Birthing a BPO: An Overview of the Three Methods | Article

beethovenBeethoven is considered one of the world’s most creative composers. His music is so melodic many listeners don’t realize the musical thinking of his day required composers to use the sonata allegro style, one of the most restrictive formulas for symphonic music. The master was able to pen profound sounds within these rigid rules.

In the same way, companies are choosing a variety of routes to launch a new BPO firm. There’s more than one way to achieve the same end; the variations are many. The result is the same: the creation of an outsourcing vendor that takes total ownership of a specific process, performing the work at a lesser cost and with more competency than its buyers could do in-house.

While BPO providers haven’t multiplied like ASP vendors, there have been quite a few new companies that have appeared on the scene in the last 24 months. As far as I can see, there are three ways new BPO firms have come into existence. They include:

  • Adding an outsourcing division to the current company;
  • Creating a shared services division within a company, which may become a spinout if it is successful;
  • Building a new company around a seasoned management team.

Adding an Outsourcing Division

Arthur Andersen partners chose to create an outsourcing division within their Big Five accounting firm. Becoming an outsourcing supplier was a logical step for Arthur Andersen. Their potential customers already valued their expertise in this area; they clearly had market permission.

The partners were able to leverage their professional reputation in the finance and accounting world and transfer their unquestioned capabilities into an attractive outsourcing offering. Becoming a business process outsourcing (BPO) provider was just the next step in their corporate history.

Like Arthur Andersen, Marriott Corporation leveraged its deep understanding of the hospitality industry to become a major outsourcing provider in food services. Marriott had market permission and unquestioned expertise in its specific business process, which contributed to its outsourcing success.

Manufacturers also have made the transition into successful outsourcing suppliers by wrapping their outsourcing services around their products. Xerox centered its outsourcing offering around its copier business and earned a great market acceptance.

Each of these companies understood both their process and their marketplace. They previously had established relationships with customers who became their outsourcing buyers. They built and nurtured strong reputations for service.

They were able to offer their customers a complete business solution rather than just a component of the process, an important consideration in today’s changing world. They have been successful because they were able to leverage their sterling reputations, existing economies of scale, and unquestioned expertise to capture a sizable segment of the market.

Creating a Shared Services Division

Creating a shared services division within a large conglomerate is another way to birth a BPO. These large corporations have many divisions who all need finance and accounting, human resources, supply chain management, real estate management or purchasing and logistics help. None of these context processes provide competitive advantage for the parent. Organizing a shared services corporation consolidates these support functions.

Powerful economies of scale emerge when one shared services division handles a single context process for all divisions. This also generates cost savings.

The consolidation has other benefits to the corporation. It exposes the true costs of the function to all using constituencies. Most divisions have no idea of their finance and accounting or human resources costs because they are buried in the corporate overhead column. A shared services division reestablishes cause and effect and balances supply with demand by making the user pay market rates, often for the first time. This requirement imposes a discipline on the using constituencies. Once they are aware of the true cost of these services, they tend to curtail unnecessary usage.

At the same time these internal users/customers demand higher and higher levels of excellence from their shared services provider. There is a real push for them to upgrade their offerings and knowledge. They can begin to expand their services using the revenue from their in-house buyers.

For the first time, shared services companies must learn to become sensitive to the needs of their paying customers. They are inducted into the brave new world of buyer-supplier relationships. Often, a learning curve is involved.

Shared services companies face other obstacles that outsourcing providers like Arthur Andersen don’t. Their biggest problem is the question of competency. Shared services companies do not have world class reputations like Arthur Andersen, Marriott or Xerox. They are not proceeding from strength.

If anything, their abilities are suspect. Internal organizations tend to be taken for granted. They have to prove themselves every day. Unfortunately, this unrelenting need to demonstrate their efficiency and competence distracts both the supplier and its customers, wasting time that could be used more productively solving problems and improving processes. This is a critical difference.

Shared services companies tend to be corporate stepchildren, which compounds their performance problem. In the beginning, creating a shared services company creates excitement and the corporation funnels dollars its way. Over time the excitement dissipates and its income-producing siblings begin to receive the lion’s share of new funds. The parent is not keen on investing in top talent or state-of-the-art technology in context areas that generate no revenue and provide no competitive advantage.

But the shared services company needs this financial lifeline if it is to succeed and perform as expected. This lack of capital retards the growth and effectiveness of the shared services company by denying it the tools it needs to improve the process. And it becomes increasingly difficult to recruit top talent. Taken together, this dearth of resources has the unfortunate effect of undermining the quality of services and efficiency of the shared services provider.

To counter these deleterious effects, shared services companies have attempted to sell their services outside the corporation to generate additional revenue. The thinking is: a revenue-generating entity will be able to attract adequate capital from the parent. And the additional volume will build larger economies of scale.

In practice, however, these efforts have been largely unsuccessful. Going outside the corporate fold requires new skills. The company’s sales force has to learn how to market these services to outsiders. Too often they don’t understand market forces, so a ramp up time is required. The solution is to bring in a coterie of executives with these missing skills. Importing talent becomes the fastest way to become competitive.

Shared services companies rarely have market permission. Often, the market does not trust them. For example, Shell Oil tried to set up a shared services company called SSI which specialized in finance and accounting services for energy exploration companies. Customers refused to knock on its doors. The company could not make the jump from exploration expert to finance and accounting guru.

Another problem was Shell’s competitors did not want Shell to take a peek at their books. Generally, competitors are loath to let the enemy take over a revealing process.

When a shared services company is able to sign up outside customers, sibling rivalry can ensue. The internal customers are jealous. They feel the best services are going to the outside customers who are paying more. They want to come first. This conflict produces an unsatisfactory long-term situation.

The solution is to spin off a shared services company that is able to generate significant revenue. This resolves the inherent tensions between the internal and external customers.

Competitors no longer worry the shared services company will share its proprietary information with its parent. Spin offs give the new company credibility it never had as a division of the parent.

Spin offs offer other advantages. They can attract capital to invest in themselves and fund acquisitions which grow the business. Typically these funds were not available under the parent who was much stingier at distributing capital. Another beneficial result is spin offs typically have higher price/earnings ratios than their parent companies.

Spin offs can offer stock options linked to their performance, an option that was not available to a shared services company. Stock options make recruitment easier.

Sabre is a shining example of a successful spinout. Before the spinout, the American Airlines’ shared services company experienced substantial resistance from its competitors. Sabre was able to overcome its competitors’ distrust and establish its own integrity and credibility after it became independent.

Forming a Partnership with a Venture Capitalist

There is an increasingly popular third way to birth a BPO. BPO providers create value and that is attractive to investors. Today, a number of specialized venture capitalists and private equity investors are funding the creation of new BPO providers.

These companies typically assemble a management team first and then match them with a business opportunity. They generally focus on a specific marketplace. The investors also work with the BPO executives to find a key customer.

The VC route has been a successful one because all the crucial elements are in place at the outset. The management team, whose skills have already been proven in the marketplace, clearly understands outsourcing. The venture capital firms make sure the new BPO supplier has enough cash to set up its systems properly and can provide executive help.

Sometimes a venture capitalist group will combine with a shared services company to form a new BPO provider. The venture firm provides the capital and management team and the shared services company provides the first customer, which creates immediate scale and credibility.

This was the blueprint for creating Exult, a human resources BPO provider. The first customer was British Petroleum. In exchange for agreeing to accept the risk of being first, BP took an equity stake in Exult. This large first client established instant economies of scale and a sizable revenue stream for Exult. Mark Hodges of Exult describes his views on birthing a BPO in this issue.

Like Beethoven, these BPO founders have taken many different paths to start a new outsourcing firm. Their success is music to management’s ears.

Lessons from the Outsourcing Primer:

  • There have been three ways to start a new BPO firm: start an outsourcing supplier within the company, create a shared services division within the company, or use venture capital to start a new company.
  • Shared services companies need to import talent who have war wounds and know how to compete in the outside marketplace.
  • Shared services companies impose discipline on internal constituencies by determining the true costs of services and charging accordingly.
  • Extending core expertise into outsourcing is a good way for corporations to earn extra revenue. Major companies like Arthur Andersen and Marriott are two examples.

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