Risks of Offshore Development Centers and How to Avoid Them

Intellectual property threats can be considered one of the most serious types of problems associated with outsourcing work to another country. This means that intellectual property such as source code, product specifications, customer information, or algorithmic data provided to the foreign team may have limited protection outside its native jurisdiction.

The International Chamber of Commerce estimates that businesses around the world lose between 225 billion and 600 billion dollars every year due to intellectual property issues. While not all of this involves offshore software development, the report identified cross-border technology engagements as a high-exposure category.

Some common examples of intellectual property issues that may arise in an offshore environment are illegal access to repositories of source codes, improper management of information by subcontractors, and unclear ownership of contractual work products.

How organizations address this: The starting point is the contract. IP ownership of all work products must be explicitly assigned to the contracting organization, not left to default terms. The signing of non-disclosure agreements by both the vendor entity and all team members is recommended. Apart from the contract, limiting access to source codes to only the particular modules handled by each team member, along with endpoint monitoring of all access devices to the production system, helps minimize the risks. Choosing vendors from countries that have strong IP laws, such as signatories to WIPO’s copyright treaty, would also help.

Offshore outsourcing presents a distinct set of problems for companies operating within industries subject to regulation when it comes to securing their data. Sharing customer data, financial records, or health information with teams in different regulatory jurisdictions creates compliance obligations that many organizations underestimate at the contracting stage.

According to the report, the cost of an attack through third parties averaged at $4.55 million, which was 16.3% higher than attacks on internal infrastructure alone. Engagements abroad where access to sensitive data is given without proper security measures amount to a significant liability in addition to any fines that might be incurred under GDPR, HIPAA, or similar regulations.

How organizations address this: Minimization of data collection is the first principle. Offshore vendors must always use data masking or anonymization where possible. In cases where actual data is required, it must be managed under role-based access control systems with logging and periodic audit reviews. Any compliance obligations must be specified in vendor contracts that allow for audits by the contract holders. Third-party security assessments are common practices in the finance and healthcare industries when working with vendors.

Organizations can eventually become structurally dependent upon their one offshore vendor over time. If the vendor increases costs, replaces management, or suffers an operational upset, there is not much that the organization will be able to do about it.

According to the survey results, 53% of companies that faced substantial disruption due to offshore engagement said that they were too dependent on one vendor only, without having any exit plan.

Offshore Development Center risks and contingency planning must take into consideration this scenario right from the onset of an engagement, rather than when vendor lock-in has already occurred. Vendor lock-in is one of those ODC risks that gets the least amount of consideration in pre-contract negotiations and the most attention post-facto.

How organizations address this: Contracting must also address knowledge transfer, documentation, and transitional responsibilities. Those companies that internally control architecture decisions, source codes, and documentation have more advantage in transferring work where required. Certain organizations may purposefully choose to allocate work amongst two vendors operating within the same geographic location to ensure competition remains intact.

High attrition in ODC  is a factor that presents continuity risk. Whenever engineers who are conversant with the program code and requirements leave the vendor company, those who replace them take time to understand what needs to be done.

According to LinkedIn Talent Insights statistics of 2023, the annual turnover rate for software engineers in India, the Philippines, and Eastern Europe was between 18 and 25%, compared to the average of 13% observed in the United States.

How organizations address this: Having the vendor keep detailed onboarding documentation and codebase documentation helps offset the expense associated with turnover. Agreements could contain clauses regarding attrition notices and minimum bench depths for crucial positions. Organizations that treat the offshore team as a long-term partner rather than an interchangeable resource pool report lower effective attrition than those that do not invest in team continuity.

The pattern across these risk categories is consistent. The risks associated with offshore development centers are exacerbated by the lack of governance, the vagueness of the agreements between companies, and unclear accountability for results. They are mitigated if companies regard ODC risks as a formal discipline rather than a checklist to be considered at contract closing.

Companies with the most stable offshore initiatives have some common traits. These include performing due diligence on the service provider prior to selection, ensuring that compliance and quality are written into the contract as opposed to being based on trust, and having sufficient technical ownership internally to control the outputs of the offshore team.

Organizations that had formal offshore governance structures suffered 42% fewer program disruptions compared to those lacking such structures.

The risks associated with offshore development centers do exist, and they may involve serious implications for both finances and operations. First of all, getting an idea about the risks involved and knowing about them before signing the contract must be considered the minimum requirement. Furthermore, risks are normally manageable as well. The companies that experience some major issues tend to overlook such important aspects as governance, IP protection, and quality alignment until the contract has been signed already. Those that address them in advance operate offshore programs that perform consistently over time.