New directions in outsourcing

Business process outsourcing is nothing new. The widespread use of payroll bureau services, for example, has been with us for more than 30 years. But advances in technology have led companies to radically rethink how back-office functions can be best performed.

Add to this the increasing corporate desire to drive down costs, enhance business flexibility and focus on the core business, and it is little wonder that this type of outsourcing has seen significant growth.

At the same time, the ways in which it is used as a business tool is evolving to further broaden its appeal.

In May, the value of BPO deals in the US overtook traditional IT outsourcing deals for the first time. This is all more impressive considering that BPO contracts tend to be significantly smaller than their IT outsourcing counterparts. With $6.9bn (£3.8bn) of business processes outsourced in the first quarter of 2004, particularly for finance and accounting, this is one area that financial directors need to understand.

The market is changing. Whereas the original impetus for BPO was cost – and this is undoubtedly still a major factor – finance directors are increasingly overseeing and driving outsourcing projects that transform how companies work.

The recent growth of back-office BPO in finance and accounting, human resources, customer relationship management (CRM) and procurement is more about facilitating change. In procurement this means the move from ‘free for all’ to coordinated, controlled purchasing. In human resources departments, it is the move to self-service.

Although cost reduction and operational efficiency remain high priorities, organisations are now harnessing the power of BPO to help increase competitive capabilities, achieve greater flexibility and respond more quickly to changing global market conditions. The focus has shifted from outsourcing for cost reasons only, to a broader focus including business outcomes.

As a potentially powerful business instrument, BPO is being used to grow and develop businesses – by accelerating speed to market for example – and it can even play a key role in mergers and demergers.

But with the emphasis firmly on the transformational aspects of BPO, rather than just people replacement and labour arbitrage, these are a breed apart from more familiar IT outsourcing deals.

There are certainly lessons to be learned from IT outsourcing, particularly those that relate to the need for both defined contractual commitment and in-built commercial flexibility over the life of the agreement. But BPO projects present new challenges that are more difficult to manage.

These challenges require more people, both within the organisation and outside, representing a higher level of spend and a higher level of buy-in, but deal structures are more complex.

Service levels and key performance indicators are more difficult to set, service provider relationships run far deeper and issues around governance, reporting and security need careful consideration.

In addition, the market for BPO suppliers is comparatively immature and fragmented. Although there are some large service providers, the market is characterised by less well-known, niche players and it is often difficult to accurately assess the skills, capability and experience of each.

This knowledge is crucial, however, because without a realistic understanding of what a supplier can achieve, it is impossible to structure the outsourcing deal to get the best outcomes and delivery from it. The issue of exploiting global resources on-shore, near-shore and offshore only adds complexity.

It is not surprising then, that so many of these outsourcing projects can leave a bitter taste in the mouth. One prominent example is the IT outsourcing by Inland Revenue to EDS, culminating in the tax credits fiasco.

Buyers, used to focusing on choosing a supplier when buying services, often neglect the fact that BPO demands more from the company looking to outsource. Failure to give proper consideration to what the company needs to achieve internally could scupper a deal, even if the best potential BPO provider is selected.

The sheer weight of complex detail thrown up by taking a function outside a business invariably comes as a shock to the team trying to outsource it. From sitting down and figuring out exactly how a process works, to isolating exactly what portion should and can be outsourced, the skills employed are seldom naturally found in an organisation.

Can all this be achieved using internal resource? Not easily. Cross-functional scope, complex operational and regulatory risks, evolving pricing models and the lack of industry benchmarks and standards in BPO, make it a tough market to negotiate for the uninitiated.

To overcome this problem, companies are increasingly tapping into direct experience, either by poaching directors who’ve been through the process before or by going to an outsourcing adviser. The impartiality of a third party is also often invaluable, as BPO can require process re-engineering.

Greater objectivity helps deliver a better result.

As well as helping define and manage a sourcing strategy, advisers’ knowledge of the market helps restore the balance of power between buyer and vendor when negotiating a BPO contract. In a market where the vendor is often in a position of greater knowledge than the buyer, advisers can help ensure that service providers field their best delivery teams – a must for successful BPO.

Some recent news stories about outsourcing have focused on the level of disappointment with projects – but all too often this is down to poor planning or a breakdown in the relationship between the outsourcing partners.

Experience shows where outsourcing projects are put together with professional advice, as few as 1% are ultimately considered failures.

Regardless of how outsourcing is achieved, one thing is clear. Businesses are waking up to the potential for using BPO in a big way. The benefits are there to be had if you know how to get them, but some of the challenges can be formidable.

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Research from Deloitte predicts that two million jobs in financial services could be displaced over the next five years, generating approximately $356bn (£194bn) of global cost savings as a direct result of offshore outsourcing. Nina Sodha, a strategist at Abbey, explains her company’s rationale behind the move.

Abbey recently followed banks such as Lloyds, Citigroup and HSBC in outsourcing certain processes to India in a bid to streamline processes and reduce costs. Its own transition commenced in December with a few back-office processes moving to a chosen partner’s operations in Bangalore. This has recently been complemented with call-centre activities.

By this month, we envisage that one-in-three Abbey customer calls will be routed to the operations in India. Although it is still too early to comment on the actual savings, it is believed the business case for this decision will be proved successful, with Abbey and other companies continuing to pursue the benefits.

The focus has now turned towards controlling costs without compromising quality. This has been particularly evident within financial services where many products are reaching market saturation and maturity, thereby forcing companies like Abbey to focus on new product investment.

At the micro-level, the laws of comparative advantage dictate that firms should source their activities from countries that incur the lowest costs.

A 2003 McKinsey study reported that the wages for data-entry personnel in India are up to £2 an hour. This broadly translates to a potential reduction in operational costs of between 40% and 60%. Savings of this magnitude are not to be ignored.

Enabling centres to conduct processes during onshore out-of-office hours increases productivity. Generally larger manager-to-employee ratios and higher motivation levels translate into more efficient and effective agent performance. So far, Abbey has found that the complaint levels are on par with current UK measures – once any teething problems are eliminated, this should gradually improve.

A loss of control, especially in day-to-day operations, is inevitable.

But with the reduction in control, comes flexibility and the ability to exit from a deal, which can be more challenging in a different country.

Recent backlash within the UK has arisen due to the widespread fear that jobs are being lost in the UK in favour of lower-paid workers abroad.

Unions have been particularly active, but companies such as Barclays have managed to reach agreements based on established levels of compensation or redeployment. It is important that companies communicate effectively to their employees and explain the business imperative to offshore.

Without crucial buy-in from key stakeholders and decision-makers, the project will not gain the impetus to deal with any conflict that arises nor to ultimately deliver. Thinking solely for the short-term and gaining quick wins is not conductive to a successful strategy. The strategy needs to be aligned to the wider group strategy so that all parts of the business can leverage the benefits and learn.

  • Duncan Aitchison, managing director of the international division of consultant TPI.

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