Beware of Myopic Cost Cutting: Use Outsourcing To Be More Competitive in This Economy

 By Phil Fersht

It’s easy for enterprises to panic in this market and jump at outsourcing opportunities, simply with the goal of shedding some cost from the bottom-line. In many situations, clients have jumped at the lowest cost option, and now live to regret their decision. Too many clients we speak with are locked into outsourcing contracts that are miserable experiences they can’t escape for years.

We polled a number of companies at our recent Business Technology Conference. Few felt they were enjoying a collaborative experience with their current outsourcing provider.

Case study: A cautionary tale

One company we talked to—a major consumer products (CP) firm—signed a seven-year IT infrastructure and applications outsourcing contract in 2005 with a global outsource service provider. At the time, the company was offered a significant price cut if it signed up with this service provider for its entire major, IT-managed infrastructure and application service requirements. The client saw a price that was about 10% better than other competitive bids from best-of-breed providers for its infrastructure and applications services.

Two years into the contract

, the service provider essentially used the same pool of delivery staff to service both its infrastructure and application requirements. While the CP company said the outsourcer performed an adequate job running the ERP maintenance and support services, its staff hadn’t managed the infrastructure services adequately. As a result, the company had to retain more staff onsite. This effectively eradicated the additional 10% savings, with the service delivery falling far short of expectations.

The client now needs to bring an additional service provider into the sourcing mix or find a way to dissolve or restructure its current contract. Both options would incur significant incremental costs, ensure management headaches, and require explaining to the board about how they managed to get into this situation in the first place. The company has found itself trapped in a situation where any initial savings have been overrun by the negative implications of a poorly executed service contract into which it’s locked for another five years.

Like this unfortunate CP company, many enterprises began rationalizing their infrastructures after the last downturn and are now looking further up and down their supply chains to find new business efficiencies. Engaging an outsourcing provider can help, but the decision your company makes now will lock it in for years to come—hence the need to look at outsourcing in the context of broader business strategy.

Outsourcing clients must think more intelligently and strategically about ways to create an experience that drives more business and delivers value to the top line. They can’t just remove short-term costs from the bottom. If clients can use outsourcing to become more competitive, a different paradigm—one other than just “shipping jobs offshore”—will be created.

Harness four specific business goals when approaching an outsourcing strategy

Smart businesses will survive this economic hardship and emerge more nimble, competitive, and globally integrated. Outsourcing alone is not the answer. It simply provides a vehicle for enterprises to gain access to new talent, better process acumen, new technology, and global markets. The advice below assumes enterprises venture into outsourcing engagements with the right objectives in mind.

The number of service providers eager for your company’s business has proliferated, with most offering attractive, short-term savings. But you must forge a partnership with a provider that will work with you to add a lot more competitive bite to your business over a multi-year contract.

Consider the following goals:

1. Expand your global business

One of the core differences between the current economic recession and those of the past, is the fact that all of today’s financial markets and economies across the globe are so much more integrated than they used to be. The Internet and global communications revolution have created unprecedented access to global talent, where you can have your mainframe computers managed in Brazil, your general ledger consolidated in Hungary and your logistics analytics performed in India. The need to enter new global markets quickly has never been as pressing as it is in today markets, and the right service partners can help you grow your business globally. Having a ready support infrastructure that can support foreign payrolls, accounting procedures, local regulations etc. can save your company months of painful work to set up shop in new markets. For example, Accenture helped Unilever hire 10,000 sales staff in China, which has already contributed to 400% growth in same-store sales in the region.

2. Develop a global ERP backbone with common business processes.

Engaging an outsourcing provider which can provide common processes around a solid ERP backbone is critical. Smart enterprises are moving ever-closer to developing commons standards to support processes that can enable them to operate and compete as global entities, and this current economic predicament is accelerating this dynamic. When you have rapid access to your global financial, HR, supply chain, customer and product information, you are in a position where you can make quicker informed decisions to enter new markets, sunset dwindling product or service lines and mobilize your resources and partners accordingly to respond to your existing and future customers. ERP platforms are far more globally-integrated now than they were a decade ago. Many enterprises have moved into global outsourcing relationships that entail the service provider managing the client’s ERP backbone and corresponding business processes, for example, Bristol Meyers Squibb now employs IBM to manage its global SAP HR services, coupled with a nearshore/offshore support model for its global HR processes. BMS’ goal is not only to reduce costs, but also to achieve access to global workforce data to support its global HR strategy.

3. Free up cashflow

A good BPO provider can add discipline to your company’s collections to speed up cashflow, eliminate bad debt, and provide a timelier cash supply. On the flip side, quality procurement processes help to keep the cash you currently have, which is critical in today’s tough economic environment.

Global drinks manufacturer InBev recently signed a finance and accounting business process outsourcing (BPO) engagement with Wipro to service from Brazil to create that discipline for its Latin American business units.

4. Approach cost containment as an ongoing objective

A good outsourcing partner should be able to help you sustain cost-savings over a long period, not simply at the onset of an engagement, through ongoing quality and process improvements. For example, you may save $10 million in the first year or your engagement, but how about the subsequent years? Those initial costs you saved will creep back if you don’t constantly refine your processes across your global supply chain. For example, one of our clients now sets specific business targets for its service provider to meet, where it is committed to applying Six Sigma methodology on an ongoing basis to reduce its cost-base over the course of a long-term outsourcing contract.

Use this time wisely

It’s not really a good time to go to your board and demand multi-million dollars to add a new service provider to your outsourced delivery infrastructure. It’s also not a good time to rip up your current contract if you rushed into an outsourcing situation without an eye on the midterm to long term. Use this economic climate to foster radical changes to your business, and be sure to consider the decision points above when starting to engage outsourcing providers.

Comments

[Stephen Cohen]

Phil - looking forward to reading your new blog. And great article :)

Stephen.

[Rebecca Edwards]

Phil,

Thanks for the refreshing insight - I especially agree with your point about continuous improvement. So many companies outsource for a one-time cost reduction, but fail to capitalize on the opportunity over the course of a contract. I think the current recession will force many companies to evaluate the longer-term business goals behind an outsourcing engagement. Many firms have already been proactive in anticipating the tough year ahead and have made sizeable labor force reductions. Clearly, they are trying to avoid desperate cost-cutting measures further down the road, and in a similar vein an outsourcing strategy needs to be well-thought out and not a panic decision, based on a bad quarter.

Rebecca Edwards

[Soumen Chowdhury]

Nice post and bang on ! thanks a lot

[Mo Khan]

Phil, great article. In many instances, clients often sign-up for the initial cost savings at face value, only to learn that the stringent contract adherence requirements create a dis-incentive towards future savings through restructuring, re-engineering etc.due to the inherent changes proposed. This is due to the fact that the client is fundamentally unwilling to change their delivery model in favor of stability. This balance has to be achieved in terms of allowance for steady state incubation period, and more importantly, a flexible and a collaborative relationship.

The matter becomes even more problematic when clients request that you re-badge their people based on the concern that they will lose in-house knowledge tied to their highly customized and voluminous list of applications, processes that differ regionally or business unit-wise. Obviously, you can't sell their own people back to them at a lower price so the business case becomes the carrot you never bite.

In the best case scenario, clients will use the savings from offshoring labor arbitrage to subsidize an ERP implementation after a couple of years, hence acquiring the transformational benefits afforded them through a smart mix of offshoring.

[Chethan D Srikant]

Hi Phil,

There is another dimension of being myopic. Companies do not recognize that its not like flipping a button. If the objective of the exercise is widely recognized as rationalizing line items in their financial statements then business leaders within the organization will perceive it just like that.

They will fail to understand that this has real impact on:

a) Business processes. This is subsumed in your point on global ERP backbone but are the business leaders committed to the business process reengineering that is implicit and necessary?

b) Change management. Apart from the changes in process due to the BPR there will be change in process due to the outsourcing agreement itself. For ex: consider SLAs. The outsourcing service provider will be required to collect, maintain and aggregate certain data points which the user might find irrelevant.

c) Reacting to ever changing business environment. If business leaders are not involved in setting business objectives (not just myopic cost cutting objectives) for the outsourcing arrangements then they might end up choosing a service provider that may not be capable of adapting to the changing business realities and market situation of the company. Sometimes the service provider might be capable but inflexible to acknowledge the changing situation.

d) Innovation. How many times have you seen this word being misused!! No contractual agreement can really pen this down to the most accurate level. However what must be evaluated is the ability of the service provider to be able to support any such effort that might be conceived in future. In some sense this should be a part of consideration for the ongoing objective (your point 4).

e) Setting unreasonable targets. It is a very competitive world out there. No service provider would want to be in a situation where they say they cannot while someone else is saying they can. However companies might be very tempted to set unrealistic goals and squeeze every basis point out of the margins of the service provider. Companies may not have completely taken into account their own internal challenges while evaluating the vendors. These two combined can really set the winning service provider up for failure!!

To give a crude analogy – its like hiring a maid. Its not just about getting more time at hand but being able to change your lifestyle in order to make the arrangement effective. The whole family has to agree to the arrangement and needs to bring in some discipline. Otherwise you might end up having less time as well as money than before.

Regards
Chethan

[Mark Scheidel]

Outsourcing is not a passive exercise and BPO service providers are not mules carrying loads. It is a very dynamic process and both the service providers and the clients must function proactively and in harmony with each other to ensure success. I thought this article might be of interest to you, BPO Service Providers & The Rise of the ‘Smart Client’. Check it out at:
http://wns.com/Insights/outsourcing-bpo-articles/tabid/81/Default.aspx?smo=amrsc