BFM2013_2_00_Introduction – Strategic outsourcing

This issue was focused on methods and solutions to manage outsourcing choices, while retaining the capability to keep the evolution of business processes on track.

Outsourcing and BPO (Business Process Outsourcing) are often considered mere economic or technical choices.

Instead, a wrong outsourcing decision could negatively affect your organization’s ability not only to carry out business-as-usual activities, but also to evolve.

As discussed in the previous issue , if you don’t know what is really “core knowledge” of your business, and the associated formal and informal organization, outsourcing could not be the best choice, unless it is a mere output-oriented activity.

BFM2013_2_01_Outsourcing as a magic wand

Since the late 1980s, a constant drive to downsize, rightsize, slice-and-dice businesses pushed many companies toward considering “externalisation of non-core activities” as a routine affair.

Outsourcing became a magic wand to convert fixed costs into variable ones, while improving the level of services received vs. what was previously delivered by internal resources.

But outsourcing is a business process to achieve change, and like any other process it requires a clear definition and understanding of your current position before you can introduce any change.

While introducing change inside your own company without sufficient knowledge could be “fixed” later on, outsourcing is usually supported by water-tight legal writs (this usually wasn’t the case with early 1990s contracts).

The previous issue described how every company works on its own eCI (embedded Corporate Identity), i.e. what is the accepted behaviour within a company, as expressed by processes, organisation, etc.

As the Cheshire Cat in “Alice in Wonderland” said: you need to know where you are heading to before you can decide which way is the right one to go.

Once you know where you are, you can define the destination, and start thinking about the “how”.

Outsourcing is more than just a solution to the “how”, and unless you are able to identify and communicate effectively the current status of what you outsource, all that you obtain is just a long-term restructuring of costs.

Some companies simply outsource out of despair, seeing outsourcing as an easy way out of a history of mismanagement and spiralling costs, while others simply are unable to find the human resources they need on the market.

As it will be discussed later, defining the priorities is obviously a bonus when short-listing outsourcing suppliers- and building the right list of priorities requires a clear understanding on the purpose of the outsourcing: what are the issues that should be solved by outsourcing?

Actually, the way most outsourcing contracts are built, if you do not document correctly the current status, you can expect a short-term decrease in costs, to be more than compensated by unexpected costs whenever you and your supplier find some “extras”.

“Strategic Outsourcing” requires a contract built to ensure the economic viability of the outsourcing activities, as explained in the next section.

BFM2013_2_02_What is outsourcing

Over the years, as the “outsourcing” concept (including the use of software solutions covering different vertical processes, e.g. ERP or CRM) was considered quite appealing and easy to explain, the meaning of the word has been bent and shaped in many ways, both from suppliers and customers.

Some activities often called “outsourcing”:

facilities management
the delivery of a service from a supplier, usually using a mix of your own and their resources, and with an high degree of control on the results, the process to achieve them, and the resources required; the main difference vs. typical body-rental agreements is that a common management team is designed, with a set of service level targets agreed to
joint venture
the delivery of services and products using resources from both companies, but under the management control of a new structure; the revenue is usually generated by a short-term transfer of the existing customer’s budget, eventually to be offset by the delivery the services to third parties; there are two main risks: 1.under-documented existing level of services; 2.constant struggles between partners over business priorities
shared services
usually it is a hybrid, but under the control of the customer, with neither external management or market; the risk is that of a company internal spin-off, with all the disadvantages of a joint-venture but without the same structural independence
outsourcing
the focus is on the outputs, with a clear definition of the inputs, but with a general framework for the service level agreement (SLA) and any additional activities.

All these approaches contain the same risk: transferring a vertical process usually results in loss of knowledge, as operational knowledge ceases to be thesaurised inside the customer organisation.

Obviously, sometimes this is an intended consequence, e.g. for companies that want to expand into new markets they have no operational knowledge of, like cash-based businesses (retailers, insurance companies, etc) entering the retail banking industry to convert their own cash-flow into an additional revenue stream.

As described in the previous issue , this risk can be easily managed by adopting a thesaurisation process that is more common sense than rocket science, i.e. by identifying “knowledge snippets”.

What you outsource is the production of a set of knowledge snippets whose “how” (i.e. the production method) you do not need to keep inside the company.

More on this aspects will be hinted at in the “Strategy and outsourcing” section, and in the next issue of BFM (focused on “Business Continuity Governance”).

BFM2013_2_03_Controlling the process

Outsourcing is quite often considered a financial decision (converting a fixed cost and the related investments and maintenance into variable costs), but quite often the decision-making process does not subject the decision to the same level of scrutiny of a financing decision.

Knowing the content of the outsourced services and processes is required not only to ensure a successful outsourcing, but also to avoid signing a contract that could result in substantial financial penalties… to obtain the same or a lower level of services!

“Outsourcing” comes in many forms and shapes- and my favourite example is what happened when in UK tax offices where given in outsourcing through a “leaseback”.

It is still a popular idea: sell your buildings, get the tax revenue, pay a fee to rent them back.

The idea? As a State, you get immediate cash, plus taxable income from what you pay to the new owner, while cutting down the costs by removing the need to carry out maintenance and “manage” buildings.

Nice idea, but… the company was revealed to be based offshore (goodbye taxation), and eventually said that it needed more income to cover the costs- or otherwise those buildings would be sold.

Can you imagine how it ended?

When outsourcing services that are delivered without technology, customers analyse all the details, sometimes up to a full due diligence.

Which details? How many people are involved, how many events, what are the qualifications of the people involved, the time and materials required, processes, etc.

Usually the quantitative analysis is less well developed when technology is involved, e.g. almost no company checks if every software component or database is properly documented, assuming that if it is working, there is obviously everything needed to make it working.

Controlling the process of outsourcing implies:

  • being able to transfer knowledge to the new organisation
  • identifying why you are outsourcing the service.

Cutting costs is the classical motivation for outsourcing, but “cutting costs” has different dimensions:

  • are you planning to reduce existing costs?
  • do you want to avoid required investments or regulatory hurdles implied in keeping the service in-house?
  • does the company need to expand, but your do not see how you could manage the expansion?
  • etc, etc.

Outsourcing requires a clear definition of the boundaries of the contract, as you can outsource the execution of activities, but you cannot outsource the responsibility of either the activity or the definition of its boundaries.

As previously hinted, some companies outsource complete processes that are not relevant to their own core business, keeping control only of core processes and communication with the outsourced ones.

These companies retain in house the knowledge required to oversee the outsourcing supplier(s), to the degree of detail required to ensure that the SLAs (Service Level Agreements) are respected and that the processes not outsourced are still working properly.

Unfortunately, most companies usually carry out different rounds of outsourcing, constantly enlarging the boundaries of the outsourced activities, but without updating accordingly the knowledge required to retain control.

Retaining the capability to dialogue with the outsourcing supplier is useful also when the customer wants to be able to manage the evolution of the SLAs according to business needs.

Therefore, selecting the right outsourcing supplier requires a clear understanding of what are the real capabilities of your own company to retain the knowledge required to manage the relationship.

Outsourcing suppliers that originate from the same market of their customers (usually as a shared supplier between customers) are able to fill the void left by the loss of knowledge inside the customers, at a price: it becomes like any other utility, and you risk losing influence on the content (and degrees of freedom) of the services delivered.

While apparently a larger, generalist outsourcing supplier could seem to be the best choice, in our experience understanding the mix of skills available inside the outsourcing supplier is the major factor enabling a successful outsourcing.

The most critical requirement is: the supplier must have internal resources that understand your own business, to deliver “backbone” services- otherwise, the supplier will outsource to a third party outside your own control.

BFM2013_2_04_Framing vs. “frameworking”

Sometimes the financial analysis of outsourcing activities is stretched too far, forgetting that any outsourcing supplier in the end needs to deliver services: a case of over-negotiation.

Any failure in delivering the agreed level of service will impact directly on the public perception of your own company, maybe affecting your business.

“Beauty contests” between outsourcing suppliers, where customers ask them to underbid each other are dangerous if the customer lacks the required in-house knowledge of the activities they are trying to outsource.

Usually, the outsourcing supplier that “bites the bullet” either is planning to gain in the long term, or quite simply lacks the knowledge to understand the real costs of the outsourcing contract.

If your outsourcing supplier lacks the resources required to understand the evolution of your business and proactively support your business, probably either you or your supplier will use third party resources to fill a temporary (?) void- usually with unpredictable impact on quality.

A contract is the typical “framing device”- but is having a contract enough?

Financial penalties are not going to recover any business lost due to the failure of an outsourcing supplier that is unable to deliver the service agreed.

Contract definition is usually quite complex, but if the “technical” annexes are properly detailed, this is usually a good sign that one of the following three events is happening:

“the good”
both you and your supplier understand the requirements, and the contract allows to deliver the services you need now, while covering also the management of possible evolutions; yes, this is a “win-win”
“the ugly”
your supplier understands the contract better than you do; probably, you will end up paying more than you expected- also to obtain the services that you assumed to be included
“the bad”
you understand the contract, while the supplier does not; if you are lucky, the net result is that your supplier will deliver services at below the market price; if you are not so lucky, this will have an impact on the long-term viability of the contract and probably a negative impact on the relationship with other outsourcing suppliers, as well as maybe affecting your business.

If a contract is no protection, another device that is becoming more and more widespread is, of course, an insurance policy. But what do you get from insurance?

An insurance policy is built around an assessment of the risk to determine the premium to pay the insurer, so that if any of the negative events covered happen, the insurer pays the agreed amount.

With this (limited) definition, it is quite clear our approach: if a set of penalties embedded in a contract is no safeguard, while should insurance be any different?

The issue is not one of reality, but of perception: unless an insurance company invests in some companies that are able to actually “supply” the services the insurer covers, the business risk is not reduced.

As usual, insurance providers spread across the system the financial risk linked to the policy using re-insurance.

Therefore, while obviously contracts and insurance policies could reduce the financial burden due to the failure of the outsourcing supplier to deliver the service agreed to, we suggest focusing your negotiation on the actual definition of the SLAs.

Reason? If you halt your business due to a continued failure from your outsourcing supplier, no matter how much you are paid by the insurance company- your business is gone.

BFM2013_2_05_The content of outsourcing

In our experience, if you decide to outsource the execution of a service, then the actual details of the execution should rest with the outsourcing supplier.

Defining the results is certainly the easiest way, but it is not so easy to implement: do you really know all the “outputs” produced by your own processes?

By “outputs” we mean not only results from IT-based processes, but also results produced by other processes- including items as number of rooms cleaned, phone calls answered per minute, etc.

If you define the boundaries of your outsourcing contracts and SLAs around outputs, it becomes easier to quantify the level of service and negotiate the price of the contract (i.e. by number of incidents or “time slots required” to execute a process).

And, of course, the price of any additional services that may be required at a later stage.

Some companies outsource only whole processes, A-to-Z, top-to-bottom: if your outsourcing supplier understands your business, probably this approach is less resource-intensive (for you) than the output-based approach we suggest.

However you build the framework for your outsourcing contract, it is important that you thoroughly analyse your business needs.

When you will first transfer a service to an outsourcing supplier, probably you will rely on partially structured and organized information to build the framework of the contract.

Some companies instead rely on the outsourcing supplier to build the framework.

In our experience, this is the worst choice, as neither you nor your supplier will really have the knowledge required to manage the outsourcing contract.

Our approach is to carry out a “due diligence”: both the prospective supplier and the customer document the framework, to confirm that what the customer perceives is what is assessed by the supplier.

Usually, such an exercise is quite expensive, and progressively suppliers started steering away from prospective customers that have a history of “serial proposals”, i.e. requiring new proposals whenever an assessment of internal processes is required- but always ending up giving the business to existing suppliers, or delivering with internal resources.

A common approach is to shortlist prospective suppliers on a limited set of parameters, and then pay the shortlisted prospective suppliers a “fee” to carry out the detailed assessment.

Sometimes, the cost of such an assessment is credited by the supplier if awarded the outsourcing contract.

BFM2013_2_06_Consequences of outsourcing

So far, we discussed outsourcing assuming that it is possible- but it is really always possible to outsource?

In our experience, outsourcing should not be considered if the set of activities or outputs outsourced is too linked to other processes that are not to be outsourced.

If you outsource such an activity, your business evolution could be impaired, notably when your supplier is delivering just economies of scale, but without any capability to manage the service and its evolution.

Whenever this is the situation, we suggest instead either to:

  • keep inside the company the process and outsource the technology to support it, e.g. using applications delivered via Web or virtual machines
  • use external resources to supplement the skills lacking inside your own company, but ensuring that the knowledge required on a day-by-day basis is transferred to your people.

Sometimes, outsourcing can still be considered, but would require a focused monitoring to avoid counterproductive side-effects.

Typical examples are call centres, account management, sales management outsourcing, and other sometimes described as “hiring a team of expert resources”.

Why counterproductive?

In this example, because the typical mistake is to leave external resources manage the relationship with your own market using their own processes.

The result? The actual improvement of the sales/account managers market visibility and Rolodex, and reduction of your own understanding of your own market.

A proper management of the services outsourced can avoid these negative side-effects, e.g. by requiring the external sales/account managers to report all the information, and then managing through either internal resources or another company the collection of market feed-back.

As described in the previous issue of BFM , another consequence of some forms of outsourcing (e.g. ERP, a de-facto adoption of external business processes) is the introduction in your eCI (embedded Corporate Identity) of processes that work fine- but only if your company behaves as somebody else has decided that your company should behave.

The focus is to identify which parts of the activities can or cannot be outsourced- and not just those whose outsourcing is economically viable.

Consultants should suggest the best solution based on their own experience and knowledge, but then execute the solution agreed with the customer.

Consultants should plan for their departure from day one, with a clear visibility of the planned knowledge transfer to the customer.

Outsourcing services should be considered for activities that require constant update (e.g. tax law) but that are not used frequently enough to both justify the investment and ensure that the internal people involved are able to be highly efficient (and informed).

BFM2013_2_07_Strategy and outsourcing

The first issue is the difference in timescale: while outsourcing is considered mainly an operational issue, strategy definition usually is considered an exercise that delivers longer-term results and impacts.

The resources released through outsourcing could benefit from the increased focus on core business processes.

But outsourcing should satisfy business needs, not be a task in itself.

Business strategy definition and appraisal should also identify a framework to define guidelines about what can or cannot be outsourced by your organization.

Once defined, it must be routinely reviewed and revised, to ensure that service contracts are tailored to your business- and not the other way around.

Our experience is that the lack of understanding of the strategic impacts of outsourcing could seriously impair the conversion of your carefully planned strategic initiatives into operational realities.

Assuming that your outsourcing supplier understands the costs involved in outsourcing, you could end with an economically efficient outsourcing contract that doubles as a straitjacket for your business development.

The results of any negotiation are strictly related to the understanding of the assumptions of the negotiating parties, and a successful long-term outsourcing contract requires a degree of empathy and willingness of both parties to see beyond the short-term cost/revenue ratio.

Also, avoid contracts that have a “dumping” upfront, to keep the price lower and win the contract, as this is usually followed by a “spiking up” of the cost once the customer is acquired.

As an example, consider your product and service portfolio, and call centre and account management requirements: did you know five years ago the level, type, and quantity of services required?

The suggested solution is quite simple: partition your knowledge of the activities to be outsourced into levels of linkage to your own strategic guidelines, and add into the framework of the outsourcing contract specific SLAs, i.e. targets linked to the flexibility required to cope with the unforeseeable.

A simple device to obtain an outsourcing contract that closely matches your strategic requirements is to “layer” your outsourcing agreement, separating the SLAs according to the level of knowledge available and the degrees of freedom required.

If your history of internal management of the activities shows that planning assumptions constantly conflict with reality, then probably using just your own planning assumptions to enter into an outsourcing contract is not the wisest choice.

As previously described, we assume that an outsourcing contract is built around the outputs to be produced and inputs, or the processes to be carried out; we do not consider outsourcing the transfer of internal resources (people, software, assets) to a supplier that then delivers the same services using them- this is facilities management.

Anyway, most outsourcing contracts start as hybrids, where the supplier takes over resources from the customer, using the value of these resources toward part of cost agreed for the contract; these resources are eventually phased out or absorbed by the supplier.

If you require a continuous facilities management for part of the activities that you want to outsource, then ensure that the contract clearly separates outsourcing from facilities management.

We saw too many contracts called “outsourcing” that were actually facilities management in disguise: and usually in the end this is a lose-lose situation (hint: look at communication channels- if everybody talks with everybody, it is doubtful that that is really an outsourcing).

Finally, you should clearly include inside the outsourcing contract the “skills mix” required to service the contract, e.g. the level of skills that both parties should have inside their own organization to ensure that that the long-term management of the contract is feasible, at least for key resources (people acting as communication channels on contractual issues, managers, subject matter experts on continuous availability, etc.).

Formally: no SLA without a matching OLA (Operational Level Agreement), stating what your resources should to do provide: inputs, processes outputs.

Also the rules for monitoring, audits, inspections should be written within the annexes.

Whenever you outsource the execution of a process or the production of outputs, you should remember that you are still responsible of the long-term viability of the processes involved.

While it is tempting to remove all the resources that used to take care of the same process within your own organization, you should control your cost-cutting instincts, and consider if you can dispose of internal knowledge by replacing it with external knowledge.

As hinted above, if your company is entering a new business, and you find a supplier that is able to provide everything to allow you to take care only of the day-by-day activities with minimal additional resources, then you probably can avoid the investment, and use the services provided by the external supplier.

The same applies if you are, say, transferring your IT department to an external company, but not necessarily if you transfer just part of your IT systems or sales processes.

Making your DBAs, Systems Managers, and credit managers redundant is the best way to lose control of critical parts of your market presence or ability to make your processes and systems evolve.

As discussed above, usually customers roll out outsourcing progressively.

But is there a suggested “speed of outsourcing”?

Beside this “how fast you should outsource”, we will discuss also internal and external outsourcing: sometimes, the first step toward outsourcing your services is… to delegate the execution within your organization.

Reason? E.g. to be able to really identify the scope of the activities that you would like to outsource.

BFM2013_2_08_Outsourcing and “internal outsourcing”

Most customers are afraid of the “Big Bang” approach to outsourcing, and try a step-by-step approach.

Interestingly, few companies have in place what is required to carry out a step-by-step approach.

As discussed in the previous issue of BFM , if you have KC (Knowledge Configuration) Management in place, you have defined the basic elements that are required to outsource parts of your processes and outputs.

The key issue is always the same: you cannot outsource what you do not know- and a step-by-step approach, seemingly the most cost-effective approach, could actually be the less cost-efficient.

A quite common mistake is to transfer to the outsourcing supplier the required internal people before the customer builds its own internal support and management structure.

Therefore, planning the rolling out of outsourcing should be based on knowledge boundaries, to ensure that you still retain internal resources able to control the interfacing with the outsourced activities.

Outsourcing is usually supposed to involve external suppliers- or this is the common wisdom.

Actually, consolidation activities are the most common type of internal outsourcing, but almost never planning activities recognize the similarities.

Our approach is to consider internal consolidation activities as overall outsourcing activities, both to ensure that the “outsourcing” organizational units still keep control of their own knowledge and that the consolidation is based on a sound economic and financial assessment.

Managing the consolidated activities as “outsourced” also clarifies the boundaries, as quite often the originating organizational units tend to “forget” that they are now supposed to focus on the outputs, not on the way they are produced (they mix up outsourcing and facilities management or body rental).

We suggest adopting sound guidelines to identify if the real solution is selecting an external outsourcing supplier, or “internal outsourcing” is the safest choice.

While talking about Business Continuity Governance in the next issue we will also discuss the concept of “maturity levels”.

Before adopting a “best practice” from somebody else (including standards or an ERP), you should assess if your own organization has the “structural maturity” to comply with rules that assume that everybody works as a “cog in the wheel”.

If that is not the case, then some adaptations will be needed.

BFM2013_2_09_Strategic outsourcing

“Strategic outsourcing” requires a clear understanding and knowledge of both the outsourced activities and the outsourcing relationship.

What is the difference with other outsourcing activities?

Outsourcing is not just a variable cost: usually, to ensure profitability and economic viability for both parties, it is a multi-year agreement with a “phase-in” and a potential “phase-out”.

If you therefore consider the outsourcing costs as an overhead within a specific profit centre, it becomes easier to manage both its own viability, and to identify how to cost and manage any change (e.g. who should pay for what within your organization, and on according to which algorithm the costs should be allocated and spread between various organizational units).

Any change on the outsourcing arrangement has to be clearly related to company strategy and linked to the organizational structure of the company, also to avoid that the outsourcing supplier builds a parallel, unsupervised structure, maybe even with “custom” cross-functional communication channels within your own company.

This process requires that both the customer and the supplier accept to be actively involved in managing the relationship.

While the customer should keep the connection to the internal organization and structure, the supplier should assess with the customer the impact of any change, and maybe even help to identify how the associated costs should be partitioned within various parts of your organization.

A strategic outsourcing partnership will eventually result in a proactive management of both the content and scope of the outsourcing contract from all the parties involved.

Managing the relationship requires identifying a way to assess the quality of the services delivered by the outsourcing company, and usually this is done by adopting one or more SLAs (Service Level Agreements), as well as a communication strategy focused on measuring trends in customer satisfaction.

In our experience, most outsourcing contracts lack the structure to actually allow a quantitative monitoring: parameters, timescales, agreements to deliver continuous process improvement.

Again, a preliminary extensive activity should be carried out by both the supplier and the customer to identify the parameters and phase-in the outsourcing contract, ensuring that no knowledge is lost in the process.

Introducing strategic outsourcing requires a frank assessment of the current status of the activities to be outsourced, with a sensible planning to ensure their proper management.

A typical sign of an outsourcing contract that has not been thought through and documented properly is the constant change of the resources in charge, both on the customer’s and the supplier’s side, and the number of meetings required at every change.

Our suggestion is to be realistic: if your outsourcing supplier gives you unbelievable short timescales, look for checks and balances to show progress.

If they are mostly qualitative (or qualitative disguised as quantitative), then probably the supplier is investing on the relationship, looking forward to long-term gains, or simply does not understand the contract.

In both cases, you are increasing your operational risk: until when the supplier will sustain an unworkable agreement?

Therefore, introducing strategic outsourcing requires that you first understand and explain your own strategy to your own people (at least those that will select and/or manage the relationship with the outsourcing supplier), and then shortlist suppliers that fit the profile, before negotiating with them, aiming for a long-term proactive relationship.

Planning and structuring the outsourcing contract and the relationship with the suppliers is only part of the picture: strategic outsourcing requires also a more structured approach to costing an outsourcing contract.