Vacationing

Taking a break sans laptops and microchips. Will be back on Sep 5th and resume posting then.

Of Outsourcing, Compliance and Due Diligence

George Mathew has an informative post on ITToolBox about the role of due diligence in outsourcing success. I thought it was necessary to add to that post in terms of its importance in an evolving regulatory environment. In a world of HIPAA, CA SB 1386: the Database Breach Notification Security Act, and Sarbanes-Oxley, outsourcing firms must document their due diligence in vendor selection and management of business processes and IT security over the life of the contract. The need to understand processes and technology becomes more pronounced and complex when a business process is offshored to locations such as India, Eastern Europe, China where the intellectual property rights regime is weak and legal liability is limited.

For example, in 2003, Ohio-based Heartland Information Services, which had outsourced some work to a firm in Bangalore, India had a close call when several disgruntled employees of the offshore firm stole proprietary information and sent anonymous e-mails to Heartland, demanding money from Heartland for the return of the information. If Heartland refused to pay, the employees said they would release the information, which they claimed contained patient records, on the Internet. Fortunately, the perpetrators were nabbed within a few hours, and the information was never publicly disclosed. Unfortunately, it was not an isolated incident. The University of California at San Francisco Medical Center and more recently, Citigroup have had close calls with the protection of their customers' personal information.

In an environment where adequate compliance is necessary for competitiveness, a thorough due diligence by the outsourcing firm is necessary. The firm must require an audit of the provider's systems and business environment. It must have a thorough understanding of how information is created, transmitted, processes and destroyed. Such audit reports and results of any testing or on-site inspections must be reviewed actively by the client firm. Finally, security responsibility and liability must be clearly documented in contracts and/or service level agreements to allow for effective and timely response to breaches when they occur.

Marne Gordan, the Director of Regulatory Affairs for TruSecure Corporation, in a recent article on ZDNet says, "Remember, it is impossible to put too high a price on information security, particularly in today’s regulatory environment. A little time and effort spent up front can save any organization potential loss in terms of revenue, resources, and reputation."

Why this Outsourcing Deal won't Fail

In this post on ITToolBox, Sandilya writes about why outsourcing (actually, offshoring) will croak. The probable reasons for failure cited by the author include process immaturity, cultural differences and the time difference. The more I think about what he says, the more I am convinced that far from croaking, outsourcing won't even catch a cold.

Process Immaturity: This point focuses on one of the objectives of BPO, i.e. process efficiency at reduced costs of ownership. It reflects simple rules that traditionally, organizations used to apply to BPO, viz.

• Outsource mature, non-core processes
• To specialized providers
• To achieve cost savings and
• Improve management focus

However, isn't that fast changing? In a recent research project, my interactions with more than 150 BPO managers from a range of organizations revealed that companies are pushing the envelope and using BPO to achieve a diverse set of strategic objectives. For example, TradeRanger, a start-up used BPO to launch its business, a utility company in my sample used BPO to restructure its business when the energy sector was deregulated, etc. More than 40% of the managers in my sample said that they had outsourced processes of strategic importance. More important, a plethora of articles point to the rapid growth in outsourcing of innovation and R&D to Asian contractors. This is the least mature of business processes. Even in the case of mature processes, the providers' competitive advantage cannot come from efficient servicing, scale and skill. When the limits of efficiency are reached, it will have to come from process innovation.

Cultural Differences: I might agree with the overall perspective but the illustrations don't do it for me. They're too simplistic. First, the language of technology, although not as universalistic as Mathematics, is fairly uniform. I agree that translating business requirements to this language of technology is the difficult part. But, Sandilya makes a broad generalization. Sophisticated coordination infrastructure and communication technologies are the very reason why BPO is so pervasive today. Coordnation and communication costs are a function of the nature of the outsourced process - think payroll vs. product design. Perhaps, in the latter case, the solution here is human resources. You pick the person who can translate store to shop, you work collaboratively with the client during the transition (of course, the nature of the process determines the coordination costs here), and "What if you needed a small piece of code in one week? Would you spend three days explaining how the system works in the US?" - No!

Time Difference: I agree that this can be a bigger problem than the prior two - limited widow of time and minimal mistakes since each mistake can cost a day. However, if you see it as a 24 hour development lifecycle, you can manage it thus. Maybe you need a teamwork approach and managers on both sides of the world who can get up early and stay up late. But, yes, this requires tight management controls, sound processes that ensure a smooth hand-off between teams, and sophisticated technology that allows the offshore team remote access to the client's network and pertinent archives. This one, I agree.

Who's the Winner?

The Financial Times recently heralded the maturing of BPO as a strategic driver for business transformation. The article reminded us that outsourcing enabled American firms to focus on their core competencies, insisting that these competencies including product innovation and important research & development would remain in-house. However, this interesting article in Business Week highlights how that pledge is now passé.

The reach and impact of Asian contract manufacturers and design houses have expanded to touch nearly every industry. The likes of Dell, Motorola and Philips are buying complete designs of some digital devices from Asian developers, tweaking them to their own specifications, and slapping on their own brand names. Similarly, Boeing Co. is working with India's HCL Technologies to co-develop software for everything from the navigation systems and landing gear to the cockpit controls for its upcoming 7E7 Dreamliner jet. Pharmaceutical giants such as GlaxoSmithKline and Eli Lilly have joined forces with Asian biotech research companies in a bid to cut the average $500 million cost of bringing a new drug to market. And Procter & Gamble Co. says it wants half of its new product ideas to be generated from outside by 2010, compared with 20% now.

The numbers are pretty overwhelming too. Of the 700 million mobile phones expected to be sold worldwide this year, up to 20% will be the work of Taiwanese ODMs. About 30% of digital cameras are produced by ODMs, 65% of MP3 players, and roughly 70% of personal digital assistants (PDAs). In a previous post, I had discussed how the Taiwanese companies believe that they are outsourcing marketing and branding to the rest of the world. That's not farther from the truth. Whether its HTC, which creates and manufactures smart phones for such wireless service providers as Vodafone and Cingular as well as equipment makers or Quanta, whose engineers are working on next-generation displays, digital home networking appliances, and multimedia players, the providers are not getting ideas from their clients, they are innovating on their own.

It is interesting that although a majority of the American firms are cash-rich - the 80 tech players in the Standard & Poor's 500-stock index have a total of $229 billion in cash and equivalents on their balance sheets, more than twice what they had at the end of 1999 - they're tightening their R&D budgets. The cash is directed towards acquiring companies and some of it makes its way back to shareholders. True, most firms still house their critical design strengths. But, as the limits of outsourcing innovation are pushed, it does raise some interesting questions - where will companies direct their profits? More important, what is the future of the firm? And finally, who's the winner? Initial evidence suggests that American firms can orchestrate global manufacturing and design networks to their benefit. Yet, as HTC and Qantas move up the food chain, they have a shot at becoming industry leaders. Which leads me to the conclude yet again - the fate of a firm is increasingly decided, not by ownership and protection of capabilities, but creative and effective coordination of such capabilities around the world.

Function-based companies

A recent article in the Harvard Business Review (sorry - you need a subscription to read it) talks about the rapidly growing discipline of “capability sourcing” which espouses the view that every single activity in the value chain can and should be evaluated as a candidate for externalization. This new paradigm in outsourcing emphasizes the strategic position of a firm as a specialized provider of a set of core functions that drive competitive advantage in its industry, and is giving rise to a new class of “function-based companies” such as UPS (logistics management), Solectron (contract manufacturing) and Hewitt Associates (HR management) that have "transformed their core functions into entirely new industries".

While highlighting the significant benefits of outsourcing and the payoffs from developing scale and skill in a single core function, the emergence of this new class of companies also points to an interesting trend - the growth in non-asset based outsourcing services. Companies like UPS Consulting and Hewitt are increasingly leveraging their asset-based expertise and core capabilities to broaden their service-oriented, non-asset based businesses that have greater margins. This is driven by the better margins at the provider's end, the increasingly strategic role that outsourcing plays in modern businesses, and the allied need for information to make the transition to an outsourcing model.

In this article, Orville Bailey, president, CEO and co-founder of B2eMarkets Inc. provides an interesting perspective on the progress of outsourcing services - "The first is where you outsource the bid-capture piece, different types of negotiation. The market is extremely comfortable outsourcing that piece." Second, "The hot area for the next 12 months is outsourcing request for information, request for proposal, request for quote. Managing the back and forth piece with the supplier. The market is getting more comfortable outsourcing that part."

The third stage in this sequence is the outsourcing of strategy formulation. Traditionally the domain of consultants, this is where the function-based companies are moving in. The article states that B2eMarkets hopes to "cannibalize" the consultants by offering learning tools and "content sensitive coaching" licensed from Accenture and others, to reduce the level of skill required for effective sourcing.

It is interesting how this keeps the sourcing process both outsourced and proprietary at the decision level. What is more interesting is the continual dissolving of firm boundaries. It seems that soon, important decisions will relate, not to ownership and protection of capabilities, but effective coordination alone.

Oops...

Just found out that comments from prior posts were deleted when I installed the haloscan trackback software. My apologies!

Chew on that

Here are some statistics that shed more light on offshoring. These have been culled from various newspaper articles and the NASSCOM website.

• 400 of the Fortune 500 companies have either set up offices in India or outsource to Indian technology firms.
• 200,000 jobs will be provided by outsourcing centres in India by 2011.
• India controls 44 per cent of the global offshore outsourcing market for software and back-office services, with revenues of $17.2 billion in 2004-5. By the end of 2005, India's software and back-office exports are expected to reach $22.5 billion and hit the $50 billion mark in the next five years with the industry growing to over $75 billion. India's market share in global outsourcing in 2008 is expected to be 51%.
• For every dollar that US firms spend on offshoring, they save 58 cents.
• Six hundred and sixty multinationals bring business of more than $1 million annually to India. All that adds up to work for over 3.5 million Indians-1.05 million programmers and other skilled workers, and 2.5 million people in support services such as transport and catering.
• NASSCOM predicts growth in exports at 27% each year.
• The share of the ITES-BPO sector in total revenues of India's it software and services increased from 6.5 per cent in 1998-99 to 29 per cent last year.

Haloscan commenting and trackback have been added to this blog.

Take a moment...

...to pause and marvel at the US economy, says the Wall Street Journal. Why, you ask? Friday's bullish Labor Department report. The findings may help to dispel the widespread perceptions and perils of outsourcing even as vehement expressions of this concern (read Lou Dobbs and the jobless recovery) now look a trifle off base.

The report states that more than 200,000 new jobs were created in July, and two million were created over the past year. More statistics ensue to provide a context for the report. For example, more Americans have jobs today than at any other time in history. Further, over the past two decades, the U.S. has created more than 40 million jobs -- twice as many as Europe and Japan combined. And finally, the U.S. has one of the lowest jobless rates of all developed nations. The WSJ reminds us that the "5% jobless rate today is almost a percentage point below what it was during the same stage of the business cycle during the vaunted Clinton expansion." The jobs recession began with the bursting of the technology bubble and stock market collapse of 2000-01 and hit bottom in mid-2003. The recovery began when the Bush marginal-rate tax cuts were enacted into law (no causal nexus there!).


The report is also testimony to a resilient, adaptable economy with a tremendous capacity for absorption. As the article concludes, "a unique feature of the U.S. economy is that Americans move in and out of jobs -- usually to rise up the income elevator -- at a rapid and persistent pace. This is the key to the Great American Jobs Machine, and it explains why Europe and Japan should be more like us, and not the other way around."

What matters to you?

In an attempt to better understand the key issues that confront managers in the design and management of BPO relationships, I recently conducted a survey among 25 large to medium-sized firms that had outsourced one or more business processes to an external provider. Governance including relationship management, performance monitoring and control, risk management, and coordination and communication in the BPO relationship was identified as a primary concern by the respondent managers. What do you think? What are some of the challenges that you face in the management of your BPO relationship to which you would like some answers?