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IT Outsourcing: Definition, Types, Pricing Structures, and More
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.
What is IT Outsourcing?
IT Outsourcing, also called contracting out IT services, is the business practice of having other parties not employed by your organization handle some IT functions. Businesses today can outsource several IT tasks or services, including programming, application development, as well as technical support.
Building an effective outsourcing strategy can help companies reap the development benefits of IT service providers. Thus, businesses need to define their mission and core competencies, choose the appropriate IT service vendors, draft clear contracts, and govern deals for sustainable win-win relationships with external providers.
Advantages of IT Outsourcing
Outsourcing can make perfect economic and operational sense. There’re some benefits of IT outsourcing that make it become one of the most effective strategies that many companies adopt nowadays:
- Benefits from the top talents: An overseas vendor can have particular IT expertise or technologies that are unavailable in the client’s country. This makes the IT outsourcing better at handling the project than the clients’ in-house team.
- Costs reduction: 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.
- Scaling staff: IT outsourcing lets you bring in additional resources on demand and release them when your project is done.
Disadvantages of IT Outsourcing
However, IT Outsourcing also comes with some disadvantages. The barriers that could slow down your project's progress include:
- Difficulty in communications: Inability to talk in the same language and culture can lead to costly misunderstandings and workarounds.
- Different time zones: Un-synced time differences can be a barrier to communication and collaboration.
- Security risks: As a company will rely on a secondary party to handle its data, your information will suffer if that business cannot provide the same safety standards or is compromised. (Learn more: Cybersecurity Risk in Software Outsourcing)
When should you outsource IT services?
Companies require technology to keep things running smoothly, and staying ahead of the competition is essential, especially in today’s ever-evolving IT world. But how would you know that it’s a suitable time to outsource?
Here’re some signs your business should outsource IT service:
- Spending significantly on IT
- Outdated system
- Your system is vulnerable to cyber attacks
- The concentration on IT is affecting your business operations
Why IT Outsourcing?
There are several reasons why businesses choose to IT outsource at least a few of their IT functions:
- Allow focus on organizational process: instead of spending time and resources on mundane and time-consuming processes, you can outsource to move forward with your core offerings
- Reduce IT costs and relevant expenses: there’re costs to consider, including labor costs, infrastructure, and ongoing training. In addition, the shortage of tech talent makes it even more difficult to form an in-house IT support team.
- Access to a global talent pool: the IT experts can help companies meet the latest technology and compliance requirements.
- Retain staff flexibility: the outsourced technical workforce can grow or shrink with your business, adding services and support to your instant demands.
What IT Functions Need Outsourcing Services?
Businesses can outsource many tasks or services, depending on their needs and budget. Some of the IT activities that are commonly outsourced include:
- Software/ Application development & maintenance
- Web development
- Software and application testing
- Data analytics
- Technical support
- Consulting and professional services
- Technical training courses
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 from your team.
Offshoring Software Development is when a company outsources its IT activities to an external provider overseas. Many choose offshoring as their preferred IT outsourcing for the main reason that the offshore countries offer cheaper costs, low or no tax, a larger technical workforce, or a stable political environment.
Example of IT offshoring: an Australia-based bank outsources its fundraising platform to the KMS team in Vietnam. This is offshoring because the two countries are in different regions that have four hours apart, and the cost of outsourcing in Vietnam is respectively cheaper.
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 difference.
A perspicuous example of nearshoring is that a Malaysian network provider outsources its testing process to the KMS Solutions team in Vietnam. This is nearshoring because the two are in the same region and have only one hour difference.
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.
Referring to the case of Asian Commercial Bank (ACB), it obtained the KMS Solutions team to build a digital banking application. This is called onshoring, as the two parties are both located in Vietnam.
Multi-sourcing 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 multi-sourcing is to diversify the risk associated with working with only one vendor.
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 software development team, and offshore development center (ODC) 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. This model 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. It helps you avoid hiring full-time workers only to have on-demand specialists for your project.
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: The ACB planned on a new mobile app that requires more staff than it currently has. As employing new professionals can take time and resources, they decided to engage the staff augmentation service of KMS Solutions until the project ends. According to the contract, the augmented staff remains under the KMS’s payroll but is entirely under the bank's management.
2. Project-based outsourcing
Project-based IT outsourcing is an excellent choice 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. The two parties can decide the timeline to follow up.
If your project is small, simple, and unlikely to change, project-based IT outsourcing is ideal. Once you clarify 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 can still 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.
3. Dedicated software development team
With the dedicated software development team model, you can get a whole group of IT professionals chosen specifically by your requirements and choose to manage the team yourself or assign a project manager from the vendor's side to coordinate the project.
The dedicated software development 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 software development team. In other words, you only have to pay for the vendor’s services, and the rest is the vendor's job.
This model of KMS Solutions often includes well enabled, train-the-trainer model, and efficient team mix. They are organized into scrum teams with 6-10 members, starting out with 1-2 scrum teams and are performed as a flexible engagement structure to plug in business existing teams.
4. Offshore Development Center (ODC)
ODC is an outsourcing model where a company builds dedicated IT resources in another country to benefit from lower labour costs and/or tax while fully owning that team. 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.
IT Outsourcing Pricing Models
Choosing a pricing structure for your IT outsourcing is as essential as selecting a suitable model. There’re four main categories of the pricing model:
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.
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.
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.
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.
How to Calculate the Cost of Outsourcing IT Services?
Once you have selected the pricing model, you can determine the cost of the outsourced IT. In terms of approaches to determining the IT outsourcing costs, the fundamental one is known as Differential Cost Analysis. This concept clearly shows the effect of outsourcing on the costs of your business through 4 steps.
Step 1: Specify the IT functions you need to outsource
The foremost step is to identify the quality and quantity of the tasks that you plan to outsource. This will help you compare what you can do with the internal team and what can be provided by the outsourced partner.
Step 2: Determine the avoidable internal costs
You can identify the costs that would be able to avoid when outsourcing by listing down the direct costs and taking out variables that you no longer need to pay for.
Step 3: Calculate the total outsourcing costs
The outsourcing cost may comprise the administration cost of contact, the transition cost that less the revenue from sales of unneeded equipment, supplies, and furniture.
Step 4: Measure the difference
By calculating the costs the distinction between the cost saved and costs incurred from outsourcing, you can identify whether it’s beneficial to outsource or not.
Where are the Best Outsourcing Locations?
If you consider cost efficiency and quality as the two most essential criteria for IT outsourcing, then Asia, Latin America, and Africa are the three most suitable destinations.
For developed economies such as the US, Australia, Singapore, or Japan, Asia is the go-to destination for IT outsourcing as most oriental countries provide high project quality at an affordable cost.
Vietnam, China, and India are the major IT outsourcing hubs in Asia, with a large number of talented software engineers. With the several potential workforces, intensive concentration on tech education, and government stability, Vietnam is considerably emerging as a promising destination for software outsourcing in Asia.
Latin America can be ideal for clients in North America because they are neighbors. This close proximity in time and location can ease many issues related to communication, tradition, or politics. Argentina, Chila, and Colombia are countries that provide high-quality services with low costs compared to other places within the same region.
Africa has more than 690,000 IT professionals. Half of them are located in South Africa, Egypt, and Nigeria. However, the cons of outsourcing in Africa is that not many staff here can communicate in other languages well.
How to Choose the Right IT Outsourcing Vendor?
When it comes to selecting a vendor to outsource, there is checklist that you should consider to ensure the development process is efficient. Based on those listed criteria, you can find a trustworthy development partner by:
- Defining a match with your needs
- Requesting references and samples
- Discussing availability, flexibility, and management system
- Ensuring there are no communication barriers
- Checking infrastructure and technologies
- Calculating costs
- Evaluating the workforce
Learn more: How to choose the right IT Outsourcing Vendor here.
Best IT Outsourcing Vendors in Singapore
The market for Singapore software outsourcing businesses is growing at an unprecedented speed with many potential solution providers, including:
- CARE - Computer Analyst and Recover Experts
- Connect Bit - Exceptional IT Support Experience for Singapore Companies
- KMS Solution - the Go-to Partner for World-class Solutions
Best IT Outsourcing Vendors in Australia
For your much-awaited project, it’s necessary to choose the perfect one from all the IT outsourcing service providers in Australia. Here’s our list of reliable IT outsourcing companies in Australia:
- Cyber Infrastructure Inc.
- Magneto IT Solutions
- Next Big Technology (NBT)
How to Manage an IT Outsourced Team?
When outsourcing software development, external team management can be a real challenge since you may have to work remotely and gain less control over what’s actually happening. Thus, it’s essential to ensure the outsourced team members work effectively under your control and can collaborate with in-house staff through:
- Clear communication: you can work in person or use different communication tools such as Slack, Skype, etc.
- Frequent catch-up meetings: it’s essential to know the process and discover the issues that the team must resolve.
- Backlog refinement: by working in Scrum, you can ensure the outsourced team stay on track and keep a clear picture of what matters the most to you.
- Agile implementation: as Agile enables businesses to make changes with greater flexibility and speed, you can adopt a Scaled Agile mindset and framework to increase productivity and team member engagement.
- Sprint reviews: you can break down tasks into distinct sprints and review what they’ve done during the sprint to ensure the team’s performance.
Nowadays, the demand 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 its first product. This article has thoroughly discussed some of the most fundamental topics of IT outsourcing.
At KMS Solutions - Top 10 IT Services Companies in Vietnam by Clutch , we provide world-class IT services that help companies of all types embrace digital transformation at ease and with speed. We have cooperated with many companies across the globe, including Australia, Singapore, Malaysia, etc. . If you're looking for high-quality and affordable IT outsourcing services, let's talk.