Strategic Outsourcing: The Alchemy to Business Transformation in a Globally Converged World

Management for Professionals

For further volumes: http://www.springer.com/series/10101

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Bharat Vagadia

Strategic Outsourcing The Alchemy to Business Transformation in a Globally Converged World

Dr. Bharat Vagadia Brampton Grove 53 HA3 8LE London United Kingdom [email protected]

ISBN 978-3-642-22208-5 e-ISBN 978-3-642-22209-2 DOI 10.1007/978-3-642-22209-2 Springer Heidelberg Dordrecht London New York Library of Congress Control Number: 2011938156 # Springer-Verlag Berlin Heidelberg 2012 This work is subject to copyright. All rights are reserved, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilm or in any other way, and storage in data banks. Duplication of this publication or parts thereof is permitted only under the provisions of the German Copyright Law of September 9, 1965, in its current version, and permission for use must always be obtained from Springer. Violations are liable to prosecution under the German Copyright Law. The use of general descriptive names, registered names, trademarks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. Printed on acid-free paper Springer is part of Springer Science+Business Media (www.springer.com)

I dedicate this book to my late father and grandfather; Khimji Karsan Vagadia and Karsan Parbat Vagadia for showing me the light

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Preface

This book is for business leaders and managers from both the user and vendor communities who make or implement strategic sourcing decisions. If you lead outsourcing programmes or teams working on outsourcing, or seek to change a function or process through the use of outsourcing, have the power and authority to make decisions, or just feel strongly about the direction of your organisation or outsourcing programme, this book is for you. This book bridges academic research and draws on practitioner experience to provide a detailed understanding of how an organisation’s value chain can be reconfigured in order to create a more effective organisation using strategic outsourcing. Globalisation and in particular convergence are forces affecting most organisations and requires a strategic response by organisations in developed countries. To meet these challenges, business leaders have turned to outsourcing and offshoring as a tool to transform their organisational structures. However, strategic outsourcing and offshoring represent significant changes to business models, and have led to success and failure for many organisations. This book provides a roadmap to successful implementation of strategic outsourcing programmes, providing down to earth approaches to outsourcing decision making and implementation, based on a grass roots understanding. Outsourcing is not new; many organisations have used outsourcing successfully to bring about cost reduction, introduce flexibility or access specialist resources. However, not many have managed to use outsourcing in a strategic context. The book examines how strategic outsourcing can help transform organisational business models, structures and mindsets. Outsourcing can be a very risky strategy, if not managed adequately. Historically the success rate has not been encouraging, with only 40–60% of initiatives being deemed successful. Failure of the outsourcing programme not only affects those processes or functions being transitioned, but also those interdependent elements, touched by or associated with such activities. The failure of such a programme can have longer term consequences for the competitive advantage of the firm and its reputation in the market.

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Managing these risks, whilst ensuring the rewards sought from outsourcing are delivered, requires a combination of strong legal contracts and a relationship with the service provider based on high levels of trust. It also requires the organisation to thoroughly understand its own capabilities to manage outsourcing and the impact this may have on its longer term strategy. This book takes the reader on a journey through its 15 chapters: from understanding the drivers for change as a result of globalisation and convergence and their impact on organisational strategies; to examining how outsourcing can transform the various processes and functions of an organisation; to the impact outsourcing is having on various industry vertical sectors. The book then examines the role of the three “R’s” – Risks, Rewards and Relationships, in understanding the scope for the use of, and management of strategic outsourcing. A whole chapter is then focused on the outsourcing decision making process, for this is the most important management activity in developing and subsequently managing a programme which delivers. Having understood the decision making process for strategic outsourcing, the focus turns to transition management and governance, and how, what is the most difficult phase of an outsourcing programme, can be managed smoothly. At this point, insights drawn from academic research are provided to complement the practitioner experience. Through these insights, the book proceeds to explain how risks can be minimised through a combination of formal controls and informal relational exchanges. The whole concept of relational governance is explored in detail with two case studies providing insights into the client and vendor perspective. A chapter is dedicated to the review of offshore destinations, detailing criteria for the evaluation of destinations and analysing the relative merits of outsourcing within more than 35 countries across Asia, Americas, Europe and MENA. The issue of managing culture, especially when dealing with offshore destinations is then considered, with insights into how cultural differences manifest themselves within the relationship and how these can be managed. The concluding chapter details the eights foundations of successful strategic outsourcing implementation, which when combined with strategic decision making knowledge, guarantees that organisations embarking on the strategic outsourcing journey will derive the transformational benefits they seek. Each chapter includes an abstract at the beginning and a take-away at the end of the chapter, which serve as useful reference checklists for practitioners. I want you to stop thinking of outsourcing as a tactical tool, but recognise that it is a business system that will be increasingly important in the future, in transforming the organisational monoliths that we see today into the agile market leaders of the future. Strategic outsourcing will become an indispensable business model for progressive business leaders. This book will show you why and how.

Contents

1

2

3

Role of Strategic Sourcing in a Changing World . . . . . . . . . . . . . . . . . . . . . . . 1.1 Economic Drivers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.1.1 Challenging Times Leading to Changing Business Models and Practice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.1.2 Contrary Forces at Work . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.1.3 All Eyes on Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.1.4 All Aboard . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.1.5 Mixed Fortunes for the Outsourcing Industry . . . . . . . . . . . . . . . . . . 1.1.6 Changing Commercial Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.1.7 Getting it Right . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.2 Take Aways . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1 1 2 2 2 3 4 5 5 6

Globalisation and Convergence: Drivers and Strategic Outsourcing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.2 Convergent World . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.3 Raising Barriers to Globalisation and Convergence . . . . . . . . . . . . . . . . . . 2.4 Adapting Businesses to Compete on a Global Level . . . . . . . . . . . . . . . . . 2.5 A Case in Point: The Rise of India . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.6 Take Aways . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

7 7 8 10 11 16 19

Social and Philosophical Considerations of Outsourcing . . . . . . . . . . . . . 3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2 Economic Consequences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3 Social Consequences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.4 Separating the Spin from Reality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.5 Policy Implications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.6 Take Aways . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

21 21 22 23 24 24 25 25

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From Tactical to Strategic Outsourcing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2 The Role of Relationships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.3 Information Technology Outsourcing and the Cloud . . . . . . . . . . . . . . . . . 4.3.1 Cloud Computing and IT Outsourcing . . . . . . . . . . . . . . . . . . . . . . . . 4.3.2 Cloud Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.3.3 The Challenges of Cloud Sourcing . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.3.4 Cloud Vendors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.4 Business Process Outsourcing and Call Centres . . . . . . . . . . . . . . . . . . . . . . 4.4.1 Defining BPO Services by Organisational Impact . . . . . . . . . . . . . 4.4.2 Drivers for Customer Service Outsourcing . . . . . . . . . . . . . . . . . . . . 4.4.3 The Future of Call Centres . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.5 Travel, Transport and Logistics Outsourcing . . . . . . . . . . . . . . . . . . . . . . . . . 4.5.1 Drivers for Logistics Outsourcing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.6 Finance and Accounting Outsourcing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.6.1 Drivers for F&A outsourcing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.7 Human Resource and Recruitment Processing Outsourcing . . . . . . . . . 4.7.1 Drivers for HRO . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.8 Knowledge Process Outsourcing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.8.1 Typical KPO Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.8.2 Challenges in Knowledge Process Outsourcing . . . . . . . . . . . . . . . 4.9 Legal Process Outsourcing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.9.1 Drivers for LPO in Law Firms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.9.2 What Not to Outsource . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.9.3 LSO Challenges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.9.4 Corporations Rather Than Legal Firms Driving LSO . . . . . . . . . 4.10 Take Aways . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

27 27 28 31 31 32 36 37 38 39 41 43 44 44 45 46 47 47 48 49 50 51 52 52 52 53 54

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Outsourcing Within Industry Verticals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.1 Banking Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.1.1 Banking Value Chain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.1.2 Outsourcing Drivers for Banking Sector . . . . . . . . . . . . . . . . . . . . . . . 5.2 Insurance Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.2.1 Insurance Sector Value Chain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.3 The Telecoms and Technology Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.3.1 Main Drivers for Outsourcing and Managed Services . . . . . . . . . 5.4 Public Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.4.1 A Means to Radically Transform Service Provision . . . . . . . . . . . 5.4.2 Evolving Generations of Outsourcing . . . . . . . . . . . . . . . . . . . . . . . . . 5.4.3 The Drivers for Outsourcing in the Public Sector . . . . . . . . . . . . . 5.4.4 Public-Private Partnerships (PPP) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.4.5 Outsourcing Offshore Versus Onshore . . . . . . . . . . . . . . . . . . . . . . . . . 5.4.6 A Closed Market for New Suppliers . . . . . . . . . . . . . . . . . . . . . . . . . . .

55 55 56 57 58 60 62 63 67 68 69 72 73 73 74

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5.5 Retail Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.5.1 Drivers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.5.2 Outsourcing Drivers not Just Focused on Cost . . . . . . . . . . . . . . . . 5.5.3 The Need for an Integrated Contact Management Strategy . . . 5.5.4 Transforming Customer Service Cost Centres into Sales Centres . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.5.5 The Need for Greater Pro-activity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.6 Charity Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.7 The SME Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.8 Take Aways . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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Strategic Outsourcing: Risks, Rewards and Relationships . . . . . . . . . . . 6.1 Rewards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.2 Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.2.1 Loss of Core Competence and Innovation Capability . . . . . . . . . 6.2.2 Cost Escalation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.2.3 Supply Market Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.2.4 Change Management Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.2.5 Selection, Contracting and Vendor Management . . . . . . . . . . . . . . 6.2.6 Communication Challenges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.3 Relationships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.3.1 Knowledge Retention . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.3.2 Trust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.4 Take Aways . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

81 81 84 85 86 86 87 87 87 87 89 89 91 91

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Sourcing Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93 7.1 Evolution of Sourcing Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93 7.2 Take Aways . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98

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Strategic Outsourcing Decision Governance . . . . . . . . . . . . . . . . . . . . . . . . . . 8.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8.2 Decisions Driven by Consensus and Debate . . . . . . . . . . . . . . . . . . . . . . . 8.3 Suggested Decision Process for Outsourcing . . . . . . . . . . . . . . . . . . . . . . . 8.3.1 Defining the Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8.3.2 Outsource for the Right Reasons . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8.3.3 Using a Methodical Approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8.3.4 Engage with All Stakeholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8.3.5 Choosing the Right Relationship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8.3.6 Negotiating a Robust Contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8.3.7 Use of Performance Incentives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8.3.8 Establish a Relationship Governance Structure . . . . . . . . . . . . . . . 8.3.9 Establish a Relationship Management Function . . . . . . . . . . . . . . 8.3.10 Managing Human and Communication Issues . . . . . . . . . . . . . .

76 76 77 78 79 80

101 101 107 107 107 108 109 109 111 112 112 112 113 113

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8.3.11 Single Versus Multi-Sourcing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113 8.3.12 Understand the Vendors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114 8.4 Take Aways . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115 9

Transition and Relationship Governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9.2 Managing the Soft Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9.3 Governance and Relationship Management . . . . . . . . . . . . . . . . . . . . . . . . 9.4 Typical Governance Structures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9.4.1 Joint Review Board (JRB) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9.4.2 Service Management Team (SMT) . . . . . . . . . . . . . . . . . . . . . . . . . . . 9.4.3 The Operating Group/Service Delivery Team (OGSDT) . . . . . 9.5 Governance in Practice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9.6 Role of the Legal Contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9.7 Service Level Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9.8 Take Aways . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

117 117 121 123 124 124 126 126 126 127 129 131 131

10

Insights from Academic Research on Outsourcing . . . . . . . . . . . . . . . . . . . 10.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.1.1 Defining Outsourcing and Offshoring . . . . . . . . . . . . . . . . . . . . . 10.1.2 From Tactical to Strategic Outsourcing . . . . . . . . . . . . . . . . . . . 10.1.3 Empirical Studies Suggest Outsourcing can be a Risky Practice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.2 Outsourcing Rewards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.2.1 Better Focus on the Core Business . . . . . . . . . . . . . . . . . . . . . . . . 10.2.2 Cost Reduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.2.3 Benefit from Supplier Investment and Innovation . . . . . . . . 10.2.4 Increased Flexibility and Technology . . . . . . . . . . . . . . . . . . . . . 10.2.5 Gain Access to External Competencies . . . . . . . . . . . . . . . . . . . 10.3 Outsourcing Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.3.1 Strategic Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.3.2 Operational Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.3.3 Commercial Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.3.4 Human Resource (HR)/Communication Risks . . . . . . . . . . . . 10.4 Outsourcing Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.4.1 Agency Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.4.2 Transaction Cost Economics (TCE) . . . . . . . . . . . . . . . . . . . . . . . 10.4.3 Resource Based View (RBV) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.4.4 Dynamic Resource (Capability) Model (DRM) . . . . . . . . . . . 10.4.5 Incomplete Contract Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.4.6 Other Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.5 Take Aways . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

133 133 133 134 135 136 136 136 137 137 137 138 138 139 140 140 141 142 142 143 144 144 145 147 147

Contents

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11

Minimising Risk Through the Contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11.2 Outcome Based Accounting Controls . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11.3 Appropriate Contractual Clauses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11.4 Contract as an Enabler of Trust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11.5 Take Aways . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

151 151 152 152 153 154

12

Minimising Risk Through Relationships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12.2 Trust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12.2.1 Organisational Trust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12.2.2 Group Trust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12.2.3 Individual Trust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12.2.4 Creating Institutional Mechanisms for Building Trust . . . . 12.3 Control and Its Relationship to Trust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12.4 Vendor Selection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12.5 Service Level Agreements as a Means of Control . . . . . . . . . . . . . . . . 12.6 Collaboration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12.7 Relationship Management and Internal Knowledge Retention . . . . 12.8 Necessity of Legal Contracts for Positive Trust Development . . . . 12.9 Adaptation to Cultural Differences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12.10 Knowledge Transfer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12.11 Managing Distance and Communication Challenges . . . . . . . . . . . . 12.12 Continuous Improvement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12.13 Risk Minimisation in Practice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12.14 Take Aways . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

155 155 155 157 157 157 157 158 159 163 164 165 168 169 169 170 170 171 173 173

13

Offshoring Leaders, Laggards and Hopefuls . . . . . . . . . . . . . . . . . . . . . . . . . 13.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13.2 Location Selection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13.2.1 From Countries to Cities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13.3 Criteria to Assess the Location Decision . . . . . . . . . . . . . . . . . . . . . . . . . . 13.3.1 Factor Weightings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13.3.2 Country Evaluation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13.3.3 Relative Merits of each Location, Based on a Rational Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13.4 Effects of the Recent Political Unrest on Offshoring . . . . . . . . . . . . . . 13.5 The Outsourcing Industry in Asia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13.6 The Outsourcing Industry in India . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13.6.1 Infrastructure Challenges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13.7 The Outsourcing Industry in China . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13.8 The Outsourcing Industry in Philippines . . . . . . . . . . . . . . . . . . . . . . . . . . 13.9 The Outsourcing Industry in Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13.10 The Outsourcing Industry in North America and Latin America . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

175 175 176 177 179 179 180 180 181 182 184 186 192 193 194 195

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Contents

13.11 The Outsourcing Industry in Middle East and Africa . . . . . . . . . . . . 196 13.12 Take Aways . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 197 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 198 14

Managing Cultural Differences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14.2 Cultural Influences on Management Style . . . . . . . . . . . . . . . . . . . . . . . . . 14.3 Cultural Influences on Hierarchy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14.4 Cultural Influences on Group Relationships and Motivations . . . . 14.5 Cultural Influences on Negotiation Styles . . . . . . . . . . . . . . . . . . . . . . . . . 14.6 Distinctions Blurring Between Cultural Dimensions . . . . . . . . . . . . . . 14.7 Cultural Differences in Evidence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14.8 Take Aways . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

199 199 200 201 202 202 202 203 206 206

15

Implementing Successful Strategic Outsourcing Programmes . . . . . . . 15.1 The Eight Principles to Success . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15.2 Principle 1: Strong Yet Flexible Contracts . . . . . . . . . . . . . . . . . . . . . . . . 15.3 Principle 2: Effective Governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15.4 Principle 3: Effective Control and Monitoring . . . . . . . . . . . . . . . . . . . . 15.5 Principle 4: Building Commitment and Mutual Dependence . . . . . 15.6 Principle 5: Ensuring Goal/Expectation Alignment . . . . . . . . . . . . . . . 15.7 Principle 6: Building Individual and Institutional Trust . . . . . . . . . . . 15.8 Principle 7: Managing Effective Collaboration and Knowledge Sharing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15.9 Principle 8: Effective Communications . . . . . . . . . . . . . . . . . . . . . . . . . . . 15.10 A Summary of Strategic Outsourcing: Risks, Rewards and Relationships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15.10.1 Don’t Start at the End . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15.10.2 Establish What is Core . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15.10.3 Establish What Success Means . . . . . . . . . . . . . . . . . . . . . . . . . . 15.10.4 Measuring Success . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15.10.5 Making It Happen: Ever Had a Yearlong Migraine? . . . . 15.10.6 The True Picture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15.10.7 It’s Not All Plain Sailing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15.10.8 Impact on Strategy and Value Retention . . . . . . . . . . . . . . . . 15.10.9 Don’t Overlook the Challenges . . . . . . . . . . . . . . . . . . . . . . . . . 15.10.10 Organisational Change . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15.10.11 Cultural Adaption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15.10.12 Detailed Contractual Agreement . . . . . . . . . . . . . . . . . . . . . . . 15.10.13 Knowledgeable Resources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

207 207 209 210 211 212 213 215 215 216 216 216 218 218 218 219 220 220 221 221 221 222 222 222 222

Further Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 223

List of Figures

Fig. 2.1 Fig. 2.2 Fig. 2.3 Fig. 4.1 Fig. 4.2 Fig. 4.3 Fig. 4.4 Fig. 4.5 Fig. 4.6 Fig. 4.7 Fig. 4.8 Fig. 5.1 Fig. 5.2 Fig. 5.3 Fig. 5.4 Fig. 5.5 Fig. 5.6 Fig. 5.7 Fig. 5.8 Fig. 5.9 Fig. 5.10 Fig. 5.11

An interconnected world . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Pillars of competitive advantage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . From a vertically integrated organisation to an allianced organisation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The historical context of outsourcing from a client and supplier perspective . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The three generations of outsourcing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Worldwide outsourcing market size . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Technology stack – the decoupled approach driving innovation in service delivery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . BPO service impact on organisations . . . . . . . . . . . . . . . . . . . . . . . . . . . . Finance and accounting value chain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Knowledge process outsourcing (KPO) services . . . . . . . . . . . . . . . . . Legal process and service outsourcing . . . . . . . . . . . . . . . . . . . . . . . . . . . Banking value chain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Banking value chain – the role of outsourcing at each stage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Insurance value chain – the role of outsourcing at each stage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Telecommunications value chain squeeze . . . . . . . . . . . . . . . . . . . . . . . . Role of outsourcing in transforming telecom operators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Outsourcing growing throughout the value chain within the telecoms industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The overriding drivers for outsourcing the telecoms industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Changing cost structures in the mobile industry through use of outsourcing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Government outsourcing trends by country . . . . . . . . . . . . . . . . . . . . . . UK government outsourcing by sector . . . . . . . . . . . . . . . . . . . . . . . . . . . Evolution of public sector outsourcing . . . . . . . . . . . . . . . . . . . . . . . . . . .

9 12 18 28 30 30 33 39 46 49 53 56 58 61 62 63 64 64 65 68 69 70 xv

xvi

Fig. 5.12 Fig. 6.1 Fig. 6.2 Fig. 6.3 Fig. 8.1 Fig. 8.2 Fig. 8.3 Fig. 8.4 Fig. 8.5 Fig. 8.6 Fig. 9.1 Fig. 9.2 Fig. 9.3 Fig. 9.4 Fig. 9.5 Fig. 12.1 Fig. 12.2 Fig. 12.3 Fig. 12.4 Fig. 12.5 Fig. 12.6 Fig. 13.1 Fig. 13.2 Fig. 13.3 Fig. 13.4 Fig. 13.5 Fig. 13.6 Fig. 13.7 Fig. 13.8 Fig. 13.9 Fig. 13.10 Fig. 15.1

List of Figures

Key issues for consideration within public sector outsourcing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72 Outsourcing drivers – academic insight . . . . . . . . . . . . . . . . . . . . . . . . . . 82 Outsourcing cost levers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83 Key drivers of outsourcing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83 Strategic sourcing choices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102 Strategic intent to reality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104 The sourcing decision dilemma . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108 The detailed outsourcing decision process . . . . . . . . . . . . . . . . . . . . . 110 Stakeholder perceptions in outsourcing – example of IT outsourcing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110 Multi-sourcing versus single sourcing . . . . . . . . . . . . . . . . . . . . . . . . . . 114 Transition phases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118 The balance between the legal contract and relational aspects of the deal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118 Transition management activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120 Levels of governance relationships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124 Factors that lead to successful outsourcing governance . . . . . . . . 127 Relationship matrix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 159 From adversarial to collaborative relationships . . . . . . . . . . . . . . . . 163 Rules for effective SLA metrics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 164 Communication management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 171 Practitioner views of outsourcing risks . . . . . . . . . . . . . . . . . . . . . . . . . 172 Practitioner views of most impacting risk mitigation actions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 172 Offshore destinations by maturity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 176 Offshore destinations – high level criteria for assessment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 177 Offshore destination – detailed decision model . . . . . . . . . . . . . . . . 178 Offshore destination criteria weighting . . . . . . . . . . . . . . . . . . . . . . . . . 179 A rational country comparison using detailed decision model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180 Rational relative merits of each country – courtesy of GovernanceDirector.com . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 181 Relative attractiveness of Asia-Pac countries . . . . . . . . . . . . . . . . . . 184 Relative attractiveness of European countries . . . . . . . . . . . . . . . . . . 195 Relative attractiveness of North and South American countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 196 Relative attractiveness of Middle East and African countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 197 Stakeholder conflicting requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . 217

List of Tables

Table 2.1 Table 6.1 Table 7.1 Table 7.2 Table 9.1 Table 9.2

Surviving in a competitive global world . . . . . . . . . . . . . . . . . . . . . . . . . . Trust indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sourcing models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sourcing engagement models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Transition risk management activities . . . . . . . . . . . . . . . . . . . . . . . . . . . Outsourcing governance procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

12 90 94 94 122 125

xvii

.

List of Case Studies

Case study of Indian BPO Service Provider........................................................ 160 Case study of Cooperative Financial Services..................................................... 166

xix

.

The Author

Dr Bharat Vagadia is a leading authority on Telecommunications, Managed Services and Outsourcing and has been involved in Managed Services and Outsourcing throughout his careers. He has advised governments, regulatory authorities, and businesses in UK, Western and Eastern Europe, Kenya, Bahrain, Jordan, KSA, Egypt, Morocco, Oman, Qatar, the UAE and India. He has worked extensively with organisations, large and small, on strategy, financing, marketing, business process management, SLA development and more generally, outsourcing. Dr Vagadia is a director of an outsourcing research and advisory firm (www.Op2i. com), is a Board Director of the UK National Outsourcing Association, the founder of a software-as-a-service decision governance system (www.GovernanceDirector. com), an advisor to the International Telecommunications Union (ITU) on policy and regulatory affairs, and teaches on MBA programs at UK business schools. He is also the author of “Outsourcing to India – a Legal Handbook”, which offers concise, digestible and relevant legal advice to help organisations ensure an outsourcing deal delivers on its promise, offering practical advice on mechanisms to reduce outsourcing risk through the contract. Dr Vagadia has a PhD researching the interplay of legal contracts and trust in outsourcing relationships. He has been awarded an LLM in Commercial Law, an MBA from Imperial Business School, a 1st Class (Hons) in Engineering from King’s College London, and a CIM Diploma in Marketing. www.Op2i.com www.GovernanceDirector.com

xxi

.

Acknowledgements

I would like to thank the many people who have provided insight and feedback on the concepts and tools described in the book, including the senior managers from the two case studies for their time for interviews, and my colleague Ross Caldwell, who has helped develop a more robust methodology through our discussions, critical analysis and his penetration and probing questions, not to mention his invaluable help in proof reading the manuscript. It goes without saying that I owe a debt of gratitude to the academic tutors I have had the privilege of meeting over the many years spent studying the diverse subjects that have contributed to my understanding of the practice of outsourcing. I would like to thank my wife Bhavna, who has supported and encouraged me in writing this book and my daughter, Divyamayi, who brings a ray of sunshine every time the dark shadows of despair hover above. There are many others who have helped, encouraged or supported me in this journey, including friends, family and colleagues who I am immensely grateful to, but in the interest of saving trees, have not listed here. London, May 2011

Dr Bharat Vagadia

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Role of Strategic Sourcing in a Changing World

The recent economic turmoil witnessed by the global economy has brought outsourcing, managed services and shared services to the top of the board room agenda. Organisations are now re-examining their business models and structures and outsourcing is being seen as a tool for business transformation. The recent focus by many organisations on cost reduction, however, may cause more problems than they solve. This chapter outlines briefly the recent forces for change in the outsourcing landscape and concludes that while the outsourcing decision must be considered as a legitimate business strategy, it must be considered with a great deal of care.

1.1

Economic Drivers

Early in 2009, organisations around the world, including many within the emerging economies which had been somewhat protected from the recession, began to fear a deep global recession brought on by the banking and credit crisis. For the outsourcing market, this presented both heightened risks with more budget constrained clients and new opportunities, arising from a real need within organisations to cut costs and restructure balance sheets – outsourcing was featuring high on the board room agenda. Although emerging countries had not been as hard hit as the Western world, they have nevertheless suffered from a drop in international demand for their products and services. Just when organisations from these countries started moving up the value curve, beyond cost savings into business transformation, customer demand turned the clocks back by a decade and again expectations shifted back towards lower costs rather than fancy value added services.

B. Vagadia, Strategic Outsourcing, Management for Professionals, DOI 10.1007/978-3-642-22209-2_1, # Springer-Verlag Berlin Heidelberg 2012

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1.1.1

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Role of Strategic Sourcing in a Changing World

Challenging Times Leading to Changing Business Models and Practice

The world went through what can only be described as an incredibly challenging time. It is at such times that innovation normally thrives. If most large organisations were to start anew, typically they wouldn’t build the organisational model they have today. Outsourcing provides organisations with a framework to help re-engineer themselves using a model that is in tune with today’s technology enabled and converged environment. What the 2009–2011 recession did, was to accelerate this transformation of industries and business models. This transformation was not too different from that envisaged by Darwin’s natural evolution theory – a change in the environment leads to changes in demand, changes in the nature of competition, and the ways of doing business. During this evolution, some business models and processes became either more common or rare – to survive, standing still was not an option. As the recession tightened its grip on business, outsourcing increased in popularity as a cost saving business strategy and rose in importance. For a growing number of businesses, of all sizes, struggling to pay rents, rates and staff salaries, the idea of outsourcing, even for those that viewed it with suspicion in the past, saw it now as the new saviour of their business. Even the public sector seriously started examining the role that outsourcing and shared services can play in an era of reduced funding and tough choices.

1.1.2

Contrary Forces at Work

Interest in outsourcing has grown over the last few years, by around over 20% according to our most recent global survey.1 However, this has not necessarily translated into more outsourcing. Many were reluctant to pursue this path; with the uncertainty of the economic recovery hovering over executive’s heads, and many simply avoided making a decision. Most couldn’t justify the up-front transition costs involved in outsourcing. However, as a new wave of optimism spreads, many executive heads are emerging above the sand of recession and seriously thinking about what lessons they have learnt; taking the opportunity to transform their costs and business structures.

1.1.3

All Eyes on Cost

The activity that distracts someone from their core business is the core business of an outsourcing service provider – that means treating it as a profit centre, not a cost

1

Op2i Outsourcing Survey 2009–2010.

1.1

Economic Drivers

3

centre. This usually translates as “cheaper”. Following this logic, one would have assumed that this increased focus on costs savings would lead to significantly more offshoring, which contrary to popular belief, is currently just a small part of the overall offshoring industry. However, what we are seeing is a very focused and selective strategy for offshoring. As the industry matures, organisations understand better which processes and functions are more appropriate for offshoring – in fact what we have seen is that some processes and or functions that had been previously offshored, are now being brought back in-house – having learnt an expensive lesson in the process. This trend to bring back processes and functions in-house may accelerate as upheaval in national markets and political pressures mount, and organisations attempt to de-risk exposure to volatile regions – just look at the political unrest in Egypt and Tunisia, and the effects this has had on business and trade. If the right processes/functions are offshored, to the right destinations and the right service providers, they have the potential to dramatically change business economics through their significant impact on costs, quality and the availability of huge talent pools. However, the “if” is a big if.

1.1.4

All Aboard

What we are also seeing is the diffusion of outsourcing to a wider business audience. When facing battle with a multinational corporation with significant resources at its disposal – an SME with somewhat limited resources (human, technical, legal, financial and global reach) may find the battle somewhat difficult and short lived. However, it can be argued that the time has now come, when (operationally at least) the many David’s of the world can compete with the few Goliaths that have historically dominated the markets. With the increasing availability of outsourcing and offshoring to the SME market, times are changing and SMEs can consider these as new ways to compete, extending their business capability and reach. I myself, running a small firm, have used outsourcing to great effect, outsourcing web development, creative design and some aspects of marketing from India to Mexico to Brazil and even the USA – albeit with a few hiccoughs along the way. Outsourcing is nothing new – probably as old as the David and Goliath story. Most large corporate organisations around the globe have embraced outsourcing in one form or another over the last decade. Mid-market companies must now embrace outsourcing and offshoring as both a means of survival and as a means to level the playing field with their larger competitors. Although the benefits and drivers for outsourcing are pretty clear, operational execution and risk mitigation strategies are more difficult for the Mid-market to comprehend (from experience the same can be said for large corporate organisations. . .).

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Role of Strategic Sourcing in a Changing World

Mixed Fortunes for the Outsourcing Industry

Clearly the ingredients are there for the outsourcing industry to benefit from the recession. However, the industry must improve its success rate if it is to convince the wider population that outsourcing and offshoring are sufficiently mature to be considered a viable business strategy, rather than just another tactical approach to cutting costs. The fear is that the recent economic climate, has brought focus firmly back to simply cost cutting, without the necessary strategic focus being given to the wider opportunities presented by an outsourcing programme This ultimately moves outsourcing initiatives from being firm level strategic options to merely tactical considerations, managed by the procurement department within the organisation. A sharp focus on reducing costs has inevitably meant that the broader benefits from outsourcing, such as flexibility, service/process reengineering and transformation, have dropped down the agenda – something that may well have longer term consequences. With the success rate of outsourcing somewhere in the range 40–60%, it will be really unfortunate if this preoccupation with costs above other benefits extends into cost preoccupied decision and programme governance. Although the primary driver for outsourcing and certainly offshoring has always been cost, what we have seen is a dramatic shift in focus towards cost, with transformation concentrating on core competencies, and time to market being down played. Business transformation, the holy grail of outsourcing, although never quite living up to expectations (not surprising, given it was the vendor community who claimed the ability to deliver business transformation and enable their client’s to be more flexible, innovative, and respond to market changes more quickly and efficiently), must be the ultimate goal for the outsourcing industry. Unfortunately, some vendors just jumped on the business transformation bandwagon without the necessary domain expertise, or indeed the resources to be able to commit to large scale transformations. Outsourcing relationships in the vast majority of cases are still therefore very much transactional in nature and far from the strategic approach that can deliver substantial value to the parties. This is not to say that (some) vendors cannot deliver transformational change, but that it requires a very different relationship and a very different approach to the whole outsourcing decision process – an approach which both parties and their respective stakeholders agree and commit to. Another dramatic change has been the expectations of cost savings. Whereas organisations were happy to outsource and offshore, investing upfront in transition activities with payback within 3–5 years, customers now expect payback within 18 months, and ideally don’t want to invest/ spend any money upfront – not quite fitting the business model that vendors and indeed advisors are familiar with. However, this change in client demand firmly creates momentum for the cloud and Software as a Service (SaaS) models now beginning to be rolled out. This focus towards costs didn’t just affect new outsourcing service users; those organisations that had outsourced, started demanding suppliers live up to the partnership hype that they emphasised during the sales and negotiation phase, and

1.1

Economic Drivers

5

share the pain and pressures that customers faced – many sought to renegotiate their contracts during 2009 – asking suppliers to deliver more-for-less, whilst also seeking to deliver substantial cost reductions from the previously agreed rates (figures between 15% and 20% had been claimed).

1.1.6

Changing Commercial Models

In a bear market, most suppliers felt they had no real choice but to respond (some may well have lived up to the partnership model, others forced) to customer demands. Most suppliers secured longer term contract extensions in exchange for short term pain – where suppliers (e.g. offshore call centres) have profit margins between 20% and 30%, they could afford to give a little. . .. However, what this period showed is that the longer term contracts, typical within the outsourcing industry, can themselves lead to less flexibility – contrary to the common perception that outsourcing delivers greater flexibility. There will no doubt be continued pressure on the industry for shorter term contracts – not quite the model required for strategic outsourcing, where a long term partnership is sought. Given the principal mantra being prudence, organisations have also sought to cut out expensive, and what they may deem as unnecessary, advisory support services. Many have gone back to the antiquated belief that outsourcing is just another form of procurement and therefore something that can be done quite adequately within the organisation. This may well save costs in the short term and the organisation may well find suppliers that can deliver some cost savings. The likely longer term impact will be a dysfunctional organisation, with decisions being imposed by one department or sponsor on others. The wider organisational benefits will be brushed aside; all the possible options that may well deliver substantial benefits in the longer term will be ignored with the blinkered lens focused only on immediate cost savings. Within this environment, all the risks and possible risk mitigation strategies will not be fully evaluated or clearly communicated with wider stakeholders. This communication challenge has also more than ever, influenced the decision to outsource; “how will the market react to us outsourcing, how will our employees react to outsourcing and possible job losses, the unions, the public. . ..”. Many would-be outsourcers, seeing the benefits of outsourcing, have been restrained by this force of public opinion. This however has not stopped public sector organisations, especially local government looking hard at their sourcing options.

1.1.7

Getting it Right

Deciding what to outsource, where to outsource and identifying the right provider are simply the opening challenges. Making outsourcing happen provides further

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Role of Strategic Sourcing in a Changing World

potential pitfalls – it calls for new forms of strong project, change and governance management skills that in most organisations don’t exist internally. The outsourcing decision making process, although only the opening challenge, must, be done correctly, otherwise you end up fighting a lost cause, trying to stop a runaway juggernaut. The decision making process must be all encompassing, assessing all options; for outsourcing is not always the answer. An appropriate rational decision making process is called for, more so than ever before.

1.2

Take Aways

• Outsourcing becoming more popular – although still a lot of uncertainty. • Outsourcing being used as a tool to re-structure business models and value configurations. • Outsourcing will be embraced by more sectors and by the SME market in the near term. • Increased outsourcing has not translated into increased offshoring. • Vendors being forced to negotiate lower prices and create innovate commercial structures to deliver greater value, quality and without the upfront investment by client organisations.

2

Globalisation and Convergence: Drivers and Strategic Outsourcing

The world has gone through incredible change over the last few decades which is creating a globally interconnected world – a flat world. This pace of change is increasing with convergence of products, services, industries, technology and knowledge. The effects of globalisation and convergence will be dramatic and impact every aspect of business in developed and developing economies. Organisations in developed economies need to adapt to this new world and reexamine the basis of competitive advantage, redefine their businesses; become much more efficient through process and cost optimisation, seek best in class skills and knowledge from a globally dispersed talent pool, utilise technology to deliver superior value to their clients, provide products and services for this new converged world and tap into the globally interconnected financial markets to access cheaper capital. This chapter examines the drivers for globalisation and convergence, their impact on business and details how organisations can compete in this environment.

2.1

Introduction

The two transformational forces of the twenty-first century; globalisation and convergence are knocking down, long established structures, business models and beliefs. The effects of globalisation have been wonderfully illustrated in the book: The World Is Flat: A Brief History of the Twenty-First Century by Thomas Friedman, which analyses globalisation, primarily in the early twenty-first century. Friedman defines ten “flatteners” that he sees as levelling the global playing field: • Collapse of the Berlin Wall signifying the collapse of the Cold War and the integration of countries from the falling physical barriers; • The web broadened the audience for the Internet from its roots as a communications medium used primarily by the academic community and geeks to something that made the Internet accessible by everyone; • Workflow software enabled equipment to talk to other equipment without the need for human involvement; B. Vagadia, Strategic Outsourcing, Management for Professionals, DOI 10.1007/978-3-642-22209-2_2, # Springer-Verlag Berlin Heidelberg 2012

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Globalisation and Convergence: Drivers and Strategic Outsourcing

• Outsourcing allowed companies to split service into those deemed core and noncore and allowed entities to subcontract activity and perform these in the most efficient, cost-effective way; • Offshoring, which Friedman described as the internal relocation of a company’s manufacturing or other processes to a foreign land to take advantage of cost advantages. The famous BRIC countries are at the foremost here; • Open source software enabled communities to upload and collaborate on online projects; • The use of technology streamlining the supply chain, such as sales, distribution, and shipping; • In-sourcing, which is seen to be akin to what marketers call brand extension, where organisations supply goods or perform services into adjacent markets from their core markets, leveraging their existing assets, be it technology, channels to market or customer trust – he uses the example of UPS, in which the company’s employees perform services – beyond shipping – for another company – e.g. UPS itself repairs Toshiba computers on behalf of Toshiba. The work is done at the UPS hub, by UPS employees; • The holy grail of efficient markets theory is about access to all information in real time – this has now become closer to reality, thanks to Google and other search engines, which gives the participants in a market the ability to find all the information required in a timely and cost effective manner; and • Finally the technology revolution, including Mobile, Voice over Internet, Broadband and other technologies which to some extent sit above the underlying Broadband networks and makes the utility of the services much greater; helping spur new innovative models, services and competition (e.g. Skype).

2.2

Convergent World

Friedman talks about convergence in a limited sense around horizontal collaboration and converging economies from a communist perspective to a market led perspective. However, the effects of convergence in its true form are much broader and much more impacting on the world – more so than the ten individual flatteners that were listed. Convergence is happening in all its forms, which is changing the nature of market structures, demand, competition, competitors and the ways of doing business. Any organisation that is not cognisant of this, and does not transform their businesses will be adversely affected. Globalisation, increasing international trade and the lowering of barriers to entry into markets will continue over time. The impact from emerging countries in terms of competition, their effect on demand for raw materials and energy will only continue to increase. Organisations will need to not only transform their internal focus – improving efficiency, accessing world class talent, better partnerships and focused on what is

2.2

Convergent World

9

core to their business, but they must also, examine opportunities to serve the emerging markets. Everyone talks about convergence in one form or another, some talk about converging technologies, others converging markets and so forth. Convergence is changing the ICT industry significantly today. It is not a theoretical argument, but an everyday reality for companies within the ICT value chain. ICT convergence is a state in which networks and intellect are globally interconnected, integrating all forms of electronic communications into a single universal transmission system which interconnect processing resources, and deliver all forms of content that is delivered from one to the other, on whatever device and wherever that individual desires such content. I tend to view convergence more broadly and as my colleague, Ross Caldwell elegantly put it, it is the interaction, overlap and absorption of different industries converging together in a more competitive and deregulated market – a world where skill sets are available everywhere, where everywhere is connected, where knowledge is ubiquitous, where everything is now and where everywhere is here, and where resources are globally distributed. Viewing convergence in these broad terms paints a very different picture of what the world will look like in the twenty-first century and what the implications are for organisations. The relatively simple diagram (Fig. 2.1) illustrates the interconnected nature of convergence and globalisation: Effects of convergence can be seen at the macro level Advanced country local demand for goods and services

Emerging country supply of goods

Local resources outstripping demand Labour rates rise

Emerging country supply of labour

Migration of manufacturing to lower cost countries Emerging country growth driven by FDI

Globalisation – reducing trade barriers Deregulation of telecom – facilitates globalisation Global connectivity Relaxation of FDI limits Labour convergence

Outflow of funds from developed to developing

Emerging country supply of services Emerging country growth driven by exports

Aging workforce – competition for skill sets Immigration from developing to developed countries

Technology convergence

Repatriation of savings and funds

World Economy convergence

Advances in technology

Knowledge convergence

- reduces barrier to entry into industries - allowing different ways of doing business

Deregulation

Emerging country growth in local demand

Globalisation of knowledge

Free market mechanism

Positioning of developed countries as “knowledge” economies Local stock market correlated to Global stock market

Focus on Finance, Banking, Insurance industries Stock market driven society – economic growth linked to stock market Deregulation of BFSI sectors

Intense competition

Cheaper products

Intense BFSI sector competition, breaks link with local and world economy

Global Credit Crunch

Local Credit Crunch

Unsustainable competition – costs rise Increase in Default payments

Fig. 2.1 An interconnected world

Disposable incomes fall

Energy prices rise

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Globalisation and Convergence: Drivers and Strategic Outsourcing

A World where globalisation and convergence are interconnected Given this scenario, what are the options for world economies to compete on the global stage? Well two, either raise barriers to entry into your local markets or adapt businesses to compete in this spaghetti of economics, politics, regulation and internationalisation.

2.3

Raising Barriers to Globalisation and Convergence

A country could attempt to counter the forces of globalisation and convergence by raising barriers. Indeed countries have or are attempting to do just this – at the time of writing this book, the UK is attempting to limit immigration, the USA is considering raising trade barriers with China, the G20 is attempting to impose more regulatory controls on the financial industry. However, these are seen as relatively short term measures, an attempt to buy time. All participants in this game know full well, that in an interconnected world, one country raising barriers is likely to lead others to retaliate, and therefore over time the act of raising barriers could over time lead to a dis-benefit. That aside, the options for countries to raise barriers include: • Raise trade barriers – where countries cannot compete with others, it may raise trade barriers unilaterally or bilaterally – sometimes these may be rational intentions sought to counter the effects from currency manipulation by a country, but mostly is a reaction to competition from countries that have a lower cost base. • Regulate telecommunications strongly – globalisation, outsourcing and offshoring have only been possible because of the ubiquitous and cheap availability of telecommunications infrastructure. During the early 1980s the price of a call from the UK to India was more than £1.50 per minute – probably equivalent to £5.00 per minute in today’s value; today the liberalisation of telecommunications markets globally means it costs only £0.01 per minute. • Limit FDI – many industries in developing economies flourished as a result of foreign direct investment, but today many of these developing countries have started investing in developed economies – usually to secure a channel to market for their products and services. Although the largest investor in the UK remained the USA, India was the second-largest investor in 2008–2009, ahead of Italy, France, Canada and the Gulf countries.1 • Limit immigration – globalisation and outsourcing rely on the free flow of talent across national boundaries. Making these national boundaries stronger can help limit the effects of globalisation and outsourcing at a national level – it also panders to public opinion around immigration.

1

UK Treasury.

2.4

Adapting Businesses to Compete on a Global Level

11

• Limit repatriation of funds – FDI and immigration are linked to the ability to repatriate funds either to company head quarters or families, for business and consumers respectively. Limiting the ability to repatriate funds makes immigration and FDI less attractive. • Limit globalisation of knowledge – the fuel that has powered globalisation and higher end knowledge based outsourcing has been the distribution and collaboration of knowledge. Cutting this fuel can reduce the pace of globalisation and outsourcing. This could mean limiting university collaboration, Joint Ventures and reduced funding for joint research projects. • Regulate financial markets strongly – the free flowing nature of financial markets has led to the cross border flows of finance, liberating companies from their local domestic markets to the international stage. Regulation of financial markets can put the brakes on the pace to globalisation. • Seek alternative energy sources or reduce demand for energy – one of the effects the growing economies of the BRIC countries have had, is on the demand for energy and raw materials. This has the inevitable impact on the price for raw materials and energy prices. These being the primary inputs to production, have fed through to final goods and services prices. It has also driven globalisation as developing countries hungry to access steel, cement, coal and so forth have ventured into overseas markets in an attempt to secure these – all eyes have firmly been fixed on African countries for now. • Enforce bank lending to affordability criteria – another periphery affect of globalisation and the free flow of finance has been the relaxation of bank lending to compete in an increasingly competitive market – apart from the effects leveraged debt has on individuals when times get tough, it has meant individuals have sought to invest in higher growth markets, fuelling globalisation.

2.4

Adapting Businesses to Compete on a Global Level

Taking the above definition of convergence, and given the first option of raising barriers has to a large extent been relegated to the cold war era, means a business within a converged world, to continue to compete needs to examine and concentrate on: • Redefining what business they are in – what is unique, core and valuable – concentrating limited resources to these and outsourcing the rest; • Optimising and reducing costs through automation and outsourcing; • Accessing skills and knowledge across the globe, by embracing international partnerships, through a distributed workforce, and by accessing the necessary tools and capability to manage staff and partners remotely; • Embracing technology developments and working with the stakeholders to create integrated networks, channels and knowledge sharing; • Developing products and services for a converged customer and for delivery in converged distribution systems – using international partners to help the expansion of the business to the international stage; and • Seek lowest cost finance.

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Globalisation and Convergence: Drivers and Strategic Outsourcing

These pillars of business transformation are illustrated in Fig. 2.2. Achieving competitive advantage in a globalised converged world requires adaption of the business to take advantage of the following macro factors (Fig. 2.2):

Achieving Competitive Advantage –5 basic pillars for adapting to the new converged world

Seek cost and process optimisation

Technology

New products and markets

Seek new products, markets and distribution channels

Redefine what business you are in and converge with partners

Skills and Knowledge

Seek to utilise technology to enhance and build customer loyalty

Efficient

Seek global skills and knowledge

Focus

Finance

Fig. 2.2 Pillars of competitive advantage

Achieving competitive advantage in a converged market therefore requires the business to (Table 2.1): Table 2.1 Surviving in a competitive global world 1. Redefine what business you are in 1.1 Determining the strategy to compete – what’s niche, and partner what differentiates you, how do you compete with emerging countries? 1.2 Using partners to implement organisational functions/processes, which they can do better and cheaper than a company can do internally 2. Seek cost and process optimisation 2.1 Seeking raw materials globally at lowest possible cost 2.2 Improving allocative efficiency–resource allocation to maximise returns 2.3 Improving productive efficiency (minimal per unit cost) 2.4 Improving dynamic efficiency–investment in innovation 2.5 Automating processes wherever possible to eliminate errors and improve efficiency 2.6 Seeking to reduce consumption of inputs (continued)

2.4

Adapting Businesses to Compete on a Global Level

13

Table 2.1 (continued) 3. Seek global skills and knowledge

3.1 Recruiting talent globally and having the workforce stationed globally working remotely, working in different time zones – seeking to become a 24 h company 4. Seek to utilise technology to enhance 4.1 Implementing best available technology, systems and and build customer loyalty management to interconnect employees, suppliers, partners, customers and knowledge 4.2 Offering superior customer service, constantly communicating and managing the relationship 5. Seek new products, markets and 5.1 Entering new product/service and geographic distribution channels markets 5.2 Developing new products for the convergent age and protection of such innovation 6. Seek lowest cost finance 6.1 Sourcing lowest cost finance, whether this is from international markets, or new social clusters (e.g. expatriate funds)

Looking at each of the above in turn: 1.1 Determining strategy to compete – what’s niche, what differentiates you, how do you compete with emerging countries? With increasing competition from domestic competitors, competition from new players enabled by reduced barriers and international competition, basic products and services will tend to get commoditised. Competing against international competitors from emerging markets for commoditised products and services will become increasingly difficult. A company has to adopt three key strategic positions: • Cost leadership, enabled through lowest production costs, efficiency and optimised processes; • Differentiation, enabled through superiority in either product or service delivery, customer service or use of technology; and • Focus, enabled through highly customised products and service to niche markets. 1.2 Using partners to implement organisational functions/processes, which they can do better and cheaper than organisations can do internally In a world where organisations need to become efficient and spend their valuable resources in achieving excellence in allocative and dynamic efficiency, it is important that any function/process which can be done better and cheaper externally rather than internally, be considered for outsourcing. However contracting out services in the “old fashion” will not enable the firm to seamlessly change its business over time. To create a firm which transforms and transitions to changing market conditions over time, the firm must partner with outsourcing service providers on a relationship where both parties’ aims and goals are aligned. However, some functions/process must be kept internal to the business: • Because they are core and essential, such that it would be too risky to outsource; and • In order to achieve dynamic efficiency – innovation will in most cases not be invested in by the outsource service provider as it would be deemed as being too risky.

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Globalisation and Convergence: Drivers and Strategic Outsourcing

2.1 Seeking raw materials globally at lowest possible cost Whatever strategic position is adopted, it is imperative that production costs are minimised through the procurement of goods and intermediate services at the lowest possible costs – usually from international markets. Where intermediate services are being procured, it is also important that lowest cost does not also translate to poor service. 2.2 Improving allocative efficiency – resource allocation to achieve maximum returns An area where a firm must pay significant attention, especially in the context of convergence, is in the appropriate allocation of resources to achieve the maximum return on investment from a range of investment opportunities. This usually calls for serious examination of the state of competition and the firm’s capability to achieve ongoing margins given incremental production, distribution and customer service costs. Appropriate resource allocation may need to change continuously over time, changing in line with developments in the markets and customer behaviour. However, to do so effectively, requires instantaneous access to relevant data – at a detailed granular level. Without this information, it would be impossible to make appropriate decisions. This requires investment in cost models, systems and automation procedures. 2.3 Improving productive efficiency – lowest unit cost It is no understatement to say it is important that achieving the lowest possible unit cost per product or service is desirable, however this may not always be achievable without significant economies of scale – i.e. only the largest can be the cheapest. What is however important for all firms, large and small, is achieving efficiency in all their operations, from operations, distribution, marketing, HR management and within the area of SG&A. This usually calls for an examination of all the business processes, ensuring maximum process optimisation, ensuring all the processes are aligned and that there are no unnecessary delays, hand-offs or blockages. In the some cases business process engineering, six-sigma and so forth may be required. 2.4 Improving dynamic efficiency – investment in innovation An area which only a handful of firms spend much attention to, is in improving dynamic efficiency, which effectively means innovation – seeking new methods of doing business, new products/services which effectively change the nature of competition. However convergence provides a perfect opportunity to do just that. Innovation can break the mould and allow firms to thrive in what may have been competitive or difficult markets to enter – e.g. Skype, ebay, Napster – they change the market and the way in which firms within the market must compete. Innovation does not always derive from technology innovation, although most do. Innovation in customer service, in bundling of products and services and procurement methods can provide a key differentiator. 2.5 Automating processes wherever possible to eliminate errors and improve efficiency Most inefficiencies and errors that occur, especially in data intensive and process driven sectors are as a result of human error. In a world where customers are more

2.4

Adapting Businesses to Compete on a Global Level

15

demanding and switching costs from one provider to another are minimal, it is vital that firms reduce all forms of errors and inefficiencies from their processes – this usually calls for the automation of such processes. Automation also drives efficiencies by utilising technology and systems. Automation also enables: • The production and delivery of sub-process to be taken offshore and managed locally; • Enables processes to be brought back in house or migrated to an alternative service provider easily and effectively. 2.6 Seeking to reduce consumption of inputs It is important to reduce consumption of inputs wherever possible: raw materials, HR, energy and so on. It is given that energy prices will remain relatively high given the steady demand from emerging countries. Governments are keen to utilise “green” sources and incentives are being offered which companies could avail themselves of. In addition many consumers are becoming environmentally conscious and will in the future reward those that they perceive to be more aligned to their beliefs and views, by giving their loyalty to such businesses. 3.1 Recruiting talent globally and having the workforce stationed globally working remotely, working in different time zones – becoming a 24 hr company effectively When competing in an ever more competitive environment, and especially when firms seek to differentiate themselves and focus on niche markets, it is important to recruit talent globally. No longer should companies be restricted in what they can achieve, just because of the limitations in accessing talent locally. Consumers are becoming more demanding, seeking immediate access to services and products whenever they demand – a 24 hr society. This also requires firms to become 24 hr businesses. Recruiting talent globally and working remotely enables a firm to provide services and products 24 hr, without necessarily increasing costs significantly. However the firm must be able to manage the disparate workforce effectively. 4.1 Implementing best available technology, systems and management to interconnect employees, suppliers and partners, to offer superior customer service, constantly communicating and managing the relationship Where switching costs and loyalty are reducing over time, there appears to be two choices that a firm has, the first is to lower prices to attract and retain customers, and the other is to offer superior customer service, which customers are willing to pay a small premium for. Competing on price alone, will not serve the firm or the industry – a declining pricing spiral only benefits the end user. It is far more sensible to compete on the basis of customer service – this effectively raises the barriers to customers switching, and builds longer term loyalty. Offering superior customer service, means making the customer feel valued, which usually calls for: • Individualisation of some aspects of service; • Constant communication; and • Managing and being honest with customers if things go wrong. Communication needs to move with the times and should also include web 2.0 based technologies. Technology must be used to differentiate your firm from the rest – but keeping up with the latest technology comes at a cost.

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Globalisation and Convergence: Drivers and Strategic Outsourcing

4.2 Distributing knowledge throughout the organisation and its partners Excellence is achieved by constantly sharing knowledge and communicating with stakeholders – letting them know what is happening, where and why. Sharing knowledge enables stakeholders to make better decisions and share responsibility for the delivery of superior services and products. Knowledge encompasses both explicit and tacit knowledge. It is important that firms capture through thorough documentation management all forms of explicit knowledge, collect this centrally and share such knowledge between its stakeholders. Tacit knowledge (know how), in many cases distinguishes one firm from another, and it is important that the firm facilitates, captures and disseminates such knowledge. Training must form an integral part of organisational learning – not only in the form of formal external training, but also facilitated workshops. 5.1 Entering new product/service and geographic markets Globalisation and the emergence of developing countries on the world stage not only creates competition, but also creates opportunities for firms in developed countries. However, a firm must adjust its offerings for the needs of the local markets, which may include significant cost reduction. Understanding the nature of such local markets and the nuances that may not be visible can only be achieved through partnerships with firms based locally. There is nothing to stop an offshore firm which provides outsourcing services for some of your functions/processes, to also become a distribution partner for your products or services. 5.2 Developing new products for the convergent age and protect such innovation The nature of demand and the mechanisms for delivery is changing – firms must develop or adapt products and services to cater for these changes in demand and delivery modes. The changing nature of demand includes; more interactivity, more demand for relevant content and more choice. In addition there are now new delivery modes for content, through TV, IPTV, Web, Mobile, Games, etc. and new delivery modes for products, such as the new retail channels created by the likes of Amazon, Ebay, Tesco (who is now seeking to sell legal services from its stores). 6.1 Seeking lowest cost finance Although it is quite obvious that a company must seek the lowest cost finance, it is most often overlooked – many firms rely on bank loans or the local equity markets. As financial systems across the world are becoming integrated, the standards and governance frameworks of the most advanced financial markets are now being applied within developing countries. It may therefore be possible to seek finance from overseas markets, without the higher risks that would be associated with such a move in the past.

2.5

A Case in Point: The Rise of India

We all know about how India is becoming a world power, growing at an amazing rate, making headlines: from the smallest car in the world, sending satellites into orbit, becoming the provider to the world’s poorest when it comes to generic medicine, buying the UK’s beloved Tetley’s tea and so on. . ..

2.5

A Case in Point: The Rise of India

17

However, what I think is more remarkable is how less than 20 years ago, India was on the verge of bankruptcy. In an age where the bureaucrats in Delhi controlled the economy and to a large extent, enterprise, through their socialist lens, the country was seen as a basket case. During the 1990s the country opened up its markets not only to the private sector, but to international competition. In a matter of two decades, India grew exports of IT & Business Process Outsourcing services, exponentially to approximately $70bn today – contrast that with UK exports of ALL services at around $250bn. The pharmaceutical sector is growing exponentially, including bio-tech, which is growing by nearly 40% every year. The telecommunications sector is growing faster than any in other country. India is by some measures the second largest telecoms market with 10–20 million mobile subscribers added every month. The automobile industry is one of the fastest growing sectors globally, with predictions that India will be among the top five vehicle producers in the next 5 years. India is a country with a middle class larger than that of USA, or Europe, a country where more than 125 million people speak English, which churns out more than 2 m English speaking graduates and over 75,000 IT graduates every year (not to mention the mathematicians, the engineers and the doctors). It is a country where education is not only a pillar of the economy, but society as well – where the average salary is a lot less than the UK, where over half the population still live on two dollars a day. There are a lot of aspiring, hungry, go-getting people, all looking to making money in the global economy – if the private sector can churn out $70bn in exports in two decades, think how far they can go in the next decade – India is the equivalent to what China was, in the manufacturing world, for the service sector. So what you may ask? First, they will come knocking on your current and future customer’s doors, and they will be a lot cheaper than you are today. Apart from creating huge barriers or huge walls, like the old days, there is not much that you can do to stop them. China did this to the manufacturing sector. China didn’t necessarily come knocking on your customers doors, but your customers went knocking on China’s doors. This is also likely when it comes to services – your customers will go knocking on India’s door. You will hear many in the developed world say we are different today – the UK economy for instance is a knowledge based economy, it thrives on education and so on – but India is building itself to be the world’s back office – to be a service industry, to compete not in manufacturing, but on knowledge. So like it or not, it will affect most service businesses in the developed world. So what are the options for organisations in this new world order? First the Indian market should be seen as an opportunity to market your products and services. Unlike developed economies where growth is stagnant, the economy is growing and is expected to do so for some considerable time. It is still a very underdeveloped country. There is a massive need for improved

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Globalisation and Convergence: Drivers and Strategic Outsourcing

infrastructure – roads, rail, airports, the health system, the education system, security, defence, energy production, green technology, more intensive farming, better logistics, better distribution, and so on. India may have the large scale graduates, but it lacks the innovative products, the R&D, the experience, the technology, the high end engineering skills which developed countries have at their disposal. The second plank of this strategy: instead of fighting this invasion, why not collaborate – it is far easier to get onboard a running train, than trying to stop it. If you go to India, you will see this is quite normal – I’m always surprised why India doesn’t have more Olympic runners, given how most of the population are wonderful sprinters, racing to board a running train. . .. If you know the markets are getting more competitive, more demanding, more challenging – why not tap into the resources that are available. There’s been a lot of resistance to offshoring by the unions, and many people will increasingly view it with suspicion, as unemployment starts to rise in developed countries – but is it not better for a firm to continue trading, retraining staff to take new roles within the firm or beyond, than a firm going under because it cannot compete on the world stage? Globalisation and convergence require businesses to move from an integrated monolith to an allianced enterprise as illustrated in Fig. 2.3.

Vertically integrated organisation

Inbound logistics Operations

Outbound Logistics Marketing & Sales Service

Procurement Technology Development Finance & Accounting Human Resource Management Firm Infrastructure

Allianced organisation 1. 2. 3. 4. 5. 6.

Solution driven capabilities Investment in knowledge networks Solution & relationship excellence Competition for relationships Align structure & systems with required capabilities Change management to transform values and behaviours

Retained functions / processes

Outsourced process and Supplier management

Fig. 2.3 From a vertically integrated organisation to an allianced organisation

2.6

2.6

Take Aways

19

Take Aways

• Globalisation is impacting organisations today and will continue to do so into the future. • Convergence in all its forms is gathering pace and changing the markets, environments and the basis of competitive advantage – organisations must adapt or be left behind and meet the same fate as the dinosaurs. • Organisations need to focus on core competences – things that will help them differentiate in the global competitive canvas. • Competition from cheaper players from the developing world means organisations must seek cost and process optimisation to compete fairly. • Knowledge and skills are globally distributed – organisations must leverage this, rather than fight the inevitable trend. • Technology can help reduce costs, improve quality or even re-define markets – organisations must utilise technology, but do so within their cost constraints. • Globalisation and convergence create opportunities for serving new markets and offering new products – organisations must capitalise on this.

.

3

Social and Philosophical Considerations of Outsourcing

Outsourcing and in particular offshoring has received a lot of media attention, usually driven by the fear of local jobs going overseas or because outsourcing is seen as a way of cutting costs which is perceived to impact quality or compliance (such as the recent BP oil spill). Certainly the fear of job losses is one that needs an urgent policy response, when unemployment in the developed economies rises and the security of domestic economies is brought into question. However, when it comes to job losses, the media hype may have been slightly more exaggerated than experience has shown to date. There is also a social perspective of outsourcing that has not received much media attention which nevertheless is important for policy makers. This is the impact outsourcing has on recipient countries; the positives have been reported, but the negatives consequences on local populations, cultures and families have failed to make the headlines. This chapter highlights some of the social and philosophical consequences of outsourcing and in particular offshoring, along with some possible policy responses.

3.1

Introduction

Outsourcing has provoked a very emotional debate, especially in the United States. There are two conflicting interests that appear to be driving the debate: workers vs. employers and source countries vs. receiving countries. Take the example of Frank LaGrotta, Pennsylvania House of Representatives who in March 2004, stated: What’s going on with this offshoring of American jobs to India and China is nothing but terrorism – economic terrorism. He may have a point. The various stated benefits from outsourcing at the organisational level, are typically reiterated by developing country governments as a rationale for changing national institutional frameworks, with the aim of increasing the deal flow of outsourcing towards its country. However, there are wider consequences that B. Vagadia, Strategic Outsourcing, Management for Professionals, DOI 10.1007/978-3-642-22209-2_3, # Springer-Verlag Berlin Heidelberg 2012

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Social and Philosophical Considerations of Outsourcing

outsourcing more generally has upon economies. These consequences are not widely discussed in the business literature, but are nevertheless important considerations, especially with respect to national policy and politics.

3.2

Economic Consequences

Two decades ago, the loss of manufacturing jobs sparked fears of a hollowing out of the USA and UK economies. Yet painful as the loss of those positions were, strong economic growth and innovation created far more jobs to replace them. Now, the same process, many economists argue, is going on in services. Yes, some individuals are losing out, as well educated programmers or engineers are doing the same job, for far less, halfway across the globe. But as developed economies evolve, innovation should, the economists argue, create new highpaying jobs. Others though, argue that the outsourcing of highly skilled service jobs is fundamentally different from what happened when manufacturing jobs were outsourced – and poses greater risks for developed economies. They argue that trade implies reciprocity – it is a two-way street, but that there is no reciprocity in outsourcing, only the export of domestic jobs. In the old manufacturing based economy, a firm’s assets were primarily tangible, e.g. plant and equipment, machines, assembly lines, etc. In the new information based economy, however, the bulk of a firm’s assets are often intangible – the creativity, knowledge, brain power, motivation of its employees etc. In an information based economy, it is this human capital and knowledge that creates worth for the firm. Exporting key knowledge from within the organisation therefore poses serious risks. It is the concepts, strategies, ideas, and information exchange that set their companies apart from their competitors. It is the workers and their knowledge that differentiates one firm from another, giving it an identity, value, and an advantage in the market place. How can these knowledge assets be transferred, without a significant adverse impact on the firm and the economy at the macro level? In a knowledge based economy, knowledge is the value! At the macro level it does raise concerns – what jobs will professional workers re-train to, after the new wave of high-tech outsourcing? If an engineer, a chartered accountant, or an architect at the top of his/her respective corporate ladder loses a job, what does he/she do next? At a firm level there are also concerns about the sustainability of a firm’s competitive advantage – where cooperative relationships and exchange of ideas between workers are needed for long-term success, who will provide these and when these jobs are shipped out of the organisation? It is most destructive when the organisation competes on the basis of creativity or sophisticated thinking problem-solving. Economic models may support this bleak outlook for developing economies. In the case of two trading nations with factor differences in labour abundance (India) and capital abundance (UK), economic theory predicts that this imbalance leads to

3.3

Social Consequences

23

a decline in the natural rate of unemployment in the labour abundant nation (India), but a rise in the natural rate of unemployment in the capital abundant nation (UK). The rise of the Indian IT outsourcing destination has been almost simultaneous with the rise in unemployment of developed countries information systems workers. The economic theory of labour/capital inequality between India and the UK predicts a rise in the unemployment rate for information technology workers in developed countries as the movement of labour is facilitated by enabling communication technologies.

3.3

Social Consequences

If one considers outsourcing purely through a ‘free market’ capitalistic lens, it is easy to ignore the social/philosophical issues associated with outsourcing. Offshore outsourcing raises complicated social/philosophical questions with multiple stakeholder costs and benefits. Some consequences are positive, but many negatives are unseen. The positives include: • The outsourcing firms’ stakeholders (shareholders, consumers, and core employees) can reap benefits by having these firms become leaner and more cost competitive in the global marketplace – they are better positioned to create even more higher paying employment at home. • Outsourcing affords assistance to workers in recipient countries in terms of job creation, technology transfer, skills acquisition and more generally poverty alleviation. However, within developing countries which are the recipients of outsourcing work, who are supposedly the winners within the outsourcing debate, there are associated negative consequences which tend to be overlooked both in the literature and in practice. Within the recipient countries, negative consequences include: the impact that a concentration of the outsourcing industry within a particular city has in terms of infrastructure, culture, and the psychological affects such work may have upon the health and wellbeing of workers and their families (Budhwar et al. 2006). Bangalore, the heart of the Indian outsourcing industry, for example, has seen infrastructure problems (Dittrich 2007), encroachment on rural land, rising real estate price rises which have driven many of the poor out of the city (Dittrich 2005), an increase in alcohol abuse, and workers suffering from psychological problems (Noronha and D’Cruz 2007). There has also been a reported increase in divorce rates which can be attributed to the growth of outsourcing service provision within the city (Times 20071). Within the developed country, as workers’ income levels, status, education, and attitudes about business and the role of government change, clearly several

1

http://www.timesonline.co.uk (1st October 2007).

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Social and Philosophical Considerations of Outsourcing

significant social effects may arise from these changes. As workers attempt to maintain their standard of living on lower wage rates in lesser status jobs, they may be forced to work longer hours to earn the same total wages. Offshore outsourcing also raises concerns about extended retirement age, deleterious effects on intellectual capital, and the security of information stored at offshore firms.

3.4

Separating the Spin from Reality

In general, corporations exist to yield profits for entrepreneurs and investors. As a result, there is significant pressure on management to increase productivity and profits. Usually, this is a good thing. Capitalism is successful because it strongly rewards the best business models and the hardest workers. Outsourcing is not necessarily unethical, nor is it unavoidable. After all, international business has opened huge markets for developed countries products and has provided customers with new and cheaper goods. With advancements in shipping and telecommunications, it is easier now than ever before to sell products and services across the globe. If businesses and customers are willing to accept the international market, then we must also accept its consequences – increased competition. Developed country corporations now have to compete against businesses in regions where operating and labour costs vary greatly. It would be foolish to attempt to block the natural diffusion of labour into these areas. Outsourcing will undoubtedly remain a natural part of business today. What about the loyal employees who have been with the company for many years and no longer have work? The ethical directive would be to maintain fairness and attempt to pursue the best possible outcome for the employees within the framework of outsourcing. Only then would outsourcing become ethical by today’s standards. During a transition, the most important factor is open, honest communication and good planning. Decisions to cutback or outsource jobs should be made long in advance so employees have time to find replacement work. The organisation still has an ethical responsibility to its laid off employees. It is the organisation’s obligation to minimise the impact of the outsourcing on its employees.

3.5

Policy Implications

Outsourcing can make globalisation fairer between countries; it creates jobs in developing countries. Some developing countries have entered markets that were long (and still are) dominated by industrialised countries. Outsourcing has benefits for receiving countries, but can also bring welfare gains to sending countries. Many jobs created in developed countries are new jobs, not jobs re-located from other parts of the country and when the labour intensity of production is likely to be higher: when labour is relatively abundant, it makes sense to re-engineer production processes towards greater use of labour.

References

25

Outsourcing calls for active national policy responses: Developing countries need to lay the foundations to participate in outsourcing as a host country. The availability of low-wage labour is not sufficient to attract outsourcing. India’s success in attracting services outsourcing shows that government policy was crucial in driving investment in human capital formation. It also calls for the abstention from over-regulation; tax exemptions and FDI promotion. Within industrialised countries, the national policy response needs to cushion the effects on the local labour market and find mechanisms to re-employ workers who may have lost their jobs. There is no easy solution available, but a number of tools such as: skills upgrading, a free mobile labour market and social protection schemes are necessary to make outsourcing politically viable. Outsourcing can make globalisation unfair within countries. In industrialised countries: Low skilled workers in manufacturing and services (e.g. call centre agents, most of them women) are disproportionately affected. Outsourcing needs active governance to make globalisation fair. Isolated interventions are not likely to succeed. What are needed are global standards that are implemented globally, such as health and safety; freedom of association etc. There needs to be social protection, giving workers that have lost their job adequate social benefits (as part of an overall social security system) and importantly, governments and businesses must ensure that workers made redundant can find new jobs.

3.6

Take Aways

• There is a mixed picture of the economic effects of offshoring. Traditionally it is seen to have a relatively small effect on developed economies, but in a knowledge based economy, the effects are likely to be greater. • The positive benefits for recipient countries have been well documented, but the negatives can be considerable and have received less attention than they deserve. • Given outsourcing and offshoring are set to accelerate, it is imperative to consider how the negative consequences on local employment can be minimised through re-training and re-location. • The policy implications from offshoring are significant. To date, the policy response from developed economies has been lack lustre and rather confused. What is needed are global standards for outsourcing – which set a level competitive playing field between countries and a policy response which gives the workers made redundant through outsourcing, the due respect they deserve.

References Budhwar, P., Varma, A., Singh, V., & Dhar, R. (2006). HRM systems of Indian call centres: An exploratory study. International Journal of Human Resource Management, 17(5), 881–897. Dittrich, C. (2005). Bangalore: Divided city under the impact of globalization. Asian Journal of Water, Environment and Pollution, 2(2), 23–30.

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Dittrich, C. (2007). Bangalore: Globalisation and fragmentation in India’s Hightech-Capital. ASIEN, 103(S), 45–58. Noronha, E., & D’Cruz, P. (2007). Reconciling dichotomous demands: Telemarketing agents in Bangalore and Mumbai, India. The Qualitative Report, 12(2), 255–280.

4

From Tactical to Strategic Outsourcing

Although the outsourcing industry is relatively young, only making an impact on the world scene two decades ago, it has gone through a dramatic evolutionary process (from applications development to ITO to BPO to KPO) and will continue to do so. What we also see in this evolution is the move away from transactional to strategic outsourcing to transformational outsourcing and in the future innovative outsourcing. This chapter traces this evolutionary journey and examines the specific characteristics within each segment, looking at cloud computing’s impact on the IT outsourcing space, the impact demanding customers are having on call centre outsourcing, the competitive advantages delivered by BPO, the growth of travel and logistics outsourcing, Finance and Accounting outsourcing, Human Resource outsourcing and the recent emergence of knowledge process and legal outsourcing.

4.1

Introduction

The outsourcing industry has been through an evolutionary process over the last two decades. The initial phase of outsourcing represented engagements that focused on ancillary activities and basic commodity offerings, which were focused purely on cost savings. The relationships were transaction oriented with little emphasis on relational investments. The second phase of the evolution, having proved that the outsourcing model works, was where organisations started to outsource various areas of supportive activities that were slightly more central to business processes, the focus started to move away, albeit slowly from just cost savings. The third phase is where outsourcing started to be considered more strategically and where an organisation adopted an over-arching outsourcing strategy that was intended to coincide with its business level strategy. At this stage, outsourcing was looked upon as a key strategic enabler that required significant management focus to be leveraged for maximum advantage – so called Information Technology Outsourcing (ITO) was born. The adoption of ITO can be attributed to two primary factors: a focus on core competencies of the firm and reduction of IT costs. B. Vagadia, Strategic Outsourcing, Management for Professionals, DOI 10.1007/978-3-642-22209-2_4, # Springer-Verlag Berlin Heidelberg 2012

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From Tactical to Strategic Outsourcing

Transformation ITO & BPO Global standardisation Global relations Focus on core competency

1995-05

Standard ITO Access to skills

Advisory role

Multi-tower partnerships

Call centres

Integrated global delivery model Collaborative relationships Scale or scope – no middle ground Best Practice implementation

KPO

Rule based BPO

Skills on demand

Provider implications

2005-11

Systems integrator role Industry specific services

Local suppliers

1980-95

Apps support Cost focus

Tech Support

Data entry

Project based pricing Being the cheapest

Periphery activities

Time

Fig. 4.1 The historical context of outsourcing from a client and supplier perspective

The fourth wave was what we now call Business Process Outsourcing (BPO), where key process activities were outsourced and contractual responsibility was granted to the service provider – this wasn’t a homogeneous phase; there were subphases here, starting with call centre outsourcing, followed by back office outsourcing and then into other areas of the business. BPO involved significant diversity in outsourcing objectives, ranging from reduction in operating costs to innovation and business transformation. The range of BPO objectives reflected significant heterogeneity in the nature and strategic context of outsourced business processes. The fifth phase is what is being talked about at present, but not quite implemented by organisations – transformational outsourcing – a form of outsourcing, where the service provider effectively becomes an extended element of the organisation, seen as a true partner, one that can be inherently trusted, relied upon and one that can deliver significant operational and financial benefits to the organisation – usually coincident with a global delivery network – the holy grail so to speak. Transformational BPO relationships are especially pertinent to recent moves by CxOs toward consolidating back office functions into shared services units. This integration of services allows for their management by work process rather than by function to leverage scale and synergies across departments. Figure 4.1 illustrates this evolutionary journey.

4.2

The Role of Relationships

Relational investments in BPO are necessary and more important when the outsourcing process is firmly interdependent on other processes that may remain in-house, and where the information requirement is high for both parties. Relational

4.2

The Role of Relationships

29

investments help manage the process, bringing the parties together as one team for seamless process delivery. The output of transformational BPO initiatives has a more pervasive impact, often forming critical input to other processes. Such firmwide integration of process output in transformational BPO directly impacts competitiveness through creation of enterprise-level competences. Transformational BPO involves a cooperative, flexible, business process management relationship, with the service provider offering a broader scope of services underpinned by the technical infrastructure. The client and its partner frequently define these services jointly. Transformational BPO is a high-payoff BPO initiative involving a deep commitment between the company and its outsourcing partner to radically transform the company’s enterprise-level outcomes. The two companies jointly define a broad range of processes they will use and may also share in a joint venture that manages the assets and employees that both contribute. Other changes that we have seen within the industry include: • Multi-country outsourcing, as clients seek arrangements that cover their global operations; • Outsourcing increasingly encompassing “strategic” activities – areas which may have traditionally been deemed too near their core competence to outsource; and • Outsourcing now more often involves a significant development component – while most outsource providers offer “commoditised” services, many clients are pressing for “customised” solutions that require significant “bespoke” development effort. Figure 4.2 illustrates the three generations of outsourcing transformation over the last two decades. Transformational outsourcing is anchored around a programme jointly developed between the outsourcer and the enterprise to integrate change, capability, resources and business structures – around shared accountability. The contract is driven by business outcomes, and accommodates re-alignment based on future realities. It is designed to maximise incentives for both parties. The relationship offers incentives to both parties to win together and rely on what the supplier and the client can generate in strategic terms. Control and governance is based on trust, transparency, integration of workflows and executive commitment to the success of the partnership. Conventional outsourcing on the other hand is inflexible, with either party usually losing if the circumstances change – these deals do not reward the supplier for investments in new technologies, tools or automation, and rely on cost reduction as a major success measure. It often outlines specific operational outcomes to be generated by the supplier in tactical terms, such as cost per transaction, cycle-time, and number of calls per agent. Control and governance is through elaborate penalties, and credits. The underlying premise is mistrust and the need to keep the supplier “in check” at all times. The outsourcing industry has evolved to a stage where a number of different processes and verticals are now served. The newer processes (BPO rather than ITO)

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From Tactical to Strategic Outsourcing

Generation 1

Generation 2

Generation 3

Cost focus

Efficiency focus

Innovation focus

IT helpdesk

IT application development

Call centres

Business Process Outsourcing

IT development & management New technology development Knowledge Process Outsourcing Application support

Human Resource Outsourcing

Data entry

Finance Accounting Outsourcing

Legal Process Outsourcing Higher end BPO

Labour arbitrage Scale

Specialisation Process improvement

Flexibility Lower cost and higher value Greater emphasis on innovation Aggressive multi-sourcing

Long term inflexible contracts

Shorter term contracts

Long term flexible contracts

Onshore

Offshore captives and offshoring

Global delivery

Fig. 4.2 The three generations of outsourcing

Worldwide Outsourcing Market $362 billion Other 3%

Customer care 7%

Logistics 4%

CAGR = 26%

Industry specific processes 8%

IT Infrastructure 35%

CAGR = 10%

General & admin (HRO, FAO, Procurement) 14%

IT Applications Development & Maintenance 29% Source: IDC Research

Fig. 4.3 Worldwide outsourcing market size

are expected to grow more aggressively over the next few years as illustrated in Fig. 4.3. What we are also seeing is the gradual convergence of what have been seen as two separate silos within organisations and within the outsourcing industry.

4.3

Information Technology Outsourcing and the Cloud

31

Traditionally ITO and BPO have been considered as separate activities, driven by different requirements, served by different vendors and managed by different teams. However, what we are now seeing is the convergence between ITO and BPO. IT is integral to process execution and management in BPO. This is true of transactional processes such as administration or processing services, where IT performs simple automation or process updates, as well as more strategic processes such as customer analytics or financial planning, where IT facilitates linkages with other processes and delivers business information to process workers in a timely fashion.

4.3

Information Technology Outsourcing and the Cloud

Ever since Kodak’s landmark decision to outsource the bulk of its Information Technology (IT) functions in 1989, IT outsourcing has been a widely publicised practice. Organisations that have outsourced significant portions of their IT functions by transferring their IT assets, leases, licenses, and staff to outsourcing vendors include British Aerospace, British Petroleum, Chase Manhattan Bank, Continental Airlines, McDonnell Douglas, Xerox, English Heritage, MetLife, National Policing Improvement Agency, Lloyds TSB, Reuters, and the list goes on. However, despite predictions to the contrary, IT outsourcing has contracted rather than expanded in the years since we entered the recent recession, according to industry watchers, and analysts forecast, IT outsourcing growth will remain slow for some time to come. A lot of people renegotiated their contracts and a lot of people dropped their services and brought those functions in house during the recession, with one dominant feature of the outsourcing market over the last 12–15 months being the emphasis on cost above all else. Cost was (and remains) the primary driver in most outsourcing transactions. The difference is that during the boom years of 2002–2008, cost was often down-played by customers and, instead, emphasis was placed on other business benefits such as transformation, concentrating on core competencies, and speed to market. 2009 saw cost and, more particularly, immediate cost savings, take centre stage when customers engaged with existing suppliers or contemplated new sourcing projects. As the recovery gets under way, banks and insurance companies – which were among the hardest hit verticals of the recession and which put more deals on hold in 2009 than other sectors, are likely to come back to the fold in 2011.

4.3.1

Cloud Computing and IT Outsourcing

Cloud computing and outsourcing are very different. Both will help revolutionise the performance of businesses but I don’t believe one is a direct threat to the other. They are not mutually exclusive.

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Cloud computing describes the offering of hardware and software resources as services across (distributed) IT resources. As a relatively new concept, cloud computing and related technologies have rapidly gained momentum in the IT world. Outsourcing, particularly micro-outsourcing for small businesses is in fact booming and cloud computing is only making the process easier, just look at Freelancer.com. Up until recently, outsourced services were not necessarily fulfilled online. BPO has become attractive to both large and small businesses with the advent of service oriented computing and specifically Web services and Web 2.0 technologies.

4.3.2

Cloud Services

Cloud services require no software to purchase and install. Cloud service fees are typically subscription based. The vendors usually charge on a month-to-month or annual basis. Cloud services are flexible and easily scale up and down, effectively a self-service on-demand provisioning model. It usually goes side by side with automation, thus meaning decreased support cost for both client and vendor. Although cloud computing is not without concerns around security, stability, and data ownership, at its best it allows businesses to unshackle day-to-day operations from the local data centre. With cloud services, small businesses reap the benefits of not having to deploy physical infrastructure like file and e-mail servers, storage systems or shrink-wrapped software. Plus, the “anywhere, anytime” availability of these solutions, means hassle-free collaboration between business partners and employees by simply using a browser. Thus cloud services offer a number of benefits beyond cost, that include: • The scale of available technology – The largest vendors now have enormous data centres with the capability to store huge amounts of data and deliver vast processing capability to businesses. Google is estimated to have over 2 million servers in over 30 data centres and can now use that scale to offer a range of corporate services at very competitive prices; • A reduced price point – A low price point with no barrier to entry is another very important driver for adoption, as cloud enables a reduction in both operational and capital expenditure when compared to traditional methods of IT delivery, which in the current economic climate is a very attractive option to any CIO looking for competitive advantage; • Improving green credentials – In parallel to reducing costs, cloud computing has the potential to significantly reduce your carbon footprint through a reduced reliance on in-house technology and through a flexible model that enables a business to flex services to cope with peaks in demand, rather than resourcing for peaks and running the day to day business with unnecessary excess capacity; • Flexibility without the capex – service on tap and guaranteed service levels, paying only for what you use; • Ease of operations with better user interfaces and APIs that allow organisations to integrate their own applications with purchased cloud services;

4.3

Information Technology Outsourcing and the Cloud

33

• Standardisation such as The Open Cloud Computing Interface (OCCI); • Ease of configuration; • Better performance, as the cloud provider can use the latest technology to tune and improve processing speed, memory speed, storage access, read and write speeds, latency, bandwidth, through access to better technology or superior engineering and operations expertise; • Reliability and security. Reliability is understandable, but many assume that cloud service surely cannot be claimed to be more secure. Using the analogy of offshoring paints a useful picture. When organisations started offshoring to India, the media made a big deal with data security concerns; however over time we find most offshore suppliers have security procedures to protect client data which go far beyond what the clients themselves ever thought of implementing. Given client concerns and the drive to satisfy client needs, security was bolstered by the vendor community to a point where security is now only a concern for those uneducated of the industry. However, one must understand cloud computing is not a simple homogenous concept or service, but a series of discrete interlinked technologies, each stacked onto each other to enable further process or service value addition as you climb up the stack, as illustrated in Fig. 4.4. Hardware is the basic underlying physical technology – the nuts and bolts so to speak. This level of the hierarchy is inherently difficult to align itself to outsourcing or sharing of resources.

SaaS Cloud Applications

PaaS Cloud Software Environment

Cloud Software Infrastructure IaaS Computational Resources

DaaS Storage

CaaS Communications

Software Operating Systems

Hardware / Firmware (Haas)

Fig. 4.4 Technology stack – the decoupled approach driving innovation in service delivery

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From Tactical to Strategic Outsourcing

Software operating systems links the underlying physical technology with the functions using intelligence through the software operating system. Up until recently the market has been dominated by proprietary operating systems from a select few – think of MS Dos, Apple’s OSS, Unix etc. However, what we see today is a host of open-source software platforms such as Linux, OpenSolaris, Symbian which are slowly penetrating the market. Infrastructure as a Service (IaaS): hardware resources (such as storage) and computing power (CPU and memory) are offered as services to customers. This enables businesses to rent these resources rather than spending money to buy dedicated servers and networking equipment. Often companies are billed for their usage following a utility computing model, where usage of resources is metered. E.g. Amazon offers S3 for storage, EC2 for computing power, and SQS for network communication for small businesses and individual consumers; typically using virtualisation technologies to address the problem of underutilisation of physical resources. When people talk about virtualisation, they’re usually referring to server virtualisation, which means partitioning one physical server into several virtual servers, or machines. Each virtual machine can interact independently with other devices, applications, data and users as though it were a separate physical resource. Different virtual machines can run different operating systems and multiple applications while sharing the resources of a single physical computer, and because each virtual machine is isolated from other virtualised machines, if one crashes, it doesn’t affect the others. In addition to using virtualisation technology to partition one machine into several virtual machines, you can also use virtualisation solutions to combine multiple physical resources into a single virtual resource. A good example of this is storage virtualisation, where multiple network storage resources are pooled into what appears as a single storage device for easier and more efficient management of these resources. Other types of virtualisation include: • Network virtualisation splits available bandwidth in a network into independent channels that can be assigned to specific servers or devices; • Application virtualisation separates applications from the hardware and the operating system, putting them in a container that can be relocated without disrupting other systems; • Desktop virtualisation enables a centralised server to deliver and manage individualised desktops remotely. This gives users a full client experience, but lets IT staff provision, manage, upgrade and patch them virtually, instead of physically. Virtualisation also allows IT systems and the business processes that they enable to be disintegrated or deconstructed, and bought and sold separately rather than as part of a long term outsourcing arrangement. Business operations can then be operated with real flexibility in response to changing circumstances – and the business processes and software systems that underlie them can be assembled as individually sourced services from a competitive market place.

4.3

Information Technology Outsourcing and the Cloud

35

This begins to subtly shift the concept of outsourcing from the traditional facilities management model (“Client outsources their operations to the Supplier”) towards a direct sourcing of services model (“Client directly sources services from the Supplier”). Companies such as Amazon, e-Bay and Google have pioneered the exploitation of virtualisation in the practical delivery of B2C (Business to Consumer) services, using the Internet as the delivery channel. They have innovated business models based on the high productivity manufacture and delivery of services, with reliability, security and commodity economics. Although clearly more complex this service manufacturing model is directly applicable in B2B (Business to Business) markets, meaning that businesses can now source services direct from a range of suppliers, rather than the supplier simply taking over the customer’s existing or future technology requirements. The technical architectures enabled by virtualisation decouple the layers of the classic “big company” technology stack. Each layer can then potentially be sourced as a distinct service. Database as a Service (DaaS): A more specialised type of storage is offering database capability as a service. E.g. Amazon SimpleDB, Google BigTable, Apache HBase and Apache Force.com database platform and Microsoft SSDS. DaaS on the cloud often adopts a multi-tenant architecture, where the data of many users is kept in the same physical table. Communication as a Service (CaaS): Sometimes called hosted communications, allows you to implement communications services like VoIP and Unified Communications without the expense of buying, hosting and managing communication equipment. This emerging cloud service is gaining ground with enterprise users who want the benefits of unified communications without making the significant hardware and management investments to run them. Hosted, Internet-based communications is not new. There have been Centrex services for a long time. We also send video, voice, and data across the public Internet today. However, this type of communication has not been the model for most business voice communication. Businesses generally have purchased and run their own communications infrastructure. What we see within the CaaS space is the emergence of a new breed of vendor, not the traditional telecommunications operators, but the likes of Skype and Google. Platform as a Service (PaaS): Refers to the provision of facilities to support the entire application development lifecycle including design, implementation, debugging, testing, deployment, operation and support of rich Web applications and services on the Internet. Most often Internet browsers are used as the development environment, e.g. Microsoft Azure Services platform, Google App Engine and Salesforce.com Internet Application Development platform. PaaS enables Software as a Service (SaaS) developers to develop add-ons, and also develop standalone Web based applications, reuse other services and develop collaboratively in a team. However, vendor lock-in, limited platform interoperability and limitations of programming platforms in supporting some language features or capabilities are major concerns of using currently available platforms.

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Software as a Service (SaaS): Software applications are offered as services over the Internet rather than as software packages purchased by individual customers. One of the pioneering providers in this category is Salesforce.com offering its CRM application as a service. Other examples include Google web-based office applications, Microsoft online CRM and SharePoint, or Adobe Photoshop and Adobe Premiere on the Web, as well as new comers like GovernanceDirector. com. Customer data is kept in the cloud, potentially based on DaaS.

4.3.3

The Challenges of Cloud Sourcing

Before we get too excited however, there are a few challenges to be aware of to ensure a smooth transition to this brave new world: • Security – Storing your confidential business data in a shared, cloud environment requires complete trust in your potentially virtual supplier, which has up until now been one of the major barriers to adoption of the cloud. However this is gradually changing as the scale at which the cloud suppliers operate at, enables them to make vast investments in security that individual companies and smaller traditional operators cannot always match; • Data protection – Many of the larger cloud computing providers use US based data centres for the storage of their data, this is at best a risk and at worst a barrier for many potential customers with sensitive or regulatory constraints that prevent data from leaving the UK or the EU; • Public vs. Private – At a high level, there are two ways to use the cloud, either public or private and there are pros and cons to each. Public Clouds (such as Amazon EC2 or Microsoft Azure) are low cost and offer easy access, whereas a corporate Private Cloud where a business buys a cloud service from a dedicated supplier just for their use is more expensive, but potentially more secure and reliable (although this is a debatable point). Selecting the right option for your business requires careful thought and consideration; • Existing contract restrictions – Most large organisations already outsource some aspects of their corporate IT. Unless their existing suppliers can offer them the cloud based services themselves, the enterprise may need to look elsewhere for cloud services and encounter in the process contractual restrictions and relationship issues or even exit penalties within their existing IT Outsourcing agreements; • Who to trust – The vendor landscape in this new services world is a new one with three main categories of vendors to consider: • Traditional IT outsourcing suppliers – The major global IT organisations are developing their existing outsourcing models to cope with demand for cloud based services. • Large scale cloud specialists – Such as Amazon, Apple, Google & Microsoft who are all offering cloud in the form of infrastructure and applications services and have the scale and credibility to become major competitors in the previously closed world of corporate IT outsourcing.

4.3

Information Technology Outsourcing and the Cloud

37

• New entrants – There are multiple smaller specialist organisations, able to offer a range of services designed around the cloud computing model, offering a low cost, high service model, often targeted at specific industries or business functionality. • Complexity – Deciding who to work with, how to work with them and integrating the services into your existing service model can require system and service integration skills; • Bandwidth – A parallel consideration will be the quality and reliability of accessed networks and bandwidth – Google Apps guarantee 99.9% service reliability, but that is in practice “at the factory gate” not at the user’s machine; • Migration – Moving data from one cloud-based storage system to another, for example, is not always easy. Buyers of cloud services must take account of the dangers of lock-in, and favour service providers who allow them to switch between services without too much hassle; and • Change – Cloud computing requires a fundamental change to the way of thinking that most organisations have followed for recent years. One of the biggest barriers to adoption is corporate inertia as change of this magnitude requires a new way of thinking which can take time to fully understand. Cloud computing is likely to take centre stage in IT outsourcing in 2011. This will be the first year in which cloud computing will have a real role in procurement decisions. The outsourcing industry is likely to begin seriously addressing these issues in 2011. That means cloud solutions will become an acceptable risk for customers. At the very least, the dramatically lowered cost of cloud providers will become a lever for customers to use in negotiations with their traditional sourcing providers. In addition, cloud is likely to create new options for combining process, software and hardware in business process outsourcing (BPO) solutions. If you’re going to have your data and applications hosted externally in the cloud, do you really need to manage them yourself anymore? Do you really gain a competitive edge with the way you process your insurance claims, or isn’t it time to find a services vendor that will host the application, the associated infrastructure and even process the transactions for you? Cloud services could well be the foundation for next-generation enterprise sourcing solutions. It can make traditional delivery of IT services more efficient and cost-effective.

4.3.4

Cloud Vendors

Many traditional IT service providers and offshore vendors are beginning to work cloud service into their portfolio – or at least give the appearance of doing so. IBM Global Services and HP are serving up more and more “x-as-a-service” items on their menus, from infrastructure to storage. Infosys is offering end-to-end IT and business processes – Source-to-Pay for procurement, Hire-to-Retire for HR – on a pay-per-use basis built on a cloud backbone. Wipro Technologies is piloting

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a central computing cloud to study the potential of the trend. Patni Computing Systems is selling a “cloud acceleration service” to help developers migrate their processes to a cloud-based model the way it did internally and is experimenting with testing-as-a-service. Given that most customers care about where their confidential information is housed, it is likely they will prefer it to be within the confines of a trusted service vendor, rather than that vendor’s alliance partner. This may well be the impetus for greater mergers between strong infrastructure services and BPO vendors as the move to cloud services picks up more steam. In the years ahead, cloud services will separate the basic IT and business process body shops from the innovators. Vendors pushing standard labour arbitrage services under a thin veneer of “cloud marketing” will quickly get cast aside. The emergence of next-generation solutions requires a high degree of provider flexibility and management will to embrace new ways of working. It’s likely that this trend will further segment the provider topography. The biggest cloud-based opportunities could exist for the newer members of the outsourcing industry, like Salesforce.com, Rackspace, Amazon and Dropbox.

4.4

Business Process Outsourcing and Call Centres

BPO initiatives include very different processes and in many senses is an all encompassing term. However, one could make a distinction between BPO activities that involve content development from those that involve service provision: • Content development involves the creation of fairly well defined outputs or products by vendors. These relations involve clear handovers, schedules and typically more precise contracts. Examples include outsourcing for application development. • Service provision involves ongoing relationships where a vendor provides a service on a continual basis. Examples include applications maintenance, call centres, help desk, and transaction processing. The impact of transition costs and interaction costs are typically more severe in service provisioning than in content development and therefore the risk greater. The relative importance of these transaction costs are also likely to systematically differ depending on how the process is organised: i.e., on the ownership model and proximity to origin. BPO service provision requires significant coordination to take place between the vendor and the client on an ongoing basis, giving rise to ongoing interaction costs. Such coordination requires the need not only for personnel with the requisite knowledge, but also facilitating exchange by means of investment in appropriate communication channels. In relationships with continually evolving processes, face-to-face interaction by means of some on-site presence of vendors at client locations and clients at vendor locations proves helpful and efficient coordination. Given the range of BPO services, each with its own coordination costs, its capability to deliver competitive advantage and its impact on the organisational processes, what we see is that traditional standard BPO services (such as

4.4

Business Process Outsourcing and Call Centres High

39

Contact Customer Services Employee Services

Opportunity for total cost reduction

NonStandard

Standard Operational Processing (Automated) Exceptions Processing

Standard

Low

Analytics

Opportunity for competitive advantage

High

Fig. 4.5 BPO service impact on organisations

employment related services and customer service) are utilised primarily for their cost benefits. Increasingly, we are seeing organisations looking for BPO services to deliver competitive advantage in an increasingly difficult market (see Fig. 4.5). Services outsourcing is not a one-time transaction, but an exchange that evolves over time. Process improvements, service level expectations and fit with other contextual processes typically evolve with changing competitive conditions and changing technologies. These improvements in both delivery and development often evolve in unexpected ways.

4.4.1

Defining BPO Services by Organisational Impact

4.4.1.1 Customer Service Outsourcing Call Centres According to various surveys, only 4% of people in the UK have had a favourable experience when dealing with a customer call centre,1 44% complain that their biggest gripe is contacting a call centre based overseas. I believe it is not the location or people per se that drives this perception, but the system and controls that determine how the work is managed, delivered and quality controlled that drives failure (or success). Offshored call centres simply reinforce any negative perceptions and experience. There is nevertheless a mixed picture for Offshore Call Centres: • Even in the face of a media frenzied backlash, many executives continued to favour the idea of “offshore”;

1

YouGov survey commissioned by Callmedia.

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• The Chairman of HSBC famously said that his workers in Asian countries were superior to their British equivalent; • Then in recent years, we have seen a number of high profile businesses predominantly in the finance sector actively promote their “UK only call centres”; • In 2006, Channel 4 produced a documentary highlighting data protection failures in India’s call centre industry; • In early 2007, Lloyds Bank announced what appeared to be a scale-back in offshore operations which seemed to many the beginning of the end for offshoring; • But just as many people thought offshoring was dead, Barclays announced that they will be sending more jobs overseas. The fact is that the triple digit growth in offshoring has ended but nevertheless the British economy does not (that may change given the downturn) have the labour capacity to cope with the complete home shoring of all the jobs offshored. There is also clearly the cost factor to consider – despite the perceived public dislike for offshoring, there is little evidence to suggest that consumers would pay more for home-grown customer service. It is estimated that £3bn worth of goods and services are sold every year in the UK through outbound telemarketing. As well as the increased competition in the telecoms and utilities sectors, much of this growth has come from “warm calling” – calls to existing customers in order to gain further revenues. In large part, this is an effect driven by CRM processes, such as relationship-building calls, cross- and up-selling and customer satisfaction calls. As data protection becomes more of an issue, businesses are increasing the effort they make to sell more to their existing or past customers. Cold calling is still present, but untargeted campaigns are increasingly being seen as less economic than targeted outbound work. Increasingly consumers are taking a negative view of unsolicited outbound calling, which along with the increased uptake in TPS registrations, will reduce the number of unsolicited outbound calls in future years. Call Centre Opportunities by Vertical Sectors Financial services organisations run the most contact centres of any business sector in the UK. This vertical market consists mainly of banks, credit card companies, insurance companies, building societies, collection agencies and credit reference agencies. The first three sub-sectors are amongst the largest users of contact centres, and many of the largest operations are within this vertical market (over 33% of 500+ agent position contact centres are finance operations). The retail and distribution sector has the second-largest number of contact centre operations. This vertical market includes catalogue/direct mail retailers (which tend to be the largest in this sector), package couriers, high street retail support and niche retailers. This industry is driven by customer service and thus contact centres form a central part of the business. The telecoms vertical market although accounting for only 5% of operations, has a much bigger impact on the industry as a whole, as many telecoms contact centres

4.4

Business Process Outsourcing and Call Centres

41

are a considerable size (13% of 500+ agent position contact centres are in the telecoms sector). This vertical market includes both fixed line and mobile operators and are beginning to use contact centres and social media aggressively to attract subscribers as their markets get more competitive. The transport and travel vertical market which includes travel agents (both High Street and web-based), public transport companies, airlines, and car hire firms has almost 11% of the UK’s contact centres market. However the opportunities for pure call centres are likely to fall as the industry is shifting more towards self help and online booking. The IT sector is made up of both technology sales and external helpdesk operations. There are large numbers of internal helpdesks which support employees – this has been the home of offshore call centres and in particular India, because of the availability of highly skilled technical engineers at a fraction of the costs in the developed economies. The telemarketing and research vertical market is centred on outbound calling. A subsector of this is printing and publishing contact centres which include newspaper and magazine subscription and advertisement operations, along with a few book publishers, who use contact centres to sell advertisement and sponsorships. Due to tighter data protection and TPS registration procedures, this sector is likely to see a challenging time ahead. Manufacturing companies account for 8% of UK contact centres, although they are generally relatively small operations, dealing with customer support and sales to other companies rather than the public. This sector offers good outsourcing potential but is driven by quality rather than scale, and may be more appropriate for onshore outsourcing rather than offshore outsourcing. Public services contact centres are leading contenders for outsourcing currently (contactable government) – but offshoring is unlikely given that local job creation is a mandate for most public sector agencies.

4.4.2

Drivers for Customer Service Outsourcing

4.4.2.1 Cost Focus The primary reason businesses consider offshoring contact centres is to reduce the 60–70% of their operating expenses which are spent on agent salaries. For a 500seat contact centre, agent-driven expenses alone can approach £6–8 m per year. Payback time for a 50-seat contact centre operation moved to India for instance could be achieved in 3 months. This reduction in cost allows businesses to initiate projects which would not otherwise be economically viable in the UK, e.g. largescale outbound operations aimed at selling lower cost items or to lower-margin customers. 4.4.2.2 Better Customer Experience Differentiation through provision of a better customer experience may be one of the few opportunities retailers have to rise above price competition. Seventy-three

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percent of European consumers2 said they would do business with a company based on a great contact centre experience. Of these, 15% would do so even if prices were higher than average. When a customer walks into a shop they expect the sales assistant to understand the products and be able to help them. The same is true if a potential customer picks up the telephone, sends an email or clicks for instant chat. Replacing a skilled operator with an automated service might save money in the short term; in the long term however, you risk losing brand advocacy and sales. Inbound customer calls can generate “sales through service”. By resolving customer issues and exceeding their expectations, a contact centre agent sustains rather than loses a revenue stream.

4.4.2.3 Multi-Channel Availability Multi-channel shoppers generate 20–25% more profit than the average customer. However, these customers have low store loyalty across channels. Multi-channel availability if not managed, can therefore potentially be a threat to retailers, nevertheless, customers have come to expect multi-channel availability. By failing to provide customers with a means to transact with the organisation at their convenience, an organisation runs the risk of losing custom to its competitors. Multi-channel experience in most cases is lacking in a number of areas: • Retailers often fail to answer e-mails from their customers in a timely manner. • Retailers often fail to take advantage of opportunities to personalise their interaction. • Proactive contact can build brand, enhance customer service and increase revenue, yet is only a small portion of all outbound contact centre activity. A majority of new customers (~70%) will hang up if the phone is not answered within 25 seconds or if they get through to an answering machine. According to E-consultancy, providing a contact number during the online shopping process can foster trust – reassuring consumers that they can discuss any issues they may have with an adviser over the phone – this is especially true of reluctant e-shoppers. The publication notes, such a strategy can be particularly useful in persuading users who have misgivings about e-commerce to buy online. 4.4.2.4 Lower Costs Means Potentially a Greater Number of Staff The case can certainly be made that lower salary costs mean that offshore contact centres do not have to be staffed as carefully as in the UK, where over-generous scheduling means much higher costs. In offshore countries, a more relaxed attitude to staffing can benefit customers: the average speed to answer calls in India for instance is less than 7 seconds – more than twice as fast as in the UK. However, research suggests that offshore contact centres may not be offering quite the same level of performance as the UK industry in some areas, (although

2

Genesys Consumer Survey 2007 – Europe.

4.4

Business Process Outsourcing and Call Centres

43

outperforms it in others: e.g. salaries for an Indian call centre agent are ~£2K p.a. Compared to ~£13K p.a. in UK) and although Indian agents answer calls more than twice as quickly as UK workers, and work 6 hours a week longer than UK agents, on average, UK agents answer 25% more calls each hour than Indian agents, and resolve up to 20% more of these calls first-time. British call centre workers tend to stay with their organisation for well over 3 years. On average, Indian call centre workers move on after only 11 months in the job.3 A key metric for the contact centre of the future will be “first time resolution”. Whether in a sales or service environment, first-time resolution is key to developing a positive customer relationship and keeping costs down – something that offshoring has not been successful in achieving, to date.

4.4.2.5 Twenty Hour Availability Twenty-four hour businesses require 24 hour support. Having a 9 am to 5 pm business no longer caters for the demanding customer. Customers expect service here and now. From time to time things can go wrong and it is critical that the retailer can address these problems efficiently to ensure that it is providing the highest level of service to its customers. Customers will demand a 24 hour help desk. The speed of response in resolving a customer’s query is as important as the content of the response. Whereas customers were once happy to wait 2 or 3 days for a reply to an email, organisations must now aim for a response time of no more than 4 hour. Email communication means that the speed of response has to be so much faster, especially since people are making purchasing decisions based on what and how quickly their emails are answered.

4.4.3

The Future of Call Centres

The industry needs to evolve from call centre businesses to business automation centres. They need to be broader than just call centres. The advisors need to take a more conversational approach to their call handling rather than following a rigid script (this is not as easy as it seems). These same scripts were introduced to help overcome some of the cultural and language barriers that naturally exist between the offshore advisor and consumer; they help to prop up the confidence of the UK based managers who are being held responsible for the offshore call centre performance. Without those scripts, those managers fear the call centre quality will reduce. The truth is with these scripts the quality of the customer experience is significantly reduced. An important factor for improving customer experience is “Empathy”. Contact centres must find ways of establishing better empathy without compromising call cost. Call centres can do this by creating an environment where empathy thrives

3

Source: Precision Marketing.

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through: robust staff recruitment, training and retention, improved technology and better call routing. Creating better empathy allows agents to reflect and align with the callers’: Values, Beliefs, Experiences and Habits.

4.5

Travel, Transport and Logistics Outsourcing

Consumers of manufactured products and other goods, world-wide, are directly dependent on logistics, and the various activities involved therein, to provide the products and services they require when, where and how they want them. Manufacturers of all sizes are also dependent on logistics to ensure that they receive the necessary raw materials, components, and ingredients when, where and how they need them in order to continue with their manufacturing operations. Many large companies are outsourcing their transportation and logistics functions, driven by pressure to cut costs combined with the challenges of increasingly complex logistics technology. Although many companies are reluctant to hand over critical supply chain functions to an outside company, many are discovering that logistics service providers are better at integrating logistics functions into their supply chain management environments, whilst offering cost advantages. Companies are finding that outsourcing logistics can be a source of savings, and over the long-term they need logistics as part of their overall supply chain strategy. Most companies understand that it is not a core competency for them. There are many ways outsourcing aspects of the supply chain can add value to an efficient cost-effective logistics network, e.g.: • The automotive industry often relies on outside providers to perform functions associated with Just In Time (JIT) operations. This is often not classified as outsourcing, but in many senses could well be classified as outsourcing; • In the grocery industry, collaborative planning, forecasting and replenishment links customer demand with replenishment scheduling to reduce inventory in the system. This results in smaller, more frequent shipments. Contract logistics companies are able to combine these smaller shipments into truckloads, reducing freight and handling costs and enhancing the distribution process; • Information technology management is perhaps the most important value-added offering that third parties have provided in recent years. For many companies, increasing demands (for new information systems resources, and real-time visibility into production and order status) can often be met most efficiently through outsourcing.

4.5.1

Drivers for Logistics Outsourcing

As manufacturers shift more and more of the production to the east, supply chains become more complex and costly. For this reason, manufacturers and retailers are increasingly outsourcing a variety of value-adding logistics functions, above and beyond warehousing and distribution.

4.6

Finance and Accounting Outsourcing

45

Beyond the usual cost drivers this sector has specific drivers in terms of capture and intelligent use of real-time information; information which increases the flexibility of supply chains and which helps optimise movement of goods and services – whether through optimising the business processes or by using the latest technology. Technology can help turn data into intelligence by capturing and collating data and turning it into information that can be used for regaining control of the assets. The second driver is securing the movement of people, products and data security. This is an essential component of any business strategy, especially in response to the demands of government legislation, e-borders, homeland security, business continuity, data protection and may include: biometric access control; baggage screening; security consulting; RFID tracking systems; managed security services; and infrastructure management. Basic services like transportation and warehousing are becoming commodities, and Logistics Services Providers are expanding their services portfolio to address more profitable segments and provide multiple services starting from basic transportation to increasingly more complex areas such as fulfilment, global trade services, light assembly, and so on.

4.6

Finance and Accounting Outsourcing

Outsourcing finance and accounting processes has recently become a strategic issue for many organisations. Businesses are under increasing pressure to improve performance and reduce costs. Although the emphasis has often been on reducing cost, there is a trend towards outsourcing to enable strategic change. The real value to be gained is that the retained finance function can focus on working more closely with the business to provide business partnering and help improve decision making. A key consideration for most organisations is an understanding of which specific finance and accounting process should be outsourced (see Fig. 4.6). Transactional processes (such as accounts payable, travel and entertainment, accounts receivable, billing, cash management, etc.) tended to be the most popular to outsource. More recently, with improvements in provider capabilities, there has been a move to outsourcing higher end or higher value services such as statutory/regulatory accounting, financial reporting and tax. In some cases, more strategic processes such as management accounting, budgeting & forecasting and financial analysis are being considered for outsourcing, what is sometimes labelled KPO services. Finance and Accounting Outsourcing (FAO) has undergone major transformation over the last 10 years. The need to ensure their systems were Sarbanes Oxley compliant encouraged many US corporations to outsource. BPO service providers gained expertise and credibility in meeting this need. With constant changes to the complex financial reporting framework and regulatory requirements – it is becoming important for organisations to meet these obligations in a cost effective manner, whilst using the finance function strategically to make better decisions for the organisation with respect to

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te Budgeting and Forecasting Capital budgeting Treasury and Risk Management Management reporting & analysis

Judgement intensive process

Internal audit

gy

Regulatory reporting and compliance Fixed assets Tax General accounting Accounts receivable Accounts payable

on sacti s Tran processe sive inten

In creasing judgement intensive and strategic

ra St Finance & Accounting Strategy

Fig. 4.6 Finance and accounting value chain

transaction processing, general ledger, accounts payable and treasury. As recruiting the best finance talent and ensuring its optimum utilisation becomes an increasingly difficult challenge, the role of outsourcing of the F&A functions becomes more important to balance these requirements. To date F&A outsourcing has been the domain of larger organisations, where the economic benefits of improved transaction processing, clearly makes sense. However, it is likely that over the near term SMEs will embrace this also, as results indicates that there is high levels of satisfaction among companies that have outsourced finance and accounting, especially in the context of meeting compliance obligations.

4.6.1

Drivers for F&A Outsourcing

• Leveraging FAO to undergo a major, company-wide, global change agenda; • Helping consolidate internal finance operations after a merger and/or acquisition;

4.7

Human Resource and Recruitment Processing Outsourcing

47

• Moving an under-performing shared services model to FAO; • Access to specialist skills; • Achieving stronger metrics and clear visibility into the activities of its financial operations; • Consolidate different finance and accounting functions distributed at several locations; • Standardising processes; • Realising business continuity planning for the organisation by leveraging the service provider’s experience and involvement with multiple clients and service provider footprint; and • Leveraging the benefits technology innovation can have to the finance and accounting function – e.g. using Software-as-a-Service and cloud-based solutions in finance and accounting.

4.7

Human Resource and Recruitment Processing Outsourcing

Increasingly human resources are seen as being the most critical assets of any organisation, as the organisation’s success and know how lies in their hands. But in order to ensure that its employees remain satisfied, the company has to have a specialised human resources department. Most of the time this proves to be a costly option. Organisations are considering outsourcing their human resources management functions, or creating a shared service centre to access the specialised skills, provide flexibility and effectively deliver more for less. Deciding which functions to offload and which firm to outsource to is a major decision. HR functions include Payroll administration (producing checks, handling taxes, dealing with sick time and vacations), employee benefits (Health, Medical, Life insurance, cafeteria, etc.), human resource management (hiring and firing, background interviews, exit interviews and wage reviews), risk management (workers’ compensation, dispute resolution, safety inspection, office policies and handbooks) and others – the drivers and appropriateness of outsourcing can differ by each HR process and functional role.

4.7.1

Drivers for HRO

Cost management • Need to reduce/control administration costs • Reduce and better control HR operating costs • Access to technology which would otherwise be unaffordable • Access to new services which would otherwise be uneconomic

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Service quality/risk • Need to raise quality of service provision – provide higher quality HR services • Increased accountability • Improved legal compliance • Gain access to skills and expertise not available in-house • Gain access to technologies not available in-house Flexibility • Provide cost and organisational flexibility • Offload activities that are non-core • Free up HR time to focus on strategic activities Strategic • Share risks of new investment in technology with external specialists • Transform the HR function’s internal reputation • Improve organisational satisfaction with the HR function • Overcome capital investment limitations preventing upgrade of new technology solutions Usually four main reasons are given by organisations who externally source HR: 1. Provide HR the chance to position itself as a strategic partner for the management of the organisation. The reasoning behind this is that being responsible for transactions and all kinds of basic HR processes distracts the attention from thinking on an abstract level; it is not possible to be a strategist and an operational leader at the same time. 2. Reducing HR total cost of ownership – External sources better enable the calculation of the total cost of ownership of HR; not only costs of salary related costs like employer costs, pension, training, etc., but also derived costs, costs of employment (laptops, phone, clothing, etc.) and of course management costs. 3. A decentralised HR function within organisations poses a risk, especially in the context of associated systems for capturing and automating routine HR tasks. Outsourcing allows the organisation to centralise HR and access best in class technology and automation capabilities. 4. Most HR departments within organisations rely upon key staff for business continuity, when such staff are not available due to leave, sickness or because of a job transfer the whole department comes under pressure. Getting external support through agency staff can only provide temporary comfort but leads to loss of knowledge. Outsourcing this HR activity ensures the organisation no longer needs to worry about staffing levels, nor business continuity problems resulting from absent staff – in essence the organisation passes off this risk to the vendor.

4.8

Knowledge Process Outsourcing

Knowledge processes are different from business processes in terms of the value proposition to the client. Differences lie in process complexity, the amount of intellectual intervention in the process, the skills required and the ability to scale.

4.8

Knowledge Process Outsourcing

49

While business processes are essentially process driven and rule based, knowledge processes involve judgment.

4.8.1

Typical KPO Services

As the outsourcing industry matures, more complex processes are being offered by providers. Knowledge process outsourcing usually refers to “high end knowledge or judgment” services. According to Outsourcing.com, a professional information institute, the KPO market was projected to reach USD 17 billion by 2010. Knowledge work, by its very nature and definition, cannot necessarily be accomplished successfully by following a set of predefined procedures. Moreover, the outcome of a knowledge process (e.g. research and development) may be interwoven with an organisation’s core competency and/or long term sustainability, as opposed to commodity processes typically included in BPO contracts. Inherent difficulties in outsourcing knowledge processes exist, since creation of knowledge and its subsequent accumulation is associated with any activity. As such, outsourcing decisions affect the knowledge base resident within an organisation. This impact is more critical for those processes associated with the generation and use of knowledge. As knowledge related function or process is delegated to an external entity, loss of knowledge concerning these functions or processes can occur and may have implications on the availability of learning opportunities from which organisational knowledge can be increased.

Financial services

Market research and analysis services

Other KPO services

Financial research & analysis Corporate financial statements Analysis of financial statements Analysis of portfolio structures

Primary and secondary research (telephone surveys) Web based market research and analysis

Analysis of prospectus, offer documents Data analytics

Ad-hoc reports, industry reports (fact books, competitor analysis) Creation and maintenance of databases and libraries

Competitive business analysis Trend analysis Company profiling

Product pricing and financial analysis Financial model validations

Management and Marketing Consultancy

Equity research and M&A analytics support (valuations and related financial modelling)

Fig. 4.7 Knowledge process outsourcing (KPO) services

Pharmaceuticals research Biotechnology research Technology research Computer-aided simulation Engineering design Professional services such as business research and legal services.

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These knowledge processes can be embedded in an organisations business processes, in terms of: knowledge generation, knowledge codification (codifying the knowledge into a form accessible to others) and knowledge transfer (facilitating interaction between and among people as well as the interaction with repositories and knowledge management systems).

4.8.2

Challenges in Knowledge Process Outsourcing

Dependence on core competency: Outsourcing implies the shifting of an organisation’s risk to the supplier. This, however, does not eliminate all risk from the client organisation. The customer can become dependent on the supplier. The level of dependency or risk incurred by the customer can be assessed by how much the outsourced process impacts other organisational outcomes/processes. This level of dependency can be viewed as the distinction between knowledge partitioning and task partitioning. This partitioning helps clarify the level of ownership retained by the customer and/or the supplier. Knowledge loss: The inherent risk is that outsourcing knowledge processes also outsources the knowledge itself. The magnitude of the risk is a function of the knowledge learning curve, knowledge holding cost, knowledge value deterioration rate and future value of the knowledge in comparison to the cost to purchase such knowledge at some future point in time. Incentive to innovate: Innovation, specifically R&D activity, is viewed as a significant source of knowledge for an organisation. Outsourcing, especially in terms of proprietary knowledge assets, is not considered a means to innovate because an outside supplier lacks the incentive to innovate for the buying firm. This view is reinforced when an organisation considers that they will receive only the codified results of R&D externalisation and not the accumulated person-embodied skills. IP, legal issues and security: Security and confidentiality of data, customer information and proprietary intellectual property will pose considerable challenges in managing KPO relationships. For example, who will own the outcome of an R&D effort if the process itself is outsourced? When information related to the core competency of an organisation is outsourced, security will be an issue. Measurability of outcome: The outcome of a knowledge process may often be fuzzy. The deliverables being knowledge items, means it is often difficult to come up with precise measurable outcomes. Arguably, without definitive objectives, relational aspects between the provider and customer play a significant role. Integration of knowledge from disparate sources: For knowledge outsourcing, an emphasis must be placed on knowledge integration to reduce the knowledge loss. Since the degree of knowledge dispersion increases with outsourcing arrangements, the uncertainty regarding where the knowledge resides increases. Customers must create conditions to integrate knowledge dispersed across the supply chain.

4.9

4.9

Legal Process Outsourcing

51

Legal Process Outsourcing

Traditionally, law firms started outsourcing their IT and business processes to outside vendors, what has been called by many, as Legal Process Outsourcing (LPO). This model was about adding low incremental value to high volume of work. It also meant that only work which was highly process and technology driven (and less knowledge driven) could be outsourced/offshored. The culture in this kind of delivery setup closely followed that of cost minimising BPO operations. The nature of work handled was commoditised. Legal Service Outsourcing (LSO) by comparison is knowledge driven; the incremental value is driven by people, enabled and supported by processes and technology. A necessary condition for the rise of LPO is the disintegration of the legal services value chain. In particular, information and communication technology (ICT) has enabled such disintegration, by (a) introducing a higher degree of standardisation and codification of legal knowledge, (b) facilitating organisational modularity between the back office and the front office; and (c) making geographically distanced delivery possible. It is generally understood that business corporations, rather than law firms, are driving the growth of the LSO phenomenon. The reason for this may be found in a number of factors that distinguish the business corporation from the law firm, including their ownership structure and its influence on strategic objectives. In particular, law firms’ relative reluctance to offshore legal work may be due to (a) lawyers’ conception of their work, and (b) the notion of partners’ autonomy to make make-or-buy decisions. From the perspective of a law firm, the value chain consists of three separable steps: (a) knowledge and information management (b) consultative advice and representation; and (c) client relationship management. Lawyers may appear reluctant to use the outsourcing and offshoring option because the billable hour does not give an incentive to necessarily lower costs rather than raise revenue. Moreover, the partnership model with distributed authority implies that decisions to outsource or offshore are typically taken at the decentralised level, practice by practice, or even partner by partner. This makes it less likely that law firms can easily adopt a centralised firm-wide decision to outsource. However, the challenges faced by law firms are significant and may lead to more lawyers looking at outsourcing as the economic woes and client demand forces change. There is likely to be a degree of flux in the industry moving forward. Law firms are well aware of what outsourcing can deliver – most provide advice to companies on their outsourcing deals. Despite this, very few law firms have considered outsourcing for themselves and even fewer have an outsourcing strategy. However, the legal sector is showing signs that it is now adopting outsourcing as a business strategy – partly driven by the economic turmoil. Clifford Chance led the field by moving back office and secretarial support to its own office in India, in order to

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carry out much of the company’s administrative work (LPO). The outsourcing programme is expected to yield more than £9.5 m in annual savings. Similarly, Pinsent Masons announced a deal to offshore its bulk typing and transcription services as part of a move to change the role of its secretaries.

4.9.1

Drivers for LPO in Law Firms

• Core cost reduction – Most expensive costs to a law firm are legal and paralegal staff – reduction of these costs mean it’s possible to provide competitively priced legal advice without reducing profitability. • Getting access to capability/resources – Legal instructions are often received ad hoc and at short notice when In-house resources/specialists may already be committed to other clients. Outsourcing means its possible to utilise external resources at short notice to enable the new instructions to be delivered, extending the ability of law firms to take on work. • Better utilisation of in-house resources by outsourcing low-value services – Many instructions are for low-value services which need to be undertaken to retain a client’s goodwill. It may be deemed better to outsource such matters and allow lawyers to concentrate on providing premium rate services. The success of any law partnership is dependent on the successful delivery of services to clients by all the lawyers in the firm. Legal service outsourcing is undoubtedly an option that can help law firms address key challenges, but only if done correctly. So how can a firm best go about using outsourcing to their advantage?

4.9.2

What Not to Outsource

• Complex, uniquely fact-driven cases – the amount of time required to bring outside lawyers up to speed require a greater amount of time than would be supported by the reduction in costs. • Fact-driven one-off cases – fairly complex, fact-driven subject matter can be reasonably outsourced only if the case is ongoing or recurring. • Complex work without local supervision – outsourcing efficiencies are undermined without proper supervision. • Unfamiliar subject matter – counsel limits their ability to provide proper supervision when, due to lack of familiarity with the area of law, they are unable to judge the quality or accuracy of the work (Fig. 4.8).

4.9.3

LSO Challenges

LSO delivers high value to organisations by providing domain-based processes and business expertise rather than just process expertise. These processes demand

4.9

Legal Process Outsourcing

• • • • • • • • •

53

Intellectual property rights & Asset management Patent search & application drafting Trade-Mark and copyright registration Legal research Document review and analysis Intelligence services Contracting, administration and standardisation Audit and compliance Contract abstraction and summarisation

Low-end Work >>

• • • • • • •

<< High-end Work

Paralegal services & legal coding Corporate secretarial services Legal memo development Transcription Document management Data entry Litigation support (electronic or paper document discovery, legal research, document review)

Fig. 4.8 Legal process and service outsourcing

advanced analytical and specialised skill of knowledge workers that have domain experience to their credit. Therefore outsourcing of legal services face more challenges than BPO. Some of the challenges involved in LSO will be maintaining higher quality standards; investment requirements for appropriate LSO infrastructure; the lack of experienced talent pool; the requirement of higher level of control and maintaining client confidentiality and enhanced risk management. Unlike BPO where the focus is on executing standardised routine processes, LSO involves processes that demand advanced information search, analytical interpretation and technical skills as well as some judgment and decision making skills.

4.9.4

Corporations Rather Than Legal Firms Driving LSO

Given the institutional context described above, profit-capturing opportunities for LSO providers vary according to whether their clients are law firms or business corporations. In a law-firm driven value chain, the major part of LSO providers’ work lies in knowledge and information management. Climbing up the value chain implies taking all steps in knowledge and information management. But even as the LSO provider accumulates internal legal process capabilities, it is unlikely to be able to take on advisory work, unless the law firm, as client, wishes to disintermediate itself. LSO providers’ growth is therefore likely to come more from new client markets, by developing low-cost efficient solutions (in effect a new product) for

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new segments in the legal marketplace which have not previously been able to afford the service, for example small and medium-sized firms and low-income households. By contrast, in a business corporation driven value chain, an LSO provider deals directly with a client corporation, specifically with its in-house counsel. Upgrading opportunities, taking on advisory work, appear larger in this value chain, with external attorneys hired directly by the corporation to deliver premium advice. In corporate transactional work, LSO providers may have the opportunity to undertake multi-disciplinary business advisory work, by combining legal and non-legal work.

4.10

Take Aways

• The industry has and continues to evolve to meet the needs of organisations. • Cloud computing is likely to affect not only the IT outsourcing sector but also the BPO sector – however there are still many questions surrounding cloud services. • The call centre industry needs to change to deliver better customer experience and empathy. The drivers for call centres are nevertheless significant, including delivering multi-channel communications availability, 24 hour availability and a more responsive service to a more demanding customer. • Growth is expected to be seen in the travel and logistic outsourcing sector driven by the complexity introduced by new technology, in Finance & Accounting through increased regulatory pressures and in Human Resource outsourcing through the drive to become knowledge driven organisations. • The recent emergence of KPO, LPO and LSO, although still relatively immature, are likely to see significant growth.

5

Outsourcing Within Industry Verticals

The adoption of outsourcing and offshoring varies by different vertical sectors. Some have been early adopters like the banking and telecoms sector. Others like the insurance sector have been reluctant, but are now being forced to consider outsourcing to drive efficiencies or even reconfigure their value chains. The telecommunications sector being an early adopter is still a major driver for innovation in the use of outsourcing and managed services. The public sector is now beginning to embrace outsourcing as a means to reduce costs, restructure service delivery and drive efficiencies, although the challenges to the use of outsourcing are significant. The retail sector has also been a reluctant user of outsourcing, but will increasingly use outsourcing to not only reduce costs but deliver multi-channel experience to their customers. Today, the charity and SME sectors are also looking to outsourcing to help compete in the global market, although the lack of operational experience and resources makes the task of successfully managing an outsourcing programme more difficult. This chapter examines outsourcing in each of these sectors in detail.

5.1

Banking Sector

Ever since offshoring and outsourcing in the services sector began to evolve, the banking industry has been at the fore-front in taking advantage of this trend. While it started with non-core activities seen as peripheral to the organisation’s main line of business, as capabilities and confidence have grown, outsourcing has progressed to business enablers such as IT, critical back-office processes and pre-sales/postsales support activities. As banks are regulated entities, the offshoring of banking services has received the attention of central banks. The Basel Committee on Banking Supervision (which is a global central banks organisation) through a Joint Forum has identified key risks in the outsourcing and offshoring of banking services and now provides recommendations on how central banks and banks should address these risks. B. Vagadia, Strategic Outsourcing, Management for Professionals, DOI 10.1007/978-3-642-22209-2_5, # Springer-Verlag Berlin Heidelberg 2012

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The Joint Forum of the Basel Committee on Banking Supervision established a working group to develop high-level principles about outsourcing. The key issues and risks and the principles are contained in the Joint Forum Publication, February 2005, but in essence its recommendations and requirements are no different than best practice applied in other sectors.

5.1.1

Banking Value Chain

The banking value chain is a complex series of activities involving: creation of financial products; bundling of such products to be made available to the mass market; branding of services; sales process which pushes the products out to the market through multiple channels; application processes used by customers, which include detailed collateral verification; back end financial operations processing; making available the financial product to the customer; the actual transaction (see Fig. 5.1). Some of these activities are appropriate to outsourcing, however some of the activities may be deemed to be core. As such the financial institution needs to be careful in understanding exactly what activities are core and which may be deemed to be too risky to be outsourced from a compliance perspective, or for the longer term success of the business.

Marketing

Branding of a Product

Product

Sales

Sales Support

Multi Channel Mgmt.

Introducing a brand e.g. “easycredit“ in the credit market

General offers to customers via letters

Advertising

Forecast projections

Management of sales via Internet branches and sales banks

Acquisition and Offering

Determine financial requirement Identification of potential collaterals Pricing

Transaction

Payments

Funding

Collateral evaluation

Credit data to treasury

Payment of interest

Booking of payments

Rating of borrower

Refinancing of credit

Payment of amortisement

Governance of in-time payments

Final pricing Credit approval Credit account opening Payout of credit

Risk Management: Management of Credit Portfolio and Credit Risk Identify the resources allocated to the consumer credit process Calculate costs and revenues for each process step Evaluate cost efficiency respectively value added for each process step

Fig. 5.1 Banking value chain

Clearing and Settlement

Credit

Bad Loan Management realisation of collaterals

5.1

Banking Sector

5.1.2

57

Outsourcing Drivers for Banking Sector

5.1.2.1 Economies of Scale The market continues to see challenging times, with banks forced to adapt from a high-growth industry to a low-growth, low-margin one. The competition among firms has changed into fierce rivalry within and outside certain parts of the value chain. The challenge therefore is to critically analyse the processes within the value chain, identify those core competences which provide a competitive advantage, and redesign established organisational layouts accordingly. While quite distinct in actual practice, banks, insurance firms and other financial services providers have several common features that predispose them toward using a large degree of outsourcing. Specifically, they handle large volumes of information, in both paper and electronic form, and they typically provide customers with a wide variety of services. According to an influential study by Deloitte,1 size is a critical factor in terms of its impact on outsourcing. Larger financial firms seem to be driving change across the financial services industry and benefiting from outsourcing to develop a competitive advantage over their smaller rivals. Approximately 80% of the world’s largest financial institutions – characterised as firms with market capitalisation exceeding $10 billion – are already working outside their home market. In 2006, 15 major financial groups had more than half their assets abroad (Gentle 2007). As for smaller companies, only about half of them procure services from an offshore location.

5.1.2.2 Efficiency Compelled to manage expansion whilst keeping a constant eye on the cost-income ratio, banks are looking to achieve a step change in operational efficiency and simultaneously improve time-to-market, and customer satisfaction. At the same time, banks are being forced to deal with the burden of extensive industry regulations (banks are required to monitor their own financial and operational performance more closely than ever).

5.1.2.3 Compliance The costs of enabling compliance, including identifying the risks of, and tackling, non-compliance, have resulted in a more systematic approach to risk monitoring and governance. Most institutions are focusing on operational risk as a separate risk category, and have consequently established separate group-level operational risk functions. The aim is to improve performance and accountability, and not just to comply with regulations. Outsourcing can help banks achieve compliance more effectively.

1

http://www.deloitte.com/dtt/cda/doc/content/Offshoring%20Final(1).pdf

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5.1.2.4 Cost Reduction Banks increasingly need to rely on cost cutting to maintain earnings growth and capture market share from competitors – banks are struggling to make further progress in terms of cost reduction, forcing them to look beyond conservative cost cutting to long-term efficiency. The financial services institutions have increasing confidence in outsourcing as a mechanism for delivering benefits, cutting operational costs and hence allowing available spend to be focused on change activities. Within the outsourcing space, there are some processes within the banking value chain that are more appropriate for outsourcing, whether ITO or BPO or Customer Service functions. There are however some activities which are seen as the core business of the bank and are less likely to be appropriate for outsourcing, as illustrated in Fig. 5.2.

5.2

Insurance Sector

With globalisation and deregulation, the business environment of the insurance industry has changed substantially. The tremendous progress achieved in IT and communication technologies are another main driver of profound change in the insurance business. Entirely new business models and a segmentation of the value creation chain, or, in other words, new forms of co-operation and competition are among the consequences of substantial IT progress. In addition, competition is Mainly IT Platforms

Mainly IT Platforms

Insurance Value Chain

Payments

Advisor Platforms

Core Banking

Cards

Investment Management

Doc Manage and Records Retention

Channel Sales and Service

Payments Services Factory

Advisor Desktop/Portal

Lending Systems

Credit and Debit cards

Investment Analytics

Audit and Controls

Claims Processing

Treasury and Cash Management

Company/ Industry Provided Serv.

Client Data File

Internet commerce

Trade Compliance

Advisory Management

Deposit Systems

Merchant services

Investment Services

Corporate and Wholesale Banking

Payment networks

Trade Floor in-a-box

Customer facing

Seen as Core competence

Channel Renewal

Risk Management and Compliance

Branch (Teller and Seller) Customer Knowledge

Seen as Core competence

Loan Origination

Risk Analytics

Underwriting

Payments Delivery Channels

Mobile

Security and Privacy Management

Core Policy Systems

Clearing and Settlement

Call Center

Business Continuity Management

Product Development

Statement of Production

Reinsurance

Credit Decisioning Loans

Internet

ATMs

Credit Decisioning Mortgages Credit Decisioning Leasing

Fig. 5.2 Banking value chain – the role of outsourcing at each stage

5.2

Insurance Sector

59

becoming more and more intense, not least due to the necessity to earn adequate returns on capital. As a result of all these factors, market structures are subject to fundamental changes since insurers increasingly work on improving their efficiency and use the new environment to their advantage. Insurance companies have resorted to a whole variety of strategies to meet these challenges. Innovative product design, novel approaches to distribution, re-organisation and automation of business processes, internal restructuring and mergers and acquisitions are different approaches aimed at coming to terms with this new environment. In addition, for many insurers striving for efficiency gains, a particularly important approach consists of focusing on core-competences by way of outsourcing non-core activities to third party providers. Whereas up to the mid-1990s, the insurance industry was characterised by an extremely high degree of vertical integration, this has changed rapidly over the last decade. Today, insurers increasingly rely on outsourcing as a strategy in order to save costs, enhance their flexibility or reduce risks. So far, only a very small number of jobs have been relocated to low-cost countries. The new offshoring possibilities have given rise to expectations and fears that a substantial part of the value chain in insurance provision will be relocated to India or to Eastern European countries over the next few years. Because of the difficulties and risks involved in offshoring in the insurance industry, which very much relies on customer confidence and a highly qualified workforce, the locational advantages of developed countries still persist. Although offshoring will certainly gain some importance, the vast majority of jobs in the insurance industries will very likely remain “onshore”. If it proves worthwhile at all, offshoring will in most instances be restricted to relatively simple tasks which are characterised by an easy and time-invariant structure, and the possibility to separate them easily from the rest of the business, without complicated and varying interfaces. It is to be expected that multinational insurance groups will use offshoring to a far greater extent than national or even regional insurers which rely on other instruments to enhance their efficiency. UK policy administration has so far been dominated by the use of onshore outsourcing resources, however the TCS-Pearl deal, which saw Pearl transfer administration of its existing closed Life and Pensions books over to a new subsidiary of TCS, illustrates the growing use of global sourcing strategies in this space. The deal saw the transformational phase offshored to India with insurance operations remaining in the UK in order to create a go-to-market centre of excellence around insurance BPO. Insurers are also using technology to support new distribution models such as work-site marketing in life insurance. Commission technologies to improve agent and broker commission processes represent another area of investment: to provide satisfactory and competitive levels of service to field agents. Automating underwriting/rating/pricing processes is emerging, with tools and configurators to support workflow and decision making.

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5 Outsourcing Within Industry Verticals

Risk management has also become more crucial as insurers address increased regulatory scrutiny. Dashboards represent a newer area of investment, often bundled with larger IT services and solutions as well as advanced analytics. Insurers are placing heavy emphasis on enterprise integration technologies to tie together legacy and newer systems, and interest in Service Oriented Architecture to gain flexibility is growing. Insurance industry’s response to market challenges: • Insurers are using technology to support new distribution models and automating underwriting/rating/pricing processes to support workflow and decision making. • Core policy administration and claims processing has emerged as an area of focus for IT investment, with technologies such as BPM and rule engines being applied to improve speed, cost and satisfaction levels associated with claims processes. • Delivering excellence in the lending processes needs lenders to create automated, standardised means of managing content and eliminating paper from the process where possible. • Users are expecting BPO providers to provide the technology, systems and applications that facilitate streamlining and automating of business processes – ITO and BPO are converging. Implications for outsourcing service providers – they are increasingly being asked for: • Automation – elimination of paper wherever possible, minimising human error and lowering unit costs via seamless workflow. • Workflow systems to capture contractual agreements accurately, while workflow timers guarantee promptness in process completion and ensure that deadlines are met. • Standardised – a consistent enterprise-wide view of the process, with a unified framework that sits across the organisation. • Ability to actively monitor events and adapt rapidly to changing business events and investor demands via business rules. • Clear and documented procedures and responsibilities in the reporting and compliance “supply chain” of information.

5.2.1

Insurance Sector Value Chain

The insurance sector is ripe for outsourcing – it has been reluctant to do so, but with increasing market pressures, the sector may be forced to outsource now. Outsourcing deals in the Insurance industry lag behind Banking and Capital Market industries. Being naturally risk averse it is not surprising that Insurance firms have not outsourced further. However, the increasing regulatory requirements, strong competitive pressures and the rise in fraud cases indicate a potential rise in outsourcing of high-end insurance processes. The FSA has developed detailed sets of principles that insurance firms should adopt in any outsourcing arrangements. They outline: the factors to be considered before deciding whether to outsource any activities; the issues to be covered in the

5.2

Insurance Sector

61

contract with the service provider; and the ongoing management of the relationship with the service provider. Behind them is the general principle that a company does not abdicate responsibility for a service by handing it over to someone else. The overriding obligation of an insurance firm is to take reasonable care to organise and control its affairs responsibly and effectively with adequate risk management systems. Firms are advised by the FSA to have ‘appropriate safeguards’ for any outsourcing or delegation of activities to a service provider, bearing in mind that different safeguards will be appropriate for different activities, and will depend on the scale, nature and complexity of the activities. Safeguards are required to be comprehensive and proportionate and backed up by regular assessment of whether the service provider is achieving the right standards. Firms should: • Identify, assess and manage the risks arising from an outsourcing arrangement; • Ensure, both contractually and operationally, that there are appropriate access rights to the service provider’s premises, people and information for themselves, their auditors and the regulators; • Consider contingencies to protect business continuity; • Have an exit strategy. What the FSA outlines is clearly what most outsourcing arrangements must consider, but having a regulator force these on the insurance industry adds an extra dimension to the outsourcing decision making process, and may influence which

Core competence

Customer facing

BPO

Application Development

Knowledge Process Outsourcing

Product design

Sales & Marketing activities

Insurance Order Processing

Insurance Maintenance

Reports Generation

• Product development and analytics • Loss modelling • Price optimisation • Customer lifetime value analysis • Competitive market assessment

• Agency segmentation • Performance measurement and incentive design • Distribution

• Verification and Validation of Application Nos and Aspirants details • Date entry • Calculating

management

Premium amount

• Agent training

• Underwriting and

• Customer satisfaction management

re-insurance

• Tracking Policies status • Maintaining

• Data mining • Payment reconciliation

individual Agent

• Yield management

records

• Hedging strategies

• Claims Management and Policy Servicing • Commission Payment Processing • History and audit trail • Keeps track of outstanding receivables

Fig. 5.3 Insurance value chain – the role of outsourcing at each stage

• Asset liability matching • Statutory reporting

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5 Outsourcing Within Industry Verticals

activities within the insurance value chain get outsourced, and which don’t, as illustrated in Fig. 5.3. The Insurance sector has also shifted many activities towards self help – many insurance products are bought online using automated systems – firms will continue with this drive. Given the regulatory requirements placed on the insurance industry, many have preferred automation to outsourcing.

5.3

The Telecoms and Technology Sector

Infrastructure isn’t the differentiator it was. Operators more than ever need to demonstrate their commitment to reducing cost and increasing profitability for their shareholders. The real differentiator for most is no longer the network, but the ability to manage partnerships with suppliers and intermediaries. Given these evolving competitive dynamics, existing players and new entrants have started examining different operating models and competitive strategies. Operators today face a number of challenges as market saturation, slow uptake of new services, and the economic downturn increases pressures to cut costs and improve efficiency. Industry deregulation has led to intense competition and rising customer expectations as shown in Fig. 5.4. In addition 3G, convergence, broadband and the Internet have transformed customer expectations, while dealing with the rise in volumes of data services and the opening of the telco value chain as a result of convergence, has changed the competitive landscape and the types of competitive levers the old guard can pull – put simply – the business has changed. What the customer desires

Content

- New channels (IPTV) - New services (interactivity etc)

Applications New breed of competitors -IT industry into telecoms -VoIP etc

etc

Telephony

Cut costs through outsourcing functions

Operatosrs with MKT power

Service and control

- QoS - Security, Authentication

Value Squeeze IP

Lowest cost per bit

Multiple access platforms

Multimedia

Web

Mobile

Nomadic Customer

Devices

Fig. 5.4 Telecommunications value chain squeeze

Fixed

Become outsourcing service provider

5.3

The Telecoms and Technology Sector

63

Outsourcing enables

Product centric Inflexible High Cost Channel restrictions Legacy systems

TECHNOLOGY (single platform, secure) PROCESS (automated, consistent, easy to change) CULTURE (outward looking, performance based, multi-skilled) INVESTMENT (freedom, leading edge, benchmarked)

Customer unfriendly

Better customer focus Agile service delivery Cost competitiveness Increase customer reach Modernisation of operations Become customer centric

INFORMATION (BI, CRM, data warehousing, mining)

Fig. 5.5 Role of outsourcing in transforming telecom operators

Whilst new technologies (3G, LTE, Wimax) and service opportunities offer operators new revenue streams to offset the declining margins of traditional services, they require significant investment in terms of licensing and infrastructure. To succeed in this environment, telcos need to automate and streamline business processes, increase efficiency, and enhance relationships with customers and partners, see Fig. 5.5. Operators are signing large network outsourcing deals with increasing frequency. There are more than one hundred major network operators both mobile and fixed, that have outsourced at least part of their networks to one of the major telecommunications equipment suppliers. The outsourcing supplier scene is also rapidly changing, with new players on the block emerging from the East, as well as old telco competitors getting in on the act, see Fig. 5.6. The industry now (and will increasingly) exist in a complex web of deep alliances. In many cases, organisations that were once arch-rivals are sitting down to collaborate. Old adversaries are forced to co-operate, given the significant financial, operational and strategic pressures they face, and the format that such collaboration takes is in the form of an outsourcing alliance or some shared service solution.

5.3.1

Main Drivers for Outsourcing and Managed Services

There are many drivers for outsourcing, driven by the pressure to increase revenues and lower costs, as illustrated in Fig. 5.7. The terminology used within the telecoms world means those unfamiliar with the industry would be forgiven for thinking outsourcing is not a major component of many operators business. However, if you equate managed services (the terminology used) with outsourcing, then you realise that the telecommunications sector is at the forefront in its use of outsourcing.

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Integrators

Equipment manufactures Motorola WiMAXnet build and management for Mena Telecom

$20m

Operators

BSS / OSS

Value chain

BT GTM Net ops for Nuetel Amwaj Island Smart City

Convergys billing services for Disney Mobile

C & W deal with Royal SunAliance

Accenture payroll for Telecom Italia

$100m

BM 4 year deal with Royal SunAlliance

$200m

IBM Bus processes & IT for Idea Cellular

Tech Mahindra Strategic sourcing services for BT $1Bn

BT Wholesale network outsourcing deal for Virgin

Alcatel-Lucent managed NGN for Telecom New Zealand Zain deal with Ericsson to outsource the management of its network and field operations in Nigeria for a five year term

TUI 5yr network infrastructure outsourcing contract to Deutsche Telekom

Patni IT services for Carphone Warehouse

Unilever extended its outsourcing contract with BT in a technology refresh deal

Ericsson Network build & management for Endesa Spain NSN a five-year services contract to manage Orange’s Spain’s fixed and mobile multivendor networks

Asiainfo CRM / BI and maintenance for China Mobile - 7 China Mobile subsidiaries

NSN 5year deal with Russian carrier MTS for O&M across Central Russia Ericsson Network build and mngt or Bharti

Ericsson Network build and management for Sprint Nextel

$5Bn

Deal value

Fig. 5.6 Outsourcing growing throughout the value chain within the telecoms industry

Issues • Maintaining profitability • Increasing competition • ARPU decline • Technology refresh • Resourcing

Outward Facing

Inward Looking

Solutions

Increase Revenues

Lower Costs Outsourcing Service provision

Wireless Broadband

Managed Services

Outsourcing

FMC & Mobile TV

Sharing

Fig. 5.7 The overriding drivers for outsourcing the telecoms industry

5.3.1.1 Restructuring the Business As competitive pressures increase, operators need to re-evaluate their business structures and their relative position in the value chain. Outsourcing and managed services simplifies the value chain and enables an operator to move closer to customers (if that is what they want).

5.3

The Telecoms and Technology Sector

MNO

65

MVNO Retail distribution

Usually lowers as they leverage their existing channels

Network O&M Marketing Customer care / billing Retail distribution

Marketing Customer care / billing

Net Interconnect / wholesale

Net Interconnect / wholesale Customer acquisition

Customer acquisition

Retention

Retention

Fixed Variable

Fig. 5.8 Changing cost structures in the mobile industry through use of outsourcing

Look at the lessons from the Mobile Virtual Network Operator (MVNO) world – the cost structure of a traditional fixed infrastructure operator (an MNO as they are called) is biased heavily towards fixed costs (Network O&M constitute ~30% of all fixed costs, Sales ~20%, Customer Care (inc. billing) ~15%, Marketing ~15%. The main variable cost elements include: Interconnect costs and Customer retention costs (see Fig. 5.8) Now look at the cost structure of an MVNO – it is almost completely the opposite of the traditional facilities based network operator. The main fixed costs are relatively small and comprise: Customer care (inc. billing), Sales, and Marketing. The variable cost proportions are dominated by wholesale airtime costs as well as customer acquisition. Wholesale costs can often represent 50–70% of a typical MVNO’s operating costs.

5.3.1.2 Regain Focus Operators need to differentiate their offering with service bundles, which may include new forms of content (video, TV, music, etc.). This requires considerable effort for developing, launching and marketing, especially with increasing time-tomarket pressures. Being able to focus on what may be perceived to be the key differentiating activities can bring about significant competitive advantage – whilst leaving the network to the outsourcer (or managed service provider). If the network is nolonger the competitive differentiator – what is?

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A next generation operator typically seeks to leverage its assets, which may include: • Brand – stretching existing brand equity towards the telecom domain (e.g. Virgin); • Existing customers – up selling services to existing customers is a lot cheaper and easier to sell, than winning new customers (e.g. Tesco in mobile, banking, insurance, etc.); • Distribution – leveraging an existing distribution channel to get new products and services to the market, at a much lower cost than those without such channels (e.g. Carphone Warehouse); • Product bundling – bundling of multiple communication services is a form of convergence which enables operators to increase the sum of the parts, build barriers to consumer switching and increase consumer loyalty (e.g. BT); and • Content – as the old saying goes content is king, but without a channel to the customer, it’s a king without an empire. Thus content owners or aggregators, view fixed and mobile as a channel to customers and simply another media for the distribution of its content (e.g. Blyk).

5.3.1.3 Improve EBITDA Operators have embarked on internal process optimisation activities for many years now, investing further will just result in diminishing returns – what is called for is access to economies of scale. By outsourcing to a managed service provider, it becomes possible to benefit from economies of scale and improve EBITDA. 5.3.1.4 Improve Quality of Service In competitive markets, the Quality of Service (QoS) offered to users matters. It may no longer be a competitive differentiator; it may not help acquire new customers, but it may stop current customers leaving or conversely encourage them to leave. Operators need to manage the end to end QoS of their networks. This calls for attention to network design, implementation and ongoing operations and maintenance. Outsourcing and managed services allows the operator to deliver services and innovation without having to worry about assuring the quality of service delivered over the network. 5.3.1.5 Manage Technology and Operational Challenges As the pace of technology increases, with new standards, protocols, interface requirements, from 2G, 2.5G, 3G, 4G, LTE and so on continually being pushed in the market, it is crucial that someone keeps a watchful eye on these developments and implements innovative technology that delivers added value (in terms of cost reduction or service potential). However, an interesting question arises, “what is the benefit in the operator keeping a watchful eye, consuming considerable resource, if they can offload that responsibility to someone else whose core business is next generation technology”?

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Public Sector

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Outsourcing to a managed service provider, can help reduce the technology and operational risk (although it might tie the operator into a technology that they may not necessarily want). . ..

5.3.1.6 Improve CAPEX Utilisation Given telco operations are highly CAPEX driven with significant upfront investment, improving CAPEX utilisation is a useful means for improving cash flow. By outsourcing, an operator can benefit from experience gained by the supplier of leveraging equipment (not something that vendors would openly deliver as a standalone service to telcos, given the cannibalisation effect it has on equipment sales). Outsourcing offers the quickest and (potentially) the least risky route to market, requiring lower levels of capital expenditure. Capital expenditure is substituted by increased operational (wholesale) costs to the outsourcing service provider, costs which scale up with growth in the customer base and usage. Outsourcing can thus reduce cash outflows in the short term and shorten the time in reaching positive cash flow.

5.4

Public Sector

Changes to public sector finance are accelerating the drivers for change within these agencies. The debate between state and private sector ownerships is being re-examined, as well as issues of vertical integration and the use of outsourcing as a real strategic lever for the public sector. When a government decides to maintain public ownership of essential assets, it could transfer responsibility for managing the asset to the private sector, thereby separating asset ownership from service provision. The transfer of service provision from the public to an external organisation is defined here as public sector outsourcing. Outsourcing enables government to retain control over the specification of the service, the management of the contract, and the evaluation of the service provider’s performance. Although privatisation and outsourcing have many common characteristics, there are a couple of important differences between the two. First, the arrangements for provision of outsourced goods and services are not forever: the contract will specify a date at which the arrangement ceases, absent a contract renewal. Privatisation, however, is generally a once-and-for-all sale of a state-owned asset. The government retains no governance control and no operating risk, although it usually retains regulatory control. Privatised assets can be re-sold (even back to the government), but this is usually caused by financial (or other) problems rather than by contractual obligations. Secondly, outsourcing does not necessarily involve the transfer of any physical assets, whereas privatisation does. Outsourcing may, in fact, simply involve the procurement of a specific service – such as cleaning or consulting – which involves trivial physical assets.

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One common feature of both outsourcing and privatisation is that their rationale hinges on the differences in incentives between the public and private sectors. The objective of the private firm is to maximise profit, which can be measured relatively easily and can be tied to a manager’s performance. Public-sector organisations, on the other hand, have a more complex set of objectives that involve the maximisation of social welfare. These objectives are hard to measure, thereby weakening the power of incentives in the public sector. The primary objective of outsourcing is thus to increase efficiency by introducing a competitive environment for the provision of the services – engaging the private sector in the practice of governance and service delivery supports the idea of people’s participation in the government. Outsourcing directly involves the non government sector in government operations and for many countries which subscribe to democratic ideals this manifests a sincere commitment to strengthening public-private partnerships. Favourable business relationships established by successful outsourcing contracts cultivate the precedence for other types of partnerships between corporations and governments. Thus, aside from the tangible improvements that outsourcing services deliver to public agencies, governments are also able to enrich their overall relationship with the public they serve.

5.4.1

A Means to Radically Transform Service Provision

The extent to which countries outsource government services differs quite significantly and is largely governed by the historic mindsets within each country (see Fig. 5.9). The UK and USA being pro-open markets and keen on opening up the Outsourcing of Government Services (purchase of goods and services v's inhouse provision) 80% 70% 60% 50% 40% 30% 20% 10% 0%

Source: OECD

Fig. 5.9 Government outsourcing trends by country

5.4

Public Sector

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Total outsourcing expenditure by sector (2007/08 - 2012/13)

Source: Kable

Fig. 5.10 UK government outsourcing by sector

markets and promoting competition are shown to have outsourced a significant proportion of goods and services that it requires, whereas some of the European countries which have been more closed and less open, such as France and Portugal have only outsourced a limited amount of goods and services, and most of that has been goods, rather than services. Within the UK, public sector outsourcing started 20 years ago and although now close to 80% of goods and services is outsourced, it still continues to grow. The range of goods and services that are outsourced by the public sector within the UK includes a full range of services, from defence to transport to activities within both local and central government (see Fig. 5.10). However, much work is still required to drive out inefficiencies. The 2004 Spending Review identified auditable and transparent efficiency gains of over £20 billion in 2007–2008 across the public sector. Over 60% of these were directly cash releasing. In 2010, the UK government identified £6 billion in immediate savings.

5.4.2

Evolving Generations of Outsourcing

Public sector outsourcing tends to follow an evolutionary path, usually starting with the outsourcing of what is called blue collar services, which tends to include services that are classified as facilities management. Building cleaning, maintenance, cleaning, the running of canteens and security are seen as periphery activities that have little impact on the direct delivery of services. These services not only consume valuable management time, but tend to be more expensive to provide in-house than through external providers that gain from economies of scale (see Fig. 5.11).

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Blue collar services

e.g. Building cleaning, canteens, security guards

FACILITIES MANAGEMENT

Professional services considered non-core

e.g. Information technology,Back office tasks

ITO & BPO

Core services

e.g. Prisons, fire and rescue, enforcement activities, employment placement services CUSTOMER FACING

Fig. 5.11 Evolution of public sector outsourcing

The second phase of public sector outsourcing includes the external sourcing of IT and some back office processes, such as HR, payroll, environmental services and to a limited extent contact centres. These activities are seen as being the underlying pillars for successful service delivery, but are not customer facing. Outsourcing these activities brings about flexibility, an injection of process improvement, efficiency and access to technology, which may have been out of reach by the public entity. The third phase is the outsourcing of core services, services which directly interface with the public. These include the running of prisons, law enforcement, employment placement services and the wide breadth of services that are delivered by the public authorities. The evolutionary path is necessary because it not only provides an essential learning path, but also allows the public to become accustomed to outsourcing within the public sector, something that tends to be met with some hostility by the public and certainly the unions. The recent financial crisis and the massive bail-outs by national governments of the banks and the significant quantitative easing measures that have been implemented, has meant that bringing down the cost of public provision of services is now seen as vital to survival of public sector services. The evolutionary phases are thus getting shorter and countries are leaping from phase 1 to 3 in a matter of months instead of the decades that previous governments took. However there are many issues that governments need to be mindful of, as illustrated in Fig. 5.12.

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a Traditional Model

Outsourcing Model

Separation of “purchaser” and “provider” Accountability and Responsibility

Hierarchical Focused on inputs and processes

Explicit specification of services Performance measures to monitor compliance

Implications

Increased transparency serves to foster accountability, avoids conflicts of interests (in-house). However, multiple organisations can blur accountability. Political considerations: public pressure; minister always responsible

b Retain the technical skills of the function being outsourced

Acquire the commercial skills necessary to manage outsourcing

Government capacity to manage This may be lost as the government is no longer directly involved in the provision of the service May lead to dependence on the incumbent supplier when re-tendered or may preclude taking the activity back in-house

Needs to become an established and on-gong function, not “one-off” Implications for career tracking policies and managerial promotions

c Government contracts = prescriptive and process oriented

Contract specificity how to get more than just the same

Private sector contracts = more output (or outcome) oriented

Issues

Concern about accountability implications Manifestation of resistance to outsourcing in agencies May be difficult to specify outputs (or outcomes) effectively

Possible Solutions

Agencies formally issues a tender offer but specifies its needs only in general terms and contractors are invited to be creative in responding to those needs. Agencies put out a more detailed tender offer based on the responses to the first round.

Fig. 5.12 (continued)

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d Creation of such markets

How to create and sustain competitive supplier markets

Commodity-like services vs. highly specialised services Government can exert tremendous influence through its volume buying

Maintaining such markets Avoiding over-reliance on a single supplier The length and size of individual contracts can impact the number of potential suppliers Policies against low-balling

The government needs to focus on the impact on the supplier marketplace of individual outsourcing decisions

e Information previously in the public domain is now in the hands of private contractors and the public’s right to access that information may be impaired.

Transparency, Confidentiality, Data protection and Knowledge transfer

Contracts viewed as commercially sensitive. Aside from protection of intellectual property rights, this is generally inappropriate in the public sector context.

Appropriate information needs to be publicly available in order for outsiders to be in a position to make an informed judgement about the contracting decision.

Contract provisions need to ensure that sufficient information is turned over from the private provider to the purchaser organisation in order for the latter to maintain up-to-date knowledge of the activity for future tendering.

Fig. 5.12 Key issues for consideration within public sector outsourcing

5.4.3

The Drivers for Outsourcing in the Public Sector

The public sector is under unprecedented pressure to do more for less. Service transformation and outsourcing remain valid ways to respond to the continued drive for benefits realisation, efficiency gains and the shared services agenda. They face the challenge of achieving these goals whilst under constrained budgets. Government organisations are not too different from large corporate firms in that both have cost savings and operational efficiency as core objectives in carrying out their functions and mandates. It is with these objectives in mind that government executives have begun to reconsider the outsourcing model for public sector functions. As governments have strived to become more technologically efficient, more attention has been given to public sector outsourcing.

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Public Sector

73

Public sector outsourcing is now a well-established mechanism for government service provision. Despite a great deal of practical experience by governments of all levels, in many countries there is still relatively little agreement about whether outsourcing is uniformly beneficial or what magnitude of reductions in government expenditure might be achieved. This debate has intensified recently as outsourcing has moved from straightforward tasks to more complex customer facing tasks.

5.4.4

Public-Private Partnerships (PPP)

The private sector financing, designing, building, maintaining, and operating of infrastructure assets, traditionally provided by the public sector (or redeveloping existing ones), represents a new form of outsourcing in the public sector, used extensively within the UK. A public-private partnership brings a single private sector entity to undertake the provision of public infrastructure assets for their “whole-of-life”, generally 20–30 years. The private sector partner then charges an annual fee for the use of the infrastructure assets. The essence of the argument is that the whole-of-life perspective can potentially lead to efficiency gains, although in practice, this has proved to be a debating point. The PPP ideology is based on the premise that the private sector is more efficient in its ability to embrace public finances and in providing services (both enhancing quality and creating new services), in acknowledging clients needs and in making demand-driven decisions. This it is claimed brings about better governance of operations/resources, better effectiveness and efficiency. However, problems have been encountered in the UK in terms of an inadequate understanding of the deals, with consequences for the private and public sector, and the quantification and management of risks (Project risks, Development Risk, Technology Risk, Performance/Operational Risk and Revenue Risk).

5.4.5

Outsourcing Offshore Versus Onshore

In public sector outsourcing, an important question that governments have to answer is whether to outsource onshore or offshore. There are two main considerations that will have to be factored in when deciding where to outsource. The first is the type of work that is being outsourced – is it handling sensitive data which need more stringent security? Those functions which require stricter security measures, if outsourced at all, are typically kept onshore. The other is the impact such outsourcing has upon the local employment. Local authorities have a dual role of providing local community services for the people, as well as promoting business in their areas. Offshoring services, with the resultant loss of local jobs will not only upset many local people, but will make their jobs harder when it comes to promoting local business and employment. Many industry analysts, from the outsourcing and government sector alike, are of the opinion that contracting out does not have grave effects to local employment.

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In fact, according to a report released by the US Bureau of Labour Statistics in 2005 only 2% had outsourcing as a contributing factor. In another report in 2006, the Duke Centre for International Business Education and research stated that 90% of all R&D offshore implementations had not created any job loss in the country. These studies show how media reports may have overstated the negative effects of offshoring on local employment. Nevertheless, public managers find themselves trying to strike a balance between maintaining a positive public opinion, whilst accomplishing processes in the most efficient way possible, which is a very delicate balance.

5.4.6

A Closed Market for New Suppliers

Despite the growing demand for government outsourcing and the large deals that they entail, government outsourcing has failed to overtake the market for business activities by traditional verticals that have held the lead in industry, i.e. BFSI, healthcare, etc. One of the major issues that have been impeding government outsourcing is rooted in the essential characteristics of the project contracts. Because of volume of work that is involved in carrying out a government contract, prospective bidders are somewhat limited. Only a few large players, many of them multinational in nature, can guarantee stable facilities to deliver the service. Furthermore, government protocols (and internal mandates) may require that only companies with specific net worth can participate in the bidding process, as a form of safety net and guarantee of the real capacity to deliver the projects. For these filters alone, a vast majority of providers would have already been disqualified. Because government agencies are under constant public scrutiny, they would rather avoid contracts with companies which are relatively less renowned than the major players in the industry to avoid controversies that may spark negative public opinion. Delivering on a public sector contract requires a specialised type of management strategy and project planning. They also demand a deep understanding of government needs that may not be accessible yet to companies which are used to servicing smaller contracts from private sector clients. This is one of the reasons why despite the forecasted US$100 billion opportunity in public sector outsourcing, only large established companies such as IBM, HP-EDS, TCS, Wipro and Infosys have explicitly expressed their intention to develop a business segment dedicated solely to competing for government contracts.

5.5

Retail Sector

According to Bloomberg, in December 2007, retail sales in the euro area declined 2% from a year earlier, the biggest drop in at least 13 years. Business has gradually picked up, but discretionary consumer spending is still under pressure in many

5.5

Retail Sector

75

countries for a variety of reasons, including higher energy and food costs, the housing slump, and high levels of consumer debt accompanied by tighter credit. The BRC-KPMG Retail Sales Monitor for February 2011 reveals that UK retail sales values were down 0.4% on a like-for-like basis from February 2010.

5.5.1

Drivers

The retail industry typically has trouble coping with peak demand preceding holidays, particularly during November to January, when most retailers earn between 25% and 40% of their entire yearly revenue. Poor service during this time will translate into permanent customer loss and lower revenues. Therefore handling peak demand traffic should be a major priority. Outsourcing can provide this flexibility.

5.5.2

Outsourcing Drivers not Just Focused on Cost

Differentiation by providing a better customer experience may be one of the few opportunities retailers have to rise above price competition. Seventy-three percent of European consumers2 said they would do business with a company based on a great contact centre experience. Of these, 15% would do so even if prices were higher than average. Multi-channel shoppers generate 20–25% more profit than the average customer. However, these customers have low store loyalty across channels. Multi-channel availability if not managed, can therefore potentially be a threat to retailers; nevertheless customers today have come to expect multi-channel availability. Outsourcing can provide the retailer access to both technical and process expertise to implement multi-channel contact opportunities.

5.5.3

The Need for an Integrated Contact Management Strategy

By failing to provide customers with a means to transact at their convenience, retailers run the risk of losing their custom to competitors. A majority of new customers (~70%) will hang up if the phone is not answered within 25 seconds or if they get through to an answering machine. According to E-consultancy, providing a contact number during the online shopping process can foster trust in consumers – reassuring them that they can discuss any issues they may have with an adviser over the phone – this is especially true of reluctant e-shoppers. The publication notes that such a strategy can be particularly useful in persuading users who have misgivings

2

Genesys Consumer Survey 2007 – Europe.

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about e-commerce to buy online. Outsourcing provides access to resources and capabilities that may not be available in-house.

5.5.4

Transforming Customer Service Cost Centres into Sales Centres

When a customer walks into a shop they expect the sales assistant to understand the products and be able to help them. The same is true if a potential customer picks up the telephone, sends an email or clicks for instant chat. Replacing a skilled operator with an automated service might save money in the short term; in the long term however, the retailer runs the risk of losing brand advocacy and sales. Inbound customer calls can generate “sales through service”. By resolving customer issues and exceeding their expectations, a contact centre agent is sustaining rather than losing a revenue stream. Outsourcing can help in transforming service into sales through a combination of representative incentivisation and by creating appropriate up-selling opportunities.

5.5.5

The Need for Greater Pro-activity

IMRG estimated that 4.4 million British shoppers spent a total of £84 million online on Christmas Day in 2007, up 269% from Christmas 2006. However, retailers stand to lose cross- and up-selling opportunities that have been facilitated in stores by sales associates. There is a strong requirement for agent interaction, providing assistance and information as customers shop online and access extended transactional capabilities across channels. Multi-channel experience, in most cases is lacking in a number of areas; retailers often fail to answer e-mails from their customers in a timely manner; retailers often fail to take advantage of opportunities to personalise the interaction. Given that proactive contact can build brand, enhance customer service and increase revenue, it is surprising that only such a small portion of all contact centre activity involves outbound campaigns. There are many ways in which retailers can engage with their customers to not only enhance the relationship with the customer, but as a mechanism to drive up the lifetime value of a customer. Possible proactive customer contact triggers include: • Customer complaints • New customer welcome calls • Lapsed payment • Retention call triggered by specific customer behaviour • Specific sales offering applicable to customer profiles • Poor satisfaction rating • Prior to maturity/completion of customer policy/agreement • Customer attrition

5.6

Charity Sector

77

• Change in personal circumstances • No contact from customer for specified period of time However, these activities cost money, and retailers need to find ways in which to engage with their customer base cost effectively. Outsourcing of contact centre activities may well serve the retailers well. Although, given the negative sentiment often encountered in relation to offshoring and offshore accents, it is likely that most retailers will go for the safer option of outsourcing to onshore providers.

5.6

Charity Sector

Charities to date have been reluctant outsourcers. Fear of alienating their donors, the risks inherent in outsourcing and the need for charity trustees to govern the organisation, often whilst holding a day-job, has meant outsourcing was never high on the charity’s agenda. However, as charities start facing increasing competition for donations, as government grants run dry, as donors themselves are starting to tighten their purse strings, and as other charities start embracing new technology, many are asking why they continue to struggle over work that is difficult and time-consuming with pre-historic technology, when they can pay an expert, with the latest technology to get the job done better than they ever could. Outsourcing is slowly creeping into the charities agenda, as many are coming to the realisation that turning to outsourcing provides them a solution that gives them access to cutting edge technologies and specialist expertise that would be too expensive to pay for in-house. If the charity can utilise and provide benefits to the recipients of their charity at the same time, so much the better. Outsourcing recruitment is well established in the voluntary sector, and using specialist firms for IT support is also growing. But getting an outside company involved in a charity’s public interface is obviously trickier. While all charities outsource to some degree, they don’t tend to shout about it too much. Charities are often worried about losing touch with their donors, and sometimes the donor perception is that outsourcing costs money – and if not managed well, is almost certainly the case over the long term. The reality is that outsourcing should save money and free up the charity to actually speak to donors, so there probably ends up being a better relationship. Access to sophisticated technology is vital in helping small charities to fundraise. Other benefits of outsourcing can include: freeing up staff to do their real jobs rather than taking on unrelated work that doesn’t justify the employment costs of a parttime post; and offsetting the risk of relying on a single individual to carry out required functions such as payroll that are not core to the charity’s mission. However, you can’t outsource the campaigning nature of a charity’s work – that goes right to the core of what that charity is about – there is a line to be drawn, but it’s a line that is edging further out. You can’t outsource the things that are strategic. In a recession, charities need to ensure that as high a proportion as possible of their donations is devoted to their mission. Outsourcing, or employing external

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providers for routine functions, may offer significant opportunities to streamline the operations and divert more funds to good causes. The charity market place for outsourcing has an income of £3.4 billion, with clients’ realising an average saving of 40% on their back office costs, these figures could mean a total of £136 million extra for charitable activities.3 A recent survey indicated that around 65% of charities were outsourcing Training, in whole or part; that IT was outsourced by 61%, in whole or part; with Annual Accounts preparation outsourced at 42%; whilst Finance functions only outsourced in 12% of cases – demonstrating that the charity sector is a significant user of outsourcing, and this trend is likely to continue.

5.7

The SME Sector

Clearly in a battle when facing a corporation with significant resources at its disposal – an SME with somewhat limited resources (human, technical, legal, financial and global reach) may find the battle somewhat difficult and short lived. No one loves Goliath. What is surprising is the world’s failure to respond to the market power of the multinational corporations as it did to the Goliaths of the past. However, the time has now come, when the many David’s of the world can compete with the few Goliaths that have dominated the markets till now. With the increasing availability of outsourcing and offshoring to the SME market, times are changing. With a slowing economy, which is expected to continue for the next few years, the impact of the credit crunch and housing crisis impacting financial markets, together with lower consumer and business confidence – the implications for business community cannot be overstated. Under these circumstances, it is very likely that larger companies will increasingly embrace outsourcing as a means of global survival. However the SME market tends to get hit the hardest when the economy slows. Larger companies may derive their revenues from multiple geographies and may be protected from the adverse economic conditions in a particular national market. SMEs also tend to be singly focused – either vertically or from a service/product perspective, and therefore less diversified in comparison to the larger organisation. The SME market must embrace outsourcing and offshoring now as both a means of survival and as a means to level the battlefield with their larger competitors – who in most cases already benefit from outsourcing and offshoring. Although most SMEs outsource something (how many SMEs do their own accounts or clean the offices?), they have been reluctant to outsource beyond these “traditional” functions. The SME market has been slow to take-up broader outsourcing and in particular offshoring, primarily because there are not many service providers who cater for this market with targeted propositions.

3

Charity Business (2008).

5.8

Take Aways

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In addition, practical experience of outsourcing and offshoring is clearly missing within the SME market. Although the benefits and drivers for outsourcing are pretty clear, operational execution and risk mitigation strategies are more difficult for the SME market to comprehend – they also lack the deep pockets of the large corporations, who can afford to pay expensive lawyers to manage the commercial process on their behalf. Offshoring may now be the only means of survival for many SMEs. Mounting margin pressure, global competition, and an increased focus on core business are driving companies like never before to look for new ways to get things done at a lower cost (typically between 25% and 50% when offshoring). While cost saving is a primary driver of outsourcing, companies benefit in other ways, including freeing up internal resources and accessing world-class skills and capabilities. The typical drivers for SME outsourcing include: freeing-up executive time and enabling on-demand access to specialist expertise not available internally; gaining access to best practice processes and best-of-breed technology and tools; gaining the ability to scale more efficiently; improving performance; and achieving the obvious costs cutting benefits. However companies must assess the risk – reward trade-off: for the benefits that outsourcing and offshoring can provide there are some real risks that need to be managed by SMEs. Because SMEs often use outsourcing as means of enabling growth of the business, it is likely that once growth has been achieved, some processes may want to be brought back in-house – how easy will this be to achieve? The innovation and efficiency that the outsourcing supplier may have achieved for the customer may not necessarily transfer back in-house with the processes/functions, and therefore there is a real risk that the quality of service will suffer. SMEs must always seek to complement outsourcing with automation, which will make the job of bringing the outsourced processes and functions back in-house easier.

5.8

Take Aways

• Competition in the banking sector is forcing banks to drive for efficiency, deliver compliance and reduce costs – these are being achieved by the use of outsourcing. • Although the insurance sector has been reluctant, it is now starting to embrace outsourcing to make the most of technology, standardise processes and automate processes wherever possible. • The telecommunications sector has seen a major shift in business due to the effects of competition and convergence. The sector is using managed services to re-configure the organisational structures, to transform fixed costs to variable costs and regain focus on what can deliver sustainable competitive advantage. • The public sector is embracing outsourcing to deliver cost savings and drive efficiencies and transform the delivery of public services.

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• The retail sector will embrace outsourcing of its contact centres to deliver customer experience and transform the call centre into a profit centre. • Both the charity sector and SME sector must utilise outsourcing to compete on the global playing field, but the resource constrained organisations will find the task of smooth transition a real challenge.

References Gentle, C. (2007). Forecast for financial services in 2010: No room for laggards. Journal of Business Strategy, 28(5), 20–28.

6

Strategic Outsourcing: Risks, Rewards and Relationships

Outsourcing can deliver significant rewards to organisations, beyond the common cost reduction benefits that are most obvious. These cost benefits are derived from labour arbitrage, process optimisation, IT enablement and scale. Other benefits include: focus, access to expertise, flexibility and faster time to market. However, there are a number of risks in outsourcing that need to be recognised and managed, from loss of core competence, cost escalation, supply market risks and change management costs. Managing these risks needs a combination of a strong legal contract and a good relationship, one that is built on mutual trust. This chapter explores outsourcing risks, rewards and relationships.

6.1

Rewards

There are numerous drivers for firms outsourcing. Some may do so to achieve cost benefits, others to access resources and some in an attempt to reduce risk (see Fig. 6.1). All models however carry risks. Although the particular objectives set for outsourcing will differ, it is possible to list some of the more common strategic stated reasons for outsourcing, as elaborated by Kakabadse and Kakabadse (2005): • Achieving best practice, because a service provider whose core business is the performance of a particular process will have better practices than a firm for which that activity is only one of many and peripheral; • Enforcing appropriate cost disciplines and controls, because the introduction of a third party will require the need for better cost control and thorough documentation of internal procedures and costs; • Better leveraging the core competences of the organisation, achieved through increased focus on core functions and processes; • Gaining access to new technology and skills not available in the organisation; and • Reducing headcount and achieving cost reductions. Service providers can achieve savings from economies of scale and scope which can be passed onto B. Vagadia, Strategic Outsourcing, Management for Professionals, DOI 10.1007/978-3-642-22209-2_6, # Springer-Verlag Berlin Heidelberg 2012

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Outsourcing Motives Financial

Strategic

Cost reduction

Other Get rid of problems

Core competence Cost control

Belcourt, 2006 Gilley & Rasheed, 2000 Jennings, 2002 Kakabadse & Kakabadse, 2000, 2002 Kremic et al, 2006 Kumar & Eickhoff, 2005 Lacity et al, 1994 Leavy, 2001, 2004 Lonsdale & Cox, 1998 Quelin & Duhamel, 2003 Zhu et al, 2001

Follow the competition

Flexibility Fixed to Variable

Belcourt, 2006 Kremic et al, 2006 Lacity et al, 1994

Improve service quality Belcourt, 2006 Gilley & Rasheed, 2000 Heikkilä & Cordon, 2002 Jennings, 2002 Kakabadse & Kakabadse, 2000, 2002 Kremic et al, 2006 Kumar & Eickhoff, 2005 Lacity et al, 1994 Leavy, 2001, 2004 Lonsdale & Cox, 1998 Prahalad & Hamel,1990 Quelin & Duhamel, 2003 Quinn, 1999 Quinn & Hilmer, 1995 Zhu et al, 2001

Alexander & Young, 1996b Belcourt, 2006 Quelin & Duhamel, 2003 Lacity & Hirschheim, 1994

Time to market Access skills Jennings, 2002 Kumar & Eickhoff, 2005 Lonsdale & Cox, 1998 Quinn & Hilmer, 1995

Spread risk

Kremic et al, 2006 Quinn & Hilmer, 1995

Gilley & Rasheed, 2000 Heikkilä & Cordon, 2002 Jennings, 2002 Kremic et al, 2006 Quelin & Duhamel, 2003 Quinn & Hilmer, 1995

Alexander & Young, 1996a Gilley & Rasheed, 2000 Kakabadse & Kakabadse, 2000, 2002 Kumar & Eickhoff, 2005 Lonsdale & Cox, 1998

Kremic et al, 2006 Lacity et al, 1994

Belcourt, 2006 Gilley & Rasheed, 2000 Jennings, 2002 Lacity et al, 1994 Quinn, 1999 Quinn & Hilmer, 1995

Belcourt, 2006 Gilley & Rasheed, 2000 Jennings, 2002 Kakabadse & Kakabadse, 2000, 2002 Kumar & Eickhoff, 2005 Lacity et al, 1994 Leavy, 2001, 2004 Lonsdale & Cox, 1998 Quinn, 1999 Quinn & Hilmer, 1995 Zhu et al, 2001

Fig. 6.1 Outsourcing drivers – academic insight

their clients. The client firm may no longer need to employ individuals for those processes which it outsources, saving on recruitment, training and other overhead costs. Offshoring also allows firms to benefit from labour arbitrage. The most common and obvious driver is cost savings. However these cost savings are realised through different means. The biggest gain comes from labour arbitrage where anything from 20% to 35% can be shaved off the costs, the second largest contributor is through IT enablement and digitisation which can deliver anything from 15% to 20%. Third on the list is process optimisation that could deliver around 10–15% savings and finally, economies of scale can bring about 3–5% savings (see Fig. 6.2). This means an outsourcing programme with an offshore service provider, where the vendor provides a technology solution to automate and enable the process to be digitised, where the vendor injects their expertise in optimising the processes, and where they can pass on some economies of scale benefits, can result in a cost saving of up to 75% to the client – not an insignificant amount. One further reason could simply be that the firm may want to ‘externalise’ the issues and problems involved in doing those processes/functions, i.e. make them someone else’s problem. Outsourcing can thus deliver a number of rewards for an organisation (see Fig. 6.3), from providing the ability for management to focus on its core competences to cost management, or access to external expertise or technology, giving the organisation increased flexibility or delivering time to market benefits

6.1

Rewards

Cost savings (%)

83

20-35%

10-15%

15-20%

3-5%

48-75%

80

Aggressive potential estimates

60 Digitisation

40

IT enablement Reengineer

Offshore

Conservative potential estimates

Optimiation

20 Nearshore

Labour arbitrage

Process optimisation

IT enablement/ Digitisation

Scale

Total

Fig. 6.2 Outsourcing cost levers

Management Focus: • Reduces effort required to manage peripheral activities Cost management: • Economies of scale / productivity (people / technology) • Committed cost structure • Capital investment avoidance – balance sheet restructuring Access to external expertise / investment or innovation: • Access to specialists, management expertise, products, efficient services • Accelerate benefits • Manage attrition and depth and breadth of resource requirements Flexibility: • Adopt best practices, manage complexity & stabilise environment • Respond to changes in business environment, leverage technology advances • Improve systems, strengthen control and enhance services • Improve scalability

Time to market

Fig. 6.3 Key drivers of outsourcing

which can help organisations bring new products/services to the market quicker than would otherwise be possible. Many outsourcing projects run into difficulties because the managers in the client organisations have unrealistic or conflicting expectation from outsourcing. The fundamental motives for outsourcing can be characterised as seeking efficiency, effectiveness, or flexibility. Each in itself is a perfectly valid motive. The problem is that many clients expect (and indeed many vendors promise) all three – efficiency, effectiveness and flexibility – in the same outsourcing project.

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As product/service features increase, so do costs, even under the most efficient production conditions. Organising for effectiveness is different from organising for efficiency. The internal structures, systems, processes and culture that enable a vendor organisation to provide “least cost solutions” are quite distinct from those that support a “full-service offering”. Procedures used to identify target processes to outsource, vendor selection, contract negotiations and relationship management also differ by outsourcing objective. While this need not necessarily imply that an organisation needs different vendors for efficiency and effectiveness, it certainly implies that the manner in which the outsourcing relationship is organised needs to differ based on the motives. Similarly, flexibility, which is the capacity to increase and decrease scale of production rapidly, is not easy to reconcile with a “lean” and low cost operation unless vendors have multiple clients across whom they can balance demand. But that, in turn makes it less likely that they can function as dedicated captive units that are highly responsive to the unique requirements of the client. Another reason why mixed motives are dangerous is that if key internal stakeholders differ in their expectations from the outsourcing project, the project is in political trouble before it begins. Outsourcing without a clear motive and organisational buy-in from senior executives (and the operational teams) will likely result in perceptions of outsourcing failure, whatever the ground realities. To have one end of the reporting chain thinking of BPO in terms of cost reduction, while the other thinks strategic transformation, can lead to conflicts of actions, goals, and eventually disenchantment with the BPO process. Organisations need to prioritise outsourcing objectives – efficiency, flexibility or effectiveness – and communicate them widely within the organisation – most organisations cannot have them all.

6.2

Risks

The challenges to successful outsourcing are significant. Studies indicate that the success rate of Information Technology (IT) outsourcing is 56% (Lacity and Willcocks 1998). Other estimates show that outsourcing clients spend as much as 15% of their IT budget on litigation in the case of IT Outsourcing (Goles and Chin 2005). Traditionally, research on managing outsourcing relationships has focussed either on the legal contract, with tight contractual mechanisms recommended to reduce opportunistic behaviour (Lacity and Hirschheim 1993), or on advocating strategic partnerships (Willcocks and Kern 1998). Saunders et al. (1997) argue that contractual mechanisms and strategic partnerships complement each other, with the legal contract providing the context in which the relationship exists and defining the interactions between parties.

6.2

Risks

85

No business process is foolproof. There always exists a risk that a process might fail (that’s why most well documented business processes are also characterised by an acceptable error rate). However, it is important to distinguish between the risk of process failure and the economic consequences of process failure. For instance, consider process failure in the context of a call centre. It could mean poor customer satisfaction with the manner in which calls are answered or their problems are resolved. The economic consequences of this process failure are customer attrition and damage to brands and reputation. The risk of failure may increase or decrease to the extent that the vendor firm is more or less competent than the client. Indeed a basic principle of outsourcing is to prevent worsening the error rate and should guide vendor selection. However, in most cases, the actual cost of a process failure when it occurs is the same regardless of who is executing the process. Therefore unless outsourcing changes the costs of process failure, it is unclear why clients should expect vendor companies to bear part of the economic consequences of process failure ex-post. Whether the process that produces an output is internal or procured, it remains the client’s responsibility to ensure that the output from the process meets quality standards before passing on the output to the next process, which could well be selling the final product to customers. Whilst the client should take every step to ensure that the risk of poor quality does not increase due to outsourcing (through well defined standards, quality inspection, monitoring, etc.), it is not clear why outsourcing should make the client less responsible for the ultimate quality of their product, e.g. when pharmaceutical companies outsource clinical research, the responsibility for the integrity of the research still rests with the pharmaceutical companies. In fact, the only “vendors” to whom one can outsource business risk wholesale are insurance companies. BPO vendors are not insurance companies. Negotiating unrealistic penalty clauses or demanding unrealistic safeguards does not help with successful business process outsourcing. There are also many risks that have been documented – some of the major risks are described below:

6.2.1

Loss of Core Competence and Innovation Capability

Loss of skills (by transferring employees and assets to the outsourcing service provider, the customer risks losing valuable knowledge and experience from displaced workers) poses a very serious risk. This can also be exaggerated by outsourcing activities that should not be outsourced (which leads to the deletion of core competences and affects the firm’s competitive advantage). The evaporation of competence regarding the process in the client organisation severely compromises the ability of the client to fuel future innovations. The client firm acts as the hub of several interrelating processes and is uniquely capable of pursuing systemic innovations by fine-tuning all the processes with respect to each

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other. Some degree of individual component knowledge is necessary to pursue such ‘architectural innovations’. For example, automakers still carry out R&D in components that they stopped making many years ago, and frequently intensely collaborate with the component suppliers in these efforts. Firms that retained the knowledge to integrate these subsystems into the over-all architecture of the firms’ products were better able to identify changing market trends and technologies, and develop enough expertise to perform systemic changes in all the processes that a new technology enables, e.g. even though all major manufacturers had outsourced the production of engine control systems, those manufacturers that had maintained R&D capabilities in control systems were quicker to identify technological changes in the control system, and were significantly more effective in performing systemic adaptation in all aspects of engine manufacture that were affected by these changes. Similarly, Intel still performs R&D on components whose manufacturing it has outsourced or has never manufactured itself in the first place. Another problem with the evaporation of competence is that the client is now in a dependence relationship with the vendor. Since the client no longer has any knowledge about the process or ability to execute it, there is significant scope for opportunism on the part of the vendor – what we know as the hold-up problem. Even with clear exit criteria with the current vendor, the client may no longer have the competence to evaluate other vendors, negotiate suitable contracts and transfer the requisite knowledge to set up a new outsourcing relationship for the process if it does not retain personnel with the necessary knowledge. Outsourcing should not mean that the process is not your headache anymore.

6.2.2

Cost Escalation

• Cost increases – the initial contract can be very competitive, however the inevitable changes over time may increase cost significantly.

6.2.3

Supply Market Risk

• Supply market risk – loss of day-to-day management control of outsourced services and the possibility of excessive dependence on the service provider for performance and strategic information on internal technology, as well as operational and business options. • Losing control over the outsourced activity – because control through direct ownership of assets and employment of staff is replaced by control through a contract. • Uncertainties associated with the stability of the service provider firms.

6.3

Relationships

6.2.4

87

Change Management Costs

• Overlooking the hidden costs of outsourcing – vendor search/contracting costs and vendor management costs. • Organisational change implications – setting up new systems, job roles, staff transfers, redundancies, etc. • Overlooking personnel issues – such as motivating retained employees and gaining commitment from employees transferred to the vendor. • Failing to plan an exit strategy – which leads to weak power bases for any negotiation with the vendor and makes it very difficult to back out of an outsourcing agreement.

6.2.5

Selection, Contracting and Vendor Management

• Selecting the wrong vendor – not looking at both soft and hard factors. • Writing a poor contract. • Issues to do with maintaining confidentiality and security.

6.2.6

Communication Challenges

• Poor organisational communication. • Cross functional political problems. • Unclear expectations.

6.3

Relationships

Much of the initial wave of outsourcing was focused on reducing cost through wage arbitrage by using cheaper labour abroad. This approach made the relationship with the BPO service provider adversarial from the outset and often led to disputes and even litigation. In addition, the scale of the change programme and the level of project management resources required were often underestimated. Many risks can be minimised through a well constructed and managed agreement, complemented by effective relationship management. The structure of the outsourcing agreement is important, because it embodies the rights, remedies, duties and obligations of the parties, and more importantly provides a blueprint for the parties’ relationship. The functions to be performed are typically business critical or strategically important and the relationship between the service provider and the customer is typically of a longer duration with greater intimacy than the relationship created in other commercial contexts. A well defined agreement aids in developing a smoother relationship between the parties. The process of creating the agreement is as important as the final product. In many senses, a well functioning engagement is usually the very reason

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that neither party later refers on a frequent basis to the written contract, or seeks to manage the relationship using the formal word of the contract. If a company decides to outsource strategic functions or processes, the contract is the only mechanism to ensure that expectations are realised. However it is unlikely that the contract can cover all possible future contingencies. There are serious challenges in governance of contractual relations, given issues of conflict, mutuality, and order. All complex contracts are unavoidably incomplete. Real world contracts are almost always incomplete. The likelihood of including all details in the contract is very limited. Reliance purely on the legal agreement is therefore potentially difficult. There is a need to move away from a pure agency relationship, to one which is akin to a partnership. Although this is far from easy, commitment to striving for a partnership relationship from both parties is essential if the outsourcing engagement is to survive the many challenges that an outsourcing engagement presents. The partnership approach requires surmounting cultural, managerial and communication barriers. Managing anything across organisational boundaries is difficult. When this is transposed to different countries, difficulties are magnified greatly. Another important aspect of this partnership relationship is the development of trust – something that is difficult to establish when contracting parties are based on distant shores, meet less frequently and where parties may have different cultures and working practices. In outsourcing relationships, especially those involving service provision, it is impossible to write “iron-clad” contracts that take all possible contingencies into account. The process and the relationships will both evolve, and the contract needs to be flexible enough to allow for such evolution. Managers must simultaneously develop conditions that facilitate the emergence of trust, with contracts that are perceived as fair by parties, allowing the interacting personnel to establish relationships. Managers learn to contract better over the course of a relationship. Contracts in such situations serve as repositories of knowledge acquired in the relationship regarding both the partners and the technology. Flexible contracts guide the relationship and change as the circumstances change. They lead to greater trust and cooperation between parties when they are used to canalise action by formalising mutually agreed upon expectations and understandings, including learning from prior interactions. Contracts do matter; a well specified contract in the drawer provides both parties with necessary assurance to draw on in the case of disasters, but the day-to-day business may be conducted based on the relationship with minimal reference to the details of the contract. Very few firms report great success with their very first outsourcing project. Depending on the complexity of the process to be outsourced, the contractual, transition and interaction requirements could be very large. However, significant learning both on part of the client and the vendor in such relationships takes place. With time partners learn to communicate better leading to more efficient

6.3

Relationships

89

coordination. Clients and vendors learn about each other’s needs and are able to negotiate better contracts focusing on value creation. Learning between partners, especially of those skills that are difficult to articulate are enhanced by encouraging and facilitating contact between the members of the two organisations. Such contact also improves trust and mutual respect that aid in free information sharing and learning from each other’s skills and capabilities. Research in both alliances and acquisitions show that having a formal process to capture lessons-learned from previous agreements also helps the organisation to perform better in the next alliance.

6.3.1

Knowledge Retention

Many firms active in offshoring are also taking active steps to escalate the pace of learning, by pooling the knowledge about BPO from different parts of the organisation. For example, in Deutsche Bank, Barclays Bank and the Virgin group, offshoring business processes started as autonomous initiatives on the part of some businesses, typically close behind the decision to offshore IT services. As these initiatives gained momentum, senior management set up more formal offshoring ‘expert centres’ that centralise and codify the knowledge from these experiences to better execute future deals. Such formalisation is facilitated by having a centralised function that is responsible for alliance related activity that serves as the coordination hub for the individual divisions, as well as having personnel with specialised expertise that other parts of the organisation can leverage.

6.3.2

Trust

Trust as a phenomenon has many meanings, but no widely acknowledged definition. The notion of trust has been studied by a number of disciplines, each emphasising different aspects. Economists tend to view trust as calculative, psychologists emphasise the personal attributes, while sociologists consider the institutional properties. Organisational scholars have noted that coordination and control rest upon a foundation of trust. Trust is seen by many as an inherently individual level phenomenon, however, individuals act within institutional and social contexts, and therefore institution based trust is important. Interpersonal trust and inter-organisational trust are related but empirically and theoretically distinct concepts. Inter-organisational trust emerges as the overriding driver of exchange performance, negotiation, and conflict, whereas interpersonal trust exerts little direct influence on those outcomes. Trust is often treated as a precondition for successful collaboration in the literature. Trust can be seen as an enabling condition, which facilitates the

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formation of ongoing networks. It is often argued that a certain minimum level of inter-firm trust is indispensable for any strategic alliance to be formed and to function. The process of trust development is central to managing an outsourcing engagement. It affects how agents negotiate, execute, and modify an outsourcing agreement and strongly influence the degree to which parties judge it to be equitable and efficient. The process influences motivations to continue in, or terminate, the relationship over time. Successful outsourcing relationships it is argued, are maintained not because they achieve stability, but because they maintain balance: balance between formal and informal processes. There are many factors which influence the development of trust. Issues such as communication, exchange of information, and cultural convergence are critical in managing the relationship. Differences in cultural background and working life could create difficulties in offshore outsourcing relationships (see Table 6.1). Outsourcing relationships in the future will be with preferred and trusted suppliers, with greater attention likely to be given to performance based contracts, strategic alliances and partnership arrangements. The confidence both parties have in a business relationship is determined by the level of trust and the perceptions of how good or poor are the controls that govern a deal. Trust and Control Long-term outsourcing deals are usually constructed to rely on “control,” which organisations understand, rather than on trust, which is often perceived to be a less objective, and therefore more difficult, concept. In reality, a combination of both trust and control is always in play. Optimal relationships rely on the right balance

Table 6.1 Trust indicators Indicators Meanings Capability The technical, management and financial skills and resources to do the job Congruency Perception and reality are the same Predictability The ability to set and meet expectations such as financial certainty, financial stability and delivering to targets Dependability Both parties can anticipate how each other will perform and behave, particularly in changing and unpredictable circumstances. They are confident in each other’s capabilities to get the job done Mutuality As shared committed to a common goal Communications Giving and receiving the correct information in a meaningful way and time Consistency Standards, processes and protocols are understood and consistently applied Responsiveness The ability and willingness to understand and react to new circumstances and to harness skills and resources to meet those needs Compatibility An understanding of the differences between the service provider’s and customer’s delivery models Reputation Built up by consistent, independent validation, usually from personal experience, word of mouth, or from client references

References

91

between trust and control, and it is this combination that results in the perceived level of “confidence” each party has in the relationship.

6.4

Take Aways

• The benefits from outsourcing are significant and go beyond cost savings. However, the rewards that are sought must be aligned to the broader organisational strategy, and must be clear between the stakeholders; • Rewards can include cost management, focus, access to expertise or technology, flexibility and faster time to market. • Risks from outsourcing can also be significant and range from loss of core competence, cost escalations, supply market risks and change management costs. • Managing risks from outsourcing requires a combination of strong legal contracts and a relationship with the service provider that is based on trust.

References Goles, T., & Chin, W. (2005). Information systems outsourcing relationship factors: Detailed conceptualization and initial evidence. Database for Advances in Information Systems, 36(4), 47–67. Kakabadse, A., & Kakabadse, N. (2005). Outsourcing: Current and future trends. Thunderbird International Business Review, 47(12), 183–204. Lacity, M., & Hirschheim, R. (1993). The information systems outsourcing bandwagon. Sloan Management Review, 35, 73–86. Lacity, M., & Willcocks, L. (1998). An empirical investigation of IT sourcing practices. MIS Quarterly, 22(3), 263–408. Saunders, C., Gebelt, M., & Hu, Q. (1997). Achieving success in information systems outsourcing. California Management Review, 39(2), 63–79. Willcocks, L., & Kern, T. (1998). IT outsourcing as strategic partnering: The case of the UK inland revenue. European Journal of Information Systems, 7(1), 29–45.

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7

Sourcing Models

There are various sourcing models available to organisations from the use of captives, Joint Venture (JVs) to traditional outsourcing arrangements. Within traditional outsourcing arrangements, there are also various engagement models available, from the basic staff augmentation model to a more comprehensive managed service model, and a number of models in between. Each model has its own pros and cons, but fundamentally the right model for any given organisation depends on the capability of the organisation to manage the relationship and what specifically is desired from the outsourcing engagement. This chapter examines these sourcing models.

7.1

Evolution of Sourcing Models

There are a number of sourcing models available to organisations with outsourcing being just one. Most of the organisations, certainly the financial sector, originally started by using captives in an attempt to manage the operations closely and manage the risks from moving from their traditional organisational structures. Some organisations used Joint Ventures to both manage the operations and get in depth local knowledge, or to create additional value from the sourcing activity – migrating from a cost centre to a profit centre. Some risk adverse organisations sought the help of local outsourcers who bared the risk of offshore sourcing. Increasingly what we see are many more organisations using the pure outsourcing model, liaising and contracting directly with the outsource service provider, wherever they are based. These models are detailed in Table 7.1. Of these models, the third and fourth are the more risky and require greater attention to the written contract, as this remains the only real means of control. The third model is the more typical, especially for small and medium sized firms that wish to benefit from offshoring.

B. Vagadia, Strategic Outsourcing, Management for Professionals, DOI 10.1007/978-3-642-22209-2_7, # Springer-Verlag Berlin Heidelberg 2012

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Sourcing Models

The first and second model are essentially followed by large multinational corporations who may have the resources to utilise consultants and lawyers to identify, evaluate and minimise some of risks that may be apparent. Indirect Third Party models are still a relatively recent addition and generally immature. Because the agreement is with a firm based locally, in the same jurisdiction, the legal and managerial relationship may not be as challenging as the more direct model. Beyond these broad sourcing models, there are different operational models, in terms of how the organisation engages with the service provider, from the basic staff augmentation model to the more comprehensive managed service model and the many other variations that sit in between the two, as detailed in Table 7.2. Table 7.1 Sourcing models Captives Direct Captive – a firm using its own resources to create, own, manage and control an organisation within an offshore destination, often known as captive centres – i.e. offshoring but not outsourcing Joint Ventures Joint Venture – a local firm may partner with an offshore entity for shared control of the offshore operation – again offshoring but not necessarily outsourcing Pure Direct Third Party – firms outsource to a third party service provider located outsourcing offshore. Control of the working arrangement is governed strictly by the contract terms agreed with the third party service provider – i.e. offshore outsourcing Local Indirect Third Party – an organisation may enter into a contract with a domestic partnerships outsourcing service provider, who then subcontracts out all, or a part of the work, to an offshore company – essentially the indirect third party may bear some of the risks for a given payment consideration – i.e. an outsourcing arrangement, whose objective is to offshore, but whose agreement may be based with an onshore outsourcing intermediary Table 7.2 Sourcing engagement models Model Features Pros Cons Staff ∙ Typically used when ∙ Client will have access to ∙ Even though quality can augmentation certain skills are not quality resources without be closely monitored by available in-house to having to budget for the client, if the execute a project corporate overheads deliverable is not up to standards, client cannot hold the vendor responsible. At best, what can be done is to get the staff replaced immediately at no cost to the client ∙ Widely used when the ∙ Tactical time to market ∙ Knowledge retention client requires additional gains remains a challenge. head-count to tide over a Clients may not always short period of increased get the same personnel work to work on projects within the same area if they re-engage the same vendor after a time gap (continued)

7.1

Evolution of Sourcing Models

Table 7.2 (continued) Model Features ∙ The client is fully responsible to manage the staff

∙ The consultants are normally located onshore at the client’s location Managed services

∙ Also known as the Fully Outsourced Model, this is where the vendor takes complete, end-to-end responsibility of a set of deliverables in a project – SLA driven ∙ Vendor also has complete decision making responsibilities in providing the agreed set of deliverables

∙ Budgets are set for a certain period of time

∙ Can resemble a fixed price managed services engagement

∙ Adopted when the work can be clearly scoped out with clear deliverables

∙ For this model to work, the vendor should have an excellent understanding of the

95

Pros Cons ∙ Quality of deliverable ∙ This model is expensive can be closely monitored in the long run as staff are directly under the control of the client ∙ Budget variances in the project will be minimal and costs can be accurately forecasted ∙ Cost flexibility ∙ Vendors are sometimes ∙ Since delivery and reluctant to assume more management of stakeholder expectations management responsibilities are the responsibility of the vendor, the client organisation can fully focus on their core strategic initiatives ∙ Culture mismatch ∙ Vendors can be more between client and independent and can vendor organisations can have a relatively often result in lack of interference-free understanding among management of the both parties, which in project turn can affect deliverables ∙ Enables vendors to make ∙ In some situations, vendors won’t be in a long term strategic position to understand investments that should all of the client indirectly benefit the organisation’s pain client organisation points ∙ Vendors can also bring ∙ In a multi-vendor scenario, blame games their best practices into are common, with both the project, thereby parties not willing to making key process assume responsibility for improvements failures ∙ Switching costs from one ∙ The SLA driven approach can, to a great vendor to another or extent, put to rest clients’ bringing back in-house can be difficult worries about management of stakeholder expectations ∙ SLA driven approach ∙ Typically only justified can also result in key for only complex process improvements, outsourcing programmes delivering significant, (continued)

96 Table 7.2 (continued) Model Features

7

Pros

Sourcing Models

Cons

client’s organisation and measurable benefits to systems the client organisation ∙ The role of the client will ∙ Knowledge retention be that of a reviewer with becomes more additional responsibility streamlined and of contract management sustainable and budget tracking ∙ Adopting a managed services model from day one comes with risks ∙ Vendors generally tend ∙ Outsourcing Co-managed ∙ Usually adopted by to take a back-seat and organisations can have organisations when the become more tight controls over nature of the process/ comfortable doing mission critical systems involved is too mundane tasks as critical processes and functions critical to allow the decisions are taken by vendor complete control within the outsourced the client, resulting in system without of the delivery of client spending more bothering about low services time in decision making level, day-to-day details ∙ Pursued when ∙ Quality of deliverables ∙ Client will spend a lot of organisations do not can be managed at a high time in tackling vendor have complete level by the client, and at issues and management bandwidth gets confidence about vendor the same time vendor unnecessarily stretched capabilities teams can be less stressed about managing stakeholder expectations ∙ This model gives the ∙ There will be a vendor teams an designated Project or opportunity to get closer Program Manager from both sides to manage the to the stakeholders and get to know their engagement expectations better so that it becomes easier to move into a Managed Services model ∙ Client needs to set aside ∙ There is an agreed rate ∙ This model is very Time & effective if there are too management hours for per hour between the Material controlling and tracking many unknowns in a (T&M) based vendor and the client vendor resources project organisation including the approval and clearance of timesheets ∙ This model also enables ∙ It is often difficult to ∙ The number of hours clocked are tracked the client organisation to provide accurate budget estimates through a time sheet quickly ramp-up and ramp-down project system teams as per requirements and budgets (continued)

7.1

Evolution of Sourcing Models

Table 7.2 (continued) Model Features ∙ Sometime vendor organisations define a minimum hours of utilisation in order to cover fixed costs

Managed capacity

Fixed price

∙ Typically used when the scope of work and the deliverables cannot be clearly defined. It is also utilised when a certain level of R&D needs to be done ∙ This model has a maximum limit on the amount that can be charged to the customer ∙ It is very effective in situations where the nature of work is likely to change or different types of work are required at various phases during the tenure of the outsourcing contract. But the final outcome of all these pieces of work will be pre-defined and definite ∙ Critical success factors include accurate definition of scope and a definite estimate of the work-load ∙ Vendor need not track the work being completed through timesheets, but the utilisation of project resources is to be conveyed to customer ∙ Fixed price model demands that the scope of work, the milestones and the final deliverables are clearly defined and agreed between client and vendor

97

Pros Cons ∙ It is the model of choice ∙ Vendor will not take for the initial phase of responsibility of new development deliverables and projects management of stakeholder expectations

∙ This model facilitates ∙ It is often difficult for better budget control and customer to track financial planning for the resource utilisation customer ∙ This model also enables ∙ Customer cannot monitor resource the customer to buy a portfolio of services and movements unless resources are named and skills from the vendor tracked on a regular organisation that in turn basis provides the customer a lot of flexibility in managing its own department/functions

∙ Ramp-ups and rampdowns of project teams are easier to manage

∙ This is arguably the only ∙ The fixed price model increases the model that provides an responsibility on the part accurate forecast of budgets of the client to select the best-fit vendor for the job, thereby adding to the overall risk (continued)

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Sourcing Models

Table 7.2 (continued) Model Features Pros Cons ∙ Project requirements are ∙ As it is a fixed price ∙ Inaccurate requirements, very clearly defined at project, it will enable the scope and estimates will the start of the project client organisation to get result in disastrous the required return on circumstances investment if the estimates have been drawn accurately ∙ Standard operational ∙ Vendors will also be able ∙ The risk increases as the procedures need to be to make strategic value of the project followed by client and investments into their increases vendor own technology ∙ Periodic reviews have to practices as well as into ∙ The model is not flexible client relationship be carried out as changes mid-way will throughout the course of management be subject to change the project control procedures, and more often a lot of ∙ Billing is typically done management time is lost in phases in such exercises Hybrid based ∙ In most organisations, a ∙ Provides flexibility, ∙ The management time hybrid model of allowing the required in developing outsourcing can be seen organisation to move to and managing multiple in operation. The hybrid a different model as deals model may comprise circumstances may Staff Augmentation, demand Managed Services, ∙ Loss of an end to end ∙ If the system is highly Managed Capacity, mature and is understood solution, with the Fixed Price, Time and inherent control clearly by the client Material or T&M and problems organisation and the Co-Managed models in vendor, then it is a operation at any point in perfect candidate for time Managed Services or Capacity. If it is not mature, then it could be subjected to Staff Augmentation or T&M or even Co-Managed

7.2

Take Aways

• Outsourcing is but one of the sourcing models available and its use must be driven by availability of resources by an organisation. • Staff augmentation is the simplest engagement model and has been the model of choice till now. It is fundamentally driven by the desire for cost reduction through labour arbitrage, rather than the broader business benefits. • Managed services can deliver broader business transformation but need serious commitment from both organisations.

7.2

Take Aways

99

• A time and materials model is similar to the staff augmentation model, fundamentally driven by the desire for cost reduction. • A managed capacity model can deliver better budget control and financial planning for the client organisation and benefit from technology innovation delivered by the vendor. • A fixed price model provides security and financial control, but vendor selection becomes important. • A co-managed model is the half way house, giving the client control whilst deriving benefits from a vendor in terms of cost and flexibility. This model however, requires strong governance structures for it to work.

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8

Strategic Outsourcing Decision Governance

The decision making process for outsourcing is not an easy one. The process must not only consider what functions or processes should be outsourced, but also the relationship that must be established to deliver those rewards, whilst containing the risks. Traditionally, organisations sought to move straight to the vendor selection process, rather than systematically considering the most appropriate sourcing and engagement model. One of the fundamental flaws of decision making is that the decision is guided by the heart rather than the head. This chapter examines the decision making process and details the seven deadly sins of strategic decision making.

8.1

Introduction

Like any organisational decision, outsourcing is not free of risk and requires effective management from the outset and through the life of the contractual relationship. Few companies have taken a strategic view of outsourcing decisions and the disappointing results are not due to there being any inherent mistake in the practice of outsourcing, but rather, are rooted in poor management decision making. The absence of such a framework has led to a situation where outsourcing decisions have been made most frequently by default, without considering the long term consequences for the competitiveness of the organisation. There are a range of option available to organisations when it comes to business improvement at a process or a function level, ranging from mere tactical outsourcing to more strategic outsourcing. The matrix (Fig. 8.1) characterises four options that are available, being dependent on how critical the process or function is to the organisation and its competitive advantage and how capable the organisation is at performing that process or function. The vertical axis considers how important the activity is to achieving long term strategic competitive advantage. For a software firm, for example, competitive advantage is largely driven by innovation, release management and support. Code B. Vagadia, Strategic Outsourcing, Management for Professionals, DOI 10.1007/978-3-642-22209-2_8, # Springer-Verlag Berlin Heidelberg 2012

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Strategic Outsourcing Decision Governance Internal • Unique historical conditions • Social complexity • Causal ambiguity • Influence of knowledge • Technology influences

Critical to competitive advantage

Not critical to competitive advantage

Invest to perform internally or strategic outsource

Perform internally and develop or strategic outsource

Outsource

Outsource or Keep internal

Less capable

More capable

External • Macro level influences • Industry level influences • Market level influences

Fig. 8.1 Strategic sourcing choices

developers who understand the business need and can consistently deliver errorfree code clearly are of strategic competitive importance. Outsourcing the code development function in this environment would, in effect, be handing over control of this potential source of competitive advantage to an external party. On the other hand, code development to a hospital may be of less strategic importance, and therefore could, potentially be a candidate for outsourcing. The horizontal axis relates to how competitively the function being considered for outsourcing is currently being performed compared to the external competitive marketplace. This relates primarily to quality, speed and cost. Putting the two elements together gives four possible outcomes: • Functions that are of strategic importance and being performed well in comparison to the market must be kept in-house or outsourced to a strategic partner; • Functions that are of strategic importance but may not currently be performed competitively with respect to the external marketplace should be re-engineered to ensure that they are performed effectively and at a competitive cost. It is possible that, as an interim measure to speed the transition process, a tactical decision is made to outsource the function in the short term again to a strategic partner; • Functions that are not of strategic importance to the company and which are not currently being performed competitively with the external marketplace should be outsourced. There is little value in investing in improving this function when there are Outsourcers who have this as their core business. • The final combination, those functions that are not of strategic importance, but which are being performed competitively with respect to the external marketplace is more interesting. If the company can perform this function competitively, then a recommended path might be to transfer it to the outsourcer for ongoing management.

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Introduction

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Strategic outsourcing transfers most equipment, staff and responsibility for delivery services to a vendor, while selective outsourcing is the outsourcing of one or a few selected processes or functions. Total outsourcing isn’t easy because of the scope of the endeavour and because of the consequences if it isn’t done well or if it shouldn’t have been done at all. The stakes are high. Strategic outsourcing is a major undertaking and no organisation should do it without considerable thought. These deals are often structured to last for long periods – usually more than 5 and often 10 years. Vendors plan to make their margins on economies of scale and on replacing hardware in the future at costs that are substantially below costs today, in the case of ITO. Strategic outsourcing arrangements only yield acceptable margins over longer periods of time. Moreover, clients who enter into strategic outsourcing arrangements must spend considerable time and effort analysing the deal and contracting with a vendor. Technology will certainly change over a 5 or 10 year period. The business environment will change, yet it is hard to set contracts that allow for large changes in scope. If the arrangement with the vendor does not succeed, it is necessary to either contract with another vendor, which involves substantial costs and disruption, or it’s necessary to bring the function back inside the organisation with all the attendant costs and problems. This is not to say that strategic outsourcing should never be considered, but must be considered carefully looking at both the legal and psychological contract between the organisation and the vendor. It is also important as part of the outsourcing decision making process to consider aspects beyond those traditionally associated with outsourcing contracts. These need to include: trust, communication, cooperation, conflict management, cultural awareness and commitment from both parties. The outsourcing decision must consider, and be driven by: • The nature of the sourcing contracts; • The contractual and informal relationships between user and provider; • The use of market opportunities for competitive advantage; and • Successful management of outsourcing relationships and contracts. Figure 8.2 illustrates the typical high level process for outsourcing decision making. Executives are entrusted to make difficult, complex outsourcing judgements critical for their organisation’s success. A wrong decision can cost the company dearly at best and can put the business in jeopardy at worst. However, many businesses (and the public sector) simply jump onto the outsourcing merry-go-round, and once they’re on, it’s more or less impossible for them to come off, as the recent defence contracts in the UK showed, where the outsourcing vendors have the client, “the UK tax payer”, in a very difficult position.1

1

The HMS Ark Royal will be axed “with immediate effect” along with its fleet of Harrier jets, but two new vessels will be built at a cost of £5.2bn, because it would cost the taxpayer more to scrap the contract than to see it completed – UK Government Announcement on 19th October 2010.

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Establish the strategic intent Strategic Fit

Which structure will best help meet strategic and operational goals given core competencies, competitive landscape, and growth objectives?

Economic Impact

What are the required investments (time and money) versus the anticipated benefits (savings and service level improvements) of each option to stakeholders?

Required Timing

What is the required timeframe to reach steady state and achieve payback on investment?

Operating Model

Which structure will best enable organisation to achieve best-in-class performance in our required timeframe?

Cultural Fit

Should you view an outsourcer as a partner and will an outsourcing partner offer bestin-class capabilities vs. In-sourcing?

Risk Management

What are the regulatory, operational, socioeconomic, and financial risks of each option and how can they be mitigated?

• Management consensus regarding vision for the Outsourcing and why it needs to be implemented • Essential to define prior to defining operating model and organisation design • ALL downstream decisions require a clear understanding of the ultimate goal

Define the model • Define comprehensive Front Office / Back Office process model • Understand real business opportunities and constraints • Take holistic approach to organisation design including ‘retained operations’ • Leverage technology

Develop the business case • Critical input for the investment decision • Necessary to convince management and businesses to pursue Outsourcing • Forms baseline for measuring progress and success • Identifies constraints / requirements for later design • All subsequent steps undertaken if the business case is attractive

Fig. 8.2 Strategic intent to reality

Organisations would be wise to have a thorough decision making process which starts by questioning why they need to change the status quo in the first place: • Why are you thinking of outsourcing anyway? • What is the most appropriate sourcing approach – is outsourcing the only answer? • What type of sourcing engagement model is appropriate at that moment in time? • What type of relationship is being sought or should be sought with a vendor, given the environment, internal capabilities, enabling infrastructure, resources etc. • What is the most appropriate project management approach? • What is the most appropriate governance model? • To what extent is security important and what does that mean in terms of sourcing arrangements? • What are the must have and nice to have contract clauses, clauses that help the organisation realise business goals, rather than tick all the boxes that a lawyer will have listed for the sake of completeness? • Which vendor meets the organisation’s requirements, will fit into the business culture, and have the relational attributes that make a partnership model possible?

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Introduction

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Many jump to the last of these stages, straight to thinking about “which vendors do we know about” and “who can we get them to respond to an RFI/RFQ”, ignoring the soft factors in vendor selection. A proper starting point should be the identification of the various stakeholders affected by, or who have an interest in the outsourcing programme. The next stage calls for an appropriate decision framework, which allows the organisation to rationally take input from these stakeholders to build a picture of what the “organisation” needs, and would require, from an outsourcing programme. Unless you get all these stakeholder requirements, and more importantly prioritise them, they will never be contractualised, and there won’t be any control over success or failure. Vendor selection should be the least of your worries. If the organisation has built a thorough decision framework and applied it to the stakeholders, and prioritised the organisational requirements, this could quite easily become the template for evaluating the most appropriate suppliers that can meet these needs – in this sense; the process aligns internal stakeholders, aligns the customer and supplier, and helps align cultures. Executives on the whole assume managers make rational decisions and chose the best option available to them, however when it comes to outsourcing, most decisions are guided by the heart rather than the head. Making the right decision is less important than focusing on how the decision is made! In constructing an outsourcing decision process, executives should be mindful of the seven deadly sins of strategic decision making: 1. Availability heuristics People usually assess the probability of an event by the ease with which occurrences of the event come to mind. However, availability is affected by factors other than frequency and probability. We have a tendency to give preference to recent information, vivid images that evoke emotions and specific acts and behaviours that we personally observe and relate to. All these cause biases in decision making – i.e. why the public sector is hell bent on going down the outsourcing route, is because they assume (sometimes wrongly) that outsourcing “always” delivers significant savings. . . 2. Representativeness Unrecognised tendency of decision makers to judge the likelihood of an event’s occurrence based on its similarity to previous events leads to representative bias, i.e. outsourcing can save at least 20% from our current costs. If managers challenged these assumptions and long held beliefs, they may come to a more realistic conclusion – i.e. around a third of deals result in an overall loss. . . 3. Anchoring and adjustment Anchoring is a widely prevalent trap in decision making. It is so common that sometimes it is hard to think that the decision may be biased. The mind gets anchored on initial assumptions so much that any decision made subsequently revolves around what was presented initially – i.e. we need to save a bucket load, therefore outsourcing has to be the answer. . .To ensure that the decision making process is not guided by such anchors, executives must view the issue from

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5.

6.

7.

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Strategic Outsourcing Decision Governance

multiple perspectives, involving people with different thinking styles and creating an environment for dissent and debate. Loss aversion Loss aversion is a human tendency to prefer avoiding losses than acquiring gains. Loss aversion leads to status quo bias in decision making where people prefer maintaining the status quo to avoid losses – i.e. we’ve been doing this for years, so it must be a core competence and surely it shouldn’t be outsourced. . . Mental accounting Mental accounting is a set of cognitive operations used by individuals to organise, evaluate and keep track of financial affairs. Existing outsourcing programmes may have less stringent controls compared to current outsourcing deals, whereas, there may well be more to gain from scrutinising existing programmes – i.e. managers should set a clear set of criteria for evaluating performance on an ongoing basis, with continuous improvement being fundamental to long term outsourcing programmes. . . Hindsight bias Hindsight bias is a tendency to see things more predictable and obvious when they have occurred, whereas in fact the event could not have been reasonably predicted before the onset of the event. It is easier to reconstruct why something worked or did not work after the event has happened. Managers can assume the future as more predictable in developing strategies than maybe the case. As a result, they may face challenges executing those strategies or may not achieve projected results when the external environment changes. In this era of high uncertainty in the external environment, there is even more need to be aware of hindsight bias – i.e. Scenario modelling and organisational flexibility are paramount. . . Over confidence Being confident is considered as a great asset, unfortunately however, we systematically overestimate our decision making abilities compared with what objective circumstances would warrant. If the skill required is great and the task is complex, we tend to get even more confident of our abilities and judgment. Related to overconfidence is a bias of over-optimism. We tend to be over optimistic in predicting what we desire will happen. When we have more information, we feel more confident (illusion of knowledge). Similarly, if we spend more time on analysing the situation and have a long of prior successful outcomes, we feel we have more control over the outcome (illusion of control). The tendency to see the future through the lenses of over confidence and overoptimism can create unrealistic forecasts which are not met – i.e. estimation of synergies in an outsourcing partnership, that never materialise post deal.

8.3

Suggested Decision Process for Outsourcing

8.2

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Decisions Driven by Consensus and Debate

Deeply held assumptions about customers, competition, business models can become so ingrained that the organisation can go on blindly accepting conventional wisdom. Pressures for conformity by individuals also arise because of the relatively homogeneous groups of like-minded people that may make up the senior management within the firm. The absence of healthy debate and dissent frequently leads to unwise decisions. Of course, conflict alone does not lead to better decisions. Executives also need to build consensus in their organisations. Consensus should not mean unanimity and complete approval by a majority of the stakeholders. Consensus must have two key components: • A high level of commitment to the chosen course of action – helping prevent the implementation process from being derailed by departments or individuals who object to the selected course of action. Commitment can also encourage managers to persevere in the face of obstacles. • A strong, shared understanding of the rationale for the decision, allowing individuals to coordinate their actions effectively, and enhance the likelihood that everyone will act in a manner that is consistent with the spirit of the decision. When executives do engage in debate (which doesn’t happen that often) during the outsourcing decision process, people can become dissatisfied with the outcome, disgruntled with their peers or seniors and putting it politely, not fully dedicated to the implementation programme. Conflict may diminish consensus, and thereby hinder the execution of a chosen course of action. The real challenge is therefore to foster conflict and dissent that enhances the quality of decisions while also building the consensus required for successful implementation of an outsourcing programme.

8.3

Suggested Decision Process for Outsourcing

8.3.1

Defining the Objectives

Before starting engaging in the outsourcing process, it is vital to think through thoroughly the outsourcing lifecycle and answer some of the high level issues, including whether outsourcing is the right approach for the organisation; what the optimum engagement model is, given the strategic importance of the process/ function and the capability of the supplier community; the relationship attributes that are deemed appropriate in achieving the longer term goals; the type of quality and project governance framework deemed necessary; the detailed security arrangements required, especially with respect to constraints imposed by regulatory obligations (see Fig. 8.3).

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1. What is the optimum Sourcing Approach, given Organisational Readiness?

• • • • •

In House Optimisation Business Process Re-engineering Outsource Shared Service Captive

2. What is the optimum Engagement Model for Organisation?

• • • • • • • •

Staff Augmentation Out -Tasking Project Based Outsourcing Managed Outsourced Service Outsource offshore Outsource nearshore Shared services Offshore captive

3. Which Relational Attributes are most important?

• • • • • • • •

Coordination & Collaboration Contractual Control Knowledge Management Communication Trust Commitment Culture Conflict Management

Strategic Outsourcing Decision Governance

4. What kind of Quality Management approach is being sought?

• • •

Service Performance Focus Business Level Impact Focus Balanced Scorecard Focus

5. What kind of Project Governance Model is suitable?

• • •

CMM methodology Six Sigma methodology Relational management

6. What type of Security Arrangement is required?

• • •

Business Continuity Focus Physical Security Focus IT & Data Security Focus

7. What type of Contract and Causes are required?

• • •

Comprehensive Global Contract Flexible Contract Balanced Relational Contract

8. Who is the most suitable Vendor to deliver? • Vendor 2 • Vendor 1 • Vendor 3

Fig. 8.3 The sourcing decision dilemma

Outsourcing must be done carefully, systematically, and with explicit goals. Organisations that rush into outsourcing without fully and explicitly understanding what they hope to gain may find themselves mired in a contractual battle with a chosen vendor. Outsourcing is not an excuse to wash management’s hands of a poorly managed, costly, or misunderstood function. Organisations must fully understand the costs of a function and manage it effectively before evaluating its potential for outsourcing, anything else and organisations may simply be deciding to outsource for the wrong reason, maybe outsourcing a sub-optimal performance which carries on being delivered by vendors sub-optimally, and starting a relationship that is destined to fail. Organisations should consider (or reconsider) the overall outsourcing decision every 2–3 years (and the contract must enable this), especially in fast moving industries and with the pace of market conditions, technology and international competition becoming increasing volatile.

8.3.2

Outsource for the Right Reasons

Organisations must assess outsourcing’s potential tactical and strategic benefits and disadvantages. Potential disadvantages (amongst others) include: outsourcing for the wrong reasons, losing control of the resource, losing personnel who have been trained in the organisation’s particular business practices and have become a part of the organisational family, and the risk that the outsourcing vendor may not be able to achieve the desired benefits or may fail in providing critical services.

8.3

Suggested Decision Process for Outsourcing

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The outsourcing initiative should be part of a larger one regarding how the function or functions being evaluated for outsourcing fit into the organisation. In deciding to proceed along the outsourcing path, the organisation must ask itself and have convincing organisational wide answers. As part of the sourcing evaluation, questions like the following should be answered: • What are our core competencies today and tomorrow and what impact will outsourcing have on maintaining our competitive advantage? • Which services or corporate functions are integral to or close to our core competencies? • What are the barriers raised by the corporate culture at the decision stage, the transition stage and at the implementation stage? • What is the likely cross-functional impact from outsourcing on the remaining processes and/or functions? • Is the process or function being considered, deemed relatively optimal, can we fix ourselves internally before we consider outsourcing? • What might be better accomplished by an outside vendor – why couldn’t we, or what is stopping us doing this ourselves? • What are the bought-into goals we want to achieve from outsourcing? • What kind of relationship with a vendor is most appropriate, and why? • How do we deal with the people issues?

8.3.3

Using a Methodical Approach

The process of deciding whether to outsource should involve numerous steps in the process. The Governance Director decision modelling framework is a useful reference here, it provides a methodology that describes the various steps to be performed and lays out the decision criteria necessary for a thorough evaluation. It consists of eight phases in the decision process, starting from an evaluation of sourcing readiness and ending at phase 8 with vendor selection. Each phase’s decision output feeds into the next phase to ensure that the decision has an end to end rationale, such that vendor selection is undertaken in a rational manner which considers the relative importance of the preceding phases (see Fig. 8.4).

8.3.4

Engage with All Stakeholders

Executives who have made the decision to outsource should be able to predict the likely impact that outsourcing will have on the organisation’s stakeholders, which includes shareholders, customers, suppliers, employees, unions etc. After anticipating the impact of an outsourcing evaluation on stakeholders, executives should include the revealed issues in the outsourcing plan. As an example the desired goals from outsourcing for an IT outsourcing programme would be very different for different stakeholders and their expectations would also differ (see Fig. 8.5 – example of IT).

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1. Sourcing Readiness Long Term Requirements Short Term Priorities Organisation-wide Readiness Performance Measurement Capabilities External Suppliers Service Capabilities Risk Manageability Stakeholder Readiness Positive Business Case Enabling IT & Security Infrastructure Project Definition In-House Service Capability

7. Contract Development Contract Heads of Terms Contract Responsibility Warranties, Liabilities, Damages Contract Commercials Transition Performance Reporting Requirements Staffing Provisions Compliance Requirements Termination Rights Data Protection and IPR Protection Provisions Technology and Infrastructure Provision

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Strategic Outsourcing Decision Governance

2. Sourcing Engagement Model Alternative Sourcing Solutions Appraisal Competences in Managing External Relationships Asset and Knowledge Specificity Organisational Constraints Transition Management Capability Contract Management Capability Supplier Location

8. Vendor Selection Vendor Business History and Specialisation Vendor Corporate Performance Vendor Governance, Measurement and SLAs Vendor Quality Assurance Vendor Management Philosophy and Capability Vendor Customer Support Capability Vendor Telecoms and IT Infrastructure Vendor Legal and Contracting Compliance Vendor Organisation Management Vendor Market Understanding Vendor Personnel Management Vendor Innovation Vendor Security & Compliance

6. Security Arrangement Confidential Information Assets Control Vendor Physical Security Controls Vendor Information Security Controls Vendor Business Continuity Assurance

3. Relationship Management Model Vendor Business History and Specialisation Coordination & Collaboration Contractual Control Knowledge Management Communication Trust Commitment Culture Conflict Management

4. SLA & Quality Management Model SLA Design Competences Metrics Design SLA Measurement Competence SLA Reporting Framework SLA Control SLA Quality Management

5. Project & Governance Management Model Project Management Capability Financial Controls Business Outcome Management Dispute Management Compliance Governance Structure Contract Management

Fig. 8.4 The detailed outsourcing decision process

Stakeholder

Perspective of outsourcing

Customer’s senior manager

Business benefits. Added value

Customer’s senior IT managers

Contractual commitments. Live within budget

Customer’s IT staff

Performance of service provider and Impact on jobs

Service users

More and better services

Supplier’s senior management

Maximise profits and Keep customer happy

Supplier’s contract

Service and profitability targets

Supplier’s IT staff

Technical focus

Fig. 8.5 Stakeholder perceptions in outsourcing – example of IT outsourcing

Early in the evaluation, stakeholders must be identified who will take leadership responsibility, perform the analysis, and make the decisions. Once the decision is made to outsource, the project team must identify stakeholders who will be given responsibility for oversight and management of the outsourcing engagement and supplier relationship management after the contract is signed; they should be part of the team that crafts the contract also. When outsourcing threatens to upset the status quo in an organisation it may not be possible to rely on internal sources for accurate estimates of internal costs or internal effectiveness. Under these circumstances, bring in objective outsiders for the assessment work.

8.3

Suggested Decision Process for Outsourcing

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Many executives in governance roles in larger organisations make the mistake of considering their role as one of “making” strategic decisions and making business strategy rather than “taking” strategic decisions and delivering strategic direction. In so doing, by taking the responsibility for making the strategic decision and business strategy they lose the right to sit in judgement or act as arbitrator when things go wrong. The strategy and strategic decision becomes their ruler, rather than them ruling the strategy. Inevitably it makes it more difficult to force a change in strategic direction when needed. Business leaders need to look more closely at how their organisation can make and propose decisions without moving the responsibility for the decision to the business leaders. The more important the decision, perversely the more important it is for a business leader to take a decision ratification role rather than decision maker/owner role. But if you take the decision making role away from business leaders, they need to be assured that the right decisions are being made. This puts the onus onto business leaders to put in place methodologies, processes, systems and tools to ensure decision making is carried out to the highest standards, that the right people and stakeholders are consulted and that decisions are robust and fully transparent and documented. An executive sponsor or champion is recommended, and in cases that involve organisational politics such support is absolutely critical. The team needs a mix of managerial and technical talent. The team should also include representatives from user areas that will be directly and heavily impacted by the outsourcing under consideration. User views may be critical for setting scope and for assessing risks. The size of the team depends on the scope and size of the project, but smaller teams are generally more effective than larger teams. Teams with full-time members are often more focused and effective than teams composed of people who work part-time. It helps to have people experienced in outsourcing on the team for the insight they bring to the issues and the realism they bring to cost and benefit estimates.

8.3.5

Choosing the Right Relationship

Contracting relationships can be viewed as a range or continuum. At one extreme are market-like relationships in which your organisation has a choice of many vendors capable of performing the work, relatively short contract durations, and the ability to switch to another vendor at the end of a contract for future work of the same type with little or no cost or inconvenience. At the other extreme are long term partnership arrangements in which your organisation contracts repeatedly with the same vendor and develops a mutually beneficial relationship that lasts a long time. Since it is a continuum, there are relationships that lie closer to market relationships and relationships that lay closer to partnerships, as well as those that are midway between the two extremes. Market relationships cost the least to set up and administer and are relevant for work that is fairly simple and straightforward. Intermediate relationships cost more

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and are relevant for work that is more complex and has substantial benefits. Partnerships cost the most and are most relevant when the benefits of a close relationship with a vendor are both substantial and necessary for success. Choosing the wrong relationship could result in excessive costs or failure.

8.3.6

Negotiating a Robust Contract

There are several critical components of a good outsourcing agreement. The emphasis from the outset should not be on who wins the best deal, but rather on negotiating a fair and reasonable contract for both parties. Because each aspect of the outsourcing relationship is governed by the contract, both your organisation and the outsourcing vendor need to agree on everything. This also means parties must try to think of every possible contingency to cover in the contract – it’s given that this is an impossible task, but the contract must be as comprehensive as possible. This therefore calls for parties to agree on how to resolve disputes or changes after the contract is signed. Such an agreement should not take the form of an open-ended assurance of goodwill (although trust is critical as I argue later for strategic outsourcing) but rather delineate the who, what, when, and where of conflict resolution. Obtaining the best value from an outsourcing contract requires a detailed breakdown of the prices for each component of the service. The organisation must build a detailed activity based costing model of its own cost structures to understand what could reasonably be offered by vendors. Sensible negotiation with vendors would otherwise be impossible.

8.3.7

Use of Performance Incentives

Successful outsourcing relationships focus on results. To be meaningful, these results must be objective, measurable, quantifiable, and comparable against preestablished criteria (the baseline). The specific performance criteria differ depending upon the types of services being provided, the customer requirements, and the level of service. Properly defined performance criteria for an outsourcing engagement are objective, quantifiable, and collectable at a reasonable cost, and should be metrics which can be benchmarked against performance of other organisations and providers, and must incentivise the right behaviour, ensuring the incentives of the individual managers on both the customer and vendor sides are also consistent with the overall goals and with each others’ incentives.

8.3.8

Establish a Relationship Governance Structure

The contract must provide for a formal relationship governance structure linking the customer and vendor. This structure typically takes the form of joint

8.3

Suggested Decision Process for Outsourcing

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management teams which have responsibility for day-to-day, tactical, and strategic aspects of the relationship. Each team has a clearly defined responsibility, agenda, frequency of meetings, and relationship to the other teams. Identification, resolution and rapid escalation of issues should be a key responsibility of these teams.

8.3.9

Establish a Relationship Management Function

A team must be established whose responsibility is to manage the outsourcing relationship for the organisation. They must be fully knowledgeable and have a complete understanding of the business goals of the contract, the specific performance criteria agreed to, and individual roles, responsibilities, authority, and reporting structure. The same information needs to be communicated to the larger end-user community. In this way, the entire organisation understands what is intended, why, how problems will be identified and resolved, what is expected, etc.

8.3.10 Managing Human and Communication Issues Although communication requires more effort than might be anticipated, it is critical to success. One of the first steps managers must take to ensure good communication is the establishment of various forms of communications (e.g., newsletters and organisation wide meetings) which help ensure that the right message is travelling as fast and as widely as possible. Keeping employees informed every step of the way and working out a deal perceived as fair for them is important because an organisation trades more than its physical assets to the vendor in an outsourcing arrangement – it often gives away its staff as well. The organisation’s employees may become the vendor’s employees, and individuals who feel they have been mistreated will have the power to bring systems down.

8.3.11 Single Versus Multi-Sourcing Single sourcing and multi-sourcing each has its pros and cons. Single sourcing can lead to lock-in, whilst multi-sourcing can lead to increased complexity which can be costly. Too many vendors can lead to too many different technologies or processes and make the task of managing all those various relationships difficult, ultimately leading to loss of management focus on what is actually core to the client, not least because of the integration challenges in creating a seamless end to end service. In multi-source deals, it is the performance of the client in terms of service management, control and governance that determines the success of the outsourcing programme (see Fig. 8.6). Arguably, clients seeking transformational benefit beyond cost, may find this is more achievable using a single sourcing, where

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Pros

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Multi-sourcing

Cons

• Better pricing from pure play providers (negotiation)

• Decreased integration between business processes

• Access to deep domain expertise (best of breed)

• Increased complexity in vendor management

• Diversified risk

• Lack of accountability

• Improved controls from separation of processes by vendors

• Difficult to get end to end SLAs

Pros

Single-sourcing

Cons

• Increased scalability and economies of scale

• Insufficient deep domain expertise

• Clear accountability

• No diversification of risk

• Better integration of processes

• No negotiation leverage

• Reduced vendor management requirements

• Less transparency and possibly control

Fig. 8.6 Multi-sourcing versus single sourcing

the organisation can bring their wealth of experience, their assets and scale without fragmenting the end to end process.

8.3.12 Understand the Vendors Vendors that offer various outsourcing services aggressively market and pursue organisations to adopt outsourcing. Executives should take care not to be misled by what other organisations are paying or what a vendor might casually offer as a possible pricing scheme (the BskyB v EDS (2010)2 case serves as a useful reminder). Because the path toward outsourcing can be a difficult one, executives should seek outside assistance to coach the internal team during the evaluation and negotiation processes. However, the organisation must have its own robust decision process in evaluating and assessing the outsourcing model, otherwise they risk being influenced by possible biases (or vested interest) that may be present within the advisory team. In strategic outsourcing engagements, it is important to ensure trust and communication is built in from the start; teams tasked with selecting the service provider should possess a comprehensive set of appropriate skills and experience that such a complex task demands. Some of these team members should continue

2 BSkyb Ltd & Anor v HP Enterprise Services UK Ltd & Anor (Rev 1) [2010] EWHC 86 (TCC) (26 January 2010).

8.4

Take Aways

115

working with the chosen service provider beyond the selection and contracting process, ensuring the continuation of the relationship and transfer of knowledge between the parties. The selection process must not only consider traditional factors (so called ‘hard’ factors) but include what may be called ‘soft’ factors in evaluating the service providers. The first place to start in determining these factors, is during the Request for Proposal (RFP) stage. Typically, many parties treat the RFP process as simply a gating process, using standard templates and processes. Firms do not view or use the process as a joint learning exercise, yet it can help form a useful basis upon which an appropriate contract and relationship can be created. Outsourcing negotiations are often protracted because confusion arises around the types and levels of services that the customer expects the service provider to provide. Drafting an RFP should include business, technical, operational and legal personnel. The approach the service provider brings to the table in negotiating the terms and conditions, may indicate the approach that it may bring in dealing with problems that will arise during the term of the deal. The process can help determine if the service provider has the requisite relational qualities that may be deemed necessary for a successful long-term relationship. The selection and contract negotiation process can be useful in getting the building blocks in place for developing trust and ensuring that the possible barriers in terms of communication, culture and commitment are understood and action initiated to surmount these, where possible.

8.4

Take Aways

• Outsourcing decisions must be guided by the head and not the heart. • The decision process must engage with all the stakeholders to ensure both buy-in and rigour in the decision process. • The outsourcing decision must be driven by consensus and debate. • Executives should be mindful of traditional flaws in strategic decision making: availability heuristics, representativeness, anchoring, loss aversion, mental accounting, hindsight bias and overconfidence. • The decision making process must follow a methodological process being driven by rationality, and stakeholder engagement.

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Transition and Relationship Governance

Transition is the greatest challenge of successful outsourcing, requiring great care and attention and needs to be guided by a transition governance framework to oversee smooth transition. A robust change management methodology must be employed to ensure transition risks are minimised and communication across the organisation managed effectively. Beyond transition, an effective governance structure must be established at different levels of the organisation. The role of the governance function must go beyond just contractual oversight. This chapter examines the role of transition management, governance and the role of the legal contract and Service Level Agreements.

9.1

Introduction

Transition encompasses the activities necessary for the vendor to take over service delivery responsibility from the organisation. Very few outsourcing projects achieve transition without teething problems along the way. The change from customer operated processes to service provider managed process can give rise to issues around culture, the usual change management fatigue that organisations suffer, as well as the resistance and misunderstanding of the changing nature of roles within the organisation. Figure 1 illustrates the various phases that an organisation must go through within transition. During transition there is a significant learning curve for the service provider to traverse. Knowledge hoarding by client employees can make knowledge transfer more difficult and successful transition problematic. Transition starts several weeks after the contractual agreement has been signed and may take many months to complete. Systems may need to be changed or upgraded, people trained and responsibilities handed over from one to another. The organisation may need to consider the effect an outsourcing programme has upon both transferred employees and those that remain within the organisation, and how this may affect the relationship that is built between the parties to the outsourcing programme. B. Vagadia, Strategic Outsourcing, Management for Professionals, DOI 10.1007/978-3-642-22209-2_9, # Springer-Verlag Berlin Heidelberg 2012

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Project Preparation

Project preparation begins with the handover of the solution design to the transition team. It involves defining the roles and responsibilities of key stakeholders to ensure a smooth transition. A dedicated transition team must be created.

Transition and Relationship Governance

Planning

Execution

Parallel Run

Creation of a detailed execution plan is required with the establishment of a governance structure for the transition phase.

The execution phase includes both the Knowledge transfer phase which is where the operating procedures, training documents and implicit knowledge is transferred.

For a period the service maybe run in parallel.

The planning phase must identify all of deliverables across different functionalities and must monitor the implementation of the plan across all phases. The team must assess and mitigate risk during the process, using workflow tools to manage the migration smoothly.

It includes the Technology transfer phase which identifies the detailed infrastructure requirements and appropriate system architecture to deliver the service. It includes the operating preparedness phase which includes recruitment, induction of staff and the possible transfer of some assets.

During this phase, the teams prepare the ramp-up schedule and manage the logistics of moving towards a steady state. This phase may also slowly migrate service execution from onsite to offshore delivery centres, managed carefully to maintain continuity of operations. During the parallel running phase more realistic service levels will be established which will become contractually binding.

Steady State

Quality Management System

Within the steady state, key focus shifts to security and business continuity and the management of the SLA and contract.

Check points are maintained after each phase of transition to enable robust implementation.

SLA metrics tracking and reporting to monitor continuous performance is systematised.

The Governance team undertakes health checks after go-live to ensure satisfactory service delivery.

Fig. 9. 1 Transition phases

Smooth transition management is important as it sets the tone for the relationship. Transition management needs to include the detailed, desk-level knowledge transfer and documentation of all relevant tasks, technologies, workflows, and functions (and in some cases employees). Detailed planning is required, and needs to be carefully coordinated with the service provider. Continuous project governance and risk management is essential. Transparent communication at all stages is required to build trust during this phase (see Fig. 2). Communication here refers to both formal communication in

Transformation

Enhancement Business value Utility

Relationship management dominates

The contract

The contract

The contract

Contractual management dominates Relationship impact

Fig. 9. 2 The balance between the legal contract and relational aspects of the deal

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Introduction

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terms of documentation, as well as informal communication. Different types of outsourcing programmes have different communications needs during transition. For example an outsourcing of an IT development activity requires more focus on documentation and specification work (formal communications) than on informal communications and relies on both parties having shared understanding of standards and process requirements such as testing and release procedures. Informal communication in this context really is focused on providing an understanding of the scope of the activity being outsourced and providing such overview knowledge that allows the outsource staff to understand the totality and context of the deal. This could be quite different to certain types of call centre outsourcing for example where the specifics of knowledge transfer is less defined and requires more informal communication and training to explore situational responses. Parties also need to be realistic about what can be achieved, in terms of quantity and quality of service delivered by the vendor, in the early days of the outsourcing programme. Certain types of transition are highly technical (e.g. it may require the conversion of databases, configuration of systems and equipment, live testing of systems or major parallel data fill activities that are essentially one off activities and only happen during the transition period) and quality control becomes vital during this process. Quality Management for some outsourcing programmes can be the critical control activity of the Transition Phase. Many outsourcing programmes provide for a steady state and a measured rampup over time to help overcome some of the teething problems that are inevitable. The transition period can be used to help develop and test robust performance measurement regimes and long term achievable SLAs. Challenges and risks within the transition phase include: • Implementation of effective programme governance structures; • Effective change management and communications plans; • Allowing sufficient time for processes to become embedded within the service provider; • Adequately testing of revised processes; • Retaining key process staff and overcoming any employee disengagement or resentment; • Transferring assets and providing familiarisation in their use; • Assignment/novation of contracts needed to maintain continuous service provision; • Continuity planning; • Learning to work effectively with the service provider; and • Determination of baseline performance and cost metrics for the service. Failure in any one of these areas can seriously inhibit the success of the outsourcing programme. There are four fundamental pillars to successfully managing transition: • Project management process – the project team completes a definition and planning phase to ensure the scope of the project and its accompanying risk factors are understood and agreed.

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• Project organisation and responsibilities – members of the project team define and agree the key project team members and their roles and responsibilities, including appropriate client sponsorship and involvement to ensure project results are achieved. • Project phases – work should be phased to provide the opportunity to reassess and mitigate risks at key milestones throughout the project. • Project management system – a management system should be established to define and apply the appropriate governing processes for all project activities. A key step for transition is a well-defined governance model that provides the client with the appropriate level of decision making and decision implementation control during the transition period. Figure 3 illustrates the detailed activities that must be considered and implemented to ensure smooth transition. The first tier of the governance structure is the Transition Steering Committee, which is made up of executives and senior managers from both organisations. It has the authority to establish the strategy, set the program objectives and determine the business priorities. Its purpose is to oversee the transition at an executive level. Establish Transition Project Office

• Jointly set up the project management control structure and relevant processes

Manage HR & Workplace

• Manage the transfer of staff to vendor • Jointly define the resource plan necessary to deliver the services • Establish a working environment for the transitioned staff

Culture Change

3

rd

Party Supplier Management

• Provide an environment where staff integrate well and feel valued within their new roles • Ensure that staff are provided workshops and training to have an opportunity to understand each other’s organisational cultures • Novate existing contracts from client to vendor as may be required • Establish working relationships with 3rd parties that now need to work with the vendor

Security Assessment

• Ensure the vendor fully understands the clients existing security policy, processes and procedures

Management Systems

• Establish the management systems that provide the controls necessary for effective service management, resource management, contract management • Undertake detailed review and measurements for key metrics in relation to the processes or services that are within scope of the deal

Billing and Finance Management

Communication Management

• Document and formally establish as baseline to determine service charges • Establish the financial controls and billing process for financial management of the relationship • Establish an effective communications plan, mechanism, and ownership for internal and external information sharing • Ensure the handover of assets (i.e. hardware, facilities, physical properties, licenses) from client organisation to vendor is completed in an orderly, consistent and timely manner. Set up a permanent, centralised asset management system • Assess and align pre-existing processes, tools, documentation and staffing between the organisations

Service Readiness

• Service Readiness should be performed in the weeks prior to service commencement • Client should audit vendor’s service delivery readiness & processes • Client should ensure the technical environment necessary for the Service Delivery team to perform their responsibilities using either existing processes and tools or “interim” processes and tools until the transformation projects are completed

Fig. 9. 3 Transition management activities

9.2

Managing the Soft Issues

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The second tier is the Transition Management Team. It includes program management representatives from both organisations. A Transition Program Office should be established to take responsibility for the overall management of the transition. This office works under the direction of the Transition Steering Committee and its role is to focus on reviewing transition plans, monitoring and managing progress, maintaining and managing a risk register, issue resolution, escalation management, status reporting and project change control. The role of the project management team also needs to change during from the transition phase to the steady state. The objective of the project management team for both vendor and client is to replace themselves with process managers post transition handover. For the client this transformational role of the project management team is essential to a successful outsourcing programme; moving from a process executor to a remote process controller. If the project managers see the problem as a project management problem they will not replace themselves, so management in transition is a critical thing to discuss. Project managers have to manage four different sets of changing relationships at the same time; the other transition project team; the other operational team; their own transition project team; and their own operational team. Depending on how much of a partnership activity the programme becomes this can be more or less complex. If it is a close partnership on client premises then team building can help significantly in resolving issues that arise, but in distance relationships this transition can be difficult purely because of the number and political implications of different communication channels.

9.2

Managing the Soft Issues

Soft issues, primarily cultural and communication issues are one of the major hurdles in efficient transition. They are also the most overlooked and hardest ones to deal with while transitioning the services. These issues create communication challenges, breed misunderstanding/mistrust and increase the overall risk of failure. Organisations must give due attention to these issues and should consider: • Cultural training – Arrange cross cultural training for both vendor and customer teams. The purpose of this is to enhance understanding of the subtleties of communications between the teams. For example, in some cultures a nod can mean yes, while in others it can mean no and in others it can be simply a submissive gesture. Cultural training should be done in the initial stages of the transition to reduce the risk of miscommunication and reap the benefits of better understanding between teams. • Right team mix – Transition phase has a huge learning curve and is a heavy pulling exercise in which team leadership and team membership skills of all members of the teams are tested. The teams need to have more senior management involvement to ensure smooth sailing in this phase. • Team building – Conduct regular team building activities to foster better understanding, open communication and working relationship. Most transition

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engagements naturally experience varying degrees of hostility between the parties. Open communication of future plans and objectives as well as arranging team building activities can help to reduce “they vs Us” barriers and help to build an effective and unified “one team” culture. • Focus on knowledge management – Encourage more/better documentation and better knowledge management and transfer practices. • Perform reviews diligently – Ensure reviews and inspections are carried out regularly at each stage of the transition. Table 1 illustrates the risk management activities that should be considered within the transition phase.

Table 9. 1 Transition risk management activities Risks Risk Management Key staff start leaving before and during ∙ Identify core processes and focus on them first transition ∙ Conduct parallel knowledge management sessions to maximise staff coverage ∙ Involve HR to manage personnel issues Business interruption with the big bang ∙ Careful transition planning transition approach ∙ Mix of transition methods – including parallel running ∙ Select team having prior knowledge of the area to facilitate quicker transition Loss of knowledge during transition ∙ Re-badge key experts ∙ Formal knowledge transfer processes Low existing level of documentation ∙ Bring in standard templates and process flows to reduce documentation ∙ Provide expert resources to document processes and procedures Hostile teams may not wilfully cooperate in ∙ Treat all employees with due respect sharing the information thereby increasing the ∙ Incentivise the teams to share knowledge risk of the transition ∙ Facilitate trust between the personnel from both organisations Low process maturity – if the process culture ∙ Ensure that the level of process maturity is and maturity is at low level, it impacts transition fully understood time and results ∙ Seek to improve process maturity before attempting process transformation ∙ Ensure both organisations work at the same process maturity level ∙ Get the vendor to bring in best practices to improve process maturity quickly Senior management commitment ∙ It is essential the senior management is kept informed and their buy-in to the programme obtained in advance ∙ Have an executive sponsor and/or programme champion who can lead and represent the team at the highest levels of executive management

9.3

9.3

Governance and Relationship Management

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Governance and Relationship Management

In any long term relationship, there are bound to be issues – avoiding these is nearly impossible. A properly structured and faithfully executed governance model is essential to provide the means to deal with changes (and problems) efficiently, amicably and fairly, thereby enhancing trust in the relationship. In general terms, governance is the overall process by which the customer and the service provider oversee and regulate their relationship. A governance schedule outlines the framework within which they should meet to: • Review and discuss reports on the progress of implementation projects and /or the performance and future direction of the services, as appropriate; and • Resolve any commercial, operational or technical issues that might arise as part of the project A successful governance model addresses all transition, transformation, service delivery and exit issues. It should: • Ensure both parties agree and understand how to engage with each other at what level and when; • Define how the service provider management team aligns and responds to its customer counterpart. The concern from the service provider’s perspective is that the service provider should not give the customer oversight which is so wide ranging or at such deep level that the customer is tempted to micro-manage inputs; • Ensure there is customer executive sponsorship throughout the contract term; • Build in flexibility for major changes in the parties’ respective rights and obligations, such as those generated by the customer’s strategic priorities and service demand; • Establish a mechanism to handle, approve and account for minor variations in day to day service delivery requirement; • Review the service level reports and agree on the actions and required changes to improve quality and effectiveness of services; • Ensure both parties fulfil all commitments and provide agreed inputs and /or properly manage the delivery of the contractual services; and • Establish a meeting schedule to discuss innovation and changes in technology and processes. An appropriate governance structure will help ensure the outsourcing agreement is proceeding to plan, but could and should also be used to monitor the softer aspects of the relationship. The governance framework must work at all levels of the organisation (See Fig. 4). Governance in this respect may need to include proactive and collaborative management, improving ongoing communication processes, appropriate performance reviews that seek to create the right incentives, and the general development of trust and a partnership/alliance relationship. Governance in this sense must go beyond the basic monitoring of contractual obligations. The governance structure should have the following specific guiding principles:

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Corporate ‘The Governing Board’

• • • • •

Representing the interests of the Business Units Customer advocacy Setting strategic direction Change authority Arbitration on critical issues

Operational ‘Process Owners’

• • • • • •

Functional process ownership Service delivery Determining policy and procedures Process controls Process improvement Service levels

• • • • •

Application of the commercial terms Service management Performance management Relationship management Change and extension to services

Service ‘Relationship Managers’

Fig. 9. 4 Levels of governance relationships

• Stable, equitable and flexible decision making structures to avoid delays in time critical opportunities; • Delegation of decision making within a predefined set of guidelines; • Clear, high communicative processes that encourage information sharing and enable efficient, effective business decisions; • An organised, focussed communications mechanism to encourage collaborative discussion of issues and ideas critical to ongoing success; and • Specific and defined escalation points and participation of executives with appropriate levels of strategic and operational responsibilities.

9.4

Typical Governance Structures

Table 2 illustrates a typical governance structure for an IT outsourcing programme. It details its constitution, what the responsibilities are, who the key stakeholders are and how often they must meet.

9.4.1

Joint Review Board (JRB)

The Joint Review Board (JRB) is comprised of key service and customer executives. The purpose of the JRB is to scope the strategic direction, resolve major issues, approve strategic change and promote leadership and commitment.

9.4

Typical Governance Structures

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Table 9. 2 Outsourcing governance procedures Body

Responsibility

∙ Evaluate overall partnership ∙ Discuss partnership development ∙ Share business visions and goals Corporate – The Governing Board ∙ Review overall – sometimes called “Joint Review performance Board” (JRB) ∙ Decide on major changes and projects ∙ Discuss development initiatives ∙ Evaluate recommendations from value creation workshops ∙ Resolve disputes ∙ Review delivery Operational Process Owners – sometimes called “Service ∙ Review contract Management Team” (SMT) financials ∙ Review strategic and operating plans ∙ Advice on forecasting and demand management ∙ Advice on technology direction ∙ Sponsor projects Service Relationship Management ∙ Service delivery – sometimes called “Operating Group/ Service Delivery Team” (OGSDT) ∙ Workload forecasting ∙ Business control status ∙ Agree and implement correcting actions Executive meeting

Participants Client CEO CFO

CIO IT/BPO Board CIO

Meeting Frequency Supplier Country CEO Customer Value Creation Head Country CEO Delivery Head

Account IT/BPO Management Team group

Head of Business Support Head of Operations

Twice a year

6–8 times a year

Once a month

Delivery BiExecutives Weekly

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The JRB guides the overall activities and phasing of the outsourced services, so that the mission and objectives satisfy customer’s leadership strategy.

9.4.2

Service Management Team (SMT)

The Service Management Team (SMT) is comprised of contract relationship manager, service provider and customer functional managers and leads. The purpose of the SMT is to address typical service delivery issues, discuss and approve changes and agree on process improvements. The SMT acts as the primary liaison between the customer and the service provider and is responsible for understanding the customer’s overall business needs and communicating those needs to the service provider delivery organisation.

9.4.3

The Operating Group/Service Delivery Team (OGSDT)

The Operating Group/Service Delivery Team (OGSDT) comprises of functional leads from the service provider and the customer. The OGSDT oversees day to day operations, monitors and reports volumes and quality and identifies and resolves tactical operational issues. The team is the first point of contact for issue resolution and escalates unresolved issues to the SMT using the issue management process.

9.5

Governance in Practice

To minimise risk, the parties should: • Conduct formal briefing sessions between negotiators and those responsible for implementing the deal to enable a smooth hand-off, and conduct joint relationship planning activities to mitigate problems arising from goal misalignment; • Develop and enable a structure to govern the relationship. They should: review and discuss potential pitfalls, and plan for how to avoid or mitigate their impact should they arise, they should develop decision-making protocols to speed implementation, develop a conflict management mechanism that ensures resolution of conflict on the merits, rather than by coercion, and implement a scope management process that helps them view scope as a joint challenge to be managed together; • The client governance team should lead, whilst the service provider delivery team put in place mechanisms that enable a continuous dialogue and change, and plan together how they will manage and embed change within their organisations during joint launch; • Ensure individuals on both sides acquire new skills, exhibit new behaviours, and make significant changes in mindset and assumptions. The parties need to ensure that their teams have the skills they need to negotiate collaboratively, manage

9.6

Role of the Legal Contract

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Define the strategic intent

• Strive to be in the first quartile by cost in the industry • Improved controllership

Develop a compelling business case

• E.g. Reduce transaction processing cost by 20 – 30 % through global consolidation • E.g. Further reduce cost by 20 –30% by automation

Set expectations upfront

• Define accountabilities • Pricing

Senior management support

• CEO / CFO / COO responsible for Outsourcing • Position outsourcing PMO as a peer of business leaders

Develop tiered Governance structure

• Plan what needs to be achieved over the next 3-4 year • Monitor performance through SLAs

Manage organisation change

• Develop a communication plan targeted at various stakeholder groups • Anticipate and manage risks proactively

Invest in training & recruitment

• Train internal resources for new responsibilities • Invest in hiring resources with skills in outsourcing implementation

Manage transition risks

• Give the organisation time to digest changes due to outsourcing and then transforming

Set up a data production line

• Standardise processes – challenge legacy and move towards best practices • Automate to reduce touch-points

Embed operations excellence

• Focus on quality and build quality at all stages and in all work-streams of the programme • Focus on compliance and improvements • Focus on building a sustainable operation

Fig. 9. 5 Factors that lead to successful outsourcing governance

scope effectively, solve problems jointly, and build alignment among critical stakeholders; • Pay attention to not only the resolution of common problems (e.g., disputed charges, disagreements over scope), but also the way the problems are resolved (e.g., acknowledgement of the impact of the problem, a focus on avoiding the problem in the future); and • Regularly monitoring the health of the working relationship, in addition to delivery and financial performance, is critical to ensuring that the ongoing management of the relationship is on track and meeting the expectations of both parties. Figure 5 summarises some of the actions that lead to successful outsourcing programmes.

9.6

Role of the Legal Contract

The legal contract, is not only important from a commercial perspective, but also defines the conditions, circumstances and the role softer factors can, and must play, in ensuring the success of an outsourcing programme.

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Typically within outsourcing contracts, there are two separate agreements; one for the transfer of existing business/assets and one for the actual services outsourced: The “transfer of assets” agreement deals with the transfer, where relevant, of any property, assets, employees and intellectual property (“the Transfer Agreement”). The “services agreement” records the outsourcing service description, service levels and the roles and responsibilities of the parties during the term of the agreement (“the Service Agreement”). An important area within outsourcing agreements from the outset, is a clear understanding of what services are being outsourced – i.e. the scope of the outsourcing relationship. An outsourcing agreement forms the core of a successful outsourcing relationship and needs to be drafted meticulously. It must capture the business strategies, concerns, operational processes, as well as the commercial understanding of the parties. It must be explicit in detailing the services to be outsourced and the resources to be dedicated in providing such services. For an outsourcing relationship to work successfully, it is important for both parties to fully understand all the business, technical, commercial and legal issues of relevance within the relationship. One of the fundamental differences between an outsourcing agreement and other commercial contracts is the length of time a typical agreement may last (sometimes up to 10 years). It is impossible for the parties to contemplate all possible eventualities within this period, and therefore the contract must allow flexibility in terms of changing scope and pricing. Without such flexibility, conflicts between the parties could easily arise. Academic research shows that lack of flexibility, as defined by the cost of reacting to changes, is the prime source of contract failure in IT outsourcing (Lacity et al. 1995). The outsourcing agreement must clearly define the process, roles and responsibilities at contract termination. The rights and duties of each of the parties upon termination or expiration of the agreement will need to depend upon the circumstances of the termination. The agreement should set out the processes the parties will follow upon termination so that transition is orderly. Good outsourcing contracts include specific commitments to support transition to another service provider, or repatriation of operations to the customer. It is foreseeable that a service provider may not perform all its obligations or meet all performance standards during the term of the outsourcing agreement. Imposing damages is a common remedy, but measuring damages for failures to perform obligations and meet performance standards can be difficult. Companies usually ensure that damage and indemnity clauses are defined as narrowly as possible, otherwise they may find enforcement of such clauses difficult. A common feature of many outsourcing agreements is the ‘transfer of staff’ from the customer to the outsourcing service provider. In the European Union (EU), labour regulations (such as the EU acquired Rights Directive 77/187/EEC) require elaborated procedures to be completed before staff transfer can take place. The regulations also ensure the transferred staff retain their existing employment terms

9.7

Service Level Agreements

129

in the transfer and with their new employer; the service provider. The regulations can apply regardless of the size of the transferred undertaking. When firms need to transfer data or have their offshore service provider undertake data processing, the firm must consider how the laws (or the lack of) may affect its own and ultimately the data subjects’ rights with respect to the information. Intellectual Property (IP) is usually an area to which lawyers pay close attention. Without transfer of IP from the firm to the service provider, many offshoring projects would not be feasible. Even a simple service project such as a call centre, derives its capabilities to a large extent from the IP that is being provided. In more complex arrangements, the need to manage a company’s IP acquires greater importance. The outsourcing agreement will need to specify ownership of any IP that may be used, developed, or improved during the relationship. There are various models by which IP may be managed within the outsourcing agreement: • The service provider owns all newly created IP and then licenses it to the customer for its internal use; • Joint ownership; • Service provider grants copyright to customer, but retains ownership of patent rights and then licenses customer to use patent rights for its internal business. The service provider could re-use the idea for other customers, but cannot copy, cut or paste from the specific custom components developed under the agreement; • Customer owns all newly created IP, grants the service provider broad use and sublicense rights, possibly subject to reasonable restrictions to protect customer competitive advantage; • Customer owns all newly created IP, where the service provider has no rights; and • A menu approach, which lists the potential options for IP ownership on a case by case basis. The most appropriate model will depend on the nature of the organisation and the degree to which innovation is fundamental to its success.

9.7

Service Level Agreements

The typical outsourcing engagement will last for a number of years and be governed by a contract setting the terms and conditions between the client and outsource provider for the duration of their relationship. To measure whether that relationship is working, and how well, Service Level Agreements (SLAs) are established. A service level agreement describes the performance levels required of the vendor of each service or product provided by the vendor. Performance standards can be extensive if a buyer wants to manage processes, or they can be limited to a few key standards if the relationship is purely results based. SLAs are usually incorporated as a schedule to the contract.

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An SLA is an essential part of any outsourcing project. It defines the boundaries of the project in terms of the functions and services that the service provider will discharge to its client, the volume of work that will be accepted and delivered, the acceptance criteria that will be used and the level of quality acceptable. Well defined SLAs correctly set expectations for both parties to the relationship, and provide targets for accurately measuring performance to those objectives. They act not only as metrics of performance by which to measure the service provider’s performance, but also as a means of providing ongoing incentives. Outsourcing contracts traditionally, have not been designed with inherent incentives which seek to build consensus and gain commitment to the partnership model. However, new pricing models are being based on ‘gain sharing and riskreward’ principles, which attempt to ensure the interests of both parties are served in trying to improve performance. Ensuring that the customer has defined an effective SLA becomes important to the performance of the relationship over the many years the agreement is likely to run. SLAs need to be designed by the people who run the business at the operational level. SLAs designed by both parties’ operational teams may create better incentives than those which are designed by one party or which are designed by executives or lawyers within the organisation. Ineffective SLAs can have a negative effect, not only in terms of contract governance but more broadly the relationship between the parties. An effective SLA must satisfy the following criteria: • Is it simple? • Is the measure the whole parameter you need? • Can the measured parameter be controlled – who controls it? • Is the measured parameter a primary measure or a derivative – if it’s derived, who controls that? • Is the measurement of the parameter a part of a control loop? • Does the measurement period provide adequate statistical data? Selecting appropriate metrics to gauge project performance is a crucial step for the success of any outsourcing engagement. The selection process is complicated by the large number of potential metrics. It may be more appropriate to select a limited number of measures, which can be studied in detail. The choice of metrics must be contingent on a number of other factors, such as: organisational experience, the type of behaviours to be motivated, the cost and effort of collection, and the impact such metrics will have on the ongoing relationship and development of trust. Subjective performance standards may include (but are not limited to): • Use of reasonable efforts in providing the services; • Use of best efforts in providing the services; and • Performance of the services in a professional and workmanlike manner or in accordance with industry standards. Objective standards may include (but are not limited to): • Conformance to specifications; • Conformance to baseline operational performance metrics;

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• Conformance to service levels previously attained by the customer or a third party provider for the same services; and • Conformance to benchmarked operational standards and service levels.

9.8

Take Aways

• Transition management presents the greatest risks in the outsourcing programme. • A transition governance committee must be established to oversee the process, with transparent communication driving the programme. • Addressing personnel concerns during transition is paramount. • The transition phase must seek to build trust within the organisation and between organisations. • The legal contract must be robust and as detailed as possible, seeking to create a joint understanding between the two organisations, underpinned by a service level agreement which creates the right behaviours in the vendor to deliver services beyond the contract.

References Lacity, M., Willcocks, L., & Feeny, D. (1995). IT outsourcing: Maximizing flexibility and control. Harvard Business Review, 73(3), 84–93.

.

Insights from Academic Research on Outsourcing

10

There has been significant academic research within the outsourcing arena, a lot focussed on the drivers and benefits of outsourcing. There has also been more recently a focus on the risks emanating from outsourcing and the role of relational exchanges. Nevertheless, traditional research has been polarised between strong contracts and relational governance. There is now the emergence of research that suggests formal contracts and relational exchanges are complementary and both required for successful outsourcing. It is not enough to simply develop an understanding of how to build and foster relational governance, but to do so in the context of a formal contract. This chapter looks at the empirical research on the drivers for outsourcing, the risks presented by outsourcing, the role of trust and partnerships in managing strategic outsourcing programmes, as well as the various academic models used to describe and understand outsourcing.

10.1

Introduction

Most literature tends to focus on legal contracts or relationships (Poppo and Zenger 2002; Goo et al. 2009 are exceptions). Poppo and Zenger (2002) published a paper in Strategic Management Journal, where they developed and tested an alternative perspective through 285 survey responses of IS managers, whilst Goo et al. (2009), publishing in another high quality journal based their findings on 92 web based surveys.

10.1.1 Defining Outsourcing and Offshoring Kern and Willcocks (2000), publishing their analysis of 12 organisations involved in outsourcing, define outsourcing as the decision taken by an organisation to contract or sell the organisational assets, people, processes and/or activities to a third party supplier, who in exchange provides and manages assets and services for B. Vagadia, Strategic Outsourcing, Management for Professionals, DOI 10.1007/978-3-642-22209-2_10, # Springer-Verlag Berlin Heidelberg 2012

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monetary returns over an agreed period of time. Elmuti and Kathawala (2000) in their extensive study which explores why and how organisations are using global outsourcing through 544 surveys, suggest outsourcing is nothing less than the wholesale restructuring of the corporation around core competencies and outside relationships. Goles and Chin (2005), use relational exchange theory as a conceptual basis for identifying the individual constructs that comprise a relationship. They develop and test a set of items to measure those constructs, using structural equation modelling and survey data collected from U.S. outsourcing customers. They define an outsourcing relationship as an ongoing linkage between an outsourcing service provider and the customer, which has a long-term orientation and a mutual recognition, where the benefits attained by each firm are at least in part dependent on the other firm. Outsourcing therefore consists of: a relationship, usually a long term one, between a firm and the service provider; a relationship where both parties may be dependent on each other and one which is typically governed by a formal contract. It also implies the transfer of internal activities to outside organisations which will change the means and ability to control the activity by the client organisation. Offshore outsourcing is here used to describe outsourcing to an entity based in an offshore location. Dibbern et al. (2008), who published their multiple case studies of six offshore software projects in a large German financial services institution and interviews with 27 client and vendors, suggest offshore outsourcing brings unique challenges compared to domestic outsourcing. According to Duggal and Simkonis (2007), initially the possible candidates for offshore outsourcing were application development and maintenance, bug fixes, call centres, data entry and system maintenance. According to Steen (1998) as quoted in Duggal and Simkonis (2007), as project management methods and infrastructure improves, more types of work can be done offshore. Elmuti et al. (1998) state that popular areas of outsourcing include: information systems/technology (40%), real estate and physical plant (15%), logistics (15%) and administration, human resources, customer service, finance, marketing, sales and transportation (30%) – the latter typically referred to as Business Process Outsourcing (BPO). Whereas Information Technology Outsourcing (ITO) dates back to the early 1960s and gained momentum through the 1970s and 1980s (according to the book by Hirschheim and Dibbern 2002), BPO is a relatively new outsourcing arrangement. It is therefore not surprising that much of the research to date on outsourcing tends to be in the context of IT/IS outsourcing.

10.1.2 From Tactical to Strategic Outsourcing McIvor (2000) in his paper published in a refereed journal provides a framework for understanding the outsourcing process. He asserts that over recent years, outsourcing has become an important issue for many organisations. Initially it was only activities that were regarded as of peripheral concern to the business, such as cleaning, catering and security that were sourced externally. However

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during the 1990s more companies started to outsource critical activities (Jennings 1997). This McIvor (2000) suggests has forced organisations to rethink their outsourcing practices and approach the topic of external sourcing from a more strategic perspective. Kakabadse and Kakabadse (2000) in their extensive review of both academic and managerial literature, assert that perhaps the greatest advantage of outsourcing is the full utilisation of external providers’ investments, innovations, specialised professional capabilities, that otherwise would have been prohibitively expensive for one organisation to replicate. They assert that a fundamental paradigm shift is underway from strictly provider-user relationships to an emerging array of partner based relationships and new outsourcing arrangements and organisational forms. They state that the emergence of partnership or alliance arrangements as alternatives to the formerly more popular transaction-based contracts, usually shorter and more tightly defined, indicates a shift to closer interactions between client and provider.

10.1.3 Empirical Studies Suggest Outsourcing can be a Risky Practice Lacity and Willcocks (1998), in their paper published in a high quality journal, builds on previous data collection of 61 IT sourcing decisions and five best practice case studies. They report that only 56% of IT outsourcing deals were deemed to be successful. Craig and Willmott (2005) in an online article, claim that about 50% of outsourcing deals fail to deliver the expected value. This rate of success is also confirmed by Aron and Singh (2005), who state that several studies indicate that about half the organisations that shifted processes offshore failed to generate the financial benefits they had expected. Lonsdale (1999) in his article published in a good journal, presenting a model for effective risk management, suggests that a majority of organisations are dissatisfied with the outcome of their decisions, but find that the disappointing results are not due to there being any inherent mistake in the practice of outsourcing, but rather are rooted in poor management decision making. Lonsdale (1999) goes on to suggest that firms are using outsourcing without any sort of guiding framework. McIvor (2000) affirms this by reporting that the absence of such a framework has led to a situation where outsourcing decisions have been made most frequently by default, without considering the long term consequences for the competitiveness of the organisation. Bettis et al. (1992) in their paper based on the authors’ research within firms in North America, Europe and Asia, advocates viewing sourcing in strategic and offensive terms instead of merely as a defensive technique for trying to fix problems. Although there are risks to offshore outsourcing, the possible rewards provide a compelling case for many firms to pursue it. Amiti and Wei (2006) in their working paper found that offshoring has a positive effect on productivity: service offshoring

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accounted for 11–13% of USA labour productivity growth over the period 1992–2000; and material offshoring for 3–6% of labour productivity. Outsourcing thus is potentially a valuable strategy for firms, whether they view its use as tactical or strategic. However it is also a risky practice – this is also confirmed by practitioner publications.

10.2

Outsourcing Rewards

The literature about outsourcing provides many reasons why firms may want to pursue an outsourcing programme. Some of the more prominent ones are detailed below:

10.2.1 Better Focus on the Core Business Outsourcing of non-core activities eliminates the effort required to manage peripheral activities, except for the need to manage the relationship with the supplier. This it is claimed, gives management the opportunity to concentrate on the important elements of the business (Jennings 1997; McIvor 2000; Kakabadse and Kakabadse 2000, who provide an overview of the thinking behind strategic sourcing based on the authors’ research and practical case studies). Kakabadse and Kakabadse (2005) in their extensive paper published in a quality journal, based on 747 survey responses and interviews with 50 CEOs, claim this creates a need for providing greater attention to identifying what is a core competency1. McIvor (2000) however suggests that in a fast changing industry, the definition of core and non-core must be revisited on a continuous basis.

10.2.2 Cost Reduction Cost reductions can be obtained either through the savings of labour costs or from improved efficiency due to the application of more sophisticated technology or processes. The reduction in labour costs are based on the assumption that a supplier can provide a certain service more efficiently due to its expertise with fewer input resources (McIvor 2000; Kakabadse and Kakabadse 2000).

1 Prahalad and Hamel (1990) in their well known paper on core competences, state that core competences are the collective learning’s’ in the organisation, especially how to coordinate diverse production skills and integrate multiple streams of technologies. They suggest three tests that can be applied to indentify core competences in a company. It should provide potential access to a wide variety of markets; it should make a significant contribution to the perceived customer benefits of the end product; and it should be difficult for competitors to imitate. Prahalad, C., and Hamel, G. (1990). “The Core Competence of the Corporation”, Harvard Business Review, pp 79–91.

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Due to considerable economies of scale available to large outsourcing vendors, outsourcing can also provide a more cost effective solution for outsourcing customers (Abraham and Taylor 1996, in their extensive survey of thousands of firms published in a high quality journal; Sharpe 1997, examining the rise of outsourcing and the benefits it offers; and McIvor 2006).

10.2.3 Benefit from Supplier Investment and Innovation Henley (2006), through the review of emerging strategies for outsourcing the provision of software and IT enabled services to India, suggests that technological change is encouraging firms to outsource services based on the availability of leading edge technologies from the service provider. Quinn and Hilmer (1995) in their brief practitioner article, also suggest that collaboration with suppliers can provide access to high quality products and highly efficient services without the otherwise required investment in human capital, processes or information technology to obtain the required level of proficiency. Sharpe (1997) suggests this is one of the main motives for outsourcing.

10.2.4 Increased Flexibility and Technology Deavers (1997), suggests that outsourcing can provide greater flexibility, allowing organisations to incorporate the latest technology and respond to changes in the business environment more quickly and at a lower cost than vertically integrated organisations. Quinn (1999) in his paper reviewing outsourcing, core competences and appropriate management techniques, also suggests that in-house functions may increase organisational commitment to a specific type of technology and may constrain flexibility in the long run. This is confirmed by Wang et al. (2008) whose study examined 120 companies’ performance after outsourcing IT.

10.2.5 Gain Access to External Competencies Quelin and Duhamel (2003), suggest that it is possible to achieve higher service levels, because firms can gain access to superior capabilities from their vendors. McIvor (2006) suggests in the case of offshore outsourcing, firms can benefit through access to skilled IT labour forces not available or very expensive in their own countries. Academic and management literature therefore identifies four main benefit categories: • Greater focus; • Cost reduction; • Flexibility; and • Access to external expertise/investment or innovation.

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However, these are only potential benefits. Translating these potential benefits into actual ones requires a good understanding of the potential risks and possible approaches to managing them.

10.3

Outsourcing Risks

Jurison (1995), publishing in a high quality journal, develops a model to describe the relationship between outsourcing benefits and risk, stating that risk refers to the chance or probability that some unfavourable event or outcome will occur. According to Lacity and Willcocks (1999) in their paper also published in a high quality journal, risk is the likelihood of loss as a consequence of uncertainty. Many researchers have written about specific risks associated with outsourcing. These include:

10.3.1 Strategic Risks 10.3.1.1 Not Achieving the Originally Planned Benefits Adeleye et al. (2004) who report the results of a questionnaire survey involving seven banks and 21 individual responses, note that the less experienced both parties are, the higher the risk compared to traditional outsourcing. Lacity and Willcocks (1999) list unrealistic expectations about what can be achieved by outsourcing as a risk also. 10.3.1.2 The Loss of Core Activities and Competencies Kakabadse and Kakabadse (2000) and Quinn and Hilmer (1994) suggest that excessive outsourcing can lead to considerable reduction of overhead so that the host organisation becomes a fraction of its former self, something they term the “hollow corporation”. 10.3.1.3 Loss of Skills and Corporate Memory Kakabadse and Kakabadse (2000) note that by contracting out goods and services traditionally produced in-house, the organisation loses skills, competences and collective knowledge, as both a producer and client of those services. 10.3.1.4 Loss of Strategic Business Flexibility and Innovation Capacity Earl (1996) based on an analysis of 11 specific risks of outsourcing through discussions with both buyers and vendors in the IT outsourcing marketplace and Khalfan (2004) who reports the results of a case study, involving public and private sector information systems/information technology (IS/IT) outsourcing projects in Kuwait, suggests as the functionality provided by the vendor is available to all customers simultaneously, there remains no first mover advantages.

10.3

Outsourcing Risks

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Quinn and Hilmer (1994) note that during the term of the contract, client firms’ business environment could change dramatically. So poorly designed outsourcing contracts may well lead to future strategic inflexibility.

10.3.2 Operational Risks 10.3.2.1 Dependency on the Supplier Quinn and Hilmer (1995) suggest in their article, that dependence on the supplier often finds its roots in: poor contracting, outsourcing into limited supply markets and high asset specificity. 10.3.2.2 Cost Increases Lacity and Hirschheim (1993) in their article and Lacity and Willcocks (1995) through analysis of 61 sourcing decisions and outcomes made in 40 U.S. and U.K. organisations from 145 interviews with case participants, suggest hidden costs emerge if managers incorrectly assume the depth and extent of activities included within the outsourcing contract. Levina and Ross (2003) who conducted a close examination of vendor strategy and practices in one long-term successful applications management outsourcing engagement, published in a good journal, state that the pursued cost efficiency of (offshore) outsourcing is certainly not always achieved. 10.3.2.3 Transition and Switching Costs Kakabadse and Kakabadse (2000) notes that outsourcing requires a redefinition of organisational boundaries. This in turn induces possible further restructuring and dislocation of resources which induces a variety of costs in the process. Earl (1996) in his article highlights these transition costs as including unforeseeable set-up costs, redeployment costs, relocation costs or parallel-running costs. 10.3.2.4 Diminished Quality of Service Aubert et al. (1998) who in their paper propose a conceptual framework for risk assessment through empirical literature, note that reduction of quality may result from several factors: the interdependence between an outsourced activity and processes which remained in house, the lack of experience and expertise of the service provider with the outsourced activity and/or the situation where the service provider does not have the necessary resources. 10.3.2.5 Loss of Management Control Quinn and Hilmer (1994) note loss of control over suppliers can occur when firms do not closely monitor suppliers and where suppliers assume leadership in their relationship. McIvor (2006) lists this as a major risk.

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10.3.3 Commercial Risks 10.3.3.1 Security Breaches Khalfan (2004) notes that a special issue in BPO is the risk to data privacy as the service provider needs access to the client’s sensitive data to be able to process it. Earl (1996) also warns of knowledge diffusion risk – the possibility of confidentiality leaks and loss of intellectual property rights by the vendor. 10.3.3.2 Customer Lock-in Quelin and Duhamel (2003) in their research through 25 semi-structured interviews in 20 large European manufacturing groups and a subsequent survey of 180 firms, note that this is mainly driven by two factors: (1) the level of standardisation and complexity of the process and (2) the level of market maturity. The more customer specific a process, the greater the difficulties associated with switching to another service provider.

10.3.4 Human Resource (HR)/Communication Risks 10.3.4.1 Loss of Internal Coherence Quinn and Hilmer (1995) note the possibility that external sourcing of certain activities will hamper the internal coherence of the company. McCarthy and Anagnostou (2004) in their paper published in a quality journal, looking at how the economic benefits of outsourcing alter the contribution that an organisation makes to a sector’s gross domestic product using an input–output method, note that employees’ morale, trust and productivity can be damaged due to job security issues related to outsourcing. 10.3.4.2 Communication Mismatches Earl (1996) and Willcocks et al. (1999) note that what initially seems to be clear and unquestionable to one side might result in disputes and litigation due to contrary interpretation by the other partner. This can be especially true for offshore outsourcing. In terms of practitioner literature, the surveys conducted by my firm, Op2i between 2009 and 2010 finds: • Selecting the right process and functions to outsource in the first place was seen as the best means of getting maximum return from the outsourcing investment – the core competence argument essentially; • The greatest financial risk remains the possibility of not achieving the cost benefits, followed by cost of reintegration of processes on termination of the outsourcing agreement. For offshoring, costs associated with managing the service provider also rank relatively high; • The two largest sources of internal risks are identified as: (1) inadequate skills, proficiency and experience in outsourcing and (2) poorly constructed contracts and SLAs;

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• The best approach to reducing the risks from outsourcing was stated as being the development of a partnership relationship between the customer and supplier. Strong contracts came second; • The most effective strategy to reduce risks when outsourcing were deemed to be the secondment of staff from the client to the service provider; and • The best means of achieving a low risk outsourcing project implementation, the survey suggests, requires a combination of having a well defined governance structure and sufficient SLA measurement and monitoring systems. The majority of respondents stated arbitration/mediation was important as part of the overall governance structure. Strategic risks to some extent form the greatest challenge as they require a combination of strong yet flexible formal contracts, better knowledge management and the development of trust and commitment which aid in developing complementary competences and achievement of the benefits being sought from the outsourcing initiative. Needless to say, the decision to outsource and a robust business case, which indentifies all costs, is a prerequisite to many of the other risk management techniques if successful outsourcing is to be achieved. When organisations outsource to offshore destinations, additional risks are introduced which includes culture (as suggested by Krishna et al. (2004)), Language and time-zone differences (as suggested by Rao (2004)) and the specific institutional features of offshore countries, such as infrastructure, security, political conditions, and intellectual property regulations within the offshore country (Rao 2004).

10.4

Outsourcing Models

There are a number of theoretical approaches that have been explored within the literature on outsourcing, including agency theory, Transaction Cost Economics (TCE), the Resource Based View (RBV) (which includes core competencies and follows on from Porter’s five forces model [Porter 1980]), Dynamic Resource Models (DRM), incomplete contract theory and other more recent models. To some extent, each theory addresses a particular problem encountered when outsourcing, but individually do not in themselves provide a holistic model for explaining and addressing the various forms of risk that may also present when outsourcing. Agency theory suggests that the contract forms the basis of managing an outsourcing relationship, whilst TCE suggests that opportunism in the relationship must be countered. It informs that this can be done through the contract. Where it may be prohibitive to manage such opportunist behaviours in a market based relationship, an organisation may prefer to retain the activity in-house. Incomplete contract theory suggests that contracts, however elaborate, will always remain incomplete, and therefore, there will remain the possibility of risk even when an organisation tries to account for all uncertainties through a well constructed contract. Both RBV and DRM suggest that an organisation must carefully assess what activities should be outsourced. Where an activity which may be determined to be

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core competence is outsourced, the organisation must ensure it has initiated processes which enable it to configure intra-organisational resources to gain competitive advantage, without losing internal knowledge and capabilities of the outsourced process – suggesting that the retention of internal knowledgeable teams is important (something discussed later). More recent models, such as the one proposed by McIvor (2000), and findings from other researchers, suggest that traditional theoretical models are not applicable or practical for outsourcing decision making today. These relatively recent models attempt to fill what appears to be a gap in the existing theoretical models using the concept of relationship management and factors such as trust and commitment. The various theories are briefly described below.

10.4.1 Agency Theory Jensen and Meckling (1976) define an agency relationship as “a contract under which one or more persons (the principal(s)) engage another person (the agent) to perform some service on their behalf which involves delegating some decisions making authority to the agent”. In their extensive paper published in a high quality journal, they suggest because the unit of analysis is the contract governing the relationship between the principal and agent, the focus of the theory is on determining the most efficient relationships given assumptions about people (e.g. self interest, bounded rationality, risk aversion), organisations (e.g. goal conflict among members) and information (asymmetry). The main finding from agency theory is the suggestion that effective use of monitoring and, or bonuses, can reduce the moral hazard in relation to the service provider (Jensen and Meckling 1976). This it would seem is too simplistic a concept. Certainly monitoring and incentive schema may be useful as additional factors, but do not on their own, provide the framework in which to manage risks within an outsourcing programme.

10.4.2 Transaction Cost Economics (TCE) Transaction cost analysis2 is an approach that explicitly considers the implications of an organisation’s choice to perform a transaction or activity internally (hierarchy) or in the market (Williamson 1991).

2 Transaction costs can be decomposed into four separate costs related to transacting (Williamson, 1985): (1) search costs (i.e., the costs of gathering information to identify and evaluate an outsourcing supplier), (2) contracting costs (i.e., the costs of negotiating and writing the contract), (3) monitoring costs (i.e., the costs of monitoring the agreement to ensure that the outsourcing supplier fulfils its contractual obligations), and (4) enforcement costs (i.e., the costs associated with ex post bargaining and sanctioning the outsourcing supplier when it does not perform according to the contract). Search and contracting costs are usually termed ex ante transaction costs.

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Markets for commodities like fuel or grain comes closest to the economists’ ideals of a frictionless market. Most real world procurement is subject to significant transaction costs. Some of these costs arise from the need to defend oneself against possible “sharp practice” (opportunistic dealings), and some arise from the fact that human beings are not infinitely rational – mistakes and coordination failures beset even the most well-meaning of human enterprises. Transaction costs are influenced by asset specificity, uncertainty, rationality and opportunism, whereas agency theory is based on findings of goal incongruence, information asymmetries between parties, moral hazard and risk aversion. The main finding from transaction costs economics is that contract completeness and transaction costs are connected. Because of the four important factors of this theory, contracts are almost always incomplete. Both agency theory and TCE attempt to find the most appropriate contract between both parties to limit the transaction and agency costs, but also to limit the opportunistic behaviour of the service provider (Jensen and Meckling 1976). Opportunistic behaviour introduces a heightened level of behavioural uncertainty to a contractual relationship (Wang 2002 whose paper published in a quality journal, adapts TCE to analyse the implications of transaction attributes on the consequences of customised software practice using 232 questionnaires from medium to large companies in Taiwan). Uncertainty arises because it is hard to foresee all contingencies that might occur during a transaction. This creates a problem in developing contractual relationships because contracts are incomplete. Aubert et al. (2003) investigating the characteristics of outsourcing contracts; find that optimal contract completeness is the result of a trade off between the costs of writing a complete contract and the expected costs associated with the level of opportunism. The transaction costs in outsourcing could be roughly divided in three categories: contracting costs, transition costs and interaction costs. Contracting costs are the costs of selecting vendors, negotiating and reaching agreement on suitable contractual deliverables, designing and implementing monitoring, measurement and dispute resolution mechanisms. Transition costs are the costs of knowledge capture, documentation and transfer from one set of personnel to another. Interaction costs are the cost of managing interactions between the outsourced processes and the processes remaining within the firm; these costs arise from the need to manage interactions between the process and context and involve costs of ongoing process mapping, interface design and costs of coordination mistakes.

10.4.3 Resource Based View (RBV) While TCE focuses on the costs associated with conducting exchanges between two separate entities, RBV concentrates on those factors that enable firms to gain a competitive advantage. RBV is a continuation of the core competences model proposed by Prahalad and Hamel (1990). Since RBV offers insight into which

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resources are of critical importance, it helps determine which resources should be kept or acquired. RBV helps determine whether one should or not outsource certain processes and capabilities. Its proponents include: • Barney (1991) whose paper published in a good quality journal, examines the link between firm resources and sustained competitive advantage; • Mata et al. (1995) again published in a quality journal, discuss RBV as a means of analysing sustainability, and observe that some companies appear to earn sustained abnormal returns. Barney (1991) argues this outcome arises because they have access to key resources. Barney (1991) as well as Cheon et al. (1995) (whose paper published in a quality journal, expands the theoretical development of IS outsourcing), identify the following four resource attributes as relevant: valuable, rare, costly to imitate, and efficiently organised.

10.4.4 Dynamic Resource (Capability) Model (DRM) The dynamic capability framework is an extension of the RBV. The term dynamic refers to the capacity to renew competences (Teece et al. 1997 whose paper is published in a high quality journal, develop a dynamic capabilities framework approach which analyses the sources of wealth creation and capture by firms). Dynamic capabilities are defined as a firm’s ability to integrate, build and reconfigure internal and external competences to address rapidly changing environments (Teece et al. 1997).

10.4.5 Incomplete Contract Theory The theory suggests that no contract can be complete. Commons (1931) highlighted the challenges of governance of contractual relations, given the challenges of conflict, mutuality, and order. Harrison (2004) noted that all complex contracts are unavoidably incomplete. The problem of incomplete contracts is aggravated by the market dynamics facing both recipients and providers. Contracts must therefore be flexible and adaptable, which puts an even greater stress on the importance of contract management. Changes in the partnership’s context necessitate “relational contracting”. This entails that apart from formal contacts, informal contracting is an important element in controlling one’s partnership (Barthelemy and Quelin 2006, based on 82 surveys of personnel in charge of outsourcing in client organisations, published in a quality journal). They further suggest, because contracts are incomplete, self enforcement mechanism must be developed to ensure performance. They suggest constructs such as: control, incentives and flexibility are important.

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10.4.6 Other Models Although traditional literature on outsourcing emphasis that only non-core activities should be outsourced, there is now literature which suggest that core activities can also be outsourced, but require additional steps within the decision making process. According to McIvor (2000) it is crucial to address the outsourcing decision from an activity perspective within a firm’s value chain. He argues that it becomes much easier to identify the value adding activities when a firm is seen from a value chain viewpoint. The role of the supply base becomes more important with the outsourcing of more strategic activities which is accompanied by a higher dependence on the supplier. He proposes a four stage model: • Stage 1 consists of defining the core activities of the business; • Stage 2 consists in evaluating the relevant value chain activities and understanding the required competencies to fulfil those activities, with benchmarking in relation to potential suppliers from outside; • Stage 3 consists in total cost analysis of core activities. This stage attempts to identify all costs of either carrying out the activity in-house or buying the activity from potential suppliers identified from the previous stage; and • Finally, stage 4 consists of relationship analysis, which looks at the “suitability” of the supplier base to outsource a core activity. Depending on the type of relationship the sourcing company seeks, different relational competencies are required from the supplier. For example if the sourcing company wants to outsource a core activity but also wishes to maintain the knowledge to carry out the activity, it has to establish a partnership relationship or a strategic alliance. Both types of relationship require intensive collaboration. Hence, potential suppliers must possess these relational competencies for strategic outsourcing to be an option. Otherwise, he suggests, investing in order to perform the activity in-house. Levina and Ross (2003), reporting a study of vendor practices in one long-term successful applications management outsourcing engagement, point out that relationships matter particularly when viewing core competencies and the economic concept of “complementarity in organisational design”. They suggest that the softer aspects of a relationship are critical from both the vendor and the client perspective. Currie and Willcocks (1998) whose paper is also published in a quality journal, distinguishes between four types of IT sourcing decisions, through interviews with 20 organisations and 4 case studies. They suggest that ‘relational’ or ‘softer aspects’ of the relationship are as important as the hard factors. Grossman and Helpman (2002) writing in the Quarterly Journal of Economics, develop an equilibrium model of industrial structure in which the organisation of firms is endogenous. They show that the viability of outsourcing is determined by the distribution of bargaining power between the two parties involved, the degree of competition in the market, and the number of potential partners in the market. Taking this as a theoretical background, one may expect that the benefits from outsourcing are not always the same, but in particular depend on the characteristics

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of the firm and industry in question. Confirming that there is not a ‘one size fits all’ model for outsourcing. These models thus suggest there are a number of steps that a firm must understand to implement an appropriate outsourcing model, which minimise risks as far as possible. These steps include: • A clear understanding of what the firm’s core competences are; • Continual monitoring of the firms core competences, as these may change over time; • Understanding and identification in order of priority, the drivers for outsourcing within the firm; • The organisation and individual departments and personnel within it, must understand the potential risks that are apparent when a decision to outsource a particular process/function to a particular vendor in a particular country has been made. They must identify how these may affect the firm’s outsourcing drivers and the achievability of these, and identify possible mechanisms to overcome such risks; • An acceptance that all contracts are incomplete and therefore something else is required to fill the gaps that may exist in formal contracts; and • The use of relationship approaches, commonly referred to as ‘soft factors’, as a means of filling such gaps. However, the academic literature does not address important areas: • An understanding of the implications of conflicting outsourcing drivers which may be driven by different stakeholders within an organisation. The literature appears to assume that an organisation has one or many goals, with the acceptance that such goal(s) are representative of all the stakeholders within the client organisation. This arbitrary acceptance may in itself lead to conflict and unsuccessful outcomes; • An understanding of what can and cannot be covered by formal contracts – the literature suggests that the contract should be as complete as possible, but given the trade-off between attempting to write complete contracts and the costs associated with this, it is important for client firms to understand what can practically be covered by the contract; • An understanding of what mechanisms within the contracts can be used as control factors which aid in minimising risks. The prime mechanism for control, contract monitoring and enforcement within outsourcing relationships is the SLA. However, there is a dearth of extant literature which provides an analysis of how SLAs should be developed to ensure maximum control for the firm, whilst the establishment of trust and commitment can be achieved; and • An understanding of how the more recent, relational approach can be implemented and managed. Much appears to have been written on the relational approach, but little on what practically can be done to achieve such trust.

References

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Take Aways

• Research now suggests the legal contract and relationships are complementary and both required for successful strategic outsourcing. • The research suggests outsourcing is moving from just a tactical initiative to a more strategic approach, although it still remains a risky practice with a number of different risks that can be categorised as: strategic risks, operational risks, commercial risk and HR risks. • The drivers for outsourcing vary but could be broadly categorised as providing either: greater focus, cost reduction, flexibility or access to external expertise or technology.

References Abraham, K., & Taylor, S. (1996). Firms’ use of outside contractors: Theory and evidence. Journal of Labor Economics, 14, 394–424. Adeleye, B., Annasingh, F., & Nunes, M. (2004). Risk management practices in IS outsourcing: An investigation into commercial banks in Nigeria. International Journal of Information Management, 24, 167–180. Amiti, M., & Wei, S. (2006). “Service offshoring and productivity evidence from the United States”, Working Paper 11926, National Bureau of Economic Research. Aron, R., & Singh, J. (2005). “Getting offshoring right”, Harvard Business Review, Toolkit, DOI: 10.1225/R0512J, 135–143. Aubert, B., Patry, M., & Rivard, S. (1998). Assessing the risk of IT outsourcing. System Sciences, 6, 685–692. Aubert, B., Houde, J., Patry, M., Rivard, S. (2003). “Characteristics of IT outsourcing contracts”, Proceedings of the 36th Hawaii International Conference on System Sciences – 2003. System Sciences, 1–9. Barney, J. (1991). Firm resources and sustained competitive advantage. Journal of Management, 17(1), 99–120. Barthelemy, J., & Quelin, B. (2006). Complexity of outsourcing contracts and ex post transactions costs: An empirical investigation. Journal of Management Studies, 43(8), 1775–1797. Bettis, R., Bradley, S., & Hamel, G. (1992). Outsourcing and industrial decline. The Academy of Management Executive, 6(1), 7–23. Cheon, M., Grover, V., & Teng, J. (1995). Theoretical perspectives on the outsourcing of information systems. Journal of Information Technology, 10, 209–219. Commons, J. (1931). Institutional economics. The American Economic Review, 21, 648–657. Craig, D., & Willmott, P. (2005). “Outsourcing grows up”, The McKinsey Quarterly, http://www. mckinseyquarterly.com. Accessed 25th February 2005. Currie, W., & Willcocks, L. (1998). Analysing four types of IT outsourcing decisions in the context of scales, client/supplier interdependency and risk mitigation. Information Systems Journal, 8(Autumn), 119–143. Deavers, K. (1997). Outsourcing: A corporate competitiveness strategy, not a search for low wages. Journal of Labor Research, 4, 503–519. Dibbern, J., Winkler, J., & Heinzl, A. (2008). Explaining variations in client extra costs between software projects offshored to India. MIS Quarterly, 32(Special Issue on Offshoring), 333–366. Duggal, S., & Simkonis, C. (2007). Offshore outsourcing: New spin or same old business? Issues in Informing Science and Information Technology, Volume, 4, 242–260. Earl, M. (1996). The risks of outsourcing IT. Sloan Management Review, 37(Spring), 26–32.

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Elmuti, D., & Kathawala, Y. (2000). The effects of global outsourcing strategies on participants’ attitudes and organisational effectiveness. International Journal of Manpower, 21(2), 112–128. Elmuti, D., Kathawla, Y., & Monippallil, M. (1998). Outsourcing to gain competitive advantage. Industrial Management, 40, 20–24. Goles, T., & Chin, W. (2005). Information systems outsourcing relationship factors: Detailed conceptualization and initial evidence. Database for Advances in Information Systems, 36(4), 47–67. Goo, J., Kishore, R., Rao, H., & Nam, K. (2009). The role of service level agreements in relational management of information technology outsourcing: An empirical study. MIS Quarterly, 33 (1), 119–145. Grossman, G., & Helpman, E. (2002). Integration versus outsourcing in industry equilibrium. Quarterly Journal of Economics, 117, 85–120. Harrison, D. (2004). Is a long-term business relationship an implied contract? Two views of relationship disengagement. Journal of Management Studies, 41(1), 107–125. Henley, J. (2006-7). Outsourcing the provision of software and IT enabled services to India. International studies of Management and Organisation, 36(4), 111–131. Hirschheim, R., & Dibbern, J. (2002). Information systems outsourcing in the new economy – enduring themes, emergent patterns and future directions. Berlin: Springer. Jennings, D. (1997). Strategic guidelines for outsourcing decisions. Strategic Change, 6(April), 85–96. Jensen, M., & Meckling, W. (1976). Theory of the firm: Managerial behaviour, agency costs, and ownership structure. Journal of Financial Economics, 3(4), 305–360. Jurison, J. (1995). The role of risk and return in information technology outsourcing decisions. Journal of Information Technology, 10, 239–247. Kakabadese, A., & Kakabadse, N. (2000). Sourcing: New face of economies of scale and emergence of new organisational forms. Knowledge and Process Management, 7(2), 107–118. Kakabadse, A., & Kakabadse, N. (2000). Critical review – outsourcing: A paradigm shift. The Journal of Management Development, 19(8), 670–728. Kakabadse, A., & Kakabadse, N. (2005). Outsourcing: Current and future trends. Thunderbird International Business Review, 47(2), 183–204. Kern, T., & Willcocks, L. (2000). Exploring information technology outsourcing relationships: Theory and practice. The Journal of Strategic Information Systems, 9, 321–350. Khalfan, A. (2004). Information security considerations in IS/IT outsourcing projects: A descriptive case study of two sectors. International Journal of Information Management, 24, 29–42. Krishna, S., Sahay, S., & Walsham, G. (2004). Managing cross-cultural issues in global software outsourcing. Communications of the ACM, 47(4), 62–66. Lacity, M., & Hirschheim, R. (1993). The information systems outsourcing Bandwagon. Sloan Management Review, 35, 73–86. Lacity, M., & Willcocks, L. (1995). Interpreting information technology outsourcing decisions from a transaction cost perspective: Findings and critique. Accounting, Management & Information Technology, 5(3/4), 203–244. Lacity, M., & Willcocks, L. (1998). An empirical investigation of IT sourcing practices. MIS Quarterly, 22(3), 263–408. Lacity, M., & Willcocks, L. (1999). IT outsourcing in insurance services: risk, creative contracting and business advantage. Information Systems Journal, 9(3), 163–180. Levina, N., & Ross, J. (2003). From the vendor’s perspective: Exploring the value proposition in IT outsourcing. MIS Quarterly, 27(3), 331–364. Lonsdale, C. (1999). Effectively managing vertical supply relationships: a risk management model for outsourcing. Supply Chain Management, 4(4), 176–183. Mata, J., Fuerst, W., & Barney, J. (1995). Information technology and sustained competitive advantage: A resource-based analysis. MIS Quarterly, 19(4), 487–505.

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McCarthy, I., & Anagnostou, A. (2004). The impact of outsourcing on the transaction costs and boundaries of manufacturing. International Journal of Production Economics, 88, 61–71. McIvor, R. (2000a). A practical framework for understanding the outsourcing process. Supply Chain Management, 5(1), 22–36. McIvor, R. (2000b). Strategic outsourcing: “Lessons from a systems integrator”. Business Strategy Review, 11(3), 41–50. McIvor, R. (2006). The outsourcing process, strategies for evaluation and management. Cambridge: Cambridge University Press. Poppo, L., & Zenger, T. (2002). Do formal contracts and relational governance function as substitutes or complements? Strategic Management Journal, 23, 707–725. Porter, M. (1980). Competitive strategy: Techniques for analyzing industries and competitors. New York: Free Press. Prahalad, C., & Hamel, G. (1990). The core competence of the corporation. Harvard Business Review, 68, 79–91. Quelin, B., & Duhamel, F. (2003). Bringing together strategic outsourcing and corporate strategy: Outsourcing motives and risks. European Management Journal, 21, 647–661. Quinn, J. (1999). Strategic outsourcing: Leveraging knowledge capabilities. Sloan Management Review, 40(4), 9–22. Quinn, J., & Hilmer, F. (1994). Strategic outsourcing. Sloan Management Review, 35, 43–55. Quinn, J., & Hilmer, F. (1995). Strategic outsourcing. The McKinsey Quarterly, 32(1), 48–70. Rao, M. (2004). Key issues for global IT sourcing: Country and individual factors (pp. 16–21). Summer: Information Systems Management. Sharpe, M. (1997). Outsourcing, organisational competitiveness, and work. Journal of Labor Research, 18, 535–549. Teece, D., Pisano, G., & Shuen, A. (1997). Dynamic capabilities and strategic management. Strategic Management Journal, 18(7), 509–533. Wang, E. (2002). Transaction attributes and software outsourcing success: An empirical investigation of transaction cost theory. Information Systems Journal, 12(2), 153–181. Wang, L., Gwebu, K., Wang, J., & Zhu, D. (2008). The aftermath of information technology outsourcing: An empirical study of firm performance following outsourcing decisions. Journal of Information Systems, 22(1), 125–159. Willcocks, L., Lacity, M., & Kern, T. (1999). Risk mitigation in IT outsourcing strategy revisited: Longitudinal case research at LISA. The Journal of Strategic Information Systems, 8(3), 285–314. Williamson, O. (1991). Comparative economic organisation: The analysis of discrete structural alternatives. Administrative Science Quarterly, 21, 48–57.

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Minimising Risk Through the Contract

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The prime mechanism by which risks in outsourcing have been managed has been through the contract, although theory and practice recognise that contracts can never be complete. Nevertheless, it is important to try to develop comprehensive contracts with appropriate clauses whilst being flexible to cope with changes in the environment. This chapter examines the role of the legal contract in minimising risks.

11.1

Introduction

Formal contracts represent promises or obligations to perform particular actions in the future. The more complex is the contract, the greater is the specification of promises, obligations, and processes for dispute resolution. When asset specificity of the outsourcing relationship increases, contracts become increasingly complex for different reasons. A complete contract therefore must specify all the actions that each party would take in response to every possible state of the world. This is an idealised concept of a contract. All contracts are incomplete. In this sense, incomplete contracts are contracts that focus on offering alternative ways to deal with aspects of the relationship that are not easily addressable by simply specifying all possible contingencies. A corollary issue is the willingness of parties to enter long-term contracts, which tends to be limited by the hazards inherent in contractual exchange. Because writing and enforcing clauses is expensive, only a limited number of contingencies are included in contractual agreements. Optimal contract length reflects a trade-off between the costs of negotiating the terms of trade on a period-by-period basis and the hazards of being bound to an inflexible agreement for an additional length of time.

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Outcome Based Accounting Controls

Accounting controls, which are a subset of formal control mechanisms, can be used to measure outcome controls and/or behaviour controls. Behaviour controls in interorganisational relationships specify both how the partners should act, and monitors whether actual behaviour is in accordance with what has been pre-specified. In contrast, outcome control mechanisms specify outcomes to be realised by the parties and monitor the achievement of performance targets. A contract must be used in order to avoid risks when dealing with an outsourcing partner. The principle is to place the risk via an outcome-based contract, because the rewards for both partners depend on the same actions. Accounting controls are incorporated into an outsourcing agreement through the use of SLAs.

11.3

Appropriate Contractual Clauses

The written outsourcing contract is the most important tool for defining work, liability, price and expectations from both parties which guides their behaviour of how to manage the contract. A tight contract is essential to ensure that expectations are met; a loose contract increases risks. Relationships with loose contracts are more likely to fail. There are a number of different contractual provisions that can be used to minimise risks in good outsourcing contracts, these include: • Precision – the extent of the room for interpretation of the terms of agreement and its procedures should be established; • The description of services to be outsourced should be comprehensive and clear; • Performance measures and targets should be determined with as many numbers of elements as possible taken into account in the contract, subject to reasonableness , ease of measurement and the impact these have on behaviour; • Audit interval and procedures should be agreed between client and provider; • Service reports should be aligned with determined service level measures; • Cash penalties should be imposed for provider non-performance; • Incentives, including cash should be used to motivate the provider to exceed performance requirements and/or provide superior performance; • Disaster recovery and business continuation plans are meant to operate when certain force majeure events occur. The force majeure provision should not operate to relieve the vendor of the obligation to perform. While force majeure events might reduce the obligations of the vendor, they should not eliminate them; • Ensuring effective provisions for the application of the EU Acquired Rights Directive (77/187/EEC). The purpose of the Directive is to “safeguard employees” rights in the event of transfer of undertakings, businesses or parts of businesses. The rules also apply when a “service provision change” takes place (i.e. outsourcing). Broadly speaking, the effect of the Regulations is to

11.4

Contract as an Enabler of Trust

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preserve the continuity of employment and the terms and conditions of those employees who are transferred to a new employer when a relevant transfer takes place; • Ensuring that money laundering legislation is incorporated within the contract. The EC Prevention of the Use of the Financial System for the Purpose of Money Laundering and Terrorist Financing Directive1 applies to outsourcing relationships. The responsibility for complying with this Directive remains with the institution or person covered and cannot be passed onto the vendor; and • Ensuring data protection legislation has been incorporated into the contract. There are three different legal relationships that arise regarding the treatment of personal data in a contract for outsourcing services: Contractual (and/or in tort, depending on the jurisdiction), between the data subject and the data controller, Contractual, between the data controller and the data processor; and in tort, between the data subject and the data processor. In any case, the data controller remains liable for the non-compliance of the data processor with applicable law, because the latter acts on behalf of the former. There are additional factors that must be considered, including: impact of local taxes, regulations, warranties, guarantees, and subcontracting provisions, which would warrant another book. Readers may wish to look at Outsourcing to India – a Legal Handbook, my earlier book for further details. Risks can be accepted, excluded or laid off. Where risks are not accepted there is a price to pay for transferring the risk to someone else. Residual risk in an outsourcing scenario is likely to lie within the customer appointing the service provider. It is paramount to pre-plan for risk management and one of the best ways of achieving this is to use a matrix clearly setting out which party accepts which risk, to what degree and where insurance is taken out and who pays for it. Where risks are accepted by the service provider, there is likely to be a corresponding risk premium built into the price calculation and businesses should check carefully the financial model to ensure that this is no greater than is fair in all the circumstances. A jointly prepared and maintained risk register can prove very useful in ensuring that both parties understand and manage all the risks involved in the project, rather than just focussing on the risks they see as their responsibility.

11.4

Contract as an Enabler of Trust

In response to exchange hazards, managers may craft complex contracts that define remedies for foreseeable contingencies or specify processes for resolving unforeseeable outcomes. Rather than hindering or substituting for relational governance,

1

Directive 2005/60/EC of the European Parliament and of the Council of 26 October 2005. “Prevention of the Use of the Financial System for the Purpose of Money Laundering and Terrorist Financing”, 25.11.2005 Official Journal of the European Union L 309/15.

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well-specified contracts may promote more cooperative, long-term, trusting exchange relationships. Well specified contracts narrow the domain and severity of risk to which an exchange is exposed and thereby encourage cooperation and trust. The continuity and cooperation encouraged by relational governance may generate contractual refinements that further support greater cooperation. Relational governance in this sense may increase the probability that trust and cooperation will safeguard against hazards poorly protected by the contract.

11.5

Take Aways

• A complete contract should attempt to specify all the actions that each party would take in response to every possible state of environment and relationship, but balanced against the costs of writing such contacts. • The contract should try to focus on outcome based accounting controls through the use of SLAs. • A strongly negotiated contract can enable trust, rather than diminish it. • Vendor selection is important in minimising risks; it can be done through a non collaborative approach, which is appropriate for tactical outsourcing or through collaborative approaches, which is more appropriate for strategic outsourcing.

Minimising Risk Through Relationships

12

The role of relationships to minimise risks is gaining importance, as organisations have come to realise that the legal contract doesn’t necessarily reduce risk on its own. Trust is central to a good relationship. But developing trust is not an easy task, at an organisational or individual level. This chapter discusses how trust can be fostered at organisational and individual level and examines the circumstances under which investment in relational exchanges are appropriate. The chapter also documents two case studies looking at the role of relationships from both a client and vendor perspective.

12.1

Introduction

There is growing realisation that the relationship itself plays a critical role in the success or failure of the outsourcing relationship. Consequently, outsourcing relationships consist of contractual arrangements together with relational based governance. Considerable research has been done within the field of inter-firm collaboration, but most of this research neglected the contractual dimension, which is an integral part in many inter-firm relations, including outsourcing. But even a very comprehensive contract with incentives and penalties cannot exclude all possible risks.

12.2

Trust

A company cannot develop a strategy for outsourcing and implement it discretely, without an understanding of the embeddedness of individual relationships within wider networks. Trust is a fundamental relationship building block. Empirical studies have found mixed evidence on the relationship between formal control (contracts) and trust (and other types of relational governance). Das and Teng (1998) in their article in Organisation Studies, which examined the notion of confidence in partner cooperation in alliances, suggest that it comes from B. Vagadia, Strategic Outsourcing, Management for Professionals, DOI 10.1007/978-3-642-22209-2_12, # Springer-Verlag Berlin Heidelberg 2012

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two distinct sources: trust and control. They suggest that trust reduces the need for contracts and hence can be conceptualised as a substitute for formal control. More recent studies have found evidence that suggest that trust and formal controls are found to be complementary (Poppo and Zenger 2002). Trust as a phenomenon is complex and has many meanings, and no widely acknowledged definition of the term exists. Whereas some scholars tend to view trust in broad terms as one’s belief and expectation about the likelihood of having a desirable action performed by the trustee, others tend to define trust in terms of one’s assessment of others’ goodwill and reliability in a risky exchange. Other scholars distinguish between cognitive and affect-based dimensions of trust. Cognitive based trust is based on predictability, past behaviour, dependability, and fairness – i.e. a rational perspective. In contrast, affect-based trust is based on non-calculative reliance on the moral integrity, or goodwill of others, based on emotional bonds between individual and social interaction. Trust primarily emerges on the basis that the other party will fulfill its commitments. Repeated personal interaction discourages attempts to behave in an opportunistic manner and thereby increases the level of trust. As relationships evolve, competence trust becomes more important than the written formal agreement. Competence trust revolves around faith that the other party has the competence to be able to deliver what is required. Ultimately, goodwill trust is the decisive factor in highly evolved relationships; it is the trust that the other party will perform tasks in excess of the agreed terms and conditions. Goodwill trust is based on the expectations that parties have an open commitment to each other. Shared values and norms are a necessary, but not a sufficient condition, for developing goodwill trust. What is needed is open commitment and reciprocity. Close personal relationships between the parties to a relationship have been identified as enhancing their commitment to the future of the customersupplier relationship. Trust is said to be inspired by rational actions. From this rational perspective, trust is a calculation of the likelihood of future cooperation. The rational perspective recognises that people must engage in self-centred actions and be ‘continually making provisions for the possibility of opportunistic behaviour’ by others. One important consideration within alliances is that conflict between partners can result in higher costs or a premature breakdown of relationships. Trust helps defuse such conflict, because trusting partners are more likely to interpret each other’s equivocal actions in a manner conducive to the stability of the relationship. If a firm encounters unexpected actions by its partner that could be ascribed to both good and bad intentions, the presence of trust reduces the likelihood of a negative interpretation. This allowance facilitates openness in sharing knowledge and reduces fear of opportunistic behaviour by partners. Hence, the benefits from trust are magnified when behavioural uncertainty is high. However, the benefits from trust may be reduced when environmental uncertainty is strong, because overconfidence in the information provided by each partner restrains the vigilant environmental scanning and cross-fertilization of views that is of vital importance under

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Trust

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these conditions – assuming these possible concerns are not recognised and addressed at an early stage within the relationship. Interpersonal trust and inter-organisational trust are related but empirically and theoretically distinct concepts. Inter-organisational trust emerges as the overriding driver of exchange performance, negotiation, and conflict, whereas interpersonal trust exerts little direct influence on those outcomes.

12.2.1 Organisational Trust Organisational trust is typically characterised by a high level of trust in a company name or brand, coupled with a belief that good controls have been established in the deal. The parties are much more likely to ‘forgive’ each other even for relatively serious mistakes. A ‘can do’ attitude pervades the deal, and usually have formal ‘co-management’ practices established. The parties in the relationship proactively, and formally, seek opportunities to improve efficiency or enhance business value.

12.2.2 Group Trust Good group trust is characterised by the groups of people managing or affected by the relationship, in both the service provider and service recipient, having a medium to high level of trust in each other, and believing the controls are adequate or effective. Group trust often starts with small groups of good people trying to do the right thing, but in an ad hoc and random way. As the group extends, or members change, it becomes necessary to formalise best practices to maintain the level of confidence achieved. This is the first step toward formal co-management.

12.2.3 Individual Trust Individual trust is characterised by the key individuals managing the relationship in the service recipient and in the service provider having high level of trust in each other, and believing the controls are adequate or effective. These individuals will likely work well together, respect each other’s capabilities and understand how others are positioned and motivated inside their own organisations.

12.2.4 Creating Institutional Mechanisms for Building Trust Given that reliance on the legal contract alone is insufficient in rapidly changing environments. I recommend managing the outsourcing programme as a strategic partnership, with emphasis on trust and flexibility. Most partnership arrangements, whether flexibly defined or more formal, involve shared risk and benefit. Even looser outsourcing arrangements are alliances,

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consortia and shared service agreements. Whatever the reasons for the alliance, transparency between the partners is considered to be vital for trust building. Trust is a multilevel phenomenon that exists at the personal, organisational, inter-organisational, and even international levels. At the inter-firm level, as already noted, trust is a key element in cooperative relationships. It is effective in lessening concerns about opportunistic behaviour, better integrating the partners, and reducing the need for formal contracting.

12.3

Control and Its Relationship to Trust

The other determinant of risk in strategic alliances is control. Control is generally viewed as a process of regulation and monitoring for the achievement of organisational goals. A key factor that enables effective control is effective governance. A firm’s critical resources may span firm boundaries and may be embedded in inter-firm resources and routines. There are two classes of governance used by alliance partners: the first relies on third-party enforcement of agreements (e.g. legal contracts), whereas the second relies on self-enforcing agreements. The TCE perspective falls primarily within the first class, suggesting that dispute resolution requires access to a third party enforcer, whether it be the state (i.e., through contracts) or a legitimate authority. In contrast, self enforcing agreements involve safeguards that allow for self enforcement. Within the self-enforcement class of governance mechanisms, we distinguish between ‘formal’ safeguards, such as financial/investment hostage and informal safeguards such as goodwill trust. Excessive concern with control however can be counterproductive. Management of alliances is critically concerned with attitudes and interpersonal relationships, and that attention should be paid to issues of trust. Trust requires familiarity and mutual understanding and hence depends on time and context, on habit formation, and on the positive development of a relationship. Repeated interactions lead to the forming of habits and the institutionalisation of behaviour. Thus, habitualisation becomes part of the ‘invisible assets’ that make future cooperation easier to implement. Trust induced by institutionalisation and habitualisation, has a negative effect on risk in the form of the perceived probability of loss. There is a portfolio of controls that can be used in combination. These include: • Accounting controls provide objective representations of the performance levels of counterparties to inter-organisational relationships; • Behavioural control is the process or the means to ‘goal achievement’ (the controller can use formal controls such as performance evaluation and reward) or informal controls (utilising social or people strategies to reduce goal differences); • Outcome control influence the outcome of the process through performance targets; • Clan controls promulgate common values, beliefs and philosophy, using shared experiences, rituals and ceremonies; and

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Vendor Selection

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• Self control is used where the controllee determines both the goals and the actions through which they should be achieved. Outcome measures also enable a level of flexibility and innovation to be preserved in the relationship as they do not require adherence to pre-specified procedures or behaviours. They only specify the end results required from the alliance.

12.4

Vendor Selection

Vendor selection can be a very complicated and emotional undertaking. The main challenge is to ensure a vendor is chosen that delivers quality services at a reasonable price point, one that reduces risks and that you can trust. There are two approaches to vendor selection (see Fig. 12.1): a non-collaborative and collaborative approach which should form the basis of contract formation: • The non-collaborative approach can be identified by the request of the outsourcer to the vendor for a formal request for proposal (RFP). In this way, there is no active interaction between the possible partners. The simplicity of this approach becomes a limitation when the outsourced process becomes strategic

Characteristics: technology intensive in rapidly changing environments. Manages the relationship for as long as the supplier maintains a strong position in the technology

Characteristics: sufficient supplier competition exists, little or no customisation required and where economies of scale can be achieved. Flexible agreements with little relationship focus, and little flow of information, but possible multiple sources of supply

Critical to competitive advantage

Competitive Collaborative

Close Collaboration

Adversarial

Secure Supply

Not critical to competitive advantage

Low

Fig. 12.1 Relationship matrix

Supply market risk

High

Characteristics: Long term focus, reduced supply side, joint problem solving, information exchange, sharing the benefits and risk, high mutual dependency, Obtaining benefits in the relationship that are unobtainable by its competitors

Characteristics: Long term relationship in order to maintain supply continuity, need internal capability for-just-incase circumstances, tries to standardise, limits risks of one supplier

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Case Study of Indian BPO Service Provider: Courtesy of Client Partner Manager Based in UK

The service provider is a BPO arm of a major IT outsourcing vendor based out of India. The parent company primarily engages in IT Outsourcing, whilst its subsidiary focuses on the BPO sector. Within the UK the firm offers Human Resource Outsourcing, Finance and Accounting Outsourcing and Data Management Outsourcing to a select number of industries; including the healthcare industry, the market research industry, the legal sector and to a lesser degree the manufacturing and engineering sector. The firm provides what may be considered traditional non-core outsourcing services such as data entry, transcription services and rules based processes, however, it is increasingly trying to position itself to provide more core services to its clientele, adding longer term value to the client and moving into what is called knowledge process outsourcing services. This is largely driven by the need to move away from a pure cost focus which the interviewee suggested tends to dominate the client’s priorities when choosing to outsource peripheral activities. This is not say that cost does not feature as a key requirement, but the aim, the interviewee; a client partner tells me, is to bring to bear additional drivers that are more important when activities which are less peripheral are outsourced – these drivers include efficiency, quality of end to end service and flexibility. Another interesting development, especially given its parentage, is the development of converged services to the market, which combine and utilise IT to automate, streamline and deliver the firms BPO services. This is seen to be critical in a crowded vendor landscape where there are a few select vendors that dominate the corporate space offering a multitude of outsourcing services and a large range of niche vendors offering specialist service offerings to certain verticals or concentrating on certain processes. Being stuck in the middle is increasingly seen as a real challenge. Converged IT and BPO services allows the firm to specialise and compete in an increasingly competitive market; this is also evidenced by the recent trend towards more single sourcing deals rather than multi-sourcing. Clients it seems prefer sourcing a vendor that can deliver more than just a single outsourcing process. The company’s response to this market trend, has been the development of applications, one specifically for the travel and logistics industry and another for the legal sector – these applications now enable the firm to establish a leadership position in the delivery of specific BPO services, driven by the applications that support these processes. What is also in favour of the firm is the greater acceptance by its clients and prospective clients towards offshoring. This aligns the vendor with the recent focus that clients place on cost reduction as their major outsourcing driver. This drive towards cost reduction also means that there is a greater appetite for outsourcing processes and functions that may have been ‘off the table’ a few years ago, e.g. Financial planning and accounting is now

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becoming something that clients are looking to outsource, whereas a few years back it was seen as central to the business and not something that should have been outsourced. In other words, the traditional boundaries and limits placed on offshoring are now changing. From an offshoring perspective, the Asian countries, and in particular India remain at the forefront. China is still very much a destination for service providers looking to access cheaper resources, but not end user clients, who still see it as a major challenge given language and cultural differences. In terms of Near-shoring, the interviewee sees this as something that appears to have been talked up by media than reality; it is still seen as an expensive choice given labour rates and the euro currency. There are however many other destinations coming up that pose a greater threat (or opportunity), such as Egypt, Mauritius, Botswana, Kenya and Sri Lanka. These destinations not only offer labour arbitrage opportunities, but offer things that are unique, such as multi-lingual language skills, diversity of talent or just natural skills that may not be available in the traditional locations, such as India or Philippines. The firm, as it moves to higher value service delivery, would like the decision making process within clients to also change. Today for peripheral activities most firms include a range of stakeholders in the decision making process, with the COO ultimately making the decision to outsource, procurement setting the boundary conditions for vendors and the line of business driving the specific requirements. Other stakeholders are involved but usually only to contribute their opinions. What doesn’t appear to happen, is client’s willingly providing the vendor end to end visibility of the operations. The procurement function in some instances inhibit this process by imposing strict interfaces – this is not to say that procurement doesn’t provide a useful role within the process (at contract negotiation stage they provide useful structures and procedures that allow both parties to make objective decisions and check the health of the relationship), but that their role should diminish post contract to allow interfaces to be built between vendor and client at multiple points within the organisations. The problem is attenuated, as clients tend to be reluctant to share deeper insights into their processes and internal performance measures for a number of possible reasons; from not having the data, to fear of losing control, to fear of the impact this may have on internal departments or teams that would face competitive scrutiny if performance data was shared with a vendor. From the interviewee’s perspective, such dialogue is essential to create a partnership model for outsourcing. From the vendor’s perspective, the contract and SLAs are important, but should be considered hygiene factors (albeit with flexibility – although this appears to be only through scope changes). What is ultimately important is to create a partnership between the client and the vendor. A partnership offers both parties’ points of reflection where each can judge the strengths and weaknesses as well as opportunities for the relationship over the course of (continued)

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the deal – such a relationship can help the client organisation meet their overall corporate objectives. However, the interviewee suggested these things take time; it would take a minimum of 3 years before you could say you have a partnership, and 5 years before you could judge the relative success of a partnership (this isn’t including the pre-contract period, but post service delivery). This time is required to build the trust that is required at all levels within the organisations, to build a good understanding of the organisation’s business and its customers and their buying behaviour and to have tested the quality of the partnership during times of need. But for a good partnership, it needs more than just time, it needs transparency, so the vendor has a good understanding of the end to end value chain of the client; and the involvement of the right people from the client and not necessarily the CxOs. Most organisations just assume because there is a good relationship at the CxO level, they have a good partnership. This is dangerous as the CxOs may be oblivious to what happens on the coal face of service delivery. The traditional approach with set interfaces and governance meetings that happen only at a peer level may hinder a partnership approach rather than help. What is required is interface and governance structures that involve the team as a whole, from the operational delivery team to the senior executives, one which paints a good and true picture of the relationship and one that harmonises perceptions and realities throughout the organisations. The interviewee was keen to point out that a good partnership doesn’t necessarily need to include a risk or equity contribution, because that positions the relationship more in terms of what value can be extracted from the other party and what control can be exerted to the other. In fact a risk or equity model assumes there is not the genuine level of trust in the partnership such that formal controls and incentive structures are required.

for the outsourcer. In this case, the vendor selection phase becomes particularly critical and is often a determinant for the whole outsourcing activity success. • The collaborative approach can be identified by the absence of preliminary formal documentation between the outsourcers and the vendors. This approach can be pursued by the outsourcer that looks for a vendor, or by a vendor that approaches a possible outsourcer. This model has significant implications in the field of innovation, since the outsourcer can explore and evaluate vendor capabilities and promote common innovation. However this solution requires high relationship investments and participation in the vendor selection phase for both the outsourcer and the vendor. What the senior manager from this Indian service provider talks about is changing the relationship between the vendor and the client from one that has typically been adversarial to one that is collaborative and which seeks to promote dialogue and relationships at all levels within the organisation, as illustrated in Fig. 12.2.

12.5

Service Level Agreements as a Means of Control

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Adversarial Design Finance Info systems Operations Logistics

Buying

Sales

Design Finance Info systems Operations Logistics

Collaborative Design Finance Info systems Operations Logistics

Design Finance Info systems Operations Logistics

Fig. 12.2 From adversarial to collaborative relationships

12.5

Service Level Agreements as a Means of Control

SLAs are a critical part of the contract and complement the relational aspect of the outsourcing programme. Within relationship management, all outsourcing agreements are governed by formal contracts; therefore these must be used as part of the relationship management process. SLAs enable certainty and help publicise common beliefs and expectations and align goals. Negotiation of contracts and SLAs can in itself be used as a relationship and trust building process – the process can aid in developing the balance between formal contracts and trust. SLAs should include not only outcome based measures, but processes and dispute resolution procedures, as well as the roles and responsibility of various people involved in the outsourcing relationships. Metrics used within the SLA should motivate the right behaviour within both organisations (see Fig. 12.3). There are three critical attributes of relational governance: relational norms, harmonious conflict resolution and mutual dependence, which can mediate the impact of SLA characteristics on relational outcomes of trust1 and commitment.2 Formal contracts affect the self enforcing nature of relational governance, and explicit clauses dealing with the three SLA characteristics may also serve to

1 Trust reflects one party’s belief that its requirements will be fulfilled through future actions undertaken by the other party and viewed as a necessary condition for relational governance. 2 Commitment entails durability (a desire to continue a relationship because of positive affect towards the partner), input (a willingness to be deeply involved in the relationship through investment of capital and effort), and consistency (a confidence in the stability of the relationship).

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1. Choose measurements that motivate the right behaviour – Each side must understand the other side, its expectations and its goals, and the factors that are within their respective control

2. Ensure metrics reflect factors within the service provider’s control – The metric should be two sided. If the service provider’s ability to meet objectives is dependent on an action from the customer, the customer performance must also be measured

Check & Acknowledge

3. Choose measurements that are easily collected – If the metrics in the SLA cannot be easily collected, then they will quickly lose favour, and eventually be ignored

Parts List Order

Check & Acknowledge

Confirm Schedule Service Provision

Create delivery plan

Service design

Service design

Order detail Create technical specification for order

Confirm Configuration and external works Plan Jobs

5. Set a proper baseline – To be useful, metrics must be set to reasonable, attainable performance levels. This is where benchmarking may be a useful tool

4. Less is more – Avoid choosing an excessive number of metrics, if the metrics generate too much data, the temptation will be to ignore the metrics

Fig. 12.3 Rules for effective SLA metrics

develop social elements in relational exchanges (including norms, mutual dependence and trust). Partnership issues in outsourcing must be considered only in conjunction with contractual arrangements.

12.6

Collaboration

Trustworthiness varies between agents. It is to some extent personal, in bonds of kinship and friendship, but also to some extent impersonal, when a person observes a given ethic or set of behavioural routines. When an agent is a firm, its trustworthiness is associated with ethics and behavioural routine, which are part of the organisation’s culture. Effective outsourcing requires the parties to view the relationship as more than just an agency relationship, but one which is seen as a partnership or alliance. This requires parties to collaborate with each other (where each party may have different practices, interests, and competences). However, because of complex internal and external dynamics, effective collaboration cannot be measured by objective outcomes alone.

12.7

Relationship Management and Internal Knowledge Retention

165

Effective collaboration is a process that (1) leverages the differences among participants to produce innovative, synergistic solutions and (2) balances divergent stakeholders’ concerns. This process is facilitated by the existence of shared identity and practices, but is impeded by status differences among participants which inhibit open dialogue. There are intentional ways of creating social capital (a fourth kind of capital beyond structural, human and customer capital) that facilitates the development of trusted knowledge paths. A side benefit of this knowledge sharing governance structure is the creation of trust and mutual obligation, which reinforces the institutional relationship. Effective collaboration is difficult to achieve in global offshoring projects as there are often multiple boundaries that must be bridged simultaneously. For example, social boundaries and physical distance separate participants and make it difficult to establish shared identity and practices. Some other boundaries that have been studied separately in the past include: • Cultural boundaries; • Organisational boundaries; and • Functional boundaries. It has been argued that differences in national culture are among the key challenges to offshore collaboration. Different cultural norms that are usually discussed in cross-cultural research such as attitudes towards authority (Hofstede 1993) are produced and reproduced through actions and reinforced through the symbolic interpretations of these actions. In turn, they alter how agents work and interact.

12.7

Relationship Management and Internal Knowledge Retention

Although vendors’ valuable and hard-to-imitate resource endowments and capabilities may confer outsourcing firms with valuable opportunities and competitive potential, a firm’s existing core capabilities enable it to make the right sourcing decision and to effectively mobilise, deploy, and leverage the competitive potential offered by the vendors. Firms that incur the cost of outsourcing without developing complementary capabilities may be at a relative disadvantage compared to firms that do. There is a need to retain a central repository of expertise within the organisation. Outsourcing does not eliminate the need to manage the function now performed by a vendor. Rather, it creates a situation requiring managers to utilise a different set of skills. Effective contract monitoring requires the creation of a reporting system that allows for tracking of performance and costs, and technically competent individuals are required to manage across organisational boundaries.

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Case Study of Cooperative Financial Services: Courtesy of Steve Briggs Head of IT Strategic Partnerships CFS

The Cooperative Group is the largest consumer co-operative in the world, employing over 120,000 employees in the UK with a family of memberowned businesses spanning food retail, financial services (CFS), farming, funeral care and pharmacies. Cooperative Financial Services (CFS), employ 13,000 staff, working in a highly regulated industry with strict data security regulations and regulatory scrutiny. The focus of this case study is on CFS and in particular their outsourcing relationship with Steria for IT applications support and development (although the group has also outsourced to SCC their desktop management and Intel infrastructure management and their life and savings back office administration to Capita). The relationship with Steria being the largest of the three deals, goes back 18 years, and for all intent and purposes can be considered a mature relationship. Over the years, some 320 people have been moved across from CFS to Steria. The initial drivers for outsourcing were in order of priority: 1. Flexibility to meet fluctuations in demand (where resources can be ramped up and down at 3 months notice); 2. Innovation to ensure CFS benefit from technology and transform the use of IT to deliver transformational benefits to the business; 3. Inject best practice in terms of next generation IT and software development; and 4. Cost savings. Cost savings is integral to any outsourcing deal, but in this case it was seen as something thing useful to have, not as the initial driver for outsourcing. In their other desktop support and Intel infrastructure management outsourcing deal with SCC, the priorities for the deal were different, this time priorities were driven by different requirements: 1. The initial drive was to refresh and standardise the environment, drive efficiency savings and improve support capabilities. A second desktop refresh was embedded into the 6 year term; 2. Second on the list of priorities was cost savings, higher up the priority list than the broader application support and development area, which was seen as being integral to the core business of CFS and something that could deliver longer term competitive advantage. Looking back at the decision to outsource, Steve Briggs says with hindsight it has been satisfactory; it has delivered on the original business case, and still remains competitive, having tested the commercial model through the use of benchmarking; the relationship with the vendor is seen to be

12.7

Relationship Management and Internal Knowledge Retention

167

positive, although as always with hindsight, there would be things that would be done differently. The relationship could capitalise on the partnership model and deliver something that CFS could consider as being beyond just the ‘business as usual’ benefits. CFS, which is still highly unionised, and aligned to local communities and one that places a lot of weight on corporate social responsibility, is not averse to offshoring. Although most of the outsourcing activity is still onshore, some 100 people within the Steria relationship are located offshore at two locations. CFS places a large value in consulting the key stakeholders, of whom the unions are one. The decision making process for large impactful decisions within CFS follows what could be considered a typical process in many larger corporations, with a three tier decision structure. At the bottom of the pyramid are the project based teams, sponsored by a senior executive and owned by a service management line, tasked with ensuring the decision has broad agreement amongst the stakeholders, which includes: Procurement, Security, Finance and Tax, Strategic supplier management teams, and Legal. Having assessed the pros and cons of the decision and having identified the risks, and considered risk mitigation actions, the signed off decision is formally put to the executive (by the executive sponsor). Only if the executive committee approves the decision, does it go to the board for final approval. There is also wider consultation within CFS to understand existing outsourcing relationships and possible economies of scale that may be obtained. The process is very much consensus driven, following the culture of the organisation generally. This cultural heritage means it is not difficult to reach consensus and there is more give and take by stakeholders than may be the case within more traditional organisations (with their inherent power bases and departmental silos). CFS places significant value on relationship management; it is seen as an activity which can add value to the bottom line, although quantification of this is not easy. The relationship however is not seen as a substitute to strong control through the contract and the need for good governance. Steve suggests a good relationship management capability can add anything between 2% and 3% on the annual contract spend – when deal sizes can run in the multi-millions, this is a considerable sum. Obviously there is an investment required in developing and maintaining a relationship management capability. This isn’t just a requirement for a very senior relationship management team, (who though they may not have authority, require considerable influence within their organisation and intra-parties), but also a retained capability. A retained capability is crucial to understand the vendor’s service delivery performance and to perform proper governance. As ever, the (continued)

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challenge is to better understand what additional changes to the service configuration or design can have on the business, as well as the true cost of these changes, rather than relying on the word of the vendor. Given the trade-off between the benefits of a partnership model and the inherent costs involved, CFS considers carefully which deals should be managed on a transaction basis, which need to be managed as a true partnership, which need close control to ensure continuity of supply in business critical applications, and those that need to leverage economies of scale, given the volume of the deal. Off the 299 suppliers that CFS engages with, 255 are managed on a traditional transaction basis and only a handful as partnerships. However, defining exactly what a partnership means is not easy. Steve suggests it usually means the vendor going out of its way to help the client when needed; working beyond the contract and worrying about the details of the financials when the crisis has passed; where the vendor shares their latest thinking on research that may be useful to the client and where the vendor works with the client to actually deliver wider benefits to the organisation through better use of technology or processes, which may actually ultimately lower the value of the revenues from the client in the short term. This ultimately needs a high degree of trust. Trust at potentially all levels of the organisation, dependent on the nature of the deal. At a base level, Steve suggests, trust provides a sense of reassurance to the client that the vendor will not exploit and display opportunistic behaviour. However the extent of trust doesn’t go as far as sharing IP with the vendor – this is seen to be problematic and potentially damaging to the relationship, especially with the insertion of lawyers, when the discussion may get adversarial. A manifestation of a partnership could be in the form of a JV, however Steve believes in most cases given the different cultures of the two organisations, a JV has its own challenges, and usually requires strong middle management for there to be any sense of success.

12.8

Necessity of Legal Contracts for Positive Trust Development

Trust itself can be a risky engagement – trust can be disappointed and then appear to be misplaced. The existence of legal norms is one of the most effective remedies for confining the risk of trust and therefore for providing those good reasons which a potential trustor seeks before actually deciding to invest trust in a relationship. Thus, it is argued, legal norms and trust are more than compatible. With reference to relationships between individual or organisational economic actors it can be assumed then, that the legal agreement can play a vital role in situations in which an actor needs to decide whether he should invest trust in the relationship with his business partner, or whether he should refrain from doing so.

12.10

Knowledge Transfer

169

Personal trust is by no means sufficient to produce the quantity of trust that is needed in highly differentiated socio-economic systems. In other words, trust based on individual actors’ integrity can only fulfill a supplementary function, compared with trust produced by institutional arrangements.

12.9

Adaptation to Cultural Differences

Culture has traditionally been defined as ‘the collective mindset that distinguishes members of one nation from another’ (Hofstede 1991). Management within a society is very much constrained by its cultural context, because it is impossible to coordinate the actions of people without a deep understanding of their values (Hofstede 1984, in his seminal work, where 50 countries were studied in a single organisation with 32 value statements). The nature of management skills is such that they are culturally specific: a management technique or philosophy that is appropriate in one national culture is not necessarily appropriate in another. The core element in culture is values. Values are broad tendencies to prefer certain states of affairs over others. Relationships between people in a society are always affected by the values which form part of the collective programming of people’s minds in that society. Management is therefore subject to cultural values. Cultural influences within outsourcing are elaborated in the next chapter.

12.10 Knowledge Transfer Successful projects need synchronisation of tacit knowledge, informal information and cultural (social) alignment. Outsourcing success is significantly related to how the supplier manages its human capital and how effective it and the client are at knowledge transfer from the supplier to the client. Customers often outsource to gain access to technical skills and expertise. For this to take place, suppliers must manage their human capital effectively by ensuring that they assign sufficient employees with the required skills to work on the project and to minimize turnover of staff. Knowledge transfer works both ways; at the beginning of the outsourcing programme, knowledge transfer from the client to the vendor is important. Some of this knowledge may be documented, whilst some will be tacit and therefore more difficult to codify and transfer. In order to exchange tacit knowledge, someone needs to communicate it to another person, and therefore communication management may form an important part of the outsourcing strategy. Partner specific knowledge absorptive capacity is a function of (1) the extent to which partners have developed overlapping knowledge bases and (2) the extent to which partners have developed interaction routines that maximize the frequency and intensity of socio-technical interactions. In addition, partner-specific absorptive capacity is enhanced as individuals within the alliance partners get to know each other well enough to know who knows what and where critical expertise resides

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within each firm. In many cases this knowledge develops informally over time through inter-firm interactions. However, it may be possible to codify at least some of it. The ability of alliance partners to generate rents through knowledge sharing is dependent on an alignment of incentives that encourages the partners to be transparent, to transfer knowledge, and not to free ride on the knowledge acquired from the partner.

12.11 Managing Distance and Communication Challenges Significant challenges may arise from geographic distance and languages barriers between the client and the vendor. Furthermore, time zone differences as well as specific institutional features of offshore countries, such as infrastructure, security, political conditions, and intellectual property regulations within the offshore country, have to be taken into account when entering and managing an offshore outsourcing arrangement. When people communicate using computer-mediated IT, such as videoconferencing systems, the effectiveness and style of their communication is affected. Verbal and non-verbal behaviour in interpersonal communication varies quite widely depending upon a person’s cultural background. Sharma et al. (2008) through responses from 71 IS outsourcing vendors and clients, found 95% of respondents agreed that information risks can be controlled by using appropriate communication modes, with 76% of respondents suggesting that the inability to communicate regularly and casually with the vendor/client can reduce trust. The preferred mode of communication to increase trust between parties was regular face to face communication (83%), and where this is not possible video conferencing was preferred over telephone conferencing. Video conferencing helps display facial expressions, gestures and body language, which help visually display clear communication intent, without which cultural nuances would be lost. Figure 12.4 illustrates how communications management must be an organisational-wide activity. From a trust perspective, it is better to use telephone or video conferencing, avoiding e-mail as much as possible to reduce misunderstanding (Joyner et al. 2005).

12.12 Continuous Improvement The key principles and objectives underlying continuous improvement process should be those of: improving quality and efficiency; reducing costs; and encouraging innovations. The process must reflect the need to achieve value for money over the full term of the outsourcing contract. Service levels can provide for gradually increasing level of performance or for additional service levels to be added through the life of the project. A sophisticated continuous improvement regime in more complex projects may use a combination of devices to provide:

12.13

Risk Minimisation in Practice

Client Executive Leadership

Resolve

Strategic Direction

Assessment of overall health of Engagement

171

Vendor Executive Leadership

Overall Vendor Performance, Strategic Planning

Escalate Vendor performance, MSA level issues

Client Sourcing Management

Resolve

Vendor Relationship Management

Top-down proactiveset strategic direction and planning

Strategy execution, prioritisation and overall portfolio balance

Global Relationship, Contracting, SLA Trends, Escalated Issues

Project level planning and monitoring

Escalate Ongoing Communication, Escalation

Program level planning & monitoring by BU

Client IT or Business Management

Resolve

Vendor Program Management

Operations Execution & Performance, Strategic Initiatives, SLA Misses

Escalate Client IT / Business / Project Team

Resolve

Vendor Project Team

Establish specific targets and initiate material ideas

Define processes, standards and ensure successful execution

Coordination of all Quality, Training, Customer Satisfaction, Sales Initiatives, Operational Performance Management

Fig. 12.4 Communication management

a more stringent and structured approach to the requirement to improve and an obligation on the service provider to commit to achieving the aims described above and in some cases guaranteeing it. Devices often used for continuous improvement include: benchmarking, targets for cost reductions and key dates for service revision/review based on predictable changes to the customer business processes or requirements. It may be appropriate to share savings with the service provider from continuous improvement programmes where the improvement was suggested by the service provider or where the implementation of the improvement requires the service provider to incur costs.

12.13 Risk Minimisation in Practice The Op2i survey conducted in 2010, Vagadia (2010), confirms the important role of contracts, partnerships, trust, control, governance and knowledge sharing. Over 100 global respondents believed the best approaches to reducing risks from outsourcing are: • The development of a partnership relationship between customer and supplier; • Strong contracts and limitations on subcontracting; • Having a well defined governance structure and process; • Secondment of staff to the service provider; and • Appropriate SLA measurement and monitoring systems.

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The largestrisk faced by business when outsourcing off-shore

Yr 09-10 Yr 08-09

40% 30% 20% 10% 0% Compromise of company's intellectual property

Loss of day to day management control

Loss of knowledge from transferred emp

Bad press

The largestrisk faced by business when outsourcing on-shore

Reduced quality

Yr 09-10 Yr 08-09

40% 30% 20% 10% 0% Compromise of IP

Loss of day to day mngt control

Loss of knowledge from transferred emp

Bad press

Reduced quality

Fig. 12.5 Practitioner views of outsourcing risks Most impacting outsourcing risk mitigation actions

Yr 09-10 Yr 08-09

80% 70% 60% 50% 40% 30% 20% 10% 0% Negotiate strong contract

Build Partnership relationship

Manage public relations and press

Impose legal obligation on supplier

Place limitations on subcontracting by supplier

Fig. 12.6 Practitioner views of most impacting risk mitigation actions

Loss of day to day control continues to be the largest risk faced by business when outsourcing, whether it is onshore or offshore, with little change from the previous year (Fig. 12.5). What is disappointing, is the fear about loss of control has been acknowledged within both academic and practitioner literature for at least a decade, yet very little appears to have been done to give customers greater management control. What has been evident is greater visibility – the provision of daily or weekly reports or, real time access to systems for clients, but what is still missing is a sense of control.

References

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The best approach to reducing the risks from outsourcing remains the development of a partnership relationship between customer and supplier. Strong contracts follow, but significantly dwarfed by the partnership approach (Fig. 12.6).

12.14 Take Aways • A strong contract is not enough in minimizing risks, it needs to be complemented with relational exchanges. • Trust lies at the heart of a good relationship, although defining it remains a challenge. • Trust can be built on the fulfilment of commitments by both parties and the demonstration of reciprocity. • Goodwill trust requires a shared understanding and shared values that can be developed through two way open communication. • Trust exists at organisational, group and individual levels, although organisational trust emerges as the overriding factor. • Outcome based controls aid in building organisational trust. • Collaboration between organisations helps build trust through relational exchanges, although effective collaboration requires a knowledgeable retained team within the client organisation. • Successful collaboration and development of trust requires effective knowledge transfer and adaption to cultural differences. However, to aid this process, mechanisms to minimize the challenges from distance, time zones and working environments need to be implemented, with effective communication central to the outsourcing programme.

References Das, T., & Teng, B. (1998). Between trust and control: Developing confidence in partner cooperation in alliances. Academy of Management Review, 23(3), 491–512. Hofstede, G. (1984). Cultural dimensions in management and planning. Asia Pacific Journal of Management, 1, 81–99. Hofstede, G. (1991). Culture and organisations: Software of the mind. London: McGraw-Hill. Hofstede, G. (1993). Cultural constraints in management theories. Academy of Management Executive, 7(1), 81–94. Joyner, B., Payne, D., & Raiborn, C. (2005). How to be a good global communicator. Journal of Corporate Accounting and Finance, 16(6), 19–28. Poppo, L., & Zenger, T. (2002). Do formal contracts and relational governance functions as substitutes or complements. Strategic Management Journal, 23, 707–725. Sharma, R., Apoorva, S., Madireddy, V., & Jain, V. (2008). Best practice for communication between client and vendor in IT outsourcing projects. Journal of Information, Information Technology and Organisation, 3, 64–93. Vagadia, B. (2010). Op2i’s second annual outsourcing survey. An Op2i report, published March 2010.

.

Offshoring Leaders, Laggards and Hopefuls

13

Offshoring, although a small proportion of outsourcing today, is likely to grow over time, as are the number of countries looking to become outsourcing hubs. However, there are a number of factors that determine the appropriateness of a country as a destination. This chapter examines the criteria that should be used to rationally examine the appropriateness of a country and proposes a mechanism to weight these criteria. The chapter also illustrates how a rational analysis can bring about unexpected results. The chapter then examines the relative strengths and weaknesses of various countries across Asia, Americas, Europe and the Middle East and Africa region.

13.1

Introduction

Despite slow-paced and fragile recovery of the global economy, the global outsourcing industry is estimated to post a decent revenue growth in 2010. The industry is estimated to earn revenue of $425 billion in 2010, up 13.9% compared with 2009, according to XMG Global, a research and advisory firm. However, the estimated growth is lower compared to the 14.4% growth in the previous year, reflecting sluggish investment expansions in offshoring countries and moderate rise in outsourcing demand from the US and European regions. One significant feature of the global outsourcing industry landscape in 2010 was the narrowing revenue gap of China compared with the leader in offshore destinations, India. China is estimated to close the year with a revenue growth of 30% compared with 14% of India. However, India is projected to lead the market with expected revenues of $54 billion, occupying 44% share of the total revenue of $124 billion of all offshore destinations. On the other hand, the Philippines, the third leading outsourcing destination globally, outpaced India in voice business process outsourcing (BPO) services. According to Everest Research, the Philippines was projected to earn $5.7 billion from voice BPO services against India’s revenue of $5.6 billion in 2010. B. Vagadia, Strategic Outsourcing, Management for Professionals, DOI 10.1007/978-3-642-22209-2_13, # Springer-Verlag Berlin Heidelberg 2012

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13.2

Offshoring Leaders, Laggards and Hopefuls

Location Selection

The approach to selecting locations for offshore service delivery has to date, been hap-hazard, with focus mainly paid to workforce availability, costs and government incentives. This is not surprising when offshoring started very much with cost reduction in mind and specifically where access to a workforce with specific skill sets was important within the IT domain. Offshoring is a widely understood concept, at least within the sourcing community – what is not so well understood is rational analysis of the destinations for offshoring. Mention offshoring, and almost all will mention India, but should organisations wishing to offshore, only think about India? There is no question, India was the first destination, which viewed outsourcing as a sector in its own right and influenced government policy. India still leads when it comes to sheer volume, however many question whether the country is suffering from its own success: where there was an abundant labour supply, today there is a shortage in some areas, where there was immense scope of labour arbitrage, today that has narrowed, as inflation takes grip, companies that benefited from the dollar exchange, no longer do so, where there was pro-outsourcing government incentives, these are slowly been eroded as government priorities shift, and where companies were eager to get business and went that extra step, today these same companies have an overflow of opportunities showing little loyalty to its old client base. There are new destinations coming up, which may offer a better “deal” for offshorers; these new destinations may also be superior in offering services where India was weak (see Fig. 13.1).

Cities competing with cities

Reaching maturity

Market value creation

Emerging rapid growth

India

Canada

Emerging hubs

Philippines

Ireland

Czech Rep China Egypt Ghana

RSA Sri Lanka Kenya

E. Europe (IT) Malaysia

Romania Hungary Ukraine

Mauritius

Maturity

Fig. 13.1 Offshore destinations by maturity

13.2

Location Selection

177

13.2.1 From Countries to Cities Most location analysis compares entire countries, such as India, when the reality is that India is more like a continent, with major differences between regions and cities. The choice of outsourcing cities is based on a combination of both country specific factors and regional/city factors – the latter are clearly more important in larger countries and may not be relevant for smaller countries. Generic factors which offshorers look for include labour arbitrage, availability of proper infrastructure and lower country risk. It is these generic factors that have made Indian cities hot destinations for offshoring. Availability of a fairly large and qualified pool of workers is imperative to the success of these Indian cities over the rest of the world. Clearly infrastructure availability varies by city and combined with the availability of skilled labour, and in particular the availability of middle and senior level management is an important determinant of a good outsourcing city. Figure 13.2 details the criteria that should be used in evaluating a location. A city’s success eventually leads to its down fall – this is the case with cities like Bangalore. Its immense success has seen wage inflation and staff retention become a major issue. Real estate prices have gone through the roof and the availability of skilled resources is becoming a problem. The very things that made the city a success is becoming its Achilles heel. However times are changing and the ‘one size fits all’ approach has lost its relevance. With offshoring emerging as a major business activity and companies offshoring both core and value added processes, and cities competing for that piece of the pie, cities will need to differentiate themselves and we will eventually see cities positioning themselves as specialists outsourcers whether this is for call

Legal system

(can you enforce the contract – what is the data and IP rights protection regime like?)

Language

(is English the predominant language? What about other languages that your customer may desire?)

Skilled workforce

(how educated is the labour market?)

Labour costs

(what is the scope for labour arbitrage?)

Cultural alignment

(do they think and work the same way?)

Existing track record

(how good is the outsourcing vendor market – can they be trusted?)

Proximity

(what if there is a problem tomorrow, can you resolve remotely – how long does it take to get there?)

Political stability

(is there a risk of security /sanctions/ change in policy stances?)

Economic stability

(how solid is the economy, is there are risk to currency / taxes etc?)

Infrastructure

(outsourcing requires robust commslinks, good power supply and road and air links – how does the country compare?)

Government incentives

(are there favourable government incentives to go there?)

Access to Resources

(Offshorer will need local support at some stage – what is the availability of skilled business services and professionals – e.g. lawyers, consultants etc?)

Fig. 13.2 Offshore destinations – high level criteria for assessment

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centres for the likes of Manila, IT development for Bangalore, creative and media for Chennai, or market research and financial services for Delhi and Mumbai, etc. Some cities in India like Bangalore today represents a relative expensive location compared to tier two and tier three cities. However, the merits of these other locations needs to be understood and trade-offs made to ensure the location meets the requirements of the firm today and in the near term. Over time, the requirements for offshore locations have matured, but the decision model is still primitive, where most decisions are based on irrational emotions, rather than a rational analysis. The choice has also risen exponentially and firms looking to offshore locations must evaluate the locations based on the full set of criteria (see Fig. 13.3: Offshore destination – detailed decision model – courtesy of Governance Director, which is based on a European client looking at possible countries for locating back office banking and insurance processes, based on a rational decision model). The priorities must be rationally assessed with a methodological process, one which trades-off one criteria with another. The firm must be clear about how much Topic Factor Assertion Risk profile Security Low Risk to personal security Low risk to property from fraud Low levels of crime and terrorism Disruptive events Risk of labour uprising low Risk of political unrest low Risks of natural disasters low

Topic Factor Assertion Availability of skills Skill Pool Good Labour pool with required IT skills Good Labour pool with required business skills Good Labour pool with required management skills Good Labour pool with required language skills Labour pool with required communication skills Staff attrition Level of staff attrition low Level of additional training required minimal University standards considered high

Regulatory risks Stability Fairness Efficiency and enforceability of legal framework Similar legal system Macroeconomic risks Low cost inflation Low currency fluctuations Good capital freedom Intellectual property risk Strong data protection regime Strong IPR regime Environment Government support Policy on FDI favourable Relaxed labour laws Bureaucratic & regulatory burden is relatively low Level of corruption is low

Vendor landscape Good sized local sector providing IT services Good sized local sector providing back office services Quality of infrastructure Telecoms and IT Low network downtime Speed of service restoration high Bandwidth connectivity good Network redundancy adequate Real estate Good availability of office space Quality of office space Good availability of quality residential estates Transportation Good scale of road and rail network Quality road and rail network Good airport connectivity

Culture Compatibility with prevailing business culture Level of business ethics compatible Shared religious, historic and other backgrounds Similar organisational cultures and management styles Similar attitudes to hierarchy Similar attitudes to individual vs group think Living environment Overall quality of life considered good Serious crimes per capita low Proximity Travel time reasonable Flight frequency is good Time difference is minor

Power

High power availability High power reliability

Costs Labour costs Low average wages for skilled workers Low average wages for skilled managers Infrastructure costs Low Internet access costs Low Power costs Low Office rents Cheaper access to specialist equipment Corporate taxes Appropriate tax breaks Good, non beauracratic tax regulations Tax incentives for FDI

Fig. 13.3 Offshore destination – detailed decision model

13.3

Criteria to Assess the Location Decision

179

of factor X they are willing to give up for a little more of factor Y. This process must also generate consensus amongst the firm’s key stakeholders, with respect to project priorities.

13.3

Criteria to Assess the Location Decision

These criteria need to be organised into a hierarchy to enable better assessment and ensure the full range of criteria are identified and evaluated.

13.3.1 Factor Weightings Figure 13.4, Offshore destination criteria weighting – courtesy of Governance Director, illustrates the weights to be applied. These priorities are generated by Governance Director from a mathematical algorithm that rationalises and makes

Fig. 13.4 Offshore destination criteria weighting

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the stakeholders really reflect on what is important, by using a technique called pair-wise comparisons. The result is that weights are rational weights, rather than just arbitrary guesses, influenced by emotions or personal biases.

13.3.2 Country Evaluation A rational compliance assessment against the full decision evaluation criteria can result in a very different picture than would otherwise be expected – e.g. Fig. 13.5, a rational country comparison using detailed decision model – courtesy of Governance Director, shows India actually scoring relatively low in comparison to other countries – a finding that would not have been expected without the detailed and rational analysis.

13.3.3 Relative Merits of each Location, Based on a Rational Analysis On paper, India is seen as a leader in the field (both ITO and low end BPO), with a long track record, significant cost advantages, a huge skill pool and has established a “Brand” – largely thanks to NASSCOM.

POLAND

IRELAND

Rationally Ireland is the strongest, only let down by living environment. It excels in most areas: experience, skills, choice, infrastructure …

Rationally Poland is strong, expect when it comes to living environment. It excels in proximity, macro environment and proven delivery capability

INDIA

SOUTH AFRICA

Based on typical decision model as used by UK end users

Rationally South Africa is strong when it comes to the environment and infrastructure, but weak in terms of risk – but in BFSI is has a solid reputation

Rationally India is quite weak, but its proven capability, vendor choice, cost base and skill pool overpower the weaknesses

Fig. 13.5 A rational country comparison using detailed decision model

13.4

Effects of the Recent Political Unrest on Offshoring

181

Fig. 13.6 Rational relative merits of each country – courtesy of GovernanceDirector.com

South Africa offers higher end BPO and good grade call centre services, with well spoken skills, it is seen as a “nice” destination and contrary to reality, seen as relatively safe – the inward investment agency has been promoting the country significantly (and doing a good job) in the last 2–3 years. Ireland has been a leader in IT outsourcing and slowly encroaching on the call centre industry as many UK firms seek near shore locations (either as a global strategy or as an alternative to offshoring). Its economic problems will mean it will be a relatively cheap destination also. Poland has been a leader in near shoring, originally in ITO, then becoming a hub for shared service centres for general back office tasks. However, it still has a fairly benign image in the UK. Portugal is unheard of in the outsourcing space, no one really has any idea of the cost advantages (initial view for most is that it is expensive), access to skills (the news of the innovative nature of ICT in Portugal has not travelled beyond Portugal) – it does not feature on the radar of anyone looking for outsourcing. However, it is surprising what a different perspective a decision based on emotions and heuristic reaches versus a decision based on rational analysis. A rational analysis would suggest India doesn’t appear to be the favourite destination compared to some of the other destinations considered here – see Fig. 13.6 (rational relative merits of each country – courtesy of GovernanceDirector.com.)

13.4

Effects of the Recent Political Unrest on Offshoring

During the early part of 2011, various countries went through an upheaval whether manmade as in Tunisia, Egypt, Libya, Syria, Bahrain, Yemen, or nature’s effects, as in Japan’s catastrophic events, Chile’s earthquake a couple of years, and New

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Zealand’s recent earthquakes. Then there were the terrorist attacks in Mumbai a few years ago. Clearly geopolitical and natural disasters are elements that are considered in the choice of an offshore country, but the weight that may be given to these is changing. Long term ingrained understanding of political factors and condition have been upset and business leaders need to be wary of changing conditions and what that means in terms of continuity of service delivery – many will reflect on their original decision and consider whether things now need to change. Customers of organisations and certainly the insurance providers will be asking if the organisation has attempted to re-risk their offshoring strategies. Many organisations have made noises about creating resilience in their service delivery to de-risk effects from a specific country, some have voiced a preference for near-shoring rather than offshoring and only a handful will consider bringing the service in-house. It is not clear if this is just a knee jerk reaction; after all, geo-political and natural risks have always been part of the decision criteria mix, however the fundamental assumptions that may have been made about a particular country’s risk may need to be re-visited. What we are likely to see is no less in terms of offshoring (cost has always been and will always continue to be a driver), but a mix of countries that are used – so the dominance of India and Philippines may be challenged by other countries, not because they are better or cheaper, but because they offer the ability to diversify risk.

13.5

The Outsourcing Industry in Asia

The outsourcing industry in Asia has matured over the years, with major players like India, China and the Philippines accounting for about 75% of the global outsourcing revenue, growing at an annual rate of around 30%. However, the recent global economic crisis created a significant negative impact on traditional markets for Asian outsourcing companies. In the United States, industry specialists and legislators are now more inclined to limit American corporations from outsourcing business processes to offshore providers in a bid to protect jobs. With this on the horizon, Asian companies involved in the outsourcing industry are now looking to open doors for new markets and industries, particularly in Asia, Latin America and to a limited extent Europe, where the global financial crisis has not taken as heavy a toll, as well as looking within their own geographical boundaries for new market opportunities. India is the predominant centre for offshore outsourcing in Asia, followed by the Philippines and now China. Aside from these countries, major outsourcing destinations include other Southeast Asian countries like Malaysia, Vietnam and Singapore. Asia is home to a large English population, coupled with the technical skills and competencies exhibited by trained technical graduates at labour costs that are much more competitive than Western countries. Silicon Valley was the first to jump on this bandwagon as early as the late 1980s when many companies began offshoring software development and coding work to

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outsourcing firms in India. Cost was the main reason; companies saved a significant amount of money while generating quality outputs. Soon, other low-cost but highly skilled IT service providers began emerging in countries such as the Philippines, which also offered other types of services such as call centres, help desks, business process outsourcing, financial and accounting processes, and human resource management. The Asian outsourcing industry, despite the significant downturn in their key markets in the United States, reflected superb stability despite this gloomy economic outlook. In fact, the industry still reflected significant growth such as the 12% upswing in India despite cutbacks from U.S. and European markets, and the 70,000 employment increase in the Philippines during the height of the economic crises in 2008 and 2009. India maintains a strong-lead in terms of language skills and vendor maturity, together with an enviable track record and strong albeit slow legal system. Evidently, the Indian IT industry went overboard in exploring new markets, scouting for talent and investing in new service lines to offer end-to-end solutions across verticals due to the revival of fortunes. The Indian IT industry has 450 delivery centres in 60 countries worldwide, which is an unparalleled global value chain. The industry has resumed enhancing its global workforce by hiring specialised talent in developed markets and building a truly global delivery model. Rising costs pose a tough challenge that is likely to continue in the year ahead however. Vietnam and Philippines have emerged as strong competitors to Indian players with their cost-effective structures. China leads on infrastructure development and growth in education, but its legal system lacks transparency and it suffers from the obvious lack of language skills. Singapore some 20 years ago was a leading outsourcing destination, but has today been overtaken by lower-cost countries now competing to establish themselves as service centres. Philippines is getting exponential business in the case of call centres, largely as firms relocate there from India to the Philippines. It also has language skills unmatchable in the region and a very good cultural alignment with the USA. It also offers one of the lowest wage locations and offers low cost telecommunications services. Malaysia‘s economic stability, its diverse language skills and the investment the government has made, in the Multimedia Super Corridor and Cyberjaya, to establish the country as a regional IT hub, are driving the region as a outsourcing destination. Thailand, Indonesia and Vietnam have also seen significant declines in telecom costs, while slower growth rates have moderated wage inflation. However they lack the language skills, scale and labour arbitrage afforded by India. Thailand and Indonesia will likely remain challenged by lesser English language capabilities and concerns over their economic and political stability. Sri Lanka and Pakistan, although they offer many of the same advantages as India, suffer from their relatively smaller population-base and obvious concerns over internal security.

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Chile

China

India

Offshoring Leaders, Laggards and Hopefuls

Malaysia

New Zealand

Philippines

Singapore

Thailand

Vietnam

Scale Labour costs English proficiency Euro language skills Education system BPO market overview Government incentives Political / Geo security Cultural compatibility Data / IP Security Infrastructure

Fig. 13.7 Relative attractiveness of Asia-Pac countries

Australia and New Zealand offer attractive destinations in terms of language, cultural alignment, legal systems and infrastructure, but lack the scale and costs structures that others in the region can provide. Figure 13.7 illustrates the relative strengths and weakness of countries in Asia.

13.6

The Outsourcing Industry in India

India currently dominates as the country that is the destination for most offshore outsourcing. Many multinational corporations refer to India as the “electronic housekeeper”. An early low end software service that benefited India was the need to fix the so-called Y2K problem (the need to upgrade computer programs to work with the dating systems post the new millennium). The Indian Information Technology Outsourcing (ITO) and Business Process Outsourcing (BPO) industry is estimated to have aggregate revenues of about US $72 billion1 in FY2009 and to generate employment for over 2.2 million people. The service provision industry consists of around 4,000 vendors, approximately structured as follows: (NASSCOM 2009)2: • 7 with revenues above US$1 billion;

1

The export revenues are estimated to gross US$47 billion in FY2009, accounting for 60% of the total IT–BPO industry revenues. The USA remains the largest export market with 60% of the share, however a large part of the incremental CAGR of 41% if coming from the UK and continental Europe with 51% CAGR. The Banking, Finance and Insurance industry accounts for the largest vertical sector user of total revenues with over 41% of the total, but the hi-tech/ telecoms, manufacturing and retail sector follow behind. 2 NASSCOM Strategic Report 2009 – NASSCOM is the trade body and the chamber of commerce of the IT–BPO industries in India.

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• 80 with revenues between US$100 million and US$1 billion; • 350 with revenues between US$10 million and US$100 million; and • 3,500 vendors with revenues less than US$10 million. India offers advantages over many other possible offshoring destinations for a number of reasons: scale, skills, quality and its constitution, which provides a stable backdrop to the country and its outsourcing industry. India’s comparative advantages include: • Democratic government and relative political stability, with an independent judiciary and Western legal and accounting systems together with a well developed banking system and capital markets; • Access to a large pool of low-cost computer literate English speaking professionals with strong technical and quantitative skills. Investments in education and infrastructure over time has resulted in a large labour pool of skilled workers; • Economic advantages: Offering savings in the range of 40–60%3 from labour arbitrage; • The world’s fifth largest public sector telecommunications network with relatively low telecommunication costs; and • Quality: Work practices largely comply with international quality assurance standards (SEI-CMM Level 5,4 ISO 9000,5 TQM,6 Six Sigma,7 BS 7799,8 and COPC9 for instance). NASSCOM Strategic Report 2009 suggests that as of December 2007, over 498 Indian centres had acquired quality certificates with 85 companies certified at SE1 CMM level 5 – higher than any other country. For all the potential benefits that India offers, there remain many challenges to successfully outsourcing to India. These challenges include those related to poor infrastructure, its relatively weak legal system which implies the unenforceability

3

NASSCOM Strategic 2009 review suggests it’s as high as 60–70%. The Capability Maturity Model (CMM) in software engineering is a model of the maturity of the capability of certain business processes. The Capability Maturity Model involves maturity levels: A five-level process maturity continuum – where the uppermost (fifth) level is a notional ideal state where processes would be systematically managed by a combination of process optimization and continuous process improvement. 5 ISO 9000 is a family of standards for quality management systems. 6 Total Quality Management (TQM) is the organization-wide management of quality. 7 Six Sigma is a business management strategy, initially implemented by Motorola that today enjoys widespread application in many sectors of industry. Six Sigma seeks to improve the quality of process outputs by identifying and removing the causes of defects (errors) and variation in manufacturing and business processes. 8 BS 7799 was a standard originally published by the British Standards Institute (BSI) in 1995. A second part to BS 7799 was first published by BSI in 1999, known as BS 7799 Part 2, titled “Information Security Management Systems”. 9 Customer Operations Performance Center (COPC) Certification provides defined processes, measured metrics, and outcomes to highlight qualified suppliers. 4

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of contracts, potential differences between inter-firm relationships with respect to human resource management, culture, as well as specific HR issues, such as high employee attrition rates.

13.6.1 Infrastructure Challenges The 2007 Global Information Technology report released by the World Economic Forum has Networked Readiness Index (NRI) rankings, which benchmark countries in their capabilities in Information, Communication and Technology (ICT). NRI measures the propensity of countries to leverage the opportunities offered by ICT for development and increased competitiveness. India is ranked low on this Index – its performance overall in leveraging ICT appears to be hindered by weak infrastructure, with a very low level of individual ICT usage. In 2002, India spent only $31 billion on infrastructure while China spent $260 billion. Low spending on infrastructure over an extended period of time has resulted in a scarcity of infrastructure in the country. This scarcity includes poor quality roads, limited power generation/distribution, limited fixed telecoms networks and poor health care systems. Such infrastructure problems not only result in the need for further expense, such as power generation and back-up facilities, but also affect quality of life, which may deter many employees from the West moving to India for extended periods, making knowledge transfer and control more difficult. These infrastructural problems have led to a concentration of the outsourcing industry within a number of major cities; putting pressure on the availability of reliable and affordable real estate – again impacting the achievement of one of the key drivers, i.e. lower costs in the long-term. A limited number of major cities in India10 are preferred destinations for locating IT-Enabled Services (ITES) businesses, due to better quality infrastructure, access to talent and the presence of support services (e.g. legal and accountancy services, research facilities, etc.). Secondary cities are following behind, but lack adequate support services.

13.6.1.1 Education and Employment Challenges A key benefit has been its low cost, qualified workforce. However, India has a literacy rate of only 61%.11 This is unlikely to change in the near-term, given that the government only spends around 0.37% of its GDP against 1.41%, 1.07% and 0.50% of US, UK and China respectively on higher education.12 This is likely to constrain the availability of teachers and suitably qualified personnel in the future.

10

E.g. Mumbai, Delhi, Bangalore, Chennai and Hyderabad. United Nations Development Programme Report 2007/2008. 12 According to industry body ASSOCHAM, as reported in the Economic Times, by Vivek Sinha on 5 January 2007. 11

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Furthermore, according to the Academic Ranking of World Universities (2007),13 not a single Indian university ranks in the top 100 of world universities. The World Development Index, Edstats, notes that in India, less than 13% of the population in the relevant age cohort received a tertiary education in 2004. In the USA the corresponding share is over 60%. Meyer (2007) notes the quality of education is also not identical, with only a fraction of the graduates being deemed suitable for jobs by industry – in Germany and the US it is around 80%. A study conducted by McKinsey found that just 10% of all Indian students with a general degree and 25% of those with an engineering degree are regarded as suitable to work in Multi-National Companies (MNCs). Kuruvilla and Ranganathan (2008) claim that four critical and interlinked HR challenges threaten the near and long-term prospects of the Indian outsourcing industry. Macro level HR problems include a shortage of skilled HR, and the difficulties India’s advanced education and training infrastructure will face as it is tasked with producing the high-skilled manpower the industry will need. The “micro” HR problems include high average turnover rates, which in 2007 were about 20% in the software segment and 50–60% in the BPO segment, and the rapidly rising HR costs in the BPO industry (particularly at the low end). The authors note that in the case of BPO, 50% of employees who leave a firm exit the industry completely, while 50% move to another company. They suggest four reasons for the high turnover: • Dissatisfaction with their immediate supervisors, who tend not to have the required levels of experience in staff management, and the actual nature of the work which is seen as being un-interesting with limited career progression opportunities; • The nature of worker demographics – most young people who work in low end BPO use this as a stepping stone to better jobs with better salaries; • A high proportion of the workers in low end BPO are women, many of whom leave once they get married; and • The requirement to work night shifts is also affecting employee turnover. The above factors may disproportionately affect low end jobs and thus the difference seen in employee turnover rates between high and low end jobs. The factors affecting attrition rates can be divided into two categories – push and pull. Some of the prominent “push” factors, include stressful work environment, monotonous work, long commutes, a sense of powerlessness or lack of control at work, daily physical confinement, over-regimentation (the feeling of being spied on), odd work hours, and abusive clients. The main “pull” factors that entice people to leave their jobs, the report notes, include a good job market, good pay, better working conditions, knowing someone who already works in the business, and a well-known brand name. Indian call centres are sometimes referred to as ‘new-age sweatshops’.

13

Shanghai Jiao Tong University, 2007 – Academic Ranking of World Universities.

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This concern for talent has been acknowledged by NASSCOM, in its Strategic Report 2009, noting that even though over 3.5 million graduates and post graduates are added annually to the talent pool, enhancing graduate employability continues to be a key focus for all stakeholders within the Indian IT–BPO industry. The report suggests that student output quality is relatively low, and have thus set up the NASSCOM Assessment of Competence (NAC) centre – an employment skills assessment scheme – something however, which carries no guarantee of solving the underlying problems. With a potential shortage of qualified labour, together with concerns over the requisite skills, client organisations may need to develop training programmes which can be delivered to vendor employees working with them. Given the shortages in talent, inevitably there will be concern for increased wage inflation. According to Budhwar et al. (2006), in 1999 the average pay packet of an entrylevel BPO agent was $160–180. In 2006 it was $300–350. The report notes that every employee who quits, costs the company another $900–1,100 to recruit and train a replacement. Although clients may feel somewhat protected from increased wage inflation through their longer term contracts with the vendors, the impact of lower margins may well incentivise the wrong behaviour in their vendors. Employee attrition presents challenges not only for the vendor but for the client as well. Knowledge transfer from client to vendor can be a time consuming and resource intensive activity – having to repeat such an exercise will not only add to costs, many of which are invisible to accountants, but will extend project timelines. Developing trust at an individual level will be difficult with such high employee attrition rates.

13.6.1.2 Legal Challenges The Indian legal system is a common law one, which undoubtedly adds to uncertainty when compared to a more highly codified system. Nevertheless, although India is described as a common law country, having inherited a common law legal system from the British, many of its laws were in fact codified during British rule. This was then overlaid with further legislation when, in post-independence India, the government implemented a socialist reform agenda encompassing all areas of commercial activity (Armour and Lele 2008). A serious pitfall is that the legal system is notoriously slow. In 1952 Mr. Motilal C. Setalvad, the first Attorney General of India, wrote: “A burning problem which the citizens, lawyers and judges face alike is that of the congestion of Courts of law and the consequent inordinate delays in the administration of justice. . .” (Setalvad 1952). Three and a half decades later in his Law Day speech, the then Chief Justice of India painted a very dismal picture, “I am pained to observe that the judicial system in the country is almost on the verge of collapse. These are strong words I am using but it is with considerable anguish that I say so. Our judicial system is creaking under the weight of arrears. . .. In spite of efforts having been made and

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being made, and support provided by the Government, it is a matter of concern that there are huge arrears of more than 2½ crores of cases (25 million) in courts. . ...”14 The 120th Law Commission report15 of India found that India had only 10.5 judges per million people, compared to Australia which has 58 judges, Canada 75, UK 51 and USA with 107 judges. Data available from Doing Business 2008 India, a joint publication of the World Bank and International Finance Corporation suggests that on an average, it requires 1,420 days of litigation and costs 39.6% of the claim value to enforce a contract. The same study also shows that in a sample of 181 countries, India ranks 180 in enforcement of contracts. A termination dispute, for example, contested until all appeals are exhausted, can take up to 20 years, while writ petitions in High Courts can take between 8 and 20 years in India (Chakrabarti et al. 2008). Procedural laws in India, particularly with respect to civil litigation, facilitate delays and are often abused to frustrate genuine litigants. The legal system magnifies the delays through the creation of layers of rights to appeals and revision (Armour and Lele 2008). This creates a real dichotomy between theory and practice. On paper, India has some of the best investor protection laws in the world. In reality, an extremely slow judicial system, marked by overburdened courts, makes application of those laws far from a simple matter. Corruption continues to be widespread. Consequently, many firms, particularly small ones, rely more on informal mechanisms of contract enforcement and dispute resolution than on the courts of law. In India, relationship based systems are usually far more important than the explicit arm’s length systems of corporate governance and contracts observed in Western businesses (Chakrabarti et al. 2008). Outsourcing clients would be embarking on a risky strategy if they were to contract and attempt to enforce contracts under the Indian judiciary. However under Indian law, parties are free to stipulate their terms of contract and lay down the law by which the contract is to be governed. Indian Courts follow customary Private International law rules.16 Choice of law made by parties is acceptable, meaning parties to contract may choose under which national law the contract is governed. Given the slow legal system, many organisations resort to using arbitration as an alternative form of dispute resolution. The Law Commission, recognising such problems, encouraged the setting up of Tribunals. Party autonomy is the basis of

14

Prime Minister’s address on April 8, 2007, available at http://pmindia.nic.in/lspeech.asp? id¼520 15 120th Report on Resource Allocation for Infra-Structure in Judicial Administration – a continuum of the report on Manpower Planning in Judiciary: A Blue Print.1988. 16 Private International Law is the law which regulates which courts should take charge, which law should apply and whether judgments should be recognised and enforced across borders in cases with an international dimension. It also includes mechanisms for co-operation and exchange of information between governments and courts in different countries, where these are designed to support mutual recognition of each other’s laws and judgments.

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every arbitration agreement, however, court intervention is necessary to have certain measure of control over the arbitration process and ensure its efficacy. For instance, arbitrators have no power, by themselves, to enforce awards. One of the most important areas of court intervention is that of setting aside or refusing to enforce an award. Thus, court intervention is a necessary evil which cannot be eliminated completely.

13.6.1.3 Data Protection and Privacy Challenges In many outsourcing arrangements, there may be a need to transfer data to the Indian service provider for processing. Under such circumstances, applicable laws and regulations governing data protection may need to be examined carefully. The EU Data Protection Directive (95/46/EC) imposes obligations on the data controller rather than the data processor. This means that it is the customer in an outsourcing arrangement which must give careful consideration to compliance requirements. A recent empirical study by internationally recognised consultants (AT Kearney 200517) asserted that India has one of the best information security practices of any of the top 40 outsourcing destinations around the globe,18 nevertheless few countries have data protection laws that are sufficiently robust to comply with European Union minimum standards. The EU has identified countries which are deemed to have adequate data protection laws (known as the ‘adequacy club’),19 India is not amongst them as yet. Most outsourcing agreements should include the EC Directive’s Model Clauses,20 as a means of complying with these regulations. 13.6.1.4 Intellectual Property (IP) Challenges The sharing and creation of IP across multiple jurisdictions creates very real potential vulnerabilities because of the ‘territorial’ nature of IP rights. This means that the host country’s (India’s) IP laws may control IP related disputes adjudicated in that country. In other words, third country IP laws may not be applied in India

17

For example, the AT Kearney Global Services Location Index 2005 ranks India highest in a detailed analysis comparing 40 sourcing destinations across the world. The fact that India is very secure, from a data protection viewpoint, has also been confirmed by independent surveys by various credible organisations including the Financial Services Authority and the Banking Code Standards Board in the UK. 18 There are legal remedies for privacy breaches in India but they are not codified in one single place. For example remedies can be provided by Indian Contract Act, 1872; Indian Penal code, 1960; Special Relief Act, 1963; Consumer Protection Act, 1986; and the IT Act 2000. 19 As of July 2006, the following countries outside of the EEA had been confirmed as adequate by the European Commission: Argentina, Canada, Guernsey, Isle of Man and Switzerland. In addition to findings relating to the above countries, the Commission has also made a finding regarding specific transfers to the United States of America by the use of Safe Harbor. 20 The EC has approved three sets of standard contractual clauses (known as model clauses) as providing adequate protection to transfer individual’s personal information. Two sets of model clauses relate to transferring personal information from one company to another company who will use it for its own purposes. The other set is for transferring personal information to a processor acting under your instructions.

13.6

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regarding IP ownership disputes even if the operative contract has an unambiguous governing law provision calling for a specific third country’s laws to govern. Logically following from this idea, it can also be the case that a third country court may not apply its IP laws, but rather India’s IP laws, to decide issues involving the ownership of IP notwithstanding the operative contract’s governing law and venue provisions. India provides express statutory protection for patents,21 copyrights,22 trademarks,23 designs24 and mask works.25 While many may perceive India as providing superior protection for intellectual property (IP) rights relative to the majority of other developing jurisdictions, its IP laws and particularly enforcement mechanisms are nevertheless weak compared to Western IP laws and practices.

13.6.1.5 Quality Standards Challenges Levina and Vaast (2008) noted through interviews with a global banking client and a vendor from India that even though the level of process maturity within the Indian company was somewhat higher, when working with CMM level five certified companies, all the client managers interviewed felt the processes were not on the par with their expectations. As one interviewee commented, pp 315:“it is funny, right, when any Indian provider comes in the first thing they talk about is their CMM level, which is hysterical, cause they don’t even know what that means. . . . Then when you move work there and try to look for a repeatable process or documentation, it is not existent. . .”. 13.6.1.6 Possible Change of Direction for the Indian Outsourcing Industry The local market for business process outsourcing in India has actually grown by more than 50% during the last 5 years, and has generated revenues of up to $1.6 billion. This is in line with the prediction of Ernst and Young that the local BPO market in India has the potential to have an average growth rate of up to 38%, which will eventually reach $6 billion by 2012, with a still untapped market potential between $15 billion to $19 billion. For India this means future economic recessions in the west will not impact the outsourcing sector to a great extent.

21

The Patents Act, 1970 and the Patents Rules, 1972. The Copyright Act, 1957 and the Copyright Rules, 1958. 23 The Trademarks Act, 1999 and the Trademarks Rules, 2000. 24 The Designs Act, 2000 and the Designs Rules, 2001. 25 The Semiconductor Integrated Circuits Layout Design Act, 2000 and the Rules, 2001. 22

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The Outsourcing Industry in China

More and more Chinese companies that are benefiting from the economic boom that China enjoys are now more open and receptive to outsourcing some of their business functions to either local outsourcing firms in China or to more established outsourcing companies in other Asian locations. Aside from the geographical destinations that are opening doors to outsourcing companies from Asia, these companies are also looking towards providing services to other industries that were not traditionally being outsourced to Asian destinations. China’s outsourcing industry is fast picking up, though it currently occupies a small fraction of the global outsourcing market. China stands second only to India in the preferred outsourcing destinations globally by some analysis. In 2009, revenues from outsourcing services in China increased by a record 152% to $10 billion, according to data from the Commerce Ministry. China’s growing presence in the global outsourcing industry is influenced by many factors such as strong infrastructure, huge talent pool, diverse language skills, government support, and demographics. Besides, China is the most preferred destination for outsourcing and shared services for companies in Asia-Pacific region taking the lead over India, according to a report from KPMG, an auditing firm. KMPG estimates the China’s outsourcing market to reach $44 billion by 2014. In August 2010, to promote growth and compete with India’s dominance in outsourcing industry, China announced business tax exemption of 5% for the outsourcing companies that will extend to the end of 2013. The tax exemptions will apply to all companies offering Information Technology Outsourcing (ITO), Business Process Outsourcing (BPO) and Knowledge Process Outsourcing (KPO) in 21 cities in China. Furthermore, China was the among 15 economies that most reformed their business environment over the past 5 years, according to a November 2010 report from International Finance Corp. (IFC) and the World Bank (WB). China has a vast talent pool that is hardly tapped. China has yet to establish outsourcing companies that can match the sizes of their counterparts in India. On average, a software developer in China, with the same level of educational background and experience, cost only half of what he could do in India. This fact brings a huge advantage to China for attracting companies that are willing to outsource business functions such as software development and IT services to offshore locations. One of China’s major strengths in global outsourcing is its vast talent pool of hardworking skilled technicians and engineers. The latest official estimates show that 6.1 million university students graduated in China in 2009, more than 730,000 of which are engineering graduates, compared to 490,000 in India, 70,000 in the United States and 23,000 in the UK. China also produced nearly 70,000 PhD graduates in the same year, 4,000 of which have computer science specialties. Another source of high quality talents is the large number of Chinese returning from

13.8

The Outsourcing Industry in Philippines

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United States, Canada and the United Kingdom with degrees from top universities in those countries. China is already the largest offshoring destination when it comes to Japan, South Korea and many other Asian countries. In recent years, Indian outsourcing companies including Infosys, Wipro and Tata have all established footprints in China in order to complement their existing work force to deliver large-scale contracts with increased cost-effectiveness. No country in the world has made as much investment in infrastructure in recent years as China has, enhancing the credibility of China‘s global position in Outsourcing. The Chinese government has authorised major capital expenditures to ensure a steady power supply and modernised telecommunication network with high-speed broadband connections in key strategic locations and major cities. More upgrades are on the way as the government invests a further RMB four trillion (GBP£ 370 Billion) in infrastructure to boost the domestic economy. All this is not to mention the new software parks and technology centres with state-of the- art facilities that have sprung up in the major cities in China. Both Chinese officials and companies that specialise in outsourcing have recognised the need for good English language skills to win business from western markets and to compete with rival locations in India, South Americas as well as many South Asian countries. The Chinese government has made English teaching a strategic priority at universities through to primary schools where English as a foreign language is now mandatory. The official statistics prepared by the Chinese government shows that there are currently over 300 million people actively learning English as a foreign language in China. It is projected that by 2014 the total number of Chinese people learning English will surpass the total population of English speakers in the world.

13.8

The Outsourcing Industry in Philippines

The BPO industry provides services to different countries all over the world. Around 65% of the services are exported to the US, 25% to other ASEAN countries (India, China, Hong Kong, Singapore, Japan and Taiwan) and the remaining 10% to Europe (United Kingdom and Germany). Other markets include United Arab Emirates and Saudi Arabia. Emerging markets are Australia, New Zealand and Canada. There were about 630 firms providing BPO–IT services in the country in 2008, roughly distributed as follows: 76% BPO companies, 19% software development companies, and 5% the rest. Under BPO, 124 are call centres (24%), 100 firms are into medical transcription (19%) 70 firms are into animation (14%), 62 firms are into back-office processing and 27 firms are into digital content (5%). Having captured around 15% of the global BPO market and 7% of the global BPO -IT services, the Philippines has established itself as a favoured BPO service provider next to India. The industry aimed to pursue its global inroads by gaining 10% of the BPO–IT market in 2010. The key success factor of the country’s BPO

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industry rests mainly on its low cost but highly qualified English-proficient labour pool, its close affinity to USA culture, and the improved telecommunications infrastructure ideal for outsourcing operations. The Philippines is considered as the centre for excellence particularly in voicebased services. The educational system of the Philippines, wherein the medium of instruction is English, produces graduates who are highly proficient in the language. American clients more often prefer Filipino call centre agents as compared to their Indian counterpart, because Filipinos have English accents almost similar to the North American agents. With the advantage of strong English-language skills, the country has emerged as the leading outsourcing destination for contact centre services. In 2009, revenues from contact centre services occupied more than one third of the overall BPO revenues of Philippines. For the year 2010, the Philippines is estimated to earn $5.7 billion from call centre services, overtaking India’s revenue of $5.5 billion, according to the Everest Group, an outsourcing advisory firm. Notwithstanding the strengths in the BPO industry, the high electricity cost and the poor business environment pose risks for investors in the Philippines. Electricity rates in the Philippines are the highest in Asia. The country also ranks very poorly in the business environment criteria. Transparency International (TI) ranked the Philippines far below the other major BPO–IT players.26

13.9

The Outsourcing Industry in Europe

European countries play a dual role, as a client outsourcing its process or functions and as a destination for other client organisations to outsource to. Europe had been lagging behind the United States in terms of outsourcing identified functions to offshore providers in Asia. However, the global financial crisis made outsourcing a viable option for European companies to cut back on costs and remain competitive. Companies such as Wipro, Tata, and Infosys are penetrating the German and European markets and have even expanded and have established sales and marketing offices in these countries. The German and European outsourcing market is expected to increase between 7% and 10%. Much of this will be focused not only in the banking and financialservices, but also in the automotive, chemical and telecommunications industries. With respect to Europe as an outsourcing destination: Czech Republic, Hungary, and Poland the leaders in the region are now losing ground to emerging locations, such as Bulgaria and Romania. Continued improvement in the business environment in the Czech Republic and Hungary cannot offset deterioration in cost competitiveness.

26

Philippine BPO–IT industry performance and prospects – Congressional Planning and Budget Department House of Representatives 2009.

13.10

The Outsourcing Industry in North America and Latin America Czech Republic

Hungary

Ireland

Poland

Portugal

Romania

Russia

195

Slovakia

Spain

Ukraine

Scale Labour costs English proficiency Euro language skills Education system BPO market overview Government incentives Political / Geo security Cultural compatibility Data / IP Security Infrastructure

Fig. 13.8 Relative attractiveness of European countries

The Baltic States, Estonia, Latvia and Lithuania still lack the infrastructure of their European neighbours, and suffer from their relatively small size. Russia the new kid on the block offers strong technical skills, but lacks the infrastructure, language skills and cultural alignment that some of the newer EU members or prospective members offer. UK and Ireland score relatively highly and would be leaders were it not for their high labour costs. Both countries offer stable political and economic environments with strong legal systems, excellent infrastructure and access to good resources, albeit smaller in population size than the Asian counterparts. Figure 13.8 illustrates the relative strengths and weaknesses of the countries in Europe.

13.10 The Outsourcing Industry in North America and Latin America Outsourcing companies are also looking for new markets in South America with firms like Tata, Wipro and TCS setting up global delivery and IT centres offering lucrative software and maintenance services. Establishing these centres is a way to address the variable time-zone issues between their main operations in India and the host market. Not only that, these centres are also intended to increase the trust and confidence of government organisations that are often sceptical about sharing proprietary information to Indian companies. Spurred on by India’s success, governments throughout the region have recognised the potential of the export services sector, particularly in the context of providing near-shore support to North America and Iberia. Brazil has begun to leverage the traditional strengths of its indigenous IT sector, rapidly expanding university enrolment and quality certifications, together with the scale it can offer.

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Offshoring Leaders, Laggards and Hopefuls

Canada

Costa Rica

Mexico

Panama

Scale Labour costs English proficiency Euro language skills

Education system BPO market overview

Government incentives Political / Geo security Cultural compatibility Data / IP Security Infrastructure

Fig. 13.9 Relative attractiveness of North and South American countries

Chile, Mexico and Argentina have seen significant sector growth and some increases in graduation rates. Chile continues to benefit from the best business environment and tax structure in the region. Mexico leverages its proximity to the US, Argentina offers relatively lower costs, whilst Costa Rica was a traditional leader in the region but has been overtaken by other heavyweights moving in. Figure 13.9 illustrates the relative strengths and weaknesses of countries within North and South America.

13.11 The Outsourcing Industry in Middle East and Africa Middle Eastern and African countries are increasing their visibility as remote services locations. Egypt, Jordan and the United Arab Emirates are all trying to establish themselves as outsourcing hubs. The former attracting a number of Asian vendors to the region as they run short of skilled and cost effective labour from the home markets. Egypt has become a prime location for Information Technology (IT) and call centre outsourcing. Egypt’s Smart Village has been the preferred destination for call centres and exported IT services in Egypt. The Village currently hosts some 12,000 employees working for more than 100 multinational companies – most of them in outsourcing – who have call centres serving English and non-English speaking clients around the world. From providing cell phone services and customer support (Vodafone call centre) to R&D centres (Orange Business Services) that provide solutions to the IT and Telecom sectors, Smart Village is positioning itself for anyone seeking to enter Egypt’s outsourcing market. Smart Village expects to host 80,000 employees by 2014, which is more than six times the current number. Xceed has been Telecom Egypt’s call centre arm since 2003 and is considered to be the biggest call centre in the local market. Wipro joins Satyam

13.12

Take Aways

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Egypt

Ghana

Jordan

Kenya

Mauritius

Morocco

Tunisia

Senegal

South Africa

Scale Labour costs English proficiency Euro language skills Education system BPO market overview Government incentives Political / Geo security Cultural compatibility Data / IP Security Infrastructure

Fig. 13.10 Relative attractiveness of Middle East and African countries

as the second Indian company to find conditions there suitable for its outsourcing operation. With a 20% growth rate in Egypt’s IT and call centre sector in 2007, outsourcing has already played its part in contributing to the local economy’s growth, up by 7% from the previous year. Mauritius a leader in the African region offers good infrastructure, political, economic and business climate, but lacks scale. Morocco and Tunisia reflect growing interest in locations with the ability to serve francophone markets. Ghana maintains its position as a low-cost English language location in Africa, while South Africa is fast becoming the India of the African world. Figure 13.10 illustrates the relative strengths and weaknesses of countries in Middle East and Africa.

13.12 Take Aways • Offshoring will be on the rise, as are the number of destinations. • A rational analysis shows the traditional favourites may not necessarily offer the best environment for outsourcing. • A detailed assessment model should be created to examine offshore countries and the criteria weighted rationally. • A rational analysis of offshore destinations may bring about unexpected results – India for instance has many weaknesses that an emotional decision would overlook. • Multi-shoring is likely to rise, given the recent global political unrest and spate of natural disasters, which highlighted the risks of putting all your eggs in one country for offshoring.

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References Armour, J., & Lele, P. (2008). Law, finance, and politics: The case of India, Centre for Business Research, University of Cambridge, Working Paper No. 361. Budhwar, P., Luthar, H., & Bhatnagar, J. (2006). The dynamics of HRM systems in Indian BPO firm. Journal of Labor Research, 27(3, Summer), 339–360. Chakrabarti, R., Megginson, W., & Yadav, P. (2008). Corporate Governance in India. Journal of Applied Corporate Finance, 20(1), 59–72. Kuruvilla, S., & Ranganathan, A. (2008). Economic development strategies and macro and microlevel human resource policies: The case of India’s “outsourcing” industry. Industrial and Labor relations Review, 62(1), 39–72. Levina, N., & Vaast, E. (2008). Innovating or doing as told? Status differences and overlapping boundaries in offshore collaboration. MIS Quarterly, 32(2), 307–332. Meyer, T. (2007). Offshoring work, not jobs, Deutsche Bank Research, April 12, 2007. Setalvad, M. (1952). Problems before legal profession. All India Reporter (Journal Section), 39, AIR, Journal 2.

Managing Cultural Differences

14

Managing cultural differences when outsourcing and offshoring remains a major challenge for organisations – these cultural differences are influenced by differences in hierarchy, management styles, group relationships and motivations. This chapter examines the basis of these cultural differences and how these might be minimised.

14.1

Introduction

The distance, cultural, coordination and communication differences between offshore destinations and Western countries are significant: • Language barriers can create communication problems. This may hamper knowledge transfer between the parties and increase the likelihood of false specifications. Similarly, control and coordination is likely to be more difficult and expensive; • The geographic distance between offshore destinations and the outsourcing firm can be significant. Although new technologies are enabling virtual meetings as a replacement to physical meetings, these do not provide an environment for the transfer of tacit knowledge and the development of trust; and • Cultural differences can make information exchange, control and management more challenging. Case studies on offshoring from Anglo-American countries to India indicate that opposing attitudes towards authority, hierarchy and power may cause differences in criticism and feedback behaviour between client and service provider personnel. To demonstrate some of these cultural differences, this chapter will predominately use India as an example of how these cultural differences manifest themselves.

B. Vagadia, Strategic Outsourcing, Management for Professionals, DOI 10.1007/978-3-642-22209-2_14, # Springer-Verlag Berlin Heidelberg 2012

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An increasing problem cited by many service providers in India (and their clients) is the high level of attrition of their employees. This not only adds costs, it also leads to a depleting pool of skilled and knowledgeable workforce within the service provider organisation, whilst making the task of trust building more challenging. A key challenge when outsourcing offshore is the management of cultural differences between the two parties, without which, building of trust will be difficult to establish. Indian professionals for instance tend to implement prescribed specifications with little reflection, and strongly adhere to hierarchies. Hofstede et al. (2002) through the analysis of perceptions of junior managers and professionals working during the day and attending evening MBA classes at local universities, suggests one hurdle to be overcome, is different traditions of corporate governance. Hofstede (2007) in his paper, building on his early study of 15 possible goals and the relative ordering of these within four countries; China, Denmark, India, and the USA, found that for example, four of India’s top five goals are among Denmark’s bottom five, and respecting ethical norms comes top in China but among the bottom five in India. Hofstede’s seminal work has been the benchmark for cultural analysis for the last 3 decades. Although it has been subject to criticism on both the theoretical and empirical levels, it remains highly influential. It is vital for outsourcing clients and vendors to understand each other’s cultures in some detail, otherwise there is wide scope for misunderstanding and goal differences, which will hamper the success of the outsourcing initiative even before the project commences. Sharing of goals, aims and objectives between the parties from early in the outsourcing process is vital in bridging differences. The process of vendor selection, the setting of SLAs and negotiating contracts becomes important, not only in terms of the outsourcing process itself, but in aiding understanding of cultural differences and aligning goals. There is a significant need for employees on both sides of the effort (Western and Indian) to learn and respect the other’s culture, while maintaining a healthy respect for their own. The commonality of language (English) should not be mistaken for a commonality of world-views. These cultural differences are explored further below.

14.2

Cultural Influences on Management Style

Indian academics characterise the Indian management style as one that demonstrates an unwillingness to accept organisational change or take risks, a reluctance to make important decisions in work-related matters or lack of initiative in problem solving, a disinclination to accept responsibility for job-related tasks and an indifference to job feedback, compared to the USA and UK.

14.3

Cultural Influences on Hierarchy

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When looking at cross-cultural comparison of individualism1 – collectivism2, the United States ranks as the most individualist with an index of 91, while India’s index is 48. In his study, Hofstede (2007) found Western countries all scored above average on individualism. The Collectivism versus Individualism distinction clearly has implications for the kind of management that is appropriate within a culture. India emerges as a cultural Island of the 13 countries studied (US, Canada, Australia, Japan, UK, France, Germany, Italy, Korea, Brazil, Argentina, Mexico and India) by Sparrow and Budhwar (1997). Both they and Perlow and Weeks (2002) suggest that in the U.S., an individualised identity is highly prized, whereas in India, there is a lack of regard for, and at times a discouragement of separation and autonomy. As a result, groups in India have priority over individual needs, desires, beliefs and values. These differences mean management styles will themselves need to be adapted for managing the outsourcing relationship between Western and Indian companies. These differences will mean traditional incentives within a contract may need to be modified; the methods of communication and monitoring will also need to be appropriately changed and the decision making process itself may need to change.

14.3

Cultural Influences on Hierarchy

Indian culture is often viewed as having a high power distance, implying an acceptance of hierarchical authority and associated work behaviours. Indian company structures are perceived by their onshore counterparts as being “too hierarchical”. Private-sector organisations in India tend to recruit their relatives to top positions, and accordingly practices related to promotion, transfer and benefits are manipulated as a result of social contacts and personalised relationships. A professional approach (based on impersonal formal rules) to managing HR in Indian private-sector organisations is generally not adopted because it is perceived as a threat to the owners’ ability to enforce control. This hierarchical system also extends to the nature of communications used within the Indian organisation. Indian firm’s communication is generally top down, driven by the hierarchical system.

1 Individualism stands for a society in which the ties between individuals are loose: everyone is expected to look after himself or herself and his or her immediate family only – Cultures and Organisations – Intercultural Cooperation and its importance for survival – Hofstede, Geert (1994). 2 Collectivism “stands for a society in which people from birth onwards are integrated into strong cohesive in groups”, which throughout people’s lifetime continue to protect them in exchange for unquestioning loyalty – Hofstede, Geert (1994).

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Cultural Influences on Group Relationships and Motivations

Indian management tends to be paternalistic with preference for personalised relationships, rather than a more divorced performance orientation. This generates a “tendermindedness” and “soft work culture” that is associated with a reluctance to take bold decisions and see them through to the end. Success is judged on a moral consideration of the text and strict observance of ritual, not on actual behaviour, absolute principles or rules. Indian work culture dictates a distinctive style of transformational leadership, which has been called the ‘nurturant-task leadership’ style. In such conditions the motivational tools have to have a social, inter-personal and even spiritual orientation.

14.5

Cultural Influences on Negotiation Styles

Negotiating is a large part of Indian culture – much more so than some other countries, and the very nature of negotiations will differ. Along with the business practices and values, cross-cultural differences in negotiation are also important to understand. The time factor becomes important in the context of cross border exchanges as people belonging to different cultures have different perceptions of time. While in a more collectivist culture, people may prefer to develop relationships during negotiations, people in more individualistic cultures like the USA may not prefer to bring the relationship dimension into negotiations. The study by Gulbrow and Herbig (1999) through around 40 surveys from Chinese-owned, Latin American, French, Italian, Japanese, and German firms, found that negotiators from a more collectivist culture would devote more time to non-task negotiating and positioning activities. Similarly, the people from high power distance cultures were found to spend less time compromising.

14.6

Distinctions Blurring Between Cultural Dimensions

However, the labels “collectivist” – “individualist” and “low power” – “high power” hide as much as they reveal. The influence of culture manifests in the different assumptions and beliefs about careers and about how success is achieved. Assumptions are shaped by national culture, but occupational and organisational cultures also influence the way employees behave. The level of cultural differences may not be as stark as researchers suggest. A study by Woldu et al. (2006) based on a study of 1,852 responses collected from the four countries over a period of 5 years (1998–2002) led the researchers to claim that employees who work for similar organisations and on similar positions are culturally converging. They suggest Indian and Polish managers for instance, show similarities on a significant number of cultural dimensions,

14.7

Cultural Differences in Evidence

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even though the overall respondents of both countries demonstrated significant cultural difference. This appears to be confirmed by Ravishankar and Pan (2006) who conducted field-work via 50 in-depth, open-ended, face-to-face interviews with 42 informants from four organisational business units. They suggest, given the high status of large Western client firms (their higher symbolic significance and economic wealth) vendor employees may identify more readily with the client organisation as opposed to the offshore vendor company, and the distinctions between Indian and Western cultures may become blurred. However, although there may be some blurring, cultural differences remain highly significant and are likely to remain so for the foreseeable future. As Woldu et al. (2006) notes the similarities between employee cultures are not always easily explainable. Thus the key issues that a client organisation must consider when offshoring include: • Directness of communication by the vendor organisation staff and its implications; • Different life/business experiences mean different assumptions; • Native language differences which may make communication between the two organisations difficult; • Hierarchy and status differences and implications of how organisations manage the relationship; • Decision making differences between the organisations impacting the how control is exercised, and how dispute resolution is managed; • Individual versus group thinking; • Perception of the importance of time; and • Management Style differences between the two organisations.

14.7

Cultural Differences in Evidence

Working in or with Indian based companies is not to be taken lightly. India is not a homogeneous country – it’s a collection of linked markets, each with its own set of specific characteristics. India has 28 states and seven union territories, 22 official languages, more than 2,000 dialects, each state with its own set of laws and regulations, and above all each with its own history and cultural traits. The following illustrates the practical cultural differences seen when working with an Indian company – some have been slightly exaggerated to illustrate the point (I apologise to my Indian readers). The classical “yes” syndrome • In Indian culture, people avoid giving negative responses. Junior individuals may not speak on an issue without permission by a supervisor. If someone asks an Indian counterpart if the task can be completed by the end of business tomorrow and the answer is “yes,” it does not mean “yes, it will be done”. This is more likely “yes, I’ll do my best.”

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Commonality of the English language should not be mistaken for a commonality of views You should not assume everything you say will be immediately understood and you must test the level of understanding – the same words have very different meanings in India – customer service standards for instance vary hugely between here and India – a shop assistant following you around intensely can be really irritating here, but seen to be quite normal in India. Hierarchy and status rule Indian culture is often viewed as having a high power distance – in academic worlds – what this means in the real world is that there is an acceptance of hierarchical authority in India. Indian company structures are perceived by their UK counterparts as being “too hierarchical”. When entering a meeting room, you should always approach and greet the most senior figure first. Meetings always commence with some conversation which is part of the “getting to know you” process. In the private-sector, organisations tend to recruit their relatives to top positions. In-decision in Decision making In UK culture, a person’s capacity for taking initiative is generally praised, and we do not like our behaviour to be restricted by too many bureaucratic structures. In India, people’s choices are much more restricted, and employees prefer to obey clear guidelines rather act alone and take a risk. Therefore you should not generally expect initiative and forthright improvement suggestions coming from your Indian counterparts. We are family – individual versus group think In the UK, people value personal freedom, and freedom of speech – but Indian culture has a far more collective attitude. Freedom of speech is subordinated to the good of the group, so individuals are careful about what they say. Investment horizons may be much longer in India than they are in the UK, as they will not only, be looking at today’s profit, but the legacy that can be left for their children, and grandchildren. Time is NOT money The UK usually equates punctuality to politeness. We see time as valuable and do not like to overrun schedules and miss deadlines. In India, time is viewed in Stephen Hawkins terms – something that is elastic and can be bent. . .Family responsibilities take precedence over business, so last minute cancellations are possible when doing business. . .flexibility and patience is paramount when doing business in India. If it was that important, why didn’t you say so? UK managers in general do not ask for frequent progress reports, since that would be considered as a lack of trust in the employee. In India, if you do not follow up frequently, then they will treat the task as an unimportant one. It’s the process, not the output that is important Indian employees and businesses tend to judge success on a moral consideration of the text and strict observance of ritual and process, not on actual output – they

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will happily follow your processes, even if it throws out garbage – so you need to be careful how you devise service level agreements. Patience is a virtue If your business dealings in India involve negotiations, always bear in mind that they can be slow. If trust has not yet been established then concentrate efforts on building a rapport. Decisions are always made at the highest level. If the owner or Director of the company is not present, the chances are they are early stage negotiations. Indians do not base their business decisions solely on statistics, empirical data and exciting PowerPoint presentations. They use intuition, feeling and faith to guide them. Always exercise patience, show good character and never exhibit frustration or anger. When negotiating, avoid high pressure tactics. Do not be confrontational or forceful. Criticisms and disagreements should be expressed only with the most diplomatic language. Indian society has an aversion to saying “no” as I said earlier, as it is considered rude, due to the possibility of causing disappointment or offence. Listen carefully to their responses to your questions. If terms such as “We’ll see”, “I will try” or “possibly” are employed then the chances are that they are saying “no”. The law is for whimps Indians tend to avoid the legal system, and for good reason – the legal system although based on English common law, and looks great on paper, is incredibly slow. Looking at recent Delhi 2010 Games for lessons: The good old yes syndrome – delivery deadlines passed by without much concern – how many times did we hear it will be done tomorrow? Commonality of language – standard of accommodation and cleanliness were apparently seen to be different from western standards. . . Hierarchy and status – problems had to be escalated up the hierarchy, causing even more delays. . . We are family – as you may have heard, one of the members of the organising committee was trying to give contracts for the construction of a project to his son’s company, keeping it in the family. . . If it was Important why, didn’t you say so – A large part of the blame must go to the Commonwealth Games Federation, who didn’t quite understand Indian culture and assumed that just because they had an agreement all was going to be well – without regularly checking on progress – i.e. it was poor governance. . .. It’s the process, not the output that is important – as you saw when the games did start, most of the stadiums were empty – but the organising committee were still congratulating themselves that they managed to open on time, and not looking at the output – that for the games to be successful, they needed to get the country behind them. . . The law is for whimps – the slow legal system, meant there was delay in the games committee acquiring the required land – the democratic process only slowed things down further. . .

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Nevertheless, in the end, they pulled it off – like a good old fashioned Indian marriage, with an extravagant opening and closing ceremony, the games proceeded without much fuss and were generally seen to be successful. So the moral of this story – India can deliver, but you need to be mindful and take action to ensure they deliver on time, to the standards required, give it the priority is deserves and you manage the relationship so you don’t need to resort to the legal system. Clearly, India is used as an example here, but each country will have its own cultural differences that must be recognised. The organisation must understand how these differences manifest themselves in the outsourcing programme and how these can be managed.

14.8

Take Aways

• Managing cultural differences requires a deep understanding of the basis upon which differences arise from hierarchy, management styles, motivations and negotiation styles, and mechanisms introduced to minimise its adverse effects. • These differences can be seen in action in the case of India. • Over time, as personnel from countries start converging and co-mingling in work, social and educational settings, these cultural differences begin to lessen, although subtle differences will continue to exist. The organisation’s need to accelerate the process of cultural convergence by introducing cultural training, social interaction and introduce different approaches to management.

References Gulbrow, R., & Herbig, P. (1999). Cultural differences encountered by the firms when negotiating internationally. Industrial Management and Data Systems, 99(2), 47–53. Hofstede, G. (2007). Asian management in the 21st century. Asia Pacific Journal of Management, 24, 411–420. Hofstede, G., Deusen, C., Muller, C., & Charles, T. (2002). What goals do business leaders pursue? A study in fifteen countries. Journal of International Business Studies, 33(4, fourth quarter), 785–803. Perlow, L., & Weeks, J. (2002). Who’s helping whom? Layers of culture and workplace behaviour. Journal of Organisational Behaviour, 23, 345–361. Ravishankar, M., & Pan, S. (2006). The influence of organisational identification on organisational knowledge management (Km). Omega-International Journal of Management Science, 32(2), 221–234. Sparrow, P., & Budhwar, P. (1997). Competition and change: Mapping the Indian HRM recipe against world wide patterns. Journal of World Business, 32(3), 224–242. Woldu, H., Budhwar, P., & Parkes, C. (2006). A cross-national comparison of cultural value orientations of Indian, Polish, Russian and American employees. International Journal of Human Resource Management, 17(6), 1076–1094.

Implementing Successful Strategic Outsourcing Programmes

15

The successful implementation of strategic outsourcing, having made the appropriate decision to outsource, requires the successful implementation of eight principles, that are based on both academic and practitioner experience. The application of these eight principles is likely to see the successful implementation of a strategic outsourcing programme. However, the investment required in operationalising these principles is significant and should not be entered into lightly. The organisation must determine that this investment is appropriate given the nature of the outsourcing programme.

15.1

The Eight Principles to Success

Successful outsourcing to service providers calls for a combination of a strong legal contract together with a partnership approach between the two parties, built on trust. There are some important principles which may help organisations reduce the chances of outsourcing failing: 1. Building strong, yet flexible contracts that avoid offshore legal systems wherever possible, and which aid in building trust; 2. Using governance as a framework for control, monitoring, dispute resolution and relationship building at all levels; 3. Implementing effective controls which enable monitoring of performance, which aid in guiding vendor behaviour and positively influence the development of trust; 4. Building commitment and mutual dependence, which drive both parties, and in particular, the offshore vendors to perform contracted tasks to a high level of performance, and wherever required performance beyond the contract, using concepts such as motivation; 5. Alignment of goals and objectives both within the client organisation and between the client and vendor, using the concept of consensus building, B. Vagadia, Strategic Outsourcing, Management for Professionals, DOI 10.1007/978-3-642-22209-2_15, # Springer-Verlag Berlin Heidelberg 2012

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especially given that the personal drivers within each organisation may differ significantly; 6. Building individual and institutional trust to enable parties to perform services as prescribed in the contract, which adjusts where necessary to environmental changes. Institutional trust is important as building individual trust may be difficult because of the high levels of employee attrition in many vendors; 7. Managing effective collaboration and knowledge sharing between both parties, including appropriate group interaction; and 8. Using communication as a key linking tool. Communication is a central tool for change management both within the client organisation and for the effective implementation of the preceding risk mitigation strategies. In what is clearly a complex relationship, with the scope of risk being significant, a straightforward transaction model is likely to prove ineffective in achieving all the aims of both parties over the foreseeable period of the relationship. A partnership model, built on trust, it is argued, will prove more beneficial to both parties. A partnership model can be characterised as having at least some of the following attributes: • Commitment from senior management (and goal congruence in terms of wider organisational strategy and with organisational stakeholders); • Open communication channels (within and between organisations); • Clear delineation of customer and service provider roles and responsibilities (for effective control and monitoring); • Good governance, with management tools available to avoid common problematic issues (including effective dispute resolution); • Pricing granularity, that details the pricing of specific services and how these change given changes in the environment, together with financial incentives that drive parties to behave in a “partnerial” way; • Acceptance that change will happen and thus include balanced and open change control processes; and • Balance liabilities and iron out termination rights and post termination assistance from the very beginning (acceptance that the outsourcing project has a finite life and at some point the outsourced activity may need to be brought back in house or transitioned to another vendor). This alleviates the common hold-up problems that clients may encounter in markets with limited suppliers or where transaction costs are high. Implementing these is resource intensive and cannot be entered into lightly, by either the client or vendor. Unless both parties are committed in seeking a long-term partnership relationship, it may be more cost effective for parties to engage in a simple transactional relationship without implementing trust building mechanisms – accepting the possibility of not achieving success – for this may provide a better trade-off. The initial search by the client for possible vendors (partners) needs to be based on an initial strategic decision about the proposed long-term nature of the proposed relationship. This must take account of not only the hard factors but also the soft factors when evaluating possible partners. It must be used to determine if the

15.2

Principle 1: Strong Yet Flexible Contracts

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establishment of trust between the parties is desired by both, and whether the parties will dedicate the necessary resources and commitment, such that trust and its required constructs can be achieved. The rest of this chapter discusses the implications for organisations of the eight principles that have been identified above.

15.2

Principle 1: Strong Yet Flexible Contracts

As discussed earlier, it is possible in some jurisdictions to contract under the jurisdiction of another country’s courts. It is vital for clients looking to outsource offshore, to explicitly state under which law the contract should be governed and precisely define which elements within the contract can and cannot be subject to another jurisdiction. Outsourcing arrangements are usually long term, and it is often difficult to fully anticipate, describe and manage contingencies and change conditions in the agreement. Contracts that shift from merely specifying deliverable outcomes to providing frameworks for bilateral adjustments may facilitate the evolution of highly cooperative exchange relations. In addition, the process of contracting may itself promote expectations of cooperation consistent with the concept of relational governance and the development of trust. In this respect, outsourcing agreements should include within the contract, broad procedures that describe the process the parties will follow when changes occur in the relationship, without having to re-write the contract. It is important for organisations to appreciate from the outset that outsourcing agreements are more successful where companies view the relationship as long-term and based on mutual respect and underpinned by trust. Procedural explicitness and transparency provides a valuable mechanism for promoting flexibility in the long-term. The activity of negotiating complex contracts requires parties to mutually determine and commit to processes for dealing with unexpected changes and determine penalties for noncompliance (this also helps build institutional trust). It is therefore important that the contracting process is seen as being an activity for all stakeholders and not merely left to the lawyers, as companies in some cases have done. The very nature of negotiation between the various stakeholders can positively affect future exchange performance and mutual trust through the development of social relations. Formal contracts should at the minimum, cover the following: • Law and place of jurisdiction – essentially avoiding the offshore legal system; • A statement of rights and obligations of each party; • Confidentiality provisions; • Transition-in support requirements from the vendor; • A clear and comprehensive description of services to be outsourced, including scope and process for adding services in the future; • Clearly defined performance measures and targets;

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• A clear pricing, charging and payment structure, including appropriate incentive scheme; • Change management provisions with appropriate implications and an allocation matrix of responsibility and costs; • Liability and limitations of liability clauses; • Indemnification/disclaimers/warranties clauses; • Limits on subcontracting provisions; • Insurance and guarantee requirements; • Narrowly defined Force majeure provisions, which ensure service continuity wherever possible; • Audit rights and provisions; • Regulatory obligations and allocation of responsibility and costs of meeting these; • Security requirements and arrangements for the vendor; • Contract breach clauses and provisions for compliance; • Penalty clauses, including the possibility of cash penalties for breach; • Incentives, including cash to motivate the service provider to exceed performance requirements or provide superior performance; • Conflict resolution provisions; • Escalation procedures; • Arbitration clauses, a definitive place of arbitration and rules to govern arbitration process; • Disaster recovery and business continuation plans; • Protection of Intellectual Property provisions; • Effective provisions for the application of the EU Acquired Rights Directive (77/ 187/EEC), or its equivalent requirements by the host country; • Effective data protection as required by legislation and additional obligations introduced through contract; • Clauses addressing the impact of local taxes and regulations; and • Contract renewal, termination clauses and transition-out support – i.e. assistance in transitioning the service either back in-house to the client or to another service provider. Clients should negotiate an outsourcing agreement with at least two service providers. Dual track negotiations, it is suggested, allows customers to get a real time comparison of the legal differences between two organisations (which may be from different jurisdictions) that will be transposed to the outsourcing agreement. Sometimes a seemingly well priced deal by one service provider is clawed back by proposed clauses in the agreement that shift too much risk back to the client.

15.3

Principle 2: Effective Governance

Trust is predicated on both social interactions at individual and inter-organisational levels, as well as familiarity, mutual understanding and confidence between the two parties.

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Principle 3: Effective Control and Monitoring

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Governance structures thus require clear authority and staffing structures, with the relevant staff empowered to make decisions. Governance must focus on proactive and collaborative management of the relationship. In this respect, governance must focus on ongoing communication processes, performance review standards, overall project management and the evolution of the services required and provided. Governance in this sense must go beyond simple monitoring of contractual obligations. Ongoing governance requires the following to be actively pursued: • Project management, including: communication, collaboration, and monitoring of the service provider; • Relationship management – helping interaction and collaboration between stakeholders, managers, and team members; • Change management – ensuring that standardised procedures are used for efficient, prompt handling of all changes; and • Risk management – including identifying, analysing, and responding to outsourcing partnership risks. Managing an external supplier requires different skills to those associated with managing an internal business function; this challenge of managing across organisational boundaries is a major one in all sub-contracting relationships. Many organisations lack the knowledge and often the skills to implement an effective outsourcing strategy. For the outsourcing relationship to work successfully, it is important for clients to fully understand all the technical, commercial and legal issues of relevance. This calls for a multi-disciplinary team, consisting of consultants, lawyers, accountants, tax specialists, technology experts, benchmarking and others with the requisite expertise within and external to the organisation. In the context of governing performance management, a “dashboard” of key metrics which combine pure Service Level Agreement (SLAs) metrics and some operational metrics (that could explain the reasons for the divergence of service delivery targets) aids in understanding what changes should be implemented by the service provider. Sharing this information between the parties can help reassure each other that both are working under a partnership model, creating incentives for each to invest further to build trust.

15.4

Principle 3: Effective Control and Monitoring

Trust is a prerequisite to cooperative relationships. It is effective in lessening concerns about opportunistic behaviour, better integrating the partners and ensuring both parties are satisfied with the relationship. However, objective representation of performance, effective discouragement of opportunistic behaviour, and evidence of commitment is required for the development of trust. High levels of trust cannot be built immediately, but must be nurtured. Formal controls and monitoring are important as they help build trust overtime. SLAs are important in this respect as they focus on measuring and managing productivity and service quality improvements, and determine the true value of an

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outsourcing engagement. Well defined SLAs correctly set expectations for both sides of the relationship and provide targets for accurately measuring performance to those objectives. They act not only as metrics of performance by which to measure the service provider, but also as a means of providing both parties with meaningful information on which to base fees, costs, remedies, and performance incentives/disincentives. SLAs should be defined and incorporated into the agreement by personnel at the operational level and not just left to lawyers. This process ensures not only that the SLAs are set at correct levels, but attempt to secure the buy-in of client employees, who may be affected by the outsourcing arrangement. Metrics should be segmented into those that need to be reported as part of the SLA and those which need to be reported separately for operational reasons. Those that are reported as part of the SLA management system should be simple and concise, whilst operational reporting should be more extensive and shared at the operational level between the parties. The term “SLA management system” has been used deliberately, to suggest that effective control requires not only the setting and agreement of SLAs, but effective organisational systems to measure, verify, communicate and discuss the SLAs and what the implications are of not meeting them. At the heart of an effective SLA is its performance metrics. During the course of the outsourcing engagement, these metrics will be used to measure the service provider’s performance and determine whether the service provider is meeting its commitments. For SLA metrics to be effective, parties must: • Choose measurements that motivate the right behaviour – each side must understand the other side, its expectations and its goals, and the factors that are within their respective control; • Ensure metrics reflect factors within the service provider’s control – the metric should be two sided. If the service provider’s ability to meet objectives is dependent on an action from the customer, the customer performance must also be measured; • Choose measurements that are easily collected – If the metrics in the SLA cannot be easily collected, then they will eventually be ignored; • Avoid choosing an excessive number of metrics. If the metrics generate too much data, the temptation will be to ignore the metrics; and • Set a proper baseline – To be useful, metrics must be set to reasonable, attainable performance levels.

15.5

Principle 4: Building Commitment and Mutual Dependence

Commitment and mutual dependence are important because they encourage parties involved in day-to-day operations to work at preserving relationship investments by cooperating with the exchange partner and resist attractive short-term alternatives in favour of the expected long-term benefits of staying with the existing partner. They are the pillars upon which trust is built.

15.6

Principle 5: Ensuring Goal/Expectation Alignment

213

Traditional outsourcing relationships have relied on rudimentary pricing models, based primarily on volume of output multiplied by the unit price per output unit model. This basic model is disadvantageous as over time the interests of the two parties diverge (e.g. the service provider consistently searches for methods to drive up the amount of service consumed by the customer, whilst the client increasingly searches for methods to reduce the units of service consumed and constantly shops around for a lower per unit rate service provider). The use of “incentive pricing” models, which attempt to ensure the interests of both parties are served in trying to improve performance – creates both mutual dependence and commitment. There are numerous types of incentive pricing models that may be deemed appropriate, such as: • Incentive pricing models based on achievement of various milestones; • Project specific gain share incentive models e.g. requirement for each party to invest a given percentage, with a sharing of savings between the parties in proportionate amounts equal to investment amounts; • Shared pricing models where the service provider’s remuneration is shared between a fixed price fee and an incentive fee. The incentive portion can be based on any number of metrics; • Gain-sharing models where the provider receives a percentage of the improvement based on achieving or exceeding targets. The provider does not however forfeit income for lower-than-expected improvements; and • Risk/reward models – these incentive schemes build on the gain sharing concept by adding the downside risk. When negotiating incentive models, the objective must be the achievement of overall organisational goals and must not be seen as being a mechanism to penalise the service provider. Their purpose is to build mutual dependence and commitment. In this sense, it is also important for the client to define clearly what is actually controllable by the service provider and therefore, gain a level of commitment to these from the vendor. Clients must avoid negotiating the service providers’ prices too low – this may drive the relationship towards a market based one and will not create the right incentives for the service provider to engage in collaboration or trust building.

15.6

Principle 5: Ensuring Goal/Expectation Alignment

Trust requires both parties (and their respective stakeholders) to strive towards the achievement of goals through joint commitments and mutual dependency. The central thesis being that both parties not only understand the goals and expectations of each other, but such goals and expectations are in congruence. As noted earlier, to realise the potential for improved competitiveness, outsourcing drivers and decisions should be strategic and made in accordance with organisation strategies. This requires that the factors driving decisions to outsource, to be in congruence with the strategic goals and competitive priorities of the organisation.

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Congruence therefore includes: goal congruence with strategic objectives within the client; goal congruence between the two organisations and goal congruence with the respective stakeholders within both organisations. The importance of taking account of additional stakeholders that maybe affected by outsourcing have largely remained unaddressed to date. Not knowing the entire range of stakeholders and their goals, makes goal congruence impossible. Many parties fail to recognise that the other has their own set of expectations, which may be very different. It is generally assumed that outsourcing failures or difficulties arise due to problems created by, or misunderstanding by the service provider. Often it, it is argued, the customer’s failure to clearly define or set appropriate expectations at the outset that leads to many of the problems within such relationships. This presupposition from an early stage within the relationship leads to the development of mistrust between the parties. Moreover, when there are problems, the onus is assumed by the client to be on the supplier to rectify, even where it may be the client that creates the problem. These assumptions prevail due to the lack of open and collaborative discussions between the two parties about their respective goals and expectations. Internal political interference or power play within a customer organisation can also have the effect of creating poor decision making and weak communication between the customer and service provider. It is therefore important for both parties to be fully aware of the issues each other faces and understand each other’s expectations, limitations and the extent of commitment before deciding whether the parties should proceed to formalise the relationship. A good starting point for doing this is during the Request for Proposal (RFP) process. Many parties treat the RFP process as simply a gating process and use standard boiler-plate templates, without putting in the necessary level of effort to use the process as a joint learning exercise. This exercise can be used to start forming a relationship and the development of trust. The approach the service provider brings to the table in negotiating the terms and conditions may be a test of the approach that it may bring in dealing with the inevitable problems that will arise during the term of the deal; clients it is argued should be willing to test the level of disagreement in a setting where the consequences of not seeing eye-to-eye are relatively insignificant. It is important to ensure the team that is assembled to undertake the task of outsourcing and selecting a service provider consists of all the appropriate skills and experience that such a complex task demands, rather than simply being implemented by the procurement department within the organisation or by external advisors. In many cases the effects of an outsourcing programme are wide ranging and impact not only the internal organisations, but its customers and other stakeholders. Without active involvement of those affected by an outsourcing decision, it will be inevitable that such stakeholders will not fully participate positively in the outsourcing process, which may lead to goal divergence. In such a circumstance, it is also likely that all the possible risk mitigations actions that could be implemented will not be willingly volunteered by the affected stakeholders.

15.8

15.7

Principle 7: Managing Effective Collaboration and Knowledge Sharing

215

Principle 6: Building Individual and Institutional Trust

Institutional trust is the belief that a trustor has about the security of a situation because of guarantees, safety nets, and other performance structures. As trust primarily emerges on the basis that the other party will fulfil its commitments and on the repeated observation of counterparts’ ethics and behavioural routines, the use of effective dispute resolution is vital in building institutional trust. Quickly escalating disputes up the chain of management often resolves problems prior to litigation and helps build trust. Parties should always strive to make decisions and address issues at the lowest possible level – this not only helps solve disputes quickly, but creates shared values throughout the organisation and at individual levels. Where simple dispute resolution fails, parties should use arbitration as a first point of call before embarking upon the litigation route. Litigation tends to harden positions and diminish trust. However, the process of arbitration is not governed by a well established set of case law and rules like litigation, so waiting for a final award can often be lengthier than may be imagined. The arbitration process should therefore not be taken lightly.

15.8

Principle 7: Managing Effective Collaboration and Knowledge Sharing

The development of trust requires parties to effectively collaborate with each other, in circumstances where each party may have different practices, processes and competences. This requires parties to facilitate the development of shared identities and practices. Underpinning this is the sharing of knowledge between the two parties. Project planning and management are important disciplines to enable successful outsourcing, and smooth transition management is a critical success factor in outsourcing. Transition management, includes the detailed desk-level knowledge transfer and documentation of all relevant tasks, technologies, workflows, and functions (and in some cases employees). It is argued that the transition period is the most complex stage of an outsourcing process lasting up to a year to complete. Transition management should involve the following: • Developing a transition plan (key activities, milestones, resources, and dependencies); • Facilitating transition of operations and/or initiation of projects; • Transferring knowledge of internal procedures and processes; • Managing strategic and operational communications; • Managing employees – redeployment, transfer, or termination; and • Documenting lessons learned to improve ongoing service provider management. One of the core challenges is the importance of motivation of client members to share knowledge and collaborate with the offshore vendor. The fear of client project members being replaced and losing their jobs may lead to information hoarding. It thus has to be resolved to let positive motivational factors evolve. This may require

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gradual restructuring with no large scale immediate downsizing, and the adoption of formal change management techniques. The scope for disagreements to arise during the course of an outsourcing agreement is significant, especially if the internal commitment and processes within the customer have not been fully aligned. Having a single point of contact within both organisations which liaises with the each other on a day to day basis – what some researchers call boundary spanners, e.g. Oshri et al. (2007), may be useful – but should not stop open dialogue at various levels between the two organisation’s staff.

15.9

Principle 8: Effective Communications

Trust requires open, honest and repeated exchanges between the two parties, good governance and decision making across the chain of command within organisations, sharing of goals and expectations, collaboration and sharing of knowledge (both explicit and tacit). In this respect, effective communications goes to the heart of the achievement of these and thus an outsourcing programme. Effective communications must be inherent from the start of the outsourcing process; in the RFP process, in transition management, in project management and for effective governance. Face-to-face communication is important to minimise uncertainty where culturally diverse personnel are involved, but is also the most expensive to adopt. Technology can be used in order to spread information to all stakeholders; however this should complement rather than replace face to face communications. Face-to-face interactions are especially important at the problem definition stage, and can be used periodically to signal commitment and promote identity required to work through problems. Such devices are especially necessary in offshoring, since cultural and communication problems could easily be misattributed to motivational issues.

15.10 A Summary of Strategic Outsourcing: Risks, Rewards and Relationships 15.10.1 Don’t Start at the End Too many outsourcing engagements start with the typical question being posed by the CxO “which vendors shall we start to talk to?” This should be the last act within the decision management process, not the opening question. An organisation needs to consider “carefully” the advantages and disadvantages of outsourcing as an option (yes it is only an option, and not always the correct option). The major considerations should include: • Is outsourcing and managed services in line with and contributing to the business strategy and objectives? What are the business objectives to be achieved by Outsourcing? • What would be the requirements for the outsourcing deal so that outsourcing complements the business?

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• What is optimal scope for outsourcing and what is the practical scope of the operations to be outsourced today? • What are the specific targets and objectives for the outsourcing deal? • What are the criteria for a successfully managed service? • How will you ensure accountability in what will be a hybrid matrix of responsibilities? • How should the organisation manage the outsourcing process, what are the interfaces and governance structures required to ensure success? • Is the organisation ready for outsourcing – will the culture inhibit possible success? • And finally, how should you select the managed service provider? The decision process should not only be seen to consist as the transfer of a specific function from the organisation to the service provider, but in defining the interfaces to all relevant organisational units. To this extent, the decision making process must include all facets of the operator and key personnel – for the last thing you need is your key personnel leaving you, when you need them the most. The key overriding consideration should not be the decision to outsource but the decision to build a process for successful outsourcing. You need to clearly differentiate between outsourcing as a project, and outsourcing as a business-as-usual activity. If outsourcing is to deliver the benefits you seek, it must be an organisational wide undertaking, being integral to the business – not a project that a few people work on in their spare time. The organisation needs to be mindful and respectful of the various stakeholders within the decision process and in the ongoing implementation and management of an outsourcing programme. Not all stakeholders will deem the outsourcing programmes’ Raison d’eˆtre to be reducing costs (see Fig. 15.1).

Customer’s Senior Managers Business benefits Added value

Customer CEO Better business focus Profitability

Customer’s Senior Managers Contractual commitments Live within budget

How do you reconcile?

Customer’s Staff Performance of service provider Impact on jobs

Customer CFO Lower costs Lower capex

Customer Procurement Commercial deal Performance management

Customer Legal Lower Risk Compliance

Supplier’s Staff Technical/process focus Supplier’s Contract Management Service and profitability targets

Fig. 15.1 Stakeholder conflicting requirements

Supplier’s Senior Management Maximize profits Keep customer happy

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This task of decision management and consensus building has been fraught with difficulties. Complications such as the need to keep activities off the radar of the media, often ensures that proper consultation is omitted amid security and PR concerns. The hope of things being all right on the night sometimes works out, but often, you can get things seriously wrong. Installing a new decision management and governance process with system support using tools such as GovernanceDirector.com helps an organisation to build a robust decision process that is so desperately required, and to embed this within the organisation. A decision management and governance system doesn’t just help an organisation achieve a robust outsourcing programme, but helps understand if outsourcing is even the right solution this year, next year and the year after, for there are always others options, and conditions change overtime. Each business situation is unique and numerous issues and drivers have to be weighed up. Outside expertise from specialised consultants can certainly help with this process.

15.10.2 Establish What is Core When deciding on the scope of outsourced activities, the most important question is “What is core today and in the future”? This must be driven by the organisation’s overall competitive strategy. Core activities are those key areas, which the organisation believes it can do better than the competition and thereby gain sustainable differentiation and competitive advantage. Not all non-core activities should be outsourced however. . .

15.10.3 Establish What Success Means Business targets need to be clearly understood and defined before entering into detailed planning and implementation of an outsourcing programme. Selected drivers need to be prioritised and further clarified to a degree that business relevant measurable targets can be defined – you need an organisational wide agreement on the definition of success – reducing OPEX may make the CFO’s day, but if that is at the cost of diminishing quality, the customer service director may not be too pleased.

15.10.4 Measuring Success Organisations going down the outsourcing route need to put in place robust and comprehensive (yet simple) Service Level Agreements (SLAs) built around Key Performance Indicators (KPIs). KPIs will typically (although this may not be the best) be based on the performance measures already used by the organisation’s

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internal teams, together with additional measures intended to prove the outsourcing arrangement is working to the benefit of the organisation. SLAs are a critical part of the contract and complement the relational aspect of the outsourcing programme. All outsourcing agreements are governed by formal contracts; therefore these must be used as part of the relationship management process. SLAs enable certainty and help publicise common beliefs and expectations and align goals. Negotiation of contracts and SLAs can in itself be used as a relationship and trust building process – the process can aid in developing the balance between formal contracts and trust. It is worth saying that successful outsourcing isn’t necessarily about tight contracts and meeting SLAs, success is more aligned to the relationship between provider and customer, nevertheless good SLAs should be seen as the grease that promotes a smooth relationship. Good SLAs should include not only outcome based measures, but processes and dispute resolution procedures, as well as the roles and responsibility of various people involved in the outsourcing relationships. In setting SLAs and the associated KPIs, care must be taken in how SLAs set expectations and guide behaviour (positive and negative). An SLA must clearly define the boundaries in terms of the functions and services that the service provider will give to the organisation, the volume of work that will be accepted and delivered, the acceptance of criteria that will be used and a level of quality for the network. Although service sometimes may be imperfectly measurable, it is still worth negotiating clearly formulated business objectives. The difficulties in measuring performance is exacerbated by the fact that some of the outsourced services may be dependent on other services. Performance degradation in one service area often has a ripple effect on other areas, thus rendering performance measurement even more difficult. To effectively evaluate provider’s performance, two things are necessary; (1) measurement metrics in terms of business objectives and (2) incorporating the notion of interdependencies among services in the evaluation process. Use outcome based incentives as a governance mechanism. Penalties/rewards associated with the services stimulate the provider to encourage its employees to put in their best efforts. The challenging issue here is quantifying the appropriate “level” of service since the goal for this type of SLA is to reduce the knowledge loss for the customer. The lack of clarity associated with the knowledge gained by the provider and lost by the customer can makes it difficult to derive optimal incentives outcomes.

15.10.5 Making It Happen: Ever Had a Yearlong Migraine? Business is today marked by volatility – there is continuous technology innovation, competitive clashes, price wars, and changing consumer behaviour – in this environment, forecasting a few years ahead for the value of the outsourced activity is impossible. Hence the key word for successful outsourcing must be flexibility – and

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the ability to renegotiate. Managing the change process with the supplier is more vital than the ability to manage a contract in the first place. In order to successfully outsource, an organisation must determine both the scope and timing for the introduction of outsourcing: whether to undertake a phased approach with more thought and analysis and less haste, or if there are pressures to outsource in a big bang manner (a means of quickly turning around the business). In either case, the organisation must define a long-term roadmap for outsourcing. A phased approach can minimise risk, as elements can be “tested” in limited scope before going for the next phase of implementation. It also enables an organisation to choose best of breed vendors, although the costs of governance need to be factored in. You also need to consider if a fragmented supply chain can deliver the transformational changes you need and if economies of scale can be generated to give you the cost savings you need. A large one-time transition will undoubtedly result in short-term challenges to the organisation, with consequences for personnel as well as organisational shock. However, a phased approach may lead to continued uncertainty for organisational staff – either way, there is going to be a challenge.

15.10.6 The True Picture The hidden costs of outsourcing could fill a small book: not all of them will turn into nasty surprises, and not all of them could be conceived upfront, nevertheless, the contingencies that need to be built into the business case can seriously affect the perceived returns (try including exit costs – bringing the service back in-house as part of the business case and you’ll see what I mean). The more successful outsourcers (there are a few) look for business outcomes. Does the deal increase revenues and overall profitability? Does the deal increase our speed to market? Have we managed to tap into innovative technology? These outcome based measures (not all of them are quantifiable) should form part of the business case, as opposed to a simple desire to restructure the balance sheet (in fact many outsourcers, create extremely precise business cases, processes maps, and forecasts – and like any forecast, they may look good, but are rarely accurate). There are always hidden problems which might change the financial picture, but a little realism, a bit of rational thinking and debate during the planning process might save many organisations from disappointment (and senior managers their jobs) later.

15.10.7 It’s Not All Plain Sailing Pressure on organisations to optimise their cost structures, while simultaneously seeking new services to drive growth, means the organisation must re-evaluate and potentially revamp its entire business model. Outsourcing and sharing, in particular, reflect aggressive new business designs that transform the relationship a business

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has with its value chain activities (and possibly its customers). While outsourcing and sharing can provide significant financial benefits, these deals can be complex and fraught with risk.

15.10.8 Impact on Strategy and Value Retention Organisations need to truly understand the outcome of the outsourcing/sharing agreements and position themselves accordingly. The outsourced activity could re-emerge as a key component in an organisations’ product and service strategy going forward. Outsourcing/sharing core processes/functions means sharing the decisions concerning future investment and development. While the partners may have very different strategies, they both need to be sure that the future (shared) resource will be consistent with their own strategic aims.

15.10.9 Don’t Overlook the Challenges Parties contribute different resources and capabilities and are looking for an appropriate return. It is easy for disagreements to arise over whether each is getting a fair payback for its investment. There is a risk that these tensions may overshadow the wider benefits being delivered. Sharing generally involves significant up-front investment in rationalising the organisation’s activity and decommissioning overlapping infrastructure before the cost benefits start to flow. Thus the short term business case is harder to prove. Outsourcing may provide more immediate benefits (but lower savings than a sharing deal) over the long term.

15.10.10 Organisational Change One of the biggest and most frequently underestimated hurdles is the size of the cultural shift required to enter a sharing deal with a rival organisation (or even straight forward outsourcing). The corporate mind-set has to move from that of historical head-on competitive hostility in the marketplace to a degree of cooperation, and away from an product view of the world to one focused more on customers and brand. Differences in business culture between the two organisations may cause misunderstandings and ultimately the demise of the deal. The service provider organisation should adapt their project organisation to the client organisation, something called “mirror structuring”. This consists of having clearly defined hierarchical and cross-organisational communication and reporting structures. This is especially important when the service provider is from locations that tend to be more hierarchically orientated than western organisations.

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15.10.11 Cultural Adaption The use of standardised templates and forms based on a glossary of terms that the client team and vendor agree on can help. This effectively means all personnel have a shared understanding. The use of replay sessions to make sure that all parties understand the functional and business requirements and expectations of the client, can reaffirm such shared understanding. Cross-cultural training workshops and more active hands-on training, including secondments or site visits for project managers should be integral to the outsourcing programme.

15.10.12 Detailed Contractual Agreement Contracts serve as the basic instrument for communication in any exchange relationship. Although it is never possible to foresee all future contingencies at the time of contracting, the customer’s efforts should be directed at making the contract as detailed and complete as possible. One option is to include a change process in the contract where requirements, performance and expectations are revisited on a periodic basis.

15.10.13 Knowledgeable Resources Crafting service level agreements to cater to the unique organisational knowledge needs is a non-trivial task, and much of the success of the service provisioning model is dependent upon the precision of the agreements. This is not possible without having personnel, from both sides, with in-depth knowledge about the process being outsourced. Coming up with the proper performance measurement metrics, implementing them, and monitoring the provider’s performance continuously are significant activities for the customer. However, the challenge arises in the cost associated with the retention of such resources, as the primary skills of such resources may seem to be less relevant to the organisation as it outsources its knowledge process. Clients should try to become actively involved in the project member selection process of the vendor and include clauses within the contract to ensure key vendor project members stay with a given project for its lifetime, to alleviate vendor employee attrition and loss of knowledge.

References Oshri, L., Kotlarsky, J., & Willcocks, L. (2007). Managing dispersed expertise in IT offshore outsourcing: lessons from Tata Consultancy Services. MIS Quarterly Executive, 6(2), 53–65.

Further Reading

Bachmann, R. (2001). Trust, power and control in transorganisational relations. Organisation Studies, 22(2), 337–365. Barthelemy, J. (2003a). The hard and soft sides of information technology outsourcing management. European Management Journal, 21(5), 539–548. Barthelemy, J. (2003b). The seven deadly sins of outsourcing. Academy of Management Executive, 17(2), 87–98. Beaumont, N. (2006). Service level agreements: An essential aspect of outsourcing. Service Industries Journal, 26(4), 381–395. Behara, R., & Bhattacharya, S. (2008). DNA of a successful BPO. Journal of Service Science, 1(1), 111–118. Third Quarter 2008. Beulen, E., & Ribbers, P. (2002). Managing complex IT outsourcing-partnerships. Proceedings of the 35th Annual Hawaii International Conference on System Sciences (HICSS-35.02) 0-76951435-9/02 $17.00 # 2002 IEEE Bhatnagar, S., & Madon, S. (1997). The Indian software industry: Moving towards maturity. Journal of Information Technology, 12, 277–288. Brynjolfsson, E. (1994). Information assets, technology, and organisation. Management Science, 40(12), 1645–1662. Budhwar, P., & Boyne, G. (2004). Human resource management in the Indian public and private sectors: An empirical comparison. International Journal of Human Resource Management, 15 (2), 346–370. Budhwar, P., & Khatri, N. (2001). A comparative study of HR practices in Britain and India. International Journal of Human Resource Management, 12(5), 800–826. Budhwar, P., Varma, A., Malhotra, N., & Mukherjee, A. (Forthcoming). Attrition in Indian BPOs: The hidden cost of outsourcing. The Service Industries Journal. I am grateful to Professor Budhwar for sight of this paper. Budhwar, P., Varma, A., Singh, V., & Dhar, R. (2006a). HRM systems of Indian call centres: An exploratory study. International Journal of Human Resource Management, 17(5), 881–897. Caenegem, W. (2003). Adversarial approach ¼ Adversarial systems and adversarial mindsets: do we need either? Bond Law Review, 15(2), 109–122. 2003 Article 9. Carmel, E., & Agarwal, R. (2002). The maturation of offshore sourcing of information technology work. MIS Quarterly Executive, 1(2), 65–78. Clemons, E., Reddi, S., & Row, M. (1993). The impact of information technology on the organisation of economic activity: The move to the middle hypothesis. Journal of Management Information Systems, 10(2), 9–35. Cramton, C., & Hinds, P. (2007). Intercultural interaction in distributed teams: Salience of and adaptations to cultural differences. Proceedings of the Academy of Management, Annual Meeting, Best Papers, Philadelphia Crocker, K., & Masten, S. (1998). Mitigating contractual hazards: Unilateral options and contract length. RAND Journal of Economics, 19(3), 327–343.

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Walden, E. (2005). Intellectual property rights and cannibalization in information technology outsourcing contracts. MIS Quarterly, 29(4), 699–720. Willcocks, L., Hindle, J., Feeny, D., & Lacity, M. (2004). IT and business process outsourcing: The knowledge potential. Information Systems Management, 21(3), 7–15. Williamson, O. (1993). Calculativeness, trust and economic organization. Journal of Law and Economics, 30, 131–145. Zaheer, A., McEvily, B., & Perrone, V. (1998). Does Trust matter? Exploring the effects of interorganizational and interpersonal trust on performance. Organization Science, 9(2), 141–159. Zhu, Z., Hsu, K., & Lillie, J. (2001). Outsourcing – A strategic move: The process and the ingredients for success. Management Decision, 39(5), 373–378.