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Strategic costs associated with business process outsourcing (BPO)

80 Comments · Business outsourcing

The strategic costs associated with BPO are centered on the potential loss of organizational learning that results from moving a process under the control of an external service provider.

Competitive advantage in most industries today is a moving target, and firms must seek it whenever they can.

In some cases, competitive advantage arises in unexpected quarters, as a serendipitous result of decisions taken long ago and improved on over time.

For instance, the Sabre ticketing system developed by American Airlines was a source of competitive advantage for the air carrier.

The efficiency of the system provided an advantage to American during a time when it was difficult for the major carriers to differentiate themselves.

American created a profit center around the Sabre system by leasing it to other carriers. The system eventually became a profitable business unit and was spun off into Sabre Holdings.

The software is now used throughout the industry to manage the ticketing process. Had American decided long ago to outsource the ticketing process, it would not have developed the Sabre system.

At the same time, American never consciously set out to make Sabre the industry standard. The airline was merely trying to develop a system that enabled efficient ticketing.

Outsourcing so-called noncore processes must be undertaken with careful forethought because it is never clear how future competitive conditions will unfold and what types of competencies will be required.

Firms must distinguish noncore activities as critical, key, or support. Those activities that are tightly coupled to the core and are fault intolerant (i.e., mission-critical processes) should usually be retained in-house.

At the very least, they should be outsourced only when the interorganizational relationship is clearly focused on developing and deriving strategic advantages.

Knowledge management should be transparent from one firm to the other, and reciprocal exchange at insights should be considered routine.

Furthermore, a quest for innovation in the interlinking of the critical and core processes must be a paramount concern for both sides at the outsourcing relationship.

In fact, the major strategic component of a BPO initiative is the relationship between buyer and vendor.

Relationship costs are those that are involved in courting, establishing, and maintaining a relationship with a BPO vendor. This complex undertaking can be as far-reaching and comprehensive as a merger or joint venture.

Such transactions are distinguished by the need to mesh information systems, governance structures, and, not least, organizational cultures into a unified whole.

The complexity of the challenges of merging two formerly distinct enterprises is often too overwhelming for the executives who engineered the deal.

One or more top executives are often either asked or forced to leave as they become increasingly disoriented amid the chaos of the combined entity.

For instance, the merger at Hewlett-Packard and Compaq in 2002 led to a quick departure of Compaq’s then-CEO Michael Capellas. Departures related to that merger continued well into 2003.

A thoroughgoing BPO relationship can have many of the same complexities of a major merger or joint venture.

Firms that determine to outsource back-office processes are entering into a relationship with a vendor that will have important implications for their ability to compete.

The risk posed by this loss of functional independence requires careful prior analysis of the capabilities and integrity of the vendor. In the ease of a BPO relationship, it is amply unacceptable for any breakdowns in performance or integrity to occur.

The directly attributable costs of a BPO relationship are those that are associated with identification, analysis, and selection of the various vendor candidates, controlling the vendor relationship, and developing strategic knowledge management capacities with the vendor.

Hidden costs associated with the vendor relationship are primarily centered on the impact of transitioning formerly internal processes to external control. For instance, in many outsourcing relationships, employees of the BPO buyer become employees of the vendor.

This is often the case in data center management where a large organization such as EDS simply acquires the existing IT infrastructure, including staff, from the outsourcer.

This transition from one employer to another can have ripple effects throughout the organization, as uncertainty and fear are typically associated with changes of this type.

Others near to or friendly with those who have a new employer may pick up on grumbling or criticism and wonder whether they will be next in line for such a transition.

In other words, the social contract between employer and employee-whether explicit or tacit-has the appearance of being violated when employees are optioned to another firm.

It does, not matter that such optioning usually results in better efficiencies and working conditions.

The perception of violation of the social contract is enough to send some employees scurrying to Montster.com to seek out a new employer. The disruption of the work environment will always have hidden costs as morale and productivity are negatively affected by change.

Strategic costs associated with outsourcing can be mitigated through appropriate vendor selection and contacting.

Using stringent selection procedures ensures that the vendor chosen has the intellectual, technological, and social resources to become a true partner in the success of the BPO buyer.

The buyer-vendor relationship should not become a cat-and-mouse game focused on price issues. Rather, both sides should constantly strive to create positive-sum outcomes from their deep relationship.

That is, rather than constantly seeking to increase service prices, the vendor should seek ways to help the buyer grow and to participate in that growth.

Similarly, rather than constantly beating down the vendor’s price, the BPO buyer should seek to deepen the partnership and find ways to leverage the vendor’s capacity for mutual benefit. This is not a typical buyer-supplier relationship as outlined in the standard strategy textbooks.

With the financial and strategic cost factors identified and estimated, it is possible to create a Total Cost Management (TCM) project overview.

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