Looking Beyond Cost Savings in Outsourcing

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By Nari Kannan

A July 2006 Aberdeen Group study 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 Summer 2006 McKinsey study recounts how a large airline could go beyond leveraging just cost savings in offshoring back office functions. The airline had options including 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 re-engineering, IT automation and consolidation of IT platforms. The savings from lowered labor costs for back office functions could be applied to work it could not do before because of costs, priorities and lack of sufficient human resources.

Many companies will share 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 back burner. Outsourcing maintenance of existing applications frees up IT and other resources to reducing that multi-year backlog of new applications that could not be touched 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 since both it and the company it is working with need it for legal purposes. While a company is going through the trouble of outsourcing, why execute the business process the same way? Why not improve upon it at the same time? The same logic applies to software development outsourcing. Why not address past project managing problems with these software development efforts? Why not come up with a new project management approach or 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 are usually low on the priority list when work is done in-house. However, the minute a business outsources software development or business processes, it may need to think of governance issues. The contracts probably have service levels specified; unless a business has 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 can often lead to getting fresh perspectives on technology and approaches. A business 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, a company may get to leverage it for implementing or improving its 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 life cycle being used? 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 more valuable to customers than cost savings. Business process cycles are shrinking all the time due to the advent of new technologies. A company's 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 be a company that can pro-actively 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 a business can demonstrably add value with an improved business process, or produce software of better quality, it gains 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 from China 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 is 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 is business process or IT outsourcing, the improvement in these processes is a 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.

Summary

Looking at just cost savings in outsourcing is a shortsighted exercise that overlooks many of the other benefits, whether a business is a buyer or seller of these services. Outsourcing causes enormous and painful change. Leveraging that opportunity to shoot for more value than 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.

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