Offshoring Spreads Its Wings

From East Asia to Eastern Europe, offshore outsourcing is taking off.
Kate O'SullivanMarch 1, 2008

During the last U.S. Presidential campaign, offshoring was a particularly touchy subject. Candidates denounced “Benedict Arnold CEOs” for sending U.S. jobs offshore, while CNN anchor Lou Dobbs kept a disapproving tally of companies with offshore operations. This time around, even with the economy looming once again as a major issue, offshoring has generated little heat in the race for the Presidency.

That’s largely because offshoring has become a fact of life for Corporate America. According to a new CFO survey, 36 percent of financial executives say their companies use offshore outsourcing. That’s twice as many as in 2004. Among companies with annual revenues of more than $1 billion, the number of offshorers rises to 49 percent. Meanwhile, research firm Gartner estimated the size of the market for offshore IT and business process outsourcing at nearly $35 billion in 2006, and forecasts a market of $70 billion to $100 billion by 2011.

Companies and offshore service providers alike have expanded their views on which functions can be offshored, with everything from traditional call-center work to legal research on the table. They have also learned how to better manage the outsourcing process. At the same time, finance chiefs have gained a healthier respect for the hazards involved in sending work overseas (see “Staying Put” at the end of this article).

4 Powerful Communication Strategies for Your Next Board Meeting

4 Powerful Communication Strategies for Your Next Board Meeting

This whitepaper outlines four powerful strategies to amplify board meeting conversations during a time of economic volatility. 

Far less fearful of a public backlash than before, companies today have a world of options when it comes to offshoring arrangements. “It’s become a global bazaar,” says Raffy Ohannesian of DLC, a finance and accounting-services firm. “Whatever you need, you will be able to find it at a lower cost, with a minimal or acceptable level of quality degradation, or sometimes even improvement. It’s just a more mature market.”

Offshoring, in short, has grown up.

Learning from Experience

This new maturity is reflected in the way executives now think about offshoring. “There is significantly more awareness,” says Vivek Sharma, a director at THL Partners, a Boston-based private-equity firm. Sharma works with portfolio companies to help them choose and deal with offshore partners. “People no longer ask basic questions like, ‘How can someone do this sitting in China?’ They ask, ‘How should I make this work?’”

Companies now regularly consider offshoring a strategic option, says Rohit Kapoor, president and chief operating officer at ExlService Holdings Inc., a New York–based business process outsourcing company with operations in India and the Philippines. “More and more companies are sitting down and planning on offshoring as part of their annual budgeting process, as opposed to just doing it on an ad hoc basis,” he says. For many companies, the question is not whether to offshore but which functions to outsource, and when.

Finance executives are also thinking about considerations besides cost savings as they weigh the offshoring decision. Dallas-based Kimberly-Clark, for example, moved many of its back-office activities first into a captive shared-services center and then to a third-party offshore provider as part of a companywide strategic shift. “We’re taking advantage of labor arbitrage, but it’s equally about building an environment that gives us more flexibility and new capabilities from third parties,” says Simon Newton, the company’s vice president of North Atlantic finance and shared services.

Lisa Donahue, now interim CFO at San Jose, California-based Calpine Corp., an electric power company, formerly worked at an auto-parts manufacturer that decided to set up a call center outside of Paris — a city not known for its low costs. “Although intuitively we might have gone to Eastern Europe for cheaper labor, we needed stronger language skills because we wanted to provide a certain level of service to both internal and external customers,” she says. The company found those skills near the Belgian border. “Cost savings isn’t always the best driver,” says Donahue, who also co-heads Alix-Partners’s turnaround and restructuring practice.

Broader Horizons

U.S. executives have also learned a lot about which functions travel best. Information technology continues to lead the pack, with 57 percent of respondents to CFO’s survey saying they outsource IT functions offshore. Finance and manufacturing tied for second place, with 31 percent offshoring those functions. Within finance departments, routine tasks like accounts payable, accounts receivable, and payroll processing are all popular candidates for offshoring (see “Workforce Migration” at the end of this article).

As executives have become more comfortable with their offshore partners, they have begun to experiment with offshoring a wider range of functions. “We are seeing companies outsourcing complete end-to-end processes rather than transactions,” says Exl’s Kapoor. In one example, a client in the utilities industry now uses Exl to handle customer dealings ranging from registering new customers to billing and collections, instead of offshoring only the billing part of the process.

“Four or five years ago, companies were offshoring IT applications maintenance, call centers, and the more routine aspects of finance, human resources, and back-office operations,” says Vinay Couto, who leads the outsourcing practice at McLean, Virginia-based consultancy Booz Allen. “Now they are offshoring much more significant things.” In health care, for example, the entire claims-management process is frequently offshored. Legal research, insurance-claims processing, and routine medical tasks (such as the reading of test results) are all activities that companies have handed over to offshore outsourcing providers.

Demanding Quality

As executives have gained a better understanding of which functions work well offshore, they have also learned that they can’t simply sign a contract with an offshore provider and assume their work is done. Companies have significantly expanded and improved their governance of offshore projects. “Executives are far more sophisticated in setting goals and objectives in their service agreements,” says Deborah Kops, chief marketing officer at WNS Global Services, an offshore service provider based in Mumbai.

Instead of signing fixed, 10-year service contracts, they are creating more-flexible arrangements and measuring the qualitative aspects of performance as well as cost. “Contracts used to be set up around productivity and efficiency metrics, like the number of calls handled in a certain time frame,” says Kapoor. “Now, companies are establishing metrics for things like customer satisfaction.”

Some organizations are designating internal teams to manage the offshored function or provider relationship. Couto of Booz Allen says he advises clients to plan on reinvesting 3 to 5 percent of the value of a deal in managing the vendor.

Tom Byrne, CFO at Novi, Michigan-based BrassCraft Manufacturing, a maker of plumbing supplies with $350 million in revenue last year, says the key to a successful offshoring arrangement lies almost entirely in the communication process. He cites the example of a sink part — a drain basket — that began generating complaints from customers who were cutting their fingers on it. BrassCraft had failed to specify that the Chinese manufacturer should round the edge, so the rim was left “razor-sharp,” says Byrne.

Now, says Byrne, “we reconfirm many times what we have communicated. Many people working with offshore partners assume that they can’t hear us or understand us, but the truth is, very often we’re not telling them.”

Passage Beyond India

Vendors, too, have learned a lot in the last few years. The large Indian outsourcing providers, such as Tata Consulting Group, Wipro Technologies, and Infosys, are expanding their service offerings and improving their grasp of U.S. business practices. Sharma of THL Partners says he is working with a portfolio company that is seriously considering a bid on an enterprise software project from an Indian company alongside bids from global accounting firms.

As offshoring has matured, India’s success in developing the industry has both created challenges for Indian firms and drawn competition from many other regions hoping to cash in on the trend. Faced with high turnover, the depreciation of the dollar, and double-digit annual wage increases, Indian providers themselves are looking to open shops in lower-cost locations. Wipro has a joint venture in Saudi Arabia and has announced plans for a center in Egypt. Tata is planning a location in Morocco to serve French speakers. Vendors are also moving to lower-cost locations within India, expanding from their bases in cities like Bangalore into cities with less labor turnover and lower wage rates.

U.S. companies are also looking further afield. Nearly a quarter of the respondents to CFO’s survey have relocated their offshore operations — to achieve greater cost savings, diversify their operations to reduce risk, or tap into a more diverse labor pool. Eastern Europe has emerged as a destination of choice, particularly for European companies in need of extensive language skills. The Philippines, and to a lesser extent Malaysia, Thailand, Indonesia, and Vietnam, are providing other options in Asia, while some experts point to Latin America, Africa, and the Middle East as emerging locations in various stages of readiness.

Still, with its educated, English-speaking, business-savvy workforce and business-friendly government, India maintains its reputation for providing the highest-quality offshore service available. “Clients complain that they don’t want to go to India, because of the wage inflation; then we take them to other places and they get a little spooked,” says Couto. “The cost escalations in India have been matched by an improvement in the quality of the labor supply.” Some companies are coping with this by sending noncore functions that don’t require English-language sensitivity to lower-cost areas.

Taking the trend to its logical extreme, some Indian companies are even beginning to outsource work to the United States. They are establishing offices and large campuses in an effort to get closer to clients and compete with U.S. rivals. Tata Group, for example, has a call center in Ohio, and Wipro is opening an office in Atlanta. In theory, a U.S. company could offshore its call center to an Indian vendor and end up having its calls handled somewhere in the Midwest, or even down the street.

Says WNS Global’s Kops: “It could be that Reno, Nevada, is the next offshoring hot spot.”

Kate O’Sullivan is a senior writer at CFO.

Staying Put

Despite all that companies on both sides of the Atlantic have learned in the last few years, many CFOs remain cautious about offshoring. More than half of the finance executives responding to CFO’s survey say they have no plans to outsource offshore.

Moreover, 13 percent of those who have done so have failed to achieve any savings. Concerns about quality, intellectual property, and internal controls continue to nag finance executives. Stories of abandoned projects abound; in the past year, a third of companies surveyed by Diamond Management & Technology Consultants canceled an offshore business-process outsourcing deal.

At Agfa, a Belgian-based imaging technology company, executives evaluated offshoring as far back as three or four years ago, but they have been far more focused on operational performance improvements. Tim Coakley, CFO of Agfa’s North American health-care business, says he doesn’t plan to offshore work anytime soon, even though a benchmarking study showed the unit’s finance costs were higher than they should be.

“We wanted to make sure our internal shop was in good order before we considered an offshore provider,” explains Coakley. “We felt that if we gave them less than perfect processes, we would be trading one headache for another.” If anything, he adds, offshoring has moved further down Agfa’s priority list as the company continues to adjust to a major global reorganization.

Another common reservation concerns the ability of offshore vendors to perform higher-level tasks and provide insight into individual industries. “There isn’t really one company that has specific capabilities that would suit our needs,” says Simon Newton, vice president of North Atlantic finance and shared services at Kimberly-Clark. For offshore providers to continue to grow, he says, “they have to start understanding our industry and providing innovative solutions.”

Given the steadily increasing sophistication of offshore outsourcers, that may be just a matter of time. — K.O’S.

CFOs' offshoring practices