Part 1: What's Driving the Growth of BPO?: The Impact of Labor Arbitrage

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Part 1: What's Driving the Growth of BPO?
The Impact of Labor Arbitrage
By Eric Simonson, Everest Group

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driving the growth of BPO To the casual observer, the fundamental sources of leverage - technology, best practices and scale -- that were behind the growth of IT outsourcing are now driving the pace of BPO outsourcing. But a deeper look reveals that the primary driver is the combination of labor arbitrage with these leverage points.

Labor arbitrage modifies the fundamentals of outsourcing. This article outlines those changes.

Adding Labor Arbitrage To the Outsourcing Tool Box

Labor arbitrage is simply the ability to pay one labor pool less than another labor pool for accomplishing the same work, typically by substituting labor in one geography for labor in a different locale. The outsourcing industry is now applying labor arbitrage widely; it is transitioning from a novel approach to a competitive requirement. India, Eastern Europe, Latin America, Southeast Asia, and other regions are all serving as labor markets for outsourcing of activities.

Historically, companies have applied labor arbitrage to manufacturing activities. Manufacturing moves tangible product from one geography to another; outsourcing moves information. Successfully doing this requires significant thought regarding work segmentation. Outsourcers have to break apart the work process into well-defined sub-activities that can then be assigned to different resources in different geographies. The challenge of managing across geographies heightens the importance of a careful segmentation.

Additionally, labor arbitrage poses a significant challenge in managing risks (e.g., political and civil unrest, languages, currency, taxes) and in sustaining a labor arbitrage benefit as the demand for labor in a market increases.

Done correctly, the leverage gained can be significant, ranging from a 30 to 80 percent savings. Some of these potential savings are "given back" through the increased cost of managing remotely and implementing a disciplined process, but companies are willing to carefully think through these other issues in order to achieve a significant impact. In Everest's experience, the best case scenario purely from exploiting labor arbitrage after all additional costs have been added back is in the 50 to 60 percent range.

So, when is labor arbitrage an appropriate strategy? Typically, the content of the process to be moved offshore is people intensive with at least 40 percent of the process cost relating to labor expenses. Examples include software application development, claims processing, and many clerical functions. Clearly, the labor content is not the only factor impacting the decision or else face-to-face sales forces would be gone forever! Indeed, the decision on what, if anything, to move offshore must be taken seriously.

Although the exact approach will differ, a tiered philosophy is emerging as the preferred strategy. In this strategy, customer intimate functions are performed on-site, high trust functions such as inbound call center are in-country or near shore (e.g., Canada), and well-defined transaction processing is performed at offshore locations.

Impact on Technology's Role

The segmenting of work flows required to use labor arbitrage as a leverage point typically changes the role of technology: It now plays a larger role in the process and it requires different types of technologies. For example, in paper-driven processes like benefits or claims processing, the paper must be converted into digital images that can be quickly and economically transferred across the globe.

The actual activities completed by the lower cost labor may not be significantly different, but the process utilizes technology more intensively (i.e., electronic filing of forms, not paper). Additionally, suppliers deploy new technologies to make the redesigned process efficient (e.g., imaging equipment, telecommunications networks). In some cases, these new technologies must address multi-lingual issues not previously considered.

This technological "turbocharging" of formerly mundane processes has a cost that frequently diminishes some of the potential labor-only savings.

Impact on Best Practices

The tremendous economic benefits of labor arbitrage also drive increased investment in reengineering the process for maximum efficiency and effectiveness. Traditionally, outsourcers have expended some effort on reengineering people processes, but seldom at the level required in offshore situations. Additionally, the reengineered processes are more rigid in order to drive the standardization that allows for management of the process across geographies. Since no one person can literally see what is going on, the process must be so well-defined that issues seldom arise and when they do, the trouble-shooting process is straightforward.

Outsourcers face another challenge in developing best practices: allowing some degree of customer-specific customization without losing the benefits of standardization. The trick in overcoming this challenge is to define the overall process in such a way that the buyer can tailor the most important requirements, while still allowing the outsourcing supplier to retain the required leverage points. In short, the best practice must reflect both the supplier's need for operational efficiency and buyer's need for customization.

In an IT environment this can generally be handled through some level of automation - not so with labor arbitrage. The customization impacts employee training and required skills sets.

Impact on Scale

In an offshore labor arbitrage situation, scale must be managed at three different levels: in-home country, local offshore sites, and across offshore sites.

In-home country
The infrastructure required to transmit the work material to the offshore site must be designed to achieve sufficient scale. In some cases, the required scale can be significant. For example, imaging centers only become economical when designed for high volumes with 24 hour operations. However, the transportation cost of paper (both time and money) to an imaging center can also be significant. In this situation, outsourcing suppliers must be able to create regional imaging centers that achieve the required scale.

Offshore sites
In many cases offshore efforts require that the outsourcing supplier develop an entire "community" within a country. These sites typically employ thousands of resources (people), thereby requiring large scale recruiting and training efforts (and sometimes even housing). The facilities must also be operationally robust, often requiring redundant power systems, satellite up-links for data transmission, and large-scale computer systems.

Across offshore countries
Over time outsourcing suppliers are developing the ability to move work between different offshore sites. The potential for short-term disruptions or longer-term changes in the labor market necessitate that work become "portable" across sites. This places another burden of scale on suppliers and their ability to quickly and cost-effectively rebalance work across different geographic regions.

Labor arbitrage is playing a significant role in accelerating the pace of BPO. However, buyers and suppliers must not forget that labor arbitrage is only part of leverage equation for successful outsourcing relationships. When labor arbitrage utilizes best practice processes designed around appropriate technologies and is executed at scale, the power of the solution can be tremendous.

Lessons from the Outsourcing Journal:

The combination of labor arbitrage with technology, best practices, and scale to create powerful solutions is driving the increased interest in BPO.
Labor arbitrage is a game-changing opportunity which requires great discipline to successfully apply.
The benefits of arbitrage are offset by investments in technology, best practices and scale that are required to access labor arbitrage. However, the economic advantage is generally still significant.

Next month in Part 2, we'll discuss how suppliers create "transaction engines" by combining labor arbitrage with technology, best practices, and scale. The series will conclude with a discussion of examples of different transaction engines.

Publish Date: November 2002

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