT outsourcing. The reason could be that the offshore countries offer cheaper costs, low or no tax, a larger IT workforce, or a stable political environment.

It should be noted that the provider of the IT offshoring vendor is at a very different timezone than you are. Whether this time difference is a disadvantage or not depends on many factors. 

Some find different time zone a barrier as they could not sync with the IT outsourcing vendor. But time differences can be beneficial to companies that look for uninterrupted tech support, or those who constantly implement updates and maintenance.

Example of IT offshoring: an Australia-based investment fund outsources its software testing to a vendor in Vietnam. This is offshoring because the two countries are 4 hours apart.

2. Nearshoring

IT Nearshoring or nearshore outsourcing means that you delegate your IT projects to a vendor in your neighboring country. Typically the provider of nearshoring services is in the same time zone as you or only one or two hours different.

Compared to offshoring, nearshoring makes it easier for your team to collaborate with the vendor and its team. Companies located near each other also share certain traditions and customs. This can make communication a lot more comfortable.           

Example of nearshoring: a US-based automotive producer outsourcing its IT maintenance to software development in Mexico. This is nearshoring because the two are in the same time zone.

3. Onshoring

Onshoring means handing IT functions to a vendor located within your national borders. Because the client and the vendor share the same homeland, onshoring is sometimes called homeshoring. 

The rationale behind onshoring is that the IT outsourcing vendors usually have expertise that your team lacks, and you also don’t want to work with overseas providers to avoid language or cultural barriers.

Example of onshoring: a company based in Hanoi engages software testing experts in Ho Chi Minh.

4. Multisourcing

Multisourcing describes the situation when a company outsources to more than one IT service vendor at a time. These vendors can come from either offshoring, nearshoring, or onshoring. The purpose of multisourcing is to diversify the risk associated with working with only one vendor.

Example of multisourcing: A Japan-based fintech company has its own software development center in Tokyo. However, sometimes it releases so many features within a short amount of time that it outsources to a testing service provider in Nagoya to ensure quality at a low cost. When it plans on a new product, it realizes that the workload could exceed the internal team plus the outsourced testing team. To aid this lack of resources, it contracts with a vendor in Vietnam, who provides it with a full digital team. This is a case of multisourcing because the financial institution outsources to 2 vendors at a time, one onshoring (in Nagoya) and the other offshoring (in Vietnam).

IT Outsourcing Models

When working with IT outsourcing vendors, you would be asked for your preferred models of outsourcing. There are several models, each is different in service structure and pricing. Staff augmentation, project-based outsourcing, dedicated team, and dedicated development center are the 4 most popular IT outsourcing models nowadays. Which one to choose depends on your project’s nature, your current resources, and your budget.

1. Staff Augmentation

Staff augmentation (or workforce augmentation) is an IT outsourcing model for filling skill gaps or talent gaps in your existing teams. With staff augmentation, you temporarily have on-demand specialists for your project. 

Staff augmentation addresses a widespread need in non-IT companies: sometimes along the line they have IT projects, but they don't want to recruit official employees. Staff augmentation helps you avoid hiring full-time workers only to have them on the bench when projects end.

Workers provided to you in staff augmentation are under the vendor’s payroll. In staff augmentation, you pay only for the service, and the augmented staff work full-time for you until the contract ends. All other costs related to compensation and benefits are the responsibility of your staff augmentation vendors.

Example: a bank in Vietnam plans on a new mobile app that requires more staff than it currently has. They don’t want to employ new professionals because that would take too long that it should choose suitable candidates. Hiring is also a waste of money for this bank because likely after this project ends, those new employees will be put on the bench. They decide to engage staff augmentation service of a local company until the project ends. According to the contract, the augmented staff remains under the vendor’s payroll, but is fully under the bank's management.

2. Project-based outsourcing

You want to opt for project-based IT outsourcing if you want the vendor to take full ownership of your entire project. It’s the vendor’s job to manage the project and deliver the final product that meets your requirements. You and the vendor also agree on a timeline that you two must stick to.

If your project is small, simple, and unlikely to change, project-based IT outsourcing is ideal. Once you make clear your requirements and specifications, the vendor will complete your project without your guidance or any more input. And you can set aside that project to focus the time on tasks. However, you still can have regular review meetings to get updated on progress.

Otherwise, if the product you plan on is complex and you know that it would take a long time to complete, you'd better consider other options.

Example: An insurance company needs to develop a new feature for its internal system. Though the feature is minor, its current resource is not enough. It then contracts with a software development company under the project-based outsourcing agreement. After the insurance provides all these requirements in this project, the vendor starts to build the feature. The two also conducts weekly meetings to review the progress

3. Dedicated team

If you choose the dedicated team model, you will get a full team of IT professionals chosen specifically by your requirements. 

In the dedicated team model, you can choose to manage the team yourself, or you could assign a project manager from the vendor's side to coordinate the project. 

The dedicated team is technically yours during the contract’s term. But unlike your paid employees, you don’t bother about the administrative and HR expenses of this dedicated team. In other words, you only have to pay for the vendor’s services, and the rest is the vendor's job. 

Example: an English school chain wants to build and pilot an ed-tech subsidiary. This plan includes a new mobile app and web app, which requires a whole squad of professionals. The problem is its meager in-house resources: only a dozen IT staff that manage the internal management system. The chain decides to engage dedicated team service, which gives it a full team of professionals under a long-term contract to handle all of its future IT projects.

4. Offshore Development Center (ODC)

DDC is an outsourcing model where a company builds dedicated IT resources in another country itself to benefit from lower labor costs and/or tax, while fully owning that team.

Opening a separate development center on your own can come with numerous disadvantages. For one, you have to recruit foreign workers in a foreign country, where you have to follow their foreign labor laws and taxes. 

Opening an offshore development center only makes sense if you want to legally expand to the target countries, where you hire at least 50 or more people.

To get started with this model, you are recommended to partner with a local agency in the targeted country. They would help you with regulatory compliance, recruitment, and office facilities.

Example: a US-based software company partners with a staffing vendor in Vietnam that recruits IT professionals for them. The hired staff work under the payroll and management of the US company.

IT Outsourcing Pricing Models

Choosing a pricing structure for your IT outsourcing is as essential as choosing the right model. You want pricing that makes no most sense to current budget and the type of work you are going to outsource.

1. Cost-plus

In the cost-plus model, the vendor would invoice you the actual cost of the service, plus a profit margin. This pricing model is the most transparent as the vendor would make clear every item that you need to pay

With the cost-plus model, you can make sure that no one in the extended team is, unbeknown to you, chosen from the vendor’s bench. The vendor would prescreen developers according to your requirements. After that, you can interview them to choose the best one for your project.

But because you are responsible for managing the extended team, their performance and quality of deliverables, you cannot blame the vendor if something went wrong outside the SLA specifications.

2. Fixed Price

A Fixed-Price agreement states that the vendor is obliged to complete a project within a fixed time. The fixed price is estimated by multiplying the volume of work by the hourly rate, together with other fees. As the client, you would make a one-time payment for the entire project. Clients also cannot change any specifications or requirements unless they pay additional fees.

A project under the fixed-price model is very predictable in terms of budget and timing. 

However, the fixed price model is not so flexible. Any change to the project after the contract is signed will incur additional fees. 

Fixed-price pricing can end up being the most expensive unless clients seriously consider all the items and specifications. Any vendor knows that a project more often than not takes longer than they internally plan without you knowing. To account for that, they usually increase the real cost (which they don’t disclose to you) to cover the risk.

3. Rate Card

With the rate card pricing model, you are billed for the IT outsourcing services on a monthly basis. A typical rate card agreement would specify the monthly rates for each of the members involved in the project.

Unlike the fixed cost, in the rate card model you won’t be worried about overpaying. It’s because you pay for a full month of service, this way the vendor doesn’t need to add costs to avoid risk. You also have a team solely dedicated to your project. They will be more committed.

In the rate card model, you can only talk to the middleman. It is commonly the vendor’s project manager, who will pass on your requirements to the outsourcing team members. Having a middleman between you and the team can literally be a barrier some time. Moreover, you wouldn’t be allowed to interview the team members or decide which one will be assigned to your project.

4. Time and Materials

Time and Materials, or shorthanded as T&M, is a pricing model where clients are billed on the number of hours team members spend on the project. T&M is the most popular IT outsourcing pricing model as it is more flexible and easier for clients to adjust requirements/specifications without being charged additional fees. So it's suitable for long-term projects where features, goals, and scope can change over time.

However, in the time and materials model, you cannot really budget as you cannot predict accurately how much you will spend. You cannot avoid idle time. Idle time is when developers make no progress since they have to wait for your feedback. In other words, you sometimes have to pay for the time the staff do nothing.

The Most Commonly IT Outsourcing Services

You can outsource almost all IT functions. Below are some of the IT activities you can entrust to an external partner:

  • Software and application development
  • Mobile application development
  • Software and application testing
  • Web development
  • Website/application maintenance or management
  • Technical support
  • Database development and management
  • Data and platform migration

Best countries for IT outsourcing - by regions

If you consider cost efficiency and quality as the two most important criteria for IT outsourcing, then Asia, Latin America, and Africa are the 3 most suitable destination

Asia

For developed economies such as the US, Australia, Singapore, or Japan, Asia is the go-to destination for IT outsourcing. It’s because most oriental countries provide high project quality but at an affordable cost. They also can speak many languages fluently. 

Vietnam, China, and India are the major IT outsourcing hubs in Asia, with a large number of talented software engineers. Other Asian countries such as Malaysia and Indonesia are also gaining more popularity.

The best outsourcing locations in Asia are:

  • India
  • Philippines
  • Vietnam
  • Indonesia

Latin America

Latin America can be ideal for clients in North America because they are neighbors. This close proximity in time and location can ease a lot of issues related to communication, tradition, or politics.

Which countries in Latin America for IT outsourcing? Consider these:

  • Argentina
  • Brazil
  • Mexico
  • Colombia
  • Chile

Africa

Africa has more than 690,000 IT professionals. Half of them are located in South Africa, Egypt, and Nigeria.

If you want to outsource your IT activities to Africa, look for:

  • South Africa
  • Egypt
  • Nigeria
  • Kenya
  • Morocco

Advantages of IT Outsourcing

Outsourcing can make perfect economic and operational sense. Here are some reasons why IT outsourcing is so popular nowadays.

  • Expertise: An overseas vendor can have special IT expertise or technologies that are not available in the client’s country. This makes the IT outsourcing better at handling the project than the clients’ in-house team.
  • Reduced costs: This is the most popular rationale behind IT outsourcing. Typically, the outsourced country offers lower service costs than when the client do the work themselves. Offshoring especially offer more reduced expenses: some countries have low tax, low cost of living, and lower operational and infrastructure cost.
  • Staffing flexibility: IT outsourcing allows you to bring in additional resources on demand and release them when your project is done.

Disadvantages of Outsourcing

IT Outsourcing is not without its disadvantages. Here are some barriers that could slow down your project's progress.

  • Language/cultural barriers: Not being able to talk in the same language and culture can lead to costly misunderstandings and workarounds.
  • Different time zones: Unsynced time differences can be a barrier to communication and collaboration.
  • Slower turnarounds: the language barriers together with time differences can unnecessarily lengthen your project's time-to-market. Depending on the pricing, slower turnarounds can incur additional fees.

Conclusions

Today, the need for IT outsourcing permeates all industries, whether it's a major banking corporation planning on a huge-scale core system, or a tech incubator looking to build their first product. This article has discussed thoroughly some of the most basic topics of IT outsourcing. 

At KMS Solutions, we provide world-class IT services that help companies of all types embrace digital transformation at ease and with speed. If you are looking for high-quality and affordable IT outsourcing services, let's talk.

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Topics: Software Testing, Digital Team, Digital Applications, Software Development