The mid-term stage of large, complex business process outsourcing deals is critical, and with many contracts now at this stage, problems are beginning to show, writes Mark Vernon.
Business process outsourcing (BPO) is booming: it grew by 18% year on year in 2003, according to analyst firm Gartner. But look at the more mature partnerships, three or four years into the outsourcing of large, complex, multi-million-pound back-office functions including human resources, procurement and accounting, and the strain is beginning to show. The problem lies with the contracts that govern such deals and the flexibility (or lack of it) built in to them. It seems they may not be ageing well - so will a mid-life problem for BPO turn into a mid-life crisis?
The critical period for assessing the efficacy of BPO begins 18 months to three years into the life of the contract, and in many cases, that is now. Xchanging, a company that specialises in BPO, commissioned three professors from leading business schools to look at what is happening. Their research is instructive.
Leslie Willcocks of Warwick Business School, David Feeny of Templeton College Oxford, and Mary Lacity of the University of Missouri at St Louis looked at hundreds of outsourcing deals and assessed where they flourish and fall short. Their work reveals that BPO tends to fail on three fronts. First, because of divergent expectations within the partnership. Second, because of unsustainable levels of innovation over time, and third, because of the inappropriate application of an outsourcing model borrowed from another business function. In other words, the mid-life period is critical because it is then that these problems solidify.
With regards to divergent partnerships, consider what can happen in a straight fee-for-service outsourcing deal. Initial benefits include the freedom the BPO partner has to bypass internal politics and act because of senior management endorsement. However, these tend to erode over time. For example, the suspicion grows that the supplier, perhaps inadvertently, shifts its goals to serve its own ends and not the needs of the customer.
When it comes to unsustainable innovation, the problem is illustrated by a BPO provider that brings in, say, management consultants to look at a back-office operation. At first, a high infusion of energy and new skills is brought to bear on the tasks at hand, as the management consultancy puts its best entrepreneurial minds on the case. However, once a solution is devised, the entrepreneurial spirits move on to the next problem. With their departure goes much of the capability to innovate. Again, over time, what the supplier brings to the table stagnates - an issue that is compounded if commercial realities change, which is likely given the long life of these kinds of contracts. The Xchanging research indicates that customers can simply be left stranded.
With the third issue, that of the applicability of outsourcing models, concerns arise because it becomes clear that the anticipated cost benefits are not realised. The deeper problem is that real change is not effected since there is a dearth of know-how to bring it about.
If Xchanging's work with Willcocks, Feeny and Lacity reveals internal problems with BPO, Angela Wyatt, director and senior consultant at Orbys Consulting, another BPO specialist, points to external issues too.
"BPO contracts typically last between five and 10 years, that is, several business cycles," she says. "Over these timescales, market changes are inevitable, so any early misalignment will only grow, and grow."
For example, a company may become involved in merger and acquisition activity or some kind of global consolidation, necessitating a fundamental renegotiation of existing BPO deals. Or, as companies outsource more business functions, perhaps adding HR to a successful first experiment in finance, renegotiation becomes vital to prevent two or more BPO providers pointing fingers at each other when these business functions overlap. "We have seen this in the retail and finance sectors," says Wyatt. "You need to find joint remedies."
Alternatively, consider the changes that have taken place in the IT industry since BPO first emerged, and perhaps when a deal was first signed. The issue of Y2K compliance has come and gone. The dotcom boom has ended. Both these events have altered the way companies think about IT services. Another effect is the dramatic evolution of the telecom sector, with falling commodity prices.
"No matter how well structured a BPO deal was, if it was designed to grapple with the operating imperatives of yesteryear, it will not be optimised for the business environment today," Wyatt says. "And that is to say nothing of how your business itself has changed. Hence the crisis that contracts face."
Offshore outsourcing is facing a similar period of reassessment. "The rewards and risks of offshore BPO are just beginning to be understood," says Sujay Chohan, research vice-president at Gartner. "As enterprises and service providers evolve, it has become clear there is no right model for a given company. Instead, enterprises will use parts of a model or a combination of models as they begin to explore and iron out the issues around sending business processes offshore. No enterprise will fully insource or outsource offshore. Most will use a combination of delivery models as they climb the learning curve to BPO."
BPO is not a one-off decision but demands ongoing renegotiation. Wyatt believes that contracts need to be managed and maintained as much as any other commercial asset. "This is not to say that contracts written two or three years ago need to be ripped up and rewritten from scratch - though some may require substantial reworking if that is the only way to avert a crisis," she says. "Rather, renegotiation needs to be built into the deal. It should be a continuous process."
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Case study: How one BPO contract pulled failure from the jaws of success
The partnership was 18 months in the making. The human resources function was to be outsourced in its entirety. The contract was signed: benefits and bonuses were keenly anticipated.
The supplier's top entrepreneurs moved in, thoroughly enjoying the year or so when processes were redesigned, staff reallocated, and savings identified. But once rolled out, they were off to the next new project.
A new set of people were brought in to manage things. They lacked the skills that lay behind the early success. In retrospect, it was from this moment on that the project was under threat. When three years in, systems and processes needed to be consolidated after an acquisition, these people were simply not up to it. HR was a poorly performing back-office function once more. The only thing that had changed was the people running it. BPO had, for the most part, failed.