The economic climate is driving businesses to cut the cost of their software estates, but offshoring development may be a mistake.

Savings from offshored software development can turn into costs because developers do not fully understand business requirements, according to research from sourcing consultant Compass Management Consulting.

Compass research showed the 40% savings on staff costs can be offset by a 60% fall in productivity. Compass analysed over 200 outsourcing contracts, accounting for a total value of more than ?3bn over the past two years.

Many organisations are already replacing legacy systems and updating applications, said Nigel Hughes, a consultant at Compass. “Complexity of the application environment is a major driver of overall cost escalation in IT, and 2009 is the best chance since the year 2000 issue to make radical change.”

 But he warned that businesses which offshore their software development to cut costs should consider the cost of lost productivity that can result in offshored development.

Compass said, “Studies of operations where the full life cycle of application development has been outsourced have shown productivity drops of up 60% as poor knowledge of the business function affects efficiency of the development. These losses are particularly high when development is outsourced to an offshore location.”

It suggested that companies considering offshoring development should look beyond the low staff costs and consider the additional management control, increased infrastructure spend, employee attrition, language and cultural issues.