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Inside Supply Management Magazine Masthead


It's Not Just About Cost


Steve Matthesen
Steve Matthesen is vice president and global leader for supply chain, The Boston Consulting Group, Los Angeles.

March 2006, Inside Supply Management® Vol. 17, No. 3, page 12

Companies that view outsourcing first as a means in which to reshape their businesses, then as a cost-cutting tool, achieve more significant results. Be sure to consider such items as risk, transition and which model makes the most sense for your organization.

The subject of outsourcing has been at the center of supply management's plate for years, as increasing numbers of companies have sought to achieve substantial cost advantages in logistics, warehousing and production. Enthusiasm is particularly high for business process outsourcing (BPO), or the moving of back-office functions to third-party providers. Companies are rushing en masse to capitalize on the potential savings, typically striking deals with providers in low-labor-cost countries such as India and the Philippines.

The argument for BPO is straightforward, as the potential savings is indeed sizable. But many companies are destined for disappointment. Research by The Boston Consulting Group (BCG) indicates that roughly half of companies engaging in BPO will have underwhelming results. Making matters worse, few of them will know where they went wrong or what to do about it.

The reason? Many companies overweight the cost factor in their original analysis and underweight (or ignore) the other relevant variables. Don't fall into this trap. If your company is contemplating BPO — or any outsourcing initiative, look beyond cost to the following considerations:

Strategic impact. Will the outsourced process be critical to our business in the future? Does the process help differentiate us from competitors?

Financial impact. Will outsourcing translate into significantly lower total labor costs? How will we invest this value?

Business impact. Can outsourcing increase our ability to deliver services? Will a supplier have better access to the tools and skills necessary for this process?

Business risk. Will outsourcing hurt our brand? Is the supplier operating in a region with high geopolitical risk?

Feasibility. Do suppliers have the necessary experience and scale? Will we need ongoing capital to maintain the required knowledge and skills in-house?

Connectedness. How much connection is there between the outsourced process and the rest of the functions left behind? How will we operate with thousands of miles and cultural differences separating the two parts of the business?

Transition. Are our processes clearly documented (such that an outsourcer would be able to replicate them)? Do we really need to do it the way we currently do, or can we adopt industry-standard methods for some activities?

The Strategic Impact

Companies need to look beyond the cost-cutting opportunity, as any savings can often be easily replicated by competitors. Instead, companies should aim higher and seek to capture benefits that create long-term value and fundamental competitive advantage.

Many companies approach outsourcing as something that only makes sense for clerical tasks (essentially as an alternative to automation), while leaving all the value-added tasks at headquarters. This is a mistake, because outsourcers can bring scale, expertise and improved operations to key activities.

Consider the case of a large U.S. financial institution that moved part of its operations to India. The company experienced productivity increases of up to 30 percent in accounting, transaction processing and customer service. Those gains were accompanied by a 60 percent reduction in accounting errors and a 50 percent reduction in the transaction-processing backlog. The company also reaped an increase of 10 percent to 15 percent in collections, resulting in an improved cash-flow position.

Choosing the Right Model

Selecting the correct operating model for a BPO effort can be difficult, as each company's situation is unique. The three basic models up for consideration include:

Outsourcing to an existing supplier in a low-cost country. This option is particularly appropriate for companies that need to leverage the scale, infrastructure, systems or management of an established outsourcing supplier. This model can be faster to execute and can allow companies to move activities gradually.

Moving activities offshore to a captive center in a low-cost country, while still owning and operating the new operation. Approximately 70 percent to 80 percent of companies moving activities offshore choose this model, because it allows companies to benefit from the cost advantages that low-cost countries afford yet still retain full operational control. In many cases, the center is run by an established outsourcing player for the company, with an option for the company to take over the operation in a few years. This model makes it easier to customize the processes, but requires the business to be of sufficient size to realize scale efficiencies on its own.

Outsourcing to a local (onshore) supplier. More than 95 percent of outsourcing is done onshore. This makes sense if the activity needs to be co-located with the rest of the business and the outsourcer can bring greater expertise and scale. In some cases, if staffing is required for the supplier to take on the client, it might assume control of some or all of the client's employees.

Keys to Success

In all cases, you need to be able to cleanly compare BPO with how you could do it internally, not how you currently do the work. You need to first reengineer and document the processes — only then do you have a good standard against which to compare external quotes. This ensures an accurate view of the potential savings, and also positions you to transition the activities much more efficiently. If you skip this important step, you might outsource processes that could be done efficiently in-house. Perhaps worse, you will almost certainly over-pay because the outsourcing supplier will capture all the value of process improvement.

Another key issue for most companies is striking a balance between impact and the degree of control. If you find an experienced supplier and your organization has outsourced in the past, you will likely be content with strategic control coupled with a close monitoring of the process. If the supplier is new to you or your outsourcing experience is limited, you will probably want to maintain some operational control — for example, by keeping some of your staff at the supplier's site for the first couple of months.

Because BPO outsourcing is accomplished through the use of contracts, a third key to success is a strong competence in contract management. Many companies' outsourcing efforts fail because of poor contract management processes.

Evaluate Readiness

BCG surveys have shown that as many as half of the companies that have outsourced processes are not satisfied with the results. For your BPO program to succeed, you must gauge whether your organization's capabilities will support it. This means examining and addressing such things as governance structures, the complexity of formal and informal networks, the level of process standardization and documentation, and your company's tolerance for change.

The key element is to have a strong communications plan and change-management program in place before outsourcing. BPO deals must be understood and managed as a long-term and continuous life cycle — one that requires concentrated monitoring and care.

Achieving success in BPO demands considerable thought and planning. In particular, it requires a willingness to think strategically and view BPO as an opportunity to fundamentally reshape the business, rather than simply as a tool to cut costs. Those companies that take this perspective and can address the challenges in implementation stand to achieve a lasting and significant competitive advantage. Those who fail to do so put their customer experience at risk and damage internal morale for little benefit in return.

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