TPI’s Peter Allen, in a recent blog posting in The Deal, asked whether it was better to offshore a business process using a captive or third-party model. Interestingly, the article offered no real conclusion to the question of which is better, but did highlight the most important aspect – and the biggest shortcoming – in many outsourcing relationships: The client’s inability to get past the labor-arbitrage model and, instead, focus on outcomes.
Of course, everyone would like to move past the labor-arbitrage model – and away from a pure cost-based measurement. Doing so would allow suppliers more flexibility in operating their model and offer, customers, theoretically, the outcomes that they desire. But moving to an outcome-based measurement can be difficult for companies who are focused on reducing their administrative expenses by next quarter.
Also, as hard as costs are to estimate accurately, they can often be measured with some level of precision. Developing outcome criteria, let alone measuring the results, can be a very difficult exercise at best. Furthermore, even the successful outcomes must be folded back into the value model so that the investment can be recouped.
A focus on outcomes can be dangerous for managers within an organization. If, for example, I outsource a process to get better results than I had from in-house staff, am I not commenting on my own organization’s and internal management’s weakness in dealing with a process and the people supporting it? Outsourcing for pure labor-arbitrage avoids those difficult issues by placing the underlying foundation on price, not skills.
I have, for years, counseled clients to look beyond the immediate bottom line and seek service and process improvements from their outsourcers. After all, a company that provides similar services across a range of customer likely has developed expertise and skill that comes from a broad base of experience. Unfortunately, this advice is rarely followed. Furthermore, legitimate concerns about proprietary processes are misused and too broadly interpreted by clients and their organizations, creating irrational lock-downs of information.
Ultimately, I do agree with Peter – that the only way to get the real value of outsourcing is to focus on outcome targets rather than labor arbitrage. However, a client must ask why those same outcomes were not looked at while the process was in-house and whether, given transactions costs and training costs, the end result will present savings significant enough to warrant the loss of skills and institutional knowledge. This remains the seminal question in outsourcing – the question that every organization will ultimately have to answer.
3 Comments
Gary;
Personally, I think that the disruptive force will come from an upstart - a new entrant to the industry that is not beholden to a legacy business model. Neither the “heritage” multi-nationals or the India-based behemouths seem to be able to muster the courage to break from their existing business models.
To be fair, neitehr are tehre many clients these days exhibiting buying tendencies for other than lowest-cost-effort. The low-hanging fruit of labor arbitrage is just too appealing.
So, does this mean that the serviecs outsourcing industry really *is* just another flavor of globalization that exploits the workign class?
If so, it’s not sustainable.
That’s why I think a new entrant will emerge - with the backing of an ambitious client or two - to break the mold.
I’m actively looking for the dance partners.
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Hi,
On the question whether the clients should choose between third party services or captives - I suppose, it depends on factors as - commoditization of services, maturity of services, scale of operations etc. In the Indian context, the scale of operations is a very significant aspect - if you wish to maintain a small operations, you need to decide whether the Captive is really worth the effort. Essentially it boils down to the management time and focus.
On the issue of business outcome vs labor arbitrage aspect - we find that it is really difficult to measure the business outcomes, especially in situations wherein a service provider provides just a link in the chain, and not the complete chain. In such situations, one can explore linking the incentives paid to the service provider based on the overall client profitability over a period - or developing some mechanism along these lines. Atleast it will ensure that the service provider’s actions are aligned with the client goals.
On the issue of labour arbitrage vs outcomes - In most of the deals, the clients do ask on how many people will be engaged to provide the services, which again goes to show that the clients and even the advisors are keen on pursuing the labor arbitrage model. The service provider community is working overtime to come up with models and approaches that removes the dependency on labor arbitrage, but the initiatives have to be taken by clients and service providers teaming up.
The next 5 years will be crucial as to how the clients and service providers respond to shrinking labor arbitrage opportunity.
Regards
Subir Dhar
Bangalore
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