Escalating Software Development Costs? Here are Strategies for Containing Them
by Raj Phalpher

Ever since Fredrick Taylor introduced scientific management almost a century ago, business managers have been attempting to reduce manufacturing costs in a systematic manner. Operations Research in 1930's and 40's, re-engineering in the eighties and more recently six-sigma [Total Quality Management] are all manifestations of the same pursuit. How to make the product faster, cheaper and better.

Software development is no exception. In spite of all the automated tools available for requirements management, code generation, testing, configuration management, etc., software development is very labour intensive. And, very well paid labour at that. Business managers are looking for ways to reduce the cost of running their software development factory. Here are four strategies that will be of interest to C-levels:

  1. Organize for success;
  2. Implement process discipline;
  3. Claim R & D tax credits for 'bleeding edge' development;
  4. Outsource offshore routine development.

Details of these strategies follow.

Process Discipline / Organizational Effectiveness

"Revenue and profit projections fail to materialize!"
"Mega investment in IT infrastructure does not result in the purported benefits!"
"'State of the art' call centre does not reduce the customer attrition rate
of a service provider!"
"Quality initiatives: CMM, ITIL, 6 sigma make a small dent in
shortening the development cycle!"

Sound familiar. Why are such failures so common? What do these failure have in common? A plausible cause for these is disconnects …disconnect between vision and business processes …disconnect between business processes and technology infrastructure…. disconnect between technology deployment and employee competencies… disconnect between strategies and tactical actions.

If these disconnects are the root cause of many challenges facing an organization, how do the successful ones address these challenges? Simply, by connecting them - by linking strategies and goals to the vision - by designing business processes that help realize the vision and achieve the goals - by devising an organization structure that is in synch with the business processes, key strategies and vision - by defining employee competencies based on business processes and organization structure - by designing technology infrastructure based on employee competencies, as well as organization's vision, mission, strategies, goals, business processes and structure - by developing tactical actions only after business processes, organizational structure, competencies of its employees and the technology infrastructure, are well defined.

The Dependencies Model

This is the gist of the Dependencies Model illustrated above. It is important to follow this sequence of dependencies, as organizations that fail to follow are likely to be operating at sub-optimal levels. Sub-optimal decisions may result from such actions as:

  • Investing in information technology infrastructure that is not aligned with organization's strategy, business processes or employee competencies;
  • Designing business processes without considering organization's strategies and goals;
  • Jumping from the vision and mission statement straight directly to tactical actions'

Reducing these disconnects, or eliminating them altogether, is the first step towards organizing for success and implementing process discipline.

Software Development Challenges

Organizations that organize for success and implement process discipline benefit from reducing software development costs as well as dramatically increase the project success rate. As illustrated above, only about one in six projects are completed on time and on budget, with all the functions and features as initially specified.

A survey shows that about one-third of the projects are cancelled (impaired) at some point during the development cycle. More than one-half of them fail to meet (challenged) one or more of the following commitments: budget, time and feature contents. Some of the other benefits of implementing process discipline are improvement in time to market, defect reduction, productivity gains and return on investment.

SR & ED Tax Credits

The second strategy for reducing software development costs is to ascertain if it qualifies for refundable R & D tax credits. Scientific Research & Experimental Development (SR & ED) is an incentive program administrated by the Canada Customs and Revenue Agency (CCRA) since the mid-1980s for Canadian companies who perform research and development within Canada. It is designed to encourage the development and advancement of Canadian technologies. The program offers tax incentives in the form of refundable and non-refundable tax credits ranging from 20% to 35% on qualified expenditures.

Additional credits are available in most provinces including Ontario. It offers a critical source of funding for many, as the refund is available regardless of whether you have paid any taxes. These incentives reduce the after tax cost of performing SR&ED in Canada to one of the lowest in the world as noted by the Organization for Economic Co-operation and Development (OECD). The SR&ED program provides nearly $2 billion in credits to over 18,000 claimants each year. However, the rules are complex, and changes in administration make it hard for companies to make sure they are benefiting from the program. It is estimated that there is almost three and a half billion dollars in funding that goes unclaimed, because companies are not aware of the program, or are not aware of the types of activities that are eligible for funding, or just do not know how to go about it.

Canadian software developers are major beneficiaries of SR&ED benefits. Software development and information technology claims represent 25 to 40 percent of the total claims. These claims are much higher in such jurisdictions as Toronto and Ottawa than in manufacturing intensive areas like Hamilton or Windsor.

For it to be eligible for the SR&ED program, a project is defined as a set of interrelated activities that collectively are necessary for the attempt to achieve the specific scientific and/or technological advance(s), are required to overcome scientific and/or technological uncertainty, and are pursued through a systematic investigation by means of experiment or analysis performed by qualified individuals. This is a lot of mumbo jumbo to a layman. Organizations often have struggled with the complexities that arise in assessing eligibility because neither the legislation nor case law provides much guidance on what aspects of software development constitute technological advancement and uncertainty.

A number of tax consultants provide assistance in the area of SR& ED tax credits. However, they are sometimes limited in their understanding of what is eligible because SR&ED tax credits require someone with a thorough grounding in the software development process and information technology. The technical assertion is more critical and challenging to deal with than the financial assertion. This has led to formation of consultancy firms that specialize in SR & ED tax credits.

Typical services and value add provided by these SR & ED consultants are:

  • Identify eligible projects and develop claiming strategies;
  • Provide technical writing or review your technical descriptions;
  • Identify and help determine eligible costs;
  • Defend CCRA's technical and financial audits.

Good consultants make the process painless for the organization, help implement 'best practices' and train in-house staff to maximize tax credits year after year. The better ones have a good understanding of both the 'intent' and 'letter' of the program and an excellent nose of smelling projects that may be eligible. They conduct business and process reviews to 'mine' projects and pre-qualify them with CCRA.

A review of the organization's activities may reveal that some of the software development is routine: feature enhancements, increased functionality or fixing of bugs reported in commercial use of software, etc., and is generally ineligible for the SR & ED credits. In that case, it may be prudent for the organization to investigate outsourcing them for an equivalent savings of 20 to 35%. The more pro-active consultants help coordinate offshore outsourcing of this routine software development.

Offshore Outsourcing

Canada often lags behind the US in adoption of new technology and business strategies. This delay can be anywhere from a few weeks to a few months depending upon the nature of the product or service. IT Outsourcing is no exception. Canada has been slow to take advantage of the competent and skilled offshore resources. According to Dun and Bradstreet, the global outsourcing market approached a trillion dollars (US) in year 2000. By 2004, more than 80 percent of U.S. executive boardrooms will have discussed offshore sourcing, and more than 40 percent of U.S. enterprises will have completed some type of pilot or will be sourcing information technology services," according to Gartner, a technology consulting firm.

Outsourcing software development to offshore suppliers has grown sixteen fold over the last decade, from US 400 million in 1993 to almost $15 billion expected in 2003. Almost unanimously, attendees polled at the recent GigaWorld US IT Forum believe that, "outsourcing would play a significant role in the rise of e-business, so we may see an acceleration rather than drop in outsourcing growth rates in some areas as organizations struggle with skills shortage and speed-to-market challenges that e-business presents". Outsourcing, especially IT outsourcing, is not a fad; it is here to stay.

There are several ways of jumping on the offshore outsourcing bandwagon, including:

  • Bring offshore resources for work on site;
  • Combination of offshore / on site with high level project managers on site and detailed work done offshore;
  • Outsourcing offshore a portion of the development effort.

The cost advantage increases with the percentage of development effort outsourced and the percentage of work performed offshore. As illustrated in Exhibit 1, they are maximized when the entire development team is outsourced and all the work is performed offshore. That may not be a savvy business decision as over time the vendor gains control of the product and your organization is reduced to nothing more than a marketing arm of an offshore organization.

Cost advantages stems from a combination of lower wages as well from not paying for the bench time. Paying for bench time between projects is a major source of frustration for a number of organizations. A number of such organizations have invested in offshore outsourcing in India to take care of their peak demand. This facilitates better utilization of in-house personnel. They avoid hiring / de-hiring for specific projects. Usually, there is no commitment or contractual obligation to pay for the bench time to the offshore organization. This ability to turn projects 'on' or 'off' has led some organizations to use offshore outsourcing successfully for 'skunk work' and prototyping.

There is no single model for outsourcing that suits all organizations. 'How' to outsource and 'when' to outsource depends on such factors as organization's strategies, business priorities, product lines, competitive pressures, management style and skills available. Here are some tips and considerations for organizations that want to pursue the offshore outsourcing option to contain software development costs:

  • Survey organizations that you can outsource to.

    There is ample choice of organizations ranging from the medium size ones (provide more cost savings and more control) to the very large ones (have diverse skills available).

  • Select the vendor with a proven track record.

    Client references for both the offshore developing organizations and their local representatives in Canada are easily available and should be checked for their ability to meet your specific needs in terms of ability to communicate, turn around time, meeting project schedule, etc.

  • Appoint an executive for all aspects of outsourcing.

    Offshore outsourcing requires a solid relationship with the vendor - the level of trust increases if there is a single point of contact within the IT organization.

  • Test waters -ramp up slowly.

    Start with a small project or a thin slice of a large project. Ramp-up outsourcing only after being satisfied with the vendor's performance and the 'shaking down' of the process.

  • Start with web services instead of legacy systems.

    Skilled support for client/server environment and net-centric systems is much more readily available than COBOL programmers for legacy systems.

  • On-site resources or local representative a must.

    Research indicates that the use of some senior resources on-site or an intermediary is a must for the success of a project.

Bottom Line

The bottom line is that organizations can substantially reduce their software costs by implementing process discipline and organizing for success. Once business managers have a good handle on what they are developing, they can save a further 20 to 35% of all their software development costs by:

  • Claiming SR & ED tax credits for 'bleeding' edge work; and

  • Outsourcing routine development.


Raj Phalpher is a Professional Engineer (P. Eng.) as well as a Certified Management Consultant (CMC). He worked for Northern Telecom (now Nortel Networks) for fifteen years and is currently Senior Consultant with Resultel Technologies Inc. He has helped organizations implement process discipline, claim SR & ED tax credits as well as pursue and manage offshore software development. He can be reached at phalpher@resultel.com . More information on Resultel is available at www.resultel.com .

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Copyright 2003 by Raj Phalpher. All rights reserved.

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