Outsourcing Becomes More SelectiveBy CIOinsight | Posted 03-25-2005
Outsourcing Becomes More Selective
In 2001, Marmot Mountain LLC was a privately owned, midsize outdoor apparel wholesaler in Santa Rosa, Calif. As the business grew, orders began to come in from retailers nationwide, often by phone and fax, and processing them became increasingly difficult. "It took hours of data entry, and mistakes were being made," says Alison Smith, the company's director of operations. "We were spending three or four days on data entry, and fulfillment was taking weeks."
Despite these difficulties, Marmot was wary when Denver-based CenterStone Technologies offered to take over and reengineer the company's order fulfillment process. "It was our first stab at using technology to help us to manage our business, and at relying on a third party to help us, so loss of control was an issue," Smith says. It took many meetings and much hand-holding, but "we finally got the picture," she adds. CenterStone connected Marmot's supply chain and ERP platforms and created a Web portal that allows retailers to view Marmot's products, check for inventory in real time, and place orders. CenterStone manages the order fulfillment process from its Denver offices and ensures that systems stay running, product descriptions stay current, and orders are accurately filledwithin days instead of weeks. Although Smith won't disclose actual figures, she says that Marmot has seen significant savings in supply chain costs thanks to the system. Today, the companywhich was acquired by K2 last Juneis experiencing 20 percent year-over-year sales growth.
For Marmot, like many other businesses, outsourcing a piece of the business can be a wrenching decision. In theory, BPO promises not just reduced costs, but also streamlined processes by letting third-party "experts" refine and evolve systems from start to finish. The problem for many companies is determining exactly what, if anything, should be outsourced. In addition, BPO deals are often plagued with poor management, badly negotiated contracts, hidden costs, and political infighting. In fact, analysts estimate that as many as 60 percent of all BPO deals will falter. And because BPO deals involve processes that directly affect important corporate stakeholdersincluding employees, suppliers and customersthe consequences of failure can be severe.
Yet despite the obstacles, BPO is growing: Gartner Inc. analysts estimate that the BPO market will increase from $113 billion in 2003, to $176 billion in 2008. Several large companies are already betting big on BPO's success: British Telecom recently renewed its contract with Accenture Ltd. to expand its HR BPO initiative from its U.K. division to all 38 countries where BT operates; and Procter & Gamble Co. has struck BPO deals valued at $4.3 billion to manage the company's HR, facilities, and some IT infrastructure and finance functions.
While managing an ongoing BPO contract presents its own challenges, the work that is done before inking the deal is perhaps the most important. The success of any BPO deal will depend on careful advanced consideration of three crucial elements: which processes you outsource and when; a detailed cost analysis; and the impact on the workforce that will be affected by the decision.
The classic paradox of outsourcing is that businesses are often told not to outsource their problems. But if a process is running smoothly, then why outsource it? Bill Martorelli, a principal analyst with Forrester Research Inc., says, "You can't outsource something you don't understand, otherwise you'll never understand what the outsourcer is doing on your behalf." Martorelli says that, many times, the better a process works internally, the more money you are likely to save by outsourcing it, because the transition will be simpler, allowing the outsourcer to focus more on optimization.
So how do you decide which processes are best suited for BPO now? It depends on two factors: deciding which ones have the least strategic value to your company, and then evaluating which of those processes are in the best shape.
Kevin Colangelo, a technology attorney with New York City-based Kramer Levin Naftalis & Frankel LLP, advises companies to formally consider their in-house capabilities before signing a BPO contract. "Make your internal group respond to the RFP as well," he says. "A lot of times that works very well because now they have to compete with a potential outsourcer." This will create one of two outcomes: Either the internal department will get its act together and prove a BPO deal is unnecessary, or it will ease the transition to the BPO vendor. This process will also create a baseline assessment of the processes in question before you send them to a third party, thus enabling your company to measure an outsourcer's effectiveness over time.
To truly transform, it's not enough to streamline processes, as many BPO vendors promise. "It's not just about doing it faster, quicker and cheaper," says Colangelo, "but integrating those systems with other technologies." For example, he says, imagine contracting an HR BPO vendor not just to take over and optimize the employee benefits process, but also to create a portal that lets employees submit and track their claims in real time. It can take several years before the BPO vendor reaches what Colangelo calls the "steady state"the point when the BPO provider has a good enough grasp on your processes to attempt transforming them. In the early stages of a BPO deal, the focus will be on reducing costs and streamlining operations.
The siren song of BPO is, of course, the 20 to 40 percent savings that vendors often promise. "But there's lots of things that aren't factored into the initial cost savings," says Colangelo. For example, many BPO deals rely heavily on head count reductions to create savings, but this works only if a company is willing to let its employees go, either over to the outsourcer, to help ease the transition, or by layoffs. "A lot of companies are unwilling to send their most senior people to their BPO provider, so instead of keeping four people on staff, they keep 30 people," which raises costs significantly, Colangelo says.
There are also important balance-sheet issues to consider. Oftentimes, when a company outsources an entire process, it sells the associated hardware and software to the vendor. That means the company no longer gets the tax break for the depreciating assets; it now has to account for that process as an expense. On the other hand, the company can often charge the outsourcer book value for the hardware and software, which is far more than the true market value. "CFOs love the effects on balance sheets in year one," says Mary Lacity, an outsourcing expert and professor of information systems at the University of MissouriSt. Louis.
Poorly negotiated contracts will also add to your BPO costs. While relationship building is key to ensuring success with the BPO partner, make sure your contracts and service level agreements (SLAs) are clearly defined and followed to the letter. If your company has regulatory compliance issues, for example, make compliance part of the formal contract. Arrange for reparations (credits) in case the vendor doesn't deliver on specific deadlines. And when it comes time to hold your BPO partner financially responsible for failing to meet a service agreement, Colangelo advises companies to take the credit but give the vendor a chance to earn it back later onas long the service they deliver is impeccable. "That way you show the vendor that you're more interested in performance than money, and that helps build the partnership without promoting bad behavior," he says.
With its promised cost savings, it's easy to get support for BPO from upper management. But the frontline employees, the people who will actually be affected by the outsourcing contract, are of equal importance to a successful deal. They will either be working for the outsourcer, managing the relationship, or without a job after the deal takes hold. Many employees already view outsourcing as a threat and are less than eager to see it succeed. "It's a political struggle," says the Yankee Group's analyst Phil Fersht. "People don't want to give up control of their processes, and IT leaders don't want someone else tinkering around with their systems."
Vendors agree that BPO deals often fail because companies plan BPO projects without the involvement of the employees they will affect. When it comes to outsourcing, honesty is crucial. "Companies have to lay out a strategy for making their people clear about the game plan, rather than waiting until the last minute," says Sunil Gujral, vice president of technology for Wipro BPO, one of the largest offshore BPO vendors in the market. "If employees hold back, it could lead to a potential failure."
Filippo Passerini, CIO and global services officer at $51 billion global consumer goods giant Procter & Gamble, says company executives began to consider BPO about four years ago. To make the transition as smooth as possible, Passerini says, P&G took a straightforward approach with its employees, holding frequent meetings and offering updates about the progress of the initiative, placing a particular emphasis on how employees would be affected. "We wanted to do what was right for our business in the long run, and also for our shareholders and employees," he says.
P&G hired three firms to handle its BPO initiativesHewlett-Packard Co. for IT infrastructure and transactional accounts payable, IBM Corp. for human resources and Jones Lang LaSalle for facilities management. Each firm not only took over a series of P&G processes, it also took on a number of P&G employeesroughly 3,500 workers in total (99 percent of all affected P&G employees were rehired by the BPO partner), who were offered similar positions at the BPO firms with the same salary and benefits as their former positions at P&G. Transferring the people along with the processes helped the BPO providers get up to speed much more quickly, he says.
Regardless of whether you transfer people along with your processes, assign a dedicated company liaison to the BPO vendor. "Relationship management is a big component to making BPO work," says Robert H. Brown, an analyst at Gartner. Initiate routine status meetings with both the BPO partner and the internal group to track progress and smooth out any cultural wrinkles.
Business process outsourcing, particularly to an offshore vendor, is a strategy that was born to get messy. But the problems that plague these deals can often be mitigated by a thorough analysis of the cost, management and people issues prior to signing the deal. Even if you don't end up outsourcing anything, you'll at least learn something about your company. And that's always a good business decision.