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Outsourcing continues to evolve with new capabilities and delivery models to meet buyers' expectations; they bring, of course, associated risks. We spoke with industry experts to get their take on the risks for 2008 along with their insights on how to mitigate the risks.

We top off this must-read information with an insightful look at how buyers and service providers are actually their own worst enemies in setting themselves up for risk at the outset of their discussions.

Risk: Market Share Plays

A risk for potential failure of an outsourcing deal--because it is unsustainable--arises from focusing on cost. Jim Way, Vice President Managed Services Operations, Siemens Medical Solutions, warns, "Buyers beware: don't take the lowest bid." Way explains taking the lowest bid inevitably results in a provider writing change orders and nickel-and-diming the client over time.

"Make sure you know the complete cost of ownership. Make sure the supplier clearly defines this cost and states what is included in what you're paying for," Way adds. "You wouldn't buy a car without knowing that the cost includes tires. But many buyers of outsourcing services neglect to find out if the cost actually includes the "tires"--technology, process changes, etc. that are necessary to get the outsourced work to the end state the buyer desires.

Risk: Attrition

Sergey Karas, Vice President Global Strategy at Luxoft, Russia's largest high-end ITO service provider, predicts the fight among providers for talent resources will increase in 2008. Buyers need to be aware of their risk regarding attrition.

"Really look at the provider's attrition levels and also learn what strategies and tactics the provider uses to keep its employees," Karas advises. "Ask about the provider's retention policies, do site visits, and also talk to the project managers. Be sure your potential provider really takes a partnering approach to outsourcing, demonstrating that it is as interested in retention for the success of your deal as you are."

Risk: Currency Fluctuations

Ross Tisnovsky, Vice President, Research (ITO) at Everest Research Institute ranks currency fluctuations (such as the dollar-to-rupee rates) as a risk. Everest estimates that nearly 40 percent of IT services firms' staff is now located offshore. "This is a very significant part of the service delivery costs, and the currency fluctuations can have a very strong effect on providers' costs and margins. We are likely to see it become a major risk factor in 2008," states Tisnovsky.

Smart buyers already transferred the currency risk contractually to their providers, but Tisnovsky warns buyers to be aware that providers will want to shift this risk.

Risk: Security

Karas of Luxoft warns that risk mitigation must include very tight security planning and policy execution. "In 2008, with greater depths of data potentially shared in innovation and transformational deals, security practices need to become a more natural and definitely proactive part of any successful outsourcing arrangement."

Security planning and procedures should span systems, data, IT, physical, and staffing, as well as disaster-recovery blueprints.

Buyers and Providers are Their Own Worst Enemies and Set Themselves Up for Risk

Gianni Giacomelli, Head of BPO Strategy and Marketing, SAP is another industry expert acknowledging "there has been a lot of sometimes unwarranted publicity about BPO failures, low client satisfaction, and BPO being a risky decision." The same risks apply to ITO, too; but ITO matured over the last 20 years, so providers know how to make money and save money in ITO, "which contributes to their ability to invest enough into all measures that lead to risk mitigation," he adds.

Giacomelli says that there must be a better understanding of risks so buyers will know whether their providers can effectively deliver on the ultimate objectives. "But buyers and providers still cling too much to governance and legal ways of mitigating risk," he explains. "Those formalistic ways, while necessary, are not sufficient, as they often do not tackle root causes--the "genetic" (i.e., design) problems of service delivery."

"This is a massive blind spot," warns the SAP exec. "The fact is if you design an outsourcing relationship badly at the beginning, no amount of contractual language will help."

Therefore, risk mitigation in 2008 needs to shift away from contractual language to better engineering of delivery. This requires putting a lot more effort and talk in the RFP process around the topic of sources of risk.

The SAP exec cites three primary sources of risks:

1. The provider must harness economies of scale and standardized processes. The buyer often does not allow the provider to make enough money so it can save and redirect some to make the necessary investments in process optimization, compliance, technology, etc. This results in tensions and, therefore, risks.
2. Best practices and process optimization ensure the provider will save money. But some providers do not implement best practices, or their customer organizations do not allow them to do so. He cautions this is a risk for the buyer that "ultimately reflects in poor deal economics which, in turn, forces providers to run things on band-aids." As an example, a tiered service delivery in HR BPO would see a sequence of tiers that the users encounter (tier 1 being call center reps using scripts, tier 2 being staff that have the ability to answer more questions, and tier 3 being experts. Best practices would ensure the user stays, whenever possible, in the lower tiers, as they are more cost-effective.
3. Buyers must allow the provider to access labor arbitrage as much as practicable so it can have an economic advantage.

Buyers and providers rarely discuss these three aspects in depth in RFP cycles, says Giacomelli. "The parties need to focus more on service delivery, not just on contracts and governance. The buyer needs to understand whether the deal is sustainable. The parties need to agree on what to standardize around the best practices of the provider."

BPO providers' service delivery people know whether something will actually work economically, says Giacomelli, but providers seldom can bring them into the RFP cycle decisions. Further, in the RFP cycle, he says providers "seldom discuss risks by focusing on the root causes of service delivery failures. Will the delivery leverage enough scale? Will it access labor arbitrage? Will the process be optimized and standardized, and in which countries? If not, the provider will not make enough money to invest in the deal," he warns.

Customers often want it "my way" and are reluctant to listen to providers talk about standardization. "In doing so--uncritically--they plant the seeds of risk," he advises.

"This is an extremely important point," says Giacomelli. "A lot of BPO providers' front-line sales people talk high level on how to deliver services (SLAs, systems, etc.) but do not address how the service delivery looks in detail for the end users and how it saves money compared to the baseline."

For example, will a client's portal have the same user interface or a new one? Which calls will go to tier 1 and which to tier 3? The answers have a lot of operational implications behind the scenes for the provider. As a result, the provider might need more people for the process--adding costs; otherwise, there may be pressure in meeting service levels or may be errors (again, adding costs).

"The buyer also needs to understand how the technology solutions underpin the processes," Giacomellli advises. For example, does the technology help deliver the economies of scale and the ongoing process optimization and innovation that the service delivery needs? Does it facilitate harnessing labor arbitrage? By asking for customization everywhere, does the client build inflexible legacy into its deal?

Contracts grow with added processes, new countries brought into scope, etc. He warns buyers to "be sure the supplier builds your solution at the outset in a way such that it can scale to that new scope without generating too much cost. If it won't scale or if it is too customized to scale cost-effectively, it impacts not just your SLAs but also your ability to switch to another provider. A new provider does not want to take over a band-aid operation from a prior provider."

The sales person in the RFP cycle generally knows there will be an implication to certain service delivery aspects but does not know precisely what the implication will be, Giacomelli explains. "So ideally the RFP cycle should include the provider's implementers and the day-to-day service delivery experts. But they are usually under water and cannot participate in the sale/RFP cycle. It also might be a good idea to bring the technology vendor to the table, as long as they know BPO well."

He sums up his risk-mitigation advice as follows: "Valuing and structuring risk is a critical skill/activity. Risk mitigation is greatly complicated by the fact that buyers usually focus on high-level risks such as strategic risks and protection of IP when, in fact, operational and organizational risks are far more likely to occur and are the root cause of many others."

Lessons from Outsourcing Journal:

• Buyers beware: taking the lowest bid inevitably results in a provider writing change orders and nickel-and-diming the client over time.
• Buyers seeking to mitigate risks must find out the complete cost of ownership of the outsourced process. Make sure the supplier actually includes in the cost all the technology, process changes, etc. that are necessary to get the outsourced work to the end state the buyer desires.
• Attrition among providers' human resources is a growing risk. A buyer should be sure a potential provider really takes a partnering approach to outsourcing, demonstrating it is as interested in retention for the success of the deal as the buyer is.
• Nearly 40 percent of IT services firms' staff are now located offshore. This is a very significant part of the service delivery costs, and the currency fluctuation can have a very strong effect on providers' costs and margins. Smart buyers already transferred the currency risk contractually to their providers, but buyers need to be aware that providers will want to shift this risk.
• In 2008, with greater depths of data potentially shared in innovation and transformational deals, security practices need to become a more natural and definitely proactive part of any successful outsourcing arrangement. Security planning and procedures should span systems, data, IT, physical, and staffing, as well as disaster-recovery blueprints.
• Buyers and providers still cling too much to governance and legal ways of mitigating risk. These formalistic ways do not tackle root causes found in genetic problems of service delivery. If you design an outsourcing relationship badly at the beginning, no amount of contractual language will help. Therefore, risk mitigation in 2008 needs to shift away from contractual language to better engineering of service delivery. This requires putting a lot more effort and talk in the RFP process around the topic of sources of risk. The buyer needs to understand if the deal is sustainable. The parties need to agree on what to standardize around the best practices of the provider.
• In the negotiation and solution-design phase of the RFP process, a lot of providers' front-line sales people talk high level on how to deliver services (SLAs, systems, etc.) but do not address how the service delivery looks in detail for the end users, how it saves money, and provides funding for improvements. This information is important, as it impacts a provider's operational implications behind the scenes, which can increase costs or impact service levels and errors. Ideally, the RFP cycle should include the provider's implementers and the day-to-day service delivery experts.
• The buyer needs to understand how the technology solutions underpin the processes. Be sure the way the provider builds the solution at the outset will be able to scale to new scope without generating too much cost. If it won't scale, it impacts not just SLAs but also the buyer's ability to switch to another provider.

Publish Date: November 2007

Copyright © 2007 - Everest Partners, L.P.

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