Sr. VP Business Development
June 19, 2014 | 4:30pm EST
This white paper provides general background to assist organizations that are considering engaging an off-shore outsourcing partner and who wish to evaluate their options. Many of the matters discussed in this paper can be equally applicable to domestic outsourcers.
This paper is primarily concerned with off-shore outsourcing of services; namely, technology related and business process related services. Accordingly, we do not discuss here the very specialized concerns of other types of outsourcing such as manufacturing and distribution outsourcing.
Overview – Best Practices
Outsourcing is the contractual use of low-cost external suppliers to provide organized skills, often for business processes not regarded as core competencies by the contracting firm. Such skills typically include Information Technology (IT), financial, benefits transaction processing and accounting, manufacturing, as well as various aspects of customer service such as outbound and inbound telemarketing.
Off-shore outsourcing is simply the sourcing of skills from non-domestic suppliers, usually at rates far below what one might expect to pay domestic suppliers. The compelling interest behind off-shore outsourcing originally was and continues to be cost savings:
- Developing countries can offer lower labor costs for highly educated, English-speaking professionals providing commodity IT and other business process skills.
- Labor costs can range from 30 to 70 percent less than what would be paid domestically.
As the global IT outsourcing market has matured over the past thirty years, competitive pressures have led to increasingly professional and high quality capabilities among off-shore providers. Many of them possess respected certifications attesting to high levels of professionalism and quality, including, among others, Carnegie Mellon’s Software Engineering Institute’s (SEI) Capability Maturity Model Integration (CMMI) certifications, and the most recent standards from the Swiss International Standards Organization’s (ISO) which certifies attainment of very high quality standards. In fact, India has as many firms at CMMI Levels 4 and 5 as the U.S. does.
Besides basic cost savings and high quality, other factors driving increasing acceptance of off-shore outsourcing include the following:
- Flexible staffing and basing models – options include full outsourcing (outsourcer takes over), co-sourcing (combination of outsourcer and client staff), staff augmentation (provision of specific, highly specialized skills), on-site in client’s domestic facilities, completely off-shore, a combination of on-site and off-shore, and near-site basing (outsourcer’s staff at a location near but separate from client facilities);
- Ready availability of highly specialized skills without a need to commit long-term to individual employees promotes the ability to form and dismiss highly specialized teams quickly and cost-effectively
- Often, a more intense focus on developing technologies that make software development and implementation increasingly cost-effective.
Of the types of off-shore outsourcing available, some are quite mature while others are less so.
- Probably the greatest degree of maturity is in software application migration and maintenance as well as legacy
applications support. All are substantial sources of revenue today, but legacy maintenance is declining as legacy environments are replaced; however, production support and maintenance of state-of-the-art environments is a strong outsourcing capability.
- Offshore outsourcing capability is maturing related to new application development, such as mission-critical applications requiring high involvement by client personnel and greater business impact. While packaged applications (e.g., ERP, SCM, CRM) and business intelligence (e.g., data mining).
Despite the substantial benefits associated with off-shore outsourcing, risks include the following:
- Global political instability that could jeopardize key operations or key projects;
- Different labor laws, tax implications and legal frameworks;
- Operational factors that are difficult to control by clients such as disaster recovery, voice/data speed/robustness, security policies and personnel attrition;
- Cultural issues that hamper effective cross-communication, of particular concern as development tends to be conceptual in nature and therefore harder to define accurately or precisely – communication bottlenecks can occur among cross-functional, virtual teams, exacerbated by the fact that many organizations do not plan for and train effective virtual teams;
- New technologies may have new features and interactions that may be unclear to all participants; and
- In the US, increasing scrutiny by Congress and regulatory bodies on displacement of American workers, which may speak more to how outsourcing is delivered rather than its inescapable reality.
In order to effectively manage the risks while exploiting the potential of off-shore outsourcing, the first challenge is to be aware of and evaluate potential options.
High Valued-Added Capabilities
As IT and commodity business process costs continue to rise, many competitors are rationalizing costs through outsourcing of commodity skills, presenting a competitive threat to those who do not.
- According to CFO.com, by the end of 2013, 36% of US CFOs said their companies were doing offshore outsourcing.
- The primary driver will be cost advantage with high quality. The strategic goal is increased competitiveness, while achieving increased profitability.
- This model has a far-reaching effect on barriers to competition as the winners, with rationalized cost structures, will dominate their markets. New entrants may be faced with requirements for organizational complexity that they are not prepared to provide, while mature competitors will scramble for years to catch up, losing market share along the way.
TBI believes that as part of an Outsourcing strategy, Corporate Governance will continue to evolve into management of sets of Core Competencies, High Value-Added Capabilities, and Commodity Capabilities. Corporate Governance and Core Competencies will be internally managed while High Value-Added and Commodity Capabilities will be outsourced in a manner that dramatically reduces cost while protecting quality. Every company that wishes to remain competitive will need to consider organizing in this way.
Where will companies go for outsourcing partners? Wherever the best balance of low cost and high quality can be achieved reliably. Anywhere in the world. Indeed, as the trend evolves, the commodity exchanges we see gaining popularity today may well be established for a wide range of services as well. Today, we see specific jobs or even long-term responsibilities of various sizes posted globally through social networking and exchanges.
What are the implications if a company wishes to embrace the model now? To prepare your organization for outsourcing, you need to evolve new control mechanisms and align yourself with knowledgeable partners to effectively manage outsourced work (whether off-shore or not) on a large scale.
How to Proceed
In order to proceed responsibly with outsourcing, a company first needs a road-map that addresses the questions:
- What business processes should be targeted for eventual outsourcing?
- Which should be outsourced to off-shore providers, and which to domestic providers?
- Which of those processes offer, if outsourced, the best mix of high payback and low risk?
Once these questions have been answered, the road map begins to take shape at its highest level for a general outsourcing strategy or for a specific outsourcing opportunity. Keep in mind, if you outsource a problem, the problem may continue—only as an outsourced problem. It is vitally important to plan thoroughly. To minimize risk, consult with experts who have broad experience in helping organizations in achieving complex outsourcing plans.
- Develop and prioritize a set of targets, each with a direction for further analysis.
- Solicit input and ideas from key management and stakeholders in order to determine general feasibility for outsourcing prior to doing detailed analysis.
- Perform detailed analysis and preparation dealing with how to go about achieving the target, which calls for answering a new set of questions.
- How must the organization and the process change in order to achieve the target?
- What steps need to be taken, in what order, to effect the necessary changes?
- Which candidates should be considered for outsourcing?
- What should be the detailed objectives of outsourcing the target process?
- What should be the evaluation criteria driving the outsourcer selection?
- By what mechanism(s) will candidate selections be made?
Once answers have been generated, it makes sense to re-examine assumptions to determine if priorities have changed with more knowledge. Once these questions have been answered and assumptions have been re-addressed and revised, the roadmap takes on substantial detail.
At this point, those assisting you to organize this effort (often a consultant) or the internal people performing the activities should contact candidate outsourcers to begin discussions.
Depending upon the results of analysis and the outcomes of discussions with potential outsourcing organizations, the next step is to prepare a Request for Proposal (RFP) for each of the target processes. The RFP is sent to every selected candidate outsourcer for each target process. An RFP should clearly define the business process or processes to be outsourced, expected service levels and commitments, and ceiling prices expected to be paid, as well as other more general requirements such as financial viability of the candidate, etc.
If the target is not a business process but is or includes a specific project of large scope, then commitments may include considerations such as specific deliverables, timelines, methodology used to secure objectives, project duration, degree of permitted operational disruption, and other matters. If an actual process is to be outsourced on an on-going basis, other issues take on more importance, including modes of on-going internal and outsourcer interaction, the extent of ramp-up required by the outsourcer to familiarize him with the process, etc.
Each candidate outsourcer will provide a response to the RFP, which then needs to be analyzed, applying selection criteria previously agreed to, resulting in a tentative selection. These steps are followed by detailed negotiations to set the terms of a service contract. If the target is the on-going outsourcing of a business process, then a Service Level Agreement (SLA) formalizing each party’s commitments, must be negotiated as well.
In summary of the above information, you may find a checklist helpful:
- Establish an organizational structure for planning outsourcing analysis;
- Define process targets, in priority order by business benefit as balanced by business risk;
- Further analyze highest-priority targets to determine impact to the business, candidate outsourcers, mechanisms for evaluation and selection;
- Validate assumptions and priorities;
- Contact candidate outsourcers, initiate preliminary discussions;
- Prepare and deliver RFPs;
- Analyze responses, apply selection criteria, tentatively select the outsourcer or outsourcers;
- Conduct detailed negotiations on price, commitments and other service levels, ending in formalizing of selection(s);
- Formalize the Service Level Agreement (SLA) and other contracts, which formalizes the selection;
- Begin the outsourcing; and
- Measure the effectiveness of the SLA, taking remedial action as required in the event of non-compliance or unacceptable performance.
Once these matters have been completed, the selection is formalized. If the results of negotiations are unacceptable, then the next most attractive candidate may be tentatively selected and better results attempted.
The work of constructing an RFP and analyzing responses, not to mention negotiating agreements and potential internal politics, is sufficiently complex and technical that the situation strongly suggests the use of an experienced consultant or staff to assist in the process.
Once agreements are in place, the actual outsourcing commences. Its effectiveness relative to the client’s expectations should be monitored continuously, and contracts and SLAs should reflect penalties, escalation mechanisms, and contingent actions for performance that is regarded as sub-optimal.
Two points of particular importance deserve elaboration here:
- How a company should organize to effectively manage outsourced capabilities, and
- How such capabilities should be monitored.
If your interest is in a project rather than an outsourced business process then the organizational structure, while important to impose an effective span of control, need not change dramatically. The one exception to this is in the need for new and more effective communication mechanisms. However, if on-going outsourcing of a process is the objective, organizations often underestimate the nature and extent of the required organizational realignment.
Outsourcing a process rarely means that a partner takes over all aspects of the process. Even when the process is expected to be substantially outsourced, the vendor partner must be managed by internal personnel accountable to management who set direction and priorities and assure quality of service. And when the relationship is one of co-sourcing, in which client and outsourcer share responsibilities, the organizational structure required to effectively manage the blending of roles needs to be robust.
When considering outsourcing requirements (when developing an RFP), take care to carefully distinguish commodity from high-value activities. The highest payback from outsourcing is to retain high-value activities closely related to overall success while shedding commodity activities that can better be performed by those who focus exclusively on them. Therefore, part of the internal organization needs to take accountability for the high-value activities, and those parts need to be defined. Because high-value and commodity activities can be organized very differently prior to outsourcing (as in the case where both are performed by the same people), the change in an organization’s environment may need to be significant after the outsourcing is put in place.
As you evaluate organization, remember that management and monitoring are key areas that will require attention. In a purely internal organization, the degree of required monitoring is often very different from that required in an outsourced environment. This is because those in an internal organization are presumed to have aligned interests because they all answer to the same authority and, share a company culture, and are managed by the performance management process, so monitoring of performance often is not as rigorously performed.
However, in an outsourced environment the culture is not shared and the interests are not necessarily the same. The extent and intensity of monitoring needs to rise. Trust but verify.
In fact, management often needs to change in the organization that outsources. In a purely internal organization, because interests and company culture are aligned, direction can often be collaborative, as can be priorities. In a well-managed organization, direction and priorities can bubble up from the ranks since the ranks are intimately familiar with what needs to be done and the political and other constraints on what can be done. Such is rarely the case in an outsourced environment, particularly one with a large off-shore component, which will tend to be far more reactive. Management will need to drive the process rather than simply coordinate it.
Accordingly, understanding organizational implications is very important before commitments are made to a relationship and a partner, and those implications should be considered carefully in selecting the partner.
Monitoring begins with choosing the right metrics by which performance can be measure. Metrics will vary by organization. The best general rules are:
- Don’t make the number of metrics so numerous that you add significantly to cost or make the measurement environment too complex; and
- Define metrics that motivate the right behavior.
What are the most important performance factors to you? Reducing costs? Reducing defects in a programming environment? Increased production/productivity? Improved time-to-market? You will need to select a set that reflects your priorities. It should be a limited set that motivates the right behavior without imposing excessive and costly burdens of data collection and analysis, on you or on the outsourcer (who will, of course, pass the cost on to you).
Select the metrics.
Metrics need to be meaningfully motivational – measuring numbers of lines of code that a programmer generates will motivate a programmer to generate more code, not necessarily to produce elegant, flexible, easily modifiable code.
When developing an SLA, clients often make the mistake of defining how metrics are to be satisfied, along with the metrics themselves. You should leave the how to the outsource vendor, and focus your attention on objective measurement of the results – the outsourced vendor will determine his methods in such a way that maximizes and optimizes performance in achievable ways for his or her organization because a successful relationship means a long-term one.
Choose metrics that can be easily measured. For example, measuring whether a newly written program meets published IT standards can require extensive manual review, and thus might not be an effective metric to implement. However, an off-the-shelf metric analysis tool can automate the same process, securing the same motivational result at a fraction of the cost.
Once the metric set is defined, the next step is to establish reasonable baselines for the metrics. Metrics need to be achievable, although an SLA may require that performance relative to the baseline improve significantly over time, with increased familiarity. Unless a great deal of relevant empirical data is available for the metrics in your environment, be prepared to revisit the baseline standard of performance, perhaps frequently, until it becomes appropriately aggressive but still achievable.
For instance, in a software development environment, Function-Point Analysis has been an often-used technique for estimating complexity of a task. A number of function-points are assigned a generic task, each point is assigned attributes such as effort required (person-hours), duration required, cost required, etc. You add up the points associated with all the tasks you contemplate and you have an estimate. You measure the actual experience against the estimate. The problem is that the assumptions underlying the number of assigned function-points and their attributes are almost always valid only for a stable organization (your organization, not all organizations), and even that assumption is challenged once personnel turnover begins to accelerate or systems are dramatically changed.
Check your assumptions.
Porting the assumptions to an outsourcer and measuring him or her on the basis of your experience may well create an unreasonable expectation (conversely, the outsourcer may dramatically outperform your organization, which might create other types of problems and fail to motivate him or her to improve).
Categories of Metrics
In general, the categories of metrics from which you might fashion a reasonable metrics set to consider in an SLA include but are not limited to the following:
Volume of Work
Usually the most visible metric category in an outsourcing relationship, Volume, is the exact level of effort to be provided by the outsourcer within the defined scope. Any effort expended outside of this scope usually requires separate billing or re-negotiation of the terms of the SLA. Broadly defined as the number of units of a work product or the number of deliverables produced per unit of time, Volume of Work metrics should be specified for every major deliverable cited in the SLA. Examples include number of outbound calls per day, number of maintenance requests per month, etc.
Quality of Work
Quality metrics are very diverse. Covering a wide range of deliverables, they seek to measure the conformance of those items to specifications or standards. When deliverables fail to meet the acceptance criteria in the specifications or standards, quality problems arise. Examples include:
- Defect Rates — number of errors in major deliverables.
- Standards Compliance — e.g., Internal standards for application source code, documentation, reports and other tangible deliverables, including number of enhancement tasks passing standards reviews, number of documented programs, etc.
- Technical Quality — measurements of the technical quality of application code, normally produced by commercial tools that look at items such as program size, degree of structure, degree of complexity and coding defects.
- Service Availability — the amount of time/window of time that the services managed by the outsourcer are available;for example, on-line availability of 99% during working hours.
- Service Satisfaction – extent of client satisfaction in service provision as measured by client surveys.
Responsiveness metrics measure the amount of time that it takes for an outsourcer to handle a client request. These are particularly visible and important from your perspective. They may include:
- Time-to-Market or Time-to-Implement elapsed time from the original receipt of a request until the time when it is resolved.
- Time-to-Acknowledgement how responsive the outsourcer is by determining when a request is acknowledged, and accessibility of status information.
- Backlog Size such as the number of requests for service awaiting action during some specific time period, or the number of person-hours required to process the requests.
Efficiency metrics measure success at providing services at a reasonable cost. However, be careful: don’t disrupt a desirable relationship between volume of work and delivery effectiveness just to measure something. For example, a commitment to process 1,000 telephone support requests per day for a fixed price of $ 10,000 per day may miss the point. If that is all that is measured, and if the outsourcer doubles his effectiveness, he still handles 1,000 calls and charges $10,000 — hardly optimal from your perspective. However, if you measure instead cost per call, you could see a drop in that metric from $.20 per call to $.10 per call, particularly if performance incentives are included. Examples of efficiency metrics include:
- Cost/effort Efficiency — an efficiency metric, such as programs supported by one person or cost per support call,that can be used to document cost reductions or productivity increases.
- Team Utilization – which measures workload of specific individuals in a team and aids in effective resource utilization.
- Rework Levels— a metric which measures the percentage of work products that are returned to a previous step for additional work, correction or completion, and which aids in assessing the quality and efficiency of a process by pointing out patterns of wasted time and effort.
Commitment to a course of extensive outsourcing, particularly off-shore outsourcing where language, culture and methods may differ extensively from yours, is not trivial and should be approached carefully. This section discusses what we believe to be the primary risks associated with off-shore outsourcing, and how the risks may be effectively managed.
One of the most serious risks is proceeding too quickly into a commitment. With time and exposure come familiarity between the partners, which can avoid misunderstandings and the perception on the part of the client that outsourcing is too complex to succeed.
If initial interest lies in a specific project as an outsourcing pilot effort, the project selected should not be mission-critical but relatively low-risk and certainly manageable; and if the interest is in on-going outsourcing of business processes, the first process to be outsourced should not be too complex or mission-critical.
By using pilot efforts at outsourcing, you shake out the modes and processes of interaction with little risk and build mutual familiarity between each organization’s culture and methods that will serve you well in more important undertakings when the price of failure could be much higher.
Global instability may be at an all-time high. Many potential outsourcing partners lie in unstable regions dealing with their own problems. These are facts, and facts that are unlikely to change soon.
However, the risks associated with instability can be minimized. If you align yourself with partners who possess domestic facilities, and negotiate commitments that key personnel will be moved to those facilities in the event of difficulties in order to keep service as transparent as possible, then some of the risk can be mitigated.
Different Labor Laws, Tax Implications and Legal Frameworks
Responsible firms protect themselves. While other judicial systems can be quite mature and not too dissimilar from ours (such as India’s) they all remain different, which could present problems in the event of disagreement.
Your legal representatives should review all contractual agreements with this in mind. Provision should be made in such contracts that any disagreements are to be adjudicated in domestic courts or mediated by domestic authorities. Your legal representatives may need to satisfy themselves that a potential partner can be effectively challenged in a domestic court.
Cultural Issues That Hamper Effective Communication
Different cultures value different characteristics and possess different sensitivities. Western cultures, for example, anticipate pleasantly aggressive personalities and a high degree of candor, particularly among technical professionals, while other cultures emphasize less direct methods of communication. Unless anticipated, cultural differences and values can cause misunderstanding and jeopardize the relationship and expected outcomes.
Language difficulties may pose a problem, even with countries who employ English as a Lingua Franca. In some outsourcing organizations, English may be at best a secondary language learned in a school setting. Language skills can be a huge challenge.
Relationships can (and often do) founder on misunderstandings, so particular attention needs to be paid by both partners to assure that understanding is complete. Contractual terms, requirements, methods, deliverable forms and all other pertinent matters need to be discussed in detail and placed in context, so as to minimize chances of legitimate misunderstanding based on dissimilar perspectives and assumptions. While this is important when employing any service provider, such rigor is particularly important when visual cues, values, assumptions, even language, are different.
Operational Factors That Are Difficult To Control
Difficult-to-control operational factors include disaster recovery, voice and data speed and robustness, security policies, personnel attrition, and many other aspects of supporting infrastructure and how challenges are addressed internally can have profound effects on client service. These factors can also include the extent to which your own and your partner’s equipment platforms, operating systems, tools, etc. are in sync. The sheer time difference between your organization and an outsourcing partner on the other side of the globe is a major operational consideration requiring careful thought before commitment.
Make a list of such issues. Discuss them thoroughly and candidly with potential partners. Arrive at mutual agreements and formalize understandings in contracts and SLAs. Visit partner facilities as appropriate to monitor compliance and to communicate how seriously you regard the matter. Contracts and SLAs should have exit clauses and defined remedial actions that can be taken if compliance is unsatisfactory.
Increased Scrutiny by Regulatory Bodies
The U.S. Congress has taken more intensive interest in the matter of displacement of American workers, a trend that is unlikely to diminish anytime soon. This issue is already of significant regulatory concern in other Western nations. We believe that such concern will result not in diminishing exploitation of off-shore opportunities but in how such services are delivered.
- Those off-shore outsourcers who provide very large numbers of personnel to clients who require long-term, on-site domestic presence may be at high risk, particularly when they rely heavily on U.S. L-1 visas. Off-shore providers who offer more balanced mixes of on-site and off-shore capabilities will be at less risk of damaging protective legislation.
- A concept that is gaining increasing currency is Mediated Outsourcing Services. In this model, a third party firm mediates the outsourced relationship with the offshore organization. In addition to providing an interpretive and quality assurance buffer between the client and outsourcer, adding high-value management consulting capabilities that usually are necessary but unavailable from outsourcers, who typically focus on commodity activities. We believe that dependence on such arrangements will avoid regulatory problems and foster creation of domestic jobs while allowing exploitation of off-shore opportunities.
Off-shore outsourcing of projects and other service relationships will continue to happen for competitors; and it will need to happen for other large, complex organizations as well if they are to remain cost-competitive and focused on core competencies. In order to successfully leverage the opportunities and effectively counter the competitive threats, organizations need to re-organize to effectively manage the outsourcing paradigm.
Often, companies postpone planning and implementing disruptive ideas until the threat is imminent. However, in this case, defining and applying an outsourcing strategy is a valuable way for organizations to dramatically improve their bottom line and take responsible action to protect themselves and their stakeholders.
Please note that this white paper presents professional opinions intended to apply generally. Organizations must take appropriate care to evaluate these ideas in light of their specific needs. Some of the opinions presented in this paper may not meet specific needs of an organization. We can help. With 50 years in outsourcing consulting, we can help you navigate the challenging outsourcing landscape.