Outsourcing Woes

The outsourcing industry in India has had its share of misdemeanors in the recent past and a fair amount of publicity too. But these blips are more than just stray incidents. They pertain to far more fundamental issues, rather a lack of understanding of the fundamental issues.


The last few weeks have been really heady for the Indian outsourcing industry. Barely had the dust on the Karan Bahree scandal (as it has come to be popularly known) settled that ABC raked up another storm.

Without really discussing too much about the widely reported incidents, let's try and figure out if these events are an augury of things to come or they are just minor aberrations that have been over amplified by our sometimes panic-prone media? Whatever, these definitely warrant are a deeper introspection by both the outsourcers and the service providers.

Let's try and first look at what really are the benefits of outsourcing (I know reams have been written on the subject, but I would like to start from the very beginning).

The key driver to outsourcing has been the huge differential in manpower costs between the developed western economies and the developing countries or the source and the destination of the outsourcing contracts. Some studies suggest that the saving on manpower costs alone can be as high as 40 to 70 per cent, of course depending on the nature of work and the skill of the worker involved. Definitely a lucrative enough saving for any company to think about outsourcing. The underlying assumption to all this number crunching is scale of operations. The scale of operations must be large enough to absorb the increase in communications and technology costs and also the increase in management costs. And it is precisely because of an inability to address and quantify these that many outsourcing deals do not meet their preset return on investment (RoI) targets. A study suggested that this number could be as high as 80 per cent. Ah, so there goes some steam out of the whole mathematics…

An oft heard and repeated remark is that anything that is not core is an ideal candidate to be outsourced. So the other big driver has been the need to focus on core business activities. A survey conducted by management consultants AT Kearney revealed that as many as 80% of the respondents opted to outsource because of these two reasons.

This however is contrary to experience of companies from the field. A poster boy example of this philosophy was the signing of seven year $5 billion IT outsourcing deal between JPMorgan Chase and IBM Global Services in December 2002. At the face of it, IT is definitely a non core function for a global financial institution. While this may definitely be true for a small or a medium sized business organization, it does not ring true for a global company. And therefore in less than two years, in September 2004, JPMorgan Chase announced the cancellation of the deal. It was in retrospect (of signing the deal) that the bank felt the direct management and control of IT was critical to gain a competitive advantage.

Identify the right candidates
So processes that are not core but require significant personal intervention or high levels of customization or change frequently often may not qualify as good candidates for outsourcing. If looked at in light of the factors listed here, experience and research seem to suggest that as many 30% of a company's typical processes are not the right ones to outsource. Its ramifications for what can be outsourced run rather deep. What in effect this means is that companies must outsource only those processes which are characterized by low management complexity and low interaction needs. In other words processes that are simple and standardized are ideal candidates to be outsourced. Further more the technology supporting these processes should be stable. Am I suggesting that more complex processes like IT are not good candidates?

No, I am not suggesting that. While I say that only simple and standardized processes are ideal candidates, at the face of it, IT gets excluded. IT processes stand being termed as simple and standardized provided the risks associated with them are mitigated by the managers. And many mangers of today are barely aware of the risks associated with any outsourcing deal.

Risks classified
Any business process, even IT, that is being evaluated as a prospective candidate for outsourcing is exposed to strategic, operational, financial, and hazard risks.

All natural and some man made risks would fall under the hazard category. On the other hand strategic risks are those that threaten to take the business in a harmful direction. The JPMorgan Chase-IBM example is a good example of a strategic risk. JPMorgan Chase felt a certain loss of control over a process that could impart it a sustainable competitive advantage thereby hurling the company into an arena of increased competition. A company faces a similar risk if the outsourcing partner is incapable of scaling operations in response to the company's growing needs. After all it's a scale game, remember.

Operational risks are more to do with the operation capability of the outsourced party. Poor service is one of the biggest operational risks. Others could include risks that rise out of governance and staff related issues. Financial risks are those that leave a dent in the financial statements. Needless to say they are those that inflate costs or lead to unforeseen expenditure. The Karan Bahree case would be labeled as a cusp of the operational and financial risk. While it was definitely a governance issue, it led to quite a few costs for the client in doing damage control with its customers.

It's very important for managers on both side of the outsourcing deal to have a clear and sound understanding of the associated risks for effective mitigation and management of the same. Recent examples suggest that many in the industry are either ignorant or wishfully ignore this fundamental. And if that doesn't happen, the episodes that have been labeled as mere blips on the outsourcing radar will only grow bigger and louder.

I was writing quite a lot a year and a half ago and this one is from that era, if I can call it that.