Aron: Why do firm really outsource processes? My field research indicates that managers think of the off-shore process primarily as a cost-saving measure and then discover that the quality of the provider (or in some cases their captive center) is excellent. Finally the engagement with the off-shore center tends to get entrenched for strategic gains which can take as long as four or five years to manifest themselves. Do you both find that the trend is driven by costs, or are other factors also at work?
Quinn: The majority of firms that I have spoken with about outsourcing are primarily looking at cost savings, though when you discuss the issue in more detail with them you often find that they are trying to solve a problem within that process. These problems are typically quality or productivity related.
Bendor-Samuel: It has been my experience that firms outsource processes for the following reasons:
1 To save money – Most of our clients who are seeking to leverage labor arbitrage are looking to achieve total process savings between 35% and 70%. This is much higher than traditional outsourcing arrangements where the cost savings often were in the range of 15% to 25%.
2 To increase focus on their core business.
3 To improve the service they are receiving from the process.
4 This improvement comes in three forms:
o Improved quality intrinsic to the service itself – for example, service level agreements (SLAs) around the time it takes to answer a call or the accuracy of the data collection.
o Improved business impact or the improvement in service as experienced by the users of the service – for example, improvement in end customer satisfaction (in the case of call centers) or the reduction of working capital as a result of a better F&A process, which signals greater efficiency.
o Improved strategic impact. This will come in some sort of breakthrough in cycle time gains or competitive positioning.
Aron: What are the principal benefits from outsourcing that these firms experience?
Quinn: In outsourcing efforts for which I was directly responsible, our goal was to improve the quality of the output of the process. In each case we believed we were not meeting our customers’ expectations and needed to radically redesign the process. We created a new Six Sigma quality process in the offshore center and then directed new transactions to the center while “sending” management work through the remaining transactions. We were able to deliver quality of execution due to our focus on standards and we gained the benefit of reduced costs as well.
Bendor-Samuel: We typically expect to see some combination of the above benefits with most clients: immediate cost savings with an initial improvement in the intrinsic quality of service, followed by a gradual improvement in business and strategic impact. Improvement in strategic impact is the rarest benefit and most difficult to achieve. However, where the potential exists, it can quickly become the key driving force behind the decision to outsource.
Aron: Is there a possibility that some important functions can get outsourced? Could this result in an erosion of organizational competence? How do you rate this danger?
Quinn: It is highly unlikely that an important function would be outsourced if there was an outsourcing strategy developed and all functions were evaluated in light of that strategy. Using a strategic approach, identification of key functions which provide the firm with competitive advantage would not be considered for outsourcing. However, there is a risk of this happening if only one criterion — such as cost — is used to evaluate the functions that are candidates for outsourcing.
If an important function which was crucial to the firm’s competitive advantage were outsourced, it could over time reduce the organization’s competence if the quality execution of the function by the third-party is not at or above the level performed by the firm. That would hurt the firm’s reputation. Secondly, if execution is maintained at the required levels, competence could still be eroded if the output of the function is critical to future product development or market distinction. If because of outsourcing the function the market feedback “loop” is broken, there is a risk that the firm will no longer continue innovating and increasing the effectiveness of their products.
However, I rate this danger as low if firms evaluate all their functions before beginning to outsource.
Bendor-Samuel: I can’t think of a single outsourced process I have seen which our client doesn’t think is important. However, almost universally our clients do not consider them to be core processes that differentiate them in the market. This is a key point. It is hard to imagine a process such as transaction processing, F&A, or HR as not critical and important, yet they are clearly not core and are increasingly being outsourced.
Almost without exception, the thoughtful divesting of non-core processes improves organizational competence because the firm can now focus on processes and issues which are in fact core. Doing so improves its competitive position and competences.
Companies that outsource in haste or without sufficient consideration of the change management and governance issues may have to spend unnecessary time and resources to implement or re-implement these functions. In these cases, outsourcing sets back an organization temporarily. Given a thoughtful outsourcing approach with a realistic time frame and the appropriate resources, we find that it is extremely rare for the firm to experience any erosion in capability. In the cases where companies make mistakes, we find these setbacks are short term and can be rectified, although at considerable expense.
Aron: These days some three-quarters of the processes off-shored by volume are going to India. What other regions do you see playing a role in the next two to three years? What kinds of processes may migrate to these?
Quinn: Philippines, China, Hungary, Czech Republic (Eastern Europe in general), Canada and Mexico. The Philippines are very competitive in call-center services and accounting functions. China has broad Asian language skills and a large labor pool for data entry and maintenance type functions. Hungary and the Czech Republic have highly educated people, strong language skills to support Western Europe and a growing technical skill base. Canada has the English language skills, an educated labor force and service capabilities for incoming and outgoing call centers while being considered lowest “risk”. Mexico has an increasing base of educated, technical labor and language skills to cover most of Latin America. India still has the best mix of breadth and depth of labor with strong English language skills and extremely well educated people.
Bendor Samuel: Clearly at this time India has the largest capability for English speaking labor arbitrage and has the most significant momentum with organic in-country firms. We do not expect any other nation to seriously challenge India for U.S.-based business over the next two years. For Europe, we expect Eastern European nations to emerge as destinations of choice, although at a higher cost point to India. We also expect the nascent markets in South America and South Africa along with additional markets in Asia, such as the Philippines and China, to emerge. However, given the growth in this market, it is unclear that they will have a significant market share impact.
We believe that the most significant development in offshore outsourcing will be the growth of large sustainable business processes such as claims processing, back office functions such as F&A and HR, and application support. We expect BPO will overtake the current IT-focused projects oriented work.
Aron: The right governance structure is an issue that C-level executives wrestle with all the time. When would you recommend that a company consider an outsourcing option as opposed to migrating to a captive center? Why? What other governance forms — joint ventures, build-operate-transfer (BOT) models — would you consider?
Quinn: From my perspective, an outsourcing option is more viable than a captive center when there are established competencies that are superior to what is available in a captive. There is no reason to “re-invent the wheel” if an established provider can deliver against your requirements. Of course that provider has to meet your requirements for financial stability and viability, critical mass, proven track record of superior performance and cost effective delivery.
Geographic availability may also make an outsourcing option more viable. If the firm has no presence or infrastructure in a region and has a need for immediate capabilities in that region, an outsourcing service provider may be the path of least resistance. So long as a provider meets these criteria, it may not be cost-effective to invest in establishing a legal vehicle and related infrastructure in every region in which you choose to do business. In either case, if the volume of activity that needs to be supported is significantly greater than the outsourcer’s reasonable capacity, a captive center becomes more attractive.
The BOT model is very appealing to a firm that would like to have a captive center but lacks the critical mass or physical presence outside its home territory. Establishing a relationship with a proven provider that has the infrastructure, people and expertise and migrating functions over time serves the firm well as they get the benefits of outsourcing without the immediate capital investment necessary to launch a de novo site. It would take a medium-sized financial institution up to three years to migrate the processes and functions which are best suited for outsourcing, so they can “rent” the capability while they build scale. The BOT model works best for all parties if it is at least three to five years in duration.
Bendor-Samuel: Factors that drive companies to outsource rather than develop a captive organization are:
1 Comfort level: Many companies do not have, nor seek to have, the skills needed to set up a subsidiary offshore. GE and other leaders set up captive operations largely because the suppliers at the time were much smaller and less experienced than today.
2 Time to impact: Companies can gain the benefits of labor arbitrage quicker by utilizing an outsourced option.
3 Risk: Typically a company can substantially reduce the risks of offshore outsourcing through utilizing a independent third party.
4 Use of capital: By outsourcing, a company will be able to leverage its providers’ investments, avoiding its own capital expenditures.
5 Economies of scale: Typically companies are not able to generate economies of scale enjoyed by the large outsource providers.
6 Management attention: Many U.S. and European-based firms are unable or unwilling to devote sufficient management attention to their offshore subsidiaries to allow them to develop a management team with sufficient depth to allow the captive subsidiaries.
Where our clients have sufficient size and scope to allow them to deal adequately with these advantages of the outsource providers, and where they have adequate sophistication and resolve to stay the course, captive solutions can be an attractive option. A captive strategy is also appropriate when the process being moved offshore is deemed core or sufficiently critical that it requires the company to maintain control.
Joint ventures and other partnership structures are the most difficult to govern. Given their inherent difficulties, we feel there are more sustainable and productive governance structures to utilize.
Aron: What industries and/or functions do you expect to see outsourced or migrated in the near future? Why?
Quinn: As it is the area I am most familiar with, I see a lot of interest in the financial services industry (broadly defined as banking, investment banking, asset management, insurance, consumer finance, credit cards). Where last spring investment bankers were not interested in exploring outsourcing, they are now leading frenetic activity in the area. Insurance providers are probably still lagging their industry colleagues, but I expect more action in that sector during the next 12-18 months.
Call-center activity is becoming almost a commodity and there is an expectation that whoever is considering outsourcing is first targeting some aspects of their call centers. Other service activities like account opening/maintenance, fulfillment, and inquiry resolution are also gaining momentum. We have already seen domestically and now internationally the various HR functions and basic accounting (payables, receivables, expense reporting) being outsourced. Now we are seeing more complex and time sensitive accounting functions (legal reporting, intra-day reconcilements, fund accounting) being teed up for possible migration.
Along with those activities a number of transaction processing support activities that which require near real-time response are also being considered. Even a paper-intensive, highly controlled process such as mortgage origination, booking and maintenance has been completely outsourced by the leaders. Higher up the value chain are various analytic functions from risk management and control through equity research.
Firms are becoming increasingly comfortable with the concept of outsourcing and as they are successful in migrating simple functions, they begin to understand the “power” of rethinking their processes. Technology continues to become faster and cheaper, providing virtual real-time access across thousands of miles. Competitive pressures are starting to become evident as well. Second-tier financial institutions are seeing the quality and cost improvements being achieved by their more advanced competitors. Outsource suppliers are becoming more mature and increasingly are providing creative input into process improvement.
Bendor-Samuel: We believe that the most significant development in offshore outsourcing with be the growth of large sustainable business processes such as claims processing, back office functions such as F&A and HR, and application support, which will overtake the current IT-focused projects oriented work. We believe that this will occur across a wide spectrum of industries, initially focusing on financial services.
As you look at the power and sustainability of the offshore model, it is hard to imagine that companies will not seek to exploit its benefits in a more systematic and sustainable manner. A simple analysis of the work companies can send offshore illustrates vividly its wide applicability.