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WeIcome to the
second edition of Optimized Outsourcing - Our newsletter is
designed to show concrete examples of how companies are using
outsourcing to drive profitability and increase shareholder
value. This edition provides a road map to use in choosing
processes for outsourcing - it is designed as a framework for
management decision-making.
The 1995 study published in
the Chaos Report by the Standish Group was an eye opener for
the industry. It reported that in 1994 alone, only 16% of
application development projects met the criteria for success
- completed on time, on budget, and with all
features/functions originally specified. Outsourcing was given
an opportunity to prove itself as a result of those dismal
success ratios.
Since then
there has been some improvement and in 2000, 28% of projects
were in the successful column. Although it is encouraging to
see this increase, it is nowhere in comparison to success
rates enjoyed by other industries. According to this report,
the top three reasons for the success of a project are -
Executive Support, User involvement and Experienced Project
Management.
However, the new dimension that has since
then erupted is "outsourcing!". It goes without saying that if
one were to survey the success rate of the projects today it
would be even higher. It is attributed to the continued rise
of outsourcing in different industries.
Frederick P.
Brooks in his famous article "No Silver Bullet" has rightly
pointed at the important fact that "The hard part of building
software [is] the specification, design and testing of this
conceptual construct, not the labor of representing it and
testing the fidelity of the
representation."
ebusinessware acknowledges the above
issues and has built the UniRAD Offshore Outsourcing Framework
to address them. UniRAD ensures repeatable success in the
delivery of offshore-outsourced projects. It is a
comprehensive framework based on our industry experience and
best practices. It applies to the end-to-end process from the
time of making the outsourcing decision through the entire
lifecycle.
In this and subsequent issues of the
newsletter we describe certain aspects of the UniRAD strategic
framework that can be used to analyze the outsourcing
opportunities within a firm, and a comprehensive set of
principles to follow in executing the outsourcing strategy. In
addition, we also discuss some of the common misconceptions
about the outsourcing process and suggest some ways to
overcome external barriers posed.
Despite all the
academic reasons to justify outsourcing, there is one
fundamental reason to do so. This is what we at ebusinessware
refer to as the 'law of globalization', which posits that each
unit of work should be allocated to the optimal provider of
processing. With the advent of technology, the world is truly
becoming a smaller marketplace. Strong interdependence between
companies is inevitable as we are racing towards a global
economy.
Consequently certain functions within
companies can be executed in a more efficient and cost
effective manner via outsourcing. Thus companies end up doing
what they know best and use the other's core competent
services to complement their inefficiencies. This practice
optimizes the use of resources and is the most efficient way
to work.
The results of an inefficient and under
informed approach can be disastrous. At ebusinessware, we
believe that a value is derived from adopting a formal
decision-making framework that ensures a coordinated approach
to outsourcing. If managed properly, companies can expect
increased profitability, competitiveness and flexibility from
an outsourcing strategy. That is the spirit of UniRAD.
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Edward Hoofnagle
Co-Founder,
Chief
Executive Officer
212.232.0285 |
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Rajesh Abhyankar
Partner,
Editor-in-Chief
732.673.6195 |
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Sanjeev Midha
Co-Founder,
President
732.221.8399
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| Despite all the
academic reasons to justify outsourcing, there is really one
fundamental reason - the 'law of globalization'. From Adam
Smith to Michael Porter, we have seen the maxim that each unit
of work should be allocated to the optimal provider of
processing. With advances in technology and
telecommunications, the world has become smaller and
additional processing providers can be identified, but the
economics still apply. In short, when non-strategic corporate
functions can be executed in a more efficient manner via
outsourcing, they should be outsourced. This newsletter
provides a framework to help identify those processes that are
good candidates for outsourcing. In the following sections,
the reader will be presented with qualitative and quantitative
tools that can be used to analyze the outsourcing
opportunities within a firm. In addition, we will discuss some
of the common misconceptions about outsourcing and suggest
ways to overcome the barriers to
change. | |
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| Some
readers may be wondering, "If the law of
globalization is so compelling, then why doesn't
everyone outsource?" Just as in physics we see
that efficient motion is reduced by friction, we
see that in business individuals and teams reject
change. Resistance to change is the largest
inhibiting factor to outsourcing, but the main
premise of globalization does not change. As we
will describe below, short-term barriers result in
inefficiencies and opportunities. Inefficiencies
will arise in companies that fail to execute or
poorly execute the outsourcing strategy, while
opportunities will accrue to those companies that
manage the obstacles to gain excess returns and
increased
competitiveness. | |
| The law of
globalization cannot be avoided - those that fight the
tide will only be eroded over
time. |
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| Inhibitors
are common excuses that companies use to avoid
outsourcing. In general, these objections are masking
internal weaknesses that need to be addressed by a
dynamic leader or change agent. With adequate buy-in,
inhibitors can be overcome: |
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- Language and Culture: Some enterprises may
find that an external provider of services cannot be
used because their company has an inability or
unwillingness to effectively communicate their
internal processes to outside partners. The excuses
that arise usually include statements that there is
too much judgment involved or there are communication
difficulties, when in reality there is inadequate
process documentation.
- Fear: Some people are scared to consider
outsourcing because they fear that it will mean the
end of their jobs. Rather than seeking the most
efficient provider of services, teams acting on fear
will use emotional excuses or will attempt to
stonewall the investigation process. Cynicism and
objections will be raised by project stakeholders and
standard change management techniques must be applied
including dedication from the top, open communication
and incentives for success.
- Legal and Political: In certain cases, a
company may be unable or unwilling to create the legal
structures that are needed to do business in places
that have imposed tax or regulatory hurdles to stem
the flow of processes out of their jurisdiction. Care
must be taken to investigate each "legal" objection to
ensure that alternatives are systematically identified
and assessed.
- Technology and Process: Once a company
decides to outsource, there are technology and process
changes required to ensure that the enterprise is
"tooled" to benefit. While the Return on Investment
will clearly support the decision to move towards a
partner-friendly architecture, some companies place
artificial constraints on the required investments to
inhibit the outsourcing process.
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| Following are some common myths that
surround the outsourcing
decision. | |
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- Outsourcing cannot fix processes: There is
a current mantra among inefficient producers that
processes should be fixed first, and then outsourced.
The logic is that one should ensure that the
inefficiencies are not exported. While this idea may
seem initially convincing, one must realize that the
sources of current inefficiencies are probably not the
best resources to use in moving to a higher level of
discipline. We believe that re-engineering should be
the first part of an outsourcing engagement and that
process realignment should be jointly addressed by the
insiders and outsourcing providers.
- Outsourcing adds operational risk: We have
seen a paradox in the outsourcing industry - people
tolerate operational risk when it is internal (within
their organization), but when the same risk is
transferred to the outsourcer, it becomes a "big
deal". Outsourcing does not, in itself, create risk.
Rather, it is often in the process of designing
outsourcing models that teams realize the current
state of operational risk. Care must be taken to
identify the level of risk pre- and post-outsourcing
and risk mitigation strategies must be in place where
the levels of risk are not acceptable.
- We will loose our competitive advantage:
The globalization of markets has been accompanied by
the globalization of legal protections for
intellectual property. Contracts can be structured
with performance and penalty clauses. In addition,
companies must ensure that knowledge management tools
are used to capture and retain intellectual property
inherent in outsourced processes. Ebusinessware has a
suite of knowledge management tools that can be used
to catalogue and manage processes to ensure that the
intellectual property remains "at home".
- Some
things are too complicated to outsource: This is
corporate mysticism at its best. Nothing is too
complicated - if it can be documented, it can be
delegated.
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| Our
goal is to establish a risk-adjusted framework for
making outsourcing decisions. While not
necessarily comprehensive, this framework provides
a base that can be refined as needed. There are
two aspects to the decision framework -
qualitative and
quantitative. | |
Qualitative
Decision-Factors
The
qualitative aspect of the decision-making process
entails defining the potential processes that are not
"core competencies" and thus good outsourcing
candidates. The goal of the qualitative process is to
drill down to the lowest level of process detail so that
the pool of potential processes can be created. For
example, think of an insurance company looking at
outsourcing claims processing operations. One approach
is to identify the entire function as a commodity and
seek to outsource the entire operation. Alternatively,
claims processing may provide an important touch point
for relationship management so only certain components
are considered for outsourcing, for example claim
registration, data maintenance, or claims adjudication.
Our recommendation is to proceed to a detailed level of
process analysis as part of the decision making process.
Wherever possible, try to drill down to two or three
levels of detail for each high level process, taking
care to identify whether or not each sub-process is a
core competence to your firm.
Once the functions
or processes of a business area are identified, one
should use a 'balanced scorecard' to determine whether
it would make sense to outsource or not. True cost
savings are not always monetary; for example, if
outsourcing results in improved efficiency of resources,
better morale, and higher customer satisfaction, then
'savings' cannot be precisely computed. As such, we
encourage the use of the balanced scorecard to
complement the quantitative measures presented in the
next section. Following is an example of balanced
scorecard.
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Processes that are Prime
Candidates for Outsourcing
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| Maybe |
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Probably |
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Definitely | |
If your answer to any
one question falls within this 
shaded area, it should most likely be
outsourced | |
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| | Quantitative
Decision-making
The
quantitative framework relies on ratios and percentages
to identify potential outsourcing candidates. Shown
below, there are three aspects to the quantitative
decision framework.
- Sort by the percentage of total cost: While
deciding what activities or processes to outsource,
look for the "low-hanging fruit". One should consider
the percentage of total cost that each process
represents as a measure of the biggest impact to the
bottom line. The rationale is that if a significant
amount of money were spent on a process that is not a
core competency, it might make sense for a company to
outsource it. Put another way, this metric helps to
ensure that the outsourcing teams don't waste time
outsourcing insignificant processes.
- Identify
fixed costs that can be converted to variable
costs: Outsourcing is a time-tested way to
convert fixed costs to variable costs. As a business
manager, this can be a great way to meet tight
baseline budgets without sacrificing quality in the
event that business levels rise in the future. If
candidates from the percentage of total cost screen
(above) are also predominately fixed, and if they can
be converted to variable costs via outsourcing, then
it is likely that such processes are ideal candidates
for outsourcing.
- Compare to an ROI hurdle: Once the
potential candidates from the above two screens have
been identified, they should be passed through a ROI
hurdle to ensure that the effort meets a minimum
threshold. In our experience, those efforts that have
an ROI which are positive and exceed 15% are good
candidates for outsourcing. The risk-adjusted ROI
calculation is as follows:
Note that
the Risk Premium is a factor that is added to take
into account the relative risk of each outsourcing
project. Usually this amount is estimated based on the
operational risk capital employed by each underlying
process. In the event that a formal operational risk
calculation is not performed, an alternative is to
apply a judgmental process - assigning standard
charges for high and low risk processes and
classifying each process as either "high" or "low"
risk.
An alternate metric that can be derived
from the ROI calculation is years to payback. In other
words,
As a rule of thumb, if the outsourcing
engagement pays for itself within 3 years, it is a
good candidate for outsourcing.
If you are interested in receiving free
analysis of how outsourcing can be used to improve
your business profile, please contact Rakesh Singal,
Sales Manager at 212.232.0285; or mail
to mailto:%20rakesh.singal@ebusinessware.com
Copyright
2002-2003 ebusinessware, Inc. | | |
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