Outsourcing: You need to understand what value means to you!

A couple of weeks ago, I was helping a client examine the efficacy of their sourcing initiative. The client had outsourced to an on-shore vendor who (apparently) was not seen as delivering value. My role was to examine the outsourced organisation and find the areas of conflict.

 

Outsourcing has been around for a while. In the post Y2K world, the business model caught the imagination of the businesses. What started off as a simple skill-augmentation based on cost arbitrage, soon developed into new forms – business process offshoring, Infrastructure outsourcing, total outsourcing and knowledge process outsourcing. The providers are continuously working on refining the business model, as customers’ appetite for sourcing grows.

 

Has outsourcing proven to be a reliable business model? Can businesses entrust all non-core activities to an outsourcing firm and confine their attention to their core-competencies? Can there be a virtual business with an extremely thin management layer, while all activities being supported by an outsourced model? We have to wait and watch.

 

While outsourcing has ingrained itself in the corporate strategy of the outsourcing companies, it still remains largely tactical. Very few organisations have approached outsourcing in a strategic manner. Having discussed the outsourcing initiatives with a number of organisations, I believe that despite all strategic intents, the outsourced operations are not perceived as an extension of the home office. There remains an intention to ‘squeeze the maximum’ out of the vendor from each new piece of work. And hence, a bumpy relationship with the vendor(s).

•  A leading life and pensions provider who had outsourced a substantial part of their IT to an outsourced vendor has recently hired a senior consultant to ‘fix’ the widening differences with their vendor. The relationship is less than 18 months old.
• The outsourcing partner of a leading mutual insurer has asked to raise the rates or agree to outsource more work. Duration of relationship – less than two years.
• A leading financial services firm has published a tender for seeking new vendor for their ITO initiative. Reason: The current vendor has not been able to understand their business priorities

There any many such cases of not-so-smooth relationship existing between the two parties in an outsourcing deal.

So what has gone wrong? Or what has changed? The current economic climate has uncovered many (potential) points of conflict which have been kept under wraps. The downturn has forced senior management to explore cost saving initiatives within the organisation. Maintaining a large IT organisation and outsourcing definitely came under the spotlight. In addition, outsourcing companies have been known to cut costs to win new clients. The initial losses are amortised over a longer term by mining the client deeply and spreading services in new areas. A recession put an end to any new initiative.

Cost arbitrage holds good for the first year. Or may be second. In the first year, the purchaser gets as much as 30% - 40% gains simply by moving jobs offshore (lift-and-shift!). It looks very attractive on the balance sheet. During the second year, some more processes and/or systems get added to the offshored operations, and the magic continues. However, from the third year, if no serious efforts have been taken to ‘fix’ the processes/systems and gain through productivity improvements, better programme management and better governance, the reality hits hard. After having spoken to a large number of users, it was apparent that little effort was paid to improving the quality, removing operational constraints and integrate the offshored operation to the home office.

Vendors, on the other hand, regularly undercut prices to win a large deal. Once they have gained entry to the offices of a new client, the onsite person is pressured into expanding to new business functions, new systems or new service lines. Often the sheer difference in CMM levels between the client and vendor is sufficient to show budgetary gains in any projects that are undertaken. Vendors are very well aware that client organisations do not have any metrics to benchmark the performance. They definitely don’t encourage building any benchmarks either. Once sufficient volume of business has been acquired, the key skills (highly paid) are often replaced by rookies to cut costs. Ask a vendor about their ‘rookie ratio’ and watch their reaction. This is probably one of the best kept secrets from the clients.

So what is the best way forward?

I was interested and intrigued to find how companies treat their captive organisations. They are very similar to outsourced organisations. However they are run on an entirely different lines. While the captives are very similar to an outsourced entity, the approach of the parent company is very different towards it. It is an integral part of the organisation. There is no ‘us versus them’ feeling existing within the organisation. Due care is taken to build the knowledge base and motivation of the employees. The captive organisation employees are regularly integrated with the home organisation to inculcate the feeling of ‘oneness’. There is no desire to ‘squeeze’; relative capabilities of different teams are assessed for an optimal performance. The performance of the home and captive teams are evaluated on a similar basis.

The difference is very much in terms of the perception of business value that a buyer seeks from their sourcing initiative. In the case of outsourced business while the intention is to ‘squeeze’; in case of captive operations, the intention is to generate a sustainable value over longer period of time.

For the buyers of outsourced services, there is a lot to learn from the management of captive operations. Outsourced vendors have a business to run. As in any competitive scenario, they would use all possible means – foul or fair – to win a new business. It is important to understand their margins, their business challenges and work with them to mutual benefits. There is an urgent need to integrate the outsourced organisation to your home organisation. The integration needs to happen at a cultural, emotional and skill levels to get the best out of the employees of your outsourced organisation.

In one of the accounts that I used to manage for my employer, I would encourage client managers to spend at least 2 weeks working in the outsourced office. On their return, the managers had a completely different perspective of the remote office than they had before. And, this was after 2 years of outsourced relationship. The returning managers had a better grasp of the capabilities, working style and ethos of the remote office. On their part, the employees at the remote office connected better with the managers who had spent some time with them.

Another company has mandated that all senior employees from the offshore are rotated to the home office to build a rapport within the team.

While at home, companies take a lot of efforts toward people development, it is interesting to note that they rely on their vendor organisation’s capabilities to do this in the remote office. Your vendor organisation’s core capability is definitely not your line of business. Any capability development that would happen through them would not be aligned to your lines of business.

John Knowles, Director IT Operations and Outsourcing at Allianz UK has setup a captive operation in India for his company.  Amidst a number of 'outsourced operations', Allianz's captive operation is an island.  It is not driven by motives of spreading across their client organisation like a rash.  Nor is there monetary incentive for employees to perform at super-human levels.  In our discussions John reflected on the challenges that he faced to maintain the employee morale.  Unlike a typical outsourcing provider, he was not operating in price-war scenario.  Nor was he interested in quick wins.  Sheer perseverence, and investment in people has helped him scale his organisation to be a shared service centre across the global business.

If outsourcing companies are seeking better value out of their initiatives, they need to explore the value that they seek out of it. I cannot it express it better than John Knowles, IT Director at Allianz, UK, who said, “You need to understand what value means to you”.

Thanks John for your insight and your wonderful comment. It aptly sums up the success of your organisation’s initiative in outsourcing!