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How To Evaluate Which Business Functions to Outsource
By Peter Bendor-Samuel, CEO, Everest Group
After years of outsourcing consulting, we realized companies need a framework to help them think through emotional business issues in a clear and logical way. We created what we call the "Everest FrameworkSM" to serve as a road map for companies thinking about outsourcing.
The Everest FrameworkSM helps our clients identify and evaluate the business functions that are appropriate candidates for outsourcing. After all, outsourcing is not always the best solution to a thorny business problem. The Everest FrameworkSM helps companies make educated business decisions about change.
Outsourcing is composed of two elements: value creation and value capture. The Everest FrameworkSM reflects these two components. I'll discuss value creation to kick off our new Best Practices series. Next month I'll tackle value capture.
The first section of the Everest FrameworkSM helps companies determine if they can actually divest themselves from a specific business process. Often, answering this question is the toughest part of the assessment process.
Can a supplier handle the supply chain management function? Would it be more cost effective to let a supplier take over the payroll? If the answer is affirmative, the next segment focuses on business process outsourcing (BPO) suppliers. Can a BPO supplier create value if it takes control of this process?
"Total Value EquationSM" Identifies Value
Everest uses what we call the "Total Value EquationSM" to understand where value comes from in a business relationship. When companies are trying to decide if they should outsource, we recommend assessing the value outsourcing can generate, if any. Outsourcing relationships should:
- Generate direct savings. Buyers always want to know if outsourcing will reduce their costs. Many outsourcing agreements lock in cost savings in the master contract.
- Create indirect savings. Fixing a business problem or restructuring a business process creates beneficial results internally. For example, recruiting and training costs go down if employee morale is improved by improved service. Outsourcing heightens these results by making the changes more tangible.
- Reduce risk. Outsourcing passes on the risk of change to the supplier. Companies who elect to solve the problem in-house must bear the risks that come with change themselves.
- Make the outsourced process more valuable to the rest of the company. Reducing bureaucracy makes it easier to get things done. Companies that upgrade their human resources (HR) function by being able to offer better benefits through their outsourcing supplier may be able to recruit higher caliber employees. Adding top talent helps the other business processes. On the financial side, many buyers outsource because they have difficulty closing their books on time each month. Outsourcing produces better financial reports and analyses. More accurate and timely information leads to better and more informed decisions.
- Ease regulatory reporting. When you hire a recognized expert as your supplier, you work with a company that has a long history of successful interactions with your regulatory agencies. Often, you have an easier time of compliance when they are fighting your battles for you.
- Mitigate antitrust issues. Say your company develops a strategy that helps the entire industry. That immediately raises the antitrust shackles. If you outsource the process to a third party, it may eliminate the antitrust worries.
- Improve customer relations. One of our clients had poor IT systems. It had lost all credibility with its customers (the ones that didn't abandon ship) because it could never satisfy their automated orders in a timely fashion. This company partnered with a supplier who eliminated the systems problem. Over time, this company restored its lost customer satisfaction. This lead to increased sales.
- Please stockholders. If a company is worried about the bottom line, stockholders much prefer outsourcing a function to layoffs to cut payroll costs, even when the savings are the same. Stockholders realize outsourcing a process allows companies to easily scale their staffs up or down in response to the economy. Layoffs, on the other hand, can damage stock prices.
- Address the difficult issue of change. Human nature makes everyone resistant to change. Organizations, too, fight change, especially when the changes involve an important business process. All companies considering outsourcing have to determine the price the organization must pay to overcome this enormous internal resistance to shaking up the status quo.
Structuring the Transaction Properly
Determining where the value is the first step in a business assessment. Once you understand where the value is, you can shape a solution to maximize those benefits.
Unfortunately, we see quite a few - if not most - outsourcing transactions that were created without going through a process similar to our Total Value EquationSM review. Because they didn't know what to protect, they created outsourcing agreements that actually diluted the benefits that could have accrued from the relationship.
We use analytic tools to help our customers quantify the answers to their value creation questions. They include:
- Cost analysis. This is an important discipline that ensures we have not forgotten any important elements. We use cost modeling to determine the financial boundaries and estimate the approximate financial benefit. This ensures we are making realistic assumptions.
- Leverage analysis. Leverage points are areas where there is a potential for improvement based on a specific process. Leverage points include:
- Economy of scale considerations. Will the cost go down with increased volume?
- Labor arbitrage. Does the supplier have access to cheaper labor than you do?
- Resources. Does the supplier have access to scare resources you can't reach?
- Investment capital. Will the supplier invest its money instead of yours in the process improvements?
- Best practices. Have you implemented best practices? If not, will outsourcing move you further along on the best practices learning curve?
We understand the organizational principles behind each business process and know where the leverage points are.
- Stakeholder analysis. We identify the key elements in the organization that will be affected by change. We determine the potential challenges and points of resistance from those who will lose power or their jobs. Stakeholder analysis helps organizations understand the price they must pay to change a business process.
- Risk analysis. We analyze the personal, financial and organizational risks involved in outsourcing a process.
- Capability analysis. We evaluate the current utilization of each leverage point and determine if there is an opportunity for improvement. Then we assess whether it will be better to change things in-house or if an outsourcing supplier make a better contribution. We do this all in percentages.
- Tactical analysis. We look at specific actions we can take to improve the situation. We examine whether the organization can do this internally or whether an outsourcing supplier is better positioned to execute these tasks.
- Supplier analysis. We understand the suppliers who are available. We know who has product offerings and competencies that fit your needs or which supplier can change its process to provide the services you require.
The numbers we generate in this analysis present a detailed blueprint to the buried treasure called value. It creates a road map that details where the various business processes intersect.
This process map is useful because it helps the organization understand the scope and the size of the transaction.
Taken together, these tools provide a useful vehicle to hold sensible conversations about a highly emotional and somewhat illusive concept. We've discovered that this framework allows business executives to look at their business functions from a new perspective. This helps them shape solutions and build an organizational consensus around their decisions.
Consider Assessing More Than One Process at Once
We recommend assessing more than one process at once when studying value creation. Since all business processes interlock, scrutinizing them all at once helps you appreciate the potential synergies available and challenges you'll have to face.
Next month I'll discuss how to capture the value outsourcing creates.
Lessons from the Outsourcing Primer:
- Outsourcing contracts can dilute the possible benefits if you don't know where the value is before you start.
- Everest's Total Value EquationSM is a tool to help buyers evaluate where they can create value in a BPO transaction.
- Outsourcing more than one process at once creates strong synergies, especially when IT is involved in a business process.
Publish Date: September 2001
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Copyright © 2001 - Everest Partners, L.P.
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