Outsourcing transactions have been taking place for about two decades. In the early years of the outsourcing movement, the financial industry led the way with large Information Technology Outsourcing (ITO) projects and later added Business Process Outsourcing (BPO) projects. ITO generally relates to a company’s outsourcing of computer technology such as mainframe computer operations or applications maintenance and development. BPO, on the other hand, usually refers to the outsourcing of business processes like accounting, human resources or facilities management. The financial industry’s more recent influence on the outsourcing movement has resulted from adverse market conditions created by the implosion of the credit markets. The economic downturn, coupled with overseas scandals and political pressures, all threaten to slow the growth of outsourcing transactions. Despite these barriers, outsourcing transactions continue to add value to customers’ operations under the right circumstances, and can indeed help customers weather the economic downturn. We address some of these circumstances and the value that can still be attained by the right outsourcing structure.
OUTSOURCING DELIVERY MODELS
There are generally three outsourcing delivery models: “onshore” outsourcing, “near shore” outsourcing, and “offshore” outsourcing. For either ITO or BPO projects, the service can take place in any of these locations. “Onshore” outsourcing generally refers to outsourcing work that takes place in the same country where the customer is located. For example, a U.S. company might outsource work to another local U.S. company located in a less expensive market or who has a specialized capability, such as accounting or computer assistance. In contrast, “near shore” outsourcing projects involve outsourcing projects where the work takes place in a country that is geographically near the customer’s operations. In the U.S. context, “near shore” outsourcing generally refers to outsourcing work to Canada and Mexico. Finally, “offshore” outsourcing is a catch-all phrase that describes outsourcing projects that are neither “onshore” nor “near shore.” India and China are two popular locations for U.S. offshore outsourcing. Besides foreign service providers located near shore and offshore, many of the U.S. based global service providers have their own “captive” operations near shore or offshore. “Captive” in this sense means companies that have opened up offices in near shore or offshore locations to minimize expenses such as labor costs, utilities, rent, legal regulation, and the like.
THE CREDIT CRISIS
Recently, several trends have developed in the U.S. outsourcing industry in response to worldwide economic conditions. Regardless of the outsourcing delivery model, the international credit crisis of 2008 and 2009 has made companies apprehensive about funding outsourcing projects. As the credit markets deteriorated, many companies were forced to delay new, or restructure existing, outsourcing projects. In some cases, projects were restructured to reduce the scope of the work. In other cases, existing outsourcing projects were abandoned altogether as companies conserved financial resources or others were forced to file for bankruptcy.
The trustworthiness of several Indian service providers has also recently come under scrutiny. One of India’s largest outsourcing service providers, Satyam Computer Services, Ltd., has been scandalized by recent revelations of substantial financial fraud. Its founder, B. Ramalinga Raju, announced in January 2009 that he overstated the company’s profits for several years, and falsely represented that the company had a cash balance of over $1 billion.
Soon after the announcement of the Satyam accounting controversy, Indian outsourcing service provider Wipro Technologies, another large Indian IT outsourcing company, came under fire for improper dealings with customers. The World Bank announced on January 11, 2009 that Wipro Technologies was on a list of companies that are prohibited from bidding for World Bank contracts for four years. The ban was in response to recent allegations that Wipro Technologies improperly offered Wipro Ltd. stock (the parent of Wipro Technologies) to employees of The World Bank Group. In general, these two scandals may only be the first of many that will be exposed over time. However, performing careful diligence prior to entering into a relationship with an outsourcing partner can help minimize some of the risks inherent in working with an offshore or near shore outsourcing provider.
DOMESTIC POLITICAL PRESSURE
In addition to the issues surrounding the corporate governance of Indian offshoring service providers, there is growing political pressure to keep jobs within in the U.S. During Congressional debate surrounding the use of federal bailout funds provided under the Troubled Assets Relief Program (TARP), several members of Congress sought to impose nearshoring and offshoring restrictions on companies that receive federal bailout funds. The final version of the economic stimulus bill, however, merely restricts such companies’ ability to hire workers with H-1B visas. Although the nearshoring and offshoring restrictions were left out of the final version of the economic stimulus bill, this protectionist sentiment could eventually lead to unfavorable regulation of the outsourcing industry.
THE VALUE OF OUTSOURCING TRANSACTIONS
Despite the pressures that have recently affected the outsourcing market adversely, outsourcing transactions are predicted to continue growing. In fact, some of the motivations for outsourcing are even more attractive as a result of the international economic slump. At a time when everybody is looking to cut costs, outsourcing services are in high demand.
Cost savings continue to be one of the key motivations in an outsourcing transaction. Outsourcing service providers continue to promote their ability to reduce a customer’s operational costs, while at the same time providing the customer with improved service-level performance, infrastructure scalability, and access to new technology and best-of-class processes.
Outsourcing also enables a customer to direct their strategic focus towards improving core competencies. Upon outsourcing portions of its enterprise, a customer may redeploy capital and reduce headcount by eliminating redundant operations. As certain functions are outsourced, a customer may then allocate its resources towards more specialized or core functions.
The downturn in the economy has affected the outsourcing industry in several ways. Nowadays, cost savings are often the “sole” focus of an outsourcing transaction, rather than the “primary” focus. Customers are asking for lower price models, and often make this the key issue during negotiations. To appease customers and obtain the business, many outsourcing service providers are more willing to accept concessions. For example, one concession may be lower pricing if service levels are sacrificed or reduced. As outsourcing service providers compete for customers’ constrained budgets, outsourcing service providers’ fees are predicted to fall.
Similarly, service providers are also changing their pricing structure to protect their interests as well. In an effort to manage their risk against potentially insolvent customers, service providers are now seeking to collect upfront payment for their services, and are reluctant to absorb or spread out any upfront or transition costs. In addition, the service providers are demanding shorter payment cycles.
During these turbulent economic times, both service providers and customers are less willing to take on risk. As a result, outsourcing contracts tend to have shorter terms and fewer renewal options. Broader termination rights and increased risk-sharing of liability are other trends that appear to be driven by the down economy.
Cost-conscious customers often have little or no money in their budgets for innovation. Most outsourcing projects today are focused on managing customers’ existing operations at a lower price, rather than improving customers’ processes and technology. Also, outsourcing projects tend to have a narrower scope. Large multi-service outsourcing projects, which were once popular, are not as in vogue these days. Instead, budgetary constraints are forcing customers to focus on outsourcing projects with narrower scopes.
IS OUTSOURCING RIGHT FOR YOU?
In light of the recent scandals involving big Indian companies in the outsourcing industry, customers should perform more due diligence before choosing an outsourcing service provider. For example, customers should consider asking for a letter of credit or a guarantee from a parent company as part of an outsourcing deal if the service provider is weak financially or not forthcoming about its finances. References can be requested and checked, and complaints to authorities and other fact-checking can be considered to help ensure that you are dealing with a reputable service provider. Despite the recent Satyam and Wipro controversies, there are many trustworthy outsourcing service providers.
Customers should also request contract provisions that will enable them to monitor and govern service provider performance. For example, outsourcing customers should consider including clauses that require regular meetings between management and the service provider. This can help prevent an outsourcing transaction from going off-track before it is too late or too expensive to fix. Customers should also consider forming a steering committee or hiring an account manager directed to oversee the outsourcing relationship. Although such precautions may seem like costly governance mechanisms during these periods of financial difficulty, they are likely be well worth the time and money spent to implement them particularly if the transaction is large. Inadequate governance is often cited as one of the main reasons for failed outsourcing projects. Otherwise, a laissez-faire attitude with respect to monitoring performance can result in inefficiency and wasted time that could reduce potential cost-savings. Simply “handing the keys” to a service provider without proper governance is unwise, particularly in the current economic climate.
The recent economic downturn has forced many companies to slash their budgets. However, outsourcing transactions can help customers maintain their operations in the face of difficult economic circumstances. Many of the motivating factors that drove the growth of the outsourcing industry during good economic times will also provide value to customers during these tough economic times. Of particular note is the ability to realize cost savings if the transactions are constructed properly.
By the same token, the same risks that were present in outsourcing transactions during the good economic times are magnified during these tough economic times. Fortunately, these risks can be addressed in outsourcing agreements. Customers who conduct the proper due diligence can negotiate more favorable, but fair, outsourcing agreements given the current buyerfriendly outsourcing market. During this economic downturn, outsourcing transactions can also provide customers with competitive advantages, and place them in a position to hit the ground running when economic conditions improve. Similarly, those outsourcing service providers who are able to align their services with customers’ needs using creative pricing structures should greatly benefit in the present marketplace.