How Should Companies Deal With Life After BPO?Published: January 14, 2005 in Knowledge@Wharton
So you finally signed that deal to send your accounts payable tasks to an outsourcer in India. Time to take a breather? Hardly. When it comes to business process outsourcing (BPO) arrangements, there is plenty to do after the ink is dry to make sure that your outsourcing partner holds up its end of the bargain and that your company makes a smooth transition.
Consider the case of a U.S.-based financial services company that outsourced back-office and customer service tasks to a leading Indian BPO provider about two years ago. The company's CEO, who agreed to speak on condition of anonymity, has had his hands full ever since. Overall, the executive is pleased with the agreement, which has saved the company from 15% to 40% of costs depending on the process. But he has had to wrestle with uneven worker quality in India thanks to high turnover there. He has also had to cut back on sending abroad more complex processes that involve making judgments about U.S. borrowers. And the CEO has had to work with his own managers to help them more effectively supervise tasks being completed half a world away.
"You just don't say, 'Just because I've outsourced this function, I'm no longer responsible for it,'" the CEO says. "Outsourcing doesn't mean exiting an activity."
More and more executives are likely to face the challenges of what might be termed "life after BPO." The BPO market is expected to grow from about $405 billion last year to $682.5 billion in 2008, according to research firm IDC.
BPO refers to companies farming out tasks that can range from employee benefits management to insurance claims processing to call center work to complex research projects. Companies have been "doing BPO" for many years when you consider activities such as hiring outside legal counsel or having paychecks cut by a provider such as Automatic Data Processing. But in the past several years, amid continued evolution of the Internet and growing corporate experience with technology outsourcing deals, expanded outsourcing options have emerged. These include shipping back-office work to lower-wage nations such as India, Singapore, the Philippines, and so on.
In principle, BPO arrangements allow companies to cut costs and focus on their core activities. But the deals can be less than ideal. A report last year from Forrester Research found that 20% of a group of North American executives currently using or investigating BPO said their lack of proper performance metrics was a major challenge in working with BPO firms. Some 9% cited overstated supplier expertise as a major challenge, and 19% indicated that savings from BPO was less than expected or had not materialized at all.
Another challenge associated with offshore BPO projects is political. Although some analysts view shifting work overseas as ultimately healthy for the U.S. economy, critics say "offshoring" hurts U.S. workers and threatens the country's long-term prospects. In this climate, critics argue that sending work abroad can damage a corporation's reputation.
Internal and External Challenges
Other difficulties surrounding BPO deals break down roughly into two categories: issues involving internal operations and risks related to working with an external partner. Those partner risks can be divided further into what might be termed strategic risks and operational risks, according to Wharton's Ravi Aron, a professor of operations and information management. Strategic risks stem from "opportunistic behavior" where the outsourcer may deliberately undercut the client company. Possible examples, Aron says, include intellectual property theft as well as intentional underperformance. "You're cutting costs, and the client pays for it," Aron says. Operational hazards, he adds, refer to problems that may arise despite the best efforts of the outsourcer, and can include poor quality of transaction processing.
Avoiding such potential pitfalls begins with client companies having a clear sense of what their business methods are before outsourcing and what they envision in the future, suggests Janice Co, a principal consultant with management consulting firm A.T. Kearney. Without a good grasp of existing operations and what's generating costs, "there's potential for high buyer's remorse," Co says.
Another key to BPO partner relations is a good contract. Aron recommends that companies sending out the work not only specify measurements to be used to hold the provider accountable, but also employ different forms of pricing. For example, he says, basic transactions that are easy to quantify could be paid for by unit of work - say a payment for a processed insurance claim. But for work that is not readily measurable - for instance legal research support - a better method is "fixed cost" pricing, where the client pays a certain amount for a given number of workers. "The really well-written contracts consist of a hybrid pricing scheme that includes more than one form of pricing, well-specified incentives and penalties ... and tight metrics," Aron says.
Forrester Research notes that ongoing negotiations should be part of the document as well. "...[T]here should be SLA (service level agreement)/cost renegotiations built into the contract at 12- to 24-month intervals," Forrester wrote in a report last year. Forrester also urged companies to get an early start describing whatever function is going to be sent out: "The process documentation and vendor training needs to start in conjunction with contract discussions in order not to delay implementation." Apart from documenting processes to be outsourced, effective monitoring and management of the provider are important, analysts suggest.
Monitoring BPO contracts well can be challenging, says Peter Cappelli, director of Wharton's Center for Human Resources. The responsibility for managing vendors at many companies falls to one specialist, but "they're often quite removed from the function that's being taken over," he says. That centralized approach to vendor management works better for the outsourcing of relatively simple, "commodity" tasks such as check processing, Cappelli says. It may not work so well for farming out more nuanced work like product design.
It's harder to monitor the work of an offshore vendor, Cappelli argues, adding that it can be useful to meet the workers dedicated to a company's account, whether the encounter takes place in the U.S. or abroad. A simple tour of the outsourcer's facilities, though, may not be of much use, he says. "I'm not sure you could kick the tires in any real way."
Sound management of the outsourcing relationship requires a great deal of interaction, according to Jeff Michel, president of Premier BPO, a Tennessee-based company offering a variety of back-office services provided from Pakistan and India. "You communicate, communicate, communicate," he says.
Premier BPO establishes official weekly "operational review" calls between the client company and a Premier account manager overseas. These can take place during regular U.S. business hours and Premier covers the long-distance phone charges. In addition, Premier sets up monthly review sessions to consider larger trends, and it strongly suggests "strategic business review meetings" once a quarter for both sides to talk about the overall direction of the company. That's a time that Premier may offer suggestions for improving the company's methods, Michel said. "If the relationship is working right, you become an extension of the (client)."
Forrester recommends a similar communications plan, and suggests companies take a collaborative approach with their outsourcer. "Given the integration of the process with your business and the need to drive costs down over the life of the contract, the relationship needs to be a partnership - the arm's length confrontation stance of many IT deals will not work," Forrester said in a report last year.
The CEO who has been outsourcing back-office tasks to India agreed that BPO deals are best done when the provider is viewed as a partner rather than a mere vendor on contract. The benefit of this approach became clear to him as the provider weathered an unexpected development: high employee turnover, which has affected the BPO industry in India more broadly. Turnover was roughly 30% on the CEO's account, and was hurting quality. The CEO spoke with his provider and it agreed to create a "cushion" of 33% more employees than are directly working on the account tasks.
This step added to the providers' costs but was not required by the contract. Instead, the move resulted from the ethical culture of the provider, the CEO said. "You have to do business with companies that are high-character. You need to look at it as a long-term relationship."
For sophisticated, high-value work, such as cash flow forecasting and financial statement analysis, Aron argues in favor of detailed, hands-on management of the offshore provider. This sort of practice is in place in some of the deals involving BPO company Office Tiger, he says. Office Tiger, which is based in New York City and has operations in India, allows its financial services firm clients to give very specific instructions about how to do such things as provide research support and present the findings, Aron says. Directions by managers of the client firm in the United States can be incorporated by workers in India within an hour.
In a paper ("Business Process Outsourcing: A Model of The Extended Organizational Form and Survey Findings") by Aron and Ying Liu, this new corporate governance structure is termed the "extended organizational form." To Aron, it is a way of combining the best feature of doing work in-house - strong managerial control - with the best part of getting an outsourcing partner - the way those external firms constantly improve their efficiency to remain competitive with peers. "It's a very interesting way of bringing together the strengths of the market and the organization," he says.
The View from Inside
Apart from focusing on partner challenges, companies that have launched BPO projects also have to attend to their internal affairs. BPO contracts require a focus on metrics - the numbers that show things such as claims-processing accuracy or call center response times or customer satisfaction - and that means making sure managers are numbers people, Aron says. "Managing by metrics," he notes, takes "people who know what is to be monitored, what is to be measured."
Strong communications skills also are needed by managers. Those are required partly to bridge the cultural gap between the United States and India, according to the CEO who spoke anonymously. Indians are less likely to express disagreement, so managers have to check in multiple times to make sure a directive has been accepted, he said. He's had to train and ultimately fire some managers who had a more tight-lipped style. "You have to be more actively engaged in management."
BPO arrangements in theory can free up a company's managers to focus on forward-looking activities, such as a human resources executive concentrating on grooming new leaders rather than wrestling with multiple payroll systems. But Bart Kocha, a vice president at A.T. Kearney, warns that here, too, the proper talents may be missing: "You find out the remaining organization doesn't have the skills to be that strategic partner."
Another possible problem when it comes to internal employees relates to how well a company has prepared its staff for an outsourcing deal, Kocha says. When a function changes - say, employee benefits that once were administered by live humans requiring self-service over the Web - dissatisfaction can follow if the shift hasn't been explained and justified, he suggests.
There's also the danger of losing unspoken employee know-how that has been vital to the operation of finance or customer-service departments. In the past, many outsourcing arrangements have retained this wisdom because the outsourcer absorbed a company's employees. In offshore outsourcing deals, though, employees of a back-office are generally let go, Cappelli says. "The risks are much greater. The tacit knowledge is something you're likely going to lose." A tactic here is to keep some would-be redundant workers on as employees or set up consulting arrangements, he adds.
Aron has not seen client-company layoffs in his study of the high-level work outsourced to Office Tiger. Financial firms using the service provider tend to have other work requiring industry expertise and critical judgment. On the other hand, he says, permanent lay-offs are likely to result from the outsourcing of simpler tasks such as basic technical support, account resolution and credit card inquiries.
In either event, he recommends that companies be very clear with employees about their outsourcing plans - including any layoffs. Advance notice and honesty can create good will and help a company rehire a good worker later on, Aron suggests.
Cappelli agrees that transparent communication with internal employees is a key in making a BPO contract work smoothly. If there's a lay-off related to the BPO arrangement, companies should explain what the long-term plans are to the remaining workers. Otherwise, he says, those "survivors" could fear for their own jobs, resulting in lower work performance or attempts to abandon the firm. "If they feel that they survived because of dumb luck, then they are inclined to think their job could be next," he says.
The CEO who spoke anonymously said he laid out his company's BPO plans clearly to workers. And he has been able to redeploy hundreds of employees whose jobs were outsourced to India, thanks to growth in the business. Just a handful of workers have been fired related to the outsourcing, which the CEO attributes to their inability to adapt to a changing business landscape. His business, which frequently introduces new financial services products to the market, is all about change, he says. And in his view a mindset open to change is all but necessary while working with an India-based partner. "It's very hard to forecast five years in the U.S.," he notes. "Forecasting five years in India is impossible."