A year ago, a customer ordered a book from Amazon.com, the online retailer headquartered in Seattle. But when the package arrived, he realized that the company had sent the wrong book. Annoyed, the customer sent a terse e-mail message to Amazon s customer-service department. Within minutes, a polite reply arrived offering to replace the book. The customer mailed back the book and e-mailed Amazon again, asking if the company would discount the cost of postage from the price. Again, a prompt reply arrived, agreeing to offer the discount. The customer, who was of Indian origin, noticed that both replies from Amazon were signed by people with Indian-sounding names.  There must be lots of Indians in Seattle, he thought.


Not exactly. Responses to Amazon s e-mail customer service are often generated by people who work near New Delhi, India. And they don t even work, formally, for Amazon. In August 2000, Amazon announced an agreement with Daksh eServices, a provider of business process outsourcing services in India. As Bill Price, vice president for global customer service at Amazon at the time, said:  As Amazon.com continues to attract new customers from all over the world, it is important that we have trained staff ready to respond to a customer s inquiry, no matter what time of day or night. Price added that his company  would work closely with Daksh eServices to ensure a seamless experience for the Amazon.com customer.

As the experience of the book buyer shows, the two companies did succeed in offering a seamless service. To the customer, it wasn t clear where Amazon s role ended and that of Daksh eServices began. From an organizational perspective, however, such blurring of boundaries between companies represents an unprecedented situation. As a result of deep connections that companies can now forge because of technology and falling telecommunication prices, companies are able to relate to one another in ways that were impossible in the past. Ravi Aron, a Wharton professor of operations and information management, notes:  The boundary of the firm is being compressed, while in other ways it is being expanded. What was once being handled inside the firm has now become a market transaction. An extended organizational form is emerging in which firms relinquish control and turn to monitoring instead.

Such extended organizations with digital ties that straddle the world are being formed at a rapid clip as global multinationals in the West rush to move their back office processes overseas. The advantages that such organizations offer appear to be clear  greater flexibility and efficiency at lower costs. In addition, however, managing an extended organization in which a third party firm providing an outsourced service is able to seamlessly represent itself as the client company also presents enormous risks and challenges. The degree of complexity in managing such relationships is much higher than that of managing a traditional vendor relationship. Yet experts at Wharton and elsewhere point out that companies that succeed in managing the risks of BPO relationships well can employ the extended organization to capture value.

Aron, who is co-director with management professor Jitendra Singh of a new Wharton executive education program on business process outsourcing, points out that in an extended organization, it is crucial to manage tradeoffs between monitoring and control. This involves paying close attention to issues such as performance metrics, the way in which efficiency is defined and measured, and aligning the incentives of clients and providers of BPO services. Pricing is another critical issue.  If you take your back office and make it someone else s front office, what sort of pricing structures do you use? he asks.


John C. Jacob, senior manager of national assurance services in the New York office of Deloitte & Touche, points out that the extended organizational form differs from traditional outsourcing in significant ways.  In order to remain competitive, today s organization must extend itself. It must depend on other organizations, irrespective of their locations around the globe, to support processes or deliver services, he says. When a business process is outsourced, however, this means that the company providing the outsourced service  takes on several key attributes, Jacob explains. These include, first, the fact that a core process (such as keeping contact with customers) is being outsourced, rather than a peripheral one (such as designing a brochure for customers). Second, the BPO service provider instantly becomes  a critical business partner on whom the core organization is dependent. And finally, the BPO service provider  lies outside the explicit control of the core organization.


Stephen Wagner, a partner who heads Deloitte & Touche s work around the extended enterprise  and also the assurance services associated with such arrangements  agrees. He notes that companies that fail to understand the risks that can bedevil extended organizations  or that don t see themselves as extended organizations at all  can stumble on several fronts. They can, among other things, have gaps in their operational and infrastructure controls; they may duplicate efforts among divisions or relationships; they could lose or misdirect opportunities; and most importantly, they could damage the brand and reputation of the core organization. (Telecommunications giant AT&T learned that last lesson in a painful way when it was accused of  slamming long-distance customers  or changing their long-distance provider without their knowledge. After an investigation, it turned out that these actions were taken by a firm to which AT&T had outsourced its telemarketing service.)


Jacob and Wagner point out that their firm has developed a risk management and value creation model to help companies identify, evaluate and deal with the risks in an extended enterprise. The Deloitte & Touche model touches upon four areas. These include the business process, trust and integrity, risk and control and performance management.


It is critical to manage each of these areas. For example, if a large financial services firm wants to outsource its back-office processes to Asia to reduce costs, at the business process level the firm should look at  the level of control over operations and financial operations that would be lost in the process of outsourcing, and how this risk can be mitigated, notes Jacob. In addition, the firm must pay close attention to issues such as setting up service-level agreements, monitor metrics to track if cost savings goals are being met, and ensure the quality and training of employees.


Wagner adds that trust and integrity are critical issues in an extended organization, just as they are in a traditional one, but the consequences can be severe if relationships and processes are not properly defined. For example, he says, a pharmaceutical company that had outsourced clinical trials of a new drug to another firm failed to define how requests for confidential information were to be treated. As a result, an investment analyst who called the firm for test data was given information that the drug tests were ineffective. The analyst wrote a negative report, which led to  a huge stock price drop, says Wagner.


Jacob and Wagner also note that in managing issues of risk and control, the appropriate framework to view the extended enterprise is the business rather than the company. And finally, they point out that performance management  or managing outcomes in the absence of explicit control  is crucial to making the extended enterprise function effectively.


John K. Halvey, partner and head of the global IT group at Milbank, Tweed, Hadley & McCloy, a global technology law firm, is the author of a book titled, Business Process Outsourcing: Process, Strategies and Contracts. He notes that in managing an extended organization, companies must consider both business and legal issues. Like Jacob and Wagner, Halvey believes that it is crucial to focus on a statement of the work to be performed. In addition, Halvey says, clients of BPO services must perform due diligence on the vendor s expertise.  It is important that BPO arrangements are not seen as mere headcount reduction exercises, he says.  Value creation is the result of process enhancement.


Halvey explains that when a BPO agreement is negotiated, disaster recovery and contingency planning should be factored into the deal.  Firms must understand what type of redundancy is required, he says.  That is crucial to risk mitigation. In addition, he notes, firms must deal with issues such as residual knowledge in an organization after a critical business process is outsourced.


The legal risks that confront extended organizations are as significant as the business risks. Among the most critical ones is the ownership of intellectual property.  This is an enormously complex issue, Halvey says.  The vendors of BPO services are getting highly sophisticated, especially those that are based in the U.S. A critical area, as expected, is who controls information about customers. Companies may outsource back office processes, but still they  feel they have a psychological need to control information about their customers, he says. Other legal factors to bear in mind in setting up cross-border BPO deals, according to Halvey, involve local laws in different countries and the tax consequences of different kinds of arrangements. Liability issues in BPO arrangements can also pose significant hurdles.  Companies should ask some critical questions. For example with which legal entity has a contract been signed? Is it the parent firm or a U.S. subsidiary? What assets does that entity have? says Halvey. He compares BPO deals to snowflakes; they may look alike but each one is different.


Recognizing the importance of these issues  and the close attention that their clients are paying to them  some management consulting firms are starting to set up units dedicated to helping companies sort out management issues of the extended enterprise. Among them is A.T. Kearney, a unit of EDS, which already has a massive footprint in the outsourcing business. A.T. Kearney has established a new practice called Enterprise Services Transformation to cater to the demand for knowledge about BPO arrangements. Bart Kocha, who is the global leader of the practice, says that A.T. Kearney and EDS plan to work closely together to leverage off one another s experience in these areas.


Kocha explains that a key question for companies is deciding what to outsource. For example, his team is working with a large auto company on projects that involve how to make various business processes  including procurement, supply-chain management, accounting and human resources  more efficient.  We are also looking at an offshore strategy and trying to define the options, Kocha says.  Many companies are moving toward offshore bundles.


Craig Albright, senior manager in the New York office of Marakon Associates, an international strategy consulting firm, points out that the role of the management team is critical. To the degree that companies take a strategic view of how their extended enterprise evolves, they should set up BPO arrangements that take the company s existing strengths into account. Albright notes that companies should also examine  choices and alternatives to business process outsourcing. The way a company transitions from performing certain functions on its own to outsourcing it to a provider is another critical issue.  It s an evolutionary plan, says Albright.  It is important to the potential of BPO relationships as well as their boundaries.


As companies try to figure out how to manage these thorny and complex issues, one thing is clear: the extended enterprise is here to stay and BPO relationships will multiply during the coming years.  CFOs of companies used to look at BPO deals and ask,  Why are those companies doing that? Now they are starting to ask,  Why aren t we doing that?  says Halvey.  The sled is pointing downhill. I don t see it stopping anytime soon.