Is Business Process Outsourcing Killing Itself?

By John Parkinson  |  Posted 10-05-2005

Ever since the process reengineering wave of the 1990s, businesses have been looking at their core operations with an eye to cutting costs. Companies typically have three options: Consolidate and standardize operating processes via a shared-services strategy; upgrade the level of automation to reduce labor costs and boost productivity; or outsource the process to a third party that can offer economies of scale, global sourcing economics or access to more focused management expertise.

Because organizational change is complex and often painful, and effective automation can be a challenge, a lot of companies have elected to jump straight to the last option and adopt a "business process outsourcing" approach. This can be a very successful strategy with the right partner—one who understands what you need, has an established capability to do the work, and can offer improved levels of service at a reduced cost. With some care over contract terms, you can build in insurance against fluctuations in demand—both up and down—and turn a fixed cost into a variable. You may also be able to take capital assets off the balance sheet and replace them with a predictable operating cost related to business volume.

Although it doesn't make sense for everything, BPO works well for "undifferentiated" processes such as IT, contact-center operations, human resources, financial accounting, sourcing and even manufacturing. The best BPO providers can get more productivity out of your processes (and often your ex-people) by better design and standardization, higher levels of automation, and better training and supervision (all the things you could have done for yourself, but didn't want the hassle—remember?). BPO providers also have access to a global labor pool that can take advantage of the best combination of labor rates, infrastructure and capital availability. Perhaps most important, if BPO is all a service provider does, it can build expertise in running a BPO operation on a local or global scale. That's not going to happen in the typical company, where nonessential, back-office functions will not get the most talented managers.

While we are by no means close to the end of this cycle of the BPO approach, we now have enough evidence of the true economics of BPO to start looking at whether this is a persistent shift in business operations or merely a stop on the journey to something else entirely—a truly optimized and integrated set of business operations.

I have been looking at BPO operations for a couple of years now, and I have seen an interesting evolution in the operating model. Because labor rates are the big cost advantage, and thus a big profit generator for operators, keeping labor rates low is critical. To combat the steadily rising costs of labor, the BPO industry has first tried to expand into new labor markets where costs remain low. Two challenges face this approach: We are running out of new places to go; and the places we can go don't have the social, legal, financial and educational structures that make it reasonable to run a BPO operation there. Customers don't just want low cost; they also want security, guaranteed business continuity and, increasingly, a sense that corporate accountability is present. So although new resource pools continue to open up, they don't represent as much new opportunity as did Eastern Europe, India and China.

In response, the BPO operators have followed the course charted by contract manufacturers and begun to invest heavily in process automation, replacing labor (which tends to get more expensive over time) with hardware and software (which tends to get cheaper over time, so long as the underlying processes don't change too fast or too much—and many back-office processes don't).

Because this approach requires capital, and capital works best in concentration, BPO operators are also focusing on a few geographic areas, which are often defined by the stability and cost structure of their electrical and communications infrastructures. This shift to automation has been assisted by a couple of critical factors. The first is the process discipline and standardization made possible by the "arm's-length" nature of the BPO servicing process. ISO 9000 and Six Sigma programs are very common in BPO operation centers, but much less so in their customers. Second is the steady maturation of ERP suites for back-office processes that now offer close to complete support for many industry-specific processes with minimal customization. Combine these two factors, and BPO operators have been able to complete large-scale automation programs in ways in which their customers seldom succeeded, and much faster.

But here's the emerging irony. What's left when you have largely and successfully automated the core operations of a back-office business process? Answer: the handling of errors and exceptions. This part of the process still requires extensive human involvement, so BPO center agents are increasingly focused on this kind of activity. Depending on the process area and the degree of standardization that has been achieved, error and exception handling represents less than 30 percent of process effort, but up to 80 percent of process cost. So BPO operators are continually using tools such as Six Sigma to look at the sources of exceptions and errors and, as they understand them better, either eliminate them or automate their handling. My preliminary data suggest that as much as 60 percent to 80 percent of manual exception and error handling will quickly succumb to one or another of these strategies, leaving only the most complex or sensitive issues to be handled by highly trained and specially skilled people, empowered with sophisticated decision support and forensic analysis tools.

In summary, the automation doesn't go away—-and could still be outsourced to someone else and/or sent offshore. The manual parts of the business process are eliminated via automation and by removing all but a small proportion of critical exception handling via further process improvement. The remaining manual activities are focused on handling the small proportion of exceptions that can't be automatically processed.

Now for the killer question: If you are a large global business and you are focused on excellent customer service, where would you want the people who handle your most sensitive process issues located? The answer probably isn't in a BPO center in Krakow or Bangalore or Guangzhou—unless that's where the customers are, too. You will probably want the people who handle such critical customer (and supplier, regulator and shareholder) interactions to be "local" to your customers for a whole host of social and cultural reasons. And you probably want them "embedded" in your business: After all, they are now only a tiny fraction of the numbers originally required to run the process, and they are all doing competitively critical work. So you will probably bring both the automation and the remaining jobs "home" again.

That's what I see happening to BPO over the next few years. Whether the intent is transformation or simple cost savings, a fundamental shift is going to happen and a lot of "globally centralized" processes are going to become "local" again—although with much more automation and much higher quality. And a lot of locally dispersed customer support work will reshape corporate organizations, policies and management processes yet again.

Whether a company can manage these changes for themselves remains problematic—after all, BPO exists for a reason, good or bad. It might however, not exist for that much longer.

John Parkinson has been a business and technology consultant for over 20 years, advising many of the world's leading companies on the effective use of business automation. His next column will appear in December.