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A clearer world view of services

In-house or outsourced? Onshore or offshore? Tight or light control? Picking the right sourcing option for services isn't easy, but a new model can help guide your decision, explains a collection of subject matter experts from Capgemini Consulting including George Yip, Director of Research and Innovation.

3 January 2008

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A panel of Capgemini Consulting subject matter experts including; George Yip, Director of Research and Innovation, Yacine Chibane, Senior Consultant, Melanie Knight, Executive Consultant and Leyton Lark, former Managing Consulting at Capgemini Consulting, discuss the outsourcing trend and how using a simple but effective model can help with the bewildering variety of choices.

Sure, we already outsource a lot of IT work to India and our customer helpline to Scotland. But what about offshoring our human resources administration to Poland, or even some of our R&D to China or Russia? And should that stay in-house even if we move it overseas? Those are scary decisions.” 

Companies and public-sector organisations are outsourcing and offshoring more and more services. But they face a bewildering variety of choices. Physical products and components constituted the initial wave of global sourcing that started in the 1980s. But since the 1990s there has been a steady growth in the number of services, particularly in financial and information technology processes, that are being sourced globally. The phenomenon of business process outsourcing (BPO) has been an element of this. During this period, more countries have become suitable locations for providing such services, and more qualified service providers have emerged. But the global sourcing of services is even more complex than that for products – the delivered service is harder to define, the process needs more constant monitoring, it happens in real time, quality varies more, and so on.

Developed from extensive and original research, this article describes an approach and supporting model that can help organisations to make sourcing decisions more effectively. It costs a lot in time and expenses to investigate global sourcing options, so we recommend starting with desk analysis to narrow the range of options. But this analysis has to be carried out on a comprehensive and systematic basis, or promising but less obvious options might be ignored. Our approach and model:

  • can be applied to any service;
  • incorporates the major elements, both internal and external, affecting a sourcing decision;
  • uses data from external benchmarks;
  • allows for the incorporation of company-specific data;
  • provide for sensitivity analysis.

By providing a systematic approach to diagnosing decision parameters, the model allows decision-makers to explore the right options for their own particular circumstances.

GLOBAL SOURCING MODES

It is well established that the two key decisions in global sourcing concern ownership (in-house or outsourced) and location (onshore or offshore). Our research found that there is a third key factor to be taken into account, particularly for services. This is the level of management required to ensure that the service delivers. Some service providers will require ongoing tight management, while others can be held at arm’s length after the transition and be only lightly managed.

There is clearly a trade-off here between cost and risk, and the right place on the spectrum depends on the characteristics of the environment the sourcing organisation finds itself in.

To make it easy to visualise and remember the choices, we have simplified these three dimensions of choice into a “global sourcing cube” (see figure 1). This cube has two choices on each of the three dimensions, although there are obviously intermediate points on each.

For ownership there is a spectrum from 0 per cent to 100 per cent, including partial ownership or joint venture. For location, there are nearshore locations (for example, Poland in the case of western European companies, or Mexico for US firms), and some offshore locations (eg, India) that are further than others in terms of both geography and dissimilarity, such as in culture. It does not necessarily follow that the nearer the location the better the fit.

By way of illustration, consider a UK business, whereby a service offshored to Australia will be culturally closer than one outsourced to Poland. Similarly, some French companies offshore to Mauritius, thousands of kilometres away but closer in language and time zone than other, geographically closer, locations.

For management, the tightness of supervision is obviously one of degree. Nevertheless, the use of eight simplified choices fits within a number that is readily grasped. To increase the intuitive understanding of these eight modes, we have chosen memorable labels for each, as shown in figure 2. Where you are on the sourcing cube will dictate the level of cost, innovation and risk. Moving from the sourcing mode at the front lower left of the cube to modes at the back upper and right side of the cube generally reflects movement to less controlled modes but potentially to higher levels of cost reduction, service quality and innovation.

CHARACTERISTICS AFFECTING THE CHOICE OF MODE

How should managers choose between the available modes? Our research suggests that there are a number of characteristics to evaluate:

  • the nature of the service under consideration for sourcing options;
  • customer demand in relation to that service;
  • the sourcing organisation’s experience and capabilitie in sourcing, including its ability to collaborate with another organisation;
  • competitors’ best practices and threats;
  • the supply market of potential providers.

By asking 30 key questions linked to five characteristics – service, customer demand, organisation, competitors and supply markets – managers can get a good idea of which mode to select. Figure 3 lists these questions and how a “highly agree” answer to each would suggest particular global sourcing modes.

To use this framework, you should answer all the questions. If you “highly agree” with a question, then you should record the recommendations. If you “highly disagree” with a question, then you should record the opposite of what is recommended. If your answer is in between “highly agree” and “highly disagree”, use your judgment to record the recommended choice(s). After answering all the questions, add up all the recommendations for all six sourcing modes and see which modes get the highest scores.

  • Service characteristics. These questions mainly cover the extent to which the service can be standardised and easily sent outside the organisation and home country. Therefore, these questions should distinguish between easy to outsource services such as travel bookings and difficult ones such as field sales. 
  • Customer demand characteristics. These questions cover such issues as internal customer demand and external customer impact, and the sensitivity of local cultural influences. These questions would probe effects such as the need to stay onshore or nearshore to get language and cultural compatibility. This is why, for example, a number of US and British companies have been bringing their customer service operations back onshore.
    An American document management company we researched set up an in-house shared services centre (SSC) for translation services in one European city. Its customers in various European countries, however, became increasingly frustrated by the SSC’s lack of local knowledge, which meant that a high proportion of queries were referred back to local teams, thereby diminishing the value of the SSC. 
  • Organisation characteristics. These questions mainly cover the ability of the sourcing organisation to perform the process itself, and also its experience and ability in managing providers. These questions directly address the choice of ownership, location and management mode. Our own firm, for example, has kept its finance and accounting function in-house because of the capabilities it has developed to serve external clients. These capabilities reside in our BPO service and are offshored in Poland and India. Similarly, a global software company we researched found that its in-house finance and accounting shared service centre was best in class and has decided not to outsource these services despite the current trend to do so. 
  • Competitor characteristics. These questions cover the extent to which competitors set precedents or pose threats in global sourcing. In many cases, companies need to globally source in order to match a competitor’s level of cost or service. A global professional services firm we studied found that its finance and accounting function cost significantly more as a percentage of total costs than those of its competitors, and decided to offshore these services in order to match industry norms. 
  • Supply market characteristics. These questions cover the extent to which suitable providers are available. It is easy to decide to source an IT process because of the extensive supply market that has developed in India, and increasingly in other countries such as China. But it is much more difficult to decide to globally source services such as product testing, which is only just beginning to see capable providers develop. The American document management company mentioned earlier finds that translation services are more readily available offshore for many languages. 

The 30 questions in our framework are both generic enough (not specific to a particular service) and detailed enough (about particular aspects of the sourcing situation) that they can address a decision about any service, from any sourcing organisation, to any provider organisation, and sourcing to and from any country.

Obviously, you should use these questions only as a checklist to stimulate your own thinking, to support your own detailed analyses, and to cross-validate decisions you have made or are considering.

HOW THE CHARACTERISTICS CAN DRIVE SOURCING DECISIONS

The following case examples show how the global sourcing of services model and the 30 questions we have outlined opposite can lead to the right decision. The decisions made by the companies featured were reached independently of our framework, but we have suggested how the framework justified the actual decisions made. In each case we highlight those questions among our list of 30 that really drove the choices along the three dimensions of our global sourcing cube: ownership, location and management.

Case 1: Managing insurance repairs

A European insurance company, “InsureCo”, has to decide how to source non-automotive repairs covered by its insurance policies. When a customer makes a claim, InsureCo has four ways of dealing with it:

1. The claim is authorised over the phone and the customer is paid and asked to arrange for their own repairs.

2. InsureCo proposes to carry out the repairs (less than 10 per cent of InsureCo’s work).

3. An expert is assigned to call the customer and assess the damage.

4. An expert is sent to the scene of the damage.

This case example focuses on option 2. InsureCo outsourced the management of this activity entirely to four different service providers, of which one company, from a different European country, holds the biggest share.

Hence InsureCo chose the outsourcing mode for ownership and a mix of onshore and offshore for the location mode. In addition, InsureCo uses the tight management mode. In other words, of the eight modes described in figure 2, it opted for a combination of “ONT – cohabitation” and “OFT – gold frequent flyer”.

How did the company choose this combination? In deciding to outsource, two supply market characteristics questions seem to determine the choice – Q30 (“Is the supply market able to provide this process at maintained service levels and at lower cost?”) and Q28 (“Is the capacity of skills required available in the vendor supply base?”) The strongly positive answers to these questions make it clear that the repair services should be outsourced. After all, InsureCo provides insurance services rather than the myriad skills needed to repair many different aspects of housing and personal property. Indeed, the company uses about 1,200 private repair professionals such as plumbers, decorators and builders.

But there are actually two services involved, of which repair is the later stage. The earlier stage is provided by what InsureCo calls the “supplier of the repair platform”. In this first stage, the policyholder contacts the supplier to establish the claim and the supplier selects and manages the independent repairer. This service was previously carried out in-house by an InsureCo team of about 30 individuals based across its home country.

So why did InsureCo outsource this first stage as well? This was because, while option 2 (InsureCo doing the repairs) accounts for less than 10 per cent of all claims, it consumed a much higher proportion of management attention as a result of the numerous tradespeople who were engaged to do the work. So a further service characteristics question that applies to the service platform activity is Q5 (“Can the service be delivered remotely without internal staff or customers’ involvement?”) The strongly positive answer confirms that the process can be outsourced.

Next, why was the largest supplier of the first-stage process an offshore company? Although language is clearly an issue, it is easily solved by the use of InsureCo home language speakers based in the supplier’s country. The customer demand characteristics question Q12 (“Is process success independent of local cultural influences?”) yields a fairly positive answer, since the customer interaction is about the practicalities of scheduling repair work rather than, say, more sensitive matters of personal information (as would be the case for health insurance claims).

Another customer demand characteristics question, Q9 (“Are internal customers more concerned about the cost of the service than service excellence?”), is the clincher with a fairly positive response, and the latter is true partly because of the positive response to a service characteristics question, Q6 (“Can decisions within the process be based on standard specified criteria?”).

Lastly, why does InsureCo use tight management? That decision derives from positive answers to two customer demand characteristics questions, Q10 (“Does the process in scope have significant brand impact?”) and Q11 (“Does the process in scope differentiate the organisation in its competitive landscape?”) InsureCo’s reputation is at stake and customers are sensitive to how they are served, particularly when the choice of repair by an InsureCo repairer is the customer’s last resort, having rejected other options. In addition, the nearshore supplier was under severe pressure from its head office to make better returns. So a real difference exists between the economic model used in the supplier’s country and that used in the home country: the supplier is more cost-conscious while the client organisation has to regulate quality.

This example also shows the importance of persistence and evolution. InsureCo’s initial forays into outsourcing the work as a managed service were not impressive. However, rather than withdrawing from outsourcing, lessons were learned and a more considered approach was adopted to further develop corporate understanding of how to make sourcing decisions work. InsureCo decided to adopt an evolutionary approach.

Its vision is ultimately to have two suppliers, but to
begin with four are being tried. At the end of the first year this will be reduced to three and then later to two based on the competence demonstrated and the suppliers’ ability to work with InsureCo.

The case demonstrates the value of regularly reviewing decisions using a set of evolving criteria, such as those used in the global sourcing decision support tool, even when an organisation is relatively experienced at making global sourcing decisions.

Case 2: Software development and support

Between 70 per cent and 80 per cent of what global business software company “SoftCo” outsources is services. The company had been offshoring non-core activities for some time and this had proved beneficial. Effective ways of working with vendors had been established, so it decided to look at offshoring more core activities.

The development of software involves the writing of code followed by the testing of code. Also, when the software is released, the support of the application in service may require training or consulting on how best to use the application. Clearly, the reputation of SoftCo is largely dependent on each of these aspects being carried out properly, and so there is a strongly positive response to Q10 (“Does the process in scope have a significant brand impact?”)

SoftCo has chosen to outsource and offshore the development of software largely to India, and increasingly its Indian service providers are involved in supporting the software in service. Performance is relatively lightly managed but a significant effort is made to tightly manage the relationships with its Indian software developers.

In addition, SoftCo is finding capability elsewhere in the world and has established captive centres – SoftCo in-house facilities – in Israel and South America. But why does the company consider the “OFT – gold frequent flyer” mode to be right for India and the “IFT – trust but verify” mode to be the right choice for other countries?

The decision to outsource and offshore software development and support to India was based on a number of characteristics. The group procurement organisation was challenged to find ways to take cost out of the operation and, having researched the supply market, it became clear that for India the responses to questions Q24 (“Is the supply market of service providers (vendors) mature?”), Q27 (“Are the key skills required in this process all available in the vendor supply base?”), Q30 (“Is the supply market able to provide this process at maintained service levels and at lower cost?”) and Q28 (“Is the capacity of skills required available in the vendor supply base?”) were all strongly positive.

However, these positives were countered by initially negative responses to Q8 (“Are internal customers convinced that outsourcing will be beneficial?”). It was therefore necessary to move cautiously to prove suppliers’ capabilities. SoftCo limited its initial moves offshore to software testing because of the strongly positive responses to Q1 (“Can the service be standardised and procedures easily documented?”) and Q2 (“Can requirements for performing this process be easily specified and effectively monitored?”). Interestingly, as the suppliers’ performance was proven, so the scepticism from internal customers changed to demand more work be carried out offshore. The range of work has subsequently expanded to include software coding and service support.

The decision to outsource or not for other countries was more complex. The supply market in India was particularly mature, but when SoftCo looked at other locations it found that the characteristics were different. For example, in the case of Israel the responses to Q27 (“Are the key skills required in this process available in the vendor supply base?”) and Q28 (“Is the capacity of skills required all available in the vendor supply base?”) were strongly positive, as they were in India. However, supply costs were high, prompting a strongly negative response to Q30 (“Is the supply market able to provide this process at maintained service levels and at lower cost?”).

As a result, SoftCo decided to set up an in-house capability in Israel to take advantage of the skills, while maintaining control over the cost of operation. South America, on the other hand, is attractively low cost, prompting a positive response to question 30. But the supply capability needs to be developed, so the responses to questions 27 and 28 were negative. Once again, therefore, SoftCo has decided against outsourcing and has instead set up an in-house captive centre.

The Indian offshore outsourced experience provides an example of how SoftCo’s approach to management changes as capability matures. Initially, processes were managed tightly, but as the capability has been proven so the management effort has reduced to the point where the contract is managed lightly, with service levels based on response times and outcomes. Hence the sourcing mode now is effectively “OFL – move and forget”.

An important distinction needs to be made, however, between the performance of the contract and the management of the relationship. Both the Indian service providers and SoftCo continue to put significant effort into managing the relationship, suggesting that even when the management mode is light, successful organisations continue to invest in their relationships with external parties.

A BUSINESS CASE MODEL

We have also used the 30 questions to drive a decision support model based on the business case for global sourcing. Although the latter has to examine many factors, our model focuses on three critical ones: the potential benefit in terms of cost savings; the costs of sourcing and implementation; and factors that might mitigate the potential cost (eg, collaboration).

The business case can be described as an algorithm with the following key elements:

1. Expected value (EV) – the bottom-line business case.

2. Potential value (PV) – the maximum possible savings from a particular sourcing mode.

3. Cost impact (CI) – the end-to-end costs associated with the sourcing of the service and the implementation of the service provision.

4. Probability (Pr) of incurring the cost impact.

5. Collaboration mode (CM) – to mitigate costs.

6. Cost of collaboration (CC) – indirect costs in relation to
the service.

These six elements come together in the following equation: EV = PV – (Pr x CI/CM) – CC

Potential value. In our model, potential value (PV) is the possible gross savings from using a global sourcing mode, as a percentage of current total costs for the activity under scrutiny. Our review of the evidence and our own research suggest that offshoring and outsourcing can save up to 35 per cent of the costs of an onshore, in-house process; offshoring and in-house can save up to 30 per cent; and onshore outsourcing can save up to 20 per cent.

Cost impact. The potential savings are reduced by various costs that have to be incurred to change the sourcing mode. So cost impact (CI) is the maximum cost of having to create the capability for a particular service or process as a percentage of the current total cost of providing the same activity. These extra costs arise in a number of ways, comprising both one-time costs and ongoing costs as noted below. The exact cost will differ by the process and specific company. For example, costs of voice and IT services tend to be higher because of the greater use of technology than for other types of services such as payroll processing.

One-time costs:

  • Search and contract: finding a suitable service provider and then negotiating the contract – about 4 per cent of the base cost of onshore, in-house light management.
  • Restructuring: rearranging the elements of work so that the service can be sent offshore and/or out of the organisation – about 5 per cent of the base cost.
  • Process changes: altering processes so that the overall service can be separated and performed in an outsourced and/or offshore environment – about 10 per cent of the base cost.
  • Transitioning work: the actual movement or transitioning of the service activity incurs costs – about 3 per cent of  base cost.

Ongoing costs:

  • Lost productivity/cultural issues: global sourcing often involves the use of fewer productive workers, albeit at much lower wage rates. In addition, there can be cultural differences that impose further ongoing costs – about 10 per cent of the base cost.
  • Governance: any form of global sourcing requires additional governance mechanisms to manage the relationship – about 10 per cent of the base cost. 

Probability of incurring the cost impact. The answers to the 30 questions determine the likelihood or probability (Pr) that the organisation will incur these costs. For example, if the answer to Q24 (“Is the supply market of service providers (vendors) mature?”) is “highly agree”, then there is a low probability that the sourcing organisation will have to incur the various costs. After all, many suppliers are already available in this mature market. On the other hand, if the answer is “highly disagree,” then there is a high probability that the sourcing organisation will have to incur the various costs.

Collaboration mode. Global sourcing, whether in-house or outsourced, places a strain on the organisation. As a result, sourcing organisations need to use the right collaboration mode to reduce the strain and get the process to work better. In our model, the collaboration mode (CM) affects the cost impact (CI). A collaboration mode of tight management reduces the cost impact by making for more effective co-ordination between the customer organisation and the provider. Numerous studies and our own research show this to be the case. Having the “right” management mode is crucial. In our model, the choice of a tight collaboration mode halves the cost impact relative to a light collaboration mode.

Cost of collaboration and management. Although tighter collaboration reduces the cost impact, it also incurs its own cost. The base case is that of in-house, onshore, light management (INL in figure 2), which incurs no extra costs. Changing the sourcing and management modes increases the cost of collaboration or management, up to an additional 10 per cent of base costs for the case of outsourced, offshore, tight management (OFT).

Expected value. Our model gives an expected value (EV) calculation for each of the 30 questions that reflects the characteristics of an organisation, mapping out the potential savings and costs for each of the eight possible global sourcing modes. The model then ranks the eight sourcing modes based on the average EV produced by the 30 questions. These ranks (from first to eighth) are the model’s recommendation for the priority in which to consider the possible global sourcing options.

HOW TO USE THE GLOBAL SOURCING MODEL

The global sourcing model is a decision support tool that should be used as part of efforts to optimise an organisation’s operating model. It should be used in conjunction with a discussion and investigation of the issues involved.

The model will act as a prompt during the process and may well generate issues for further investigation. The interactive nature of the model (via the ability to change both the answers to the questions and even some of the parameters in the model) means that it can be used in a number of situations, including:

  • assessing the impact of changing assumptions (for example, on the cost savings from offshoring);
  • resolving disputes (for example, how much difference it might make to the decision if there are differing opinions on the brand impact of the service);
  • examining which services are more suitable for the global sourcing process;
  • running alternative scenarios;
  • comparing the output of the model with your organisation’s internal views on strategy. 

Making decisions on global sourcing can be a real headache, and risky too. Key choices concern the three dimensions of ownership, location and management. You can conduct this analysis in a qualitative way using the 30 questions we have provided. Or you can do it in a quantitative way using our business case model. In either case, conducting thorough and systematic analysis of the type we recommend here will not make the decision for you. But the analysis can guide you to the sourcing options worth deeper, and more expensive, investigation.

BRIEFING:

The research methodology

The development of our global sourcing of services model has been driven by several research methods:

  • A review of prior research, by other organisations and by academics.
  • Extensive original research working with a number of major multinational companies, all leaders in their industries: a US document company, a US computer and related technology company, a British consumer packaged goods company, a British financial services company, a British marketing services company, a European insurance company, a European software company, a European energy company, a European telecommunications company, and our own company, Capgemini.
  • In addition, we conducted research at a British local government entity and obtained advice from the UK’s National Outsourcing Association.
  • Our company’s extensive consulting experience around the world in outsourcing, offshoring, our Rightshore service, business process outsourcing and shared services.
  • Advice from two leading academic experts on global sourcing, as well as their own expert contacts.
  • Input from Capgemini subject matter experts.
     

The model derived has been validated by the testing with the companies that participated in the original research. 

Acknowledgements: the authors would like to thank Dr Phanish Puranam of London Business School and Professor Mari Sako of Saïd Business School, University of Oxford, as well as Yoram Bosc-Haddad, Bart van Geluk, Neil MacKenzie, Oedger Meijborg, Carole Murphy and Greg Watkins – all of Capgemini – for their contributions.

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