Return to Archive Runtime - The Software Outsourcing Newsletter for Executives and Investors from Accelerance and Steve Mezak How To Build A Subsidiary In 24 Months (Or Less) Some software companies form an offshore subsidiary to take advantage of the high quality engineers available at a low cost in other countries. In contrast, many other companies contract with outsourcing providers on a project basis. There is an intermediate approach where you have the option to convert your outsourced contract team into your own subsidiary later. In India this is known as Build Operate and Transfer, or BOT. There are two purposes in creating a subsidiary. First is ostensibly greater control by the owning company compared to contract outsourcing. Second is lower cost. The appearance of greater control and ownership enhances the value of the company - an important issue for a young company seeking to be acquired or to complete a successful IPO. However, creating a subsidiary is a major commitment. There are setup costs for finding an office, legal and accounting services, etc. Then you must hire one or more experienced managers to run the operation and to hire and manage the engineering team. The entire process of setting up a subsidiary takes four to six months. A contract outsourcing engagement can usually get started in a few days. Your team can be assembled quickly by the outsourcing company. Some amount of computer setup, networking and office configuration may be necessary to form your team but this is expected, and is completed in the first couple of days. Most contract outsourcing companies welcome a long term relationship with their US-based clients. If a contract outsourcing arrangement does end, the outsourced team is reassigned to other client projects. You may continue developing and enhancing your software with your internal team or perhaps a different outsourcing company. Under a BOT arrangement a different kind of ending is possible. Your outsourcing team can be transferred over to be employees of a new subsidiary created for you by the offshore company. This form of BOT is similar to a contract-to-hire arrangement companies can use to fill some full-time positions. The benefit to the US company is they get a subsidiary at little or no additional cost with an offshore team they have worked with, know and trust. The benefit to the offshore company is a project that lasts two to three years before the transfer is made, building and operating a team that grows with an increasing number of engineers. BOT is a good choice for a US company that wants to start with a handful of engineers, grow a team over time and build a valuable subsidiary asset. You can start with five or so engineers and grow to a team of thirty or forty or more. You also have the flexibility to grow and shrink the team as needed over time. After an agreed upon amount of time, you have the option of transferring the team to your subsidiary. If you have bigger plans to build a large engineering team more quickly than two years then there is a second BOT approach. It is similar to creating a subsidiary but lets you get started programming right away. Here is how it works. The offshore company assigns a team to develop your software. They get started immediately and charge typical offshore contract software development rates (See example below). Then for a fee the offshore company sets up a facility and handles the legal and accounting requirements to create your subsidiary. At transfer time, you may have to pay additional recruitment fees to move over the existing team to be employees of your subsidiary. These fees are paid to the offshore firm for the original interviewing and hiring process. These fees are negotiable but can range from zero to 50% of each engineers annual salary. Rather than setting up a subsidiary first and then start programming, this BOT approach starts producing software right away. You can have your team operating as a subsidiary within six months to a year, depending on the speed that you need. Which BOT approach is better? It depends on how large an offshore team you want and how involved you need to be in interviewing and hiring the team. It depends on how quickly you want to be operating as a subsidiary and how much you want to spend up front versus spend over time. Let's look at an example. Suppose you need to build an engineering team of twenty-five engineers over a two year period. The table below shows the estimated costs of each BOT approach for six month intervals during a two and a half years. Both offshore teams grow at the same rate and have the same number of engineers employed during each time period. Both use ten engineers during the first six months as a contract programming team.   Year 1 Year 2 Year 3 H1 H2 H3 H4 H5 Engineers 10 15 20 25 25   BOT 1 - Subsidiary in Year 2 contract contract contract contract + setup subsidiary + transfer Half Year Cost $240K $360K $480K $600K + $0 $300K + $0 Cumulative Cost $240K $600K $1,080K $1,680K $1,980K   BOT 2 - Subsidiary in Year 1 contract contract + setup subsidiary + transfer subsidiary subsidiary Half Year Cost $240K $360K + $150K $240K + $48K $300K $300K Cumulative Cost $240K $750K $1,038K $1,338K $1,638K Cost assumptions are as follows: Contract rate for each offshore engineer is $4K per month (x 6 = $24K per half year) Burdened cost for each engineer as an offshore employee is $2K per month (x 6 = $12K per half year) Six month setup to create subsidiary in BOT 2 at $25K per month (x 6 = $150K) Transfer costs are 10% of the annual offshore salary which is $2.4K per engineer (x 20 = $48K) As you can see, using BOT 2 and paying to create a subsidiary in year 1 saves money ($342K) over time. The downside is the lack of flexibility and the distractions during setup a subsidiary brings. Having to shrink the team halfway through year 2 would be a major problem requiring the disruptive lay off of workers. BOT 1 costs more over time, but gives you the most flexibility and does not require a relatively large investment to create the subsidiary in year 1 when you may not have the cash. This table presents just one scenario of many that can be modeled. The number of engineers can be increased and varied over time and costs will vary from one company and country to another. However, it is interesting to note that over the same period of time the cost of a US-based engineering team of the same increasing size would be $5,700K (at an estimated cost of $10K per engineer per month). That is more than double the cost of contract offshore outsourcing. Again, the decision to create a subsidiary must be made with a careful analysis of your situation. If you have a budget, then creating a subsidiary may be the correct move for you. If you are not sure of the quality of the team and worried about cultural differences, then a BOT approach can give you the time and flexibility you need to gain confidence. If you would rather focus on the creation of your product and not think about the political, legal and business issues of creating a subsidiary, then on going use of contract outsourcing is a time-tested approach. Vision Resources Are you wondering how you will select an expert offshore team to develop your software? Use the Accelerance Vision Resources(sm) outsourced vendor selection service and cut the time of your vendor selection process by as much as 90%. Vision Resources leverages members of the Accelerance's 17 teams in 14 countries around the world. Click here to learn more about Vision Resources Accelerance, Inc. delivers impartial & expert strategies and services for risk-free outsourcing of your software development. Visit our web site at www.Accelerance.com   Until next time, Steve Mezak Accelerance, Inc. Risk-Free Outsourcing www.Accelerance.com 213 Garcia Avenue Half Moon Bay, CA 94019 1-650-712-8990 Contact me by email (c) 2005 Accelerance, Inc. All rights reserved. You are free to use material from the "Runtime" eZine in whole or in part, as long as you include complete attribution, including live web site link. Please also notify me where the material will appear. The attribution should read: "By Steve Mezak, CEO of Accelerance, Inc. Please visit the Accelerance web site at http://www.Accelerance.com for more information and resources on outsourcing and creating great software products."