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IT Outsourcing Costs Breakdown & Cost Savings Analysis

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Last updated on
October 4, 2023

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IT Outsourcing Costs Breakdown & Cost Savings Analysis

Introduction

As the demand for custom software solutions rises, more companies are choosing to outsource their software development. 

Let’s delve into the reasons behind this trend, the costs involved, the benefits, potential challenges, and tips on selecting an outsourcing partner.

Costs related to IT outsourcing

IT outsourcing costs breakdown

IT outsourcing involves a variety of costs, some of which are direct, and others that are indirect. Here's a list of the most common costs associated with IT outsourcing:

Setup costs

These are the costs associated with setting up the outsourcing agreement. They might include costs for infrastructure setup, transition, and migration of services, processes, or data to the outsourced company.

Service costs

This is the cost of the actual IT service being outsourced. It may include software development, application maintenance, system administration, managed IT services, cloud services, and more. These are usually the primary costs and can be charged on a fixed-cost, per-user, per-device, or per-service basis.

Management costs

These costs relate to the management of the outsourced services and the outsourcing provider. They include the cost of dedicated internal staff responsible for liaising with the provider, the cost of management time spent on oversight and governance, and costs associated with coordinating and integrating the services of the outsourcing provider with the rest of the business.

Operational costs

These are the ongoing costs of maintaining the outsourced IT service. They include costs related to system upgrades, software licensing fees, and technical support.

Change management costs

These costs are associated with any changes in the outsourcing agreement, such as scaling up or down, adding new services, or changing providers. It can also include training costs if your team needs to learn new systems or processes due to the change.

Legal and consulting costs

These are costs associated with negotiating, drafting, and reviewing the outsourcing contract. It might also include ongoing legal and consulting fees to ensure the company remains compliant with all relevant laws and regulations.

Exit costs

These are costs related to terminating the outsourcing relationship. They can include the cost of transitioning the service back in-house or to a new provider, as well as any contract termination fees.

It's important to note that the specific costs incurred will depend on the nature of the services being outsourced and the terms of the outsourcing agreement. Some costs, like setup and exit costs, are one-time costs, while others, like service and management costs, are ongoing. By understanding these costs, businesses can make more informed decisions about IT outsourcing.

What influences the price of outsourcing?

Factors that influence IT outsourcing cost

When considering the cost breakdown for outsourcing, it's important to note that the exact costs will vary depending on a multitude of factors such as the type of project, the location of the outsourcing partner, and the level of expertise required. However, in general terms, the cost breakdown for outsourcing might include the following:

Project complexity and scope

The more complex the project, the more resources it will require. This includes time, skilled professionals, and potentially more advanced technology. For example, developing an app with multiple features and advanced functionality will likely be more costly than creating a basic website.

Hourly rates or fixed costs

Outsourcing providers typically charge based on hourly rates, although some projects might have a fixed cost. Hourly rates can vary significantly depending on the region. For instance, North America and Australia are known for higher rates (usually $50-$250/hour), while in Europe you might find rates ranging from $50/hour, and in Asia from $25/hour.

Experience and expertise

Highly experienced professionals or those with specialized expertise generally command higher rates. For example, a senior developer with specific expertise in a niche area, like machine learning, will be more expensive than a junior generalist developer.

Additional services

Some projects might require additional services such as user interface design, quality assurance testing, or ongoing maintenance and support. These services, while sometimes integral to a project, will add to the overall cost.

Overhead costs

These are costs that the outsourcing company needs to cover, like office rent, utilities, hardware and software, taxes, and more. These are usually included in the price you're paying.

Cost-effective outsourcing destinations

Eastern Europe is among the most prominent and popular IT outsourcing destinations. One of the most crucial reasons for that is the quality-price ratio. Companies choose Eastern Europe also because of the access to the great tech talent pool, English proficiency, and high work ethic. 

Sounds interesting? Discover the 5 top locations in Eastern Europe [detailed info about the conditions in these countries is included in this research].

Custom software development rates in various countries

Let’s take a quick look at the comparison of custom software development rates worldwide.

custom software development rates worldwide - by country

To analyze each of these destinations in detail, read “Custom software development rates by country [2023]”.

How exactly outsourcing saves money?

Eliminating the recruitment process: Hiring software developers is a costly and time-consuming process. It involves advertising vacancies, screening resumes, conducting interviews, and potentially paying recruitment agency fees. By outsourcing, companies can bypass this process entirely, saving both time and money.

Avoiding ongoing employee costs

Full-time employees incur costs beyond just their salaries. These can include health benefits, retirement contributions, paid leave, and costs associated with employee retention and turnover. Outsourcing allows companies to only pay for the services they need, without incurring these additional costs.

Avoiding training costs

As technology evolves, developers need to be trained in the latest languages, methodologies, and tools. This ongoing training can be costly. Outsourcing companies, however, are responsible for their employees' professional development, removing this burden from the client.

Accessing global talent

Outsourcing opens up a global pool of talent. You can hire top developers from regions where the cost of living, and thus labor costs, are lower. This lets you work with high-quality developers at a fraction of the cost.

Reducing idle time

Software development can be project-based with peaks and valleys in terms of workload. Having a full-time, in-house team during quieter periods can be an unnecessary expense. Outsourcing allows businesses to scale their team size up and down based on demand.

Project Management

Many outsourcing providers include project management within their service offerings. This eliminates the need to hire a full-time project manager, helping the company save on salary and benefits.

Reduced hardware and software costs

Outsourcing can eliminate the need for certain costly software licenses and hardware resources that would be required for in-house development.

Tax benefits

Depending on the jurisdiction, outsourcing work to foreign countries can provide tax benefits. This is a more complex area and specific benefits would depend on local tax laws and regulations, but it is another way that outsourcing could potentially save costs.

Hiring vs outsourcing - cost comparison

When comparing the costs of IT outsourcing to the costs of hiring an in-house team, several factors come into play. Here's a comparison of the key cost considerations for both options:

IT Outsourcing Costs:

Lower labor costs - IT outsourcing can often be more cost-effective due to lower labor costs in certain regions. Outsourcing to countries with lower wage rates can result in significant savings compared to hiring locally.

Reduced overhead expenses - Outsourcing eliminates the need for investing in office space, equipment, utilities, and employee benefits like healthcare, retirement plans, and paid time off. These overhead expenses can be substantial when hiring an in-house team.

Flexible pricing models - Outsourcing offers flexible pricing models, such as hourly rates or fixed project costs, allowing businesses to choose an option that aligns with their budget and project requirements. This flexibility can be advantageous in managing costs effectively.

Access to specialized expertise -Outsourcing provides access to a global talent pool, allowing businesses to engage highly specialized professionals who possess the specific skills and expertise required for their projects. Hiring such talent locally may be more challenging and expensive.

In-House Hiring Costs:

Recruitment costs - Hiring an in-house team involves costs associated with recruitment, including advertising job openings, conducting interviews, and onboarding new employees. Recruitment costs can be substantial, particularly for specialized IT roles.

Employee compensation - In-house teams require competitive salaries and benefits to attract and retain top talent. This includes salaries, healthcare, retirement plans, paid time off, and other employee benefits. These costs can add up significantly, especially for larger teams.

Training and development - Companies need to invest in continuous training and development programs to keep their in-house team up-to-date with the latest technologies and industry trends. Training costs can be ongoing and can vary depending on the skill requirements.

Infrastructure costs - Establishing an in-house team requires investment in infrastructure, including office space, equipment, software licenses, and IT infrastructure. These costs can be substantial, particularly for startups or businesses expanding their operations.

Administrative and HR costs - Businesses need to allocate resources for administrative tasks related to payroll, benefits administration, employee management, performance evaluations, and compliance with labor laws. These costs can add administrative overhead.

Risks of staffing changes - Hiring and maintaining an in-house team carries the risk of turnover, requiring additional costs for recruiting, onboarding, and training new employees. Additionally, the loss of key team members can impact productivity and project continuity.

It's important to note that the cost comparison between IT outsourcing and in-house hiring is not always straightforward and will depend on specific circumstances, such as project scope, duration, location, and the availability of local talent. Conducting a comprehensive cost analysis specific to your business needs is recommended before making a decision.

When IT outsourcing will cost you more than hiring an in-house team?

IT outsourcing may end up costing more than hiring an in-house team in the following situations:

Lack of proper vendor selection

Choosing the wrong outsourcing partner can result in inefficiencies, rework, and increased costs. It is crucial to select a reputable and competent partner with a proven track record to mitigate such risks.

Low quality and rework

Opting for the cheapest outsourcing offer may lead to subpar quality work that requires significant rework or fixes. This can result in additional expenses, project delays, and compromised deliverables.

Communication challenges

If there are language barriers, cultural differences, or inadequate communication channels, the efficiency of collaboration and understanding may be impacted. This can lead to errors, misunderstandings, and increased costs.

Lack of expertise and skills

Choosing a provider with insufficient expertise and skills in your specific technology or industry can result in prolonged development cycles, low-quality outputs, and the need for additional resources to rectify the issues, leading to increased costs.

Hidden costs and poor transparency

Some outsourcing providers may offer seemingly low initial prices but have hidden costs or unclear pricing structures. Lack of transparency can lead to unexpected expenses, budget overruns, and disputes.

Security and Intellectual Property risks

Outsourcing involves sharing sensitive data and intellectual property with a third party. If proper security measures are not in place, the risk of data breaches or intellectual property theft can result in significant financial losses and reputational damage.

Dependency and vendor lock-in

Over-reliance on a single outsourcing vendor without clear exit strategies or options for transitioning back to an in-house team can lead to increased costs in the long run, as the vendor gains leverage and may increase prices.

Lack of control and flexibility

Outsourcing can sometimes limit your control over project management, decision-making, and resource allocation - mainly if you choose a fixed price contract model. This reduced flexibility may result in additional costs to adapt to changing needs or overcome project roadblocks.

Other benefits of IT outsourcing

Apart from cost savings, there are numerous other benefits of outsourcing software development. Here are a few:

Access to expertise and specialized skills

Outsourcing can give you access to professionals with specialized skills that might not be readily available in your local labor market. This can be especially useful for niche or emerging technologies.

Scalability and flexibility

With outsourcing, you can scale your development team up or down as per your project requirements. This is particularly beneficial for businesses with fluctuating workloads.

Focus on core business functions

Outsourcing non-core activities, such as software development, allows your team to concentrate on their core competencies. This often leads to increased productivity and efficiency in your business’s primary functions.

Speed up time-to-market

Having a dedicated outsourced team working around the clock or in a different time zone can speed up your development cycle, helping you get your product to market quicker.

Risk mitigation

Outsourcing can help distribute risks, especially in large-scale projects where the outsourced vendor shares responsibility and accountability.

Innovation

Outsourcing partners are often experts in their fields and stay up-to-date with the latest industry trends, tools, and technologies. They can bring fresh ideas and innovative approaches to your projects.

Improved compliance

Software development firms are knowledgeable about standards, protocols, and software development methodologies. Their expertise can help ensure compliance with industry standards and best practices.

24/7 operations

Especially when outsourcing overseas, companies can take advantage of different time zones to get continuous work done, potentially speeding up the development process.

Quality Assurance

Many outsourcing firms have dedicated QA teams to ensure the final product is up to standards, reducing the need for extensive in-house testing.

Challenges of IT outsourcing

While software development outsourcing comes with numerous benefits, it also has its set of challenges. Here are some common issues and potential solutions:

Communication difficulties

Language barriers, cultural differences, or timezone mismatches can all create communication problems, which can lead to misunderstandings, project delays, or low-quality outputs.

Solution: Choose an outsourcing partner with strong English skills or proficiency in your preferred language. Also, try to overlap working hours as much as possible and use collaboration tools to streamline communication.

Quality control

Maintaining high-quality standards can be challenging when your development team is not on-site.

Solution: Establish clear quality criteria and expectations from the start. Regular check-ins, project updates, and deliverable reviews can help ensure quality. Also, consider a vendor that follows an Agile methodology for more frequent deliverables and adjustments.

Data security

Outsourcing involves sharing sensitive information with a third party, which can increase the risk of data breaches.

Solution: Vet your potential partners for their security measures. They should adhere to the highest security standards and comply with international data protection regulations.

Loss of control

Outsourcing may lead to a perceived loss of control over aspects such as project direction, timeline, or resources.

Solution: Clear project specifications, regular communication, and use of project management tools can help maintain control. Also, establish a single point of contact or project manager to streamline communication.

Cultural differences

Cultural differences can lead to miscommunication, differing work styles, and misunderstanding of business requirements.

Solution: Take time to understand your partner's culture and business etiquette. Regular communication can help bridge cultural gaps.

Hidden costs

The final cost of outsourcing can end up being higher than expected due to hidden fees or unanticipated needs.

Solution: Make sure all potential costs are discussed and agreed upon before starting. An experienced outsourcing partner should be able to provide a comprehensive quote, highlighting any potential additional costs.

Dependency on the vendor

Over-reliance on a single outsourcing provider can lead to problems if the vendor experiences difficulties or if the relationship ends.

Solution: Develop a contingency plan from the start. Ensure proper documentation is done throughout the project so that another team could pick up the work if necessary.

By recognizing and addressing these challenges, businesses can better position themselves to reap the benefits of software development outsourcing while mitigating potential risks.

Choosing a cost-effective IT outsourcing partner

How to choose the right partner?

Choosing a software development outsourcing partner is a crucial decision that can significantly impact the success of your projects. 

One of the best ways to select the right partner is to ask for referrals. But is you don’t have such an option, check out some trusted ranking of top companies in particular areas or industries, like:

Qualities of the right IT outsourcing partner

Here are some factors to consider:

Technical expertise and skills: The provider should have demonstrable expertise in the technology stack you're using. Review their portfolio, ask about their developers' qualifications, and consider asking for a technical trial task or code samples.

Relevant experience: Look for an outsourcing partner with experience in your industry or in developing similar types of software. They should understand the specific challenges and regulations of your sector.

Reputation and references: Check their reputation. Look at online reviews, ask to speak with their previous clients, and consider how long they've been in business.

Communication: Effective communication is crucial in an outsourcing relationship. Evaluate the potential partner's communication skills, their fluency in your language, their willingness to adapt to your time zone, and their understanding of your needs.

Project Management: Understand their project management process. Familiarize yourself with the tools they use and their approach to meeting deadlines and staying within budget.

Cultural fit: The partner should align with your company's culture and values. This can facilitate better understanding, cooperation, and mutual respect.

Security and compliance: Assess their security measures and their experience with compliance in your industry. They should be able to demonstrate that they can handle your data securely and comply with relevant laws and regulations.

Pricing model: Consider their pricing model and ensure it aligns with your budget. However, don't compromise on quality for cost. An initially cheap but inexperienced provider may cost more in the long run due to poor quality work.

Scalability: The outsourcing partner should be able to scale up or down as your needs change. They should have enough personnel to handle larger projects if needed.

Post-development support: Understand the level of support they provide post-development. This could include maintenance, updates, troubleshooting, and dealing with unexpected issues.

How to choose an IT outsourcing company

Next steps

Choosing an outsourcing partner should be a careful, thoughtful process. Take your time to evaluate multiple providers against these factors and choose the one that aligns best with your business needs and goals.

Frequently Asked Questions

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Authors

Olga Gierszal
github
Software Engineering Editor

Software development enthusiast with 6 years of professional experience in the tech industry.

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