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Eye on ROI:
To Outsource or Not: The ROI Question, Part 2

online columnist The Gantry Group     Column published in DMReview.com
October 28, 2004
  By The Gantry Group

This month's column is the second of two on the topic of enterprise technology solution outsourcing. Part 1 focused on the determination of total costs of outsourcing (TCO); this month the focus is on capturing net benefits of outsourcing.

Continuing our discussion concerning the business justification of business process outsourcing (BPO) from last month's column, we now put the spotlight on the other side of the ROI equation: net tangible benefits.

Outsourcing of business processes is gaining in popularity as early adopter companies learn from their initial experiences and move into the second phase of outsourcing. More and more enterprises are introspectively examining internal business processes, asking themselves questions such as, "Do we want to be experts at transaction processing?" Unless the process in question has a direct effect on the company's competitive advantage (or is mission critical to delivery of product or service), the answer is typically "no." In cases where an outsourcing provider really has expertise and best-of-breed technology in these areas, it is likely that they will have developed better processes than those being executed in house. In such situations enterprises can not only save on the transaction costs but they can also "variable-ize" back-office costs thought to be fixed costs.

We want to stress that economic gains from BPO are not a certainty. They are highly dependent upon many factors driven by the individual processes involved, capabilities of the BPO provider and capabilities and business model of the enterprise. Please refer to the note at the end of this column for a brief discussion on corporate BPO best practices).

The net tangible return on outsourcing is felt in many of the same areas where most technology automation solutions impact a company, namely, revenues, cost of goods sold (COGS) and operational expenses. In addition to P&L impact, a BPO outsourcing solution can also have an effect on the balance sheet, where capital investments appear. When an outsourcing decision is made in lieu of purchase of an in-house license there is no need to enter a capital expense on the balance sheet.

Of course the specific areas of economic return will depend upon your industry and the business processes being outsourced; however, we can nevertheless provide an overview of how a BPO solution can provide net tangible benefits. The benefits areas listed are meant to represent a compilation of possible returns - it is unlikely that any solution can provide net benefits in each and every category.

Staffing Costs

There is no getting around it - outsourcing, whether on or offshore is synonymous with staff reductions. When you are outsourcing to replace a set of in-house processes - no matter what functional area - there are sometimes instances where the in-house staff is no longer needed. The savings come in the form of reduced wages and the associated cost of employee benefits. (Note - one of the areas of outsourcing cost that is often neglected in a TCO analysis is the one-time cost of severance or other types of termination packages.) In other cases, however, outsourced service providers can hire the replaced employees. Obviously where possible these are desirable situations. However, while cost savings from fewer employees can be sizeable, there are other opportunities for cost reduction that are as or more significant.

The intangible benefit (not to be included in your ROI assessment) related to staffing comes in the form of the increased focus that remaining employees can have on the strategic elements of their work. In human resources, for example, there is a desire to free up staff to work on more value-added, strategic initiatives such as talent management and leadership development - things that ultimately enable the enterprise to grow profitably. This increase in value-added work product has an intangible benefit that can generally be quantified through increases in revenue (see below for more on revenue benefits).

Transactional Costs

The other area of cost savings most commonly attributed to outsourcing is the cost per transaction. Enterprises generally have some degree of knowledge of cost per transaction for in-house processes. The greatest reduction in cost per transaction usually occurs when the process being replaced (or some part of it) is manual. One of the drivers of outsourcing is access to technologies that streamline and automate. When business processes are automated and reconfigured for outsourcing, transactional efficiencies have measurable impact on cost per transaction.

Operational Costs

The operational costs related to BPO vary widely depending upon which functional areas are being converted. Particularly where business processes that were previously manual are being outsourced, hard savings are realized when paper storage is no longer a factor. Manual processes are typically paper-based, and where there is paper there is usually a need for paper storage. One of the major motivators for BPO is often adoption of Six Sigma programs implemented to reduce or eliminate paper. Outsourcing such business processes can reduce paper storage costs that can run into the hundreds of thousands annually for warehouse rental, paper handling and storage equipment.

Another operational line item that is favorably impacted by BPO is non-compliance cost. With Sarbanes-Oxley in full force, public companies are now required to demonstrate specific levels of control and governance over a variety of transactions. The enterprises affected can now calculate the non-compliance fees that would be levied should they fail to provide adequate evidence of controls and transaction transparency. Many of these companies see outsourcing as a means of complying with Sarbanes-Oxley to avoid costly fees. Outsourcing providers that offer transactional expertise are aware of these regulatory issues and have developed processes to ensure compliance.

While there are also operational efficiencies that come from increased efficiency and productivity, these are intangible and thus difficult to include in a quantitative analysis. Reduction of waste however, is a quantifiable metric that can result from BPO. Process outsourcers who have developed and implemented best practice automation in their functional areas can eliminate workflow discontinuities that result from lack of communication between parties or simply from human error. This is especially important in manufacturing companies where waste has a material cost.

Finally, outsourcing can enable enterprises to improve cash management through decreased days sales outstanding (DSO - the time a receivable goes unpaid), better leverage with vendors, avoided late fees and early payment discounts. Savings such as these are usually associated with outsourcing of finance and accounting processes that were previously manual.

Cost of Goods Sold

For product manufacturing companies COGS largely reflects the cost of materials required to build the product. Next to the human resources department, procurement and supply chain are two of the most common areas for BPO. Outsourcing procurement can lead to improvements in materials and sourcing decisions that can show up in materials cost reductions. Outsourcing business processes in supply chain management can have a measurable effect on product time to market (which impacts sales revenues) and, perhaps more directly, on inventory. Improvements in inventory management (increases in inventory turns) will impact cash flow when just in time delivery reduces warehousing costs while freeing cash that would otherwise be tied up in material assets.

IT infrastructure Costs

When outsourcing is replacing in-house business processes there are often IT infrastructure costs that can be eliminated or reduced. In last month's Eye on ROI column (http://www.dmreview.com/article_sub.cfm?articleId=1010521), we laid out the costs associated with total cost of ownership of the IT infrastructure required for in-house deployment of licensed applications. Below is the top-level list of expense categories that may be reduced or eliminated with a BPO implementation:

  • License fees
  • Annual maintenance fee
  • Premium support
  • Major upgrades, not included in maintenance fee
  • Data integration
  • Customization
  • IT infrastructure
  • IT support and consulting
  • Training
  • Network costs
  • License Management

In addition to this list of potential savings categories is another cost impacted by BPO - that of system integration across functions. When enterprise IT solutions are licensed for in-house deployment, the issue of integrating these solutions for seamless presentation at the front end can consume human and financial resources. When business processes from multiple enterprise functions (say HR and finance and accounting) are outsourced to a single service provider, integration issues are removed from the IT department. An outsourcer with process expertise in multiple functional areas can manage integration so that their corporate customers can offload IT resources from ongoing integration problems. Cost of achieving best-of-breed integration of best-of-breed in-house applications can be another major category of IT savings.

Revenue Improvement

Revenue impact can also be an outsourcing objective. When employees are freed from administrative tasks, they can focus on value-added work. If the impacted employees are in roles that affect sales, clearly they will have more time to sell which should have a favorable impact on revenues. Outsourcing customer-touching work elements such as call centers or offering self-service can lead to customer retention and increased repeat sales.

To the extent a business process outsourcing relationship enables companies to go to market faster, revenues are also increased. For example, when strong outsourcing partnerships are forged in product design and development, access to improved collaboration and communication technology and processes can result in less rework driving faster time to market, greater customer satisfaction and greater market share. Ultimately all these benefits show up as improved revenues.

Note - Tips for Successful Outsourcing

While Gantry Group does not provide consulting services to companies advising them on business process outsourcing, our primary research has revealed "lessons learned" from enterprises with experience implementing BPO. While these tips will not guarantee success, they will certainly assist with achieving it.

  • Do your due diligence on vendors; call and visit reference customers and investigate performance records and claims thoroughly.
  • Look for vendors who are really committed to servicing the process area(s) you are interested in. Their level of commitment will show up in the investment they have made to establish best practices for the functions they cover.
  • Make sure the vendor not only understands what process(es) you want outsourced, but also what you are trying to accomplish by outsourcing. Share your objectives and align them with those of the vendor. Maximizing transaction volume might be in the interest of the outsourcing vendor but not your department.
  • Successful BPO relationships are only possible when there is a cultural fit between the enterprise and the outsource provider. Your vendor should have the same values and similar work ethic as you do.
  • There will always be issues that must be resolved - no matter how good the fit or how much pre-planning has been done. Ensure that the proper mechanisms are in place for problem resolution - from designating contact people to enforcing performance standards.
  • Help the vendor get to know your company. Prior to going live with the vendor, spend as much time as necessary to familiarize the vendor's implementation team with your current business processes. You cannot do too much pre-implementation planning and it is vital that both you and the vendor have an implementation team that communicates and collaborates.
  • Protect yourself and the relationship with a detailed, tight contract. Your outsourcing contract agreement should include clear performance metrics and remedies if there is deviation from these metrics. Service level agreements are mandatory to success and should not only specify the performance standards but also the mechanisms used to measure them.

For more information on related topics visit the following related portals...
Outsourcing and ROI.

Dawna Paton and Dale Troppito are managing partners of the Gantry Group. Paton has helped guide the Gantry Group's rigorous ROI best practice models based on a 25-year career as chief executive officer, CFO, sales and marketing executive, and venture capitalist in high technology companies. You can reach her at dpaton@gantrygroup.com. Dale Troppito, company cofounder, believes that the technology leaders of the future will be those that understand the crucial role that a market-validated, value delivery strategy and compelling ROI play in shaping corporate competitiveness and customer satisfaction. You can reach her at dtroppito@gantrygroup.com.

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