Fifteen to 20 years ago, companies such as Nike and Mattel began moving their manufacturing operations offshore, fundamentally changing the shape of their organizations. Services companies are now following suit, with equally dramatic implications for their business. So dramatic, in fact, that we have never worked with a services company considering offshoring that did not take the decision to its board of directors.

What's driving offshore migration of services comes straight from Econ. 101: Companies want to optimize their resources globally. Containerization, the opening of China, and large pools of relatively unskilled workers were among the factors that made migration possible for manufacturers decades ago. Only recently, with the huge drop in telecom prices, upsurge in bandwidth and the emergence of an educated, low-cost workforce in places like India, the Philippines, China and parts of Eastern Europe, has the migration of services become feasible for services companies. As a result, many companies are saving as much as 40-55 percent of the costs of the services migrated.

American Express, among the first to place a major component of its critical business services in a developing market, opened a financial processing center in Delhi, India, in 1995. Today, the company has operations in India and the Philippines that provide voice-based customer support, account and transaction processing, and, on the more sophisticated end, fraud and risk modeling and software development. The firm plans to boost the number of its approximately 3,000 full-time equivalents (FTEs) in India and the Philippines to some 6,000 by the end of 2004. Its annual savings already exceed $100 million.

AOL Time-Warner has about 1,300 people handling email and online-chat customer service functions in the Philippines. Delta Air Lines recently announced that it will outsource reservations calls to realize cost savings of over $20 million annually. Investment banks like Morgan Stanley, Goldman Sachs and Citigroup are reportedly considering moving research jobs to India. Morgan Stanley will beginby hiring stock analysts in India to support its US and European analysts, while J P Morgan Chase & Co. will hire 40 junior stock analysts in its Mumbai office

Transforming organizations

As companies like these consider whether to move more pieces of their business offshore, they are ultimately deciding whether to utterly transform their organizations. Nike began as a conventional manufacturing company, employing large numbers of factory workers and manufacturing managers. Today, it is primarily a marketing organization, and the structure of its human capital and its business strategy has changed accordingly. Moreover, such farreaching decisions cannot be easily reversed. With so much at stake-for everything from human resources, public relations and brand integrity, as well as operations and financial structure-CEOs of services companies are understandably reluctant to make such momentous decisions without fully consulting their boards. Despite the opportunity, there are several roadblocks to realizing the full economic value of "offshoring." These include domestic and internal organizational issues as well as pitfalls that are inherent in operating in a new environment- inexperience, poor planning and delays in execution have led to sub-optimal outcomes or a "late to the party" problem for some multinational companies such as AT&T, IBM and CapitalOne Financial. As an organization considers migration of services, directors need to fully understand those opportunities and pitfalls.

Assessing domestic and organizational issues

When it comes to offshoring, of course, no issue is entirely domestic or internal. Each has its mirror image in the offshore location. Nevertheless, distinguishing between them for purposes of analysis provides a systematically rigorous approach to achieving a comprehensive understanding. Key domestic and internal organizational issues include:

Regulatory/legal issues: Many service-sector companies operate in industries-such as telemarketing, bill collecting, insurance, banking and securities-that are heavily regulated. For example, the National Association of Securities Dealers imposes stiff requirements on operators who handle brokerage transactions. Telemarketers must conform to the code of conduct of the Direct Marketing Association. It is crucial to choose a vendor that is fully versed in regulations and is fully insured against the risks posed by the American system of torts, with its enormous damage awards.

Effect on customers: When outsourcing of services was in its infancy, companies feared that many customers, animated by protectionist sentiments, xenophobia or inability to understand foreign accents, would be alienated by offshore service representatives. In fact, such reactions have been rare. In the increasingly multicultural US, most people are already accustomed to a wide range of accents. Most important, what really counts for most customers is the quality of the service. Choose a vendor that can provide excellent service, and the effect on customers is likely to be positive.

Effect on workers and communities: Going in search of cheaper labor inevitably creates resentment among workers whose jobs are threatened and, often, a backlash in communities that are affected by the loss of jobs. Management must have proactive HR and PR programs in place to deal with these painful issues. Both programs require openness and honesty, as well as a vigorous defense of the company's determination to re-deploy labor and capital to create more high-value jobs in the US.

Effect on the company: Just as sending blue collar jobs abroad reshaped manufacturing companies, the exporting of white collar jobs will transform services companies. Directors must ask what the company will look like in five or ten years. What kind of employees, capabilities and leadership will the company need to compete? Is there a plan in place to acquire them and to facilitate the transition?

Core competencies: Make sure you retain the knowledge your company has so painstakingly acquired over the years. In the first rush of manufacturing migration, a number of US shoe manufacturers found Asian markets flooded with shoes that had been sold directly by the companies' contract manufacturers. Similarly, can you be sure that a vendor won't pirate your services model? It is crucial to make sure that available legal remedies fall under US jurisdiction or international arbitration. The danger of losing core competencies also comes from within. Crucial employees who monitor quality and productivity or under- stand eenablement and can be critical for automating processes in the future must be retained.