By Eduardo Alvarez, , Amit GuptaVinay CoutoChris Disherand It is more challenging than ever to improve business performance. The global economic downturn, diminishing returns on capital, internal business constraints, and new security and governance requirements all conspire to depress companies' results.Faced with these mounting pressures, most major corporations have already assessed their internal services and employed a series of cost reduction strategies. Traditional outsourcing has increased in scope and impact with the inclusion of business process outsourcing (BPO) and offshoring as new instruments. Evolution of the MarketplaceNow a market that totals hundreds of billions of dollars, business process outsourcing has evolved dramatically since the 1980s. The latest frontier in outsourcing lies offshore in places such as India, China, Malaysia, Singapore, even South Africa and Australia. Through offshoring by moving processes offshore allows companies to achieve greater savings than they could through traditional business process outsourcing alone.By outsourcing operations to its 2,500 employees in India, Citigroup realized an estimated $75 million in 2001.GE Capital now has over 15,000 employees in India.Prudential Insurance UK outsourced its call centers to ICICI OneSource in India and has achieved savings of 30% to 40%.American Express has reported savings of 50-plus percent on its Indian-based operations.Offshoring is growing at double-digit annual rates in both the United States. (11 percent) and Europe (12 percent) and is steadily migrating beyond IT applications development and transactional HR services. The Pitfalls Behind the PromiseIn a survey Booz Allen conducted last year with 100 U.S. companies, 80 of those companies that outsourced were satisfied with their outsourcing arrangements, and 94 indicated they would outsource again& so outsourcing is clearly here to stay. That said, outsourcing is no "silver bullet," and it comes with its own challenges and risks. Given the impressive economic arguments in its favor and the growing size of the market, BPO should be driving major improvements in overhead efficiencies, but that is not always the case. Our survey respondents cited weak cost controls, excessive standardization, and insufficient responsiveness to changing business needs as some of the significant challenges that remain (see Exhibit 1). When you add offshoring to the mix, additional political, economic, social, technological and operational risks emerge. Some of the factors that need to be weighed include:Political (homeland) - loss of white collar jobs; resistance from labor unions, local government, and professional associationsPolitical (offshore) - government stability, tax laws, legal system, educational systemEconomic - exchange rates, repatriation of profitsSocial - size and competition for talent pool, cultural differencesTechnological - infrastructure requirementsOperational - reaction of customer to voice-facing activities; reaction of unions to all activities; ability to manage interfaces, service levels, loss of competencies, data security, loss of customer contactKey Outsourcing LessonsOur work helping clients outsource both information technology and business processes has offered a few key lessons for those moving forward in this dynamic market. Understand Your True Objectives - Outsource for the right reasonsDon't Outsource a Mess - Eliminate the complexity firstMaturity Matters - Assess market maturity in developing strategyKnow Yourself and Marry Well Understand what you and the vendor really bring to the tableActively Manage the Relationship - Exercise good governance1. Understand Your True Objectives Financial services firms, as a group, are contending with margin compression, mounting customer expectations and increasing technology costs (see Exhibit 2). These trends contribute to a set of strategic imperatives that lend themselves well to an outsourcing agenda.The precise objectives for outsourcing will vary by company and by service. It is imperative that these objectives support a company's strategic goals, and that management is rigorous in executing them.2. Don't Outsource a MessIn our experience, too many companies try to outsource broken or needlessly complex processes and fail to capture the total savings possible as a result. Management either takes too long to clean up internal processes or gives up and outsources the mess. Excessive complexity generally stems from a "one size fits all" approach to delivering services. Over time, this sort of "standardized" approach often embeds unnecessary complexities and inefficiencies. In fact, the cost of complexity can overwhelm other value drivers, including scale and scope. In our experience we have observed that lower cost, scale-sensitive operations do not necessarily reap the expected economies as they grow in size and revenue. The cost of complexity is the culprit. 3. Maturity Matters All outsourcing is not created equal. Markets for these services mature subject to the same supply and demand dynamics we see in any other markets (see Exhibit 3).The way a company approaches and manages an outsourcing relationship will depend on where the process and supplier are on the market maturity curve. In the emerging and growing outsourcing markets, consistent standards for performance have not yet emerged, and players tend to be entrepreneurs with high margins. As the outsourcing market matures for a given business process, standards and creating conditions for scale advantages. The call center segment of the outsourcing market is going through this stage, as exemplified by Wipro's recent acquisition of Spectramind. Finally, in mature\/commodity markets, you see significant levels of automation and further consolidation take hold. On the other hand, in growth and early adoption markets, a consistent standard of performance is not assured, nor is the longevity of the supplier. Contracts tend to be more flexible and relationships more tightly monitored. 4. Know Yourself and Marry Well In understanding an outsourcer's true value proposition, it is important that executives assess their own company's strengths and virtues. To extract as much of the potential benefits from outsourcing as possible, companies need to thoroughly understand their own underlying economics and performance as well as those of the outsourcer. An external supplier may initially appear to offer cost advantages given its lower labor costs or higher utilization rates, but when total costs are taken into account - including remaining fixed overhead, new supplier management expenses and transition costs - outsourcing may be more expensive than keeping the function or process in-house. So it is also wise to understand the nature and source of a vendor's value to you in terms of maturity, reliability, industry experience, service breadth, service levels and contract flexibility. 5. Exercise Good Governance and Relationship ManagementNow the hard work begins. All too many companies negotiate a rigorous agreement and then fail to oversee it in a disciplined way. Outsourcing customers need to build the right organizational capabilities to manage outsourcing relationships, including a governance board.In any outsourcing environment, building the right governance structure is essential to ensuring that costs go out and stay out. Many clients create a board comprising business unit and functional leaders vested with the authority to set direction, fund, prioritize and evaluate and equipped with the requisite tools, systems, skills and well-defined processes. This governance board handles BPO provider management, performance analysis, contracting and risk management, alliance strategies and end-user liaising. The governance board agenda needs to address:Scope: Are we doing the right things?Delivery: Are we doing these things the right way?Performance: Are the right things being done well?Value: Is the corporation getting the benefits?Operating under the assumption that you need to walk before you can run, companies need to manage the transition to outsourcing methodically and systematically beginning from day 1. The Road AheadBPO is here to stay - the fundamental value proposition of outsourcing and offshoring is solid and only getting better as technology improves and experience grows. Over the next few years, the changes will be felt along three dimensions: Creative commercial\/partnership models: As they gain experience, suppliers will continue to improve their service delivery capabilities, understanding and alignment with customer needs. Relationship models will grow in terms of sophistication, and "industry vertical" and deep functional specialists will emerge.Scope of services: Innovation will drive improved service offerings and more sophisticated business models each year. Looking ahead, the services now frequently offshored will be rationalized in certain areas where intelligent automation tools will begin to offer a more cost-effective and reliable solution (e.g., scripted calls). That said, new services will be offshored and eventually all remote touch point services (barring political and legal constraints) will be commoditized and outsourced\/offshored Technological advances (e.g., increased bandwidth), aligned incentives, and geopolitical drivers will fuel the next wave of outsourcing and offshoring. Value capture: Value capture mechanisms will evolve as factor costs level off, differentiating the leaders, who will compete on the basis of innovation and best practice transfer. Companies will tend to use offshoring solutions as incubation labs to lead innovation and develop new processes. In summary, outsourcing will continue to drive tremendous shareholder value when implemented with care& and eyes wide open.