Reverse trend - why companies are re-thinking outsourcing

Many companies are starting to refine their sourcing strategies to capitalise further on the advantages.

Aviva, one of the largest insurance groups in the UK, recently announced that it would be transferring 5,000 outsourced employees back in-house over the next 15 months.

And Pearl Group, the closed life fund management specialist, has just transferred 90 per cent of its business operations to Indian-based outsource firm TCS.

The unusual aspect of these deals is that the Aviva in-house operation is based in India, while TCS has just opened its first onshore operation centre in Peterborough.

Although the two are usually spoken of together, outsourcing does not necessarily mean offshoring – and offshoring does not always mean outsourcing.

‘The two are related,’ says Phil Codling, senior analyst at Ovum. ‘Outsourcing is any use of another company to run a part of your business, while offshoring is sending work to another location to take advantage of lower costs. We talk about global sourcing in the sense of using global locations, whether in Europe, India or elsewhere to gain cost or skills advantage.’

According to a recent survey on the impact of global sourcing on the UK software and IT services sector, analyst Ovum predicts that the total number of UK-facing staff employed offshore will double to 131,000 over the next three years.

The shift will have an effect on the number of people employed onshore, and the size of the UK-employed workforce will drop by a total of 15,500.

‘The Indian providers are getting more sophisticated in terms of the services they offer,’ says Codling.

‘Rather than just coding they are taking on whole projects, maintenance and support, as well as moving into managed services including infrastructure and looking for the longer-term contracts rather than the short-term fix.’

The report suggests that at least 70 per cent of today’s software and IT services workload could feasibly be carried out from remote offshore locations.

Originally, functions deemed to be non-critical and non-differentiating were selected as ideal candidates for outsourcing as the risk to the business was minimal, while labour intensive processes benefited from offshore outsourcing taking advantage of lower labour costs.

‘Customers also considered outsourcing processes that were problematic in one way or another,’ says William Martorelli, principal analyst at Forrester.

‘But they need to think twice before outsourcing a broken process unless an explicit method to improve the process is built into the outsourcing engagement.’

Offshoring is not just about cost reduction, although Aviva has reported cost savings of £225m – most of that through moving jobs to India.

Other advantages include the ability to provide superior service levels, access to scarce skills, gaining advantage from the research and development budgets, and the option to undertake smaller, previously uneconomical pieces of work.

‘The primary reason for initially using an Indian third party was to gain faster time to market,’ says Rajnish Virmani, chief executive of Aviva Global Services.

‘They had the people and expertise, and although that benefit had a price and a premium, it reduced our risks far more than if we had set up our offshore in-house operation from day one.’

The offshore business model has matured and outsourced processes are no longer exclusively low-level. ‘Some offshore providers are adept at offering business process services heavy on knowledge and judgement that would stretch most definitions of what are considered to be commodity services,’ says Martorelli.

With these developing skills, offshore companies, particularly those from India, are increasing their UK headcount to support new business sales and marketing as well as consulting opportunities that need to be carried out close to the client.

Because of the rapid growth and high margins delivered by the offshore-based segment of the industry, vendors are able to sustain onshore employee growth, through hiring and selective acquiring of UK-based firms.

‘It is inappropriate to put some processes offshore,’ says David Power, chief executive of Diligenta – the UK arm of Indian outsourcing company TCS.

‘Other players such as Accenture, IBM and Siemens have started onshore and then built offshore capability to provide global delivery. TCS is putting the same model in place only moving in the other direction.’

The trend is confirmed by Ovum’s report estimating Indian specialists will employ 13 per cent of their UK-focused staff in UK-based jobs within three years.

Codling, meanwhile, says the UK is generally seen as a relatively easy place to do business, primarily because UK customers are more receptive to the notion of offshoring and contracting with an offshore supplier than many of their European counterparts.

While the trend for offshoring is growing, John Lord, leader of risk management solutions at business information firm Dun and Bradstreet, urges caution.

‘Offshoring and outsourcing is great when it works, and it has been good at controlling costs and enabling key strategic projects, although for some companies it has lost them their agility in the marketplace,’ he says.

‘However, because the outsourcing market is now more mature and offers more choice, customers need to start thinking about their future, including possible exit strategies.’

When the Aviva outsourcing contract was put in place three years ago, there was a clear exit strategy. ‘It was always part of our plan and intention to bring this capability in-house and that functionality was built into the contract,’ says Virmani.

‘When the transfer is complete at the end of 2007, it will be the biggest transfer of Indian offshoring with more than 5,000 people in nine areas of work.’

The project has been so successful for Aviva’s outsourcing partners that they are now offering a build, operate and then transfer service to other clients looking to set up offshore capability with minimal risk.

While the legal experts ensured that the appropriate get-out clauses were added to the Aviva contract, Virmani and his team refused to consider failure.

‘An exit strategy is for the lawyers, but on a daily basis we look to succeed with our partnering arrangements, and keep asking the question: “How do we make this work?” We treated it like any large project and followed the change management processes, erring on the side of over-communication,’ he says.

The Indian offshore business process outsourcing industry is continuing its impressive growth, despite undergoing a dramatic change in emphasis from voice-based, contact centre solutions to transaction and knowledge-based services.

However, Martorelli says the benefits of lower labour costs are coming under severe pressure from new entrants to the offshore market – especially China and Brazil who are vying for the number two position.

What the experts say

Price remains the overriding factor offering competitive advantage and margin improvements that can be passed on to customers. Taking your research and development budget offshore makes it go so much further. Up to 60 per cent cost savings can be achieved on most offshore arrangements and even with 15 per cent wage inflation in India, it still remains attractive.

Phil Codling, senior analyst, Ovum

Keep in mind that cost savings through labour arbitrage are typically a one-time benefit unless specific process transformation and improvement is involved. However, offshore business process outsourcing (BPO) providers are extremely well qualified to improve process performance from a quality control standpoint.

William Martorelli, principal analyst, Forrester Research

If you are contemplating BPO at this level, it is vitally important to understand your outsourcer’s financial model really well. Don’t just go in and hope that it all works. Underpinning it all is trust. Both parties need to be clear about what is being provided, be prepared to be honest in dealings, disclosing all problems from the earliest stage so there are no surprises. It needs open dialogue all the way through.

Tony Kassimiotis, chief operating officer, Pearl Group

A common mistake in outsourcing is to believe that it will solve problems – it does not and often exaggerates them. First, the problem needs to be resolved – either by the organisation or the outsourcer – then the best practice documented and those processes built into the contract.

John Lord, leader of risk management solutions, Dun and Bradstreet

With any business strategy it is important to focus on the results. At Aviva it is all about keeping expenses low and customer satisfaction high. A bonus that was not on the original wish list has been productivity enhancements because of the energy and enthusiasm of our people offshore. Our next challenge is to upgrade our skills to deliver even more value to the business and to do it cheaper, faster and better.

Rajnish Virmani, chief executive, Aviva Global Services

Conventional wisdom says that the more complex, lower-volume activities should stay onshore because the costs of obtaining them offshore are too high. However, the complexity is diminishing and the utility model, such as the one we are developing for life policy management, plays a central part in allowing companies to outsource both complex and low volume processes.

David Power, chief executive, Diligenta

Further reading:

Case study: how Pearl Assurance gained from outsourcing

Lloyds TSB outsources HR