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ARC Advisory Group is in the process of doing a
study on outsourcing of Product Engineering to
Offshore Service Providers. In other words, the
majority of engineers are based in low cost countries,
and there are cost arbitrage advantages that can
result from outsourcing of product engineering.
At this point we have had initial discussions with
most of the significant suppliers who compete based on
the Global Service Delivery model. Perhaps the two
most interesting conversations involved
Satyam Computer Services, who sent a large team
into visit ARC last week, and Quality Engineering &
Software Technologies (QuEST).
Satyam, with revenues of over a billion dollars, is a
provider of diverse IT and Business Process
Outsourcing services, including engineering services.
In what they call "extended engineering services",
they did over $80 million in business in the last
calendar year. In contrast, QuEST is a much smaller
company. They had 2006 revenues of about $40 million.
They were also much more focused on product
engineering services (about 90 percent of their
revenues come from engineering services).
Satyam emphasized that they could be a strategic
partner that they could speed the customer's time to
market. While they are willing to do simpler and more
mundane forms of product engineering, they make it
clear that they are also capable of providing much
more complex services.
In contrast, QuEST was more willing talk about their
desire and ability to do non-core engineering.
Further, they stress the cost arbitrage advantages of
offshoring. Initially, they argue, "Our engineers may
only be 60 percent as productive as yours, but in 6 to
12 months, perhaps our engineers will be 80 percent as
productive as yours."
Satyam's folks absolutely disagreed with the idea that
Indian engineers had to be less productive than their
client's. They pointed to one client that measured
both Satyam's engineers and their own engineers on
productivity. Satyam's engineers, based on these
metrics, were indistinguishable from the client's
engineers. With time, the right management, processes,
and metrics, parity can be achieved.
While I accept the idea that with time, trusted
outsource partners will be used more strategically,
and their value will go beyond simple labor arbitrage,
most companies will begin their engineering
outsourcing with less complex tasks, and the initial
focus will be cost savings. Based on that premise,
what are the economics?
Economics
The surface economics of outsourcing product
engineering are very positive. While pay differs by
industry and specialization, a fully loaded (salary
and benefits) American mechanical engineer with 10
years of experience will cost a company about $10,000
per month. In comparison, offshore providers charge as
little as $2,400 per month for relatively simple
activities like converting Computer Aided Diagram
(CAD) diagrams for use in technical publications to as
much as $7,500 for complex Computer Aided Engineering
(CAE) modeling and analysis, where engineers are in
short supply. $3,000 is a good estimate for the
average rate for a seasoned mechanical engineer.
However, in a new engagement with an offshore
supplier, there would typically people sent to the
company's site, particularly early in the engagement
to scope the requirements. The higher the ratio of
engineers on site with the customer (the customer pays
for travel), or near site (supporting the customer
from an office in their home region) as compared to
offshore, the more it will cost. However, as a rough
industry guide, Western companies should expect to pay
a blended rate of about $25 per hour ($4,150) per
month.
However, Indian engineers will not be as productive as
American engineers. The offshore productivity ratio is
the true key to the economics of offshoring Product
Engineering Services. Let's assume that offshore
suppliers are being overly optimistic on their
employee's productivity, and that the true
productivity range is from 25 percent to 70 percent.
Let's further assume your blended fee for an Indian
engineer is $25 per hour versus $60 for an American.
If the offshore engineer is 25 productive as the
American, the Western firm would have better off
keeping all the work internal. They will find
themselves 40 percent less cost effective than if they
had done the work themselves. If the Indian engineers
are 70 percent as productive as the US based
engineers, the Western firm is a clear winner. They
will find have spent 68 percent less on labor to
accomplish a given amount of work. The break even
productivity rate is 42 percent. That is the point at
which there is no cost advantage, or disadvantage,
from offshoring.
This analysis does not consider the extra costs of
supervision and travel that would be incurred by a
Western firm, which can be substantial.
Factors Affecting Productivity
It is clear that a primary consideration affecting the
cost efficiency of an outsourced arrangement is the
productivity of the engineers at the out-sourced firm.
What are the factors that affect this?
First of all, good metrics are critical. But beyond
that, the more seamlessly the two companies' PLM
systems are integrated, the easier it is for offshore
engineers to be productive.
The offshore, nearshore, on site ratio also matters.
Offshore engineers are the least expensive. On site
engineers, foreign engineers from low cost countries
that spend several months at a customer's development
center working on a project, cost more. Near shore
engineers, engineers in a development center in the
same region, cost the most, and in fact will cost more
than a Western companies own engineers. While some
suppliers tout the advantages of 24 hour follow the
sun development, these advantages can be more mythical
than real, particularly with more complex engineering
or projects that are difficult to scope. The vast
difference in time zones between North America and
India - 6:30 am in Boston is 5:00 pm in Bangalore,
India - make having telephone conversations onerous.
This makes ongoing supervision and control very
difficult. Thus, the higher the ratio of offshore to
onshore (or nearshore to offshore), the higher the
productivity, but the higher the cost will be.
The ratio of on site, or near site, to offshore should
differ depending upon the complexity of work
undertaken and a particular supplier's business model.
If CAD migration is done, or drawing conversions, all
that may be needed is a relatively quick trip to the
customer's site to understand the requirements and how
they will be measured. With time, as the customer and
the outsourcer get to know each other, not even that
is required. Specs can just be faxed or emailed over.
In contrast, higher value activity, like conceptual
design, analysis, and design validation will usually
require a higher onsite presence to guaranty
productivity.
The tool, industry, and customer experience of the
outsourcers' engineers also affects productivity.
CAD/CAM/CAE tools are complex. It takes time to learn
how to use them well. According to QuEST, many Indian
students graduate with no experience having used any
of these tools. To deal with this problem, QuEST works
with six engineering schools. Experienced QuEST
engineers teach courses on how to use CAD tools. The
college students can take this course as a paid
elective. Of their 900 engineers, about 200 have come
out of these CADAM programs. This allows them to get
people they know are dedicated to mechanical
engineering, and it gives them better insight into
which of the graduates have the right skills.
The folks at Satyam vehemently disagree with this
premise. They believe that if you recruit more
prestigious Indian schools, the typical graduate has
better CAD skills than the typical American graduate.
One Satyam manager used to work at
GM
and was responsible for hiring engineers. She argued
it has been far easier to find Indians with tool
skills than Americans.
From a productivity perspective, even after you have
learned to use one tool well, for example Dassault
Catia v5, if a customer needs the firm to use
different tool, say UniGraphics' NX, the time required
to come up to speed on the new tool is significant.
Industry experience affects productivity, including
the productivity on a particular tool. If an engineer
has aeronautic industry experience, they understand
how an airplane is assembled, how they are stamped,
and because of this knowledge, they can use the tool
in a more productive fashion. Similarly, knowledge of
a customer's processes and operations can make the
offshore provider more efficient. Unlike in
manufacturing, where Lean and Six Sigma are considered
operational best practices, there is little agreement
on what constitutes operational excellence in product
development. The product development processes vary
greatly company to company. To the extent that a
Western company develops a long term relationship with
an offshore company, and the offshore supplier
dedicates staff to that customer, productivity can
improve.
Satyam has a required course that new engineers
assigned to important clients most pass through. The
course trains the young engineer on their client's
processes and works to pass on some industry domain
expertise. Further, they attempt to train their
engineers on the industry domain knowledge by actively
rotating engineers onsite to see first hand the
manufacturing processes.
Productivity can also be adversely affected by the
different culture's communication styles. Indians can
be very agreeable. In an effort to please they may
tell you that work is complete, when it is not done
yet. Having Indian managers, who are trained in "soft
skills", to manage their own Indian engineers can be
one way to avoid this problem.
Finally, it is clear that the cost of Indian engineers
is rising and that retention of good engineers is an
issue. However, at Satyam the attrition rate is in the
single digits, lower than the double digit rates in
the IT area. To the extent that Indian companies can
keep their engineers engaged on interesting projects,
they can help to retain their best engineers. For this
reason, a certain amount of rotation of engineers into
and out of key accounts may be necessary. Satyam also
points out that while wages are rising, young
engineers are available. At one of their client's, the
average age of the internal engineering force is in
the high 50s. In some multinational manufacturers, a
whole generation of engineers is on the verge of
retirement, and there do not appear to be enough young
domestic engineers to fill the vacancies.
One thing is clear; it takes time for offshore
engineers to become more productive. This is one
reason that companies that are looking to offshore
peak engineering demands, rather than engaging in a
long term relationship, will never have the
productivity and cost efficiencies from their
engineering services vendors of companies that view
these relationships more strategically. Companies will
find it very difficult to engage with large firms,
like Satyam, if they are not interested in longer term
relationships. But even smaller firms, like QuEST, are
unwilling to engage in short term tactical
engagements.
Related Link
http://www.offshoringtimes.com/Pages/2007/offshore_news1463.html
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