Outsourcing: A Risk Too Far?
1 September 2005 Andrew Kakabadse
The jaw-dropping financial rewards of offshore outsourcing can be hard to resist. However, as Steve Coomber discovers, a number of pitfalls await the unwary.
In June 2005, the theft of personal details from several call centres in India made headline news in the UK. An IT employee in India's mushrooming IT and business process outsourcing (BPO) services industry offered to sell the banking and credit card details of some 1,000 UK nationals to a UK national newspaper.
This was hot on the heels of former employees of another call centre operation in Pune, India being accused of stealing over $300,000 from customers of Citigroup bank. These may be relatively isolated incidents. However, they highlight the fact that, despite the potential benefits, offshoring is far from risk-free.
THE CASE FOR OFFSHORING
Today, outsourcing covers almost every aspect of corporate life. As competitive pressures force firms to increase performance while reducing costs, so companies look to outsource aspects of their business. HR, PR and marketing, customer relations and call centre operations are all now routinely outsourced – much of it offshore.
The cost reductions available in some offshore destinations can be staggering. When online travel company ebookers established a back office facility in India it saved an estimated $2.5m in as little as three months during 2003.
"There are two contrasting views of the outsourcing market," says Andrew Kakabadse, professor of international management development at Cranfield University School of Management and author of Smart Sourcing: International Best Practice. "One emphasises the core competencies perspective, and the other adopting a cost discipline view. But both views agree that to be competitive companies need to outsource."
Outsourcing is fast becoming obligatory. And it is not just about low costs. "Apart from cost reduction, companies are increasingly using outsourcing as a tool to drive strategic value, to transform their businesses in ways that allow them to become more flexible and adaptive, while focusing on their core strengths," says Mary-Sue Rogers, global HR consulting leader for IBM Business Consulting Services.
Potential benefits, such as faster and higher-quality service, improved efficiency, access to new skills and technology, lower long-term capital investments and lower costs, are considerable.
The rapid growth in outsourcing is not confined to IT. BPO, where processes such as facility operations, engineering, legal services and even customer care are outsourced, is the fastest growing segment of the outsourcing industry.
The BPO market is growing rapidly. In 2003 research firms were predicting a global BPO market of $585bn in 2005 and $827bn in 2008. More recently, consultants Technology Partners International reported that BPO accounted for almost 30% of outsourcing contracts worth $1bn or more. The value of these large BPO deals was some $9.8bn, up from $2bn in 2003.
One of the biggest beneficiaries of offshoring to date is India. High education standards, a large English-speaking population, and low wage rates make India an ideal offshore destination. Corporations such as Citigroup, American Express, and Amazon have outsourced business processes to locations such as Delhi, Mumbai, Hyderabad and Bangalore.
Research firm Gartner estimates that India's share of the third-party offshore BPO market in 2003 was about $2.8bn, 80% of the total market. That figure is expected to rise to $27bn by 2007.
The National Association of Software and Services Companies (NASSCOM), India's main association of IT companies, puts the figures for growth of the Indian ITES-BPO industry at 46% and export revenues at $3.6bn in 2003–4, up from $2.5bn in 2002–3. In 2004–5 revenues were up 40% at $5.1bn. Breaking down the BPO revenues, some 70% come from call centre activities, another 20% from low-value volume data work.
A RISKY BUSINESS
Besides the significant benefits on offer, however, the recent data security scares highlight the fact that outsourcing has its share of commercial risks. And, security is far from the only issue that companies looking to offshore should be concerned about. "Fundamentally, the risks involved with offshoring are the same as if you are outsourcing, but at a distance," says Kakabadse. "So unless you have excellent partnering skills, you are at risk. Unless you have a very clear contract and a clear idea of what the value of that contract is, you are at risk. Unless you have local representation and you have made that local representation almost part of your company's structure, you are at risk."
To reap the full benefits of outsourcing, it is necessary to have a good understanding of the outsourcing process and the key success factors. Evaluating what is core to the business and what is not, defining and identifying business processes suitable for outsourcing, choosing a partner, drafting appropriate service level agreements, managing expectations are all critical to the success of an outsourcing arrangement.
Other risks include issues relating to control. Reacting to distant events may take longer; it may be harder to maintain quality standards. Kakabadse believes that it is often less an issue of control and more an issue of prime purpose when it comes to outsourcing problems.
"The biggest key to a successful offshoring contract lies with the company that wants to do the offshoring," says Kakabadse. "'Before it does anything it must ask: What is core and what is critical to this business?"
As Kakabadse explains, something that is core to a business may no longer be critical. The problem is that an activity may still be perceived as critical, because it is core. Also, people in different roles have a different perspective on the matter. The director of marketing, for example, will see things differently from the director of production. Obtaining clarity about what is core and critical to a business turns out to be one of the biggest challenges for companies considering offshoring.
This was certainly the case with many of the companies that Kakabadse studied. He found that the debate about what outsourcing could do for the company did not take place at a sufficiently high level, even though the impact of the outsourcing arrangements was felt throughout the company. So, for example, general managers might enter into sourcing relationships and sign sourcing contracts without thinking through the effects on the rest of the organisation.
"Out of 750 or so companies surveyed, over half didn't get as far as a debate at top team or board level about sourcing practice, let alone get near to any distinct outsourcing contract," says Kakabadse. "So the debate over what was core and critical never took place."
Instead, Kakabadse discovered that most sourcing contracts were undertaken by general managers who are not at the appropriate strategic level. While they were often aware of the strategic issues, they were not held directly responsible for making things happen.
It is clear, then, that offshoring transactions are complex commercial arrangements. They are not to be entered into lightly. Companies must not underestimate the potential risks, and they need to treat outsourcing as carefully as they might treat a merger or acquisition. Offshoring destinations will do their best to build in safeguards against data theft and similar problems. However, such risks will always exist.
In the longer term, as technology continues to progress, automation may mean that companies begin to repatriate activities once outsourced. For the moment, however, companies must continue to shoulder the risks involved, as the rush to offshore shows little sign of abating.