Companies can save thousands of dollars by outsourcing the development of custom-software projects to low-cost, offshore locations such as India and China, say researchers.

In a new study, Michigan Business School professors Sendil Ethiraj, Prashant Kale and M S Krishnan and Pennsylvania's Wharton school professor Jitendra Singh estimate the average annual decline in quality-adjusted price for software projects developed offshore is about 14 per cent -- or $56,000 per project.

"This is significant in an industry where projects are normally expected to exceed budget and delivery schedule," the researchers say.

• India and Outsourcing: Complete Coverage

However, there are tradeoffs between the low prices  customers enjoy and the potential for increased dissatisfaction due to greater uncertainties associated with distributed development.

"The offshoring movement in software development is driven by a strong cost-saving motive," says Krishnan, U-M associate professor of business information technology.

"In order to improve both quality and cost, some of the successful offshore software vendors have adapted and disciplined their development processes to squeeze costs out of the system."

Krishnan and his colleagues examined 160 projects executed by a large India-based custom-software vendor for 73 different clients between 1999 and 2002. To better understand the economics of custom software, they incorporated demand-side considerations, i.e., from the standpoint of the software user or client rather than the developer or vendor.

As the potential for further cost savings declines over time, reducing other sources of client dissatisfaction becomes more salient, the researchers say.

In addition to estimating the cost savings accruing to US-based clients, their study explored potential sources of customer dissatisfaction and how offshore vendors might address them.

For example, more experienced development team members command higher wages and raise project-execution costs, so vendors have an incentive to staff projects with less experienced members who are paid lower wages. Although this helps to reduce costs, it also may increase quality problems and, consequently, customer dissatisfaction, the researchers say.

"The problems of contracting in custom software are compounded when the development moves offshore," Krishnan said.

"While offshore locations such as India are a fertile source of low-cost labor, the cheaper labour available locally can also create incentives for the vendor to staff the project with less-qualified employees, which potentially can increase defects and schedule spillovers and may lead to significant opportunity costs for customers," Krishnan said.