Looking beyond Cost Savings in Outsourcing

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By Nari Kannan

An Aberdeen Group study in July 2006 found that in a survey of companies outsourcing their software application development and maintenance to vendors in the United States and other countries such as India, "best-in-class" companies reaped many more benefits beyond just cost savings than "industry average" companies or "laggards." These benefits included an increase in end-user satisfaction and a higher percentage of projects delivered on or below budgets. Best-in-class companies planned for and leveraged these efforts beyond just using cheaper labor.

A McKinsey study published in Summer 2006 recounts how a large airline could go beyond leveraging just cost savings in offshoring back office functions. This article talks about expanding the scope of fare audits, revenue management and tactical customer relationship management with the cost savings effected. The airline was also looking beyond simply executing business processes to process reengineering, IT automation and consolidation of IT platforms. The savings from lowered labor costs for back office functions could be applied to work it couldn't do before because of costs, priorities and lack of sufficient human resources.

Many companies will share with you their own anecdotes about how, when they added up the costs of travel, coordination, delays and changes, the promised cost savings in outsourcing were always much smaller than originally expected. Looking beyond cost savings in outsourcing is strategically beneficial for both buyers and sellers of outsourcing services.

Benefits for Buyers of Outsourcing Services

Taking Advantage of Strategic Opportunities like Compliance Imperatives

The demands of compliance requirements like Sarbanes-Oxley in the United States and Basel II in Europe are persuading many public companies to consider partnering with multi-billion-dollar private equity firms and going completely private. Best-in-class companies are leveraging the cost savings in moving routine back-office functions offshore to implement many of these compliance imperatives that have been on the backburner. Outsourcing maintenance of existing applications frees up your IT and other resources to reducing that multi-year backlog of new applications you could never get around to before.

Documenting, Streamlining, and Improving Existing Processes

The longer the company has been in business, the more manual and undocumented business processes are likely to be. In many real cases, if a key employee is hit by a truck, a large portion of the business process knowledge may be lost temporarily or permanently! Outsourcing provides a golden opportunity to document these business processes; the service provider will do it for you since both of you need it for legal purposes. And while you're going through the trouble of outsourcing, why execute the business process the same way? Why not improve upon it while you're at it? The same logic applies to software development outsourcing. Why not address problems you've had in the past with project managing these software development efforts. Why not come up with a new project management approach or even try out some of the new agile methodologies?

Formalizing and Instituting Metrics and Measurement

Outsourcing provides a golden opportunity in many cases to institute metrics and measurement. Metrics and measurement is usually low on the priority list when work is done in-house. However, the minute you outsource software development or business processes, you may need to think of governance issues. The contracts probably have service levels specified; unless you have a proper way of measuring and reporting them, those service level agreements become meaningless.

Getting Fresh Perspectives on Technology and Approaches

Outsourcing to a service provider that has done similar work for other customers like you can often lead to getting fresh perspectives on technology and approaches. You may also get to leverage a service provider's investment in technology. If a service provider has already invested a lot of money in a state-of-the-art document management and workflow system, you may get to leverage it for implementing or even improving your own business process. If a software development outsourcing service provider is an expert in Agile Methods, why not try a small software development project using these new methods and see how it compares to the traditional software development lifecycle you've been using? How about a new language, a new hardware platform or a new operating system platform?

Benefits for Sellers of Outsourcing Services

Building and Leveraging Expertise across Multiple Customers

Competing on price alone is a no-win situation, especially from a service provider's perspective. Building and leveraging business process or software development expertise in specific verticals and for specific types of customers will provide a much more sustainable and credible value proposition than just cost savings alone. In some cases, a service provider may also be able to charge a premium if they can show that they bring something unique such as specific vertical expertise to the table.

Demonstrating Continuous Process Improvement

Both in business process outsourcing, and software development, process improvements are much more valuable to customers than cost savings. Business process cycles are shrinking all the time due to the advent of new technologies. Your customer may have to match a competitor's shorter business process cycle or face the prospect of going out of business in the longer run. Why not show them how you can proactively make these process improvements and help them compete better rather than showcase how much money they can save with cheaper labor?

Better Manage Margin Pressures

Escalating wages, especially for those with superior skills and experience, is a fact of life whether the service provider is in the United States, India or China. If you can demonstrably add value with your improved business process, or produce software of better quality, you gain an edge when it comes to demanding better prices from customers. This will alleviate some of the margin pressures that plague service providers.

Fending Off Competition from Other Countries

Many manufacturing activities have started migrating China to places like Vietnam simply because labor is less expensive. Cost savings are only as far away as the next country that is ramping up to provide those services. While it may be tempting to think that manufacturing is different from business process outsourcing or software development, it's only a matter of time before we view services work in the same way. "Moving up the value chain" may need to go beyond just being a slogan to some definable set of activities.

Cutting Edge Processes more Valuable than Mere Execution

Whether it's BPO or ITO, the improvement in these processes is a much more valuable deliverable than the mere execution of the business process or software development project in the current contract. Improvements in processes lead directly to larger benefits for the outsourcing seller, in the name of future business. This is the best way to increase credibility with a buyer and pave the way for larger projects in the future.

Don't Be Shortsighted

Looking at just cost savings in outsourcing is a shortsighted exercise that overlooks many of the other benefits, whether you're a buyer or seller of these services. Outsourcing causes enormous and painful change. Leveraging that opportunity to shoot for much more value than just cost savings is both practical and mutually beneficial. Realizing the various ways in which this can be accomplished can be highly empowering. The buyer of outsourcing services should also look upon this as an opportunity to improve and better compete in the marketplace. For the seller of such services, it can open many more doors, if only they do not get mired down in pushing cost savings alone.

Useful Links

Ajira
http://www.ajira.com

"Outsourcing Application Development and Maintenance" by the Aberdeen Group
http://www.sourcingmag.com/content/c070124a.asp

"Taking Offshoring beyond Labor Cost Savings" by Vikash Daga and Noshir F. Kaka and published by McKinsey Quarterly (registration required.)
http://www.mckinseyquarterly.com/article_page.aspx?ar=1784&L2=13&L3=13&srid=27&gp=0

About the Author:

Nari Kannan is CEO and co-founder of Ajira, a company that designs and develops service process management tools. Nari has 20 years of experience in information technology and started out as a senior software engineer at Digital Equipment Corp. He has since served variously as VP of Engineering or CTO of five Silicon Valley startup companies dealing with a variety of problems in IT consulting, automotive claims processing, human resources and logistics applications. He has written a number of articles in the area of Six Sigma, services and BPM. Contact Nari Kannan at nkannan (at) ajira.com or visit http://www.ajira.com.

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