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Outsourcing in 2003: How Offshoring Is Changing the Industry

The biggest event in outsourcing last year — and the biggest event since outsourcing’s inception — was the growing use of offshoring. Both buyers and suppliers realized the profound power of labor arbitrage.

The move to offshore work to take advantage of low cost labor is affecting every area of outsourcing. In the IT space, offshoring is making major inroads in the applications development and management area. The offshore service providers have made this area extremely competitive. I predict every company needing applications will have to outsource or create its own offshore captive if it is going to have the work done cost effectively. This year the same will probably be true for IT infrastructure.

Offshoring also enabled a big push into BPO, the second major trend of 2003. Offshoring allowed suppliers to outsource many business processes they couldn’t touch before because they couldn’t drive down cost. Last year the universal mantra for buyers was: cut our costs. Offshoring finally allowed suppliers to do that.

For that reason, BPO suppliers expanded their capabilities last year, moving higher up the value chain.

The combination of these two trends has significant consequences for the future of the outsourcing industry.

Trend 1: Offshore Suppliers Come Into Their Own

Last year offshore labor arbitrage finally got some respect, as Rodney Dangerfield used to say. Offshore firms created a new credibility in IT applications work and data center operation. On a recent trip to India I visited a number of suppliers who could support substantial data centers in India while leaving the assets in North America or Europe. This is a very interesting development with serious implications for the IT market; it allows buyers to retain their assets and still drive out cost.

Last year offshore service providers moved from project work to true outsourcing. Now that they have earned the respect of their buyers, the offshore suppliers are entering into long-term outsourcing relationships. I expect to see substantial migration of work to India, the Philippines, and Eastern Europe.

Moving work offshore presents different risks. How do you think about governance when the supplier is eight times zones away? Buyers had to revamp their governance models to deal with a different set of challenges.

Trend 2: The HRO Transaction Model Gained Traction

Transaction engines rule in human resources outsourcing (HRO). Transaction engines are rules-based outsourcing where a supplier uses technology, people, and a new process to automate routine and recurring transactions like payroll and benefits administration. Offshoring is a key part of the transaction engine success story. 2003 was the year that proved they work.

This is good news for both buyers and suppliers because the engines allow for more value capture. For buyers, they reduce cost and improve the service; for suppliers, they can spread their investment over a lot of clients.

Trend 3: The BPO Market is Dividing

We see the BPO market dividing in two: some buyers just want to outsource transactions, while others want to achieve a bigger business impact. For example, an Everest survey released in December 2003 found the finance and accounting outsourcing (FAO) market segmented almost equally into two distinct pieces – full service and transaction-based. The study found 44 percent of the last 85 FAO transactions signed were full-service in scope.

Trend 4: Niche Outsourcing Is Thriving

Various industries are enjoying big wins thanks to outsourcing. One of the big winners is the insurance industry. Outsourcing third-party administration and claims processing produces both cost reduction and high business impact. Outsourcing can dramatically reduce the cost per claim while improving customer service and retention.

Banking is benefiting from outsourcing clearing functions. Healthcare is outsourcing its revenue cycle for greater profit, to name a few.

Trend 5: American ITO Slowed Down

There was also a slowdown in the American IT infrastructure and applications development outsourcing market. Historically, companies outsourced their IT infrastructure to save money. Today, sending that work offshore to take advantage of the labor arbitrage is becoming the best way to cut costs. Companies unwilling to deal with suppliers that use offshore labor are not receiving the value they expect from outsourcing these processes. This led to last year’s slowdown.

What’s Ahead in 2004

This year offshoring will gain even more traction. We expect more and more companies to focus on the benefits labor arbitrage can bring. At the same time, we believe service providers will take their successful offshore models in established processes like HR and finance and accounting and apply them to other business processes. We expect a rapid adoption across all BPO processes.

How long will the offshore providers be able to provide an economic advantage through low cost labor? That debate began last year and will continue this year. We predict the offshore providers can maintain this advantage for at least 15 years and maybe considerably more.

We also expect one of this year’s high impact areas will be in the order to cash space. Outsourcing this payment and fulfillment process will result in substantial wins for buyers by reducing their required working capital. Automating this process allows the outsourcer to move buyers from simple cost reduction to business impact, creating more value.

This year we expect the transaction engine process will expand to three other processes. One will be indirect purchasing. It’s too early to determine who the winning suppliers will be. It may be the firms specializing in logistics. But it may be the big finance and accounting providers like Accenture, ACS, IBM, or EDS. All are assembling compelling offerings in this space. For example, if you combine the offerings of A.T. Kearney, an aggressive sourcing company, with EDS, together they can create a very strong value proposition.

Another candidate for transaction engines is customer relationship management (CRM) for use at the call center. A third possibility is commercial real estate (CRE), an extension of the traditional outsourcing offering.

We don’t expect the indirect purchasing transaction engine to be fully validated this year, but it will make great strides. We predict by year’s end it will have evolved to where F&A outsourcing is today.

Predictions for 2004:

  • Offshoring will grow faster and gain more traction in 2004.
  • Offshoring will spread to other BPO processes.
  • Order to cash, customer relationship management, and commercial real estate may become prominent outsourced processes using a transaction engine this year.

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