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Outsourcing business processes hits much closer to home than simply outsourcing IT. Here's how some executives balance the risks and rewards.
Russ Banham, CFO.com | US
September 3, 2003
Blue Cross Blue Shield of Rhode Island wanted to leverage the cost efficiencies and performance enhancements of business processes outsourcing, but was concerned about the risks of transferring critical functions to a third party. "There are a lot of loose strings associated with an arrangement such as this, and we wanted to make sure everything was tied up nicely to assure success," explains George Calat, executive vice president and CFO of the Providence, Rhode Island, health insurer.
Calat was wise to take his time. In the rush to outsource, many companies fail to recognize the myriad risks posed by shifting critical business processes like HR, finance, accounting, and supply-chain systems to providers with little, if any, experience managing such processes. Some companies haven't even taken the pains to measure their in-house performance to ascertain if BPO will improve it. "Many companies fail to benchmark process performance," says Stan Lepeak, a vice president at Boston-based consulting firm Meta Group.
"They outsource finance and accounting because others are doing it," adds Lepeak, "and yet they lack comparative metrics like 'how many payables are processed per accounts payable clerk' or the 'spend per purchasing agent' to compare against industry and BPO benchmarks. If you don't have current process performance metrics, how do you know outsourcing will improve upon what you already do?"
There are other risks that can doom a well-intentioned BPO effort. So-called offshoring of customer and employee care functions — call centers are a cottage industry in India and China — invites political and public relations risks (see "Off Limits?" at the end of this article). Then there's the risk of selecting an inferior BPO provider, one failing to live up to the expectations of the partnership. Perhaps 2,000 companies claim to offer BPO services, says Julie Giera, a research fellow with Forrester Research, a Cambridge, Massachusetts-based technology research firm. Although methods exist for measuring and comparing the IT outsourcing providers, notes Giera, "there is scant data to compare and measure the capabilities of BPO providers."
Little wonder Calat was anxious. Blue Cross Blue Shield is Rhode Island's largest provider of health insurance, covering some 650,000 individuals, or 65 percent of the Ocean's State's population. The 10-year, $600 million BPO agreement it signed with outsourcing service provider Perot Health Systems calls for the "Blues" to outsource information technology, insurance claims, and cash disbursements to Perot, and to shift significant technology and intellectual capital — the 600 employees who performed these functions — to the provider. If the relationship turned sour in, say, year three, the Blues would be more than blue.
That's why the CFO turned to an intermediary, Houston-based outsourcing advisor EquaTerra, to craft the tightest possible deal. "EquaTerra made sure we outsourced the appropriate functions, reviewed project bids on an apple-to-apple basis and created a contract with clear service-level benchmarks," says Calat.
"For example," he adds, "if Perot fails to process a certain volume of claims within a specified time horizon, the contract holds them accountable." A governance team comprised of individuals form both companies meets regularly to review performance against the benchmarks.
BPO is big stuff, with nary a day passing without the announcement of another multiyear, billion-dollar deal. But just what is BPO? Simply put, it's the management of a related set of core business processes, as well as the underlying technology, by an organization other than your own. "Unlike traditional outsourcing of, say, the payroll administration function, BPO involves the outsourcing of payroll and other related HR functions like benefits administration and employee hiring and training, which string together to create a process — hence business process outsourcing," explains Lepeak. "The benefits of BPO are many, but then so are the risks."
Every BPO engagement begins with the premise that another company can perform a certain business process better than you can. Unfortunately, proving the premise is often left to the wind. "There's an age-old maxim: If you automate a mess, it's still a mess," says John McCarthy, group director of research at Forrester. "Same applies to BPO. I've seen all this external due diligence where every vendor known to man is analyzed in 100-page RFPs, and consultants are hired for tens of thousands of dollars, when all the company really needed to do was take a good look in the mirror. Yet so many fail to answer simple things like 'how do we do the process today, what's the level of our documentation, and how does this compare with other organizations.' Without doing this, how else can you prove you're getting a good deal or not — that you'll actually save money?"
Few companies measure the performance of internal business processes, maintains Lepeak. "What constitutes running a process well, and what constitutes running it better, are key criteria requiring evaluation before undertaking BPO," he adds. "If you can't understand process performance in-house, you can't understand it outsourced. You must measure your own performance first and then benchmark it to others to understand where that stands — good, better, or worse."
Indeed, some companies that have analyzed and measured their business process performance have determined that BPO would be inferior to current practice. "A prominent client in insurance came to us for advice about outsourcing their applications management, basically the management of their ERP system," says Michael Doane, a Meta Group vice president and service director. "They'd received half a dozen unsolicited offers from BPO providers promising tremendous cost savings. But as the offers piled up, they had trouble seeing the value proposition. They had measured the IT costs of managing the ERP system internally and couldn't find any savings from the providers. So they called us and asked if they were maybe missing something. In point of fact, they weren't."
Choose Your Partner
Other risks posed by BPO also should give pause, especially given the breadth of BPO compared with less complex IT outsourcing. Katrina Menzigian, director of BPO services research at Framingham, Massachusetts-based research firm IDC, puts it this way: "Companies need to realize that BPO is a long way away from IT outsourcing, which presented little change for the workforce at large. With IT outsourcing, the employees that experience change in the organization are those in IT, but with an HR outsourcing effort the employees that feel change are not just those in the HR department but everyone who interacts with the department."
"They now have to interact in a different way," adds Menzigian, "and their personal information will now be handled by someone outside the company. These people issues and change-management concerns increase the risk of failure if not properly addressed and managed."
Then there's the risk of picking an inferior partner, says Alison Youngman, chair of the outsourcing group at Stikeman Elliott LLP, a Toronto-based business law firm specializing in mergers and acquisitions. "Suddenly those people and assets are gone, your business processes have been taken over and reengineered, and now they're worse than ever. We've seen this happen time and again with joint ventures, where one partner doesn't live up to the other and the whole deal sinks in a sea of rancor."
Selecting a provider is a difficult task, stymied by the relative newness of BPO. "When it comes to something like IT outsourcing, there is at least the CMM (Carnegie Mellon Maturity) model that gives you a common way to compare the performance of different IT outsourcing service providers on an applications development level," says Lepeak. "There's nothing comparable with BPO providers by which to measure their capabilities. A lot of these firms frankly don't have a lot of experience, and what constitutes their performance of a business process" often can't be easily compared between one organization and another.
BPO providers must have both process knowledge and strategic industry knowledge, he contends. "IBM and Accenture, two BPO providers, have smart people who know vertical industries, but can they translate that knowledge into performing my business process on a daily basis?" says Lepeak. "Do they have enough business process knowledge and vertical industry knowledge to perform the process better than I can? The senior partner in the pharmaceutical practice at IBM can talk about the future of the pharma industry, but can he or she map out the best way at an operational level to perform clinical trials?"
Lisa Stone, vice president and research director at technology research firm Gartner, says a provider may have expertise in administering certain business functions from a transactional level — but perhaps not an array of functions all wrapped up in a BPO assignment. "When you're talking end-to-end HR outsourcing, you're literally depending on a third party to handle payroll, benefits, personnel administration, hiring and recruiting, and training and education," notes Stone. "The provider probably has different levels of maturity involved in that holistic offering, maybe expertise in just payroll or benefits. There's a tendency when thinking about these holistic offerings that they are market-tested solutions when, in fact, only pieces are market-tested."
Giera agrees, arguing that some companies that "have never serviced a business process before but have serviced a particular function like a call center are jumping into BPO as the next big thing," she says. "You've got offshore people in India who've been doing call centers for years now thinking they can do HR, procurement and shipping, and finance and accounting. You've got systems integrators like IBM, EDS, and Accenture, companies that traditionally were involved in IT outsourcing, now doing things like HR and finance and accounting, and basically learning as they go. And yet here they are handling key business functions that define the way a company does business. To me, lack of experience is the biggest risk of BPO."
Those 2,000 companies that claim to be BPO providers aren't all likely to remain in business, either. Ed Lawler, distinguished professor of the Marshall School of Business at USC in Los Angeles, says "bankruptcy" is a word rarely uttered regarding BPO providers, yet bankruptcy poses enormous risk. "If your outsourcing provider doesn't survive, how do you make a quick, agile transition to a replacement?" Lawler says. "What happens if your outsourcing provider abandons the market or sells this part of its business to another company? Separating when you're joined at the hip can be painful."
Giera concurs: "If a massive end-to-end HR outsourcing contract calls for you to send over a lot of your technology and 500 of your employees to the BPO provider, what happens to that technology and intellectual capital if you want to end the agreement? Can you at least lease it back?"
Negotiating changes in service during the BPO engagement is difficult, contends Stikeman. "If you go back to the provider and say I'd like to negotiate a change in the way service is provided, the provider is likely to respond that it will cost you more money since this was not priced out in the original agreement," she says. "Everything looks good on paper," she adds, but since BPO is all so new, "not everything can possibly be spelled out."
"The key question is whether or not you will have the flexibility to change a process down the road," says Lepeak. "What typically happens within an organization is one group will select the BPO provider, another will negotiate the BPO agreement, and a third will manage the relationship. All three areas must be intertwined, however. Otherwise you run the risk of a partnership that fails to meet expectations."
Out of House, but Not Out of Mind
BPO risks can be managed to create benefits for both the client and the provider. The first part of managing the relationship is contractual — the establishment of service level agreements (SLAs) that stipulate what the provider promises to do and measures progress toward this objective on a regular basis. "If you're going to have an accountable vendor, you need to hold them accountable," says CFO Calat. "We've got a detailed set of SLAs that our governance committee reviews monthly. If they are below contractual agreements, there are penalties."
But contracts don't guarantee a successful relationship. "It sounds corny and trite, but the key to a BPO endeavor really is partnership," says Sekhar Ramaswamy, vice president of HR at Prudential Financial. When Prudential engaged BPO provider Exult in January 2002 to service multiple HR functions on a consolidated, integrated outsourced basis through 2012, the Newark, New Jersey-based insurer spent considerable time and effort beforehand ensuring the best possible partnership.
"For us to win doesn't mean Exult has to lose," explains Ramaswamy. "Ten years is a long time to engage a BPO provider. We do joint planning on business goals, many of which are joint goals. We have a joint roadmap for success." Managing the partnership is a steering committee that includes representatives from both companies. "The committee's job is to review a weekly project-status scorecard that reviews performance against project milestones," says Ramaswamy. "Everything is measured and tracked."
Indalex, a Chicago-based provider of aluminum extrusions, bases the success of its procurement process outsourcing to ICG Commerce on "routine, friendly meetings between us and them," says Mike Alger, executive vice president of the $750 million company. "We've got SLAs that require certain responsiveness from ICG and penalties if they fail, but what makes this work is that we are partners in the truest sense. They're the part of our team doing procurement, and we hold them accountable in the same way we would our own people."
Relationship management also is the cornerstone of a BPO engagement for CIBC, a Toronto-based financial institution with 1,200 branches and 8 million customers that outsources end-to-end HR to Plano, Texas-based EDS. "We've created a governance model that requires structured meetings, so there are regular opportunities for folks to meet and work on issues, even if there aren't any," says Hugh MacDonald, vice president of strategic alliance management in CIBC's HR division.
Without these meetings, says MacDonald, "it would be like a guerilla leader and a NATO platoon commander meeting out of the blue at the Khyber Pass to negotiate. That's no way to run a partnership."
Russ Banham is a contributing editor for CFO.com.
BPO presents risks beyond the transactional. Indeed, companies that have shifted key business processes to service providers in India and China have endured negative public relations. Not that this is slowing the trend toward "offshoring" — Forrester Research predicts that American employers will move about 3.3 million white-collar service jobs and $136 billion in wages overseas in the next 15 years, up from $4 billion in 2000.
"Companies should be nervous about taking a key business process and moving it to a country 10 times zones away, particularly when the country is politically unstable and where the protection of intellectual capital is not their strongpoint," says Forrester's Giera. "Offshore may be OK for a call center, but it's not the place yet for BPO. And is offshoring really worth the bad public relations?"
The risk of a foreign government mandating anti-American business sanctions also looms large. "India is extremely bureaucratic," says John Minor, head of political risk at Chicago-based insurance broker Aon Trade Credit. "In Maharashtra, where a new Enron power project was in the works, a new provincial government campaigned on the slogan 'Throw Enron in the sea.' And when they were elected, they fulfilled their promise, canceling a multibillion-dollar project that involved not only Enron, but also General Electric and Bechtel. It doesn't take much of a spark these days to ignite anti-American or xenophobic attitudes overseas."
Political risks associated with offshoring business processes can be managed through the purchase of specialized insurance, or through arrangements with providers that offer service in more than just one country. Kanbay International, a BPO provider focused on the financial services industry, offers clients the opportunity to outsource processes to multiple locations, including India, Canada and the United States. "Our model is not to walk into a client's office and say, 'Take this offshore'," says Kanbay president Shiraz Patel. "We offer a diversity of delivery locations. We don't force jobs to any locale."
As for the insurance, Aon recently introduced a policy for its clients that reimburses them for the cost of relocating an offshore BPO arrangement "back home or to another country," says Minor. Lloyd's of London is the underwriter of the policy, which costs roughly 1 percent of the coverage limits provided. —R.B.