The Outsourcing Bandwagon Can it Continue
Can outsourcing continue to grow at the rate we have seen over the last decade or so, during which it has become the management tool of choice for many major corporations, as well as the engine of growth for an army of suppliers drawn not only from the traditional ranks of the hardware suppliers, systems integrators and consultants, but more and more from the new industrial heavyweights of India?
To answer that question we need to look at how this growth started, what sustains it now, and what options are open to the current protagonists.
The current outsourcing boom has its roots in the IT outsourcing deals pioneered in the 1980s by the likes of EDS and IBM. The levers used were a mixture of focused expertise, economies of scale and financial and commercial engineering. These disciplines were expanded in the 1990s into wider functional areas – finance for example, with Accenture’s landmark deal with BP in 1991 – and BPO was born. Clients bought into the concept for a number of reasons, high amongst them the management theory that organizations should focus on what was core, and leave everything else to someone else. And success was delivered – along with a few spectacular failures, and, one suspect, many very average deals which plodded along like tired suburban marriages.
And outsourcing could, probably would, have remained a minority sport, below the radar for most corporate executives, but for the seismic shift in the economics of the deals which came from the brave new world of offshoring. Offshoring meant that labor costs in many deals could be cut by 80-90%. By the time this translated into a price to the client, the saving was probably closer to 40 or 50%, but nevertheless this was real cost reduction. Of course, you didn’t need to be an outsourcer to take advantage of this, and most of the early adopters (American Express, BA, HSBC to name a few) were captives. But the outsourcers grabbed the opportunity in both hands, the established players spurred on by the arrival on the market of Indian-based suppliers who suddenly started punching above their weight, exploiting their location advantage by undercutting traditional deals and creating a new delivery model.
Almost every outsourcing decision now made involves sending work offshore to a low-cost location – traditionally (we already speak of tradition for a trend less than a decade old!) India for English-language work, and Eastern Europe for other languages, but increasingly other destinations as well – Latin America, the Philippines, Malaysia, Vietnam. This is delivering real cost benefits, as well as facilitating the re-engineering of processes, and accessing hitherto untapped pools of skilled labor. It is a clear example of the globalization of services, following the path well-trodden by manufacturing decades earlier.
So is offshoring enough to sustain the rise of outsourcing? Probably yes, although perhaps not on its own. There seems no doubt that offshoring will continue – the forces of globalization show no sign of retreating, the delivery model is proven, and competitive pressures will demand action. Take-up has been significant in terms of raw numbers and high-profile organizations, but overall penetration as a percent of the total potentially offshorable population is still low, and therefore has plenty of room for growth.
And although it is possible for any large organization to set up a captive offshore, it has become increasingly apparent that it is generally lower-risk and easier to piggy-back offshore on the existing facilities and experience of the outsourcing suppliers. This isn’t always true – there is some evidence that in certain industries (e.g. investment banking) and for certain services (e.g. KPO) there is an advantage to having an offshore captive – the people who are right for the job want to work for a bank, not for an outsourcer. But in most cases established outsourcers have huge inherent advantages over captives: they have done it before; they have size and scale; they have professional, formal service delivery tools and techniques; they understand the local environment and recruitment market; and because the back-office services they perform for their clients are essentially front-office for them, they can offer careers to their employees which captives can’t compete with.
But there are of course arguments against using outsourcing to access the benefits of going offshore – the interests of outsourcers and clients are seldom perfectly aligned, fundamentally because the outsourcer needs to grow revenue and margins, and the client is typically looking to control or cut costs. Arguably outsourcers are at a cost disadvantage in any like-for-like comparison with captives because of their profit margin, but like-for-like isn’t a simple concept – the different models require different approaches with different cost profiles. Captives may, for example, take longer to set up, and require more external support and more expensive ex-pats to run them than outsourcing deals. There is no rule of thumb, but experience shows that there is in fact no inherent cost advantage for captives versus outsourced centers.
And there are myriad variations on the outsourcing theme, mostly to do with joint-ownership and/or shared value creation. But for the purposes of this analysis these can be probably be regarded as outsourcing, albeit outsourcing in a form which offers the opportunity to share risk and reward in a more open way than the traditional vanilla deals.
The threat to the expansion of outsourcing may, arguably, come at the renewal stage of the original contracts. If the work is already offshore, and clients can negotiate the right to take over the service and cut out the margin, why wouldn’t they? The theory is superficially seductive, but the reality may be less alluring. Certainly there are few examples of deals which have reverted to the client in the offshore location – which may of course be due to weak termination provisions in the original contracts which make this difficult or impossible. Even where the much hyped “Build-Operate-Transfer” (BOT) model has been adopted from the beginning, there is evidence that post-Transfer it has been harder than expected for the client to run the centre, separated as they are from the mother-ship support of the wider outsourcer entity. And there is evidence that many BOTs have simply decided not to “T”.
Add to this the expansion in the kind of roles which organizations are willing to offshore – moving from the transaction processing of BPO to the technical and judgment based world of KPO – and the growth opportunity for outsourcers is clear. Their challenge will be to prove to clients – especially those who are now renewing their arrangements – that the theoretical added cost of using them (their margin, their overhead, etc) is worth it. And to do that they may well have to deliver better on the promises they have made for years on partnership, risk-sharing and investment. Given that caveat, it looks like outsourcing is here to stay, and grow.
About the Author
Rick Simmonds is a Partner in Alsbridge PLC, the award winning advisors on outsourcing, shared services and offshoring.
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