Total Cost of Engagement (TCE)

The whole concept of 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 outsourcing engagements.

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 is the fact that time-zone differences and distance with India, and other Asian outsourcing destinations is a barrier.

Although Near Shore rates tend to be a little higher, the overall cost of nearshore engagements is equivalent or less than 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.

TCE Defined

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.

Engagement Cost Components

Project Team Cost
The rate differential for IT services in the US and those of outsourcing to other countries has certainly been the most appealing argument for this oursourcing. 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.

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

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:

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/Hr

Project Trips
Most outsourcing 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 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

Nearshore vs. Offshore
  • While evaluating the difference of Man/Hour rates between offshore and nearshore, managers should consider the two components of a typical offshore engagement; the onsite rates and the offShore/nearshore rates.
  • 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.
  • 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 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.
  • Near Shore promotes higher retention levels due to better communication between the onsite and offsite members of the team.
  • Brazil is business-friendly and culturally attuned to American Business Practices.
  • Same work calendar: In some cases there are more than 20 combined, non-sychronized holidays of the US and Asian or India offshore destinations