Completing the Total Cost of Outsourcing Model

In a previous post, I showed that the simple inclusion of the onsite: offshore ratio (a.k.a the inverse of the offshore leverage) on the blended rate calculation can dramatically change the perception of price in outsourcing.  Now, let’s try to add another element to our TCO model:  the cost of the attrition rate (a.k.a turnover) in the team working on the contract.

The attrition rate is the percentage of the team that is changed/replaced over the course of one year, for various reasons.  An attrition rate of 30%, for instance, means that 3 out of 10 resources that were on the engagement at the beginning will have been replaced within the next 12 months.

The attrition rate can vary considerably, and often depends on factors such as the overall economy in the locality where the labor pool is, how “hot” the industry is at a given time, how rigid the labor laws are, how a particular company handles HR matters and a company’s culture and business model.

It’s always a good idea to verify the attrition rate of different vendors in the selection process, use it in the TCO calculation, and monitor it during the contract.

Regardless, each time you need to replace one resource in a given project or contract, that generates a series of additional costs that would not be generated otherwise.  Here a summary of these costs:

Hiring costs

You (or your partner) need to have an HR resource screening and selecting possilble candidates for replacement.  A hiring manager needs to interview the screened candidates and make a decision on who you’ll hire for the position.  All of this is additional cost that someone will need to absorb, and sooner or later that cost will find its way to the client’s check.  Even if the resource is being reassigned from another project, there are additional costs associated with this transition.

Learning curve

A new resource on the team is certainly not going to be as productive as someone that has been on the team for some time.  The learning curve costs can be divided into:

Training

Developing software is a complex task, and if you want to have a productive team, all members of that team must be trained in several things like the basics of your business, the most important processes, the overall architecture, standards to be followed and others.

Coaching

The best training is done on the job… So, you will need somebody from the team to oversee and help the new member with the new activities.

Productivity Loss

Even with all the training and coaching, a new resource takes time to be fully productive.  Depending on resource’s seniority level, the time to reach peak productivity can vary from several weeks to several months.

Opportunity costs

The opportunity cost comes from not doing something else while you’re training, coaching and waiting for the new resource to reach peak productivity.  There are two main sources of opportunity costs:

Time-to-Market

With the knowledge transfer and productivity loss, the application may not be released as planned – either with time delays or reduced functionality.  That, in turn, may result in lost revenues, customer dissatisfaction or other undesired consequences.

Use of resources

Finally, as it becomes necessary to use resources to cover for the knowledge transfer (either to do some coaching or to work directly on the project), obviously these resources cannot be used somewhere else, as they would in the event that the turnover were lower.

The opportunity costs are undoubtedly the most difficult to calculate.  Much of this certainly depends on the business and the project itself.  The other factors are much easier to include in a generic model of Total Cost of Outsourcing.  Most large corporations with a mature structure for outsourcing have a way to reduce the cost of turnover, or, in realistic terms, to push these costs onto the supplier.  However, let’s not be naïve: these costs will be felt either directly or indirectly.  That’s why it’s a good idea to include them in the spreadsheet used to compute the TCO.

In our estimates, which do not take into consideration the opportunity costs, each percentage point in turnover represents, on average, an increase of 0.24% in costs. This means that, given two companies with exactly the same blended rate, if one of them has a turnover rate of 5%, and the other one has a turnover rate of 20%, the latter company will be 3.6% more expensive (not to mention the headaches and the opportunity costs).  So, it’s always a good idea to verify the attrition rate of different vendors in the selection process, use it in the TCO calculation, and monitor it during the contract.