Taking the Measure of Outsourcing Providers

Senior executives frequently express dissatisfaction with back-office processes and functions in areas such as human resources, information technology, indirect procurement, finance and accounting, perceiving them as too costly to operate, limited in their capabilities and frustratingly slow. Some of the largest companies — particularly those that have grown through mergers and acquisitions — are saddled with disparate and poorly performing processes that only major investments in dollars and management capacity can correct. Even if senior executives agree to commit the necessary management time and other resources, many are skeptical about creating the proper environment for back-office success.

Not surprisingly, rather than address these challenges themselves, many companies are choosing to outsource some functions and areas — in some cases, even their entire global back offices — to business-process outsourcing providers. One example of a BPO provider is call centers; increasing numbers of companies are outsourcing their service support function to either local or offshore providers that can handle it more efficiently and at lower cost. More recently, companies including BP Plc and Bank of America NA have decided to outsource the transactional side of their human resources activity.1 This trend toward outsourcing of business processes continues to gather steam as companies seek alternative and improved ways of leveraging their assets.

Some BPO providers speak of the “transformational” impacts that upgraded processes can have on client business performance.2 Suppliers can furnish companies with more than simply expertise. Some provide upfront capital to convert cumbersome, decentralized human resources and administrative systems into shared utilities, which they then deliver through new offices, new business processes and Web-enabled technology. In addition to setting the stage for internal efficiencies, BPOs can provide opportunities for other benefits. Recently, for example, the London-based Society of Lloyd’s, the global underwriting group, worked closely with London-based Xchanging, a major business-process outsourcing firm, to revamp its policy administration and claims processing capabilities. The subsequent changes allowed Lloyd’s to achieve substantial cost savings and service improvements; it has since partnered with Xchanging to sell services that grew out of their business relationship to external customers, creating a new stream of profits.

BPO has become a large and diverse market in recent years, populated by an increasing number of providers. Organizations interested in exploring the potential benefits of outsourcing business processes need to look carefully at their own goals and be clear about what supplier capabilities they need. Over the course of 15 years of research, initially focused on IT outsourcing but more recently expanded to include other types of BPO, we have described ways to analyze appropriate outsourcing goals and have provided a widely used model for identifying the capabilities that need to be retained in-house. (See “About the Research.”) This article identifies and describes what BPO providers can bring to outsourcing relationships. Finding the right suppliers is essential to BPO success.

Understanding Supplier Competencies

Regardless of their specific areas of expertise, every BPO supplier operates in three domains. To greater or lesser extents, they possess competencies in delivery, transformation and relationships.

• Delivery competency encompasses how well a supplier can respond to the client’s requirement for day-to-day operational services. It reflects the supplier’s scope and complexity of services: What levels of cost, quality, robustness and flexibility are the supplier able to meet? Few companies will be eager to out-source their business processes unless they are confident that their minimum required standards of service can be met during the life of the contract.
• Increasingly, clients expect that the services they outsource will improve over time and provide them with some combination of cost, quality and functionality improvements. Transformation competency represents how well a supplier can deliver on these formal or informal expectations. Suppliers use several potential levers for achieving radical change and improvement, and competing suppliers can vary greatly in this domain.
• Most outsourcing deals are made up of “fee-for-service” contracts, which separate the price the client pays from the costs the supplier incurs in providing the services. This seemingly straightforward arrangement can lead to serious conflicts, especially when the contracts extend for many years. Clients typically use their bargaining power to negotiate the best price they can, but their position weakens once the contract has been signed and the supplier seeks control. For this reason, savvy clients attempt to gauge the supplier’s relationship competency — the extent to which the supplier is willing and able to cultivate a “win-win” relationship that will align client and supplier goals and incentives over time.

The first step in identifying potential suppliers is for a company to consider its own requirements. (See “Client Needs and Supplier Competencies.”) Does the company need a supplier who can deliver the highest level of service, or will a moderate level be sufficient? Is the present service in need of radical change? Or is the company looking to phase out an internal service that is performing satisfactorily in order to free up more management time to address core activities? Does the company want a services vendor that can be replaced easily if its performance is unsatisfactory? Or would it like to have a long-term partner whose business success over time will be closely tied to its own (recognizing, of course, that this means higher switching costs should it need to make a change)? A common mistake in outsourcing is choosing a partner through a procurement process that encourages a bidding war. This often leads to a “winner’s curse,” in which the supplier that gets the contract almost immediately feels pressure to restore profitability to a flawed business model.4

At the same time, client companies must determine which suppliers have the appropriate level of ability in each area of need. A common pitfall is that client executives have a tendency to overemphasize supplier resources, such as physical facilities, technology and workforce composition, while overlooking the critical capabilities and resources that will be deployed for the customer’s benefit. An executive at a company that has identified technology as a key driver for transformation might ask a prospective supplier for evidence that it has first-rate employees in the technology area. Realistically, all credible suppliers will have excellent technology people. Understanding the cultural differences among competing suppliers may be more valuable: Which ones have a culture of rapid and regular delivery of benefits to client businesses through component-based platform architecture, and which prefer to bundle system requirements into large infrastructure projects?

Evaluating a supplier involves understanding the infrastructure, values and methodologies it brings to its area of expertise. Successful evaluation also requires an awareness of the range of processes the supplier uses and its available skills. The following section examines 12 capabilities that support these supplier competencies, drawn from case studies of BPO suppliers working with major corporate clients. The supplier capabilities model serves as a tool for helping clients assess potential service providers, but it may also prove useful to suppliers who wish to assess their relative strengths versus their competition.

12 Supplier Capabilities

Depending on their specific needs and circumstances, companies will look to BPO suppliers for different capabilities. Some capabilities will support a single element of supplier competency, while others will contribute to two or even three different domains. (See “12 Supplier Capabilities.”)

Domain Expertise

The first and most obvious capability to evaluate is the supplier’s capacity to apply and retain sufficient professional knowledge of the target process to meet the user requirements. Many supplier organizations acquire domain expertise from clients through employee transfers. For example, Barclays Plc, the financial services company, transferred its check-processing staff to Unisys Corp.; conversely, Hewitt Associates Inc. and Xchanging acquired human resource expertise by transferring people from Bank of America and BAE Systems Plc, respectively. This method of building expertise has two potential advantages from the client’s point of view. First, it becomes the supplier’s responsibility rather than the client’s responsibility to adjust capacity, eliminate poor performers and leverage the untapped potential of the best people; second, both parties are assured that the staff operating the service are familiar both with the functional domain (such as HR) and the specifics and idiosyncrasies of the client’s existing service. As the suppliers grow their own critical mass of expertise in the target domain and become less reliant on transferees, new clients should consider whether suppliers have enough knowledge to operate in their specific context.

Depending on their goals, clients will view domain expertise differently. A client seeking to build external capacity to handle periodic variations in service demand will want a commitment from the supplier that it is prepared to build expertise specific to that specific context. On the other hand, a company seeking to reduce labor costs through offshore outsourcing might be wary of going too far: “It has become very clear [to us] that in order for offshore to succeed, we need to groom, reward and retain our own subject matter experts,” says a senior vice president of a Fortune 500 financial services company.

Business Management

The second requirement of any BPO arrangement is that the supplier consistently be able to meet both client service-level agreements and its own business plans. Clients must understand that failure on one front inevitably leads to failure on the other. In some adversarial client-supplier relationships, clients focus on the high-priced items within the supplier’s bundle of services and threaten to erode the supplier’s margin by scaling back on or eliminating these items. They frequently fail to give their suppliers credit for other items in the bundle that are priced quite favorably compared to external benchmarks of unit price. In successful relationships, business managers on both sides are able to have frank discussions about the supplier’s business returns and service performance.

Another example of business management in action is the procurement deal BAE Systems developed with Xchanging. The issue here was not pricing but volume. During the first year of their contract, Xchanging realized that there was a significant shortfall in the expected value of the transactions it handled. The two parties collaborated over several months to identify additional categories of business they could add to the contract, thereby allowing Xchanging to get back on track with its business plan while also providing BAE Systems with ways to achieve new savings.

As the contract manager of an Australian public sector agency explains: “Suppliers have to make a reasonable margin to stay in business. You don’t want them to lose money because the worse their business gets, the worse your business gets.”

Behavior Management

When considering outsourcing services, clients often seek qualitative as well as quantitative improvements. For example, some managers worry about whether morale will suffer if employees are transferred to the supplier’s organization or whether employees will find a new sense of purpose. Every major BPO supplier has employees with impressive experience, skill and knowledge. However, clients also should evaluate the supplier’s track records in motivating and managing people to deliver superior service. This involves looking for signs that the supplier understands training, managing and motivating people.

Different suppliers use different methods. For example, CGI Group Inc. of Montreal puts employees slated for transfer through a process it calls “harmonization” even before the final contracts with client companies are signed. “This is much more than an orientation,” says Ed Standridge, a CGI partner. “We want to show every employee — not just a subset — this is what we do, how we do it, the timing. We want to set the stage for good behavior management beforehand, not react to bad behavior afterwards.”

Other BPO suppliers also place significant emphasis on making sure that transitions are handled effectively, and managers at some client companies have been pleased by the results. Since 2001, for example, Xchanging has provided third-party HR services to BAE Systems, running former employees through its extensive orientation program. As a result of the program, people have become “a lot more professional,” says Kim Reid, divisional HR director at BAE Systems. “They have a lot more understanding of what drives a business. They understand the cost base and how you actually get value out of a business. It has been quite a nice surprise to see that happen, and happen so quickly.”

Sourcing

Another potentially critical factor in meeting client goals is the supplier’s capacity to tap the resources needed to meet service targets. Clearly, client needs will vary depending on the nature of the service and how much change the client is looking to generate. Some clients may want access to economies of scale or lower labor costs; others may need specialized professional skills, improved infrastructure or help with supply management. The procurement services deal between BAE Systems and Xchanging, for example, was based on two considerations: Xchanging’s superior ability to attract high-level professional skills for procurement of supply categories such as office supplies, health plans and training; and its ability to take advantage of scale by aggregating BAE’s part-time needs with those of other clients.

AT&T Corp.’s desire to access the high skills and low costs of India’s IT sector provides a contrasting example of the role of sourcing. Rather than building a new service center itself, the company’s CIO managed to persuade IBM Corp. — which has a long history as AT&T’s BPO and IT supplier — to open a service facility in India with all of the capabilities it needed. In effect, AT&T was able to trade some of the potential cost savings it would have garnered, if it had set up its own center, for reduced risk (both management and political). Up to 40% of AT&T’s application development work is done offshore through IBM’s captive center, with reported cost savings of around 30%.

Technology Exploitation

Many companies know that they are very out of date when it comes to investing in back-office processes that could transform their services’ cost, quality and functionality. At the same time, top management is increasingly wary about embarking on costly new technology initiatives they aren’t able to manage closely. As they contemplate outsourcing, many clients want to know how swiftly and effectively suppliers will be able to deploy technology to support critical service improvement targets. This capability requires careful evaluation, looking beyond the purely technical skills that all major suppliers have and assessing the supplier’s approach. What values and behaviors does the supplier bring to technology exploitation? What processes does it employ? And what existing infrastructure does it plan to use as a base? As some BPO suppliers are finding, the ability to deliver improved business processes such as “e-enabled” HR services directly to the end-user’s desktop can surprise and delight their clients.

Technology is expensive, and clients will want it to be the servant of the business, not the master. The role of a good technology supplier is to help client companies find cost-effective business solutions. For example, CGI works with each client to develop an annual technology plan that identifies the mutually agreed-upon investments and projects the client intends to pursue within the existing contractual framework.

Process Re-Engineering

Another powerful lever for service transformation is the ability to design and implement changes to the service process to meet improvement targets. Capability in this area is well established for many major BPOs. Given the prominence of General Electric Co.’s corporate initiatives during the 1990s, many clients are familiar with Six Sigma and the Capability Maturity Models. But it is important to look beyond well-known tools to consider the human and behavioral factors. Who has the critical skills? Who will own the change process? Who defines what qualifies as an improvement? And who benefits? There are many cases, particularly in IT outsourcing, in which process improvements seem to have been designed more for the convenience of the supplier than for the benefit of the client and the end user.

Customer Development

“When I became the Accenture partner responsible for the London Stock Exchange,” recalls David Andrews (now CEO of Xchanging), “I found I had 200 users who complained about everything. A critical task was to change their mind-sets so that they became customers.” This points to one of the fundamental challenges confronting both suppliers and clients. Rather than thinking of those who avail themselves of internally provided services as “users,” suppliers need to think of them as “customers” — people who make informed choices about service level, functionality and costs. The senior management of client organizations and BPOs typically negotiate outsourcing deals, but it’s the business units and end users who must live with the day-today effects. To maximize chances for success, clients need to identify suppliers who can manage the user-to-customer transition.

Suppliers should take three steps to achieve the re-orientation from user to customer. First, the supplier should have personal contact with a large number of end users in order to build a real understanding of how they want to use the service. This will help create a climate of trust. Second, the supplier should work with client managers to gain agreement on a detailed definition of the required service, which everyone involved with providing the service must understand. This will become the basis for regular reviews of performance and user satisfaction. And third, the supplier should work to create a business relationship in which the end user becomes a customer who feels fully informed of service options, potential enhancements and cost impacts; the customer then can make new choices to meet the changing needs of the business.

Although these suggestions might sound rather obvious, they are not easy to achieve under most fee-for-service contracts. Suppliers typically set out to provide a centrally specified service level and price package, but this often differs from what the user claims to be receiving. As a result, a significant amount of the supplier’s management time is consumed by extensive (and central) negotiation over long lists of “anomalies” that pre-contract due diligence failed to identify. The net result is that the user feels neglected and taken advantage of, rather than developing trust. Even though the supplier’s capability to develop customers is considered part of its transformation competency, in practice this is tied more closely to the supplier’s relationship competency.

Planning and Contracting

A supplier’s relationship competency starts with its ability to develop and execute business plans that can deliver win-win results for both customers and suppliers over time. The planning component involves creating a vision of the potential prize and a coherent process for achieving it. The details of this vision and process should be shared openly with the client in order to build trust. A few years ago, a client and a supplier were reporting disappointment with lack of progress in the strategic partnership they had announced six months earlier. The breakthrough came when a manager for the supplier agreed to reveal his company’s revenue goal, which it had thus far been unwilling to specify. To the manager’s surprise, the client’s response was extremely favorable; the client even stated that unless the supplier achieved at least that level of revenue, he would consider the partnership a failure. As they worked together to identify additional projects to support this goal, the supplier gained sufficient confidence to invest more resources in the effort.

Presenting the plan upfront clarifies the expectations for all parties. For example, a recent procurement services deal between Deutsche Bank AG and Accenture Ltd. spells out the vision, the rewards and the plan for their achievement. It commits Accenture to funding and creating a new platform for procurement, with 200 people assigned to its development. Accenture receives a substantial new revenue stream from Deutsche Bank and an opportunity to attract other clients to the new service. In turn, the plan is slated to deliver 15% to 20% in savings for Deutsche Bank through consolidation, standardization and retooling of its existing 14 procurement units.

Beyond the importance of planning, suppliers should be well versed in the art of contracting. Among other things, this requires understanding options for sharing rewards between themselves and their clients as the plan is delivered. Many variations are possible. When Bank of America arranged to outsource HR services from Exult Inc. (now part of Hewitt), it negotiated to take an equity stake in the supplier as well as a share of the supplier’s revenues from external clients;5 Xchanging structures its major deals as profit-sharing arrangements, with open-book accounting. The essential principle is that if the supplier and client do their parts to make the business plans successful, both parties will win.

Organization Design

Business plans are executed through organizational structures and processes. Clients need to assess whether suppliers have the capability to deliver the necessary resources to achieve the stated business plan. Suppliers vary greatly in terms of their organizational approach, the choices they make and their flexibility. Some emphasize a “thin” front-end client team, interfacing with consolidated service units that have profit responsibility and ownership of most of the resources. Although such arrangements take advantage of economies of scale, they can constrain a supplier’s ability to deliver the business plan for a specific client. By contrast, other suppliers allocate most of their resources to “enterprise partnership” units that are created for each major deal. The units have their own chief executives, full executive teams and dedicated core resources. They are responsible and accountable for delivery of the business plan.

A critical issue in supplier organizational design is resource allocation. Clients seeking to achieve service transformation must evaluate this area with particular care. A potential supplier may have impressive capabilities in all of the important elements of transformation, such as sourcing, technology and process re-engineering, but the need for many of these capabilities will fluctuate dramatically during the life of the contract. Clients thus need to select suppliers who will be responsive to their needs (and the needs of the shared business plan) as they change over time.

Governance

Every supplier points to some type of service review committee or board that defines, tracks and evaluates how well they have performed over time. Large relationship- oriented deals, such as Accenture and Deutsche Bank or Xchanging and BAE Systems, typically include a joint board of directors, which underscores the expectation that clients will be active partners in the enterprise.

Having previous experience with jointly staffed governance mechanisms is helpful, but clients need to ask suppliers important follow-up questions. What kind of reporting processes does the supplier envision to ensure that each part of the governance structure remains properly informed? What procedures does it intend to institute for dealing with escalating problems? What powers and sanctions will be available through the governance structure?

Having joint boards of directors can lead to managerial schizophrenia.6 There may be confusion over exactly which hat the client executives wear when they sit on the board of the service business. Should they press for more services at lower cost to benefit their own employer? Or should they encourage the service business to maximize external revenues by taking on more clients, even when this might divert attention from their own service needs? The best way to deal with potentially competing objectives is to have multiple joint boards to provide checks and balances. For example, Lloyd’s, the International Underwriting Association of London and Xchanging have developed a three-way insurance services deal; they established a joint board of directors that is focused on achieving revenue and profit growth for the enterprise partnership. Xchanging, which owns 50%, has a majority on this board to ensure operational control. But to protect the service quality, there is a separate service review board on which clients have equal membership with the supplier. When a service problem escalates to this board, a remedial action plan must be worked out within a maximum of three months. The service review board also has the power to reduce prices. The ultimate sanction for continual poor performance is the removal of the enterprise partnership CEO.

Program Management

A BPO supplier cannot survive without highly developed project management and change management capabilities. But clients interested in service transformation and a long-term relationship should look beyond the supplier’s project-level capabilities and evaluate its program management capability. Program management involves prioritizing, coordinating, mobilizing the organization and promoting a series of interrelated change projects. As discussed earlier, it is important to provide multilevel orientation and support for transferees, to think of end users as customers, to have technology- and process-based projects that deliver service improvements over time and to have an overarching business plan. Managing change at this level is not for the faint of heart; it demands sophisticated methodologies, processes and professional skills. However, clients also should assess potential suppliers based on their values and motivations. Is the supplier so proud of the apparatus it uses for program management, for example, that it risks operating a bureaucracy that is unable to adjust to the client’s particular needs?

An experienced practitioner described program management this way: “[Program management] is guided by a healthy paradox. It blends the rigorous project management disciplines exemplified by world-class consultants with the practicality and pragmatism that is only gained from running operations. … It requires intellectual flexibility to vary or reverse a traditional approach according to circumstance. … As a result there are no rules, only guidelines.”

Leadership

Although governance provides a structural and procedural context for leadership, effective suppliers exercise leadership more directly. They know how to identify, communicate and deliver the balance of the activities required to achieve success, both for the client and the supplier. Management literature generally credits individual leaders with a surprising degree of influence over business results. Our research into the effectiveness of services suppliers confirms this overall view. In relationships in IT outsourcing, we found that the individuals fulfilling supplier leadership roles had a considerable impact on relationship success.7 Although individual supplier firms were consistent in the way they contracted and governed, 76% of the deals under study were judged by participants to be successful, and 24% were seen as unsuccessful. The main differentiator between success and failure was the individual leading the supplier account teams. When examining how these leaders make a difference, three patterns emerge:

• In unsuccessful cases, the leader of the supplier team was often seen as too focused on delivery, meeting contractual service levels while delivering the required margin to the host supplier company. These issues clearly are important, but they seem more a matter of business management than leadership.
• The quality of the supplier leader’s personal relationship with the client leader is usually a driver. This can have an important impact on the wider relationship between client and supplier organizations.
• Least obvious but perhaps most important, the relationship between the leader who the supplier assigns to the client and the top management of the supplier’s organization can be a critical factor in success. Because most suppliers tend to create more of a front-end team to serve the client rather than a full-function business unit, the local team is extremely dependent on its leader’s clout with headquarters to gain access to key resources and approval for client-aligned business policies.

The recent experience of a large corporate client highlights the importance of leadership in selecting suppliers. The company negotiated a $200 million outsourcing contract with Supplier A. Supplier A assigned an individual who one client executive described as “a great person” to lead the account team, but the leader had no clout with headquarters and could not get anything done. The client terminated the contract and hired Supplier B, who assigned an account leader with an impressive track record in managing previous large contracts. Unfortunately, having recently been recruited from a rival supplier, this leader also had very little influence with the head office. The client eventually called Supplier B’s CEO and asked him to “send someone who can act on your behalf.” The CEO complied and assigned a person from the head office, who brought 18 of the supplier’s best people to the client team. The contract with Supplier B has now been in effect for more than a year and is considered by both sides to be a great success.

From Capabilities to Performance

The objective of this article is to provide a framework for helping client companies evaluate which suppliers possess the competencies required to address their BPO requirements. However, choosing capable suppliers is not enough to ensure performance. The research suggests three imperatives for companies wishing to add value through use of the BPO services market:

• tify which competencies to assess in the BPO marketplace, client firms should think carefully about each of the processes they eventually may want to outsource. This will involve evaluating the roles individual processes play within their overall business model and then assessing what improvement goals — measured in terms of cost, quality, functionality or flexibility — will be most valuable to the business over time. As clients conduct this type of in-depth analysis, they should decide what combination of delivery, transformation and relationship competencies would be most important in light of their particular needs. The research confirms the value of the “selective” approach we presented in 1996,8 with the added refinement that multiple relationships with a single supplier can be effective.
• The decision to choose a particular supplier (or extend the relationship with an existing one) should then be guided by a thorough evaluation of relevant strengths in the 12 capabilities. Capabilities, not skills and resources or brand name, determine the right choice.
• Finally, even with outsourcing it is essential for client firms to remain involved with business processes rather than step aside and assume that “it’s now up to the supplier.” The actual level of client involvement and the extent and nature of the resources needed will be a function of the specific context.9 Part of understanding that context is identifying the particular supplier capabilities that are most important and the client-side involvement required for their successful deployment.

For too many companies, outsourcing has been a case of “marry in haste, repent at leisure.” As one senior executive of a major supplier recently observed, “Outsourcing contracts are agreed to in concept but delivered in detail, and that’s why they can break down.” By benchmarking supplier capabilities against strategic and operational intent, companies have an opportunity to establish relationships that are properly calibrated with the business objectives they seek to accomplish.