Offshoring

Transcription

Offshoring

08/2003/#8
the
journal of financial transformation
Offshoring
Justification
Implication
Potential
Recipient of the 2002 & 2003 APEX Award for Publication Excellence
Our 200 mph laboratory.
The BMW WilliamsF1
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It’s mission-critical computing for fast-moving enterprises,
JOURNAL 8 -v3
29-04-2010
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Editor
Shahin Shojai, Director of Strategic Research, Capco
Advisory Editors
Predrag Dizdarevic, Partner, Capco
John Owen, Chief Operating Officer, Capco
Roger Preece, Partner, Capco
Editorial Board
Franklin Allen, Nippon Life Professor of Finance, The Wharton School,
University of Pennsylvania
Jacques Attali, Chairman, PlaNet Finance
Joe Anastasio, Partner, Capco
Philippe d'Arvisenet, Group Chief Economist, BNP Paribas
Rudi Bogni, Former Chief Executive Officer, UBS Private Banking
David Clark, NED on the board of financial institutions and a former senior
advisor to the FSA
Elroy Dimson, Professor of Finance, London Business School
Nicholas Economides, Professor of Economics, Leonard N. Stern, School of
Business, New York University
Michael Enthoven, Chief Executive Officer, NIB Capital Bank N.V.
Stuart Feffer, Partner, Capco
George Feiger, Partner, Capco
Jordan W. Graham, Managing Director, Financial Services Industry,
Internet Business Solutions Group, Cisco Systems, Inc
Alasdair Haynes, Chief Executive Officer, ITG Europe
Anthony Kirby, Group Marketing Director-STP, Reuters
Thomas A. Kloet, Chief Executive Officer, Singapore Exchange Limited
Christopher Kundro, Partner, Capco
Herwig Langohr, Professor of Finance and Banking, INSEAD
Mitchel Lenson, Global Head of Operations & Technology, Deutsche Bank Group
Donald A. Marchand, Professor of Strategy and Information Management, IMD
and Chairman and President of enterpriseIQ®
Colin Mayer, Peter Moores Professor of Management Studies, Saïd Business
School, Oxford University
Robert J. McGrail, Chairman of the Board, Omgeo
Jos Schmitt, Partner, Capco
Kate Sullivan, Chief Operating Officer, e-Citi
John Taysom, Founder & Joint CEO, The Reuters Greenhouse Fund
Graham Vickery, Head of Information Economy Unit, OECD
Norbert Walter, Group Chief Economist, Deutsche Bank Group
JOURNAL 8 -v3
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The European Banking Technology Fair now has a new name:
European Banking & Insurance Fair, or E.B.I.F. for short
And that's not all that is new:
The financial services market is subject to enormous changes. Today, the lines of division between banks and insurance companies are becoming increasingly blurred.
By changing the fair's name, we reflect this development and clarify in our name that all financial service providers have a home at this European event.
In the sixth year of existence, the EBIF will assert the top position in its market in Europe. Within the frame of a top-class two days congress, the EBIF 2003 will focus
on the following main topics:
• Asset Management
• Company Pension Scheme
• Cash Management
• Customer Relationship Management
• Document Management
• E- & M-Business
• E-Government
• Financial Planning
• Knowledge Management
• Multi-Channel Management
• Outsourcing
• Private Banking
• Private Public Partnership
• Retail Banking
• Risk Management
• Damage Management
• (IT-) Security
• Telecommunications
• Transaction Management
• Visions und Strategies
Review on European Banking Technology Fair (EBTF) 2002
More than 350 exhibitors from 17 countries presented their products and services, and more than 100 expert rounds and workshops featured a high degree of orientation and an intensive relation to practical experience.
www.ebif.com
Congress
European Banking Insurance Fair GmbH
Member of Maleki Group
Wiesenau 1 • 60323 Frankfurt am Main
Phone: +49 (0)69 9 71 76-177 • Fax: +49 (0)69 9 71 76-355
Internet: www.malekigroup.com • e-Mail: ebif@malekigroup.com
Fair
Messe Frankfurt Ausstellungen GmbH
Taunusstraße 7a • 65183 Wiesbaden
Phone: +49 (0)611 9 51 66-16 • Fax: +49 (0)611 9 51 66-23
Internet: www.ebif.com • e-Mail: ebif@mfa.messefrankfurt.com
Project Management: Alihan Sav
Project Management: Doris Harsch
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TABLE OF CONTENTS
THE NOBEL LAUREATE VIEW
6
The bugaboo of double taxation
Franco Modigliani, Institute Professor Emeritus,
Massachusetts Institute of Technology, and 1985 winner
of the Nobel Memorial Prize in Economics
Robert Solow, Institute Professor Emeritus,
Massachusetts Institute of Technology
8
Rethinking pension reform
Arun Muralidhar, Managing Director - Investment
Research, FX Concepts Inc.
83
Offshoring: Not just for the first movers
Suresh Gupta, Partner, Capco
Lilach Nachum, Associate Professor of International
Business and Management, Baruch College,
City University of New York
POTENTIAL
JUSTIFICATION
95
13
Business process outsourcing - A mechanism
to galvanize shareholder value
Dev Ghosh, Financial Service Partner, Tatum Partners
21
It’s no longer a wave, it’s a Tsunami: Risks, rewards,
and trade-offs of offshore outsourcing
35
Offshore services – Maximizing the benefits for
financial institutions
Vinay Kumar, Lead, Capital Markets & Wholesale
Banking, Client Solutions Group, EDS
Gabe David, Managing Director, Global Industry
Solutions, Global Financial Industry Group, EDS
43
‘Pete at Night, Pradeep by Day’: The offshore
contact center phenomenon
Vishnu Nidhin, Financial Services Practice, Hewlett-Packard
IMPLICATION
53
Outsourcing and labor migration in China
Xiaodong Wu, Department of Economics, University of
North Carolina at Chapel Hill
63
Cross-border outsourcing and risk management
for banks
Hugh C. Kelly, Senior Advisor for Global Banking,
Office of the Comptroller of the Currency
Daniel E. Nolle, Senior Financial Economist,
73
Overseas outsourcing by financial institutions:
Assessing the legal and regulatory landscape
Robert M. Finkel, Partner, Milbank, Tweed,
Hadley & McCloy LLP
Winthrop N. Brown, Partner, Milbank, Tweed,
Hadley & McCloy LLP
More than offshoring: SmartSourcing
Michael Baldwin, Chief Information Officer,
Global Markets and Corporate Finance,
Deutsche Bank AG
103 Discovering the endgame in the offshore debate
Bill Irving, President, Capco
Shahin Shojai, Director of Strategic Research, Capco
113
Outsourcing helps improve your firm’s
performance – or does it?
Holger Görg, School of Economics,
University of Nottingham
Aoife Hanley, Industrial Economics Group,
Business School, University of Nottingham
119
Funding transformational change
through offshoring
Marilyn Hignett, Partner, Capco
Michael Rude, Managing Principal, Capco
Ilene Grossman, Managing Principal, Capco
Lisa Berk-Lidsky, Managing Principal, Capco
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Offshoring – Topic du Jour
We hear much about offshoring these days, not only in business journals but also, increasingly, in the popular
press. It is a topic du jour and yet one on which views are still all too often clouded by misunderstanding,
confusion, even fear. In such an environment, I am delighted to introduce you to an issue of the journal that
provides some clarity on this issue with an impressive collection of balanced and clearly articulated, factbased contributions.
Many of the issues facing those wishing to offshore to a third party are the same as we have faced and
addressed before when considering outsourcing strategies in the past: restructuring the organization to facilitate separation of activities, building trust with suppliers, establishing performance benchmarks, etc. There is
therefore much that can be learned from these earlier, typically on-shore attempts at outsourcing.
There are also many ways in which third-party offshoring – outsourcing to a service provider based in a different country – presents new and unfamiliar opportunities and challenges. It can, of course, massively
improve the economics of the outsourcing option and it has, for this reason, brought outsourcing firmly back
onto the agenda and almost all of the executives that I meet these days have it on their priority list too.
Offshoring does, however, present organizations with unique, new challenges even when offshoring in-house
as we at Capco are ourselves doing with our own offshore operation. Some of these challenges are covered
in detail in this issue: political and currency risks associated with the offshore location obviously, new types
of operational risks, and change management challenges, of course.
Less obvious, but equally important, is the potential for a political and press backlash that a number of companies have already faced because at the root of the offshoring decision is a much deeper macro-economic
and political debate that is far from being resolved. It is a debate that we, as senior executives with responsibilities to our workforce and our communities, need to participate in.
Much has been written about outsourcing, and more is now being written on the offshoring phenomenon. But
there is still much that is unresolved and too few truly successful models in the financial services industry for
anyone to provide a guaranteed road-map. Offshoring can offer our companies and our industry enormous
benefits and can play a significant role in accelerating development in less developed countries. It is an issue
of huge and pressing importance but not one without risks or concerns.
I trust that the insights collected in this issue will challenge and stimulate your own thinking on this important issue and make a valuable contribution to the wider debates.
I hope that you enjoy this issue.
Rob Heyvaert,
Founder, Chairman and CEO, Capco
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The offshoring challenge
The number and types of organizations that are considering moving non-client-facing operations offshore,
whether within captive or third-party control, has experienced a dramatic growth in recent years. The longterm economic slowdown, combined with increasing global competition has now made offshore business processing an integral component of an organization’s overall strategy. Financial institutions are not immune to
these forces and are now following in the footsteps of their manufacturing peers in increasing numbers and
are moving parts of their operations offshore.
Of course, moving offshore is not an easy task and a number of issues need to be resolved before such a
dramatic decision is taken. This issue of the journal aims to highlight a number of these important issues and
to provide some guidelines as to how these challenges have been faced and managed by pioneers of this
industry.
This issue of the journal, as is typically the case, is separated into 3 sections. The first section provides a
primer on why and how financial institutions might consider moving operations offshore. Section 2 discusses
the experiences of a number of financial institutions that have moved operations offshore and provides guidelines on how it can be utilized within the overall strategy of a financial institution. In addition, Section 2 highlights a number of legal issues that need to be addressed when considering moving offshore. Section 3, looks
at the potential for this industry and where it can go in the future.
We are especially proud of a new feature to the journal, an additional section in which a Nobel Laureate provides their views on important issues facing the world of business. In this issue, we are very pleased to introduce
two papers from Prof. Franco Modigliani, Nobel Laureate and the founding father of Modern Corporate
Finance. In his opinion pieces, Prof. Modigliani gives us his views of the latest dividend tax legislations in the
U.S. and how the current pension time bomb can be best managed.
We hope that you will enjoy this issue of the journal and continue to support us by submitting your best ideas
to us.
On behalf of the board of editors
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The bugaboo of double taxation
Robert Solow, Institute Professor Emeritus,
Massachusetts Institute of Technology
The President is pleading for a drastic reform of our tax sys-
impact effect per dollar of incremental deficit (U.S.$400 bil-
tem that would exempt corporate dividends from the personal
lion), and most of its effect would consist in reducing national
income tax, using the bugaboo of double taxation and of a
saving permanently, which is already so inadequately low, as
weak economy. However, upon closer examination, one must
evidenced by the trade deficit.
conclude that these are but excuses for advancing his real
agenda, namely to make the richest richer at the expense of
To be sure, the President has claimed that his measure would
everybody else, including future generations. One big step is
have other very positive side effects. In particular, the higher
to give them a free tax rebate, estimated at U.S.$400 billion
profitability of corporate equities would encourage invest-
just for the first ten years. But an even more powerful step in
ment, give a strong boost to the stock market which, together
this direction, dear to extreme conservatives, is to replace the
with higher after-tax income, would encourage consumption
progressive income tax with a flat tax. This is precisely what
and thus give needed support to a sluggish economy. But
the President is recommending: at present, dividends are sub-
these side effects are questionable and may even go in the
ject to two taxes, a flat rate corporate tax and a progressive
opposite direction, and there are more that need to be con-
personal tax. His recommendation is, of course, to abolish the
sidered.
progressive tax and keep the flat rate corporate tax! If his recommendation passed, he would have made a great stride
One effect that everybody seems to take for granted is a large
toward the abolition of the principle of progressiveness.
rise in the price of stocks. The reasoning is simple. The elimination of the dividend tax will increase net of tax earnings but
We submit that double taxation is a paltry excuse: it is not a sin
should not significantly affect the price-earning ratio; hence it
and, although there are several other cases of double taxation
must increase the stock price. But the reasoning is wrong for
in our economy and other market economies, there is no evi-
the "price-earning ratio" that matters and investors refer to, is
dence that it is a significant source of inefficiency. In the spe-
the ratio of the price of each share to the corporate earnings
cific case of dividends, it does have some negative effects on
per share and not to the personal earnings, which vary from
the efficiency and stability of the economy, which have long
holder to holder depending on his tax status. But the price-
been recognized – such as encouraging the use of debt as a
earning ratio - in the long run - reflects the (real) productivity
source of financing – but these are rather minor and have not
of capital, which is presumably unaffected by personal taxes;
visibly interfered with progress. But the important point is that
and similarly personal taxes cannot affect corporate profits.
there are many possible ways of eliminating the double taxa-
Hence, there is no reason for the price to change, except to the
tion, which have been successfully tested in other countries
extent that higher returns from corporate equities attract cap-
(see below), and which do not require making a huge gift to
ital from other sectors or instruments. In particular, since the
the richest, or giving up progressiveness.
taxation of debt instruments would not change, while the
after-tax rate of return on equities would rise appreciably,
The other excuse, the weak economy, is equally weak. It is gen-
there would be a large rise in the risk premium that would
erally agreed by knowledgeable observers that the weakness
have to be closed by a substantial rise in interest rates, with
is of a short-term, cyclical nature and that such disturbances
negative effects on government budgets, taxes, housing, etc.
require remedies with concentrated immediate effects and a
And yet, the interest effect has not even been mentioned by
minimum of delayed effects. In fact, many such measures can
the administration (and others).
be and have been put forward. On the other hand, the pro-
6 - The
posed tax reform has precisely the opposite characteristics. It
How about the supposedly favorable effect on investment? It
is a permanent change. It would, therefore, have a small
is more likely to be unfavorable. Indeed, the impact effect of
Journal of financial transformation
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the proposal is clearly to discourage investment, for (as is well
of the alternative consists again in eliminating one of the two
known) the present tax on dividends has the effect of a sub-
taxes, but instead of maintaining the proportional tax and
sidy to investment financed by retained earnings, reducing the
eliminating the progressive one as in Bush’s proposal, one
cost of capital by the tax rate. Hence, the elimination of the
eliminates the proportional tax and maintains the progressive
dividend tax will have the same unfavorable effect as an
component. Concretely, this could be done by requiring stock-
increase in the cost of capital for investment now financed by
holders to include in their personal income, taxed at the exist-
retention. The negative effect may be even larger when the
ing progressive schedule, their share of the before tax profits
economy is near full employment. From elementary econom-
of every corporation in which they own shares, whether
ics, we know that in the long-run domestic investment must
received in dividends or not. The only possible objection to
equal the sum of private saving, government saving, and
this reform is that for a corporation paying low or no divi-
investment of foreigners. We presume that we cannot count
dends, the shareholder would be required to pay tax on
on increasing foreign borrowing beyond its already dangerous
income not received in cash. If that is considered unaccept-
current level. Thus, increasing investment requires higher pri-
able, the simple remedy is to require companies to pay a divi-
vate saving and/or lower government deficit.
dend no less than their tax liability per share. Stockholders of
companies retaining earnings would still be subject to a capi-
We know that government saving is bound to decrease by
tal gain tax on the appreciation, but this could be handled by
the tax cut. What can we expect for private saving? Since the
allowing them to add the retained earnings to the cost base.
beneficiaries of dividends (and only they) will have a larger
after-tax income, we expect them to use some of it to increase
But, we may ask, if the President is so worried about the double
saving and the rest to enjoy more consumption. But their addi-
taxation, why does he not worry about other kinds of double
tional income from the tax rebate is precisely the revenue lost,
taxation? In particular, what does he propose to do about the
or reduction in government saving. If then the increase in
disturbing case of Social Security, where contributions are
private saving is less than the rebate, it is less than the fall in
first taxed when made and then taxed again as they are paid
government saving, i.e. net saving and investment will
out as pensions? It is a more disturbing case because the vic-
decrease (by the extent of the increase in consumption). Only
tims are not the super-rich, but the working middle classes!
someone who thinks this response (a fall in consumption) is at
all likely can believe that investment can increase. Incidentally,
our conviction that national saving would decline gives us an
additional reason to expect that the Bush proposal would
result in an appreciable rise in interest rates. In addition, the
proposal would result in a substantial reduction in corporate
saving, which has always been a major component of private
saving.
But our most serious criticism of the President’s proposal is
that if the real issue is deemed to be the elimination of double
taxation, there are far more efficient and equitable ways to
achieve that result, several of which successfully in use in
other countries. While these approaches differ somewhat in
details, we may outline here a general prototype. The essence
7
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Rethinking pension reform1
Arun Muralidhar, Managing Director - Investment Research,
FX Concepts Inc.
We have developed a permanent solution to Social Security’s
under the name of ‘privatization of Social Security.’ There are
problem of maintaining current benefits levels and stable con-
a number of reasons why this approach is finding support.
tribution rates.
In the first place, the name privatization and the notion of
Our approach, which we label ‘risk diversification through a
eliminating a public pension agency (like the Social Security
common portfolio,’ achieves lasting reform by gradually shift-
Administration) appeal to the many (especially the fans of the
ing Social Security from pay-as-you-go (PAYGO) to a more tra-
market) who were easily persuaded that the malady affecting
ditionally funded pension system typical of those in the cor-
all PAYGO systems was due to the usual presumed shortcom-
porate world. The pensions would be funded by the capital
ings of publicly managed agencies (stupidity, wastefulness,
accumulated through contributions made during the working
dishonesty, personal interests, etc). Hence, returning to the
career, while maintaining the attractive defined benefit struc-
private investor the right to decide how to invest his retire-
ture. The basic reason so many national retirement plans
ment reserves was bound to appear a great improvement.
worldwide are affected by aging populations, slowing productivity growth, and increases in longevity is that they are not
But this view of the cause of Social Security’s problems is
funded. They are financed instead on a PAYGO basis, by the
largely fallacious. The current difficulties arise from the inter-
current contributions of the younger working generations.
action of the structure of PAYGO and the trends discussed ear-
These unfavorable trends would tend not to impact a funded
lier. The troubles are not due to public mismanagement, but to
system, because the pensions of the retired are paid by their
poor design, which can be eliminated without recourse to indi-
own accumulation and not by the contributions of the young.
vidual accounts. At the same time, those who have pushed for
privatization have failed to recognize some very fundamental
To cover the growing funding gap in Social Security, its
flaws. The crucial one is that privatization eliminates the ‘pro-
resources must be gradually increased above the level projec-
gressive’ pensions guaranteed by the government under the
ted with the current system. We agree with President Bush’s
current defined benefit structure. It replaces them with a
Social Security commission that one way to secure these
defined contribution structure under which the contributions
additional resources is to invest reserves in the securities
remain government mandated, but benefits become highly
market, rather than in low-yielding loans to the government.
erratic, depending on luck in choosing one’s portfolio (and
date of retirement, if not date of conception).
But we hold that the cost and risk effective way to do so is not
through individual accounts managed by some manager from
Indeed, privatization leaves to the government all major deci-
a government approved list, but by continuing to direct all
sions. The only thing that is truly ‘privatized’ is risk. This
contributions to the existing trust funds that will invest all
results in an arbitrary and capricious redistribution of pension
reserves in a common portfolio. We require that portfolio to
income. To be sure, some will end up above average, as is fre-
be highly diversified, under the supervision of a blue ribbon
quently emphasized by the supporters, but who conveniently
board. Ireland and Canada have successfully created such
forget about the rest who will do worse. The inequalities gen-
boards.
erated by privatization are especially repellent because they
are artificial and serve no useful (e.g., incentive) functions. In
Faced with the problem of insolvency, many well meaning
addition, the management costs, combined with additional
reformers have come out in favor of moving towards a type of
costs of administration and regulation are prohibitive, often
radical restructuring of the current PAYGO system, centered
causing a reduction in pensions of as much as 15%-20%. And
on shifting contributions to individual accounts, which goes
these costs are a total social waste for the competition
1
8 - The
The authors’ ideas are discussed more fully in their forthcoming book, Rethinking
Pension Reform, Cambridge University Press. The authors express special thanks
to Thomas K. Philips, chief investment officer, Paradigm Asset Management Co.,
New York; Ronald van der Wouden, The World Bank; and Maria Luisa Ceprini.
JOURNAL 8 -v3
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between portfolio managers is a zero sum game! It cannot
But, if we procrastinate until the trust funds are exhausted,
increase the overall return earned on reserves.
individual contributions needed to maintain benefits would
have to rise by approximately 50% to a tax of 20% of wages.
When all of these flaws are taken into account one must con-
But if we act now, Social Security can be saved for the indefi-
clude that privatization, or individual accounts, must be rejected
nite future, in substantially its present form with a few simple,
unconditionally in favor of defined benefits.
affordable reforms.
With our reform, we continue to direct all contributions to the
existing trust funds that will invest all reserves in a common
portfolio to ensure all participants enjoy the same, safe return,
thereby providing the foundations for the continuation of
defined benefits. We ensure that the same, safe return is guaranteed to all (fundamental to Social Security is a guarantee of
benefits or equivalently of returns) through an innovative
swap contract between the Treasury and the Social Security
Administration. Pooling reserves also dramatically lowers
management and administrative costs.
But to carry out the reform of the system from the present
PAYGO to (partial) funding that we are advocating, requires
some accumulation of capital through extra levies during the
‘transition’ period. It is frequently claimed that, during the
transition, current participants would have to pay double contributions: one to finance the old pensions and one to fund the
new system. This claim is a gross exaggeration, but this is
especially so in the case of the U.S. In fact we calculate that,
provided our reform is executed promptly, the required
increase in contribution could be contained within amazingly
small limits. The increase would be a bit more than one percentage point or raising contributions from approximately 12.4
percent to 13.5 percent, assuming a trust fund long-run real
return of approximately 5.25%. And that increase could be
reduced, or even eliminated, with a higher return and/or by
introducing some reasonable modifications, such as indexing
the standard retirement age to life expectancy. The reason for
this low cost is that the U.S. can count on some special favorable circumstances, including the accumulation of reserves
from past surpluses, now held by the trust funds, and the gain
from investing these reserves and future surpluses in the
securities markets.
9
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Justification
Business process outsourcing - A mechanism
to galvanize shareholder value
It’s no longer a wave, it’s a Tsunami
Offshore services - Maximizing the benefits
for financial institutions
‘Pete at night, Pradeep by day’:
The offshore contract center phenomenon
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Justification
Business
process outsourcing A mechanism to
galvanize
shareholder value
Dev Ghosh
Financial Service Partner, Tatum Partners
Abstract
Over the past few years, business process outsourcing (BPO)
has emerged as a powerful strategy too for optimizing and enhancing the operating results of organizations. The confluence
of technology, globalization, labor arbitrage and quality, and
cost pressures unleashed the fundamental drivers necessary
for this transformation. Executives seeking value creation in
their companies would do well to consider outsourcing noncore business processes. This paper will discuss the pros and
cons of BPO and will further make the case that it would be
prudent to consider undertaking this endeavor only after
appropriate analysis and investigation.
13
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Business process outsourcing - A mechanism to
galvanize shareholder value
Over the past few years, business process outsourcing has
have been able to offer comparable or improved manufac-
emerged as a powerful strategy to optimize and enhance the
tured products at significantly lower prices. These items
operating results of organizations. The confluence of techno-
ranged from consumer electronics to automobiles to gar-
logy, globalization, labor arbitrage and quality, and cost pres-
ments. While the Western democracies ceded parts of the
sures unleashed the fundamental drivers necessary for this
manufacturing sector to these Asian economies, service jobs
transformation. Once the province of a select few large com-
were for the most part retained. In fact, up until recently, com-
panies, today more and more companies are either doing
panies also tended to perform most of their service functions
"BPO" or are increasingly looking to do so. This paper is
in-house.
intended as a briefing for the lay reader. It is thus targeted at
a C level (CxO) executive desirous for a primer on the subject.
Although outside providers were used for certain specialized
functions, companies preferred the security of keeping inter-
Gartner Dataquest, an organization that provides coverage of
nal processes within their ambit of control. The earliest
the key trends and issues relating to the Information Techno-
process to be outsourced was payroll processing. Here spe-
logy (IT) market, defines BPO as ‘the delegation of one or
cialized payroll houses such as Automatic Data Processing
more IT-intensive business processes to an external provider
emerged, which could process the payroll for companies at a
that in turn owns, administrates, and manages the selected
fraction of what it might cost them internally. Then, in the
processes, based upon defined and measurable metrics.’
1970’s data processing providers began to emerge who would
Accenture defines BPO more globally: ‘Contracting with an
routinely process MIS data for those companies that could not
external organization to take primary responsibility for pro-
afford the investment or expense of their own in-house MIS
viding a business process or function.’
department. Other institutions that arose were shared service
entities. These were, in effect, organizations distinct from
BPO processes have been successfully used in customer rela-
other group companies, with the express purpose of accom-
tionship management, human resource management, finance
plishing a particular activity for all group companies. An exam-
and accounting management, credit card processing, loan pro-
ple might be a travel agency for a large group of companies
cessing, and insurance claim processing, among others.
whose responsibility it was to take care of all the travel-related
‘Enterprises around the world are attempting to focus their
needs for company employees. With the reduction of telecom-
investments on their core business processes and are increas-
munication costs and enhancements in service levels, it
ingly looking at outsourcing non-core business processes.
became profitable for companies to relocate certain functions
Early adopters of BPO services, primarily large organizations,
from high labor and infrastructure cost areas to lower cost
continue to expand their relationships to include new process
locations within a country.
areas, and new technology and media are creating opportunities for outsourcing entire lines of products and services…’
However this model of cost transference remained essentially
said Rebecca Scholl, principal analyst for Gartner, in a recent
domestic, as global labor arbitrage for service jobs was not
press release. According to their forecasts, the BPO business
really possible. It was well known by people venturing overseas
is projected to grow explosively from U.S.$110 billion in 2002
that there were many services which were incredibly cheap in
to U.S.$122 billion in 2003, and U.S.$173 billion in 2007, a com-
certain locations, however it was not possible to realize these
pound annual growth of 9.5%.
cost savings commercially on any concerted basis. In my overseas perambulations, for instance, I had noted that the cost of
14 - The
Evolution
a shoeshine was vastly cheaper in developing countries.
Over the past thirty years, millions of manufacturing jobs has
However, it was not possible to capture the low cost of a com-
moved from the West to Asia. A number of Asia based countries
parable shoe-shine in Indonesia relative to Germany in a com-
JOURNAL 8 -v3
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Page 15
mercial sense. I remember thinking that if the transportation
Shareholder value creation is facilitated by the following
cost and time could be eliminated, it might be commercially
mechanisms (Figure 2):
feasible to send the shoe-shine work to low cost destinations.
A few pioneers began to explore moving service jobs to cheaper
Industry
Overall cost saving EBITDA multiple
destinations. Recognizing that they could save significant
Insurance
10-15%
amounts of money, General Electric Company and American
Banking
8-12%
Express started setting up establishments in India where they
Pharmaceuticals 5-6.5%
1.3
transferred certain routine operations. This attracted publicity
Telecom
1.5-2.5%
1.1
and other providers followed not just to India, but to other
Automotives
1-2%
1.1
overseas locations where cost advantages were indicated.
Airlines
0.8-1.8%
1.2
The strategic imperative for
Business process outsourcing
40-60% cost saving for processes outsourced
The fundamental impetus for BPO is the creation of sustainable shareholder value (Figure 1 highlights most of the justifi-
3.5
1.5
Figure 2: Shareholder value creation through BPO
Source: Mckinsey-NASSCOM Report on ITES 2002
cations posed for BPO). That in itself dictates that management consider those strategic actions that enable company
Cost reduction - One of the prime motivations for BPO is that
valuations to increase. Clearly improved business perform-
the cost of a certain process can be significantly reduced. This
ance and focus on its own core competencies over time
is generally the first consideration for evaluating a BPO
translates to the growth and profitable expansion of the
process.
organization.
Increase speed of access to market - By partnering with an
organization with proven expertise in a particular area of comConverting capital to expense
petence, a client company can leverage the skill set of the
Access to technology
provider without having to expend the time, energy, and
Standardization
investment to ‘home-grow’ that capability.
Unique expertise
Management focus
Acquire access to best of breed processes - BPO providers
Speed of execution
can harness best of breed processes by concentrating on a
Lower costs
particular function, and making sure that they perform to
Ability to handle capacity fluctuations
world-class standards.
Increased business discipline and transparency
Increased revenues
Eliminate non-core processes - Functions outside the core
competence of a company can be outsourced. In the past com-
Figure 1: Reasons to consider BPO
Source: Accenture
panies would undertake most of the functions required to run
their business without necessarily considering whether that
particular function needed to be performed in-house. Other
than payroll processing and IT, tradition used to dictate that
non-core processes too, be dutifully be carried out.
Improve quality - By accessing best practices from a dedicated provider, quality of the product or service is enhanced.
15
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Types of BPO services available
area of expertise. As BPO companies mature and consolidate,
The provision of BPO services is only limited by the ingenuity
multi-channel outsourcing could become more prevalent.
and capability of the provider. We have seen BPO applied to
human resource management, finance and accounting mana-
Services that straddle most industries are known as horizon-
gement, customer relationship management, risk management,
tal services. Providers in these areas undertake solutions that
printing processes, drug testing, procurement, supply chain
work for most companies. For instance, there are providers
management, and legal support among others. BPO services
that specialize in CRM, or finance and accounting (F&A), who
are categorized into vertical and horizontal focused offerings.
would solicit business from all companies that want to outsource CRM or F&A issues, respectively.
Initially, BPO providers undertook commodity types of issues,
but with increased provider maturity more value-added offer-
Industry-centric offerings are referred to as verticals. An
ings are emerging. With this, companies are able to leverage
example would be insurance, healthcare, or real estate. For
the skill-set and talent pool of their BPO partners. There is a
instance, an insurance BPO would be focused on that particu-
growing desire for BPO customers to seek one-stop shopping
lar segment and offer its services to all insurance companies.
for multiple services from their providers. For instance, if a
It would have to have strong understanding of the insurance
customer is pleased with, say, a BPO provider’s CRM practice,
industry - what is referred in industry parlance as ‘domain’
they might want to consider the outsourcing of its supply
strength in that business line.
chain management to that same provider if that was another
HORIZONTAL
Human Resources
Finance and
Accounting
Procurement
Customer
Support
Insurance
Financial
Services
Healthcare
Real Estate
Payroll
processing
Financial
reporting
Vendor
analysis
Customer
relationship
management
Application
processing
Loan and
mortgage
processing
Medical billing
Property
management
Recruitment and
staffing
Management
reporting
Bidding
reviews
Underwriting
Check
processing
Claim
management
Collections
Retirement
benefits
Financial
analysis
Just in time
processes
Claim
processing and
adjudication
Account
reconciliation
Physician
support
Tax analysis
Hiring and
training
Accounts
receivable
Cost analysis
Payment
processing
Financial
analysis
Account
reconciliation
Travel and
entertainment
Accounts
payable
Risk
management
Asset
management
Accounting
E-learning
Tax compliance
Source: Author & Avendus Advisors
16 - The
VERTICAL
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Other ways to categorize BPO offerings are as commodity,
■ Is the process that is being considered for outsourcing a
niche, or premium services. Premium or comprehensive BPO
core competency of the organization? (viz. do we need to
seeks a higher order value added solution coming out of out-
perform this process in-house?) Core competencies should
sourcing. As the industry matures, buyers of BPO services are
increasingly investigating ways in which the BPO provider can
influence the value premise. At the same time, the client companies themselves will have to grow the expertise and experience of managing partners located in different geographies
not be outsourced under any conditions.
■ Are we willing to make an appropriate investment in
human resources, technology, and infrastructure to make
the process ‘best of breed’?
■ To ensure that a particular process is superior, the investment that companies have to make will include not only
and serving different constituencies.
the systems required to run the process but the people
Key questions before you outsource
a business process
that would make the process run. For instance, companies
The decision to outsource a business process is not something
tomer relationship management system or whether they
to be done without a serious analysis. Before considering
would do better to outsource part or all of that function.
whether to outsource, an executive has to perform a feasibility
analysis and determine which of all of a company’s activities
merits outsourcing. All of the company’s activities should be
sequentially listed, so that they can be formally evaluated.
need to consider if they should implement their own cus-
■ Can the process be outsourced without surrendering
competitive advantage?
■ If the process being considered for outsourcing might
result in the reduction of any competitive advantage, then
outsourcing should not be contemplated. Examples of
competitive advantage can be control of patented
processes or methodologies.
■ Will the outsourcing activity result in creating value for
Is the process a
core competency?
shareholders? These can range from cost reduction to
gaining specific expertise to increased revenue - all of
NO
which should increase future results and therefore the
value of the stakeholders of the organization.
Willing to make
appropriate
investment
Evaluation process
The first consideration is to assemble good cost data for the
NO
process. In this evaluation, it is important to accumulate all
Will we lose
competitive value
by outsourcing?
YES
trend data and all the direct and indirect costs for the process.
While direct costs are generally easily accessible, indirect
NO
YES
costs are oftentimes not as easy to tabulate. For example, in
the consideration of an HR BPO, one may miss the cost of
Will the outsourcing
create shareholder
value?
YES
managers’ time during the recruiting process. Therefore, a
holistic approach is often necessary to bring out all of the indirect costs of the process.
YES
NO
Do Not Outsource
Leading questions:
Next, one should send out a formal Request for Proposal (RFP).
Consider Outsourcing
The RFP should define the ‘what’ but not the ‘how’ of the
process. While not mandatory, since the company can certainly
17
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Page 18
take charge of its own RFP, it is certainly desirable to utilize a
arise, since effective BPO relationships are founded on solid
consultant to bring professionalism and objectivity into the
inter-personal relationships.
process. There are many consulting firms that specialize in
taking charge of this step. Additionally, attorneys and other
Many companies use at least two different BPO providers so
advisors should be lined up at this time.
that one can be benchmarked against another.
Responses from the RFP should be scored and a short-list of
Management and legal considerations
two or three providers developed for in-depth review and con-
A BPO relationship is basically a strategic alliance between
sideration. This analysis should include an assessment of the
two independent organizations. These agreements are gener-
financial strength and staying power of the BPO provider(s),
ally multi-year in nature; accordingly the destinies of the parties
the cultural fit with the company, and an assessment of the
are tied together for extended periods of time. In that sense,
domain strength. It would be appropriate at this point to visit
it is more like a marriage than a contract. Management issues
the BPO providers’ offices to review their process and method-
with managing a BPO provider tend to be very different from
ology. Attributes to score would include an assessment of:
managing an internal department or employees. It has to be
performed at the macro level, unless there are significant
■ Reputation and record of success
operational issues that have to be resolved.
■ Domain expertise and experience
■ Process strength
Issues will surface that are not explicitly contemplated or dealt
■ Partnering skills
within the SLA. These will have to be satisfactorily resolved to
■ Process delivery capabilities
mutual agreement using a ‘governing body’ that is comprised
■ Infrastructure
of the senior-most couple of executives involved on both sides
■ Scalability of solution
of the relationship. This process is aided if there is a solid rela-
■ Perceptions of quality
tionship between the parties and mutual trust. If the BPO
■ Cultural fit
provider is privy to the broad strategic direction of the company, they will be more able to be in sync.
The foregoing analysis will culminate in a Memorandum of
Intent that sets out the primary considerations for the BPO
Problems can arise if the BPO mechanism has not been prop-
process. Thereafter, attorneys on both sides need to start
erly thought out:
work on the primary document, the Service Level Agreement
(SLA), that will govern the relationship between the parties.
■ The costs of the process have not been properly
calculated, so that the savings from outsourcing cannot
Before formally transitioning the process, a detailed transition
plan has to be developed and detailed. Concurrently, a pilot
has to be run, which will show how the process is expected to
work at the BPO provider. At this time, it is important to designate the people at the company and the BPO provider who
will be in charge of the relationship. These would be the
Relationship Managers at the BPO provider and the company
respectively, who would have primary responsibility for the
relationship, and the operations manager, who would run the
day-to-day BPO process at the provider. It is important that all
these people be able to communicate and mediate issues that
18
be correctly calibrated.
■ The proper amount or level of resources has not been
allocated to managing the BPO relationship.
■ Appropriate professional assistance has not been used
at the front-end.
■ The provider charges a ‘teaser rate’; the real rate
turns out to be significantly higher.
■ The BPO agreement does not have appropriate
release provisions.
JOURNAL 8 -v3
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Once substantive agreement between the company and the
dous potential for both labor utilization and economic growth.
BPO provider is reached, it has to be codified by means of a
Tax incentives and telecom investment and deregulation fos-
legal agreement. The service level agreement defines the con-
ter an unusually supportive environment. The leading
duct of the BPO relationship. Incorporated within are details of
providers have the ISO 9000, Six Sigma, and CMM Level 5 cre-
the service level to be provided, the metrics to be measured,
dentials as evidence of their strong emphasis on quality. Don
performance levels, and the pricing for the service. Inasmuch
Ganguly, CEO of U.S.-based start-up Equinox Corporation
as some of the attributes are not known up-front, there will be
which delivers BPO services to the financing industry and is cur-
successive amendments to the SLA to capture new informa-
rently hiring a significant number of employees, discussed the
tion. Mediation and ‘divorce’ provisions will generally be
labor situation in India this way: ‘Labor quality there tends to
included in the overall agreement and not in the SLA. It is
be superior as the young energetic employees, typically upper
important to remember that this ought to be a collaborative
quartile university graduates now do the work that would oth-
rather than a contractual agreement.
erwise be done by clerical workers in Western settings’. India
is soon expected to upstage Australia as the leading BPO
Both sides will want to focus on the metrics to be measured.
provider in the world (Figure 3).
The focus on a few key metrics is ultimately desirable, recognizing that overemphasis on too many metrics is time-con2003
2004
% of growth
be best achieved by including appropriate bonus and penalty
India
95,000
177,000
85%
provisions in the SLA.
Australia
135,000
145,000
8%
China
38,000
54,000
42%
Philippines
20,000
40,000
100%
suming, expensive, and meaningless. Goal synchronization can
Off-shore and near-shore venues
Cost and quality issues have propelled a lot of BPO work overseas. While quite a lot of BPO work has traditionally been done
in Australia for many years, a significant number of providers
Figure 3: BPO workers
Source: The Times of India, June 5, 2003
are now located in India. Other places where there are emerging concentrations of BPO are China, The Philippines, Russia,
In the near future, India’s primary competition will come from
and Eastern Europe. Near-shore locations typically tend to be
China and the Philippines. China in particular is liberalizing
in Canada, Mexico, and the Caribbean.
government regulations. Additionally, with its vast pool of
labor, mushrooming middle class, focus on technical educa-
It is desirable to have a mix of on-shore, near-shore and off-
tion, and the lessons learned from its premier position as a
shore locations for BPO work. Some experts use 10% on-
manufacturing location, China is going to be a serious con-
shore, 20% near-shore and 70% off-shore as a rule of thumb.
tender for new BPO work. English language skills though will
GE Capital used the rule that 70% of processes are out-
take much time to develop, although there is anecdotal evi-
sourced, 70% of outsourced processes are sent off-shore, and
dence that China is starting to import English-speaking labor
70% of off-shore processes are put in India!
from the Philippines.
With its huge college-educated workforce that is fluent in
Philippines has a natural draw to BPO work based on its his-
English, falling telecom costs, and improving technology infra-
torical connection with the U.S. and the fact that the educated
structure, India is currently the dominant venue for off-shore
intelligentsia is proficient in English. Russia, too, is emerging
BPO. The federal and state governments in India have been
as another possible location because the education system
very supportive of BPO initiatives, recognizing the tremen-
there turns out so many technically qualified people.
19
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The controversy about off-shore outsourcing
Characteristics of strong BPO players
Recently, there has been an increasing crescendo of opposition
Being a young industry, the industry itself has not yet consol-
in the United States and the United Kingdom to outsourcing
idated. There are many BPO providers, and over time larger
work overseas. Much of this angst is directed at India, perhaps
companies are beginning to emerge. Generally, BPO providers
the most visible segment of this controversy. This anti-out-
specialize in particular activities. For instance, Exult is cur-
sourcing movement has been fermenting as the United States
rently the pre-eminent provider in HR BPO, and Affiliated
grapples with a 6% unemployment rate (Figure 4).
Computer Services in government-related BPO work. As the
industry matures, we would expect to see several larger com-
State
Unemployment
panies with defined staying power. Since the BPO industry is in
1,300,000
its formative stages, there are only a handful of large compa-
California
Texas
622,000
nies. However, by looking at other service businesses, one can
Missouri
302,000
speculate on the characteristics of desirable BPO companies.
Illinois
376,000
Georgia
189,000
Companies must demonstrate staying power by having strong
Pennsylvania
342,000
balance sheets and high doses of liquidity. They should have
New York
520,000
visible domain strength, and have high process knowledge and
141,000
experience. They must be technologically leading-edge, with
New Jersey
222,000
their offerings delivered through a scalable transaction man-
Virginia
155,000
agement engine. Further they must demonstrate continuing
Massachusetts
investment in technology. In common with the real estate
Figure 4: Loss of Jobs
Source: Business World, June 16, 2003 issue
Most significantly, a major component of the unemployed constitute white-collar workers, who are more visible in their
opposition to jobs flowing overseas. There is a movement to
enact legislation to prevent jobs from being taken overseas.
Stories about the pain and suffering caused by the migration
of jobs abound. A recent case of a Bank of America software
industry, there would be a premium for a company with anchor
customers, and multi-year BPO agreements that provide stability and financing strength. They must be able to provide
flexible solutions using a mix of on-shore, near-shore and offshore locations - one size fits all will clearly not work in this
space. The ability to execute on a scalable manner will be key.
Lastly, they need to have failsafe telecom and disaster mitigation systems.
programmer who committed suicide after he had to train his
From a company perspective, more comprehensive offerings
replacement, an Indian engineer, has also brought visible
from BPO providers are desirable, such that they can provide
negative publicity to the off-shoring movement
one-stop shopping. Larger providers that hitherto specialized
in specific areas may invade each other’s turf, in an effort to
It is believed that the curtailment of off-shoring may violate
become dominant.
the General Agreement on Trade in Services, under which
20 - The
every signatory is required to open up its service sector sub-
Conclusion
ject only to some limited exceptions. The protectionism and
BPO is an idea whose time has arrived. Executives seeking
jingoism now being witnessed will most probably dissipate
value creation in their companies would do well to consider it.
once the growth rate of United States economy improves from
It would be prudent, however, to consider a systematic, modular
the current 1.9% to around 3%. Furthermore, to the extent
approach to implementing appropriate outsourcing processes.
that the BPO business is based on competitive economics and
Further, it should only be considered after appropriate analy-
shareholder value enhancement, it is felt that it will continue
sis and investigation. Finally, it should be managed with con-
to thrive, albeit with some minor reductions in its rate of growth.
comitant risks and rewards in mind.
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Justification
It’s no longer a wave,
it’s a Tsunami:
Risks, rewards, and
trade-offs of offshore
outsourcing
Suresh Gupta
Partner, Capco1
Abstract
The world of offshoring has come a long way in recent years.
This experience allows us to make certain inferences about its
potential and recommendations on how it can best be utilized.
This paper aims to provide a description of the state of offshoring, a summary of best practices, and to answer the key
questions in the minds of management today regarding this
massive trend.
1
I would like to thank Andrea Lowe for the great work she did in editing this piece.
21
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It’s no longer a wave, it’s a Tsunami:
Risks, rewards, and trade-offs of offshore outsourcing
In a very short time, offshoring has evolved from a clever cost-
The popular press and local politicians find that the trumpet-
saving experiment to the sourcing linchpin for global delivery
ing the job loss/’exporting jobs’ aspect of offshoring provides
models used by major financial services firms and other multi-
them a platform. This has put a further spotlight on offshoring
national companies. A year ago, in 2002, we wrote a white
while raising the stakes for companies to handle community
paper titled, ‘Riding the Offshoring Wave,’ to provide some
relations and the re-training and ‘re-skilling’ of their workforce
insights into the then popular trend of migrating call center
effectively.
jobs and applications development work to offshore destinations such as India, Ireland, the Philippines, etc.2 The momen-
The decision to move work offshore is, in some ways, the
tum has continued to build. The offshoring wave of yester
easiest to make. Choosing the right country, vendor(s), and
years has turned into a tsunami. High satisfaction levels expe-
business model, specifying work and performance metrics, all
rienced by the users have encouraged other firms to take the
require careful analysis. This paper provides a description of
offshoring route to improved quality at reduced costs. In an
the state of offshoring, a summary of best practices and
era of profit pressures, offshoring can make or break the via-
answers to key questions in the minds of management today
bility of some product offerings and affect competitive position.
regarding this massive trend.
In fact, Gartner suggests that today enterprises will no longer
ask External Service Providers (ESPs) to bid on an IT out-
The state of offshoring – How did it all begin?
sourcing project unless the ESPs can demonstrate availability
As a companion article in this issue of the journal indicates,
of low-cost offshore resources.3 Over the next five years, IT
the manufacturing sector was the first to move plant opera-
offshore services are expected to grow by 20% every year
tions to low-cost destinations. The first wave of this outflow
while the offshore BPO services are expected to show a whop-
occurred in the 1980’s in heavy industry. The second wave of
ping growth rate of 79%.4 Our 2003 Offshoring Survey reveals
major outflow of manufacturing jobs occurred in the late
that 89% of the respondents plan to increase their future
1990’s, chiefly driven by the high-tech sector. The first big wave
5
level of offshoring.
of the offshoring of white-collar work was driven by the Y2K
scare – the India-based software firms jumped at the opportu-
This bandwagon has created a flurry of activity. The top
nity to undertake the massive ‘low-end’ code-fixing work that
offshore vendors have increased their global coverage, with
few in the U.S. were willing to do. Simultaneously, certain off-
marketing offices in client countries and an array of sites in
shoring pioneers, such as GE Capital and American Express,
India and other offshore locations to ensure that they meet
had begun to process back-office transactions. This provided
business continuity planning concerns of their clients and are
further impetus to movement of white-collar work to offshore
positioned for the future. Smaller vendors and new offshore
locations such as India.
locations are pitching up, offering lower cost deals and risk
22
sharing. Large consulting firms like Accenture, Bearing Point,
While IT services were the first candidates for white-collar off-
and IBM Business Consulting have also joined the party: they
shoring, increasingly companies are considering a range of
now compete head-to-head with traditional offshore firms,
business processes, including finance and accounting, sales
such as Tata, Wipro, Infosys, etc., having built large offshore
and marketing, customer service, back-office operations, and
centers of their own.
even research. Figure 1 contrasts the maturity among various
2 We define ‘offshoring’ to indicate the movement of white-collar work to offshore
destinations in three areas, namely IT (applications development, maintenance
and operations,) business processing (e.g., back-office operations, finance and
accounting, HR, etc.) and contact centers (call centers, e-mail processing, help
desk, etc.) Many firms choose to offshore by establishing wholly-owned (‘captive’)
offshore centers while others outsource activities to third-party vendors.
Still others may offshore to a jointly owned center (‘JV’) or some other hybrid
arrangement with an offshore vendor.
4 IT offshore growth rate based on forecast by the Meta Group (17 February 2003,
‘Companies Expected to Boost Offshore Outsourcing,’ Computer Weekly)
Offshore BPO growth rate estimates from Gartner (R. Scholl, S. Chohan, D. Sinha,
R. Datar, 20 June 2003, ‘India Will Generate $13.8B from Offshore BPO Exports in
2007,’ Gartner, Inc.)
3 Terdiman, R. and Young, A., ‘Management Update: Application Outsourcing Trends
for 2003 and 2004,’ Gartner Inc., 5 February 2003
5 The survey suggests that most firms expect to source as much as 20-30% of their
information technology budget from offshore location within the next 2-3 years
and they expect the levels to continue to grow. Moreover, 38% of the firms are
currently offshoring business processes.
JOURNAL 8 -v3
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Page 23
Penetration
HIGH
(Proportion of
enterprises currently
using offshore
resources for these
activities)
OEM
Product Dev.
New
application
Dev.
App.
Migration
EAI
BI
Legacy
Application
Dev.
App.
Maint. and
Mgmt.
Infrastructure
Services
Packaged
Apps.
Call
Centers
BPO
LOW
MEDIUM
LOW
HIGH
Leverage (Offshore/onshore resource mix – high means more resources offshore)
Figure 1: Relative maturity of various activities in offshoring
Source: Gartner Group
white-collar activities in their offshoring endeavors. However,
fold to over one million workers.7 And, almost all applications
this is a fast moving picture – certain activities, such as call
outsourcing will include an offshore component by 2007.8 This
(contact) centers, are rapidly approaching higher maturity levels.
momentum is fueled by very high (89%) satisfaction levels by
current offshoring participants (TPG/Baruch 2003 Offshoring
The market is poised for significant growth
Survey). The type of IT work being offshored is shifting from
The trend towards offshoring is expected to continue unabated
traditional development and maintenance to more high-end
in all three areas: Information technology, business processing,
activities involving Java, XML, Oracle, etc. In addition to India,
and contact centers. According to Forrester, 3.3 million U.S.
many other countries have begun to offer offshore resources,
service jobs would move offshore by 2015. An indication of the
e.g., Russia, Eastern Europe, and Israel in complex, algorithm-
breadth of this trend is that these service jobs cover 770 job
intensive projects.
6
categories, as defined by the U.S. Bureau of Labor Statistics.
While the offshore IT market is expected to demonstrate sigThe information technology offshoring, as noted earlier, was
nificant growth, the market for offshore business processing
the first big wave in utilization of offshore resources. By now,
(including back office operations and contact centers) is set to
we would be hard-pressed to find a CIO who is not actively
explode: from U.S.$1.3b in 2002, it is expected to grow to
considering offshoring of at least some activities in her shop.
U.S.$24b by 2007, at an annual compounded growth rate of
Indeed, according to Forrester, by 2007, 70% of the world’s
79%!9 And, the types of back office work being offshored is no
computer programming will take place in offshore countries.
longer limited to routine activities.
The number of offshore IT workers will have increased three-
6 McCarthy, D., et.al, 11 November 2002, ‘3.3 Million U.S. Service Jobs To Go
Offshore,’ Forrester
7 Spivey Overby et.al., September 2001, ‘The Coming Offshore Services
Crunch,’ TechStrategy Report, Forrester
8 Davidson, D., Feb 10, 2003, ‘Offshore Applications Outsourcing,’ Meta Group
9 Scholl, R., S. Chohan, D. Sinha, and R. Datar, 2003, ‘India Will Generate $13.8b
from Offshore BPO Exports in 2007,’ Gartner, Inc., 20 June
23
JOURNAL 8 -v3
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Opportunities
Description
1998
2010
Research in banking, finance, securities, and insurance
Data search, integration, & management
Research and information services in human resources
Market research, competitive intelligence
Engineering & design
Animation and simulation services
Legal and paralegal content and services
Medical content and services
Remote education
Network consulting and management services
Corporate finance research, books, M&A research, etc.
Analysis of data, modeling
Compensation modeling and benchmarking
Industry reports & data analysis
CAD/CAM, plant designs
Simulation of new designs for cars, engines, etc.
0
0
0
0.4
-
1.0
18.0
1.0
1.0
5.0
2.0
1.0
1.0
15.0
5.0
-
50.0
Counseling, remote diagnosis, etc.
Continuous medical education
N/A
Total ($ billion)
Figure 2: Examples of High end Business Porocesses Expeted to be Offshored
Source: Evalueserve
The offshoring trend is beginning to embrace
high-end processes…
reported gains in quality.11 Access to skills, reducing cycle time,
etc., were the other key motivators.
The knowledge work (characterized by typical back office
operations and other business processes) varies dramatically
Savings of 40-60% in processes offshored could make signif-
in the amount of worker expertise and strategic input
icant contribution to overall performances of selected indus-
required. Today many of the tasks being sent offshore can be
try verticals. McKinsey/Nasscom estimate that for banks this
classified as data transformation, but there are increasing for-
could lead to an improved performance of 8-12% (cost savings
ays into processes that require expertise and judgment, for
plus EBITDA increase), and for insurance firms, 10-15%.12 In
example, in broker research, preparing ‘pitch books’, and secu-
fact, according to Deloitte, Financial Service firms in the devel-
rities back office operations. In fact, some analysts are pre-
oped world would save U.S.$138B over the next five years from
dicting a U.S.$50b offshore market for high-end processes by
offshoring.13
2010 as more and more businesses seek the benefits of offMoving offshore provides cost savings, improved quality,
shoring. (See Figure 2.)
speed (with 24/7 coverage), and access to skills, all of which
Rewards are significant…
lead to greater competitiveness. If outsourced to a third party,
Offshoring has delivered significant benefits to the pioneers.
there is potential to build greater organizational and opera-
GE alone is said to have enjoyed savings of over U.S.$300 mil-
tional flexibility, since it would be easier to scale up or down to
lion from its offshore operations in India. P&G says it has saved
accommodate business volatility. Finally, just as in domestic
U.S.$1b since 1999 by consolidating back-office work in the
outsourcing, offshore outsourcing has the potential to build
Philippines, Costa Rica, and Britain. However, more than cost,
improved operational efficiencies and capabilities by leverag-
it’s the quality and other benefits that are providing further
ing vendors’ investments in state-of-the-art processes and
fodder to offshoring. Besides savings of 40-50%, in the 2003
technologies.
10
TPG/Baruch Offshoring Survey, 66% of the participants
24
10 Kirkpatrick, D., 2003, ‘The Net Makes it All Easier – Including Exporting U.S. Jobs,’
Fortune.com, 12 May
11 Our survey results are consistent with other studies. For example, in a survey of
U.S. firms, Forrester found that offshore firms rate higher in quality than their U.S.
counterparts. (See John McCarthy, February 2003, ‘Unlocking The Savings in
Offshore,’ Forrester)
12 McKinsey Analysis, Nasscom, New Delhi, India.
13 Currently 13 million people are employed in financial services in mature
economies; two million, or 15% of those positions will migrate to offshore locations
over the next five years. Deloittes expect U.S.$356b of costs (out of a total of
U.S.$2,340b) will be relocated offshore. Since the move should reduce these costs
by 39%, offshoring will generate additional profits of U.S.$140b for world’s top FS
companies by 2008 (possibly over U.S.$1b each for 100 largest groups) AT
Kearney estimates that over the next five years the American financial services
firms alone would save U.S.$30b annually by moving 500,000 jobs, or 8% of the
workforce overseas.
JOURNAL 8 -v3
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The statistics to consider offshoring are compelling, but even
more consideration needs to go into what and how to offshore,
with process, country, business model, and vendor selections
all significant variables.
What to Offshore
A number of considerations come into play when considering
migrating work to an offshore destination. The considerations
boil down to three broad topics: Suitability, rewards, and risks.
Suitability
Level of clarity re: user needs
Level of end-user interaction
Hardware/software standardization
Application modularity
Level of documentation
Business criticality
Level of integration with
other applications
Stage of the life cycle
At its most basic level, any activity that does not require faceto-face interaction with customers or ‘front-office’ employees
Figure 3: IT Project suitability funnel example
(e.g., sales and marketing personnel) is a candidate for offshoring. Availability of high-capacity communications infrastructure and internet technologies greatly facilitates such
‘remote processing.’ Thus in developing application systems,
while it would be prudent to complete ‘user requirements’
through on-site meetings, workshops, etc., with the intended
users of the system, many other phases of the development
cycle, including actual programming, systems testing, documentation, etc, could be performed in a remote location.
Similarly, a typical back-office activity - such as accounts
payable, customer account maintenance, payroll processing,
etc. - could be performed anywhere given on-line connectivity
Regulatory constraints
Level of integration with
other processes
Process maturity
Customer interaction
Overall operating model
Maintaining competitive
advantage
with on-site staff. Contact centers activities were among the
earliest to move offshore, since customers were interested
more in how quickly their calls were answered rather than the
Figure 4: Process suitability funnel example
location of the contact center agent (provided the agent can
be understood on the phone.)
Rewards
To give guidance as to which activities are most suitable, we
An obvious reward of offshoring is cost savings. However, as
have developed a set of filters. Figure 3 looks at IT projects,
the 2003 Offshoring Survey reveals, there are many other
while Figure 4 highlights the considerations that determine
benefits that could be considered in making the offshoring
the suitability of a process for offshoring, dealing with the
decisions. In information technology, these include improved
nature of the process, the operating model, and competitive
quality, access to rare skills, speed of development (because of
and regulatory issues.
24/7 development cycle) and greater staffing flexibility (especially when using third-party vendors.) In offshore business
processing, these include cost savings, quicker turnaround
(because of 24/7), and improved quality (although this may be
less true in some specialized business processes depending on
availability of more highly educated resources).
25
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Page 26
Contact Centers
Business Processing
Information Technology
FUNCTIONAL RISKS
LOCATION RISKS
VENDOR RISKS
Skills availability
Geo-Political
Political stability
Regulatory system
Attitude towards foreigners
Financial
Limits on FDI
Taxation
Currency risk
Inflation risk
Repatriation of investments/profits
Legal
Judicial system
Local employment laws
Employment of foreigners
Intellectual property
Security and privacy
Business
Bureaucracy
Barriers to trade
Loss of control
Knowledge transfer
Technical
Infrastructure
Deregulation
Cultural
Social system
Work norms/ethics
Communication styles
Diversity
Other
Health/safety standards
Natural disasters
Cultural Compatibility
Work norms/ethics
Performance metrics
Communication style
Project complexity/development methodology
Domain experience
Communication/training
Competition for employees
Lack of integration with other processes
Process maturity
Customer/regulatory constraints
Underdeveloped communications infrastructure
Domain expertise
Communication/training
Lack of integration into CRM processes
Underdeveloped communications infrastructure
Contact center operations expertise
Inadequate language and cultural training
Vendor Experience/Capacity
Domain experience
Recruiting/training processes
Scalability
Vendor Infrastructure
Reliability
Redundancy
BCP
Vendor Viability
Financial strength
Business model
Price Risk
Currency risk
Inflation risk
Legal and Contractual
Liability for errors
Judicial jurisdiction
Termination – cause or convenience
Market Consolidation
Management changes
Going out of business
Figure 5: Potential Risks in Offshoring
Risks
shoring. Figure 5 summarizes the three categories of risks. We
In assessing potential risks of offshoring, firms need to con-
have attempted to include only those risks that are linked to
sider three categories of risks: functional, location, and vendor
the offshoring decision. Thus the category ‘Vendor Risks’ does
risks. Functional risks are specific to the type of activity being
not necessarily document every risk associated with out-
considered for offshoring. For example, in the case of an appli-
sourcing. For example, ‘potential loss of competitive advan-
cations development project, the lack of adequate availability
tage’ is a risk common to any outsourced activity, whether
of specific skills in offshore destinations may pose a risk.
onshore or offshore. Hence, it does not appear in Figure 5. On
Similarly, for certain business processes, potential lack of
the other hand, Business Continuity Planning (BCP) while
domain experience may pose a risk. In considering contact
common to all outsourcing arrangements, becomes doubly
center offshoring, language and communication skills become
important in offshoring because of an increase in potential
critical variables. Location risks are specific to the offshore
points-of-failure and therefore makes our list.
country/location being considered and are not dependent on
26 - The
whether it is an IT, OBP, or contact center activity that is being
Making the final selection: Risk/reward matrix
offshored. Finally, vendor risks are specific to those situations
Having assessed the relative risks and rewards of each of the ‘suit-
where firms choose to utilize third-party vendors for off-
able’ offshoring candidate activities, the final selection is a straight
JOURNAL 8 -v3
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Page 27
HIGHER
OTC derivatives
processing
Outsourcing
When offshoring business processing, if a firm chooses to outsource the process to a third party (instead of building a ‘cap-
2
OTC derivatives
documentation
Potential
risk
Data cleansing
1
5
to include another consideration, namely, ‘how strategic the
process is?’ In this respect, we are down to answering the clas-
7
Asset income
processing
6
tive’ center) then the selection approach should be modified
sical question of when and if it makes sense to outsource a
Corps actions
3
Reference data
particular process. A lot of research has been devoted to
answering this question.
Fine et al,1 provide a useful framework for contrasting strategic value with economic value. The Strategic Value Added is
LOWER
derived as a qualitative score by considering customer imporPotential annual cost savings
tance, speed of technology change, competitive position (in
Figure 6: Risk/reward matrix example
the candidate activity), supply base, and the level of integration of the activity to the overall architecture of the product
forward process: each suitable activity can be mapped on a
risk/reward matrix; the most desirable set of finalist activities is the
one that promises highest reward and the lowest risk. For
example, see Figure 6.
being manufactured. The Economic Value Added follows the
standard break-even analysis. Combining the strategic and
economic value analyses, the authors provide the following
four choices for the manufacturing value-chain design: insourcing, outsourcing, leveraging, or harvesting. We suggest that a
similar analysis would be an appropriate framework for making
third-party outsourcing decisions in the FS sector.
Ravi Aron and Jitendra Singh2 provide another useful model
STRATEGIC VALUE ADDED
for making smart outsourcing decisions regarding business
processes. Introducing a term, ‘Threshold of Criticality,’ they
HIGH
argue that the potential errors caused by a third party vendor
are tightly linked to the criticality of the process being considLeverage
ered. ‘Low Threshold of Criticality’ processes are those in
Insource
which a single execution of the process can cause significant
‘direct’ as well as ‘carry-forward’ errors. ‘Direct’ errors result in
immediate financial liability and customer impacts while the
MEDIUM
‘carry-forward’ errors contribute to losses in related downstream processes. ‘High Threshold of Criticality’ processes, on
Outsource
the other hand, could tolerate several executions of the
Harvest
process before experiencing significant financial or customer
loss. Clearly, it would be less risky to outsource High Threshold
LOW
of Criticality processes. Additionally, rather than dictating to
vendors how to execute and measure processes, they suggest
Low (negative)
ECONOMIC VALUE ADDED
Medium (break even)
High (positive)
breaking processes into ‘high functional value elements’, and
specifying tolerance levels (proxies for minimum quality) for
these elements.
1
Fine, C.H., R. Vardan, R. Pethick and J. El-Hout, 2002, ‘Rapid-Response Capability
in Value-Chain Design,’ MIT Sloan Management Review, 43:2, 69-75
2 Aron, R., and J. Singh, 2003, ‘Two Major Errors That Companies Make in Outsourcing
Services,’ Knowledge@Wharton, 12 March
27
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The human side of offshoring…
example, in information technology, firms need project man-
Offshoring is an inevitable result of globalization and economic
agers who can manage globally diversified application devel-
integration. As organizations seek to create value, they gravi-
opment teams or information architects with ability to design
tate to securing the lowest costs of the factors of production,
component-based systems, whereby each component may be
as the history of the manufacturing sector attests. The advent
sourced from a location best suited to its design characteris-
of the internet economy has sped up the rate at which history
tics. More people will be needed in managerial job categories
14
is repeating itself in the services industry. Shojai et al. in their
of this sort.
study of ways to increase the liquidity of human capital suggested that new technologies would allow new mediums of
Nevertheless, in the near term, there is a human cost of off-
exchange: employers would have increased access to ‘interna-
shoring that must be considered by the firms actively pursu-
tionally diverse high-quality staff’ and ability to reduce com-
ing offshoring.17 The near-term displacement of jobs has to be
pensation costs.
dealt with through employer initiatives (e.g. reskilling, retraining, etc.) and also through public policy. Honesty in dealing
Given the new technologies and ever-increasing bandwidth, it
with employees and good internal and community relations
is an organization’s fiduciary responsibility to seek resources
are crucial parts of any outsourcing decision.
from any location that offers the most optimum cost-quality
combination. There is no alternative but to continue to exer-
The current arguments pit a misplaced patriotism against eco-
cise this responsibility in order to stay efficient and competi-
nomic efficiency. Nevertheless, honesty in dealing with
tive in a global economy. Efforts to stem this trend may slow it
employees and good internal and community relations are
down but ultimately they would prove as futile as trying to
crucial parts of any offshoring decision.
stop a flood with bare hands.
Country selection
Economic integration does cause temporary displacement of
While geopolitics has always been a factor in choosing where
workers in certain jobs, but eventually it benefits both the
to locate a business (or outsourcing work), globalization has
‘donor’ country as well as the ‘receiving country’ by raising liv-
meant that knock-on effects matter too. The recent Iraq war
ing standards in both. There has been a 1.25% increase in the
slowed offshoring decisions as site visits were canceled or
worldwide GDP because of economic integration. An analysis
postponed. SARS both disrupted travel and raised the possi-
of the history of the manufacturing sector in the U.S. supports
bility of quarantining a workplace location leading to new per-
this view. Today’s blue-collar jobs are better paid than they
mutations in business continuity planning. Businesses are now
were a generation ago. In 2000, manufacturing jobs in the U.S.
wary of over-reliance on any one location, and are trying to
averaged U.S.$54,000, 20% higher than the average of all
build in the ability to move from one country to another.
15
American workers. And while, the percentage of U.S. workforce in manufacturing jobs has declined, the actual number
In selecting a country, companies need to consider: govern-
of jobs in the manufacturing sector is roughly the same it was
ment support, infrastructure, communications, education sys-
in 1950: around 16 million. Moreover, in the last decade, U.S.
tem, English proficiency, cultural compatibility, labor cost
manufacturing output grew by 47%.16
advantage, quality initiative, labor pool characteristics, country laws (especially employment), etc. Moreover, IT suppliers’
28
Thus, while the displacement that took place in manufacturing
business culture and social culture can be strongly affected by
is now being mirrored in service industries, we must have faith
the country in which they are headquartered.18 However, the
in the service sector’s ability to reinvent itself. As certain jobs
‘country first’ approach is eroding somewhat as vendors tran-
migrate to offshore locations, new jobs will be created. For
scend national lines and strive to be truly global players. Some
14 Shojai, S., P. Gray, C. Keeling, and S. Wang, ‘Liberating Human Capital: The Search
for the New Wave of Liquidity,’ Journal of Financial Transformation, 3, 117-126
15 27 September 2001, ‘Globalisation and Its Critics,’ The Economist.
16 Clare Ansberry, 30 June 2003, ‘A New Blue-Collar World,’
The Wall Street Journal.
17 Karamouzis, F., A. Young, C. Young, and D. Sinha, 2002, ‘Understanding the
‘Human Cost’ of Cost Savings,’ Gartner, Inc., 23 December
18 Terdima, R., 2002, ‘Going Offshore: Country before Company is our Motto,’
Gartner, Inc., 4 January
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Page 29
of the top Indian vendors have made great efforts to establish
With 90% of IT offshore resources now in India comes a depth
operations in other Asian and East European countries, and
of experience. They have also built their onshore presence,
opened marketing/client service offices in the U.S. and else-
sometimes through U.S. acquisitions (Wipro buying Nervewire)
where to increase the comfort level of their clients. Many U.S.
or joint ventures to aid in onshore consulting and handholding.
outsourcing suppliers, anxious not to be left behind, have
All of this has led to a high U.S. acceptance of Indian vendors.21
either established their own offshore centers or have formed
Software and IT services exports are expected to go from
relationships with other offshore vendors for offering low-cost
under U.S.$8b in 2002 to almost U.S.$10b in 2003 according
offshore resources.
to Nasscom, India, while India-based BPO centers would grow
to U.S.$13.8b by 2007 (over 70% growth) according to Gartner,
In looking at offshore alternatives, an occasional ‘reality
making it the number one BPO destination.22
check’ is helpful. ‘Follow the sun’ has advantages, but keep in
mind that the best people do not want to continually work
However, there are some concerns for India beyond the obvi-
nights in any culture (although extended shifts may be possi-
ous, e.g. continuing need for people. Although sales are up,
ble.) If a need for high interaction is anticipated, nearshore
this is being neutralized by existing and incoming clients
options may be the most cost-effective. For example, the
demanding lower prices and often a basket of higher-end
North of England is 30-40% cheaper than London. What is not
services. Since 1990s Indian margins have dropped from 30%
desirable, in nearshore or offshore activities, is to export more
and more to the low 20s, affecting ability to fund expansion
than one or two existing (highly paid) employees; an expatri-
into new services and new industries; also the rupee is appre-
ate package defeats the economics. It is also important that
ciating against the dollar.23 This pricing pressure may result in
there is a sufficient pool of qualified personnel that your pres-
Indian vendors taking contracts they should walk away from,
ence there does not actually move the market and destroy the
resulting in an inability to deliver, or at least deliver profitably.
cost advantages. While it is important that global sourcing
Indian vendors need to continue to invest in their businesses
options build in capacity and diversification; if operations are
to stay competitive.
too diffuse, no economies of scale are possible. Additionally
too much time can be spent investigating new vendors and
Prudent diversification suggests looking at multiple sites, mul-
countries rather than making existing partnerships work.
tiple vendors, and multiple countries for risk diversification
business continuity planning. There is much jockeying for posi-
India is a major IT offshoring success story. According to
tion between countries, and all the risks alluded to earlier
Forrester, the amount of work done there for U.S. companies is
must be considered. At present, for OBP, particularly contact
expected to more than double this year.19 Its strong attributes
center work, South Africa and the Philippines have made
include a 40-60% cost advantage and quality. India is home to
major strides. Although there is still some socio-political con-
54 of the 78 CMM Level 5 certified firms in the world;20 over 250
cern about South Africa, it has a good supply of low-cost labor
Indian firms are ISO 9000 certified (some ISO 9001). A good
and well developed infrastructure, particularly telecoms. The
education system, widespread use of English, and rigorous hir-
Philippines offers labor arbitrage opportunities but there is
ing procedures also help. There is a breadth of skills, and the
concern about the depth of the labor pool. It is unclear, how-
second largest pool of qualified programmers in the world,
ever, that either of these countries would be well placed for
with 900 software firms with currently over 400,000 profes-
higher end processes (Figure 7).
sionals (70,000 added each year), 40% are (college) graduates. There have also been tax incentives to facilitate direct
Of nearshore alternatives, with some savings but not massive
foreign investment, such as duty free imports and exemption
labor arbitrage opportunities, Ireland and Canada have won
from taxes on earnings for the first five years of operations.
substantial business. Eastern Europe, especially Poland, has
19 Overby, S., 2003, ‘Inside Outsourcing in India’, CIO magazine, June 1
20 ‘The Quality Bug,’ Business Today, 10 January 2003,.
21 According to Tower Group, India has bagged 88 percent of the total outsourced
work from the U.S. security industry in 2002. See 25 June 2003, ‘India Corners
88% of U.S. Market for Securities Outsourcing in 2002,’ Indian Business Insight.
22 Scholl, R., S. Chohan, D. Sinha, R. Datar, 2003, ‘India Will Generate $13.8B from
Offshore BPO Exports in 2007,’ Gartner, Inc., 20 June
23 May 2, 2003 Financial Times.
29
JOURNAL 8 -v3
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Page 30
Country
Representative
firms
English
speaking
Infrastructure
quality
Cultural
compatibility
Risk
Notes
OBP
expertise
South Africa
AIG, SAP,
Corel, Swissair
Good
Fair-Good
Good
Low
Robust domestic outsourcing
Up and coming
3
Philippines
FedEx, Amex
Northwest, Dell,
Walt Disney
Good
Good
Good
Moderate-high
Political instability
Limited supply of managers
3
Poland
IBM, PWC
Good
Good
Fair
Low
Limited scalability
High potential
1
Mexico
Coke, GE,
Principal Fin. Group,
P&G
Poor
Good
Good
Low
Limited high-end skills
Language barriers
1
India
260/Fortune 1000,
Films
Good
Poor
Fair
Moderate
Offshore leader
Demand could outrun supply
5
Brazil
GE Xerox,
Goodyear
Poor
Good
Good
Moderate
Outsourcing leader in
South America
Minimal U.S. exposure
1
Argentina
BankOne, Citibank,
Principal Fin. Group
Fair
Fair
Good
Moderate
No IP protection
Highest salaries in
South America
1
Malaysia
Sec. First, Unisys,
MNC Call Centers,
CSC
Fair
Good
Poor
Moderate-high
Geopolitical risk
Growing contender
5
Russia
Dell, GE,
Sun
Poor
Fair
Fair
Moderate-high
Poor IP protection
Erratic government
1
China
IBM, Nortel,
TCS, Infosys Satyam
Poor
Fair
Poor
Low
MNCs eating up labor supply
Low offshore penetration
1
Figure 7: Our list of top ten offshore countries
Source: CIO.com and TPG analysis
made notable progress both in IT and BPO, particularly where
educated technical staff. There are a host of other Asian coun-
a multilingual workforce is needed. Eastern Europe is the obvi-
tries, with varying cost structures, all keen to capture their
ous choice for many Western European companies, particularly
share of the offshore pie, including Malaysia and Vietnam.
the Germans. However, accession to the EU in the next few
years may erode those Eastern European countries’ labor cost
Business models
advantages.
Having selected a country, the next step is to focus on the
sourcing governance structure (Figure 8). For the relatively
30 - The
On a 5-10 year view, most are betting on China to become a
mature area of IT offshoring, most firms choose between
dominant player in the IT area, although concerns about intel-
Offshore Development Centers (ODCs) and ‘arm’s-length’ third
lectual property protection remain, and English fluency is a
party outsourcing. Some firms initially adopt an offshore devel-
major problem. Russia, like China, also provides low cost, highly
opment center approach for control and security reasons.
JOURNAL 8 -v3
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Page 31
When all processes have been mastered there, the ODC retains
minimize the ‘performance’ risk when third-party providers
high-end development and operations and farms out simpler
lack domain experience.
tasks to local third-party alternatives, in each case ensuring
the task is done by the most cost-efficient, competent source.
U.S.–based outsourcing giants are buying or setting up offshore facilities, which may increase comfort levels for some
For offshore business processing and contact centers, however,
companies looking to adopt the outsourcing model. But it is
new business models are emerging. Examples include ‘captive,’
perhaps worth remembering that home country outsourcing
‘extended organization’ (joint venture, ‘build-operate-transfer,’
experience has been mixed for many, and a rigorous approach
facilities management, etc.) and third party outsourcing.
following offshore outsourcing best practices is needed to ensure that cross-border (and cross-cultural) efforts fare better.
Captive offshore centers are the models-of-choice for those
firms who are highly risk-averse, wish to retain control, want to
Certainly a key question must always be: are outsourcers big
realize full value of the benefits of offshoring, or are dealing
enough to deliver? And, increasingly in the case of some ven-
with processes of proprietary or strategic nature. However,
dors being put under pressure, have they been able to invest
they require heavy management commitment and are com-
sufficiently to do so?
plex to setup if the firm does not have prior local presence.
The JV or the BOT models are partial solutions to lack of local
knowledge. A firm gives up a part of the value from offshoring
in return for the ‘local’ experience. Also, such models help to
Captive
Joint Venture
Build-Operate-Transfer
Facilities Management
Outsourced
(BOT)
Firm’s own offshore ‘shared
service center.’ Examples
include GE, American Express
and HSBC.
An offshore center with joint
ownership of the firm and a
third party
An offshore center built and
operated by a third party for a
finite time period after which
the ownership transfers to the
client firm.
An offshore center fully owned
by the firm; facilities management services (real estate,
security, transportation,
cafeteria, etc.) provided by a
third party .
Popular choice for low-end
business processes or contact
centers. Could have two or
more vendors and multiple
countries
■ Highest investment
■ High management
commitment
■ Potentially high risk if no
local knowledge
■ Greatest opportunity to
realize value
■ Potential to insource
■
■
■
■
■ Helpful when a firm wants
to retain control but lacks
local knowledge
■ Also appropriate when
vendors lack domain
experience
■ Opportunity to realize
value as a ‘captive’ facility
■ Helpful when a firm wants
to retain control but lacks
local knowledge
■ Also appropriate when
vendors lack domain
experience
■ Opportunity to realize full
value as a ‘captive’ facility
■ Requires robust vendor
management
■ Heavy management focus
in the multi-vendor model
■ Opportunity to employ best
of breed providers
More complex to set up
Moderate investment
Opportunity to share reward
Local knowledge of the JV
partner helpful
‘Extended organization’
Figure 8: Popular business models for offshore business processing and contact centers:
the eventual choice should reflect the organization’s culture, and the risk/reward tradeoffs
31
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Potential Pitfalls
‘Must Haves’
■ In offshore countries, third party vendors often lack
■ Clear understanding of the business case - current costs
domain knowledge or experience.
■ Inadequate planning and execution of ‘turn over’
and opportunities for improvement, and expected benefits
(cost, quality, service).
processes, especially when considering the difficulties `
■ Right focus for the ‘pilot’ - low risk/ high reward
introduced by time zone differences can be fatal.
■ Adequate provision for incremental management effort
■ Underestimating the impact on the organization,
especially during the transition phase can stall progress.
and costs in offshoring.
■ Anticipating and preparing for the potential impact
E.g., managing an offshore program requires incremental
on organization during transition.
management effort. Barring that, disappointments can
– Manage change - managing staff displacement issues,
be frequent!
■ Finally, without appropriate training, vendor
cultural training, etc.
– Customer experience
communications, and risk management strategies,
– Regulators
there are many things that can and do go wrong in
– Track and communicate the benefits of offshoring
an offshore program.
– Invest in training and development
■ Effective management of the function, location/vendor
selection process (well-structured due diligence,
risk assessment, robust SLAs, etc.)
■ Not underestimating the cultural integration requirements
■ Robust governance process: Program management.
Figure 9: Offshoring delivers significant benefits but the potential pitfalls are many – to realize the full benefits,
there are a few ‘must haves.’
Vendor selection
Vendor relationship management is one of the biggest chal-
Many of the vendor selection issues are the same whether
lenges to outsourcing, particularly staying alert to cultural dif-
onshore or offshore, with the addition of the offshoring risks
ferences and, when difficulties are encountered, approaching
we discussed earlier. Vendor selection brings many challenges,
them constructively. In fact, a common reason why many out-
and certainly focusing on cost, and often a narrow definition
sourcing deals fail at some point during the life of the contract
of cost, is one of the frequent mistakes. The total cost goes
is that few companies have invested in people, processes, and
beyond price; and certainly should encompass the cost of
resources for effective management of these contracts.24
things going wrong. Quality, delivery, and customer impact all
are cost elements. Certainly well-structured due-diligence, risk
Moving beyond IT services, it is important that companies are
assessment, and robust SLAs are important.
mindful that vendors may not be as mature and experienced
as they would like to appear. Most third party vendors will need
The most frequent problems in outsourcing agreements are
to acquire particular industry domain knowledge to secure
performance metrics and underestimation by the vendor (over
large scale offshore BPO contracts.
what’s required).
32
24 Redshaw, P. and R. Arthur Cox, 2003, ‘Outsourcing in Financial Services:
Hit or Miss?’ Gartner, Inc., 16 January
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Vendors wish to please generally; in some cultures, there are
2002 Survey of Offshoring Best Practices, the following
major barriers to acknowledging problems. This is in sharp
aspects are critical:
contrast to the U.S., for example, where problems are faced
and brainstormed to a solution. The internal team may be
■ View offshoring as a strategic sourcing initiative
aggressive with the vendor, with little sympathy for the reality
■ Use multi-country, multi-vendor solution for
large programs
of slim margins and predictable delays. In one case, a vendor
solution, to have the head of quality assurance report to head
■ Think beyond cost savings in developing an offshoring
of project delivery, resulted in making deadlines, but with
strategy, e.g. access to scarce skills, ‘ability to follow the
products that did not work. The project management office
sun’, infusing of better process management discipline,
can play a crucial role in defining deliverables and creating
lower turnover, etc.
realistic expectations. Master agreements must be put in
■ Use robust vendor selection process
place, but then you have to live by them.
■ Establish a Program Management Office (PMO) for
Establishing best practices and living them
■ Manage risk - ‘on-site due diligence’; assess infrastructure,
managing offshore initiatives
business maturity, business processes, including
In this section, we summarize the best practices in offshoring,
contigency planning and security.
largely drawn from the experiences of the leading users of offshoring who were interviewed as part of two offshoring sur-
■ Start with a pilot project where there are clear
veys in 2002 and 2003 (Figure 9). Based on the TPG/Baruch
expectations and deliverables, and the requirements
2003 Offshoring Survey, following on from PwC Consulting’s
are well-documented. Scale-up as benefits are realized.
Offshore program Mgmt. office
Offshore steering committee
■ Vendor management
■ Define overall strategy
■ Reporting/metrics
■ Establish IT, business, HR, legal, audit,
■ Best practices DB
■ IT staff retooling plan
and compliance support
■ Charter program Mgmt. office
■ Communications
Due diligence
Negotiations
Transition
Project mgmt.
Document internal processes
Craft SLAs
Security
Weekly check-ins
Assess apps
Set rates
Telecom
Quarterly review
Evaluate vendors
Craft compliance terms
Licenses
Bi-yearly visits
Size savings
Productivity bonuses
Knowledge
SLA review
Culture training
Business units
Business units
IT teams
Figure 10: Illustrative example of program management roles and responsibilities for IT offshoring
Source: John McCarthy, 19 March 2003, ‘Offshore: the good, the bad and the ugly,’ presented at the Wipro Strategem)
33
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■ Manage change, including proactively managing any staff
displacement issues and conducting cultural training
sessions at the outset to prevent misunderstandings.
■ Invest in training and development
■ Track and communicate results - incorporate continuous
learning and fine-tuning of SLAs based on actual results.
Conclusion
Offshoring works, and must be part of the agenda for any
global business. There are significant benefits. However,
avoiding common pitfalls requires a clear understanding of the
business case for offshoring, including current costs and
opportunities for improvements and expected benefits (cost,
quality, service). Also, instead of viewing offshoring purely as
a replacement of onshore resources, the leaders need to view
it as one element of a global delivery model, ‘in which enterprises use a combination of on-site, onshore, nearshore and
offshore resources to ensure that they have the right skills at
the right price at minimal risk.’25 To get off to a good start
choose a pilot that is low-risk but high reward. Plan, and provide for the incremental management efforts and costs in offshoring. Anticipate and prepare for the potential impact on
current organization during transition. Provide effective management of the vendor selection process, with well-structured
due diligence, risk assessment, and robust SLAs. Do not
underestimate the cultural integration requirement and finally, establish a robust corporate governance process.
34
25 Terdiman, R., and A. Young, 5 February 2003, ‘Management Update:
Application Outsourcing Trends for 2003 and 2004,’ Gartner Inc.
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Justification
Offshore services Maximizing
the benefits for
financial institutions
Vinay Kumar
Lead, Capital Markets & Wholesale Banking,
Client Solutions Group, EDS
Gabe David
Managing Director, Global Industry Solutions,
Global Financial Industry Group, EDS
Abstract
This paper identifies the offshoring trends, drivers, risks/challenges, and their impact on financial services institutions. It
sets out a new value proposition to maximize the offshoring
benefits for the financial institutions, based on lessons learnt
and offshoring capabilities of service providers.
35
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Offshore services - whether from offshore providers, offshore
outsourcing, or from ‘Big Iron’ global outsourcers providing
Israel
services from their offshore service centers – holds a com-
Ireland
pelling value proposition for the G7 financial institutions (FIs).
Singapore
TOTAL LABOR COSTS
This paper aims to provide insights in this world by examining
offshore services trends, drivers, impact on FIs, risks, challenges, operational risk in offshoring, and discussing a new value
proposition to maximize the benefits realization.
Offshore services trends
Canada
Mexico
Hungary
Malaysia
Philippines
China
According to European Central Bank estimates, developing
Russia
economic markets will be the main source of global growth
India
and that the emerging markets will account for the majority of
the middle-income population by 2015. G7 FIs are attuned to
QUALITY OF SUPPLY (AVAILABILITY, CULTURAL FIT, SKILLS, PROCESSES)
this market economics and want to have a presence in the
growing emerging marketplace offshore. As a result, it is fore-
Figure 1: Off- shoring locations
Source: McKinsey Forrester Neoit, in CFO IT Spring 2003
casted that by 2015 [sources are Forrester Research and
Gartner Inc.] U.S.$136.5 billion in labor costs will be moved offshore, representing a 26.5% compound annual growth from
lower wages than elsewhere. Because of the huge volume of
2000 to 2015. We expect that this trend will result in tighten-
these services trades and ‘brain arbitrage’, India will become
ing of budgets within the G7 countries, causing FIs to turn over
the U.S.’ primary trading partner in South Asia. During the
their important non-core processes either to outsourcers in
2002-2003 period, India’s export revenues were worth
other countries or to G7 outsourcers with a presence in off-
U.S.$9.5 billion, which accounts for 90% of global offshore IT
shore locations. As part of this relocation, it is estimated that
business.1
the world's G7 banks (top 100) will transfer an estimated
U.S.$351 billion of their operations and two million jobs off-
Increasingly FIs are also outsourcing overseas many of their
shore over the next five year. Major U.S. outsourcing providers
business processes to cut costs and there are many attractive
are establishing operating centers offshore in order to drive
destinations competing for this. Offshoring back office and
out costs from their own operations and offer cost-reduction
other operations are gaining momentum at a rapid pace.
capabilities for their customers. A Deloitte research report
Getting offshoring experience as soon as possible translates
finds that 33 percent of respondents in a survey of financial
into greater benefits — from higher cost reductions to more
institutions have already relocated parts of their IT workforce
business processes being handled by the low-cost centres. FIs
offshore and that 75% acknowledged that they will have off-
that can utilize their existing offshore facilities expect signifi-
shore presence within the next 24 months.
cant future savings because they leverage offshore scale and
scope; the challenge being achieving economies of scale.
India seems to be the major benefactor of these shifts. It has
become the major offshoring hub due to its combination of
Functions traditionally transferred offshore include applica-
low cost and high technology and quality expertise (Figure 1).
tion development, coding and programming, accounting and
Of those financial-services firms that are transferring func-
finance, operations, processing and administration (such as
tions offshore, nearly half are targeting India, which has a
check processing and payment processing), contact support,
huge market of operations and IT professionals who earn much
and call-center operations. In addition, HR administration, pay-
1
36 - The
Financial Times Special Report, July 2, 2003
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roll, helpdesk, medical transcription, legal transcriptions,
India are moving up the value chain into product development
e-mail support/response center, responses to questions direct-
and innovation.
ed to companies’ web sites, are also among those outsourced
offshore. Functional offshoring, involving business processes,
Offshoring has also become a key strategic option considered
is a newer trend.
by FIs CIOs (Figure 2), as it allows them to access low-priced
services that lower their IT and operational expense base,
As offshoring acceptance and experience grows, the types of
while giving a positive impact on flexibility; achieve faster time
work transferred to offshore locations will include a company’s
to market through advanced software engineering practices of
core competencies and functional outsourcing, creating an
the offshore vendors, and enhanced software development
element of competitive advantage. A growing number of off-
and service quality. Offshoring has evolved to a point where it
shore firms now deliver cutting edge web-based solutions and
is being considered as a strategic, long-term decision by lead-
provide higher quality capabilities in developing innovative
ing securities firms like Merrill Lynch, Goldman Sachs, and
solutions. Previously, offshoring did not allow a FI to gain com-
Fidelity Investments. North American brokerage firms spent
petitive advantage, but entailed a big competitive disadvan-
U.S.$417 million on offshore contracts in 2002 and will spend
tage if they did not. Citigroup, for example, grew its revenues
U.S.$1.31 billion by 2005, a compound annual growth rate of
by U.S.$35 billion over the last five years, but incurred only
46.4%.
U.S.$12 billion in cost increases, benefiting mainly from offshoring. Recent experience shows that cutting-edge work that
Indian offshore vendors2 have become preeminent providers of
can sustain innovation and competitive advantage is quite
these services to the U.S. securities industry. Combining low
possible for offshoring, and the service providers based in
labor costs, sophisticated processes to manage offshore projects,
Offshoring
IT Lift-out
Typical IT & BPO
outsourcing
Standards & STP
Transformation
outsourcing
Potential cost
Vendor restructure
Six Sigma
savings over 5
Package software
Staff restructure
years
Infrastructure upgrade
IT centralization
Negative impact on flexibility
Positive impact on flexibility
Figure 2: Offshoring is a key strategic option considered by CIOs
Source: Tower Group and EDS
2 Tower Group report on Indian Offshore Vendors, March 2003
37
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and CMM Level 5 certified staff, they have won the hearts and
U.S.$20,600. India’s wages are expected to go to
minds of Wall Street firms. Contrary to popular wisdom, even
U.S.$4,000 by 2008 (McKinsey). This cost differential
if the economy improves, securities firms will not pull back
advantage is going to exist for the next 20-30 years even
their offshore initiatives, since they have signed massive deals
in the most conservative case. Indian BPO sector is
and incorporated the offshore option into their long-term
estimated to grow at 50% for 5 years.3
strategy. India’s share of outsourced work from U.S. securities
■ Shareholder value increase due to such factors as cost
firms is 84% to 94%. In the next two to three years, there will
reduction, potential to grow revenue by leveraging utility
be a more broad-based movement toward offshoring, as bro-
based services, flexibility, and speed to market to introduce
kerage firms that have been sitting on the sidelines will no
new services.
longer be able to ignore the compelling advantages offered by
■ Low-cost communications bandwidth now make it possible
the offshore option and will decide to jump on the bandwagon.
for FIs to cost effectively ship huge volumes of scanned
documents overseas for processing and leverage
The banks that are currently sending work offshore are predominantly using outsourcing as their business model. In the
future, a hybrid model will emerge where the banks will create
joint ventures with their outsourcing partners. For example, a
bank may own the facility and hire the people. The outsourcing service provider runs the operation and owns 55 percent
of the venture. In this model, the banks have more control over
videoconference links.
■ Efficiencies due to improved productivity, such as through
net-based collaborative tools (emails, instant messaging,
shared whiteboards).
■ Need for G7 FIs to focus on core competencies to drive
shareholder value.
■ Greater acceptance of the offshore outsourcing model, and
the process. They can ensure the offshore systems and
the success achieved in outsourcing projects across
processes comply with their business models. This can also be
different industries, is encouraging more FIs than ever
important for tax and liability considerations.
before to consider offshore outsourcing.
■ Greater architectural leverage means that FIs are able to
Drivers
reduce the number of systems they need to maintain,
Continued growth in offshoring is inescapable. And there are
manage, and integrate. This makes the development of a
certain key drivers which will continue to fuel this market.
desired architecture and migration from legacy easier
These include:
■ Expense issues faced by the financial institutions and the
to achieve.
■ Improved software development and maintenance quality
high cost and inflexibility of information technology infra-
levels from service providers (SEI CMM Level 5, COPC,
structure, including severe overcapacity (business and IT
PCMM, ISO 9001:2000) and hot government policies and
processing capacity) in North America, Europe, and some
governance structure, such as legal framework, trans-
parts of the Asia Pacific region, e.g., Japan.
parency, regulations, and incentives in selected countries.
■ Need for FIs to establish a base in developing countries to
gain a greater market share in their economies. Wage
The impact of offshoring on FIs
differentials, demographics, and availability of subject
Offshoring is evolving into a complex, sophisticated model
matter expertise, flexible workforce and capacity.
that has a radically new risk/reward composition. Case studies
Demographics of the developing countries show that the
of those FIs that have utilized offshoring suggest a high
15-39 year old age group will continue to drive labor cost
degree of satisfaction, with the major benefits realized being
dynamics in the long-term. As an example of the cost
cost reduction, service quality enhancement, expansion of
differential, yearly wages per back-office operator in 2001
skills and capabilities, and productivity improvement.
in India was U.S.$2,400, while in the U.S. it was
38 - The
3 NASSCOM (National Association of Software and Service Companies,
India), June 20, 2003
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Off-shore scale
No. of people
% Saving identified
GE Capital
9500
60%
HSBC*
3,100
75%*
Citigroup
1,100
50%
Insurance claims, payroll,
accounting, contact center,
loan processing, IT help desk
Retail bank account maintenance,
mortgage processing, contact centers
for business banking
Cash management, trade finance,
retail account maintenance,
card processing
Travel and expenses administration,
finance and accounting, payroll,
processes, call centers
American Express
1,500
Example of activities
40%
Payment processing for 30 countries
Standard Charter*
1,700
70%*
250
55-75%*
World Bank*
Payment processing facility in India.
Savings identification not yet completed,
but is expected in the range of 55-75%
*HSBC, Standard Charter & World Bank savings are from offshoring to India.
Figure 3: Range of savings from offshoring
Source: McKinsey and EDS
A McKinsey study (coupled with more up to date information
continuity risks, financial risks, outbreaks of new diseases,
from EDS India) finds savings ranging from 40 to 75% in
geopolitical concerns, computer viruses that can cause damage,
moving financial services offshore, e.g., insurance claims, pay-
market volatility, natural and man-made disasters, legal risks,
roll, accounting, loan processing, credit card processing, IT
data privacy risks, and white-collar lobby/backlash in devel-
help desk, retail account maintenance, mortgage processing,
oped countries are some of the key risks. Most critical risks to
cash management, product development, and R&D. If they can
corporate operations are: Operational disruption, corporate
be combined with standards based straight through process-
governance issues, political & social disturbances, country
ing and systems integration, cost savings of 80 to 90% are
financial risk, supplier financial risk, currency/interest rate
achievable. The study also notes that thirty percent of the
volatility, government regulation/legal decisions, absence of
respondents surveyed in the study currently have existing off-
rule of law, disruption of key supplier/customer/partner, data
shore operations and that it is expected to climb to 75 percent
risks – security, privacy, fraud, security threats to employees/
within two years.
assets, labor risks, and terrorist attacks.
Key risks
Protectionist pressure
New emerging market opportunities are occurring simultane-
Over the next 15 years, 3.3 million U.S. services industry jobs
ously with increasing risks. Risks and potential backlash are
and U.S.$136 billion in wages will move offshore to countries
undeniable. These risks include operational and business
like India, Russia, China, and the Philippines.4 The dramatic
4
Source: Forrester View, November 11, 2002
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economic advantage of moving work to low-cost locations is a
inadequate involvement in understanding and managing
powerful force that is inevitable in a free-market global economy.
resources, and misalignments in processes, infrastructure,
However, there is a mounting protectionist pressure, particu-
and organizational design.
larly in the U.S. Emerging public and media concerns are gene-
■ Inability to measure effectiveness on an ongoing basis.
rating political actions, such as the Save America Manufac-
■ Scope not well defined. A narrower scope with fewer
turing Act 2003, The Job Protection Act 2003, and New Jersey regulation on offshoring of state contracts, New Jersey bill
functions moved offshore.
■ Too short a timeframe for planning and execution.
seeking to force call center workers to reveal true identities,
and the German federal constitutional court blocking the
Successful execution requires:
government’s pro-immigration bill.
■ Careful analysis of opportunities and risks.
■ Systematic selection of optimal locations,
To combat the protectionist issues, companies need to articulate the benefits of offshoring on the originating country’s
consumers, workers, and firms, such as taxes paid by foreign
short-term and long-term considerations.
■ Well-crafted communication of benefits to shareholders,
consumers, employees, and society, in general.
workers, greater productivity and shareholder value increase,
■ Implementation with effective governance structure,
export earnings increase and greater market share in devel-
performance management, best practices, standards
oping countries, balance of trade benefits, and greater competitiveness in the global market place.
and continuous improvement to leverage offshoring.
■ Operational risk management and resiliency.
■ Subject matter and domain expertise.
Ralph Szygenda, group vice president and CIO of General
■ Focus on total cost of ownership (TCO).
Motors Corporations, states:
■ Converting a fixed cost expense to variable cost.
‘I believe offshoring will stimulate new opportunities for busi-
■ On demand service model – utility based computing.
ness in the U.S. In the last few years, we had trouble getting
enough IT people. The U.S. wasn’t producing enough IT people.
Offshore outsourcing is a major area of concern as part of the
So offshoring started. The U.S. is still the most significant
new Basel II agreement; CAD III provisions will address this for
developer of information technology. But protectionism never
financial institutions in EU. This will mean that the offshore
played out very well in the U.S. in any industry.’
entities should have a structure that will make it possible for
them to be reviewed by the banking regulators. They should
Key offshoring challenges
also be able to comply with best practices in all operational
The advantages of global sourcing are convincing, but chal-
areas and capable of accommodating operations risk metrics
lenges are equally intimidating. Obstacles ranging from the
and factors such as political risk, systemic risk, etc., on their
complexities of managing widely dispersed projects to cultur-
balance sheets in regulatory capital reserves. Additionally,
al nuances and geopolitical uncertainties. Unsuccessful moves
they should have complete transparency, in terms of auditable
have a number of common characteristics:
compliance with EU regulations such as data privacy, etc.
■ Cost reductions significantly below
A new value proposition to maximize
the benefits realization
the average – costly learning curve.
■ Locked into specific geography which is
no longer competitive.
40 - The
Offshoring can be leveraged to create a new value proposition
to accelerate the benefits realization for a financial services
■ Political and economic instability.
institution, if it is based on the lessons learnt in offshoring and
■ Ineffective governance structure, which results from
the levers of value realization.
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Key lessons learnt in offshoring:
performance reporting that allows the FI to keep a finger
■ Carry out an internal assessment of offshoring
on the pulse of what the offshore team is doing.
vision and objectives.
■ Win on both sides. Develop a migration strategy that
■ From the outset of the relationship, give the offshoring
team remote access to the FI’s network and software
up-skills onshore workers for other positions and targets
archives, with security and controls. Then the offshore
growth and attrition for offshore as partners, not vendors.
team can access the right modules without losing a day.
■ The offshoring service provider must focus on a crucial
■ A surprising realization for most firms is the extent to
balance between comprehensive service offerings and
which they need to change internally to get the most out
vertical financial services industry subject matter expertise.
of offshore contracts. Transforming organizational struc-
■ Consolidate processes to shared services, standardize and
ture so that internal IT staff can manage software devel-
then offshore. You must re-engineer processes prior to
migration – an automated workflow can significantly
opment in a collaborative onsite/offsite model and conduct
effective project management is crucial to success.
improve processing speed and accuracy. Exporting internal
■ A long-term, comprehensive plan to develop skill sets suited
problems to an offshore vendor will only exacerbate them.
to offshore management is necessary, covering onsite/
■ Look for quick wins - Initially migrate functions that can be
brought up to speed in six months or less; migrate blocks
of work.
■ Select the right vendor - ensure vendor has the capabilities
offsite project management, conflict resolution, managing
change, handling international labor disputes, and intellectual property issues.
■ Processes need to be structured to ensure a tighter
and can mitigate the overall risk. Most FIs contemplating
hand-off from one team to the other. Testing of deliver
offshoring place too much emphasis on hard issues, like
ables is critical – the more the outsourcer knows about
cost savings, technical merits, and security concerns. They
the FI’s system complexities, the better they can test.
should also consider the soft issues of cultural differences
Documentation is critical.
and assessing the ability of both groups of staff to handle
■ Select the right approach in leveraging offshore services.
the imminent changes.
■ Quality of client interface is critical for daily communica-
A new value proposition for offshoring:
tions and interactions between the company and its
As the offshore model gains popularity and contracts grow
service providers. Some local presence is important for
bigger, longer, and more comprehensive, going offshore is
creating an effective interface, ensuring proper communi-
becoming a strategic decision for financial firms, especially
cation of requirements and issues, setting performance
large broker/dealers and commercial banks that are most
expectations, and handling the nuances of cultural exchanges.
aggressive. This option is no longer merely about labor sav-
■ Since any sourcing model that distributes work across
ings, but about gaining strategic advantage by leveraging
multiple locations involves many handoffs and requires
sophisticated software processes, vendor R&D, faster time to
close co-ordination to manage to service levels, need for a
market, and higher quality of IT service and support. Moving
quality governance structure is critical.
quickly is critical, since early adopters lock in the top talent.
■ Leverage vendor’s mature knowledge management
and best practice processes.
■ Train/deploy a select group of key offshore workers to
The new value proposition seeks to maximize the FI’s market
differentiation and shareholder value and is based on three
key principles. Firstly, fix the current threat, which typically
provide world class innovation, such as new products and
emerges from not being cost competitive in the current eco-
services. Hold innovation workshops every quarter.
nomic and regulatory climate and the need to price services
■ Put in place a mechanism for status/management
that represent value to customers and profit to the institution.
This is typically achieved by outsourcing back office and related
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functions to offshore. Secondly, improve the value capture by
Innovate for market leadership - Offer new, time to market
carrying out continuous improvements to improve core
products or cross-product services to help attain market leader-
business’ effectiveness, efficiency, quality, return on capital,
ship position, such as cash and treasury management, cross-
performance management, integration, and enterprise wide
border and domestic payments, trade finance, lending, liquidity
leveraging. Finally, create competitive advantage by leveraging
management, etc.
the offshore resources for innovation that can position the FI
for market leadership.
FIs that are highly successful in the offshore market consider
offshoring a major, long-term strategic initiative and conse-
These principles are achieved by focusing on four key objec-
quently are committing considerable resources to developing
tives that can provide order of magnitude benefits to the FIs.
an internal organizational structure and specific skill sets to
leverage offshore opportunities. These firms are convinced
Protect the franchise objectives - Protect shareholder value
offshore sourcing can be a huge competitive advantage and
by fixing the present high cost and fight off competitors.
they recognize the importance of developing internal expert-
Radically reduce cost of processing and enter into a commodi-
ise to realize its benefits. They do not think of offshore out-
ty driven, scalable on-demand variable cost model. Leverage
sourcing as a one-off, project-based approach but as a long-
standards to reduce cost, achieve flexibility, and straight
term relationship with the vendor. There is a clear focus on the
through processing. And finally, manage global operational
overall relationship rather than on particular projects.
risk for offshore operations and address regulatory requirements, such as Eurozone regulations on cross-border pricing
An adaptive architecture should be considered for the off-
and CAD3/Basel II requirements, through appropriate dash-
shore model to provide the optimal balance and agility across
boards and key risk and performance indicators.
IT and business resources, ensuring that people, processes,
and technologies work together to meet evolving business
Position a vertical for growth - This can be achieved through
requirements, while meeting the best practice requirements of
focusing on the core business by offloading non-core to the
a service oriented architecture. It should also be able to
offshore provider, providing a powerful rationale to allow the
receive, consolidate, and report information received from
FI to attract new insourcing business by leveraging the off-
those partners/systems. On-demand utility-based computing
shore services and benefiting from economies of scale, and
model is also appropriate for offshoring where the processing
gaining market share in the vertical division.
demands are variable.
Leverage to grow the FI - Provide a platform for other divi-
Conclusion
sions to use the offshore service and help achieve enterprise-
The trend in offshoring is moving from commodity back office
wide integration. Provide a flexible, but consistent client facing
outsourcing and application development/maintenance
capability that is future proof in the market to provide several
towards how a financial institution can leverage functional off-
integrated services to the customers, ensuring that the client
shoring to gain greater advantage. This requires management
interface serves as a consistent portal and interface engine for
of operational risk and other challenges. The positive experi-
multiple client connectivity, decoupled from the product specific
ence gained and lessons learnt from offshoring to India, in
applications. Allow leveraging the offshore service to provide
particularly, dictate that a value proposition can be constructed
additional services, e.g., business process management which
that can help FIs to maximize benefits from this endeavor,
can help reduce costs substantially.
including gaining competitive advantage, innovation, time to
market, and shareholder value.
42 - The
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Justification
‘Pete at night,
Pradeep by day’:
The offshore
contact center
phenomenon
Suresh Gupta
Partner, Capco
Vishnu Nidhin
Financial Services Practice, Hewlett-Packard
Abstract
The number of financial services firms that are using contact
center offshoring has been on the increase in recent years.
While this is a welcome trend, there are a number of pitfalls
that they face. This paper will address the risks, rewards, and
best practices in offshore contact center sourcing, using lessons from both the offshoring pioneers and from the U.S. call
center industry.
43
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The offshore contact center phenomenon
‘At 10 p.m., as most Indians end dinner and prepare for bed, a
U.S.) The offshore contact centers, particularly in India and the
grand four-story building in a dusty industrial park comes alive
Philippines, are enjoying heady growth rates of up to 60%5.
with chatter about the weather, the Yankees, and Hollywood’s
latest. Twentysomethings …log onto work stations and throw
IDC estimates that offshore contact centers will approach over
on headsets. Against the hum of air-conditioners fighting the
U.S.$5 billion in revenue by 2005.6 In an IDC survey conducted
heat, they check the weather report for temperatures so low
in February 2003, India was expected to corner 70% of the
1
they haven’t felt them in months.’ And Pradeep becomes Pete,
contact center services market in the region by the end of the
ready to receive calls from Americans...
year, rising to 73% by 2006. The Philippines, with its long
association with the United States, wide use of English, and
This scenario is being repeated in over 1200 offshore contact
2
good telecommunications infrastructure, comes second, with
centers in India, and with some variations in the numerous
15% of market share in 2003, although this is expected to
contact centers in the Philippines, South Africa, and elsewhere.
decrease to 13% in 2006 (Table 1).7
Some of the largest multinational companies utilize offshore
contact centers, including GE, American Express, Citigroup,
Table 1: Contact Center Services Market Share
Prudential, J.P. Morgan Chase, Aviva, Axa, Eastman Kodak, Intel,
2003
2006
India
70%
73%
Philippines
15%
13%
Microsoft, Dell Computers, Chevron Texaco, Delta Airlines,
British Telecom, and British Airways3.
Contact center offshoring to low-cost locations began as a way
Singapore
7%
7%
to save money, but has taken off because of many other fac-
China
3%
4%
tors. These include lower turnover, higher quality, and ready
Malaysia
1%
1%
availability of well-educated young women and men who are
New Zealand
1%
1%
seeking careers as customer service representatives (CSRs).
Source: IDC
Financial services firms cannot afford to sacrifice quality and
customer satisfaction just to save money. So it is heartening to
Although data is not yet available, anecdotal evidence indi-
learn of multinationals which have found that with the correct
cates that some offshore locations have greater success with
approach, offshore contact centers can provide improved pro-
certain types of contact center work, perhaps for cultural rea-
ductivity and quality, and on a lower budget. However, the path
sons. For example, the Filipino culture seems to be better at
to this ideal is replete with pitfalls. This paper addresses the
telemarketing (outbound contact center work), while Indians
risks, rewards, and best practices in offshore contact center
do well with customer service (inbound contact center work.)
sourcing, using lessons from both the offshoring pioneers and
from the U.S. call center industry.
Other offshore areas with significant numbers of contact
centers include Ireland, South Africa, and Eastern European
44
Market dynamics
countries (especially where contact is by internet rather than
The dominant location for offshore contact centers is India,
telephone). South Africa enjoys a favorable time zone, particu-
where 154,000 people are employed, followed by the
larly for callers from Europe. Moreover, it has many domestic
Philippines with 10,000 people4. (While significant, this con-
call centers that could be tapped for experienced hires in
trasts with 3 million customer service representatives in the
establishing offshore contact centers. However, South African
1 Kalita, S. M., 2001, ‘India Calling’, Newsday July 15.
2 We use the term ‘contact center’ instead of the more popular term ‘call center’ to
include centers that not only handle in-bound and out-bound calls but also respond
to e-mails or assist customers by engaging them in ‘on-line’ chat sessions, etc.
3 October 2002, ‘Call-Center Workers Straddle Two Continents and Cultures,’
Knowledge@Wharton; Engardio, P. et al., 2003,
‘The New Global Job Shift,’ Business Week, February 3.
4 2003 Asian Call Centre Industry Benchmark Study, callcentres.net, Sydney, Australia
5 Merchant, K., 2003,’India’s call-centre sector expanded by 59% in the year to
March 2003 over the previous 12-month period,’ Financial Times, June 4,
6 IDC Asia/Pacific Press Releases, Offshore Services Will Rise to 37% of the
Asia/Pacific Call Center Marketplace by 2006’, September 2002.
7 IDC data as reported by Feb. 28, 2003 rediff.com
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wages are higher than the wages in India or the Philippines.
Recently a number of contact centers have also been established
At a major credit card call center in Bangalore, India, the
in Latin America, e.g., in Costa Rica, Panama, and Argentina.
author witnessed the following incident:
Many American contact center vendors have also call center
It was post 9/11. The CEO of a North American credit card firm
facilities in Mexico. Initially most of these centers were estab-
took the unusual step of coming on-line for a few seconds
lished to service Hispanic customers but they now also provide
during each in-bound call to apologize for any inconvenience
English-speaking CSRs and are being promoted as ‘near-
caused by 9/11 aftermath. In one case this nearly backfired
shore’ alternatives to offshore centers in India and the
when the caller at the other end was an irate senior citizen
Philippines, etc. While these centers do not offer the impres-
who announced that the CEO was a hypocrite - if he really had
sive savings of 40-50% being delivered by Far East contact
any empathy towards his customers, he would not let his firm
centers, they are still significantly cheaper than U.S.-based
send six dunning notices to this customer for a ‘piddly’ U.S. $60
centers. Moreover, because of their proximity to the U.S., they
balance! The situation was rescued by the able Bangalore-
have easier access to American firms and are perceived to be
based CSR who handled this call with unusual finesse and
‘less risky’ by some. Many firms are willing to trade some of
empathy, and won the customer over by the end of the call.
the potential savings to enjoy these advantages.
Could an average CSR in a U.S. call center have matched this
performance? Given the unusually high turn-over rates expe-
In some ways India is repeating the experience of the U.S. call
rienced by the U.S. call centers, the answer is probably not!
center industry of the 1990s, but this time we can apply the
The impressive quality levels achieved by some of the Indian
benefit of hindsight. The Indian market is extremely fragmented,
contact centers could also be because Indian CSRs, on aver-
with many operators out to make a fast buck; after all, how dif-
age, are better educated (a large proportion are college grad-
ficult is it to answer a telephone? In the U.S., after an initial ex-
uates) and they view their job as a ‘profession’ and a ‘career.’
plosion fueled by telephone company deregulation, there was
considerable consolidation. Of the dozen or so publicly-listed
contact center companies in the U.S., few have found the last
The initial pressure for investigating contact center offshoring
seven years a very profitable time. Even as we are discussing
was driven by both potential savings and concern about scarce
explosive growth rates for India and elsewhere, companies
resources. An ability to ‘follow the sun’ to provide customer
evaluating long-term relationships with offshore vendors
service 24 hours a day was also attractive. The demand for
should be prepared to deal with the impact of likely consolida-
customer services representatives (CSRs) seemed inexorable,
tion and change.
with rapidly rising wage rates. However, as the economy has
turned and cost pressures on companies mount, supply of
The drivers
potential onshore CSRs is no longer an issue in managing con-
The value proposition of offshore contact centers is simple yet
tact centers; indeed, fear of a possible backlash over ‘losing
compelling.8 Not only does it deliver dramatic cost savings but
jobs to overseas’ is a variable that needs to be actively man-
also, more often than not, it delivers those savings with signif-
aged. Now the concern is truly one of ‘value-for-money.’ Of
icantly higher quality and access to large and highly talented
course, at the same time it is critical for financial services
labor pools. (See the side bar.) Increasingly important, offshore
firms under pressure to ensure the highest level of quality in
contact centers can also enhance risk management and fulfill
customer handling, thereby building customer loyalty.
business continuity planning needs of diversified resources
and facilities.
When we refer to CSR quality, we are considering both the caliber of employee and the training they receive. In many offshore contact center, e.g., in India, the CSRs typically undergo
8 According to an estimate by Mercer Oliver Wyman, offshoring call centers and
other back office activities could provide 10-12% increase in market price and
share value of an average bank.
45
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intensive English training sessions (including for British versus
may impact the vendor in the future.
American English). When properly executed, it is difficult to
distinguish the offshore CSRs graduating from these training
At present, the vast majority of offshore firms lack world class
courses from their onshore counterparts in their usage of
contact center management processes and technologies. In
everyday spoken English. Last year, in interviewing a dozen
some countries, including India, one cannot be sure of uninter-
CSRs in Bangalore, India, who were handling inbound and out-
rupted power supply or a flawless public communications net-
bound calls for several American financial services firms, we
work. Therefore without fully redundant infrastructure, ‘high
found every one had at least a college degree, three had masters
availability’ (uninterrupted calls) could be an elusive goal.
degrees, including one MBA - and these CSRs were in it for the
Firms looking to offshore contact centers by outsourcing to
long haul! Also, many readers may recall how last year the
third party vendors must ensure that the vendor would pro-
chief executive of a global bank with a large British presence,
vide sufficient, dedicated high-bandwidth, leased line access
caused a storm by saying that not only were the bank’s Indian
between their communications network and offshore facilities.
call-centre workers much cheaper than those in Britain but
This is important for providing adequate capacity to handle
they were often much better. ‘They are quicker at answering
voice traffic and allow ‘1-800’ calls to be routed overseas.
the phone, highly numerate and keen to come to work every
day,’ he said. ‘Staff are hugely enthusiastic about their jobs.
In addition to scrutiny of infrastructure, recruiting and training
They dress well. A lot have degrees.’ Indian workers, he said,
need to be very carefully assessed. One American communi-
were ‘exceptional.’9
cations firm learned this lesson the hard way. In an offshored
‘outbound’ telemarketing program, they experienced only one
Consider also the impact a wider qualified human resources
‘conversion’ per CSR per day in the offshore facility compared
pool offshore can have on process management (and discipline).
to over five conversions per CSR per day in the onshore centers.
An insurance firm experienced tremendous improvement in
They had failed to ensure that the vendor provided sufficient
the quality of health claims processing, as in India they could
‘sales’ training to the CSRs nor did they monitor vendor’s
hire physicians to oversee claims processing; something that’s
recruiting processes.
hard to imagine in any Western country. As a result, they
decided to double their offshore staff of 800.
Cultural differences can also contribute to the need for specialized training. For example, in some Asian cultures, ‘aggres-
Results from the 2003 TPG/Baruch ‘Best Practices Survey on
siveness’ or ‘self-initiative’ are not always considered desirable
Offshoring’ support the notion that offshore contact centers
traits in youngsters. Therefore, CSRs from these cultures may
can provide higher quality at lower costs. The respondents
be excellent with scripts but need to be trained and rewarded
reported satisfaction levels of 89% with their offshoring activ-
to be proactive with customers.10 What is needed is not just
ities while achieving cost savings of 40-50%. Furthermore,
training in specific job content, but providing a cultural dimen-
61% of participants experienced quality improvements, with
sion to enable the CSR to be effective in a conversation where
39% finding quality the same.
idiom, nuance, context, and emotions must be quickly understood and responded to.
Avoiding the pitfalls
To escape the pitfalls when evaluating capabilities, the constant
We have already mentioned training to neutralize accents, but
refrain must be ‘Take nothing for granted.’
an interesting question arises as to how far ‘Westernization’
should go. First accents are changed, then a Western name is
46
We have already alluded to the wide disparity in vendors,
used to be more memorable, then a fictitious U.S. or U.K. loca-
which leads to concerns about whether the vendor is investing
tion may be given in an effort to increase customer comfort.
in the necessary infrastructure and how industry consolidation
At what point do these white lies break the bond of trust with
9 O’Connell, D. and L. Armitstead, 2003, ‘The great Indian takeaway’,
Sunday Times, June 8
10 In a newspaper column titled ‘On the line to Dell hell,’ (The Guardian, May 17, 2003)
Phillip Inman describes his frustrating experience in dealing with an India-based
contact center. It took him six weeks of waiting and over 25 calls to the center to
receive a satisfactory resolution to his problem. Every time he called, the
customer service agents stayed close to the ‘script’ without understanding the
true nature of his problem.
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the customer? Perhaps, it is a reflection of the immaturity of
per call’ buildup based on in-house experience; this facilitates
the offshore contact center industry that the vendors train
‘unbundling’ the rate card to make comparisons with a typical
their employees to indulge in this duplicitous behavior (‘I am
vendor in an offshore location. Personnel turnover rates also
based in Omaha, Nebraska, not in New Delhi, India…’) but we
need to be considered: contrast 24% in India11 with the U.S.
wonder how many American and European firms realize that
where turnover of up to 50% for inbound call centers and up
in condoning this behavior from their vendors they may be
to 300% for outbound call centers are not unusual.
riding a very slippery slope of dubious ethics!
There are particular challenges for financial services firms in
Another major area to be tackled is the service delivery
deciding which activities could be done offshore; certainly
process and the associated performance metrics. A company
early consideration needs to be given to data privacy and
which already has onshore contact centers should have consi-
regulatory restrictions which may determine where activities
derable experience in ensuring that the correct metrics, e.g.,
must be conducted. However, many firms wrongly perceive
‘first call to resolution,’ ‘customer satisfaction,’ etc., are dep-
that data security dictates keeping information in-house; when
loyed. In a cross-cultural situation, with perhaps less sophisti-
what is needed (indeed, whenever engaging third parties) is
cated measurement abilities, a contact center may need guidance
control over how the data-base is used to ensure it is handled
to deliver the required focus. Beware the easiest measure,
appropriately and cannot subsequently be used to competitive
‘talk time’, which in encouraging more calls per hour may actu-
disadvantage. In fact, many offshore contact centers access
ally be harming customer satisfaction and brand perception.
data from the client’s CRM systems remotely by using common
‘screen scraping’ technologies, (e.g., Timbuktu). In this way, no
Other due diligence areas, usually conducted on-site, included
real data is transferred to the offshore locations and the
assessing the management team, financial strength, infra-
remote access is limited to only the essential data elements
structure, business maturity, and business processes, includ-
needed to handle customer calls.
ing continuity planning and security. Financial services firms
will be acutely aware of reputational risk should customer data
Thorough consideration needs to be given to how the offshore
be mishandled.
contact center would integrate into the CRM processes of the
firm (initially and on an ongoing basis). Will there be near-real-
How to begin in contact center offshoring
time transfer of customer related information? Not many off-
Offshoring is a strategic initiative; commitment needs to be
shore vendors have made the necessary investment in CRM
secured at the outset from senior management and the ‘C’
process expertise or have the requisite IT service capabilities.
level (CEO, CFO, etc). Public and community relations need to
This may influence the business model chosen, particularly
be considered from the beginning. A project management office
given the fragmented industry, shortage of process and man-
(PMO) should be established for managing offshore initiatives.
agement expertise, and development and integration of IT sys-
Also needed is a clear and realistic understanding of the busi-
tems. A wholly-owned subsidiary may be preferred, or a joint
ness case for offshoring – current costs and opportunities for
venture either between the financial services firm and a vendor,
improvement, and expected benefits (cost, quality, and service).
or perhaps an alliance between an Indian firm and U.S./U.K.
However, this is more complicated than just comparing CSR
contact center or CRM service provider. If going with a pure off-
wage rates. If we take the case of India (with the largest num-
shore vendor, a long-term contract (e.g. for five years, rather
ber of call centers and therefore the most data available) and
than annually) may encourage the necessary investment.
the U.S., India may be a fraction of the cost, but one needs to
also add in the cost of cultural training that will be necessary
When outsourcing the contact centers to a third party off-
for the Indian CSR to be productive. Ideally the firm would
shore firm, it may be preferable to seek an offshore firm with
already have a clear idea of the individual elements of a ‘cost
capabilities not only in the contact centers but also offshore
11 2003 Asian Call Centre Industry Benchmark Study, callcentres.net, Sydney,
Australia. The study also found that with much of the work being done at night to
accommodate western time zones, India had the highest attrition rate in
Asia-Pacific, and that more than 50% of agents who quit, leave the industry
completely.
47
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business processing. One such instance where this would be
Generally companies refrain from outsourcing work they con-
desirable is when the contact center activities are closely
sider ‘strategic.’ Although there would be cost savings if
intertwined with back-office operations. Should the vendor be
Platinum Customer Service were moved offshore, the impor-
capable of providing both types of services, it would allow the
tance of keeping key customers happy and the opportunity to
client firm to ‘re-engineer’ the workflow between the back
‘upsell,’ means this will be done only when the firm feels con-
office and the contact center by offshoring both to the same
fident of achieving superb handling of service requests by the
vendor. Moreover, it would also facilitate improved retention of
high-value segment. Normally this would require a CSR inti-
offshore contact center employees knowledgeable of firm’s
mately familiar with the account. Moreover, dealings with high
business – should they feel ‘burnt out’ after long stretches of
priority strategic customers require close day-to-day coordi-
night-shift work, they could be given the opportunity to move
nation with sales and account management staff. The agents
to firm’s back office activities performed during the day.
at the contact centers servicing these accounts are highly
skilled customer relationship people and prime candidates to
The starting point for any offshore venture should be a pilot
assume account management responsibilities. Thus, this cate-
project, which has been chosen from a low-risk category, for
gory of contact center work is best suited to an onshore facil-
example, ‘pay-by-phone’ for a credit card company. This pilot
ity. However, with collections (chasing bad debts), while there
should have clear expectations and deliverables, with well-
is some financial risk, the rewards to the firm may be sufficient
documented requirements, and the benefits should be tracked
to make this a suitable candidate for offshoring. Additionally,
and communicated. At the same time, there should be a high
the threshold of which debts are worth chasing is lowered by
level vision of the potential growth of offshore beyond the
the economics of the lower cost structure offshore, so that
pilot, so as benefits are realized, the firm can begin scaling up.
more debts are chased.
LOW
There needs to be clear definition, both in the pilot and in all
E-mail/chat
subsequent dealings regarding pricing, services, and service
level agreements (SLAs). The SLAs need to be accompanied
Scripted Promotions
by a robust monitoring process for measuring results, and
Tier 1 (Simple)
inbound
fine-tuned appropriately based on actual results. A governance process must be established and adhered to through
Risk
the life of the contract.
‘Up-sell’
Platinum
customer
service
Also needing to be addressed explicitly are the ‘turn over’
Collections
processes. One example where this becomes critical is when
offshore contact centers handle the initial customer call, but
turn over the fulfillment process to onshore staff. Such ‘turn
HIGH
LOW
Rewards
HIGH
overs’ must be supported by strong contact center processes,
workflow, and discipline to ensure seamless customer service.
Figure 1: Offshore pilot selection matrix
Transition management
There is no doubt that getting an offshoring initiative right will
48 - The
There are a wide variety of contact center activities/functions
require incremental management attention. Companies need
which could be done offshore; the evaluation matrix in Figure 1
to manage change, including proactively managing any staff
attempts to make explicit the risk/rewards of doing so.
displacement issues. Training is the key, both for career devel-
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opment of the re-deployed onshore employees as well as for
doing to help communities in the host countries as in its sup-
cultural assimilation of those working with the offshore
port of a local community in the U.S. or U.K. Customers are
employees (to prevent misunderstandings). Also, the offshore
often more concerned about the service they are getting, e.g.
employees need training designed for them to understand
how quickly their calls get answered and problems resolved,
their job, the national culture, and the specific corporate culture.
than from where the service is provided. Keeping customer
satisfaction metrics, as well as data on improved profitability,
Also, when engaging a third party vendor, it may be desirable
provides the company with ammunition in the face of press
to allow for potential ‘on-site’ partnership with the selected
negativity about job losses. Financial services is a dynamic
vendor for a while until the vendor performance matches or
industry, so preserving the status quo, particularly in this eco-
exceeds U.S./U.K. contact center performance. However, this
nomic climate, can be viewed as sentimental and expensive. In
must be carefully handled to avoid low morale among onshore
the words of the chairman of a large British bank, ‘We have to
employees who feel they are being asked to train their
relocate these functions to India. Not only are the running
replacements.
costs a fraction of what they would be here, but the quality of
the workforce is significantly better. Taking advantage of that
One phenomenon that has become pronounced in the difficult
is a no-brainer.’13
economy of 2003 has been external intrusions in corporate
affairs, particularly political and union targeting of any
Conclusion
attempt to move jobs overseas. Many contact center locations
Where is it going to end? Are onshore contact centers destined
in the U.S. and U.K. were attracted to areas of high unemploy-
to be replaced by offshore centers? The answer, in my view, is
ment (often by government incentives), when manufacturing
an emphatic ‘no!’
industries moved jobs overseas. So this is the second wave of
offshoring affecting these communities, in specific locations
Global businesses will continue to need a mix of onshore and
with a political voice, and unions dedicated to preserving the
offshore contact centers. Dealings with priority clients that
jobs of their members. A specialist consultancy, Mitial Research,
require intimate knowledge of the customer and close interac-
notes that the U.K. (with the most contact centers in Europe),
tion with numerous departments are best handled by well
employs about 500,000 people across 6,000 sites. They esti-
trained onshore employees. Certain recent regulations regard-
mate that one-third of Britain’s larger contact centers would
ing privacy and data security also make it difficult to share
shut down by 2005, with the loss of 90,000 jobs.12 Unions have
highly sensitive customer information with offshore centers.
been vocal in the press and hinting at strike action to protect
members’ jobs. In the U.S., New Jersey, Maryland, Connecticut,
Reasons of business continuity and risk management will
Missouri, and Wisconsin are all considering legislation to pre-
almost always dictate that a pure ‘offshore’ model would not
vent public sector work from being conducted offshore,
be prudent. Realistically, the sheer number of people
despite earlier (unrelated) court rulings that states cannot
employed in the onshore contact centers would preclude a
conduct their own foreign policy. Domestic politicians may
potential scenario whereby all these jobs would move off-
seek to defy international economics to please voters, but the
shore. So despite scare-mongering hyperbole, while some jobs
financial services firm must consider economic necessity and
will go overseas, those left onshore will often be more inter-
its corporate governance responsibilities.
esting and managerial.
Any publicly-held company has a variety of stakeholders,
We believe the debate onshore versus offshore centers is mis-
including shareholders as well as employees. Their client base
guided. The best model for a global firm is a ‘multilocation-
may be worldwide, and as interested in what the company is
networked-centers’14 solution incorporating multiple countries
12 Ringshaw, G., 2003, ‘Call Centers Take Passage to India’,
Sunday Telegraph, May 25,.
13 Ringshaw, G., 2003, ‘Call Centers Take Passage to India’,
Sunday Telegraph, May 25.
14 Sinha, D., 2002, ‘Offshore Contact Centers: Still a Long Road Ahead,’
Gartner, Inc., July 18.
49
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and vendors, and a blend of insourced and outsourced centers.
well as cost savings. But the bandwagon created by the suc-
American Express is a good example of such a model. It has
cess of offshore contact centers has sown seeds of potential
contact centers in North America, Europe, India, and the
disaster. Jealousy at home, fanned by politicians and unions,
Philippines. And in most locations, the company uses a mix of
means that transition management and community relations
both ‘in-house’ and outsourced contact centers. In this way,
must be effectively handled. The euphoria has also attracted
American Express is able to ensure high levels of business
offshore contact center vendors who will have difficulty delive-
continuity and risk management. Were there a disaster in one
ring, and could create disillusionment. Other vendors (respon-
location or should a vendor go out of business, American
ding to tough negotiation by buyers) are accepting uneconomic
Express has sufficient alternatives sources of supply to
contracts in their bid to build critical mass, which may force
assume the extra volume of contacts that were handled by the
them to cut corners and not allow them to invest in infra-
affected centers. Of course, many firms do not have the scale
structure. This is not to deny that some offshore contact
to deploy multi-location contact centers. For such firms, a glo-
centers in India and elsewhere are making real progress in
bal contact center vendor might present a suitable alternative.
striving towards world-class contact center processes and
technology. But for a happy ending (and a smooth ride), its
50 - The
Offshoring has proved a crucial strategy for a host of financial
‘Caveat Emptor’ not just in choosing an offshore vendor but in
services firms, in both boom and lean times, because it pro-
ensuring, through monitoring and metrics, that management,
vides improved quality, productivity, and business flexibility, as
training, and performance are all delivered.
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Implication
Cross-border outsourcing
and risk management for banks
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Implication
Outsourcing and
labor migration
in China
Xiaodong Wu*
Department of Economics,
University of North Carolina at Chapel Hill
Abstract
Outsourcing has been increasing in recent years as more firms
in the developed countries have decided to outsource part of
their production activities to their subsidiaries or local firms in
the developing countries. Outsourcing either reduces a firm’s
cost of labor or gives a firm better access to the local market
so as to gain a larger market share. This rise in outsourcing
activities has created both new opportunities and challenges
to the developing countries, not only in the product market
but also in the labor market. This is especially true for China,
as its labor market adopted a soviet-style command-and-control system for many decades before China’s economic reform
in the State-Owned Enterprises (SOEs) started in 1998. This
paper will analyze the impact of outsourcing on the productivity of the SOEs and hence labor migration between the
state sector and the non-state sector. The paper will then discuss how the development of a market-oriented labor market
can intensify this impact of outsourcing. Finally, the paper will
draw policy implications for China’s labor market reform in the
presence of increasing outsourcing.
* I would like to thank Kenneth Swinnerton, Bob Bednarzik, and participants at the
ILAB Symposium on Improving Labor Market Opportunities and Security for Workers
in Developing Countries for their valuable comments on an earlier version of the
paper. I am also grateful for the financial support from the Bureau of International
Labor Affairs at the Department of Labor.
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With increasing international competition following China’s
rural households. Limited employment supporting services
accession to the World Trade Organization (WTO), more and
combined with the absence of social institutions to deliver
more foreign companies in the developed countries are out-
basic social services, such as unemployment benefits, pensions,
sourcing their production activities to China to capture the
and health care outside the state sector, have forced the gov-
cheap labor market and to compete for the huge product
ernment to restrict the SOEs from laying off surplus workers.
market. This increase in outsourcing has increased foreign
The development of an efficient urban labor market is crucial
capital inflow into China in terms of both foreign direct invest-
for the government to extend the economic reform to the
ment (FDI) and foreign portfolio investment. Since 1993, China
SOEs while maintaining social stability in this transition from a
has been the second largest FDI recipient country after the
planned economy to an open market economy.
United States (UNCTAD, 1999). Outsourcing from the developed countries into China has increased competition in
Second, since China started its rural economic reform in 1978,
China’s labor, as well as product, market. However, the impact
more and more labor has been released from working on lands
on the labor market has not received much attention until
to become a ‘floating population’ in the cities. Looking for jobs
very recently, partly because the percentage of employees in
mainly in the private sector, as most jobs in the state sector
the foreign-owned enterprises in China was quite small up
require urban residency permits. The development of an effi-
until the late 1990s. However, since then it has increased expo-
cient urban labor market to facilitate the settlement of this
nentially to reach 15% of total employment.
floating population will not only release the burden of redeployment of surplus urban labor and support the continuation
This paper will focus on how outsourcing from the developed
of SOE reform, but it will also allow the deepening of rural eco-
countries into China (hereafter referred to as foreign out-
nomic reform, which due to increased agriculture productivity
sourcing) will change the relative productivity in the state and
will lead to more rural to urban labor migration. On the con-
non-state sectors and hence the labor migration between
trary, blocking this migration trend by tightening and strictly
them. Labor migration becomes an important issue as more
enforcing laws on urban residency permits will only let this
farmers are released from farming, as a result of China's rural
river of migration overflow, increase social tension, and slow
economic reform, and more urban workers are either em-
the speed of economic reform.
ployed but redundant or are already laid-off because of the
state-owned enterprise (SOE) reforms.1 Although urban workers
The current job placement system in China’s state sector, to a
in the state sector only account for 30 percent of the total
large extent, still allocates workers administratively to avail-
labor force, with the rest being in the rural sector, their
able positions without allowing much information exchange
employment and the re-employment of those laid-off are
between employers and employees. Such redeployment of
critical to push the economic reform forward. This is mainly
surplus labor is neither effective nor efficient and often results
because of two reasons.
in mismatch of skills. In 1999, more than 11.2 million job vacancies were registered, but less than 9 million job seekers
First, most urban households live on jobs, while most rural
successfully found a job (China Labor Statistical Yearbook,
households live on land. Employment in the state sector has
2000, 91-92). The re-employment rate of laid-off workers from
been not only the basic source of urban household income,
the SOEs was only 4.3 percent in the first quarter of 2002
but also a key channel for receiving most of the social services
(First Quarterly Report 2002, Ministry of Labor and Social
provided to urban residents.2 Unemployment is a much more
Security).
apparent and devastating problem for urban families than for
1
54
The latest population census conducted in November 2000 in China revealed that
the economically active population had reached 711.5 million. By some estimates
as much as 25 percent of this labor force is redundant (including disguised
unemployment).
2 In most of the years since 1985, the SOEs have employed 70 to 75 percent of the
urban employees, and provided wages account for over 60 percent of total urban
household income (China Labor Statistical Yearbook 1999, p.78).
JOURNAL 8 -v3
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On the other hand, the huge influxes of foreign outsourcing
mation exchange will increase productivity and wage as the
have been the driving force behind the growth in the non-state
quality of job match improves. This benefit will outweigh the
sector. In 2000, the non-state sector, including local non-state
short run cost of increasing competition faced by the SOEs.
enterprises, as well as wholly foreign-owned or joint-owned or
share-holding enterprises, employed over 17 percent of
Finally, the paper will draw policy implications for China’s labor
China’s total labor force. The foreign-owned or shareholding
market reform in the presence of increasing foreign outsourcing.
firms in China, together with the domestic firms in the non-
One important policy recommendation is to create an efficient
state sector, have opened many job search channels in the
labor market to accelerate the redeployment of redundant
urban sector, including private employment agencies, news-
urban and rural labor. This will facilitate China’s accession to
paper advertisements, job fairs, and Internet job boards. These
the WTO without triggering unbearable unemployment, which
channels have enabled effective information exchange
is especially important for China, the world’s most populous
between job seekers and potential employers, offered more
country. China’s stability and growth are also globally benefi-
job opportunities to qualified workers, increased productivity,
cial. Improving job information exchange is a key to developing
and led to faster wage increase in the non-state sector, espe-
an efficient urban labor market. Better job opening informa-
cially in foreign firms either wholly foreign-owned or joint
tion dissemination will facilitate the labor redeployment by
ventures.
matching workers to their potential employers and providing
enterprises with more discretion in redeploying surplus labor.
Given the uneven development of job opening information
dissemination between the state sector and the non-state sec-
The rest of the paper is organized as follows. In the next sec-
tor, a mixed scenario of labor migration is likely to unfold as
tion, I will review the development of China’s emerging labor
foreign outsourcing increases. A predictable positive outcome
market. In the following section, I will discuss the hypotheses
is that more job information dissemination in the non-state
that will be tested in this paper and the empirical results.
sector provides more employment opportunities for the sur-
Finally I will discuss the policy implications of my findings.
plus labor released from the state sector and agriculture.
However, more job information dissemination outside the
China’s emerging labor market
state sector also facilitates firms in the non-state sector to
China’s current employment system has inherited heavily
recruit (or compete for) high-caliber workers from the SOEs.
from that of a traditional planned economy, in which unem-
This can hinder the productivity in the state sector, increase
ployment was seldom a noticeable problem. The command-
the number of non-profitable SOEs, and make SOE reform
and-control system aimed to allocate a piece of land to work
more difficult.
on for every household in the rural area. Everyone in the urban
labor force was allocated a job at a given wage through a central
This paper will analyze the impact of outsourcing on the pro-
placement system monitored by the government. The govern-
ductivity of the SOEs and hence the labor migration between
ment also monitored closely internal promotions and external
the state sector and the non-state sector. The paper will then
job transfers. Migration between rural and urban sectors was
demonstrate how the development of a market-oriented labor
highly restricted due to the household registration (Hu Kou)
market can intensify the discrepancy between the state and
system. The SOEs had an advantage to choose employees
the non-state sector and hence impact the redeployment of
from the job candidates first. Job seekers entering the labor
China’s urban and rural surplus labor, who become urban job
force had few legitimate ways, except via connection and cor-
seekers. The paper will demonstrate that enhanced job infor-
ruption, to approach potential employers. The jobs of formal
55
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employees in the SOEs were extremely secure and were called
Besides reducing productivity and creating disguised unem-
‘iron rice bowls’ (Tie Fan Wan).
ployment, there is another pitfall of the command-and-control
system. Most SOEs have covered all medical expenses, hous-
This command-and-control system faced a serious challenge
ing and food subsidy, and social security of their employees.
from the rapid population growth, which grew at an annual
Some firms have even had their own daycare centers, kinder-
rate of in excess of 2 percent for over two decades from 1949
gartens, and pre-schools offering high quality education services
to 1974 (Population Census of China). As the government
at heavily subsidized rates. The state sector, therefore, became
found it increasingly difficult to place new job candidates,
three bodies: a firm, an insurance company, and a social wel-
increasing numbers of young people were classified as ‘waiting
fare agency.
to be employed’ (Dai Ye) during the mid-1980s and early
1990s. From the late 1990s, all job candidates were encour-
Before the economic reform, urban workers were unable to
aged to look for jobs by themselves. Anyone who entered the
buy any insurance on their own, including medical and unem-
labor force and failed to find a job was then classified as unem-
ployment insurance. This was because only a limited number
ployed. Jobs in the state sector remained very secure up until
of agencies could provide these services due to government
1994. However, since then, the SOEs are allowed to lay off
restrictions and limited funding. Thus, most of the fringe bene-
workers purely on economic grounds and can claim bankruptcy
fits offered by the SOEs were available only for employees in
if the government declines to bail them out. To help the unem-
the state sector. Also, most of these benefits were distributed
ployed workers, the Labor Department and other organiza-
among workers according to their seniority, regardless of their
3
tions first set up re-employment service centers in 1994. By
effort to acquire experience on the job. In a sense, the gap
1998, the first year of the SOE reform, the State Council
between wage and marginal productivity was a premium paid
required that all SOEs with laid-off workers create a re-
to receive a uniform welfare package designed for all employ-
employment service center.
ees with the same number of years in service. Now, more than
three years into the SOE reforms, private insurance compa-
Re-employment service centers created a new category in
nies and separate government agencies that provide social
China’s labor force: laid-off workers from the SOEs who are
safety nets - including unemployment benefits, medical insur-
not classified as unemployed. These laid-off workers receive
ance, social security, housing, and food subsidy - to the poor
from the centers a monthly income and social benefits (rang-
and needy, not to employees as a bonus or substitute for
ing from medical insurance to subsidized housing, but varying
wage, are emerging. However, this market is still very imma-
among centers). An additional function of re-employment
ture. There have been many complaints about obtaining reim-
service centers is to provide skill-training workshops to laid-off
bursements from these private insurance companies. Thus,
employees. Their monthly income is less than the wage
due to all the problems of acquiring human, physical, and
received previously but more than the unemployment benefit.
financial capital, many collectively owned domestic enterprises
Individuals in the re-employment service centers receive
in the non-state sector had ‘backward’ technology.4 Jobs in the
retraining and have a priority to be hired into a new or restruc-
non-state sector were considered as second-class jobs until
tured SOE. They can stay in the center for up to three years
the late 1990s.
and are eligible for unemployment benefits for up to two additional years after that. By the end of 2000, about 6.1 million
This paper identifies the impact of increasing foreign out-
workers were in the various re-employment service centers,
sourcing together with more job information flow on the
which almost doubled the number of workers who received
potential employees’ perception and awareness of job oppor-
unemployment insurance benefits elsewhere that year.
tunities outside the state sector, in both foreign and domestic
firms. With regards to the two most important advantages of
56
3 The unemployment rate in most of the years from 1981 to 1993 was below 2.5
percent, and over 80 percent of unemployed were youth who were waiting to be
assigned a job. This percentage of youth unemployment dropped significantly to
just over 60 percent in 1994 (China Statistical Yearbook 1995, p.106).
4 The central and local governments used to allocate raw materials, capital, and
loans to all firms, as a private financial sector did not exist until very recently.
SOEs received most of their funds and some machinery and raw materials at
discounted prices. Even now, non-state-owned enterprises still have less access to
loans because a majority of financial institutions are still owned by the
government or operated by government-appointed officials.
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jobs in the state sector: Security and fringe benefits, increas-
non-state sectors in the labor market. It is my intention to
ing foreign outsourcing and more efficient labor markets with
improve the literature in this space with this paper. This objec-
improved job information flow play an important role in
tive will be undertaken using the asset-value approach in
increasing the chance of re-employment once unemployed,
Davidson and Matusz (2000a and 2000b) and Shapiro and
thereby reducing the insecurity of jobs in the non-state sector.
Stiglitz (1984) to develop a job search model with two partially
Moreover, as the percentage of employees in the non-state
integrated markets: one for the state sector and one for the
sector increase, more people are willing to purchase health
non-state sector. This model is used to test the following
and unemployment insurance out of their own pocket. This
hypotheses5:
surge in demand is contributing significantly to the emergence of a mature private insurance market and government
Hypothesis 1: Workers in the non-state sector, on average, are
welfare agencies separated from the SOEs.
more productive than those in the state sector, due to higher
education or better health or other factors related to higher
This ‘privatization’ of the labor market is indeed the vision of
productivity. As a result, the average wage in the non-state
the Chinese government. By 1999, the percentage of private
sector is higher than that in the state sector.
career service centers increased to about 11 percent, while that
of those run by the Labor Department fell to 72 percent (China
Hypothesis 2: As foreign outsourcing increases and job infor-
Labor Statistical Yearbook 2000, p.90). The State Council also
mation flow improves faster in the non-state sector than in the
decided that newly laid-off workers should no longer enter the
state sector, the average productivity of workers staying in the
re-employment service centers after the end of 2000. In prin-
state sector either decreases or increases at a slower rate
ciple, the re-employment service centers will cease to function
than that in the non-state sector. In the state sector, the
by the end of 2003. In the future, laid-off workers will go
reward to productivity drops, while seniority becomes more
directly to the regular employment service agencies and the
rewarding in receiving fringe benefits.
unemployment insurance programs. The re-employment service
centers will disappear, having accomplished their historic role
Hypothesis 3: Since workers with higher education or in better
in facilitating the transition of the welfare system from depen-
health status are in shortage in the job market, it is even harder
dency toward self-sufficiency, as the United States Family
for firms in the state sector to keep these workers without
Support Act of 1988 did in the U.S. [Bane and Ellwood (1994)].
increasing the relative reward to productivity in the compensation scheme, especially when foreign outsourcing surges.
It is, therefore, quite clear that the Chinese labor markets have
undergone tremendous change in recent years. A major stim-
Before we discuss the impact of foreign outsourcing on labor
ulus being the foreign outsourcing market. My objective in this
migration between the state sector and the non-state sector, a
paper is to identify how all these changes, with specific focus
question that comes to mind is whether the non-state sector
on the foreign outsourcing market, have impacted the Chinese
or foreign outsourcing is large enough to have any impact on
labor markets. These hypotheses will be highlighted and tested
China’s labor market. This non-state sector, including both
in the next section.
domestic and foreign-owned or share holding corporations,
increased from employing only 0.36 percent of long-term
The hypotheses and results
employees in 1985 to 17.18 percent of total employees by the
There have been many studies of the implications of job mar-
end of 2000. In 1978, over 72 percent of newly employed per-
ket segmentation. But few have focused on the implications of
sons in urban areas were in the SOEs, and this rate fell to below
foreign outsourcing, job information dissemination, labor
32 percent in 1997 (China Statistical Year book 1998, p.156).
migration, and hence competition between the state and the
5 Please note that the methodology used to test the hypotheses has been excluded
from this paper due to high mathematical complexity.
57
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China has in recent years experienced two significant turning
I will now examine whether hypothesis 1 holds so that the
points. The first was in 1993 when China first became the second
major assumptions in the theoretical model can hold, and the
largest FDI recipient country after the United States (United
model can provide good explanation and prediction of the real
Nations Conference on Trade and Development (UNCTAD),
world phenomenon.
1999). The annual growth rate of employees in the state sector
fell significantly from above 2 percent in 1992 to 0.28 percent
My analysis shows that the average wage of permanent staff
in 1993, while the annual employment growth rate in the other
and workers in the state sector was higher than the national
ownership enterprises jumped to 90.07 percent in 1993. By
average and that in the collectively-owned enterprises, but
1994, the composition of long-term employees in the other
was lower than that in the other ownership enterprises in all
ownership enterprises first exceeded 5 percent of the total.
years since 1984. This average wage gap between the state
This coincided with FDI growth that more than doubled
sector and the other ownership enterprises reached its highest
between 1992 to 1993, while the total value of foreign capital
peak in 1993 when FDI more than doubled, and then dropped
used also doubled in the same period. The dollar value of FDI
almost by a half from 1997 to 1998 when the SOE reform
inflow reached its historic high in 1998, only a year after the
started. By 2001, this gap further dropped to only 8.61 percent
East Asian financial crisis.
above the wage paid in the state sector after the deepening of
enterprise wage reform. I also find that in terms of productivity,
The second turning point was in 1998 when the SOE reform
tested using per-capita industrial output value added, other
was launched. Employment in the state sector fell dramatically
ownership enterprises rather than collectively-owned enter-
and continued to fall into the year 2000, which clearly indi-
prises are the main competitors of the state sector in China’s
cated the disguised unemployment problem resulting from the
labor market. Additionally, productivity was higher in other
command-and-control system. On the other hand, the employ-
ownership enterprises from 1985 to 2000.
ment in the other ownership enterprises grew almost 50 percent in that year and showed a clear sign of expansion in spite
Together, these findings support the proposition that workers
of the obvious contraction in the state sector.
in the non-state sector, on average, are more productive and
earn a higher average wage than those in the state sector.
Meanwhile, the collectively owned enterprises in the non-state
Moreover, I find that the percentage of engineers and techni-
sector were squeezed by the other ownership enterprises, as
cians in the other ownership enterprises exceeded the national
well as the state sector. Their employee numbers kept falling
average and those of both the state and collectively-owned
throughout the 1990s. By 1999, the total number of employees
enterprises from 1994 to 1997, although this percentage was
in the other ownership enterprises surpassed that of collective
the highest in the SOEs back in 1993. Also, each year’s share
owned enterprises by over 1 million, although the latter was
of engineers/technicians out of the national total was the
almost 76 times higher than the former back in 1985. One
highest in the other ownership enterprises’ national shares,
explanation could be that many had inherited the disadvan-
while the percentage of other employees was the highest for
tages of the collective owned enterprises of the command-
the SOEs, and that of workers/apprentices was the highest for
and-control system, which was in existence since 1949. In sum,
the collective owned enterprises. This evidence further sup-
the above findings have confirmed that it is important to ana-
port hypothesis H1 by indicating a higher percentage of skilled
lyze labor migration between the SOEs and the other ownership
workers in the other ownership enterprises than in the SOEs.
enterprises in studying the impact of foreign outsourcing on
China’s urban labor market.
As for hypothesis 2, my findings suggest that that the increase
in FDI inflow during the early 1990s initially coincided with a
greater increase in productivity in the state sector, from an
58 - The
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annual productivity growth rate of 17.89 percent in 1992 to
decreased by over 5,000 in 1999 and then fell again by over
28.15 percent in 1993. However, the annual growth rate of pro-
1,000 in 2000. This coincided with the narrowing wage and
ductivity in other ownership enterprises was much higher for
productivity gap between the state sector and the other owner-
two consecutive years from 1994 to 1995. On the contrary,
ship enterprises after 1998, which is consistent with the pre-
during this period, the annual growth rate of productivity in
diction in hypothesis H2.
the state sector fell to 5.27 percent. This supports hypothesis
H2 that productivity grows more slowly in the state sector
Finally, I find that the average pension paid to retirees was
than in the non-state sector.
higher in the SOEs than in the other ownership enterprises
from 1982 to 1998 except in 1987, 1988, and 1993. The average
I also find in support of hypothesis 3, that the huge influxes of
pension in the SOEs exceeded that in the other ownership
foreign outsourcing did draw away more productive workers
enterprises in 1998 by a record amount. The SOEs accounted
and hinder the productivity growth in the state sector.
for 73.38 percent of total expenditure on employee welfare, of
which 93.75 percent was spent by domestic enterprises.
Looking at the data on career service centers (including the
However, the average welfare expenditure per employee in
re-employment centers run by the SOEs) to analyze how more
foreign funded enterprises was higher than all the other
job information flow can intensify the above impacts of foreign
enterprises in 1999. This was true for all categories of spending
outsourcing on employment, wage, and productivity, I find that
except medical care, which was the highest in the SOEs. Since
the increase in the number of career service centers between
the SOEs usually obtain more favorable treatments in providing
1995 and 1998 coincided with the state sector’s decreasing
social welfare, due to government intervention, these num-
employment share and lower annual growth rate of wages and
bers can underestimate the real welfare benefits from the
productivity. I find that over the same period, the percentage
SOEs. Nonetheless, the data confirm the assumption that
of privately sponsored career service centers was increasing
there is a positive, although decreasing, gap in fringe benefits
faster than that of enterprises, institutions, and other organi-
offered by the SOEs and the other ownership enterprises.
zations, while the percentage of the centers run by the Labor
Department was decreasing. The latter fell to below 70 per-
Policy implications
cent, and the total number of career service centers also fell
This section will explore the policy implications of foreign out-
in 2001. This indicates that the probability of being employed
sourcing on China’s overall labor productivity and labor migra-
each period in the non-state sector increases faster than the
tion between the state and non-state sectors, and hence
fall of the probability that a worker gets laid off each period,
China’s transition from a command-and-control system to an
and hence our empirical findings that the average wage as
efficient demand and supply driven labor market. The previous
reward to productivity in the state sector was falling further
section suggested that the compensation scheme under the
below that in the other ownership enterprises support hypo-
traditional command-and-control system favored less produc-
thesis H2.
tive workers. As a result of more foreign outsourcing and improved information flows in the non-state sector, higher caliber
Since the State Council required in 1998 that all SOEs with
workers are moving to other ownership enterprises. The go-
laid-off workers create re-employment service centers, the
vernment-administered job allocation procedure under this
number of career service centers run by enterprises, institu-
command-and-control system was indeed a barrier to more
tions, and other organizations increased dramatically from
effective job matches in the state sector. Thus, both the wage
1998 to 1999. But, this increase was smaller than the fall in the
and productivity gap between the non-state and the state sec-
number of career service centers run by the Labor Depart-
tor had widened before the SOE reform took place in 1998.
ment. The total number of career service centers actually
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Foreign outsourcing has not only pushed up wages toward
However, both of these subsidy policies drain the govern-
workers’ marginal productivity, but also introduced a market
ment’s limited resources and cannot be a long-term solution.
system for potential employers and employees to exchange
their mutual interests. Under the traditional job allocation sys-
There are other more radical policies aimed to provide a long-
tem that administratively allocated workers to available posi-
term solution. One is to reduce probability that a worker gets
tions, the value of the probability of being employed each period
laid off in each period by abandoning government job alloca-
in the non-state sector was close to zero. As the number of
tion and increasing job information exchange between state
foreign firms increases with more foreign outsourcing, an effi-
employees and the SOEs to increase each worker’s chance of
cient job market is gradually emerging in China. Examples are
getting another job in the state sector once laid off. This
the newly developed private employment agencies, newspaper
decreases a worker’s incentive to migrate to the non-state
job advertisements, job fairs in major universities, and Internet
sector and helps the SOEs to keep their high-caliber workers.
job boards. This emerging job market has changed people’s
The re-employment service centers have partly served this
perception and boosted the employment prospective of all
purpose. This goal can also be satisfied through the new
firms in the non-state sector, not only foreign firms.
channel of job search established in 1997, where the municipal
governments have received the delegated responsibilities
The analysis shows that foreign outsourcing can provide more
from the state government to coordinate the layoff and re-
employment opportunities and increase the overall productivity
employment of SOE workers (Qian and Xu, 1993; Qian, Roland,
of China’s labor force and stimulate economic growth even
and Xu, 1998).
without bringing in any technology transfer. On the other
hand, foreign outsourcing can also cause more competition
The other more uncontroversial one is to increase job infor-
not only in the product market but also in the labor market,
mation flow in all sectors and integrate job searches between
which creates greater challenges to the already troublesome
sectors. A surprising finding of my investigation is that the job
state enterprises due to many other reasons discussed in
placement rate (the number of placed job-seekers over total
Gordon and Li (1991). Although more job information flow in
registered job-seekers) and the recruitment rate (the number
the non-state sector than in the state sector aggravates this
of placed job-seekers over the total registered job vacancies)
latter shortcoming, the solution is not to discourage foreign
both have been decreasing since 1995, although the job seekers
outsourcing or job information flow outside the state sector,
to job vacancies rate has stayed relatively unchanged at
but to revamp the SOEs to be profit-seeking enterprises in the
around 1.3. In 2000, the placement rate was below 50 percent
current economic reform so that they will survive the chal-
and the recruitment rate was below 65 percent. The re-
lenge from the other ownership enterprises and minimize the
employment rate of laid-off workers from the SOEs was also
cost of labor redeployment as China increases its openness to
decreasing and fell to 4.3 percent in the first quarter of 2002
trade and investment after joining the WTO (Wu, 2003).
(First Quarterly Report 2002, Ministry of Labor and Social
Security). These data reveal a poor match of job seekers and
To compete for more productive workers, the state sector can
potential employers. One possible explanation is lack of job
implement two types of subsidy policies. One is to increase the
information dissemination and another is lack of skills of job
amount and duration of subsidy to laid-off workers from former
seekers.
SOEs, such as the services provided by the re-employment
60 - The
centers. This partially offsets the impact of likelihood of being
In response to the first cause, the Chinese government has
employed each period in the non-state sector on each worker’s
been working hard to provide more occupational training pro-
incentive to migrate to the non-state sector. The other is to
grams and implementing professional certificate-based sys-
increase the subsidy in providing fringe benefits for the SOEs.
tems in every industry to improve the skills of laid-off workers.
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In response to the second cause, the government has been
First is to further encourage and facilitate private involvement
trying to hand off career services to the private market. The
in the dissemination of job opening information, for example,
number of career service centers run by the Department of
by facilitating the operation of private job search centers, job
Labor has been decreasing and the re-employment service
search agents, and Internet job boards. Although a majority of
centers for laid-off workers from the SOEs will cease to func-
these private advertisements of job openings are from foreign
tion by the end of 2003.
firms, including foreign funded and those funded by entrepreneurs from Hong Kong, Macao, and Taiwan, this job informa-
My analysis shows that increasing job information flow is as
tion flow greatly changes people’s perception about jobs in the
crucial as improving job seekers’ skill in solving the unemploy-
non-state sector in general. These job advertisements also
ment problem eventually. In particular, according to the 2002
provide good examples and an active environment for domes-
First Quarterly Report of the Ministry of Labor and Social
tic private firms and town and village enterprises to expand
Security, 68.18 percent of the employers require workers with
their labor forces. As the number and scale of these private
at least a senior secondary school diploma, which 75.84 per-
and town and village ownership enterprises increase, their
cent of the job-seekers have. Also, 56.52 percent of the
productivity will also increase, and they can become a promi-
employers require job applicants to have certain certificates
nent source of employment for China’s surplus labor.
indicating their skill levels, which 56.68 percent of the job
seekers do. These data further prove that after a long period
Second is to increase government’s participation in job infor-
of having the command-and-control system in China’s labor
mation dissemination. Our analysis shows that increasing job
market there is a need for more government support to pro-
information flow is as critical as increasing job seekers’ skill in
mote job information dissemination.
the redeployment of China’s surplus labor. China did not have
a free labor market until the early 1990s, and it takes time and
Technical assistance
effort to convert the traditional command-and-control system
This section summarizes the policy implications of the above
into a job market operated by the ‘invisible hand.’ More specif-
section and provides some technical assistance for China’s
ically, the government should make an effort to integrate the
labor market reform to confront the increasing foreign out-
government job search agencies and job opening information
sourcing. The study advocates implementing favorable policies
exchange centers with those in the private network. To establish
to promote government and private participation in marketing
a free market for labor, there should be no artificial barriers or
job openings, investing in information infrastructure, and cre-
discrimination between job candidacies and vacancies in the
ating opportunities for new institutions to emerge to reduce
state sector versus those in the non-state sector. An integrated
labor market transaction cost and facilitate job search.
job market will increase the success rate in matching workers
with their potential employers and will also increase workers’
With increasing foreign outsourcing as China enters the WTO,
effort and willingness to participate in training and the overall
it becomes inevitable to eventually revise the compensation
productivity across sectors in the long term.
scheme for state employees to reflect more productivity
rather than seniority. However, this will harm the less produc-
Third is to revive the SOEs by abolishing all the social obliga-
tive and more needy workers in the SOEs, at least in the short
tions and to provide a nationwide social safety net for the
run. Therefore, it is crucial to develop an efficient urban labor
employed as well as the unemployed in both the state and
market for the redeployment of surplus labor during this tran-
non-state sectors to replace the social obligations from the
sition. The analysis in this paper recommends the following
SOEs. As studied in Wu (2003), freeing the SOEs from their
policies to achieve a smooth transition from a planned economy
social welfare obligations will bring many SOEs from deficits
to a market economy confronting increasing outsourcing.
to profits so as to minimize the distortion to the economy and
61
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sustain the economic and political stability in the transition
•
from a planned economy to a free market economy.
•
Since 1998, the Chinese government has started to implement
a series of policies to provide a broader market-based social
welfare system, including health insurance, social security, and
•
•
•
unemployment insurance and benefits. The empirical evidence
in the previous section has already showed some promising
•
signs of this gradual movement toward completely freeing the
•
SOEs from their social welfare obligations and allowing them
to compete equally with other firms in the non-state sector,
not just in the product market but also in the labor market.
This is an ultimate solution to the problem. And, although its
•
•
•
full benefit to productivity growth and, eventually, the well
being of the majority of the population may not be fully
•
appreciated, its process may turn out to be quite radical and
painful in the short term.
•
References
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•
•
•
•
•
•
•
•
•
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62 - The
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Implication
Cross-border
Evolution
of
the financialand
outsourcing
software
risk
management
market
for banks1
Hugh C. Kelly
Senior Advisor for Global Banking,
Daniel E. Nolle
Auteur
Senior Financial Economist,
Firma
Abstract
Managing the risks associated with cross-border outsourcing
U.S. banks are increasingly outsourcing an expanding range of
is extremely important, especially in the case of the banking
their operations to third-party service providers. Recent indus-
industry where problems can take on systemic significance
try estimates show that outsourcing by U.S. banks accounts for
and can affect confidential customer or bank records. In con-
almost 20 percent of their information technology services spen-
sequence, the Office of the Comptroller of the Currency has
ding. Importantly, the prospect of considerable cost savings
published risk management guidelines for banks engaging in
and access to scarce information processing and development
cross-border outsourcing. This article summarizes that guid-
resources has led a growing number of banks to consider
ance, placing the discussion in the context of the recent rapid
making greater use of foreign-based service providers – that
growth in outsourcing. Among the most important risk man-
is, of engaging in ‘cross-border outsourcing’. Notwithstanding
agement challenges to assess and address are: 1) the strate-
the potential cost savings that can result from outsourcing
gic fit that cross-border outsourcing will provide for a bank’s
offshore, banks face significant risk management challenges
overall operations; 2) country risk, which includes social, eco-
from these activities. Some of these challenges are unique to
nomic, and political instability; 3) legal and compliance risks
cross-border outsourcing while others, associated with risk
related to the potential applicability of foreign jurisdictional
management for domestic service providers, may take on
laws to the outsourced activities; and 4) operational risks
added significance for cross-border outsourcing.
related to security and confidentiality of bank and customer
information.
1
The opinions expressed in this article are those of the authors alone, and do not
necessarily represent those of the Office of the Comptroller of the Currency or the
U.S. Treasury Department. The authors thank Jim Devlin, Jeff Gillespie, Virginia
Hagan, Carter Messick, Nancy Wentzler, and Cliff Wilke for insightful comments.
63
JOURNAL 8 -v3
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U.S. banks are increasingly outsourcing an expanding range of
Bulletin 2002-16, published by the Office of the Comptroller of
their operations to third-party service providers. Recent indus-
the Currency (OCC) in May 2002, provides specific risk mana-
try estimates show that outsourcing by U.S. banks accounts for
gement guidelines for national banks engaging in cross-border
almost 20 percent of their information technology services
outsourcing.2 This article summarizes that guidance, placing
spending, while industry projections estimate nearly a 40 per-
the discussion in the context of the recent rapid growth in out-
cent increase in such outsourcing by 2005. Importantly, the
sourcing.
prospect of considerable cost savings and access to scarce
information processing and development resources has led a
The article is organized as follows. The next section sketches
growing number of banks to consider making greater use of
the magnitude and recent growth of outsourcing of informa-
foreign-based service providers – that is, of engaging in ‘cross-
tion services, focusing in particular on cross-border outsourc-
border outsourcing’.
ing. This look at the outsourcing ‘landscape’ includes a brief
discussion of the characteristics of cross-border outsourcing
Notwithstanding the potential cost savings that can result
that have made it an increasingly attractive alternative for a
from outsourcing offshore, banks face significant risk manage-
growing number of firms, including in particular financial serv-
ment challenges from these activities. Some of these challenges
ices firms. The following section begins with the observation
are unique to cross-border outsourcing while others, associated
that along with the benefits come risks. Managing the risks
with risk management for domestic service providers, may
associated with cross-border outsourcing is extremely impor-
take on added significance for cross-border outsourcing.
tant, especially in the case of the banking industry where
Among the most important risk management challenges are
problems can take on systemic significance and can affect
the following:
confidential customer or bank records. In consequence, the
■ Assessing the strategic fit that cross-border outsourcing
final section summarizes recent risk management guidance
will provide for a bank’s overall operations, a process which
issued by the OCC for national banks to apply to their cross-
includes conducting appropriate due diligence and risk
border outsourcing plans and activities.
assessment before deciding to contract with an overseas
service provider.
■ Assessing country risk, which includes social, economic,
and political instability.
■ Assessing legal and compliance risks related to the
Cross-border outsourcing landscape
Outsourcing of information-related services is not new.
Indeed, many industries have been outsourcing some or much
of their information technology (IT) services – e.g. customer
potential applicability of foreign jurisdictional laws
software development, application maintenance, and IT pack-
to the outsourced activities.
age implementation – since at least the start of the technolo-
■ Assessing operational risks related to security and
gy boom of the 1990s.3 Nor is the use of foreign-based third
confidentiality of bank and customer information.
party vendors new. However, outsourcing - including cross-bor-
■ Monitoring and oversight of vendor performance.
der outsourcing - has seen significant growth recently, as
firms facing stiffer competition in an increasingly globalized
64 - The
In addition, particularly since September 11th, the increased
economy look to control costs and obtain expertise. The nature
threat of terrorism has heightened the importance of ensuring
of IT services that are being outsourced has also changed
that business continuity planning and disaster recovery capa-
recently, as firms have increased their outsourcing of IT ‘busi-
bilities are addressed during the outsourcing agreement, with
ness processes’ – e.g., loan and deposit processing, payroll pro-
an eye toward the possibility that the need for an unplanned
cessing, mortgage servicing, and customer interaction services
termination of the agreement could arise.
such as call centers. Some of these business processes are
2 The Office of the Comptroller of the Currency charters, regulates,
and examines national banks.
3 PwC Consulting, ‘Riding the Offshoring Wave,’ PricewaterhouseCoopers (2002).
JOURNAL 8 -v3
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regarded as higher value-added ‘strategic’ activities as com-
Further, Gartner estimated a similar level of outsourcing world-
pared to traditionally outsourced ‘commoditized’ services.4
wide for business processes, at U.S.$123.6 billion in 2001.
In addition, while historically financial services outsourcing
The studies are in rough agreement about likely substantial
was generally limited to a single service provider for a given
growth in outsourcing. Gartner projects a 44 percent increase
functionality, in recent years banks’ outsourcing relationships
in business processes outsourcing between 2001 and 2005.
have increased in scale and complexity as a direct result of
IDC’s and TowerGroup’s projections for the growth of IT out-
advances in information technology and the emergence of
sourcing by U.S. firms over the 2001-2005 period are similar,
electronic banking. Many outsourced services, particularly in
with the former projecting a 53 percent increase and the latter
the area of electronic banking, are ‘sub-contracted’ to addi-
a 61 percent increase. IDC also expects rapid growth for IT out-
tional third party service providers and/or conducted in a for-
sourcing by U.S. banks from 2001 through 2005.
eign country. Further, as electronic banking services have
become more technologically advanced and have grown in
strategic importance, certain online functional applications,
Clearly, outsourcing of information services is substantial and
such as electronic bill presentment/payment and account
set to expand greatly. What about an important subset of out-
aggregation services, are dependent on a small number of
sourcing – outsourcing to foreign-based vendors? While data is
specialized third-party vendors and service providers.5
currently hard to come by, Table 2 gives some idea of the fact
that cross-border outsourcing has become quite substantial.
Outsourcing
The data are from a PriceWaterhouseCoopers study that
To illustrate both the extent and growth of IT and business pro-
approaches the subject via the phenomenon of ‘offshoring.’8
cesses outsourcing, Table 1 compares estimates and projections
Offshoring includes both the use of foreign-based facilities
from several recent studies for the U.S. and worldwide. The top
owned by a firm for production processes formerly done
half of the table compares estimates of the current or recent
‘onshore’ in the home country (i.e., production that is not out-
levels of outsourcing (domestic and foreign-based). The bottom
sourced),9 as well as the use of foreign-based third-party ven-
half shows growth projections for outsourcing. For example,
dors – i.e., cross-border outsourcing.
an International Data Corporation (IDC) study estimated that
IT outsourcing by U.S. firms in 2001 was U.S.$29.04 billion,
with the banking industry’s U.S.$5.7 billion accounting for 20
percent of that amount - the largest single industry share.
Further, the U.S.$5.7 billion spent by U.S. banks in 2001 on outsourcing represents 19 percent of U.S. banks’ total IT spending.6
TowerGroup has estimated worldwide IT outsourcing for 2003
at U.S.$120 billion, a figure that accounts for over one-third of
the estimated U.S.$340 billion in total IT spending worldwide.7
4 See, e.g., Schroeder, Michael, ‘More Financial Jobs Go Offshore,’ The Wall Street
Journal (May 1, 2003); PwC Consulting, ‘Riding the Offshoring Wave,’
PricewaterhouseCoopers (2002); ‘Back office to the world’
(May 3, 2001), The Economist.
5 Electronic Banking Group, Basel Committee on Banking Supervision,
‘Risk Management Principles for Electronic Banking’ (May 2001).
6 Celent Communications estimates that U.S. banks spent $32.8 billion on IT in 2001,
and TowerGroup estimates IT spending by banks was $26.5 billion. The average of
these two estimates is $29.7 billion; $5.7 billion is 19.2 percent of this (average)
total IT spending by U.S. banks. For the Celent and TowerGroup estimates of IT
spending totals see Rountree, David, ‘Technology Spending Persists in Downturn,’
Bank Technology News, Vol. 15, No. 3 (March 2002).
7 Sisk, M., ‘Outsourcing Goes On-Demand,’ Bank Technology News, Vol. 16,
No. 2 (February 2003).
8 PwC Consulting, ‘Riding the Offshoring Wave,’ Price Waterhouse and Coopers
(2002). This approach is typical of recent accounts in the press and in industry
studies that focus initially on the location of production, and subsequently
distinguish between ‘captive’ foreign-based production facilities owned by firms,
and the use of foreign-based vendors. See also PwC Consulting, ‘Offshore
Resourcing: Once Adventurous, Now Essential for Financial Services Firms,’
PricewaterhouseCoopers (2002); ‘The Rush to Send Back-Office Business
Overseas,’ http://knowledge.wharton.upenn.edu; and ‘Raising the Bar On Offshore
IT for Insurance,’ Celent Communications press release, May 23 2003.
9 Some industry observers have begun to refer to this aspect of offshoring as
‘insourcing.’ See for example Patel, Divya Verma, ‘Banks benefit from insourcing,’
The Asian Banker, June 19, 2003.
65
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TABLE 1. LEVEL AND GROWTH OF INFORMATION SERVICES OUTSOURCING
(estimates and projections)
Study
Time Period
Region
2001
United States
Outsourced Operations
Estimates/ Projections
Information Technology (IT) –
$29.04b
Level of Outsourcing
International Data
Corporation (IDC)1
IDC1
All industries
2001
United States
IT - Banking
$5.70b
1
IDC
2005
United States
IT – All industries
$44.34b
IDC1
2005
United States
IT - Banking
$8.83b
TowerGroup2
2003
Worldwide
$120.00b
Gartner3
2001
Worldwide
Business processes – All industries
$123.60b
2005
Worldwide
$178.50b
Gartner3
2001-2005
Worldwide
44% increase in business
IDC1
2001-2005
United States
IT - All industries
53% increase in IT outsourcing
TowerGroup3
2001-2005
United States
61% increase in IT outsourcing
IDC1
2001-2005
United States
IT - Banking
39% increase in banking
3
Gartner
Growth of Outsourcing
processes outsourcing
IT outsourcing
Sources: Office of the Comptroller of the Currency using various industry sources, as follows:
1 Hallerman, D., 2002, ‘Bank IT Outsourcing: A Trend without a Direction,’ eMarketer.com, October 8
2 Sisk, M., 2002, ‘Outsourcing Goes On-Demand,’ Bank Technology News, 16:2
3 Rountree, D., 2002, ‘Technology Spending Persists in Downturn,’ Bank Technology News, 15:3
As illustrated in Table 2, the majority of the 51 large North
done so by using foreign-based service providers for IT activi-
American and European firms (the majority of which are
ties. In addition, the majority of the companies offshoring their
financial services companies) surveyed by PwC have moved
business processes do so via cross-border outsourcing. Finally,
some of their IT (69%) and business processes (56%) activi-
on average, companies engaged in cross-border outsourcing
ties to foreign locations. Consistent with recent accounts of
use more than one vendor, both for IT and business processes
offshoring, India dominates as the foreign location of choice,
activities; the maximum number of foreign-based vendors
primarily because of its relatively large pool of well-educated,
used by a company is 10 for IT activities and 5 for business
English-speaking workers.10, 11 For the clear majority of compa-
processes activities.
nies ‘offshoring’ some of their production, 87 percent, have
66
10 See also, e.g., Schroeder, M., 2003, ‘More Financial Jobs Go Offshore,’ The Wall
Street Journal, May 1; and The Economist, ‘Back office to the world’ (May 3, 2001).
11 Note that the flow of outsourcing is not exclusively from developed countries to
developing countries. For example, recently the Bank of New York announced it
will provide third-party settlement services to Banco do Brazil, and EDS (a U.S.headquartered vendor) recently signed a six-year IT outsourcing deal with Banque
Hervet, a French subsidiary of HSBC Holdings. See, respectively, The Asian Banker,
‘Banco do Brazil signs CLS deal have done so by using foreign-based service
providers for IT activities. In addition, the majority of the companies offshoring
their business processes do so via cross-border outsourcing. Finally, on average,
companies engaged in cross-border outsourcing use more than one vendor, both
for IT and business processes activities; the maximum number of foreign-based
vendors used by a company is 10 for IT activities and 5 for business processes
activities.
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TABLE 2. ‘OFFSHORING’ AND CROSS-BORDER OUTSOURCING
OF INFORMATION TECHNOLOGY AND BUSINESS PROCESSES
Characteristic
Operations
Offshoring: Percent of 51 large companies locating significant operations offshore
Information
Technology
Business
Processes
69%
56%
86%
57%
Location: Offshoring companies locating operations in:
■ India
■ Philippines
7%
17%
■ Ireland
5%
16%
■ Other
2%
10%
Cross-Border Outsourcing: Offshoring companies using
87%
51%
Average number of cross-border vendors per company
3
2
Maximum number of cross-border vendors by a single company
10
5
foreign-based 3rd party vendors
Memorandum: Total U.S. financial services jobs moving to offshore outsourcing (2003-2008) projected at 500,000 (8% of industry total) by A.T. Kearney.
Source: Office of the Comptroller of the Currency using information from ‘Riding the Offshoring Wave,’ PwC Consulting, PriceWaterhouseCoopers (2002),
and Schroeder, M., 2003, ‘More Financial Jobs Go Offshore,’ The Wall Street Journal, May 1
Notes:
■ Fifty-one companies (43 North American, 8 European) with offshore outsourcing experience surveyed by PwC Consulting.
■ Twenty-three of the surveyed companies were financial services firms.
■ ‘Offshoring’ refers to the practice of a company moving work from its home country to a foreign location, either by establishing its own operations or by outsourcing.
■ Outsourcing refers to the use of 3rd party vendors for the provision of work formerly done by the company itself.
■ Cross-border outsourcing refers to the use of a 3rd party vendor located in a foreign country.
■ Business processing includes functions such as back office processing, finance and accounting work, and operation of call centers.
The degree to which companies rely on cross-border out-
cross-border outsourcing cost savings of 20 to 50 percent for
sourcing is likely to increase because there are substantial
activities such as call center operation and loan servicing. A
perceived benefits. Table 3 summarizes key benefits and their
Celent study estimates cross-border outsourcing has resulted
estimated magnitudes. The first four rows in Table 3 focus on
in cost savings of 30 percent for insurance companies, relative
cost reductions from cross-border outsourcing. Relative to
to retaining selected activities in-house.
using U.S. vendors, the Wharton and Gartner studies estimate
67
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TABLE 3. ESTIMATED BENEFITS OF CROSS-BORDER OUTSOURCING
Study
Benefit
Estimate
Wharton1
Cost reductions –
20% - 40% vs. home-country (U.S.) vendors
business processes
Gartner2
Cost reductions -
call centers
Wharton3
Cost reductions -
loan servicing
Celent4
Cost reductions – IT for North
30% vs. in-house
American insurance companies
Wharton5
Reduced worker attrition
Forrester Research6
Quality improvement – IT:
88% of 145 surveyed financial service firms responded that off
‘Value for the money’
shore vendors ranked ‘somewhat better’ to ‘much better’ than
12% - 35% in India vs. 70% - 120% in U.S.
analogous U.S. vendors.
Forrester Research6
71% of 145 surveyed financial service firms responded that offshore
‘Quality of deliverables’
vendors ranked ‘somewhat better’ to ‘much better’ than analogous
U.S. vendors.
6
Forrester Research
‘On-time delivery’
shore vendors ranked ‘somewhat better’ to ‘much better’
than analogous U.S. vendors.
Forrester Research6
‘Having the right skills’
shore vendors ranked ‘somewhat better’ to ‘much better’ than
analogous U.S. vendors.
Sources: Office of the Comptroller of the Currency using various industry sources, as follows:
1
2
3
4
5
6
68 - The
’The Rush to Send Back-Office Business Overseas,’ http://knowledge.wharton.upenn.edu.
’The Case For, and Against, Shifting Back-office Operations Overseas,’ http://knowledge.wharton.upenn.edu.
’Case Study: Inside the Progeon-Greenpoint Mortgage Transaction,’ http://knowledge.wharton.upenn.edu.
’Raising The Bar On Offshore IT For Insurance,’ Celent Communications press release (May 23, 2003).
’Business Processes Are Moving from the West to Other Parts of the World,’ http://knowledge.wharton.upenn.edu.
Breitkopf, D., and Kingson J.A., ‘E-Strategists Humbler, But No Less Ambitious,’ American Banker (May 8, 2003).
Table 3 includes estimates of other benefits as well. Workers in
played in Table 3. Furthermore, in a growing number of coun-
many countries providing cross-border outsourcing find jobs
tries the educational and skill levels of workers employed by
in the outsourcing industry relatively more attractive than do
vendors are high compared to workers attracted to similar
U.S. workers. Hence, attrition can be substantially lower at for-
jobs in developed countries.12 As a result, many companies are
eign-based vendors, as indicated by the wide gap between
finding that the quality of service provided by offshore out-
attrition rates for Indian versus U.S. outsource workers dis-
sourcers is superior to the quality they have experienced
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using home country vendors. Table 3 summarizes the results
ever, it also cautions that relative to dealing with U.S.-based
of a Forrester Research study that includes the percentage of
vendors, cross-border outsourcing can raise unique risk issues
surveyed U.S. firms responding that they perceived quality
that require additional risk management oversight efforts. The
improvements in work done by offshore vendors relative to
bulletin places particular emphasis on the management of key
U.S.-based vendors. For example, 71 percent of the U.S. firms
aspects of strategic risk, country risk, and legal (compliance)
found the ‘quality of deliverables’ from foreign-based vendors
risk. In addition, OCC Bulletin 2002-16 stresses the need for
to be superior to that of U.S. outsourcers.
banks to establish adequate monitoring and oversight processes before entering into a contract with a foreign-based third-
Risk management for banks engaging in
cross-border outsourcing
for a national bank to establish cross-border outsourcing rela-
Use of foreign-based third-party service providers is substan-
tionships in a way that does not diminish the ability of the OCC
tial, and there is an emerging consensus that it is set to grow
to access, in a timely manner, data or information needed to
substantially in light of the cost and other benefits companies
effectively supervise the bank’s operations. OCC Bulletin
have reported experiencing. The story is not all one-sided of
2002-16 sets forth the following risk considerations for banks
course, because the benefits are accompanied by risks that
contemplating cross-border outsourcing:15
party service provider. Finally, the bulletin addresses the need
must be managed. In an effort to help banks balance their riskreward decisions about cross-border outsourcing, the OCC
Strategic risk
recently published guidance on identifying and managing
The board of directors and senior management are responsible
cross-border outsourcing risks. This section summarizes OCC
for understanding the special risks associated with the bank's
Banking Bulletin 2002-16, Bank Use of Foreign-Based Third-
outsourcing relationships with foreign-based service providers
Party Service Providers, issued in May 2002.13
and ensuring that effective risk management practices are in
place. A first step is a risk assessment and due diligence
In its bulletin, the OCC notes that a national bank’s use of
process undertaken before a national bank enters into a con-
third-party service providers located outside the U.S. is gener-
tract with a foreign-based service provider.16 The due diligence
14
ally permissible,
and may offer cost-effective means of
process should include an evaluation of the foreign-based
processing data and transactions and of providing expertise in
service provider’s ability - operationally, financially, and legally -
processing, marketing, and technology-related functions. How-
to meet the bank’s servicing needs given the foreign jurisdiction’s
12 The attrition and skill-level stories are likely more complex than this ‘attractiveness of outsourcing jobs’ scenario implies, however. In general, the mid-to-late
1990s ‘dot.com’ boom opened opportunities for IT workers in the U.S. and other
developed countries, many of whom moved from relatively mature IT industries –
including some traditional aspects of outsourcing - to new, higher paying IT jobs.
Subsequently, the ‘dot.bomb’ shakeout of the early twenty-first century has added
to IT industry attrition rates, including once again, some outsourcing sectors.
Nevertheless, the U.S. and other developed countries still offer greater mobility to
IT workers than most developing countries, and hence attrition rates are bound to
be different for some sectors. The authors are grateful to Carter Messick for this
insight.
Management of Outsourced Technology Services (November 2000), and OCC
Bulletin 2001–8, Guidelines Establishing Standards for Safeguarding Customer
Information (February 2001). The term ‘foreign-based third-party service
providers’ refers to third parties whose servicing operations are located in a
foreign country and subject to the law and jurisdiction of that country.
Accordingly, this definition would not include a U.S.-based subsidiary of a foreign
firm because its servicing operations are subject to U.S. laws. It would include U.S.
service providers to the extent their actual servicing operations are located in or
outsourced to (e.g., subcontracted to) entities domiciled in a foreign country and
subject to the law and jurisdiction of that country. Also, Bulletin 2002-16 applies to
international branches of U.S. national banks that use third-party providers
domiciled in the same foreign country or in another foreign country.
14 Subject to economic and trade sanctions of the Office of Foreign Assets Control
(OFAC) of the U.S. Treasury. The Office of Foreign Assets Control of the U.S.
Department of the Treasury administers and enforces economic and trade
sanctions against targeted foreign countries, organizations sponsoring terrorism,
and international narcotics traffickers based on U.S. foreign policy and national
security goals. For more information, refer to the OFAC Website at
http://www.treas.gov/ofac/
15 Note that, in a knock-on sense, failure to manage these risks can result in public
recognition of substandard performance by a vendor, a possibility that raises
reputational risk for a bank. The authors thank Cliff Wilke for this insight.
A labor market issue gaining increasing attention is the impact of offshoring,
including cross-border outsourcing, on home country workers. For example, five
states in the U.S. have pending legislation aimed at keeping jobs currently being
lost to offshoring. The bills include measures blocking firms from using foreign
workers on state contracts, and requiring foreign-based call center workers to
identify their location to customers. See Schroeder, M., 2003, ‘States Fight Exodus
of Jobs,’ The Wall Street Journal, June 3.
13 Bulletin 2002-16 on cross-border outsourcing supplements OCC Bulletin 2001-47,
Third-Party Relationships: Risk Management Principles (November 2001).
Also relevant are OCC Advisory Letter 2000–12, FFIEC Guidance on Risk
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laws, regulatory requirements, local business practices,
Three legal risk issues warrant particular attention:
accounting standards, and legal environment. The due dili-
■ Contracts - Contracts between the national bank and a
gence should also consider the parties’ respective responsibil-
foreign-based service provider should take into account
ities in the event of any regulatory changes in the U.S. or the
business requirements and key factors identified during
foreign country that could impede the ability of the bank or
the bank’s risk assessment and due diligence processes.
service provider to fulfill the contract. Without an effective
In particular, bank management should consider inserting
risk assessment process, outsourcing to foreign-based service
contract provisions that will protect the privacy of
providers may be inconsistent with the bank’s strategic plans,
customers and the confidentiality of bank records given
may introduce unforeseen risks that are difficult to manage, or
U.S. law and the foreign jurisdiction’s legal environment
may be too costly.
and regulatory requirements.19 In addition, contracts with
third-party service providers should contain a provision
Country risk
indicating the provider agrees that the services it performs
In outsourcing to a foreign-based service provider, a bank may
for a national bank are subject to OCC examination.20
be exposed to country risk, which is the possibility that economic, social, and political conditions and events in a foreign
■ Choice of law - Before entering into an agreement or
country might adversely affect the bank. Such conditions and
contract with a foreign-based service provider, national
events could prevent the foreign-based service provider from
banks should carefully consider which country’s laws they
carrying out the terms of its agreement with the bank. To
wish to control the relationship and then insert choice of
manage country risk, a bank must closely monitor foreign gov-
law and jurisdictional covenants that provide for resolution
ernment policies and political, social, economic, and legal con-
of all disputes between the parties under the laws of a
ditions in countries where it has a contractual relationship
specific jurisdiction.
with a service provider. The bank’s risk assessment process
should take into consideration relevant country risk factors
Contracts that include choice of law and jurisdictional
and establish sound procedures for dealing with country risk
covenants will help to ensure continuity of service,
problems, including having appropriate contingency plans and
to maintain access to data, and to protect non-public
exit strategies.17
customer information. Such contracts and covenants,
however, can be subject to interpretation of foreign courts
Legal (compliance) risk
relying on local laws. These local laws may differ substan-
A bank’s use of a foreign-based service provider must not in-
tially from U.S. laws in how they apply and enforce choice
hibit its ability to comply with all applicable U.S. laws and reg-
of law covenants, what they require of banks, and how they
ulations. These include requirements concerning accessibility
protect bank customers. Therefore, as part of its due
and retention of records, such as the Bank Secrecy Act, the
diligence process, before a bank enters into a proposed
national sanctions and embargo programs of U.S. Treasury’s
contract with a foreign-based service provider it should
Office of Foreign Assets Control (OFAC), and other relevant
obtain a legal review from someone experienced in that
U.S. consumer protection laws and regulations. National banks
country’s laws regarding the enforceability of all aspects of
that use a foreign-based service provider should consider how
the subject contract and any other legal ramifications.
foreign data privacy laws or regulatory requirements may
interact with U.S. privacy laws and regulations and how any
possible conflicts can be managed.18
70
16 OCC Bulletin 2001–47 and OCC Advisory Letter 2000–12 identify factors that
banks should consider when performing due diligence on potential third-party
service providers.
17 The Comptroller’s Handbook ‘Country Risk Management’ (October 2001), and the
Interagency Statement on Sound Risk Management Practices for Country Risk
(March 2002) describe the elements of an effective country risk management process.
18 Banks should be aware that some foreign jurisdictions may have data privacy laws or
directives that apply to information transferred from the United States to that foreign
jurisdiction over the Internet or to information collected within the foreign jurisdiction
using automated or other equipment in that jurisdiction.
19 OCC Bulletin 2001–47 provides additional guidance on factors that national banks
should consider when entering into a binding contract.
20 12 USC 1867(c) sets forth OCC’s authority to examine third-party service providers.
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■ Confidentiality of information - Bank management
reviews (for example, SAS 70 reviews24), and internal reports
should ensure that any contract with a foreign-based
provided by the bank's own auditors.25 Banks must be aware of,
third-party service provider prohibits the service provider
and prepared to effectively deal with, obstacles that geogra-
from disclosing or using bank data or information for any
phic distance and language and cultural differences may pose.
purpose other than to carry out the contracted services.
The contract should state that all information shared by
Access to information
the bank with the foreign-based third-party service
Bank access to information - Critical data or other informa-
provider, regardless of how the service provider processes,
tion related to services provided by a foreign-based third-
stores, copies, or otherwise reproduces it, remains solely
party service provider to a national bank must be readily avail-
the property of the bank. Also, any sharing of non-public
able at the bank’s U.S. office(s).26 Such information should
customer-related information from U.S. offices with a
include copies of contracts, due diligence, and oversight and
foreign-based third-party service provider must comply
audit reports. In addition, the bank should have an appropriate
with the OCC’s privacy regulation, including requisite
contingency plan to ensure continued access to critical infor-
disclosures to and agreements with customers who would
21
mation and service continuity and resumption in the event of
be affected by the bank’s relationship with that provider.
unexpected disruptions or restrictions in service resulting
Further, contracts between a national bank and a foreign-
from transaction, financial, or country risk developments.
based service provider must include a provision requiring
the service provider to implement security measures that
22
are designed to safeguard customer information.
Regulator access to information - A national bank’s use of a
foreign-based third-party service provider and the location of
critical data and processes outside U.S. territory must not
Monitoring and oversight
compromise the OCC’s ability to examine the bank’s opera-
As with domestic outsourcing arrangements, national banks
tions. Accordingly, the OCC expects a national bank to establish
should implement an effective oversight program to monitor
such a relationship in a way that does not diminish the OCC’s
the foreign-based service provider’s ongoing financial condi-
access to data or information needed to supervise the bank.
tion and performance.23 In addition, the bank must determine
that the service provider maintains adequate physical and
For this reason, a national bank should not outsource any of its
data security controls, transaction procedures, business
information or transaction processing to third-party service
resumption and continuity planning and testing, contingency
providers that are located in jurisdictions where the OCC’s full
arrangements, insurance coverage, and compliance with appli-
and complete access to data or other information may be
cable laws and regulations.
impeded by legal, regulatory, or administrative restrictions
unless copies of all critical records also are maintained at the
Bank management should ensure that it has sufficient expert-
bank’s U.S. offices. Further, copies of the results of the bank’s
ise to perform the oversight function. As part of this function,
due diligence efforts and regular risk management oversight,
the bank should evaluate independent audit reports prepared
performance and audit reports on the foreign-based third-party
by the service provider’s audit staff, external audits and
service provider, as well as all policies, procedures, and other
21 See OCC Bulletin OCC 2000–21, ‘Privacy Rules and Regulations’ (June 20, 2000);
and 12 CFR Part 40, ‘Privacy of Consumer Financial Information,’ which was
published in the Federal Register on June 1, 2000 at 65 FR 35162.
22 See section 501(b) of the Gramm–Leach–Bliley Act, 15 USC 6801(b), and the
‘Interagency Guidelines Establishing Standards for Safeguarding Customer
Information’ contained in 12 CFR Part 30, appendix B. Also note that a bank should
not share any non-public OCC information, such as an examination report, with a
foreign-based service provider except with express OCC approval. Such non-public
OCC information remains the OCC’s property, and the bank should take all
required measures to protect the information’s confidentiality.
23 OCC Bulletin 2001–47 and OCC Advisory Letter 2000–12 provide additional
guidance regarding oversight of third-party relationships.
24 AICPA Statement of Auditing Standards 70, ‘Reports of Processing of Transactions
by Service Organizations,’ known as SAS 70 Reports, are one form of external
review. Type II SAS 70 reports review the service provider’s policies and
procedures and provide tests of actual controls against policies and procedures.
25 Based upon the bank’s own risk assessment, the bank should monitor its service
providers to confirm that they adequately safeguard bank customer information.
As part of this monitoring, a bank should review audits, summaries of test results,
or other equivalent evaluations of its service providers. See 12 CFR 30,
appendix B, III.D.3.
26 In instances where the national bank’s foreign branches have outsourced local
operations or services cross-border to third-party service providers domiciled in
another foreign country, copies of such records can be maintained at the bank’s
foreign branch office.
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important documentation relating to the bank’s relationship
Conclusion
with the service provider, should be maintained in English for
Both outsourcing – whether to domestic vendors or foreign
review by examiners at the bank’s office(s).
vendors operating in the domestic market – and cross-border
outsourcing have seen significant growth recently, as firms
OCC supervisory approach
facing stiffer competition in an increasingly globalized econo-
As outlined in Bulletin 2002-16, the OCC’s supervisory approach
my look to control costs and obtain expertise. As with out-
to cross-border outsourcing emphasizes the responsibility of
sourcing relationships with domestic third-party service
the serviced national bank to conduct adequate due diligence,
providers, a national bank’s board of directors and manage-
manage risks appropriately, comply with applicable laws, and
ment are responsible for ensuring that the bank effectively
ensure access to critical information with respect to the serv-
oversees any relationships with foreign-based third-party
ices being provided by a foreign-based third party. Examina-
service providers. Before a bank contracts for the services of
tion focus is placed on the results of the bank’s due diligence,
such a provider, it should properly assess the associated risks
risk assessment, and ongoing oversight program as well as the
and carry out appropriate due diligence, including careful con-
internal and/or external audits arranged by the service
sideration of contract matters and choice of law and forum
provider or the bank. If any of these risk management proces-
provisions. Additionally, the bank should have sufficient poli-
ses are found deficient, then the OCC will require the bank to
cies, practices, expertise, and access to critical information to
take the necessary steps to strengthen risk management con-
enable it to oversee the risks of the outsourcing relationship,
trols or terminate the outsourcing relationship.
including ensuring compliance with U.S. and foreign laws.
If circumstances warrant, the OCC may examine a national
bank’s outsourcing arrangement with a foreign-based service
provider. If the provider is a regulated entity, then the OCC
may arrange through the appropriate foreign supervisor(s) to
obtain information related to the services provided to the
bank and, if significant risk issues emerge, to examine those
services.
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Implication
Hoofdtiteltje
Bodycopy bodycopy bodycopy bodycopy bodycopy bodycopy
bodycopy bodycopy bodycopy bodycopy bodycopy bodycopy
Tussentiteltje
Overseas outsourcing
by financial
institutions: Assessing
the legal and
regulatory landscape
Robert
M. Finkel
Bodycopy bodycopy bodycopy bodycopy
bodycopy
bodycopy
Partner,
Milbank,
Tweed,
Hadley
& McCloy
LLP
bodycopy
bodycopy
bodycopy
bodycopy
bodycopy
bodycopy
Winthrop N. Brown
Partner, Milbank, Tweed, Hadley & McCloy LLP
Abstract
As the number of financial institutions that are moving operations overseas has grown, so has the attention of regulators.
This article looks at some of the regulations that financial
institutions need to be aware of when considering moving
operations overseas and some guidelines on how contracts
should be structured with overseas vendors in order to ensure
compliance with these requirements.
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America's financial institutions are very much in the forefront
into a variable-expense item. By entering into an arrangement
of a rapidly growing trend by U.S. companies to reach beyond
that has variable-cost pricing, a customer may be able to con-
our own borders for software development, information tech-
trol more effectively its overall cost structure, which may
nology, and business process outsourcing services. Indeed,
prove especially beneficial in the event the customer expects
overseas outsourcing, which was merely an interesting devel-
that its demand for services will fluctuate over time.
opment as recently as the end of the last decade, has of late
become an essential component of the overall sourcing strat-
Third, outsourcing can enable a company to shed unwanted
egy of a significant number of U.S. companies. Over the past
assets or software licenses, either by selling the assets to the
several years, virtually every major U.S. financial institution
vendor, or another interested third party. In such an event, the
has outsourced, or seriously considered outsourcing, various
customer may be able to raise additional cash or redeploy
services to overseas providers.
funds to more productive uses elsewhere in the organization.
In a period characterized by extremely tight capital markets, in
The rush to outsource services overseas is reflected in a num-
which financings have been extremely difficult, freeing up cap-
ber of recent statistics, a number of which are quoted in the
ital by any means possible can prove to be especially attractive.
other articles in this issue. There is little doubt that this offshoring trend will certainly have a number of important eco-
Overseas outsourcing can also help a company achieve vari-
nomic, social, and political consequences. Indeed, we are per-
ous strategic objectives. By sourcing services to a third party,
haps beginning to witness the first signs of a potential politi-
a financial institution can jettison certain non-core assets and
cal backlash against overseas outsourcing. As will be dis-
functions, thereby permitting it to focus scarce resources on
cussed below, a number of state governments have become
its core business. A decision to outsource overseas can also be
concerned in particular about the job exodus. Draft legislation
part of a financial institution's vendor diversification strategy;
is currently pending in a number of states that would hinder in
selecting an overseas vendor that has a lower cost structure
various ways offshore outsourcing by U.S. companies.
may facilitate the management and control of a financial institution's other outside service providers, by placing added
Benefits of outsourcing
pressure on the them to keep their costs and service levels
There are a variety of reasons that explain why U.S. financial
competitive. Finally, an overseas outsourcing strategy can
institutions and other companies are increasingly reaching
enable a financial institution to improve the overall quality of
beyond our borders for information technology and business
its services. A recent Forrester survey revealed that 88 per-
process outsourcing services. By far, the prime motivating
cent of companies that outsourced overseas believe that they
factor has been cost savings. The recession and the corre-
obtained greater value overseas as compared to U.S.
sponding pressure it has placed on companies to cut their
providers. The same survey revealed that 71 percent of the
expenses in ever more creative ways has greatly contributed
surveyed companies claimed that offshore workers performed
to the acceleration of overseas sourcing. The seemingly end-
better than their U.S. counterparts. U.S. companies are clearly
less supply of high-quality engineers and other service profes-
outsourcing for reasons other than just cost savings.
sionals, as well as the comparatively favorable labor rates
offered internationally, are being seen as increasingly attrac-
Emergence of India
tive means to preserve profit margins that have eroded over
When U.S. financial institutions and other companies look for
the past few years.
overseas technology and other service partners, they increasingly turn to India. According to Gartner Inc., software devel-
74 - The
A second cost-related reason for a financial institution to out-
opment alone now represents a U.S. $4 billion export industry
source overseas is to convert a fixed-cost internal operation
for India and supports more than 900 software exporting
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firms and 400,000 information technology professionals.1 The
Business risks - Any outsourcing, whether domestic or inter-
predominance of English as the business language of choice
national, will also create additional business risks that a finan-
has certainly helped India emerge as the market leader. The
cial institution should consider in its transaction evaluation
development of a legal regime that has recently granted
process. Outsourcing of service functions may effectively re-
enhanced protection to the holders of intellectual property
duce the control that the financial institution has over the out-
rights has contributed too.
sourced function and therefore could potentially have adverse
effects on the provision of its financial services to its end-user
A number of developed and rapidly developing nations are
customers. This risk can prove to be especially problematic if
also emerging as key competitors to the Indian providers,
the outsourcing contract does not contain appropriate control
including Russia, China, the Philippines, a number of Caribbean
and other supervision rights for the financial institution over
nations, as well as Ireland and Israel. As U.S. companies seek
the service provider. Outsourcing can also limit the future flex-
new ways to cut costs, and as Indian and other overseas
ibility of the customer; once a financial institution makes a
providers continue to gain greater service provider experi-
decision to outsource a function, as a practical matter, it typi-
ence, international services firms are likely to place even
cally is difficult to either bring the services back in-house or
greater competitive pressure on their U.S. counterparts and
contract with another third party vendor to perform the same
assume an even larger share of the U.S. market in the future.
services at the end of the term of its outsourcing contract.
Either of these scenarios would involve the incurrence of addi-
Risks of overseas sourcing
tional costs and expenses, and perhaps more importantly, the
While sourcing a financial institution's service requirements
diversion of the time and attention of the management from
overseas certainly has the potential for significant benefits, it
more important matters.
is, of course, far from a risk-free enterprise. A decision to outsource overseas will entail additional business, political, legal,
Overseas outsourcing also may have additional financial and
and regulatory risks, a number of which we have outlined
other risks. First, any party to an overseas transaction should
below. In making its sourcing decision, a financial institution
assess prior to entering into the arrangement the potential for
must certainly answer the threshold question whether the po-
local inflation and exchange rate fluctuation. This assessment
tential risks of outsourcing overseas will outweigh the cost
will be particularly important if the transaction is priced in
and other advantages that may be obtained through the trans-
local currency or otherwise has its pricing pegged to local cost
action.
fluctuations.
Geopolitical concerns - A number of the countries that pos-
Cultural issues should also be considered in the outsourcing
sess the most capable and sophisticated service-provider
decision-making process. While many of the foreign vendors,
industries also happen to be situated in comparatively unsta-
especially the large multinational Indian providers, have made
ble regions. And a number of them are also emerging democ-
enormous efforts to address cultural, language, and accent
racies that do not yet have political, economic, or legal sys-
concerns, issues relating to culture and compatibility must be
tems that are as developed, or stable, as those found in the
considered and monitored by U.S. financial institutions consid-
U.S. and other industrialized nations. Any financial institution
ering going overseas.
should assess as a business matter, and as discussed below
may be required to do so under various U.S. regulations, this
A financial institution considering outsourcing to a foreign
geopolitical risk and protect itself in its outsourcing contract
country may also be confronting for the first time an unfamiliar
against the possibility that geopolitical events may impede the
legal and regulatory landscape, and should therefore educate
vendor's service delivery.
itself on matters such as the enforcement of laws regarding
1
Overby, S., 2003, ‘Passages Beyond India,’ CIO, Jan. 1
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confidentiality, privacy, and the protection of intellectual
that a national bank should be prepared to manage when out-
property rights. While a number of the leading service
sourcing functions to non-U.S. service providers.3 The OCC's
providers countries have made significant progress in the past
bulletin applies by its terms only to national banks; however, it
few years in the area of intellectual property protection, as a
offers a particularly useful guide for any financial institution
general matter protection of IP rights in many of the leading
seeking to anticipate the reaction of its regulator to such an
outsourcing countries lags greatly behind the U.S. and other
arrangement.
E.C. countries.
Among the areas identified by the OCC as requiring particular
Some of the significant legal, regulatory, and contractual
attention by any bank outsourcing to a foreign vendor are an
issues a U.S.-based financial institution should address when
assessment of country risk, thorough due diligence on the par-
considering entering into an outsourcing transaction with an
ticular vendor to be selected, the monitoring and oversight of
overseas supplier are outlined below.
the vendor's performance, and the bank's and its examiners'
access to information. These are discussed in detail in the pre-
Regulatory landscape
vious article written by Kelly and Nolle.
Financial institutions must take into account a growing numservice providers. These considerations range from general
Compliance with particular regulatory
requirements
guidance issued by their primary regulators on the subject of
A key objective of any outsourcing arrangement with a foreign
outsourcing itself, to specific statutory or regulatory require-
service provider will be to ensure that the provider performs
ments with which a service provider must comply in order to
its obligations under the outsourcing contract in a manner
ensure compliance by the financial institution with these
designed to enable the financial institution to comply with its
requirements.
regulatory obligations to the same extent as if it were per-
ber of regulatory considerations when outsourcing to foreign
forming the services itself. The risk that a vendor will fail to
Agency guidelines on outsourcing
live up to these requirements – identified by the 2002 OCC
The federal agencies that regulate bank and other financial
Bulletin as ‘compliance risk’ – must be managed particularly
institutions have individually and often jointly issued recom-
carefully by a financial institution when its service provider is
mended guidelines to follow when retaining third-party service
based in a country that does not itself impose these require-
providers for particular purposes.2 In 2002, the Office of the
ments. Of the various regulatory requirements with which an
Comptroller of the Currency (the ‘OCC’) published a bulletin
institution must ensure compliance, three are particularly
(the ‘2002 OCC Bulletin’), a summary of which is published in
important in today's environment.
this issue of the journal, that specifically identified the risks
76
2 Amended Interagency Guidance on the Internal Audit Function and Its
Outsourcing, FRB SR 03-5 (Apr. 22, 2003); Third-Party Relationships: Risk
Management Principles, OCC Bulletin 2001-47 (Nov. 1, 2001); Guidelines
Establishing Standards for Safeguarding Customer Information: Final Guidelines,
OCC Bulletin 2001-8 (Feb. 15, 2001); Risk Management of Outsourcing Technology
Services, OCC AL 2000-12 (Nov. 28, 2000); Guidance on the Risk Management of
Outsourced Technology Services, FRB SR 00-17 (SPE) (Nov. 30, 2000);
Outsourcing of Information and Transaction Processing, FRB SR 00-4 (SUP)
(Feb. 29, 2000); Outsourcing Financial Services Activities: Industry Practices to
Mitigate Risks, Federal Reserve Bank of New York (Oct. 1999); Technology Risk
Management: Guidance for Bankers and Examiners, OCC Bulletin 98-3
(Feb. 4, 1998); Interagency Policy Statement on the Internal Audit Function and Its
Outsourcing, FDIC FIL-133-97 (Dec. 22, 1997); Interagency Guidance on the Internal
Audit Function and Its Outsourcing, FRB SR 97-35 (SUP) (Dec. 22, 1997).
3 Bank Use of Foreign-Based Third-Party Service Providers: Risk Management
Guidance, OCC Bulletin 2002-16 (May 15, 2002) (Although the bulletin is the only
guidance by a banking agency devoted entirely to the risks of outsourcing to a
foreign vendor, other agencies have pointed to the particular issues raised by
foreign vendors in their publications. See Country Risk -Interagency Statement
on Sound Risk-Management Practices, FRRS 3-1510.1, SR-02-5 (Federal Reserve);
2002 FIL-23-2002 (FDIC) (Joint issuance from the Board of Governors of the
Federal Reserve System, OCC and FDIC (Feb. 22, 2002))).
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Bank Secrecy act and related statutes - A financial institu-
dor's continue compliance with the FCPA as a potential agent
tion’s outsourcing arrangements with a foreign vendor must
of the financial institution. The FCPA prohibits U.S. companies
be carefully designed to make sure that they do not inhibit its
and their affiliates from paying or promising to pay anything
ability to comply with U.S. laws and regulations designed to
of value to a foreign government or party official for the pur-
combat money laundering, terrorism, and criminal behavior.
pose of ‘obtaining or retaining business’.15
These laws, updated most recently by the so-called ‘USA
PATRIOT Act,’9 impose a wide variety of obligations on finan-
Proposed state outsourcing statutes
cial institutions to report certain currency transactions and
Several states, including New Jersey, Maryland, Connecticut,
‘suspicious activities,’ to perform adequate due diligence on
Missouri, Washington, and Pennsylvania, have been reported
customers of the bank, and to maintain records designed to
as considering proposing or having already proposed legisla-
enable them to promptly identify any individual or entity sus-
tion that would restrict offshore outsourcing for government
pected of terrorist activity by the government.
contracts and contractors. The significance of such legislation
with respect to financial institutions could vary greatly de-
Privacy and confidentiality - Particular attention needs to be
pending on the phrasing of any such bill that may eventually
paid to ensuring that terms are included in any outsourcing
be enacted. State bills introduced thus far have sought to
contract that adequately protect the privacy of ‘non-public
require that workers on state contracts be American citizens
personal information’ about the institution's customers11 and
or legal aliens,16 or that state procurement units be prohibited
the confidentiality of the institution's examination and other
from awarding contracts for services to contractors who
12
records given to regulatory authorities and their examiners.
would render such services from outside the country.17 As yet,
Contract provisions ensuring confidentiality of information
no state bill has made it through both legislative houses and
should prohibit a service provider from disclosing or using
been signed into law. Nonetheless, the issue is rapidly becom-
bank data or information for any purpose other than to per-
ing a political hot-button and it should be monitored by any
form its obligations under its contract. In addition, the con-
financial institution that provides banking services to state or
tract should ensure that ‘all information shared by the bank
local governments, acts as a conduit for government funds
with a foreign-based third-party service provider… remains
(e.g. welfare programs), underwrites municipal bonds, or other-
solely property of the bank’.13
wise receives revenue from state or federal governments.
The Foreign Corrupt Practices Act - In entering into an out-
Sarbanes-Oxley
sourcing arrangement with a foreign vendor, a financial insti-
The Sarbanes-Oxley Act of 2002 (‘Sarbanes-Oxley’) made
tution must be careful to ensure its own initial compliance with
sweeping changes relating to corporate governance, the regu-
14
the Foreign Corrupt Practices Act (the ‘FCPA’) and the ven-
lation of audits and audit firms, and disclosure. Sarbanes-
9 The United and Strengthening America by Providing Appropriate Tools Required to
Intercept and Obstruct Terrorism (USA Patriot Act) Act of 2001, Pub. L. No. 107-56,
115 Stat. 272 (2001).
10 See e.g., id.; The Currency and Foreign Transaction Reporting Act, 31 U.S.C. 5311530 (implemented by regulations found at 31 CFR 103.11-103.77); Bank Service
Company Act, 12 U.S.C. 1867(c) (giving regulatory agencies such as the OCC, FDIC,
and FRB authority to examine and regulate the functions or operations performed
or provided by third-party servicers to the same extent as if they were performed
by the bank itself on its own premises); USA Patriot Act § 319 (‘The 120-hour Rule’
– which requires financial institutions to make information on anti-money
laundering compliance by the bank or its customers available within 120 hours of
a government request).
11 Gramm-Leach-Bliley Act of 1999, §501(b), 15 USC 6801, et seq.
12 Right to Financial Privacy Act of 1978, 12 U.S.C. 3401, et seq.
13 Bank Use of Foreign-Based Third-Party Service Providers: Risk Management
Guidance, OCC Bulletin 2002-16 (May 15, 2002).
14 Foreign Corrupt Practices Act of 1977, 15 U.S.C. §§ 78dd-1, et seq.
15 Id. at 78dd-1.
16 H.R. 644, LCO No. 2065, January Session (Conn. 2003);
S1349, 210th Leg. (N.J. 2002).
17 H.R. 176, Regular Session (Md. 2003).
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Oxley generally applies to any company, including a bank or
nies to certify periodic reports filed with the SEC.20 Sarbanes-
bank holding company, that has registered securities or files
Oxley also requires certification as to internal controls estab-
periodic reports under the Securities Exchange Act of 1934
lished and maintained to ensure that material information is
(the ‘Exchange Act’). The details of how Sarbanes-Oxley will
made known to such officers. The SEC rules require the certi-
affect public companies and their executive officers and direc-
fying officers to make a series of representations concerning
tors will become clearer over time as the SEC issues releases
‘disclosure controls and procedures, a newly-defined concept
and practice in this area develops. Sarbanes-Oxley, however,
referring to controls and other procedures of a company
will likely have important implications for the outsourcing and
designed to ensure both the quality of the information con-
services marketplace, as well as to the systems and processes
tained in its Exchange Act reports and that such information
that support financial reporting functions.
is recorded, processed, summarized, and reported within the
time periods specified in the SEC's rules and forms. The SEC
One of the more significant provisions of Sarbanes-Oxley pro-
also has a new rule relating to disclosure of an internal control
hibits accounting firms from providing the following non-
report to state the responsibility for establishing and main-
auditing services to its audit clients: (i) bookkeeping or other
taining adequate internal controls and procedures for finan-
services related to accounting records or financial statements;
cial reporting purposes.21
(ii) financial information systems design and implementation;
(iii) appraisal or valuation services, fairness opinions, or con-
In response to the new certification requirements and other
tribution-in-kind reports; (iv) actuarial services; (v) internal
provisions of Sarbanes-Oxley, financial institutions should
audit outsourcing services; (vi) management functions or
review their internal procedures and third party vendor rela-
human resources; (vii) broker or dealer, investment advisor, or
tionships, including overseas vendor relationships, to ensure
investment banking services; (viii) legal services and expert
that the company can comply with the requirements of
services unrelated to an audit; and (ix) any other service that
Sarbanes-Oxley and SEC rules. This review should include an
18
the Public Company Accounting Oversight Board prohibits.
assessment of the IT and related systems to ensure that the
Under Sarbanes-Oxley, accounting firms will be allowed to pro-
systems have the capability to respond to the requirements of
vide other non-auditing services to an audit client only if the
Sarbanes-Oxley, including the requirements related to the col-
company's audit committee approves the transaction.
lection of information and preparation of reports. If any of
these functions are performed by a third party, this review
The SEC rules prohibit accounting firms from providing any
should include an assessment of the capabilities of the third
services related to their audit clients’ hardware or software
party vendor and the relevant obligations of the third party
systems that aggregate source data or generate information
under its service agreement. The vendors under outsourcing
that is reasonably likely to be material to their financial state-
arrangements should also be required to provide services and
ments. The SEC rules also set forth transition time frames for
have systems that will meet the applicable disclosure and
the unwinding of existing transactions that are now prohibited
other requirements imposed under Sarbanes-Oxley.
under the Act.19 The prohibition on providing non-audit services will have obvious implications to public companies, which
Other contractual protections
will no longer be able to receive these non-auditing services
In addition to the foregoing regulatory considerations, a finan-
from their accounting audit firms generally and will have to
cial institution should build into its overseas outsourcing con-
seek alternative service providers.
tract other appropriate protections. As a threshold matter, the
institution should first determine whether its proposed off-
78
Two sections of Sarbanes-Oxley impose a continuing obliga-
shore projects are even suitable for overseas work; not all
tion on the CEO and CFO of Exchange Act reporting compa-
services can be, or should be, sourced internationally. This is
18 Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, 116 Stat. 745, 771-72 (2002).
19 S.E.C. - Standards Relating to Listed Company Audit Committees,
17 C.F.R. § 240.10A-3 (2003).
20 Sarbanes-Oxley Act of 2002, 116 Stat. at 777, 806.
21 S.E.C. - Management’s Report on Internal Control Over Financial Reporting and
Certification of Disclosure in Exchange Act Periodic Reports, 17 C.F.R. §§ 210, 228,
229, 240, 249, 270, 274 (2003).
JOURNAL 8 -v3
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particularly true in the case of services that may involve core
sourcing engagement can have especially valuable commer-
business processes or that require a particular industry
cial applications. The agreements should clearly delineate the
expertise. In these cases, the cost savings achieved through
allocation of IP rights between the financial institution and
offshore development could well be outweighed by the added
overseas vendor. Most customers will take the position that
complexity of managing a foreign-based vendor. For this rea-
they should own all IP rights in the work product since they are
son, many financial institutions should continue to rely on U.S.
typically the party that finances the development. A vendor
companies to serve their mission critical needs. Those cus-
will often, at least in the initial stages of negotiation, argue
tomers who have gone overseas for mission-critical services
that it should own some of the IP rights so that it can apply
have sometimes addressed confidentiality and other consider-
new developments to its other client relationships. How IP
ations by separating their projects into discrete parts: either
rights end up being allocated among the parties is a matter to
requiring the vendor to assign separate teams to work inde-
be negotiated.
pendently or using multiple vendors. In this way, customers
have been able to reduce the risk that any single vendor or
It is important in the consideration of overseas outsourcing
employee would gain access to sensitive information regarding
transactions by financial institutions to understand how IP
an overall project or services. It should be noted, however, that
rights are allocated under local foreign law. For example, we
this approach will generally create inefficiencies and result in
have been advised in past transactions by Indian counsel, that,
an overall increase in the costs of procuring the services.
under Indian law, in the absence of contractual language to
the contrary, there is an automatic assignment of copyright
Key contract terms
rights by employees to their employers. This assignment, how-
Form of contract - A financial services customer may want to
ever, does not extend to the work of independent contractors.
consider entering into a master agreement with the vendor
Also, no automatic assignment in India of intellectual property
that would establish the overall terms and conditions that
rights exists in respect of patent rights or inventions by either
would govern the vendor’s provision of multiple services to
employees or independent contractors.
the customer over a period of time. One of the benefits of
negotiating a master agreement is that it will save the financial
To ensure that the work product and other IP developed by a
institution the time and expense of negotiating a new agree-
vendor are owned by the financial institution customer, regard-
ment for each project or service. Any such agreement must be
less of the applicable local law, the agreement between the
flexible enough to accommodate changing needs over time.
parties should have a clear grant and assignment of ownership providing that all work product, inventions, and other IP
Regardless of the contractual framework a financial institution
developed under the agreement will be owned by the cus-
chooses, the outsourcing contract will have to address core
tomer and that the customer has all right, title, and interest
issues such as the price for the services, performance require-
(including patent rights) to such materials. The agreement
ments, acceptance testing, liability allocation, indemnification
should also mandate that the vendor cause each of its employ-
for IP infringement, and the like. A number of additional issues
ees, agents, and contractors to execute a similar assignment
raise unique concerns in any overseas arrangement, a few of
of rights. These assignments should be executed prior to the
the more important of which are the following:
commencement of the performance of any services on behalf
of the financial institution.
Intellectual property rights - One of the more important
issues in any overseas outsourcing agreement is ensuring the
Services and service level agreements - Any properly con-
proper protection of the financial institution’s intellectual
structed outsourcing arrangement should contain a detailed
property rights. IP rights developed in a business process out-
description of the services and service levels, along with
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mechanisms to provide for the adjustment of service levels
ment should also mandate that the vendor cause each of its
over time. The financial institution should also consider having
employees, agents, and contractors to execute similar non-dis-
specific performance credits tied to the failure to achieve
closure agreements.
service levels in order to create the proper incentives for perThe financial institution customer may also want to consider
formance.
requiring the vendor to segregate physically the individuals
The agreement should also include a clearly defined delivery
performing services on behalf of the customer from the rest
schedule for the various vendor deliverables. If a delivery date
of the vendor’s staff. Physical segregation may include providing
is missed by the vendor due to the vendor’s fault by more than
a separate walled off space within the vendor’s facility with
an agreed period of time, the agreement should require that a
controlled access available only to those individuals providing
senior representative of the vendor justify the reasons for the
services on behalf of the customer. If such a physical segrega-
delay and how it will be rectified. The agreement should also
tion is not practicable, the financial institution customer may
include provisions that tie payment of the fees to achievement
consider requiring dedicated workstations with password pro-
of specific milestones.
tection for the individuals providing services on behalf of the
customer.
Choice of law - We strongly advise that any agreement be
governed by U.S. law. However, in the absence of significant
Vendor contacts - It is important to the success of an offshore
domestic assets or operations of a vendor, the financial insti-
agreement to identify a primary vendor contact person who is
tution customer may have difficulty establishing personal
acceptable to the financial institution. Ideally, the contact
jurisdiction over the vendor. Moreover, even if personal juris-
should be based in the United States, but also have a clear
diction can be established, the customer could face practical
channel of communication and authority to the foreign
difficulties in enforcing judgments. If the financial institution
provider. This contact should be in a position to play a vital role
has to pursue a vendor overseas, it should be aware that in
on the customer’s behalf in the event that any issues arise
some instances, foreign courts may not enforce a domestic
with respect to the vendor’s performance of its obligations
judgment without a separate action being brought in the foreign
under the agreement.
jurisdiction.
Covenant of non-competition - It is often the case in domestic
Agent for process - The financial institution customer should
agreements that customers will seek a limitation on the ven-
also include a provision in its agreement that establishes an
dor’s and its employee’s ability to perform similar services for
agent for service of process. Generally, such a provision pro-
a competitor of the financial institution. The enforceability of
vides that the vendor will consent to service of process from
such limitations in the United States varies from state to state
certain designated courts by registered or certified mail at a
and is often dependent on whether the scope and duration of
designated address. This eliminates the need for the financial
the limitation is reasonable. One of the more important reasons
institution customer to track down a vendor in the event of a
to choose U.S. law to govern the agreement is that under cer-
dispute, which could be especially difficult in certain countries.
tain foreign jurisdictions these limitations may be unenforceable.
Confidentiality/Segregation - The outsourcing agreement
80 - The
should clearly define what information constitutes confiden-
Audit rights - As discussed above, the financial institution
tial information and, as discussed above, only permit the use
customer should also consider including in the agreement an
of a party’s confidential information for the narrow purpose of
audit provision that permits the customer to conduct audits of
the service engagement. Moreover, the outsourcing agree-
the vendor sites to ensure compliance with the terms of the
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agreement. In particular, a customer would likely wish to confirm the vendor’s compliance with obligations relating to physical segregation, quality assurance, data security, business
interruption, and applicable law.
Performance bond - In the event that a vendor selected by a
financial institution has a limited history in the United States,
the financial institution customer may consider requiring the
vendor to post a performance bond to secure the vendor’s
performance obligations with respect to specific obligations
under the agreement. The amount of such performance bonds
normally range from 10 to 25 percent of the fees payable by
the customer in respect of the applicable deliverable. The performance bond would typically be released upon delivery or
acceptance of the applicable deliverable.
Termination - In addition to other standard termination rights,
the financial institution should consider including a termination right in the event that there is a change in the control of
the vendor. Such a termination right is particularly relevant
given the ever changing corporate landscape for overseas
technology and other service companies.
Conclusion
The foregoing is only a summary of certain significant regulatory and contractual issues that typically arise in connection
with offshore outsourcing transactions. As U.S. financial institutions continue to look overseas to outsource services, they
would be well-advised to continue to monitor regulatory developments and to protect themselves by addressing the issues
discussed in this article when negotiating their transactions.
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Implication
Hoofdtiteltje
Offshoring:
Not just for the
first movers1
Tussentiteltje
Bodycopy bodycopy bodycopy bodycopy
bodycopy Gupta
bodycopy
Suresh
bodycopy bodycopy bodycopy bodycopy bodycopy
bodycopy
Partner,
Capco
bodycopy bodycopy bodycopy bodycopy
bodycopy
bodycopy
Lilach
Nachum
Associate Professor of International Business
and Management,
Baruch College, City University of New York
Abstract
This articles reports the findings of the 2003 Offshoring survey that was conducted in order to identify key trends and
best practices, including how companies made offshore sourcing decisions and how they planned to handle potentially
explosive issues around jobs displacement, community relations, protectionist ‘backlash’ against offshoring, and workers’
retraining/skills development, etc. Thirty-eight firms from
North America and Europe participated in the survey.
1
I would like to thank Andrea Lowe for the excellent work she did in editing this
article. All remaining errors remain the sole responsibility of the author.
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The results of the ‘2003 Best Practices in Offshoring Survey’
from their client base as a result of offshoring, at least two
confirm the high satisfaction levels among companies moving
respondents reported that managing public relations was
the IT and business processing work offshore, as well as their
increasingly becoming a top management focus because of the
commitment to further offshoring. These results further rein-
negative press coverage regarding their offshoring initiatives.
force the findings of the ‘2002 Best Practices of Leaders in
Offshoring Survey’.2 Of particular interest in the 2003 survey
Survey population
is the evidence that followers, as well as pioneers, have
The survey, conducted by the Weissman Center for Interna-
derived substantial benefits from offshoring. Those now trying
tional Business at Baruch College and The Paaras Group (TPG),
offshoring are able to access, and to learn from, vendors who
provides in-depth case studies of 38 companies (30 North
have risen to the high expectations of pioneering American
American and 8 European), a large proportion (64%) of which
and European companies. Indeed, many companies are
were banks and other financial services companies. More than
importing the faster process mechanisms and better docu-
half were global firms with revenues in excess of U.S.$5 billion.
mentation standards learned from offshore vendors (many of
the IT vendors are CMM5) in their onshore operations. The
It is worth noting that although the term ‘offshoring‘3 may be
fear that latecomers would find skill shortages or rising wages
new, many companies have had work done offshore, in the IT
when they go offshore has not been borne out in practice
area in particular, for as long as 12 years. What is new is the
because of the global economic conditions. However, the bar
rapid growth in offshoring of business processing and contact
is being raised as U.S./European wages drop, so offshore must
centers. This year’s survey indicates the following rates of
continue to offer a substantial differential in both cost and
adoption of offshoring in the three areas: IT at 85%, OBP at
quality. Additionally, almost all companies in our survey are
40%, and contact centers at 36%. However, in addition, 44%
benefiting from increased experience in handling knowledge
and 20% of the respondents are at the beginning stages of
transfer and transition issues associated with implementing
contact center offshoring (actively ‘considering’ and planning)
offshoring solutions. The leaders in offshoring, however, are
and OBP offshoring respectively. The survey indicates that
no longer focused solely on seeking offshore sourcing – they
while OBP and contact centers offshoring is relatively more
have graduated to embrace a broader model of ‘global’ or
recent, some firms have gained as much as five years experi-
‘smart’ sourcing. In this model, they employ multi-location,
ence under their belt (Table 1).
multi-vendor, and both ‘in-house’ as well as outsourced solutions for IT and business processing.
Years of
IT Offshoring
Years of
Contact
Centers
Offshoring
Years of
OBP
Offshoring
20%
Change management is beginning to receive the focus it
deserves. A majority of the survey respondents cited program
management as a key variable in ensuring success in offshoring – those without adequate program management
Beginners
5%
44%
structures reported ‘mixed’ results from their pilot programs.
1-2 years
32%
33%
50%
Also, while a large number of firms were able to handle job dis-
3-5 years
36%
22%
20%
placement issues through reduction in the number of contract
6+ years
27%
10%
employees or through attrition, many others employed a variety
of different techniques, including granting generous sever-
Table 1: Years of offshoring experience
ance packages, providing opportunities for re-training and
redeployment, and implementing intense communication programs. Finally, while no firm reported experiencing backlash
84
2 Gupta, S. et al, ‘Best Practices of Leaders in Offshoring:
2002 Best Practices Survey’, PwC Consulting.
3 ‘Offshoring’ refers to the movement of white-collar work to offshore destinations,
whether through wholly-owned (captive) offshore centers, a joint venture/ hybrid
arrangement with an offshore vendor, or third party outsourcing to offshore vendors.
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KEY NUMBERS IN OFFSHORING
In a major way
Somewhat
Total
SATISFIED with offshoring
43%
+
46%
=
89%
Offshoring has GROWN
63%
+
32%
=
93%
Plan to INCREASE offshoring
65%
+
24%
=
89%
QUALITY has improved
23%
+
38%
=
61%
The results indicate continued momentum…
The offshore satisfaction levels remain high, at 89% (43%
offshoring because of unrealized expectations or poor results.
extremely satisfied, 46% somewhat satisfied), which is slightly
In spite of geopolitical concerns among the survey partici-
below the lofty 94% level in 2002, but still a resounding
pants, many view offshoring as a way to manage risk through
endorsement of success. In every case, among the 11% report-
geographical diversification and as another avenue for their
ing ‘mixed’ experience in 2003, the respondents attributed the
business continuity planning.
lack of total success to inadequate transition management:
‘they were ill prepared for the level of effort required during
the initial launch,’ ‘they did a poor job of knowledge transfer to
Today’s economic downturn has had some interesting
the vendor,’ ‘the program managers lacked experience in man-
impacts on the current trend toward offshoring – the gap
aging globally dispersed teams,’ or ‘the top management was
between ‘onshore’ and ‘offshore’ rates appears to have
not fully committed to see it through,’ etc. Nevertheless, in
shrunk dramatically. A small number of participants reported
each case the respondents cited ‘success’ in the next ‘go-round.’
that they were able to get very attractive ‘onshore’ rates,
e.g., U.S.$55-60 an hour for some of the applications development work. In such cases, they chose not to offshore,
0%
20%
40%
60%
80%
100%
particularly if the project was small.
Grown Somewhat/
Significantly
Almost all respondents are scaling up future plans for offshoring. Two-thirds (65%) indicate they would significantly
Remained about
the same
increase their future plans for offshoring, which is higher than
the figure onbtained from the 2002 study, around 58%. 24%
Reduced
2002
will slightly increase their offshoring efforts and 8% maintain
2003
status quo. One company is pulling back from offshoring
because of business retrenchment and changed focus of the
Figure 1: Evolution of offshore initiatives
company.
Equally impressive is the growth of offshoring in 2003: nearly
Clearly, cost savings that can be achieved through offshoring
two-thirds (63%) of respondents say offshore initiatives have
has been a major impetus for its growth, but the growth is also
‘grown significantly’ and 95% indicate overall growth (Figure 1).
fueled by the fact that firms are able to improve quality while
Not a single respondent indicated that they planned to reduce
cutting costs (Figure 3). Almost half (48% in 2003, almost
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0%
10%
20%
30%
40%
50%
quality as the key drivers, and over half go through the procedure of a well-documented and well-thought-out business
9%
0-10%
case. For 41% a key driver is access to skills that are either rare
19%
or more expensive in their local area. Almost a third of the participants utilize offshoring to exploit the potential 24/7 win-
42%
11-30%
dow certain offshore locations like India offer for applications
33%
development or offshore business processing.
40%
31-50%
38%
9%
>50%
0%
2002
10%
20%
40%
60%
identical to 2002) indicate savings in excess of 30%.4 A majority
of the respondents (61%) reported improvements in quality
(23% significant improvement, 38% somewhat), with 39%
finding quality unchanged. As a contrast, in 2002 seven per-
92%
51%
Improving
quality
41%
Accessing skilled
resources
41%
Reducing
cycle time
63%
32%
32%
cent had reported deterioration in quality (relating to teething
pains with contact centers). Presumably, the firms and the
100%
94%
Saving cost
2003
Figure 2: Cost savings realized
80%
2002
2003
Figure 4: What drives offshoring?
vendors are following more mature approaches in ensuring
that offshoring is carried out appropriately.
IT continuing while OBP rises
0%
10%
20%
30%
40%
50%
Fully, 100% of firms had offshored IT development work and a
whopping 90% offshore maintenance work. Offshoring sys-
27%
Significant
improvement
tems work is on the rise; 35% have sent systems management
23%
responsibilities offshore (up from 24% in 2002). The notice41%
Some
improvement
able change in this year’s survey is the rise of Offshoring business processing and contact center work, especially in the
38%
functional areas of finance/accounting, transaction processing
(i.e. credit card processing and claims processing), data/cus-
25%
Unchanged
39%
tomer order entry, customer service, collection, and
sales/marketing. Interestingly, some firms see this as an ‘out-
Somewhat
decreased
7%
2002
reach effort’ and are deferring pursuing and expanding these
2003
components of their business until the economy gains more
Figure 3: Degree of quality improvement
86
momentum, so better times may bring additional impetus to
the OBP area.
It is enlightening to see the motivators for moving offshore
Although only 36% of the respondents are currently off-
(Figure 4). As expected 92% cite cost savings and 41% cite
shoring contact centers, 44% are actively considering off-
4 For most newcomers, start-up costs keep true cost savings from being revealed
until Year 2 or later, but a few respondents in our survey indicated that they were
able to achieve break-even in Year 1 by carefully timing their offshore initiatives.
JOURNAL 8 -v3
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shoring or are pilot testing it; thus we expect a notable short-
0%
20%
term rise in the number of firms moving seats to foreign locations. Current contact center work leans toward inbound
40%
60%
100%
20%
Australia
sales/service (57%), with 43% conducting outbound contact
4%
OBP
center work. Almost a third of respondents (29%) have offshore web support (telephone/internet help desks).
80%
Contact Center
Singapore
9%
Looking at OBP (excluding contact centers), 38% of partici-
IT
10%
China
pants are offshoring business processes, primarily transaction
9%
processing (78%), finance and accounting (33%), and data
entry 33%.
Eastern Europe
4%
Offshoring locations
10%
Malaysia
20%
4%
India is clearly the leader in terms of offshore locations.
Spain
However, other parts of the world, such as the Philippines,
20%
4%
25%
Ireland, Eastern Europe, Latin and South America, are
rapidly catching up as firms begin to look for alternative
Ireland
5%
locations to take advantage of time differences and mitigate geopolitical risks.
5%
Philippines
20%
17%
India remains the favorite destination for offshoring IT and
Central and South
America
10%
40%
13%
business processes, although other locations are becoming
90%
increasingly popular as companies seek to diversify risk and
meet other specific needs.
India continues to dominate IT services offshoring: 91% of the
participants use India for offshoring IT services, taking advan-
India
80%
91%
Figure 5: Offshoring locations
tage of the country’s political stability, educated/certified labor
pool, language skills, and strong industry presence (Figure 5).
Jury still out on business models...
According to some of our participants, the cost-quality value
While for IT, third-party outsourcing is still the offshore
proposition of India is unmatched by any other country. In con-
method of choice, in other areas the option of companies set-
trast to generally reported numbers, our survey, which includ-
ting up their own offshore centers is growing in popularity.
ed a number of American firms with Hispanic clients, had
This is noticeable in OBP (30% ‘ownership’) and contact cen-
Central and South America (particularly Panama, Argentina,
ters (25% ‘ownership’). Partially, it may reflect concerns about
Brazil, and Guatemala) as their second most popular contact
the maturity and domain experience of vendors, and possibly
center location (after India); these contact centers would have
corporate culture. Only a small number have set up joint ven-
both Spanish and English-speaking CSRs. Intriguingly, it is not
tures, although many companies have a variety of models in
just south of the U.S. border; Spain is also being used for
place, perhaps reflecting different activities, but also giving
Spanish-speaking contact centers for U.S. clients).
them an opportunity to experiment as they strive to find the
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perfect balance between ownership and outsourcing (Table 2).
Helping to ensure success
The vast majority (85%) in 2003 judge their launches a suc-
As one would expect, newcomers to offshoring display a
cess, but they acknowledge major challenges.
strong preference for using those third-party providers who
have had experience in working with large North American
0%
20%
40%
60%
80%
and European firms. The newcomer companies are benefiting
from the track record of success established by the pioneers
and their vendors. These vendors can invest in highly skilled
people to provide good quality work and have strong project
management skills. Additionally, many of these vendors pro-
64%
Knowledge
transfer
76%
63%
Internal
commitment
76%
vide risk mitigation within their firms with sister locations and
centers of excellence both within their home country and in
other up-and-coming offshore locations. Accordingly, many
38%
Project
management
65%
newcomers expressed a bias for hiring leading IT vendors for
offshoring not just IT but OBP and contact center work as well.
Total (%)
IT (%)
CC (%)
OBP (%)
Outsource
41
45
25
50
JV
10
9
13
10
Ownership
20
14
25
30
Combination
29
32
37
10
Quality
NA
2002
52%
35%
Job elimination/
resource redeployment
Infrastructure
2003
50%
24%
48%
Figure 6: Significant challenges in launch
Table 2: Offshoring business models (of participants)
Knowledge transfer and internal commitment continue as the
most significant challenges (Figure 6). In addition, project
The leaders in offshoring prefer to use the term global
management is emerging as the next big hurdle in the off-
sourcing: they use a blend of on-shore, near-shore, and off-
shoring journey. Finally, as one would expect, issues around
shore sourcing models, as they strive to find the perfect
jobs elimination and resource deployment received increased
balance between the risks and rewards of various sourcing
attention by the respondents. It is crucial to get senior man-
alternatives. 10% of the surveyed companies have moved
agement commitment to offshoring, but it is also important to
beyond the often sought benefits of cost savings or quality
inform and motivate all those involved and affected. The 2003
improvement. In using global sourcing, they identify what
survey, coming at a time of heightened anxiety everywhere
they can do best and what they may be lacking, what loca-
about job security, picked up increased internal concerns
tion and/or what vendor partner could help fill in the gap.
regarding ‘lack of knowledge about their new job roles’, and
For these firms, offshoring is merely one element of global
fear of the unknown. It helps if employees have answers to
sourcing.
‘What’s in it for me?’ before asking them to go the extra mile
in making the offshore initiative a success.
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Successful offshoring companies have also given utmost prioPotential displacement of existing employees when firms
rity to gaining commitment from the top executives of the
launch offshore initiatives does not appear to have become
company. Once C-level buy-in is achieved, it becomes relatively
a huge HR issue yet. When offshoring IT activities, with a
easy to convince the staff down the line. Intriguingly, ‘past
few exceptions, most firms reported that they were able to
experience of top management’ was mentioned as a key
shrink their onshore staff either by reducing the number of
change agent for facilitating offshoring by a number of com-
consultants/contract employees or through attrition. To
panies. These individuals, whom we will dub ‘Offshore
some extent, it might reflect the fact that while many firms
Champions’ use their prior experience of offshoring as a way
have used offshore sourcing for as many as 5-10 years, bar-
for a ‘quick win’ (and continuing success) with their new
ring some well publicized examples of pioneers, a majority
employer (and indeed, their prior offshoring experience may
of the firms are still in the ‘growth’ stage of offshoring –
have been a reason for their hire).
they are increasing their level of offshoring but they have
not yet reached a point where they have had to lay off hun-
Two-thirds (67%) of the survey participants stressed the
dreds of employees within a short time frame.
importance of a well-structured communications program for
successful offshoring. Most companies address employeerelated obstacles and knowledge transfer by conducting train-
Managing change and risks of offshoring
ing programs for staff, holding team-building sessions, and
How do the successful firms handle the key challenges of
educating staff about the benefits (and in these times, the
knowledge transfer, internal commitment, jobs displacement,
necessities) of offshoring. They regularly and repeatedly com-
uncertainty, and the common risks of offshoring?
municate issues among groups and solicit feedback to teams
in order to boost team morale and improve performance.
According to a majority (85%) of our respondents, a project
Some firms go so far as to enlist outside academic help to
management office (PMO) is the foundation for success in off-
design training programs using internal and external case
shoring. It acts as a gateway for managing all offshore activi-
studies to address outsourcing and offshoring issues. A
ties by planning and monitoring the overall initiative. Some
reminder of current economic realities, while providing career
favor a centralized PMO with dedicated manager/staff for
development opportunities for staff to move up the value
managing all offshore activities, including coordination
chain, helps too. As one respondent stated, ‘responsibility for
between management/project managers and offshore ven-
success does not depend on the offshore team alone, but on
dors. For others the PMO is an oversight role: coordinating off-
the vertical and horizontal program leaders.’
shore activities including vendor selection, vendor visits, and
risk management, while the work itself is managed by the indi-
The approach to job displacements runs the spectrum. Some
vidual business unit project managers. Still others choose not
firms are bending over backwards to help FTEs (full-time
to have a centralized PMO and have lines of business and proj-
employees) by providing employee retraining programs and
ect managers manage the offshore activities, but usually form
offering better severance packages. Others, especially in the
a committee to share offshoring information. Offshore teams
banking sector with lean HR departments, do not mollycoddle
are treated as an extension of onshore teams/divisions.
employees and expect all within the firm to realize the
inevitability of job displacements.
Offshoring champions are the key to mature and
A few (10%) companies have treated change management as
successful pursuit of offshoring
a separate project in itself. They have assigned managers from
The success of offshoring initiatives can often be tracked to
their human resources departments to manage the project.
top executives, usually at the ‘C’ level, who are passionate
Employees are encouraged to constantly ask what, why, when,
about offshoring and in many cases, have had experience
and how, etc. in order clarify issues as and when they arise. As
of offshoring from a previous job...’
one respondent stated, ‘we have to handle issues culturally
and philosophically’.
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0%
20%
40%
60%
80%
100%
■ There are benefits to having captive offshore development
centers (ODCs) in addition to the vendor option, for example
Multiple locations
Improving quality
assurance
processes
37%
to move from onshore to ODC, then outsourcing lower
35%
process work to local vendors.
■ Upgrade IT governance; have more control on IT site.
68%
■ Maximize training of own staff to smooth transition.
38%
2002
Vendor process
audits
36%
2003
43%
Communication
and change
management
Program
management
■ Do more team building and formal change management
programs.
■ Dedicate more time in choosing right blend of
onshore/offshore talent.
68%
■ Infrastructure is costly; offshoring infrastructure
67%
projects will increase.
80%
86%
Conclusions
As discussed at the beginning, 89% of respondents intend to
Figure 7: Important risk mitigation factors
increase their offshoring plans, 65% significantly. In 2003, no
respondents describe themselves as dissatisfied, although 11%
Firms also differ dramatically in how big a bite they take of off-
said their experience had been mixed, primarily because of
shoring. For many, particularly in this sample, they start with
inadequacy of their program management processes: insuffi-
small pilots to win internal commitment and develop guide-
cient upfront planning for transition, weak offshore gover-
lines and experience, before moving on to more complex pro-
nance structure, and lack of trained personnel for managing
jects. Others are more ambitious, sometimes getting assis-
offshore activities.
tance from vendors in determining what is suitable to offshore, but never exceeding pre-established resource splits
The satisfaction numbers with offshoring in all its aspects are
(e.g. 50/50 onshore/offshore). This split also helps lessen
outstandingly high. Even as economic conditions change, off-
onshore paranoia about offshoring taking over, and provides
shoring continues to offer the solution. Additionally, individuals
more onshore managerial jobs in technical areas (Figure 7).
with prior experience of offshoring are speeding up penetration of offshoring in American and European companies.
Many of the offshoring pioneers are now in fact ‘global sourcing’,
which gives them maximum opportunities for cost saving and
Meanwhile, this success has not gone unnoticed offshore. It is
extreme flexibility, should disaster strike - or if a change in
attracting scores of opportunists to set themselves up as ven-
business strategy requires a U-turn. A number of these pio-
dors seeking foreign business. Therefore, due diligence has
neers set up their own offshore development centers (ODC)
become a dire necessity more than ever before. This is
mirroring their domestic high standards, consistency, and
particularly true for financial services firms where vendor
security. This is particularly true in newer activities, such as
incompetence or misuse of customer data (by accident or
contact centers and higher-end business processes, where
design) could have devastating effects on their business and
there is concern about the financial strength and domain
reputation.
expertise of vendors.
The best vendors, which have worked so hard to achieve their
90 - The
Some of the ‘benefits of hindsight’ our respondents wished to
reputation, should be commended for raising performance
share are listed below:
levels of the outsourcing industry – their offshore perform-
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ance is beginning to influence onshore vendors as well.
However, even experienced vendors are not resting on their
■ Many view offshoring as an irreversible process and
a necessity for growth and cutting cost.
laurels; they face many challenges in addition to new competitors and locations. They are finding their negotiations with
Establish a clearly defined offshoring strategy that fits
existing and new customers tough, as those firms seek to drive
your needs
down their costs (flaunting other alternatives and citing drop-
■ Getting commitment from the top management/key
ping wage rates). In activities such as contact centers, where
scale is important, vendors may be taking on uneconomic
business. As vendor margins are pushed, they cannot invest in
infrastructure upgrades and may be tempted to take short
cuts. It would be tragic, but perhaps inevitable, that a major
business failure may occur in offshoring and that inflating
expectations may be brought down to earth. Now is not the
time to cut corners on employing Best Practices in Offshoring,
highlights of which are provided in Appendix 1.
decision makers is crucial.
■ Do as much research upfront and establish a
clearly defined offshore strategy.
■ Seek outside advice and establish a clearly defined
offshoring strategy with buy-in from all the stakeholders.
■ Consider near-shore options too while defining the
offshoring strategy.
■ Get executives and the project managers to travel to
the potential offshoring locations to have a good
understanding of the partner’s facilities and capabilities.
The current era of belt-tightening adds even more impetus to
‘saving cost,’ as the overwhelming reason for offshoring,
Establish offshore program management office
although respondents make clear that this assumes at least
■ Establish PMO for managing offshore initiatives,
equivalent quality, and 41% list ‘improving quality’ as a driver.
reporting to a senior executive.
■ Set-up strong governance models, including a clear
Finally, there is increasing evidence that the term ‘offshoring’
structure and guidelines for managing offshore initiatives.
may soon be passé - the leaders in offshoring, almost all of
■ Set and manage expectations from the beginning.
whom are global companies, are pursuing a ‘global sourcing’
■ Establish company standard procedures for identifying
strategy that encapsulates a relentless pursuit of ‘low cost,
projects/tasks for offshoring to vendors as well as own
high quality’ locations around the globe. This gives them
offshore captive centers.
resilience and the assurance that they will not be held hostage
to skill shortages/wage increases in any one location.
Establish a strategy for vendor and country selection
■ Explore all potential locations, including near-shore, and
Appendix 1 - Recommended best practices
In this section, we list best practices based on the 2003 and
2002 surveys for achieving success in offshoring. We have
short-list those that are most suitable for your business
needs.
■ Depending on the scale of your offshoring requirements,
highlighted mainly those areas where there are significant
define the size, capabilities, and the number of vendors
differences in respondents’ approaches, or dramatic changes
required.
from 2002.
■ If the size of the offshore initiatives is small, particularly
for small and midsize companies, limit the number of
Consider offshoring as a strategic initiative
vendors to two. If the size of offshore is initiatives is
■ View and establish offshoring as a company strategic initiative.
expected to grow requiring large number of offshore
■ Establish offshoring as one of the options to be considered
resources, consider three to five vendors depending on the
for any future initiatives in the company and make it a part
number of locations preferred.
of company standard procedures.
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Manage risk
Have a strategy for expanding the offshoring initiatives
■ Consider choosing more than one location to mitigate
■ Consider establishing own captive centers to retain the
geopolitical risks as well as any site-specific disruptions.
■ If considering only one vendor, consider the vendor that
has presence in multiple locations/countries.
■ Make sure that disaster recovery process and procedures
are in place, including clearly defined roles and
responsibilities.
■ Establish network and data security rules and perform
regular audits to make sure that they are strictly adhered to.
■ Have clearly defined statement of work and service level
agreements, including clearly defined rules and
responsibilities and performance measures.
■ Start with a clearly defined plan and scope of work for
offshoring, but start with a small and manageable pilot
with clear requirements, deliverables, and expectations.
Manage change
■ Have a clearly defined plan with dedicated program
managers identified for managing change, before
launching any offshore initiatives.
■ Start small to manage change effectively.
■ Have a communication plan and communicate frequently
with all the stakeholders in the company, and the press
whenever it is essential.
■ Have training courses both for own and the vendor
staff regarding the culture and language differences,
offshoring process, and goals.
■ Establish team building programs between the
vendor/offshore team and the company staff.
■ Let the staff know what you are planning to do and why
you are doing so that the expectations are clear between
management and staff.
■ If planning to replace staff, first consider replacing thirdparty staff and consultants before replacing own staff.
■ Plan offshoring new initiatives versus existing work to
minimize change management issues.
92 - The
knowledge base and also for offshoring any proprietary
and confidential functions/tasks.
■ Invest in training and development of onshore staff so that
they are better prepared and motivated to deal with
offshoring initiatives.
■ Create incentive structure for promoting offshoring and
cutting cost.
■ Involve second tier managers too in the planning and
decision making process.
■ Make all the stakeholders, including the second-tier
managers, visit the offshoring facilities to have a better
understanding of the offshore facilities and the team.
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Potential
More than offshoring:
SmartSourcing
Discovering the endgame
in the offshore debate
Outsourcing helps improve your
firm’s performances - or does it?
Funding transformational change
through offshoring
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Potential
More than offshoring:
SmartSourcing
Michael Baldwin
Chief Information Officer, Global Markets and
Corporate Finance, Deutsche Bank AG
Abstract
Many financial services firms are embracing diversified sourcing of their IT and operations activities, which can provide
lower and variable costs (up and down), improved quality, and
flexibility, both in current conditions and emergency situations. While many firms are approaching sourcing incrementally, Deutsche Bank is pursuing a holistic approach, termed
SmartSourcing, which examines all sourcing options – and
their implications – rigorously in one go. Deutsche Bank’s corporate culture, with its strong linkages between people, processes, and performance, is also ensuring that SmartSourcing
is accompanied by a major upskilling of its workforce through
re-training and enhancements to its hiring processes. To
implement SmartSourcing effectively brings many challenges
and requires new skills, which will be discussed in this paper.
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In 2000, following five years of significant growth and spiral-
doesn’t seem possible, it probably isn’t. The only question
ing costs, Deutsche Bank began a major reorganization of its
is when and whom the pain will hit. Both vendor and buyer
IT and operations functions and radically altered its struc-
must be able to achieve value for the lifetime of the contract.
tures, processes, and values, as explored in sixth issue of this
journal: ‘2001: A transformation odyssey’ by Mitchel Lenson.
Understanding the nature of the task
Throughout this transformation Deutsche Bank Global
Deutsche Bank differs from many financial services firms in
Technology and Operations (GTO) identified four clear goals:
keeping central GTO staff to a minimum, and making most of
them part of line management teams. The execution energy
■ Consistently high client satisfaction
for SmartSourcing is thus coming from line managers, who
■ Best-in-class cost performance
perceive it as a way to maximize the value they can bring to
■ Scalable and resilient capability
the firm in terms of costs, capabilities, and quality. There is,
■ Risk-weighted control.
however, a full-time SmartSourcing project management office
(PMO) that acts as a consultant and advisor, serving as a
In the last twelve months, SmartSourcing has emerged as a
repository of vendor information, and assimilating Deutsche
key mechanism for achieving and maintaining these goals.
Bank’s experience to provide guidance in investigating Smart-
SmartSourcing seeks to provide a holistic approach to sourc-
Sourcing projects and in maintaining vendor relationships.
ing the human resource, software, and physical capabilities
needed to run Deutsche Bank’s business infrastructure. This
The starting point of any SmartSourcing is an internal review
paper focuses on the strategic logic and transition manage-
to probe the nature of the business activity and processes. The
ment questions arising from SmartSourcing, and in particular
goal is to determine how, ideally, such a process, or even clus-
how GTO is building on the changes of the last 21/2 years to
ter of tasks within a bigger process, should be performed. We
begin transforming its skilled technicians into business mana-
then compare this ideal with the current situation to begin to
gers and designers.
estimate the potential size of the prize from optimal sourcing,
including whether first to source or re-engineer the process.
A word of caution
SmartSourcing looks at the full range of internal and external,
The dozen questions listed below are among those Deutsche
nearshore and offshore options. However, as many firms are
Bank has developed which, together with expert judgment,
embracing outsourcing as a panacea, some caveats need to be
enable us to make considered sourcing decisions:
kept in mind when developing a sourcing strategy:
External context
■ You can outsource tasks but not accountability in the eyes
of the client, the shareholder, or the regulator.
■ If a process is dysfunctional, outsourcing will only
compound the problem.
■ Good internal controls and robust service delivery metrics
from our competitors?
■ Is there potential for substantially greater critical mass
from which significant economies of scale can be realized
(based on what other firms are doing/could do)?
must be in place before outsourcing, as they serve as a
■ What data privacy and competitive considerations apply?
sensitive early warning signal to put things right.
■ Are there specific factors that favor in-house solutions
■ In order to deliver a sustainable value proposition the
vendor must typically absorb your current costs, to which
they add their own management overhead, sales tax, and
profit margin. When reviewing a specific proposal, if this
96 - The
■ To what extent does this capability differentiate the firm
(e.g. regulatory or intellectual property issues)?
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Activity analysis
Personnel considerations
■ How many people does this activity currently employ, and
■ Does the process require lots of experience, or can it be
how will technology change that number, and perhaps
change that activity, over the next one, two, three years?
(This helps determine whether to reengineer,
SmartSource, or both, and in which order.)
■ How well is this activity currently done, relative to others?
learned quickly? What kind of educational background
is typically required to succeed?
■ Do those carrying out the process need to understand the
firm’s way of thinking and have a compatible approach to
the corporate culture?
It is important to assess objectively whether the current
capability is competitive. Benchmarking surveys are
From this multitude of considerations, we must choose
available for both IT and Operations, and companies are
whether the activity should be conducted internally or exter-
often surprised to find how poor their internal capabilities
nally and a location type. After reviewing the answers, we
are. For example, the Capability Maturity Model (CMM) uses
commit to one square of the context grid below for each major
a 1 to 5 scale to evaluate how well an organization follows
component. Obviously the grid is simplified in that there are
common and repeatable processes to perform software
many ownership and cost variations, but we have found that
development (and other IT activities.) A company rated 5
99% of the SmartSourcing choices can be reduced to this
(top) would use defined and repeatable processes, collect
simple context grid, which helps clarify thinking and decision
and use metrics to improve their processes continually,
making greatly.
and seek creative ways to keep improving. Few internal
IT departments would rate above 1 or 2, doing much of
their work on an ad hoc and chaotic basis; almost all
The SmartSourcing context grid:
self-respecting offshore software houses would be rated
Deutsche Bank
at least a 4 if not 5.
Non-Deutsche Bank
■ Does the task need a very flexible approach or would more
discipline actually be welcome? A frequent benefit of going
High cost
to an outsourced model (regardless of location) can be to
bring a discipline and transparency to the activity that
Medium cost
cannot be realized easily with in-house models, particularly
in high cost locations immediately adjacent to the trading
Low cost
environment. However, the arm’s length advantages
provided by outsourcing could prove problematic should
the task require a rapidly-changing approach.
■ Is this a mature process or one subject to frequent and
perhaps unstructured change?
Guidelines for high/medium/low cost
High – Central business districts of financial centers in G-7
countries (London, New York, Tokyo, etc.)
■ Is the volume of work very volatile (up and down)?
■ Is the outcome time-critical and urgent (e.g. trade capture)
or can it be delivered less urgently (next day)?
Medium – More remote areas of G-7 countries (Northern UK,
Southern US, etc.) and several developed countries (e.g.
Australia, Singapore, New Zealand, etc.)
Low - Typically developing countries with low labor costs but
robust education systems (e.g. India, Russia, etc.)
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It is only once we place the sourcing solution in the context
cost reductions were limited and the team decided to evaluate
grid that we move on to strategy execution issues, such as
the current portfolio of application development projects for a
countries and vendors. These come after we have carefully
potential SmartSourcing proposal and received advice from
decided which approach is the right solution for the firm to
the SmartSourcing PMO on how to proceed.
bring sustainable and enduring value.
An initial application suitability evaluation was performed and
An indication of the magnitude of net costs we would expect
three strategic applications were recommended based on
to see from each option follows, with the index 100 being the
their business domain, development maturity, requirements
high cost, Deutsche Bank alternative:
stability, team size, location, development skills, and process.
The goal was to choose a mature suite of applications which
would ensure critical mass with a vendor, but did not require
Net cost comparison by type of location
too much transition time to acquire the business knowledge,
Deutsche Bank
Non-Deutsche Bank
or be rich in key Deutsche Bank intellectual property. (It is
important to note that the data contained in the live system is
High Cost
100
90
Medium Cost
70
60
very sensitive and subject to rigorous controls). The profile of
the applications suggested that they would be suitable for
development outside of Deutsche Bank in a low-cost location,
which would help to ensure that the project would self-funding
Low Cost
50
30
(i.e. be able to recover the initial start-up costs) for 2003,
another prerequisite for approval. The initial applications proposed accounted for 70% of the current GCF technology
As an example, below is a case study of how a corporate
application development team size and 60% of the 2003 GCF
finance applications delivery project (falling into the low-cost,
technology budget.
non-Deutsche Bank grid square) was awarded to a third party
vendor in Moscow:
The search began for a vendor with good problem-solving and
software development skills that would be able to increase the
Case study: applications delivery in Russia
functionality and capability of the applications and provide
improvements over the current development process. Equally
You don’t have to be a rocket scientist (but it helps…)
essential was demonstrated expertise in supporting an enter-
The global corporate finance (GCF) area has complex technol-
prise-wide global document management system used as the
ogy requirements in the areas of client relationship manage-
foundation for the ‘pitch book’ production process. Ideally, the
ment, deal logging and tracking, and the creation of ‘pitch
vendor would be able to support three core functions: new
book’ documents for potential deals. It is also an area under
development, ongoing enhancements, and maintenance of the
significant pressure to reduce costs but with a continual
existing systems. In assessing requirements, there would be a
demand for better processes, increased efficiency and flexibil-
high need for ongoing interaction (beyond the training stage)
ity, and the ability to scale up or down depending on business
between the vendor and Deutsche Bank’s European (London
volume. Throughout the last two years the technology team
and Frankfurt) and New York offices, so simplified travel and
had been very successful in reducing costs through strict gov-
time zone overlap were desirable.
ernance processes, application and server retirements, head-
98 - The
count reductions, and more stringent cost controls for travel
A formal evaluation matrix was constructed to review each
and other ancillary expenses. However, options for further
potential vendor based on a weighted assessment of develop-
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ment skills, development process, commercial attributes, scal-
Retained within Deutsche Bank are the project management
ability, location, communication/ travel logistics, and relation-
and business analysis skills, and developers with specialist
ship with Deutsche Bank. Senior representatives from the GCF
knowledge and experience whom the bank would not wish to
technology team (both management and technical) then visit-
lose. Several of the existing team have already attended the
ed seven organizations throughout India, Europe, and North
joint Deutsche Bank-London Business School SmartSourcing
America. After a three-month investigation, Deutsche Bank
training program to help them be successful in this new envi-
chose a Moscow-based vendor with substantial experience in
ronment and more will follow. One of the biggest challenges
document management for global blue-chip companies,
will be managing the three-month transition period (which will
although few financial services clients.
occur this summer) for integration of the onshore and offshore development teams, while continuing to deliver applica-
A major attraction of Russia was the high number of mathe-
tion enhancements and new functionality and also ensuring
matically and scientifically trained graduates (indeed, some
transparency to the business.
rocket scientists) with payscales less than India. Interaction
would benefit from a three-hour time difference and a four-
Following the transition period, the Deutsche Bank onsite team
hour flight from London (and an eight-hour time difference,
will be 40% smaller, while the total team size (both onshore
ten-hour flight from New York). With substantial activity
and offshore) will increase by 35% compared to the beginning
already in Bangalore, risk management also dictated a prefer-
of 2003 (providing improved capability, controls, and process
ence for a different location for application development.
at a reduced cost). For the complete team, forecasts show a
Deutsche Bank has been doing business in Russia for some
pay-back period of eight months with a further potential year-
time, and the country manager was an additional asset in
ly cost savings of 33% (or Euro 3.3 million) beyond 2003.
undertaking a very thorough due diligence review process.
Additionally, this Deutsche Bank process now has the option of
The review focused on both the technical and company man-
scaling up for approximately 50% (depending on the onshore
agement side, since in Russia it is particularly important to
/offshore team structure) of what it cost in 2002.
choose your partners with care. Along with legal, audit and
compliance, the PMO office assisted in drawing up the master
In summary, this initiative has allowed Deutsche Bank to:
service level agreement which, once in place, could be lever-
■ Increase its scalability options.
aged by other groups within Deutsche Bank. The agreement
■ Gain access to a deeper pool of document
provides incentives for both parties to improve application
delivery quality and standards and to expand the relationship
further.
management IT talent.
■ Lower overall costs while actually committing more
people/energy to solving the IT challenges of our
Corporate Finance business.
Deutsche Bank’s biggest concern was the scarcity of English
language skills and mandated that client-facing roles (project
managers, business analysts, and lead developers) had good
English communications skills. Thus far, English fluency has
■ Provide enhanced training and career opportunities
for many staff.
■ Reduce our disaster recovery risk concentration in
New York and London.
been more available than anticipated. Although the vendor’s
client-facing and process tools for working with Deutsche
Thus, while the project began mainly for cost reasons, we have
Bank are less developed, and the outsourcing market is less
ended up with a much improved overall operating model. The
mature, than in India, there is less competition for highly-
project will be evaluated over the coming months, but if
skilled people. There is thus considerable capacity to expand
development capability increases with the ability to deliver
without moving wage rates or competing with other large-
additional high quality functionality, and direct costs decrease,
scale projects.
then the SmartSourcing strategy would have proved successful.
End of case study.
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Before reaching the optimal solution, each specific project
This change means that new skills are required to fulfill roles
requires a great deal of consultation along the way, as the box
in vendor management, extended team leadership, knowledge
below indicates:
transition and so forth. Expertise is now needed in:
At Deutsche Bank, SmartSourcing proposals usually
■ Collaboration and influence skills
require sponsorship/sign off from these departments in all
■ Language and cross-cultural skills
relevant jurisdictions:
■ Creativity and visioning skills
■ Problem solving skills
■ Legal
■ Business analysis skills
■ Compliance
■ Process reengineering skills
■ Regulatory
■ IT architecture and design skills
■ Audit
■ Information management skills
■ Insurance
■ Human resources
A very important way that we are seeking to differentiate our-
■ Technology risk management
selves from many firms instituting sourcing programs is
■ Corporate purchasing
Deutsche Bank’s commitment to maximize the reskilling
■ Controlling
and/or repositioning of our current work force who are knowledgeable, loyal, and high performing. We have no doubt that
the overall number of traditional full-time Deutsche Bank
Furthermore, diversification of risk and business contingency
employees in IT and Operations jobs will decline significantly
planning are embedded within all aspects of the sourcing deci-
over the next 21/2 years if we are to remain competitive, espe-
sion. Typically these have considered vendor and country or
cially in locations with high and/or inflexible labor costs.
city risk, but each year seems to teach us another lesson in
However, many of these roles will continue either in our own
continuity management. In 2001, the tragic events of Septem-
firm in new locations, or in partner firms, sometimes with pre-
ber 11 taught us that business disruption could take place on a
vious Deutsche Bank staff. Furthermore, open-minded staff
scale far bigger than firms historically anticipated. In 2003,
who are willing to step up, can acquire many of the new skills
SARS has once again challenged business continuity planning
Deutsche Bank will need as we are committed to assisting
by creating the need for totally segregated pools of labor. If
through teaching and providing opportunities to use these
properly considered up front, SmartSourcing can create a nat-
new skills. Attributes, such as employee commitment, loyalty,
urally resilient network of capabilities within an enterprise, in
knowledge of the firm, understanding of the business, and our
addition to the cost benefits so often the primary goal of
clients, etc., are extremely valuable and often painstakingly
sourcing programs.
built over years. So it is in everyone’s interest to try to transition as many people as possible. To do this in a way that is fair
From craftsmen to merchants and architects
to everyone, we are harnessing the people principles, prac-
These ambitious plans raise enormous transition management
tices, and processes that the GTO leadership team has spent
questions. Our substantial daily business has to continue flaw-
the last two years putting in place and therefore are already
lessly while embarking on these new and inter-related
familiar to everyone. These were described in Lenson (2002),1
approaches. Infrastructure professionals in IT and Operations
which in summary cover objective setting, performance
must be transformed to best-of-breed business managers
assessment, development planning, and the clear linkage of
and/or designers. We talk about this as moving people from
rewards to performance.
the mindset of craftsmen to that of merchants and architects.
1
100 - The
Lenson, M., 2003, ‘ 2001: A transformation odyssey,’
Journal of Financial Transformation, 6, 73-81
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We recognized early on that while our standard people prac-
list these skills on their resume in much the same way they
tices would serve us well through the transition, additional
might list a driving license.
specific formal training would be required. We partnered with
the London Business School (LBS) to develop a short formal
Jobs are changing throughout the organization, as the
training program ‘Strategic Outsourcing and Vendor Manage-
SmartSourced future calls for multi-disciplinary skills and tal-
ment’, which helps employees acquire the skills they need to
ent. Willingness to work in multinational teams and openness
be effective in the new SmartSourced environment and in
to travel and cultures, as well as a strong commercial mindset,
their careers. It enables each individual to understand their
will become key features for many. As I can attest, even the
own position – and that of others – in a broader context, as well
CIO’s role is being transformed. Today, the CIO’s role places
as to identify critical links between different parts of a
immense importance on the ability to lead more than 3,000
SmartSourced process. So far we have delivered the program
employees, based primarily in New York, London, and
to about 80 managers in London and New York and expect
Frankfurt, many of whom are engaged in clerical or low-level
several hundred more to go through the program in the com-
technical roles. Tomorrow the CIO’s role will be even more
ing months. With academic underpinnings and internal and
strategic and commercial in orientation, requiring the ability
external case studies, the curriculum covers not just the hard
to develop and integrate a broad array of internal and external
skills but also the soft skills. We explore how to manage in dif-
capabilities around the world to meet the ever more demand-
ferent cultures and in different organization/execution mod-
ing infrastructure needs of Deutsche Bank’s businesses and
els, and how to help manage other Deutsche Bank staff
clients.
through significant change (the latter module is entitled
‘Changing the deal while keeping the people’). In our internal
For companies making the transition to improved sourcing,
project and program management training and standards, we
honesty with employees and deft management of community
have similarly begun to upgrade to cover both traditional
relations is critical. Most publicly held-firms have a balanced
‘hard’ and all-important ‘soft’ skills, which often make the dif-
model of obligations to shareholders, clients, and the commu-
ference between success and failure.
nities in which they operate, as well as employees. It is in
everyone’s interest to make companies healthy and cost-com-
While our present focus is on transition management, we are
petitive. Social agendas can batter companies on both sides
already starting to think about the future challenge of how to
when it comes to the equity of protecting high-paid jobs:
ensure that those managing technology and operations func-
Criticism of not maintaining status quo to support a local com-
tions (albeit in some cases through vendor relationships)
munity versus derision for not doing enough to help develop-
obtain and maintain the technical expertise that they need.
ing countries raise their standards of living. For global firms,
Organic career paths will change. For example, we do not
such as Deutsche Bank with private and public sector clients
expect to offer entry-level jobs in basic coding (writing the
in developing and developed countries, as well as sharehold-
actual computer code), but good managers will need some
ers around the world, the sensitivity is magnified.
knowledge of the process to design, buy, and manage the
product delivered by others. Will our new hires have this back-
Some critics issue blanket statements that global sourcing
ground from academic or previous work experience, or will we
destroys jobs and employment, but they are being selective
need to arrange for junior placements with our vendor part-
with the evidence. In our case, what SmartSourcing does is to
ners? Just consider how personal computer skills of most
optimally align jobs in a proactive way with the organizations
employees have changed. In the 1980’s graduates entering the
and locations that can deliver the appropriate talent to exe-
industry typically did not have spreadsheet, PowerPoint, or
cute the task, rather than relying on history and past practice.
Word skills and firms were required to provide opportunities to
As such, the focus needs to stay on retraining and reskilling
develop these skills. Today virtually all applicants are able to
employees who have the capacity and the desire to align their
101
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skills and interests to the new vision, while allowing those
employees who do not to relocate with their existing roles and
skills (if appropriate) or to exit with dignity and pursue other
opportunities. In these economic conditions, such dynamic
alignment is paramount, and expected by our shareholders.
Only then will the enterprise stay strong and competitive,
enabling it to continue to provide rewarding and meaningful
careers for thousands of people throughout the world and to
make its appropriate contribution to society.
102 - The
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Potential
Discovering
the endgame in the
offshore debate
Bill Irving
President, Capco
Shahin Shojai
Director of Strategic Research, Capco
Suresh Gupta
Partner, Capco
Abstract
The financial services industry is just beginning to take full
advantage of the benefits of offshore business processing.
Some have taken the steps to outsource parts of the lowerend value chain to third party providers within emerging
economies. We predict that similar to the manufacturing
industries, financial institutions will over time outsource significant parts of their business processes, including certain
components which require complex processes, to cheaper, and
perhaps more efficient, third-party providers based offshore.
103
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Discovering the endgame in the offshore debate
In the race for global competitiveness, companies of all sizes
that over time, these third-party vendors will enjoy increased
have focused on achieving optimal rates of production effi-
participation and responsibility for managing a large cross-
ciency. For industrial and consumer goods manufacturers this
section of a financial institution's operations. We envisage a
has not only meant investments in new plant and equipment,
world in which financial services firms learn to take full advan-
but also offshore relocation of production facilities to benefit
tage of third-party contract manufacturers, who not only pro-
from lower labor costs. For many companies today these
vide business processing services but make it possible for the
investments and offshore relocations are outsourced to third-
financial services firms of tomorrow to become virtual organ-
party contract manufacturers who play increasingly important
izations that focus predominantly on servicing their clients.
roles in driving innovation and efficiency in these sectors.
This is not an imaginary world. It has already been created in
the world of manufacturing. The aim of this paper is to find
Ever since the global stock markets started their downward
ways for our industry, the FS industry, to learn from the expe-
spiral and highlighted the significant margin pressures across
riences of our manufacturing peers in order to become the
the world's leading financial institutions, financial services
world class institutions of tomorrow that we expect. We begin
firms have also been forced to consider moving parts of their
our analysis with a review of contract manufacturing and dis-
operations to an offshore center in order to take advantage of
cuss how it has been utilized by manufacturers across the
cheaper labor and lower overhead costs. In response, a num-
globe. Next, we will review the experience of using third party
ber of institutions have moved parts of their information tech-
providers by financial institutions, and finally we will assess
nology (IT) development and maintenance and, in some cases,
the extent to which offshore contract processing will be an
back-office operational activities to a number of these low-
important strategy for the financial services industry.
cost locations around the world, with India being major the
beneficiary thus far. For example, a number of retail financial
The evolution of contract manufacturing
service companies have moved certain parts of their operati-
For years, companies have outsourced certain parts of their
onal value chain - such as call centers, collections, loans pro-
operations to third-party providers to take advantage of lower
cessing, insurance claims processing, etc. - to third-party ven-
costs, which are derived through economies of scale and
dors based in India and the Philippines, among others. In the
scope, and to benefit from focusing on their core competen-
wholesale financial services (FS) sector, however, experience
cies [Shojai and Hahn (2001),1 Cachon and Lariviere (2001)2].
has been that while certain business processes have been
Initially organizations only outsourced non-strategic and com-
moved offshore, they have typically remained within ‘captive’
moditized processes, such as payroll, to third-party providers.
centers – overseas centers fully owned by the FS firms. In other
As companies became more familiar with the potential bene-
words, while operations have begun to move overseas, they have
fits of outsourcing non-core competencies, they began to out-
remained within the FS organization's own global four walls.
source even complex processes, such as the design and manufacturing of components used in their overall production facili-
We suggest that with the current economic pressures facing
ties, to organizations known as contract manufacturers or
the financial services industry a growing number of financial
more broadly as supply chain services providers. This process
services firms will be forced to consider the offshoring option.
has became so advanced today that companies such as General
As the number of institutions that move offshore increases,
Motors, Phillips, and Hewlett Packard derive a large proportion
the percentage that retain captive overseas operations will fall
of their production from assembly plants using components
and the third party offshoring model, or a combination of the
supplied by contract manufacturers based all over the world. Of
two, will become more prevalent.
course, it is the distribution and marketing prowess of these
leading companies that enables them to sell the sophisticated
However, third-party offshore business processing is only a
products they make. However, the fact that many of the com-
means to an end. It is by no means the end game. We suggest
ponents used in the assembly of their products come from
1
104 - The
Shojai, S., and N. Hahn, 2001,‘The new wave of liquidity,’
Journal of Financial Transformation, 2, 7-21
2 Cachon, G. P., and M. A. Lariviere, 2001, ‘Contracting to assure supply:
How to share demand forecasts in a supply chain,’ Management Science, 47, 629-646
JOURNAL 8 -v3
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contract manufacturers is a testament to the high levels of
product and the time it takes to bring it into the marketplace.
efficiency and quality achieved by these third-party providers
That is why in some industries, such as pharmaceuticals, out-
3
and the trust placed with them by such respectable companies.
sourcing represents over 50% of all manufactured goods [van
Arnum (2000)].5 Standardization across sectors can also be
The contract manufacturing business model leverages the
facilitated through contract manufacturers themselves. For
benefits of outsourcing. These specialized firms generally
example Symbian OS, formerly a division of Psion Plc, has
start with the assumption of facilities and resources from their
engaged many of the world's leading mobile technology com-
customers in return for long-term production contracts.
panies - their shareholders are Ericsson, Nokia, Panasonic,
Contract manufacturers then leverage these contracts to build
Motorola, Psion, Samsung Electronics, Siemens, and Sony
a cost-effective and scalable business that requires relentless
Ericsson - to come together and help develop the next gener-
focus on efficiency and quality. Critical success factors in this
ation of mobile telephony software.
business focus on bringing together world class process, technology, and people. Free to focus on only a portion of their
Just as there is nothing novel about outsourcing, there is also
customers’ value chain, contract manufacturers can efficiently
nothing new about moving operations offshore to take advan-
invest in the latest technology, create ISO compliant processes,
tage of cheaper labor and resources. As far back as 1963,
locate production facilities in the lowest cost regions, and
Siemens of Germany took advantage of low labor costs in
attract the best engineering talent from across the world.
Mexico for exports into the U.S. by establishing manufacturing
Their customers realize the benefits of lower cost, high quality
plants in Guadalajara. However, it took more than a decade for
manufacturing, and access to global best processes. According
organizations to realize the benefits of combining contract
to Tim Tyson, senior vice-president and director of worldwide
manufacturing with offshore relocation. In the 1970’s this real-
manufacturing and supply at Glaxo Wellcome and the desig-
ization led to the formation of companies such as Flextronics
nated president of manufacturing and supply for the new
and Solectron who were quick to recognize the benefits of
GlaxoSmithKline organization, Glaxo Wellcome was able to
such combinations and today are two of the world's largest
reduce its labor and overhead costs from 70% of total manu-
offshore contract manufacturers, with combined annual reve-
facturing expenditure in 1993 to below 40% in 1999.
nues of in excess of U.S.$26b. Many contract manufacturers
had similar start-up models, which entailed providing circuit
Additionally, contract manufacturing can help enhance inno-
boards, in case of Solectron, to manufacturers who had could
vation. According to Plambeck and Taylor (2001)4 when com-
not meet the ever growing demand.
panies utilize their own manufacturing capabilities, their
investments in innovations will typically only benefit them.
Today, countries such as Mexico, which was an early benefici-
Furthermore, they will only invest in innovation ‘when capaci-
ary of offshore contract manufacturing, are now facing serious
ty and innovation are cheap.’ However, in situations where the
threats from the Asian markets of India and China, where
in-sourcers aim to collaborate with their customers, as they
labor costs are even lower. Over time those countries with the
typically do, they can achieve sub-game perfect Nash equilib-
lowest costs and comparable or higher quality will attract the
rium. In other words, investments will be made in innovations
contract manufacturing business of producers from all over
that benefit all, rather than just individual companies.
the world. Consequently, if you take this process to its logical
Innovations in supply chain management and access to best-
conclusion, you can predict with reasonable certainty that
in-class manufacturing expertise that contractor firms pos-
the current process of human capital arbitrage will achieve,
sess can help to significantly improve the final manufactured
through private sector ambitions, what public sector
3 Over the last few years the contract manufacturers have increasingly moved from
the fabrication of simple to more complex products. For example, Nokia has most
of the components used in its mobile handsets made in Singapore, and Taiwan's
Acer also manufactures for Compaq, now HP, and IBM.
4 Plambeck, E. L., and T. A. Taylor, 2001, ‘Sell the Plant? The Impact of Contract
Manufacturing on Innovation, Capacity and Profitability,’ Research Paper no. 1750,
Graduate School of Business, Stanford University
5 van Arnum, P., 2000, ‘Bulls or bears? Outlook in contract manufacturing,’
Chemical Market Reporter, Feb 14, FR3-FR6.
105
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organizations, such as the IMF and World Bank, could only
tomers will have developed specific skills and understanding
dream of, i.e., a material integration of economies across the
around migration of operations. Skills necessary for relocat-
developed and the developing worlds driven not by NGOs or
ing, reengineering, and retooling operations are quite different
state aid, but rather by fundamental economics.
to those required for steady state processing activities.
Consequently, for those companies that have decided to take
Of course, outsourcing parts of your business to offshore con-
the plunge, they might find that they could avoid incurring the
tract manufacturers does not come without risks. According to
huge market penetration life cycle costs by using an offshore-
Plambeck and Taylor (2001), as of 2000, around 10% of total
based contract manufacturer.
global electronic production, approximately U.S.$75b, was outsourced to contract manufacturers. In 2002 the electronics
If you accept the argument that offshore contract manufac-
manufacturing services business increased its market size to
turing has been an important strategy for the industrial and
U.S.$93b with the top 50 providers taking a market share of
consumer goods industries, can we assume that financial
approximately 80%. In addition the global slowdown over the
services companies will also embrace it?
past three years has increased the pace of consolidation
among the providers.6 As the contract manufacturers increase
Lessons from the financial services industry
their market share, they could increase their pricing power
The global financial services industry is also no stranger to the
and ability to structure contract terms in their favor. Moreover,
practice of outsourcing. The industry has a long history of pro-
for certain companies, contract manufacturing diminishes the
viding outsourcing options to participants in the form of ‘cor-
differentiation of their products. Finally the resultant job loss-
respondent services,’ including corporate trust, custody, cash
es when manufacturing moves offshore can have significant
and securities clearing, and credit card processing, to name a
socio-political consequences. It is estimated that over 20% of
few. The industry has also created numerous cooperatives and
manufacturing jobs have been lost to overseas locations in the
utilities to facilitate both domestic and cross-border process-
U.S. alone.
ing efficiencies across many components of its value chain
It is up to individual companies to decide whether it is in their
ing both retail and wholesale processing services. Moreover,
best business interests to enter into contract manufacturing
the industry was early to recognize the benefits of relocating
relationships, but for those that have, the benefits have largely
operations to lower cost areas outside of the major financial
been clear. For many of these firms they been able to both
centers for operations such as credit card processing, pay-
reduce costs and benefit from the advances in quality and
ments, and call centers. A few of the larger global financial
innovation that contract manufacturers have achieved
institutions have also established offshore captive processing
[Plambeck and Taylor (2001)].
‘centers of excellence.’
Additionally, due to having production facilities in a number of
Why then, more than 25 years after the industrial and con-
regions, offshore contract manufacturers will usually have deep
sumer goods industries have aggressively adopted offshore
local market knowledge about how to set up and run operations
contract manufacturing, it has yet to become the norm in the
in a given country, including experience with local regulatory,
FS sector? Perhaps a key answer lies in the economic per-
tax, salary, and benefit structures. Many companies have found
formance of these different industry sectors over the past 25
that starting their own operations offshore can be an expensive
years. Manufacturing companies, particularly those with inter-
investment if there is not sufficient local knowledge and
national markets, realized from early on the implications of
experience available. Service providers such as offshore con-
global competition and high labor costs. In the 1970’s manu-
tract manufacturers that routinely take on processing for cus-
facturers in the developing world were producing goods of
and spawned many successful third-party companies provid-
106
6 Since 2001, Solectron has acquired iPhotonics, IBM's global asset recovery
operations, and Ce.Mar Srl; and Flextronics International has acquired in excess
of 30 companies.
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comparable quality at materially lower costs. Many of the most
Consequently, a gap was left that emerging offshore providers
recognized brands in the industrial and consumer products
filled. In particular it was the Indian technology firms such as
industries were forced to shed businesses or move to lower
Tata Consulting Services, Infosys, Wipro, etc., which had long
cost production facilities. By the 1980’s major recessions in
marketed themselves as low-cost, high quality (SEI CMM®
these industry sectors (Stat-USA) launched a period of signif-
Level 5, ISO 9001: 2000, eSCM) services providers that were
icant restructuring and innovation in supply chain manage-
willing to accept the risk of this work for an opportunity to
ment, manufacturing processes, logistics, and demand mana-
penetrate the lucrative financial services market. As a result,
gement. By the late 1990’s global manufacturing had under-
the foundations for moving IT development and maintenance
gone a significant transformation in operating models, eco-
by financial services institutions to India, and consequently
nomics, and leadership positioning.
other markets, were laid. More importantly, new radically low
cost models, not only for IT support, but for back-office opera-
While the manufacturing sectors experienced these significant
tional processing, were introduced to the financial services
economic pressures during the past 25 years, the services sec-
industry. As this economic slump enters its third year and the
tors, including financial services, continued to grow, aided
clouds of deflation hover over the industry, these alternative
largely by a combination of product innovation, geographic
offshore models offer attractive opportunities to improve
expansion, and information technology adoption (Fed-Stats).
operating performance. As a result, most institutions have
Despite several significant industry challenges, including
moved beyond the first level staff reductions, expense con-
deregulation, high profile financial company failures, and
trols, and supplier consolidation to considering more structur-
regional and country financial collapses, overall growth in
al cost improvements. Strategic cost programs now cover new
demand for financial services continued unabated. The 1990’s,
utility models, increased industry shared services, expanded
in particular, saw a period of increased revenue growth and
outsourcing, and offshore business processing.
global expansion in financial services (SIA Hand-Book 2001)
that masked underlying overcapacity, inefficiency, and margin
While the immediate driver for most financial institutions con-
pressures. However, in the post-crash world it quickly became
sidering offshore business processing was to save costs in
apparent that the new economic realities that drove such
response to long-term revenue and margin pressures, a large
structural change in manufacturing over the past 25 years
number of them are now beginning to recognize that relocating
have now reached the services industries, particularly finan-
processes to offshore providers can offer additional benefits,
cial services. It is no surprise then that the financial services
such increased quality, pooled investment in new technology,
industry is looking seriously at structural opportunities to
and efficiencies associated with greater levels of continuous
improve operating performance, including increased offshore
process innovation. In addition, offshore process relocation
business processing.
can increase opportunities to focus on core competencies. As
interest in offshore business processing grows in the financial
Ironically, the financial services industry’s encounter with
services industry, many firms are now evaluating what
third-party offshore service providers came during the height
processes and functions are suitable for this strategy.
of the last global expansion of the late 1990’s. It was during
the Y2K scare that financial institutions that were seeking to
Figure 17 provides an overview of the level of sophistication
minimize costs and risks started considering offshore service
that currently exists in the area of offshore business process-
providers as serious alternatives. The reason being that the
ing (OBP) across multiple industries. We can see that in addi-
world's major financial services IT suppliers decided that the
tion to manufacturing a number of activities are showing
risks associated with accepting liabilities for the remediation
increasing offshore movement. While few financial institutions
of mission critical software for Y2K compliance were too high.
have fully embraced offshoring of business processes, they
7 Gupta, S., 2002, ‘Riding the Offshoring Wave,’ PwC Consulting.
107
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Level of offshore processing
Low
High
Product Development
Manufacturing
Sales & Marketing
Finance & Accounting
Operations
Human Resources
Customer Service
Finance & Accounting
Sales & Marketing
Accounting transactions
Tele-sales support
Customer software development
management
Tele-marketing
Package implementation
General accounting
Market research
Application maintenance
Billing
Enhancements
Financial analysis
Conversions
Operations
Customer Service
Credit card processing
E-mail response
Claims processing
Customer Interaction
Loan processing
Inbound
Transaction processing
Outbound
Figure 1: While OBP is a relatively new trend, certain activities have been offshored for several years
are increasingly moving beyond offshoring of IT development
While, there are many reasons for their hesitation, the most
and maintenance or ‘simple’ processes represented by call
common concerns that we have heard, boil down to the fol-
centers, or technical help desk, etc. There are many such
lowing: data security, potential theft of intellectual property,
examples in other services sectors as well. We are all familiar
customer and regulatory impacts, and risk management.
with the blockbuster movie, Lord of the Rings, but what many
are not aware of is that Weta FX, a New Zealand-based sub-
Many firms believe that working with third-party providers can
sidiary of Wingnut, did the entire creature effects, digital
lead to breaches in firm and customer confidentiality. Others
scenes, and props. There are also many such examples in the
are concerned about intellectual property leakages. Emerging
pharmaceutical industry where offshore providers are utilized
economies have not generally developed high level of safe-
in new drug research and development processes, and in the
guards for protecting intellectual capital as their more devel-
healthcare industry where offshore resources process medical
oped counterparts. Moreover, financial institutions are heavily
claims and invoices.
regulated and compliance with these regulations must be
accommodated in any offshore relocation. And, an error in
108 - The
Of course, financial services institutions are moving cautious-
back office operations could have devastating impact on
ly in considering the relocation of operations offshore and,
customer relationships in many FS firms. Finally, in the whole-
more importantly, in utilizing third-party providers to do so.
sale FS sector, where significant proportions of back-office
JOURNAL 8 -v3
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operations involve multi-million dollar transactions, a single
transfers to the customer firm. A recent example of this model
error could result in multi-million dollar financial liabilities.
was a major contract between Prudential U.K. and ICICI
Most third party providers in offshore countries would be
OneSource. In September 2002, Prudential U.K. announced
unable to shoulder such a liability.
plans to move 850 call center jobs to India. It appointed ICICI
OneSource to establish the facility, which remains a wholly
Desire to maintain control over their destiny is the other very
owned subsidiary of Prudential U.K.9
important reason why financial institutions wish to keep certain services in-house. Many financial institutions have been
Each financial services organization will have to assess its own
taken aback by the experiences of a number of their peers in
ability to work through the confidentiality, regulatory, risk
outsourcing relationships, which in some situations had locked
management, and governance issues presented by moving
companies into very rigid service level agreements and where
operations offshore under each of these models. But that is
any exceptions were charged at premium rates. The compa-
not where the lists of concerns end. There is also the problem
nies have felt trapped with no recourse but to renege on the
of instituting the parent company's culture across their global
contract, which is usually punitively expensive. In spite of
network. This is expressed in the way offices look and feel
these concerns, there is much more experience in the industry
across the globe, and the way in which values, staff policies,
now around how to craft long-term win-win contracts that take
and training activities are replicated across the group.
into account business change as well as creating the incen-
Offshore business processors have recognized this need and
tives for supplier and customer to work together to continue
have gone to great lengths to ensure that staff working in
8
to improve the operations. Palmbeck and Taylor (2002), for
shared service centers have the chance to benefit from recre-
example find that there are now manufacturing contracts that
ating as much of the client culture as possible, even though
even have renegotiation clauses inserted into the original
they are not in their employ.
contract.
So while offshore business processing is a relatively new pheBecause of these varied concerns, a number of alternative off-
nomenon in the financial services industry, there is a great
shore business processing models have begun to emerge as
deal of familiarity with outsourcing and a growing interest in
financial institutions explore this operational strategy dimen-
exploring strategic alternatives in this area.
sion. These alternative models include building their own
with an offshore business process vendor to provide services
Offshore contract manufacturing
in financial services
to themselves and other potential clients (joint ventures),
The concept of manufacturing financial services has been
developing a co-sourced offshore processing center (co-
around for some time. Over the years, the industry has emplo-
sourcing), and creating a collaborative offshore/onshore oper-
yed constructs, such as product factories, functional factories,
ational team (extended team) (See figure 2.) The onshore
and the financial services factory, to suggest the disaggrega-
component of an ‘extended team’ model is staffed commonly
tion and realignment of business processes. While leading
by the financial institution while the offshore component may
financial services institutions have long employed concepts
be staffed by the vendor or the financial institution itself. One
such as shared services and ‘global centers of excellence,’ we
of the most recent models to emerge is popularly known as
are seeing a renewed emphasis on structuring highly rational
‘Build-Operate-Transfer (BOT.)’ In this model, a third party ven-
and efficient processes without regard to previous barriers
dor establishes and operates an offshore business processing
related to legal entity structure, locations, products, or tech-
facility on behalf of a customer. After an initial period lasting a
nologies. These efforts will encourage increasing debate con-
few months or years, the ownership of the offshore facility
cerning the merits of offshore relocation and third-party
8 Plambeck, E. L., and T. A. Taylor, 2002, ‘Renegotiation of Supply Contracts,’
Research Paper no. 1764, Graduate School of Business, Stanford University
9 Prudential U.K. Press Release, September 30, 2002, ‘Prudential PLC announces
plans to create offshore service centre in India.’
captive offshore operations (build), establishing new ventures
109
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MODEL
DESCRIPTION
Outsource
■
Build
■
PROS
Outsource components
of operations to an
offshore vendor
■
Build own operations at
an offshore location
■
■
CONS
Leverage expertise of
a vendor
Economies of scale (vendor
serving other clients)
■
Offshore BPO is not as mature as,
say, offshore IT; capabilities of
existing vendors is limited
Complete control over
operation
■
No experience in India (if that’s
the preferred location)
No economies of scale
Takes time to build
■
■
Joint venture
■
Co-source
with other FS
firms
■
Extended team
■
Create a new venture with
an offshore vendor to
provide services to the firm
and other companies
■
Develop an offshore center
that serves the firm and like
operations of other FS
companies
■
Create an offshore operation
jointly managed by the firm
and offshore vendor
■
■
New stream of revenue
Significant control over the
new entity
■
Leverage economies of
scale across multiple
companies
■
Can maintain control while
leveraging the expertise of
an offshore vendor
■
■
■
Focus away from core business
Longer time to market may
compromise immediate objective
of cost reduction
Structure may be very complex with
too many companies involved
Differences in processes, systems
and priorities across companies may
make this difficult to execute
A more complex relationship than
outsourcing (but less complex
than JV or co-sourcing with FS companies)
Figure 2: Several alternatives to establishing offshore operations
process provision. In addition many developing economies,
labor and overheads - such as GE,10 Citigroup,11 HSBC,12 The
long accustomed to the benefits of attracting contract manu-
World Bank,13 and American Express,14 which has captive off-
facturing, are now focusing similar energies on the services
shore operations. But, thus far the two have rarely been com-
sector. With the current economic pressures in the industry
bined, and certainly not for anything other than non-core pro-
there is certainly a confluence of interest on both the supply
cessing. The reasons most mentioned for the caution in this
and demand sides in the financial services offshore business
space, as noted above, have been protection of client confi-
processing landscape. Will this interest, however, result in the
dentiality and intellectual property, regulatory constraints, risk
creation of an offshore ‘contract manufacturing’ model in the
management, and in many cases, desire to maintain control.
FS sector?
Assuming that the industry finds ways to resolve these issues,
Despite its extensive adoption in manufacturing, third-party
for example through alternative ownership models, our
offshore business processing has had only limited adoption in
analysis of the evolution of offshore contracting in the manu-
the financial services industry thus far. There are a number of
financial institutions that have outsourced, or are beginning to
consider outsourcing, certain non-core functions to thirdparty offshore providers and others that have established
operations in emerging economies to take advantage of cheaper
110 - The
10 GE has 22,000 personnel in India focused on back office operations including,
credit card customer service, collections, finance and accounting, etc.
11 Citigroup has over 3,000 personnel in an India-based subsidiary, e-Serve. e-Serve
provides call center and back-office processing operations in Mumbai and Chennai.
12 HSBC will have 9,500 call centers and processing staff in developing countries by
the end of 2003, including 5,500 in India and 3,500 in China.
13 The World Bank, having established a small back office in Chennai, India in 2001,
has grown to a couple of hundred positions by now.
14 American Express has over 3,000 personnel near Delhi, India, engaged in a variety
of back-office activities including, finance and accounting, collections and
customer service.
JOURNAL 8 -v3
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facturing industry suggests two additional factors necessary
able to communicate with it [Dizdarevic and Shojai (2002)18].
for driving third party offshoring: the maturity of the supply market and the ability to decompose and standardize business
An alternative framework is provided by Fine et al (2002),19
processes.
which provide a useful value chain assessment methodology
that contrasts between strategic value and economic value.
Firstly, with a few exceptions, such as call centers or finance
The strategic value added is derived as a qualitative score by
and accounting, the offshore supply market is still immature
considering customer importance, speed of technology
and fragmented. While, there is a plethora of prospective ven-
change, competitive position (in the candidate activity), supply
dors eager to undertake any business processing that the
base, and the level of integration of the activity to the overall
North American and European FS firms would choose to out-
architecture of the product being manufactured. The economic
source, they lack the domain knowledge or experience neces-
value added follows the standard break-even analysis.
sary to inspire confidence in their ability to deliver quality
Combining the strategic and economic value analyses, the
results.15 According to Shamus Rae, ‘If a company goes down a
authors provide the following four choices for the manufac-
pure outsourcing path in an immature market...,the process of
turing value-chain design: insourcing, outsourcing, leveraging,
selecting suppliers, negotiating contracts, building service
or harvesting.
level agreements, and interfacing with regulators, all become
more complex.’ This creates a potential reputational risk if the
Recent developments suggest that the FS sector is becoming
third party fails to deliver.16
increasingly comfortable with the concept of offshore business processing, but not necessarily with third-party off-
Secondly, financial services participants with few exceptions
shoring. We have begun to see increased activities by financial
have only now begun to undertake the necessary full decom-
services institutions to move business processes offshore.
position of their business process value chains in order to
Many of these processes have tended to be in the retail space
identify which components are strategically best suited to
where onshore third-party processing models are widespread
deliver internally and which components have the economic,
and mature. In offshoring business processes, the retail FS
regulatory, and non-strategic attributes that are suitable for
firms have tended to use both ‘captive’ as well as third-party
outsourcing and/or offshore processing. In short, there is a
offshore operations. The most common examples of third-
need for a top-down view of a financial institution’s overall
party offshore providers are in the in-bound and out-bound
business architecture in order to organize the various manu-
call centers. Prudential, Aviva,20 American Express, Bank of
facturing activities into unique components. Each of these
America, Discover Card, Providian Bank, etc. are among
components can then be defined as discrete services with
numerous retail FS firms that have utilized third party off-
specific interactions across businesses and functions and a
shore call center firms. Within the last couple of years, there
decision can be made as to by whom and where that manu-
have been some examples of third-party offshoring in other
facturing will yield the optimal cost and quality returns. The
processes as well: insurance claims processing, loans process-
redesign of processes and the development of Web Services
ing, and asset accounting, etc. For example, Swiss Re uses
17
technology [Lee (2002) ] may also help accelerate the cre-
Bangalore, India, as the outsourcing locale. The outsourced
ation of new financial services factory (FSF) units, because
activities include technical reinsurance accounting, contract
they permit standardized processes to be set up and made
administration, claims settlement, current account manage-
available securely over the Internet. So once a fixed income
ment, and writing special business reports for external and
settlement FSF is set up in a web services framework, any
internal needs.21 Greenpoint Mortgage of Novato, CA uses
related trading system using the standard protocols should be
Infosys staffers to process home loans.
15 According to TowerGroup research (see ‘Indian Offshore Vendors Muscle in On
Wall Street: Truly Blessed or just Lucky?’) FS institutions are keen to outsource
reconciliation or risk management activities but held back by low-vendor expertise.
16 Rae, S., 2002, ‘Offshore Resourcing: Once Adventurous, Now Essential for
Financial Services Firms,’ PwC Consulting.
17 Lee, J., 2002, ‘Web Services: Feel the Burn’, Journal of Financial Transformation,
6, 10-16
18 Dizdarevic, P., and S. Shojai, 2002, ‘Web services: The enabler of the new business
service operating model,’ Journal of Financial Transformation, 6, 70-72
19 Fine, C.H, R. Vardan, R. Pethick and J. El-Hout, 2002, ‘Rapid-Response Capability
in Value-Chain Design,’ MIT Sloan Management Review, 43:2, 69-75
20 Ringshaw, G., May 2003, ‘Call Centers Take the Passage to India,’
Sunday Telegraph, U.K.
21 Chordas, L., May 2003, ‘Eyes on India,’ A.M. Best Company, Inc.
111
JOURNAL 8 -v3
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Page 112
The movement of wholesale processes to offshore locations
solutions. As a result it will take some time before offshore
has been less evident to date, but the interest is growing. For
business processing growth rates take off.
example, recently, JP Morgan Chase announced plans to hire
40 junior stock analysts and research analysts in Mumbai this
But the world of finance is by necessity changing, and fast.
year. Morgan Stanley plans to hire stock analysts in India to
What many took for granted 15 years ago, such as stickiness of
support its U.S. and European analysts.22 Lehman Brothers and
clients, can no longer be relied upon. Financial institutions
Bear Stearns are also beginning to use Indian financial ana-
have begun to understand what their colleagues in manufac-
lysts for number crunching work, including equity analysis,
turing learned a long time ago, you can increase profits by dif-
industry reports, and summaries of financial disclosures, etc.23
ferentiating your products or being more efficient at manu-
While it is a slow movement, it is a trend nonetheless.
facturing. Whether financial institutions can become more
truly innovative at a time when there is a genuine pressure on
There are, of course, a number of key questions that remain
margins, is beyond the scope of this paper. However, in spite of
unanswered when trying to determine the offshore endgame
the many open questions here we believe that the long-term
in financial services. Which types of financial services firms
deflationary forces that are affecting our industry will force
will be the early adopters? In this environment of Sarbanes-
many of the world's leading financial institutions to follow in
Oxley, will the regulators facilitate or impede offshore process
the footsteps of their manufacturing peers and start seriously
relocation? Will the large industry suppliers and utilities move
considering an increased role for third party providers in off-
their services offshore for competitive advantage? Is there an
shoring business processes. As noted previously, there are
opportunity for a new industry supply chain model with radi-
many alternative models emerging for offshoring of FS
cally different cost levels? Who will provide the necessary
processes, whereby the FS sector would employ third party
capital for the creation of new entities? Will the current eco-
providers in truly value-added activities, while retaining con-
nomic forecasts for the industry be proved wrong and the
trol of the overall offshore operations. In this sense, the FS
drivers for offshore relocation disappear? Will the threat of
sector may even pave some new paths for the manufacturing
industry job losses prompt local job protection policies and
sector to follow!
legislation? Will increased threats of global terrorism dissuade
the transfer of processing offshore?
This is by no means the end of the debate, as the decision will
no longer be framed as a choice between onshore or offshore
Conclusion
business processing. Rather, the question will be how financial
It is too early to say what proportion of a financial institution's
institutions can justify in-house end-to-end operational struc-
processes could be moved offshore. A target of perhaps 20%
tures when lower cost, more innovative, and efficient options
could be reasonable, but theoretically any function that does
increasingly become available. Like their counterparts in man-
not need regular physical contact with customers or counter-
ufacturing, financial services firms will have to seriously con-
parties could be processed remotely. Moreover, using an
sider this global sourcing, third-party contracting, and compo-
‘extended team’ concept, whereby a business process is sup-
nent assembly model to remain competitive. The global finan-
ported by a collaborative team of onshore and offshore
cial services industry is likely to demonstrate the same degree
resources, would open up many new opportunities for off-
of response to the current challenges as it has in the past.
shoring FS sector processes. However, as mentioned above,
Whether the industry employs a captive offshore model,
even the decision to outsource or move offshore has in many
spawns new offshore suppliers, or outsourcers to third parties
cases been forced upon financial institutions by the recent
is simply the means to a more competitive endgame that rec-
economic environment rather than the institutions them-
ognizes the benefits of offshore business processing.
selves making a strategic decision to take advantage of these
112
22 Chandran, R., 2003, ‘Shipping Research Jobs to India – Will it Work?’
The Hindu Business Line, May 4
23 Engardio, P., A. Bernstein and M. Kriplani, 2003, ‘The New Global Job Shift,’
Business Week, Feb
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Potential
Outsourcing
helps improve your
firm’s performance or does it?
Holger Görg
School of Economics, University of Nottingham
Aoife Hanley
Industrial Economics Group, NUBS,
Nottingham University
Abstract
We set out to give a brief outline of key studies that look at the
benefits/costs of outsourcing production and services. The bulk
of the evidence suggests that farming out physical components, both domestically as well as from overseas, enhances
both productivity and profitability. However, the net benefit
arising from outsourcing services is less clear-cut.
113
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performance - or does it?
In 2000, PriceWaterhouseCoopers conducted a survey of 440
between domestic and foreign suppliers. The available studies
CEOs from their benchmark Trendsetter Companies. These
on purchasing decisions deal with various permutations and
companies had been chosen by the U.S. media on the basis of
combinations of these issues.
their recorded growth rates over the previous 5-year period.
They found that outsourcing was viewed by 62 percent as a
The case for domestic outsourcing
way of achieving cost savings and by 60 percent as a way of
We first look at the issue of buying in services from a supplier.
gaining access to technical expertise.
In the majority of cases, we assume that our supplier is domestic. Abraham and Taylor (1996) look at the procurement of
This simple survey demonstrates that CEOs from a sample of
specialised services (e.g. accounting) and traditional low-wage
strongly performing U.S. firms assign an important role to out-
services (janitorial) for 2,700 U.S. firms. They argue that firms
sourcing in reducing costs and providing access to technical
choose to outsource for three main reasons: to smooth pro-
skills. It does not, however, answer the following question:
duction cycles, to benefit from specialization and most impor-
Does outsourcing cause higher growth rates? Since we know
tantly, to realize labor cost savings. Interestingly, they find that
that the U.S. firms chosen for the Trendsetter sample are
one of the most likely reasons for outsourcing, both high-wage
already defined as high-growth, we cannot attribute this
as well as low-wage specialists, is likely to be wage rigidity with-
growth to outsourcing alone without a detailed analysis of
in an establishment.
other factors contributing to it. What we can conclude is that
firms that are already growing vigorously continue to out-
‘Our finding that high-wage establishments are more likely to
source for strategic reasons.
contract out for janitorial services suggests that these establishments cannot easily pay low wages to janitors on their own
Kimura (2002) who examined a sample of 3,723 Japanese manu-
payrolls’. [P 417]
facturers for the year 1994 found that poorly performing firms
(low surplus to sales and low value added to sales), were the
A further finding is the significant association between estab-
ones most likely to use subcontractors. This negative result
lishment size and the likelihood that a firm uses outsourcing.
highlights outsourcing being used for defensive reasons by
A firm with no internal IT department, because the scale of its
Japanese companies anxious to stabilize their poor financial
operations do not justify this overhead (economies of scale
performance. In order to evaluate outsourcing as a strategy,
argument), can outsource this activity to an IT provider. This
we need to go beyond the evidence from cross-section surveys
provider can easily serve several clients and pass on the cost
that provide data on what the amount of outsourcing that is
savings to the procurers, if the market for these services is
carried out by firms at a certain point in time. Such evidence
sufficiently competitive.
will not shed any light on the causal relationship between outsourcing and firm performance measures such as profitability,
We noted that service vendors are able to operate more effi-
growth, or productivity.
ciently if they supply several clients simultaneously (economies of scope). However, do competitively priced intermediary
We set out to give a brief outline of key studies that look at the
goods result in higher profits? Görzig and Stefan (2002) using
benefits/costs of employing outsourcing strategies. We con-
data on German firms from 1992 until 2000, find that farming
clude by summarising any practical insights we can gain from
out the production of intermediates enhances profitability.
these studies.
However, higher levels of outsourced services were shown to
result in lower profitability.
Outsourcing studies
114 - The
When dealing with purchasing decisions from a supplier, we
According to the ‘specialization’ motive for outsourcing men-
differentiate between service and materials inputs and
tioned in Abraham and Taylor as one of their 3 motivations for
JOURNAL 8 -v3
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outsourcing, a firm can turn to its core competency and out-
other hand, the arguments for international outsourcing are
source non-core activities. Farming out non-core production is
more driven by skills differentials [Glass and Saggi (2001),
believed to raise worker output. In every-day parlance, highly
Grossman and Helpman (2002), Jensen and Thursby (1987), and
skilled workers should not have to pack components for ship-
Segerstrom et al. (1990)]. Therefore we say that one country
ment but this type of activity should be contracted out. Görzig
(symbolically called a ‘Northern’ country) has a comparative
and Stefan find that while outsourcing does indeed increase
advantage in production technologies that require high skill
the output level per worker, that firms achieve this improve-
levels or educational attainment. On the other hand, a ‘Southern’
ment in productivity only after incurring expense that eats
country has a comparative advantage in labour provision. This
into their profit margins i.e. the marginal cost of using out-
assumption leads to a prediction that upstream processes
sourcing outweighs the marginal productivity gains.
such as research and development are more effectively provided by countries with comparatively high skills intensities
Görg and Hanley (2003), who use data on individual firms in
whereas routinized downstream processes, such as packing and
the Irish Electronics sector, corroborate the finding by Görzig
assembly, are more efficiently handled by a low-wage country.
and Stefan (2002) that farming out services erodes company
profits. However, the procurement of physical components,
This theory predicts that international outsourcing will lead to
does not undermine profitability.
wage rises in the ‘Northern’ economy as the demand for high
skill workers rises. The level of employee productivity should
A snapshot of the studies on domestic outsourcing shows
also rise because high-skilled workers are more productive
therefore that outsourcing 1) increases employee productivity
than their low-skilled counterparts and low-skilled workers are
and 2) has an ambiguous effect on profitability, depending on
shed in the ‘Northern’ economy. ‘Northern’ economies are pre-
whether procurement is for tangibles or services. Essentially,
dicted to specialize in upstream specialist activities, such as
if managers need to evaluate the benefits of domestic out-
R&D, and attract higher skilled workers by offering high wages
sourcing, they should look beyond productivity and think more
to applicants with these high-skills profiles. We assume that
in terms of the costs involved in delivering this productivity.
labor markets can adjust relatively quickly to labor prefer-
Here we recall the conclusion of the Abraham and Taylor
ences and employees migrate easily between countries.1 The
(1996) paper. Any cost reductions as a result of subcontracting
composition of skills and wages is predicted to change as the
are not necessarily due to improved supplier efficiency.
level of international outsourcing changes. Consequently, a
Service vendors and manufacturers of intermediates will only
firm is better off fragmenting its production if there is a bias
pass on joint input efficiency gains to their business clients, if
across countries in terms of skill levels and relocating the low-
the market for these inputs is competitive. More clear-cut evi-
skilled activities abroad if the home country has a comparative
dence for the benefits of domestic outsourcing will arise from
advantage in the provision of high-skilled labor. This argument
a company’s employee compensation policy. On the basis of
is very intuitive and has been employed by practitioners who
the literature, the need to avoid labour disputes, to ensure
outsource activities as diverse as sports shoes manufacture to
flexible pay and work conditions, and to avail of non-core
IT support.
services, represent the strongest motivations to outsource.
While we know that international outsourcing in widely prac-
The case for international outsourcing
tized, is it advantageous as a strategy? Similar to the argu-
The next issue concerns the benefits of international out-
ments for domestic outsourcing, we begin by looking at pro-
sourcing. We recall that the arguments for domestic outsourc-
ductivity gains to international outsourcing. Then we can turn
ing, which are mainly driven by efficiency gains that a firm
to the implications of fragmenting production abroad on com-
hopes to capture because a vendor can supply his firm and a
pany profits.
certain number of other firms, at lower average cost. On the
1
This assumption is likely to be flawed in practice. Labor markets are relatively
slow to adjust as pointed out and investigated by Egger et al. (2001).
115
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The studies that use aggregate, economy-wide data are for
6
prod. for upstream
the most part unanimous that productivity in more developed
prod. for downstream
‘Northern’ economies, such as the U.S. and Japan, rises with
increases in levels of international outsourcing. This productivity increase can be inferred from aggregate studies on wages
4
for high-skilled employees [Feenstra and Hanson (1999), Egger
et al. (2001)] or the demand for high-skilled labor [Feenstra
and Hanson (1996), Head and Ries (2002)].
2
To our knowledge the only conflicting evidence we have that
international outsourcing does not induce a change in the
demand for, and hence wages of, high skilled staff in the
‘Northern’ economy is cited in Slaughter (2000). This U.S.
0
0
Log of worker productivity
-5
study notes that Multinational Enterprises have been fragmenting production abroad over the last 20 years but that the
5
Figure 1: Distribution of labor productivity by production stage
effects of this fragmentation on the demand for high-skilled
U.S. labor is insignificant.
We now examine the motivation for international outsourcing
Included in the downstream processes are software production
in the context of stages in the production process. Carr et al.
and software development.
(2001) assume that knowledge-capital intensive activities,
such as administration, can be fragmented. We should visualize
Although not immediately obvious from the graph, the accom-
the stages of production, not as a continuum moving from low
panying statistics show that on aggregate, upstream processes
to high skilled, but with a diversity of skills within each pro-
are less productive than downstream processes [the test-
duction stage. Hence the arrow diagram shows that it would
statistic for the smaller group (upstream) shows lower pro-
not be possible to fragment all downstream processes, on
ductivity associated with upstream processes].
account of supposing them to be lower skill for a ‘Northern’
economy. Downstream processes, such as high level client
support for complex products, still require a high level of skill.
Component
instrumentation
116 - The
Software
development
Software
production
Two-sample Kolmogorov-Smirnov test for equality of
distribution functions
Lower values of labor
productivity (lnkl1)
Downstream
Upstream
Combined K-S
Test statistic D
P-value
0.06
-0.11
0.11
0.33
0.02
0.04
Figure 1, taken from Görg and Hanley (2003), shows the pro-
Given the productivity differences for industries located at
ductivity distributions for upstream compared to downstream
several points in the production process, any attempt there-
processes for a selection of subsectors within the Irish electro-
fore to measure the effect of international outsourcing on pro-
nic engineering sector. Included in the upstream processes are
ductivity, should take into account industry subsectors or the
components and instrumentation manufacture.
stage in the production process that the firm is engaged in. In
JOURNAL 8 -v3
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the same study, Görg and Hanley find that productivity rises
services on overall costs is more ambiguous than the impact
with increases in international outsourcing in both upstream
of outsourced intermediates.
and downstream stages in the production process for both
outsourced physical inputs as well as services. However, the
Evidence shows that the outsourcing of materials dominates
productivity change as a result of outsourcing services for
the outsourcing of services, in value terms (Figure 2). We sur-
downstream activities surpasses expectations. Here the meas-
mise, based on the evidence collected for the profitability of
ure of association with productivity is higher than the corres-
buying in inputs on local markets that the same relationship
ponding measure registered for upstream activities. An expla-
holds true for inputs outsourced internationally.
nation for this finding might be the ability of firms in the sample
of firms from the engineering sector to farm out non-core
services at later stages in production to external contractors.
£ (IEP)
25,000
materials:
This permits their own employees to concentrate on core business functions. One example of productivity gains generated
when downstream firms buy in sales services might be the
services:
20,000
15,000
subcontracting of after-sales support to a call centre.
10,000
On balance we can conclude that the bulk of the studies on the
effects of international outsourcing indicate improvements in
5,000
labor productivity as a result of international outsourcing. This
effect is achieved when less productive stages in the manu-
0
1990
1991
1992
1993
1994
1995
1996
facturing process are farmed out to suppliers. However, one
may question whether this productivity results in higher prof-
Figure 2: International outsourcing for the Irish electronics sector
itability. The answer is that we do not know.
Conclusion
A clue might lie in the motivation behind international out-
We conclude on the basis of the bulk of the evidence that
sourcing vis-à-vis domestic outsourcing. We know from Görg
farming out physical components, both domestically as well as
and Hanley (2002) and Görzig and Stephan (2002) that out-
from overseas, enhances both productivity and profitability.
sourcing services locally, on balance, erodes company profits.
The net benefit arising from outsourcing services is less clear-
One reason for profits erosion could be the non-transparent
cut. While productivity gains are to be expected when a firm
way in which outsourced services are priced vis-à-vis more
outsources services, the lack of competition among suppliers
tangible inputs. While the markets for intermediate products
leading to expensively priced services, may undermine or
appear to function because a manager can easily evaluate the
negate completely the benefits that a firm earns from special-
quality of a physical input, outsourced services may be subject
ization.
to certain inefficiencies. The pricing of services, such as consultancy and legal advisory, are not necessarily transparent
and the value added more difficult to tie to the end product. A
further reason for poor profitability when services are outsourced is the lack of adequate competition among suppliers
due to a relatively small number of providers catering for the
whole market. Irrespective of the reason behind poor profitability from outsourcing services, the impact of outsourced
117
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References
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
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Feenstra, R. C. and G. H. Hanson, 1999, ‘The impact of outsourcing and
high-technology capital on wages: estimates for the United States, 1979-1990’,
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Glass, A. J. and K. Saggi, 2001, ‘Innovation and wage effects of international
outsourcing’, European Economic Review, 45, 67-86
Görg, H. and A. Hanley, 2003, ‘Does outsourcing increase profitability?’,
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Görzig B. and A. Stephan, 2002, ‘Outsourcing and firm-level performance’,
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Grossman, G. M. and E. Helpman, 2002, ‘Integration versus Outsourcing in Industry
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Head, K. and J. Ries, 2002, ‘Offshore Production and Skill Upgrading by Japanese
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Kimura, F, 2002, ‘Subcontracting and the performance of small and medium firms
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Slaughter, M. J., 2000, ‘Production Transfer within Multinational Enterprises and
American Wages’, Journal of International Economics, 50:2, 449-72
JOURNAL 8 -v3
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Potential
Marilyn Hignett
Partner, Capco
Funding
transformational
change through
offshoring
Michael Rude
Managing Principal, Capco
Ilene Grossman
Lisa Berk-Lidsky
Abstract
After three years of cost cutting in their domestic operations,
most financial services companies have little remaining fat.
They have reached the proverbial muscle, and must strategically address how technology and operations, in particular, will
help their organizations grow with fewer resources. In this
article, we argue that the organizational imperative of doing
more with less can be achieved through operational transformation, or the reshaping of business processes to achieve significant improvements in operational performance. Further,
we suggest that companies can fund transformation by moving offshore the legacy activities that are the target of transformational change. An example of how a company might offshore a legacy reference data function is provided in this article. We close by presenting the primary risks associated with
outsourcing a function to an offshore services provider, and
sample mitigating factors.
119
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Funding transformational change through offshoring
Since the market downturn began in March 2000, financial
Outsourcing in financial services
services companies have struggled with realigning expenses
Outsourcing is the delegation of a task or function to an
and revenues. Traditional cost cutting measures, such as head-
external service provider who is retained to fulfill them, often
count and capital expenditure reductions, were the first line of
in conformance with a service level agreement. Outsourcing is
defense. Companies subsequently turned to outsouring and
typically subcategorized into either technology outsourcing,
offshoring as they sought alternative approaches to cost
which is the outsourcing of a technology function like systems
management.
management, or business process outsourcing (BPO), which is
the outsourcing of a business activity like accounting or cus-
After three years of cost-cutting, financial services companies
tomer account maintenance.
have little remaining fat. They must address how technology
and operations will help them become more profitable with
The financial services industry was largely introduced to
fewer resources. Given this organizational imperative, we
technology outsourcing in the late 1990’s when companies
argue in this paper that companies must pursue transforma-
needed assistance with the remediation and testing of legacy
tional change, a wholesale reshaping of business processes to
software platforms for Y2K compliance. Outsourcing providers
achieve operational efficiencies and permanent cost reduc-
gained traction as they demonstrated their ability to perform
tions. We also argue that transformational change can be
minor application development or maintenance at a relatively
funded by offshoring the functions that will be transformed.
low cost.
In the following pages, we explore the history of outsourcing
As the outsourcing industry has matured and proven its ability
and offshoring in financial services, focusing primarily on the
to provide strategic and not just tactical value, companies are
outsourcing of functions to offshore service providers. We dis-
increasingly embracing outsourcing to delegate non-core
cuss the emergence of transformational change, providing a
competencies within their organizations. Indeed, companies
theoretical example and describing how it can permanently
are placing increasingly larger bets with outsourcing providers
reduce operating costs, thereby improving profitability. Next,
to support their technology and/or business processing needs.
we show how to fund the transformational change initiative.
The financial services industry has aggressively outsourced
By outsourcing the legacy maintenance functions to an off-
non-core competencies, including infrastructure maintenance,
shore services provider, the cost savings associated with off-
application development, and select operations functions.
shoring can be applied directly to the reshaping of the functions.
TowerGroup estimates that financial institutions spend nearly
A financial analysis is provided, which enumerates projected
one-third (or U.S.$ 120 billion) of their technology budget on
savings for our theoretical example. Our analysis is intended
third-party providers.1
to arm decision-makers with the information necessary to go
beyond cost management, and pursue profitability manage-
Outsourcing with an offshore provider
ment. This article closes with a summary of the primary risks
The next wave of outsourcing is to delegate functions or tasks
associated with offshoring, as well as potential mitigating factors.
to a provider whose employees are located in a foreign country, a migratory process that is referred to as ‘offshoring’. It
should be noted that outsourcing is not the only business
model that is applicable to offshoring. Companies can offshore
tasks and functions through a wholly-owned captive business,
a joint venture or other means. Regardless of the business
1
120 - The
Eckenrode, J., and G. Kopp, 2003, ‘Outsourcing in Financial Services: Cost Savings
or Competitive Advantage?’ Bank Systems & Technology Online
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Employment costs
Pay
Average annual costs*, 2001, 2002
Social security
Other benefits
60
50
40
30
20
10
Ch
ina
Ind
ia
Gr
ee
ce
Po
Sp
ain
rtu
ga
l
Ire
lan
d
Ita
ly
Au
Br
ita
str
in
ia
Fin
Ne
De
Lu
Ge
Sw
Be
Un
Fra
xe
lgi
nm
rm
th
ite
ed
lan
nc
mb
er
um
en
dS
e
an
ar
d
lan
y
k
ou
t
a
ds
tes
rg
Ja
pa
n
0
*Average earning for full-time male employees
Source: Mercer
model, companies have been aggressively pursuing offshore
business process may shave 40 percent to 60 percent off the
contracts to reduce their employment costs and overall oper-
bottom line.’4 American Express, which uses outsourcing and
ating expenses. A TowerGroup study from March 2003 high-
captive business models, ‘reported savings in excess of 50%
lighted this trend, stating ‘financial services companies spent
annually [since its entry into India in 1993].’5
U.S.$ 417 million on offshore contracts in 2002 and will spend
U.S.$ 1.31 billion by 2004.’2
Additional benefits
While cost remains a compelling reason for financial services
Offshoring allows companies to take advantage of labor cost
companies to outsource, particularly during the current eco-
arbitrage, or the difference in employment costs between two
nomic slowdown, a number of other reasons have emerged as
countries, such as India and the United States. A study by
the capabilities of outsourcing providers have expanded. With
Mercer points out that the average cost of employment was at
respect to technology outsourcing, respondents to a Gartner
least 10x more expensive in the United States than in India in
survey indicated that the most important reasons for pursuing
2001 (Figure 1). A more recent study by Mercer suggests that
outsourcing included (1) freeing up management to concen-
the multiplier approaches 8.5x for work requiring more domain
trate on strategic IT initiatives; (2) improving efficiency; and,
expertise and education, such as a finance manager.3
(3) reducing operating costs, in that order.6
Offshore services providers can pass along the savings associ-
With respect to BPO, Michael F. Corbett & Associates found
ated with labor cost arbitrage to their outsourcing customers.
that 35 percent of surveyed companies sought reduced oper-
According to Affiliated Computer Systems, ‘outsourcing a
ating expenses while 32 percent turned to outsourcing to
2 TowerGroup, March 2003, ‘Offshore Outsourcing Onslaught to Impact Brokerage
Spending, Staffing, and Services Landscape’
3 Mercer Hurman Resource Consulting, 2002, ‘European Employment Costs 2002’
4 Frauenheim, E., January 14, 2003, ‘IT Firms Expand From PCs to Payroll,’
ZDNet UK News
5 Gupta, S., November 2002, ‘Demystifying Offshore Outsourcing,’ CMA
Management Magazine, pp. 36-38
6 Gartner, May 2002, ‘Finance Sector Seeks IT Outsourcing to Meet Business Goals’
121
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Offshoring – A difficult but necessary decision
Grow revenue 2%
Foster innovation 2%
Conserve capital 5%
Improve quality 5%
Despite all of the benefits that are ascribed to offshoring,
many companies continue to hesitate before pulling the trigger. Of the financial services companies that have offshored
Increase speed
to market 5%
tasks or functions, we largely characterize their efforts as beta
testing. A handful of companies have proven that they are
fully committed to maximizing the cost effectiveness of their
Reduce operating
costs 35%
organizations through the use of an offshore program. Some
Create a variable
cost structure 13%
of the financial services companies that have committed to
substantial offshore efforts include Citibank, GE Capital, Bank
of America, HSBC, JP Morgan Chase, Standard Chartered, and
American Express.
Focus on the core
of the business 32%
Pulling the trigger for most firms remains difficult for a number of reasons, including concerns regarding geopolitical risk,
management (logistical) difficulties, and cultural differences.
Companies are particularly worried about demoralizing exist-
Figure 2: Why companies outsource
Source: 2002 Outsourcing World Summit, Michael F. Corbett & Associates Ltd.
ing staff as tasks and functions are moved offshore, potentially offsetting any benefits gained by lower labor costs.
However, we believe that the cost savings that can be achieved
enable them to focus on their core business functions. Other
through offshoring cannot continue to be ignored. Traditional
goals included creating a versatile cost structure, increasing
cost-cutting initiatives, such as project cancellations and
speed to market, and improving quality (Figure 2).
employee terminations, have run their course. After three
years of cost-cutting in their domestic operations, most com-
Outsourcers appear to be delivering. According to a survey
panies have little remaining fat. They have reached the prover-
conducted by PricewaterhouseCoopers Consulting in 2002, 41
bial muscle, and must strategically address how technology
percent of respondents have observed a ‘significant increase’
and operations, in particular, will help the organization grow
in service quality after outsourcing. Of the remaining respon-
with fewer and fewer resources. Technology and operations
dents, 27 percent observed ‘some improvement’, 25 percent
managers are faced with a difficult decision of how to do even
observed ‘unchanged’ and 7 percent observed ‘some decrease’
more with less. Given this organizational imperative, the next
in service quality.7 Separately, Wipro Technologies reports that
avenue for addressing the ongoing need for continuous cost
its outsourcing customers have observed up to a 75 percent
savings requires more dramatic action.
improvement in time-to-market, a 35 percent cost savings,
and a 10 percent improvement in productivity.8
122
7 The Paaras Group, January 2003, ‘The Offshore Outsourcing Market
and Its Future Direction’
8 Wipro, ‘Outsourcing 101’
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Model for Transformational Change
similarly stored centrally. The model is supported by work-
Tactically, within the financial services industry, transfor-
flow automation tools, which expedite exceptions for real-
mational change can be construed as the reshaping and
time resolution. The handling of exceptions is driven by
rationalization of a company’s operating model-using
controls (intrinsic and proactive). Transformational change
exception-based workflow management. Exception-based
of this magnitude is a significant undertaking that requires
workflow relies upon shared services, shared data,
considerable time and expense. However, transformational
automation, and controls to intelligently and efficiently
change yields substantial savings, possibly through
manage workflow throughout the organization. A high-
improved efficiency, reduced headcount, or fewer breaks.
level functional model that could be used to support
It is important to note that transformational change does
exception-based workflow is provided below. The high-
not necessarily imply a rewrite; it seeks to yield more out-
level functional model seeks the grouping of functions,
put at less cost from the company’s existing infrastruc-
the elimination of redundant activities, and the creation
ture.
of shared services across asset classes. Primary data is
Providers
Business
units/Emloyees
Regulators
Clients/Costumers
Market participants
SLA
SLA
SLA
SLA
SLA
Shared service function
Exception based workflow
Enterprise date management
Client-facing organization
Controls
Single common user/client interface
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Transformational change
We suggest that companies pursue transformational change
Transformational change may be the answer.
by starting with one of the building blocks of a shared service
environment and exception-based workflows, such as data
We define transformational change as the wholesale reshaping
consolidation. In the following section, we provide an example
of business processes to achieve significant improvements in
of outsourcing offshore a company’s legacy maintenance infra-
operational performance, which lead to permanent cost
structure for reference data, and funding transformational
reductions. Refer to the sidebar, above, for a thorough descrip-
changes within the function.
tion of how we envision transformational change being
Transformational change in action
applied in the financial services industry.
A historically inefficient support function, reference data relies
Transformational change holds out the promise for radical
heavily on manually intensive maintenance and intervention.
cost reduction, but comes at some cost because of the effort
The function is complicated by the volume of data and data
involved. It is our opinion that transformational change can be
stores. A TowerGroup study indicates that 50 percent of the
funded by outsourcing certain legacy technology and opera-
respondents to a survey said managing data was made
tional maintenance activities to an offshore services provider.
increasingly difficult by the fact it was stored in ten or more
Firms should consider moving offshore the legacy activities
different systems with only 4 percent of data records updated
that are the target of transformational change. The difference
automatically. The reference data area is also typically reactive,
between the current legacy maintenance expenditures and
updating data once an error has been detected due to, for
the costs associated with performing the maintenance off-
example, a trade break. The TowerGroup study indicates over
shore could be used to fund transformational development.
30 percent of trade failures are caused by incomplete or inaccurate data.9
On/offshore Mix
(up to 60% offshore)
Onshore only
(no change)
Year
2003
2004
2005
2006
2007
2008
Headcount
Labor costs
Occupancy
Fully loaded cost per employee
Total cost of onshore labor
275
$80.000
$20.000
$100.000
$27.500.000
275
$83.200
$20.400
$103.600
$28.490.000
275
$87.360
$20.808
$108.168
$29.746.200
275
$91.728
$21.224
$112.952
$31.061.844
275
$96.314
$21.649
$117.963
$32.439.837
275
$101.130
$22.082
$123.212
$33.883.227
Onshore headcount
Fully loaded cost per onshore employee
Total cost of onshore labor
Percentage of employees offshored
Offshore headcount
Fully loaded cost per offshore employee
Total cost of offshore labor
Total cost of on/offshore labor
Implementation costs
275
$100.000
$27.500.000
0%
0
$50.000
$$27.500.000
$200.000
210
$103.600
$21.756.000
24%
65
$51.800
$3.367.000
$25.123.000
$800.000
160
$108.168
$17.306.880
42%
115
$54.084
$6.219.660
$23.526.540
$400.000
110
$112.952
$12.424.738
60%
165
$56.476
$9.318.553
$21.743.291
$300.000
110
$117.963
$12.975.935
60%
165
$58.982
$9.731.951
$22.707.886
$-
110
$123.212
$13.553.291
60%
165
$61.606
$10.164.968
$23.718.259
$-
Savings (Expenditure)
$(200.000)
$2.567.000
$5.819.660
$9.018.553
$9.731.951
$10.164.968
Assumptions:
1 2003 Average per employee salary + benefits = $80,000
2 2003 Average per employee occupancy + furniture = $20,000
3 2003 Fully Loaded Cost = $100,000
4 Positions are offshored to India at 50% of the fully loaded cost in the U.S.
124
9 TowerGroup, Reuters, and Capco, October 2001, ‘Reference Data: The Key
to Quality STP and T+1’
5
6
7
8
Compensation grows 4% in 2004, but 5% in 2005 and beyond
Occupancy costs grow 2% per annum
The total cost of labor assumes 275 employees through 2008
24, 42 and 60% of positions will be offshored in 2004, 2005 and 2006, respectively
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For the purpose of the remaining discussion, reference data
most of which will be incurred in the first year of the project
comprises name and address, security, and involuntary corpo-
when the management team is created and the assessment is
rate actions. Our experience suggests that the operational
performed. However, please note that this number may vary
and technical maintenance of reference data and data stores
substantially based upon a number of factors, including the
within a large institutional broker-dealer could require
availability of current state documentation, the complexity of
between 250 and 300 operations and technology support
the environment, the number of systems, and other factors.
personnel. Although there were situations where as many as
As our model indicates, offshoring presents the company with
400 were used to just manage the name and address data.
a cost avoidance opportunity of approximately U.S.$6.3 million,
We estimates that a large broker-dealer based in New York
as well as run rate savings of approximately U.S.$3.8 million,
spends, on average, U.S.$80,000 per year in salary and bene-
in 2008. Transformational change funding will be U.S.$2.5
fits for a technology or operations professional. Coupled with
million, U.S.$5.8 million, and U.S.$9.0 million in years 2004,
occupancy, furniture and equipment, we estimate the fully
2005, and 2006, respectively, and total anticipated savings
loaded cost of an average employee to be around U.S.$100,000.
through 2008 are U.S.$37.1 million.
This implies that operations and technical support for reference data maintenance could cost between U.S.$25 million
and U.S.$30 million for a large institutional broker-dealer.
$40,000,000
For each position that is outsourced offshore, the broker-dealer
$33,8MM
can recognize approximately a 50 percent reduction in fully
success factor in any offshoring initiative. Our model suggests
a three-year horizon during which the offshore provider will
assume responsibility for legacy system maintenance and
modifications, as well as day-to-day reference data maintenance. The financial implications of offshoring are compelling.
The following table reflects the net savings that can be
achieved through offshoring up to 60 percent of the reference
$25,000,000
}
$10.1MM
phased approach that transfers domain knowledge, a critical
$30,000,000
$27.5MM
can outsource operations and support maintenance in a
Fully loaded cost of labor (in millions)
loaded labor costs. Our offshoring model suggests the company
$35,000,000
$23,7MM
$20,000,000
Total cost of onshore labor:
$15,000,000
Total cost of on/offshore labor:
$10,000,000
2003
2004
2005
2006
2007
2008
data function, assuming a constant staff of 275.
Operating expenses (onshore versus on/offshore blend)
Our financial model assumes that transition costs will be largely borne by the outsourcing provider, an increasingly common
As discussed earlier, offshore staff will be responsible for legacy
tactic being employed by offshore service companies seeking
system maintenance and modifications, as well as day-to-day
to acquire customer share. The implementation costs to be
reference data maintenance. A key contingent of staff will
incurred by the outsourcer will be limited to the costs neces-
remain onshore to manage the offshore team, provide subject
sary to assess the effort and manage the transition. For a ref-
matter expertise and interface with clients, vendors, and other
erence data project like the one described above, we estimate
constituents.
that the personnel costs will approximate U.S.$1,700,000,
125
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The onshore team will begin to design, build, and implement
the function or task being offshored, the business model
the company’s next generation reference data infrastructure.
being employed, the country (or countries) being targeted,
Once the next generation reference data infrastructure is
and others. However, we believe that all companies will face
complete, the legacy functions and tasks that were offshored
the core set of risk factors articulated below:
should be decommissioned. This strategy helps overcome the
morale issues associated with offshoring the jobs of cowork-
1. Business disruption and disaster
ers by retaining the thought-leading and innovative work
Geopolitical risk, infrastructure quality, pandemic disease, and
onshore.
various other factors raise the specter of business disruption.
Worse still, recent history evidences these risks may convert
Regulatory environment
into the loss of knowledge, or even the loss of life. This fact
Rules and regulations do not prescribe how financial services
was painfully clear during the recent outbreak of severe acute
companies must outsource or offshore functions and tasks.
respiratory syndrome (SARS), which affected nationals from
However, the lack of specific rules or regulations should not
over thirty countries, and felled nationals from ten. Entire
be mistaken for a laissez-faire regulatory approach. Financial
commercial and academic facilities were shut for two weeks in
services companies should view their service providers as
China - a precautionary measure to help prevent the spread of
jointly responsible for complying with the law, and should take
the disease. Recent attacks by terrorists in Indonesia, the
the necessary precautions to ensure adherence.
Philippines, Russia, and India provide further evidence of the
risks that companies may face when offshoring a critical func-
If business processes are being offshored, the firm should
tion or task. Potential mitigating factors may include:
anticipate that the same certifications could be required for
offshore employees, including Series 7 or 27 (Fin/Ops Principle)
■ Calibrated screening of countries for geopolitical risks,
certification. In addition to individual resources, the actual
government stability, infrastructure quality, education,
process offshored may need to adhere to regulatory guidelines. Adherence to these guidelines may require the development of tools, policies, and procedures necessary to exhibit
10
compliance to external regulators.
and other factors.
■ Maintaining a blend of onshore and offshore resources
with shared knowledge, tools, and capabilities.
■ Selecting an offshore service provider who maintains
redundant facilities and systems in more than one country.
Recognizing and overcoming
the risks of offshoring
2. Domain expertise
Offshoring is a potentially risky endeavor that may be compli-
Local populations may lack the domain expertise necessary to
cated by time zones, language barriers, cultural differences,
rapidly assume ownership of a function or task. This fact may
and other factors, any one of which may impact the project’s
be particularly true in financial services, which is a heavily
timely and successful completion. Therefore, it is imperative
regulated industry that requires strict adherence to policies
to recognize, plan for, and identify mitigating factors that
and procedures governing certain functions or tasks. This lack
address these risks.
of knowledge poses substantial execution risk, and may
increase the cost of implementation. Potential mitigating fac-
In this section, we identify a core set of risk factors that will be
tors may include:
observed on any offshoring engagement. We also identify a
sample of mitigating factors that firms can employ to help off-
126
■ Selecting onshore employees who will be charged with
set the presented risks. We recognize that additional risks may
overseeing the knowledge transfer process, as well as the
be present, and that mitigating factors may vary, based upon
ongoing management of the offshore center, to create the
10 For further information on the regulatory implication please refer to the article
in this issue of the Journal by Hugh Kelly and Daniel Nolle.
JOURNAL 8 -v3
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project steps for the knowledge transfer effort.
■ Documenting onshore expertise, including workflows,
exception handling procedures, and business processes.
■ Firms should develop a clearly defined policy for managing
internal and external communications.
■ To the extent possible, the design of the offshoring
initiative should be inclusive to protect domain expertise in
3. Transition plan
the home country, and focus key employees on strategic
The offshoring of a function or task is a complex initiative that
initiatives.
requires a thoughtful and precise transition plan. Its implementation involves incremental management effort, necessi-
5. Intellectual capital
tating clearly defined milestones, ownership, and interdepen-
Some countries are not known for adequately protecting intel-
dencies. Aside from infrastructure support, such as facilities,
lectual capital rights of companies, especially foreign enter-
telecommunications, and power, the plan should account for
prises. Without proactive safeguards that protect a company’s
human transition. This should include the creation of teams
intellectual capital, property may be lost with little recourse.
that will be charged with, for example, managing offshore per-
Mitigating factors may include:
sonnel, transferring knowledge, and communicating with
internal and external parties. Firms that do not make ade-
■ Physical and technical security safeguards are critical to
quate provisions for managing the entire effort, including the
preserve the assets of the company. Safeguards may
costs associated with developing and running the program,
include property fencing, security guards, authentication
jeopardize the program’s success. Mitigating factors may
software, computer controls, and threat detection.
include:
Conclusion
■ Deploying a clear transition plan with milestones,
deliverables, and accountability (company and provider).
■ Establishing an organizational structure that reflects each
Outsourcing a function or task to an offshore services provider
is a complex endeavor that presents each company with a
unique set of risks and rewards. Companies choosing to off-
work stream, such as knowledge transfer, infrastructure,
shore must prepare for a wide range of complicating issues
and communications.
that will vary based upon the function being offshored, the
■ The plan should address external variables (foreign and
business model being employed, the country being targeted,
domestic), such as regulatory and legal requirements,
and other factors. Companies must particularly focus on the
infrastructure providers, or service providers.
human element of migrating functions offshore, including the
creation of a management team, the development of a knowl-
4. Employee morale
edge transfer program, and the implementation of a commu-
The process of moving jobs offshore can impact the morale of
nications strategy.
remaining employees, which may in turn neutralize the benefits of offshoring. Poor morale may portend other conse-
The risks of offshoring are offset by the potential for substan-
quences as well, including disruption of customer service, mis-
tial reward. In addition to the cost savings that can be gained
handling of intellectual capital, and adverse publicity. Firms
through labor cost arbitrage, a properly executed offshoring
must not underestimate the impact of offshoring on employ-
program may yield a range of strategic benefits, such as
ee morale. Mitigating factors may include:
improved time to market and a renewed focus on core business
functions. This article highlighted just a few of the companies
■ The offshoring initiative must be properly designed,
that have successfully implemented offshoring for comparative
executed, and communicated to set realistic expectations,
and competitive advantage. These companies have proven that
and to help obtain buy-in.
offshoring is a legitimate cost management weapon.
127
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Page 128
More important, in this difficult economic climate, offshoring
can be viewed as the financial lever to implement transformational change, a program that is intended to permanently
reduce operating costs through gains in operational efficiency. The offshoring of manually intensive and inefficient functions can lead to substantial savings that can fund onshore
development of the building blocks of transformational
change, including exception-based processing, workflow
automation, and shared services. Finally, this strategy can
help to overcome the morale issues associated with offshoring the jobs of coworkers by retaining the thought-leading and innovative work onshore. Using offshoring to fund
transformational change enables companies to think beyond
cost management, and pursue profitability management.
128 - The
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Guidelines for manuscript submissions
Guidelines for Authors
Manuscript Guidelines
In order to aid our readership, we have established some guidelines to
ensure that published papers meet the highest standards of thought
leadership and practicality. The articles should, therefore, meet the
following criteria:
All manuscript submissions must be in English.
1. Does this article make a significant contribution to this field of
research?
2. Can the ideas presented in the article be applied to current business
models? If not, is there a road map on how to get there.
3. Can your assertions be supported by empirical data?
4. Is my article purely abstract? If so, does it picture a world that can
exist in the future?
5. Can your propositions be backed by a source of authority, preferably
yours?
6. Would senior executives find this paper interesting?
Subjects of Interest
All articles must be relevant and interesting to senior executives of the
leading financial services organizations. They should assist in strategy
formulations. The topics that are of interest to our readership include:
•
•
•
•
•
•
•
•
•
•
•
Impact of e-finance on Financial Markets & Institutions
Marketing & Branding
Organizational Behavior & Structure
Competitive landscape
Operational & Strategic issues
Capital Acquisition & Allocation
Structural Readjustment
Innovation & New sources of liquidity
Leadership
Financial Regulations
Financial Technology
Manuscript submissions should be sent to
Shahin Shojai, Ph.D.
The Editor
Editor@capco.com
Capco
Clements House
14-18 Gresham Street
London EC2V 7JE
Tel: +44-20-7367 13 21
Fax: +44-20-7367 1001
130 - The
Manuscripts should not be longer than 5000 words each. The maximum
number of A4 pages allowed is 10, including all footnotes, references,
charts and tables.
All manuscripts should be submitted by e-mail directly to the
editor@capco.com in the PC version of Microsoft Word. They should all
use Times New Roman font, and font size 10.
Where tables or graphs are used in the manuscript, the respective data
should also be provided within a Microsoft excel spreadsheet format.
The first page must provide the full name (s), title (s), organizational affiliation of the author (s), and contact details of the author (s). Contact
details should include address, phone number, fax number, and e-mail
address.
Footnotes should be double-spaced and be kept to a minimum. They
should be numbered consecutively throughout the text with superscript
Arabic numerals.
For monographs
Jensen, M., Corporate Control and the Politics of Finance. Journal of
Applied Corporate Finance (1991), pp. 13-33.
For books
Copeland, T., T. Koller, and J. Murrin. Valuation: Measuring and Managing
the Value of Companies. John Wiley & Sons, New York, New York (1994).
For contributions to collective works
Ritter, J. R., 1997, Initial Public Offerings, in Logue, D. and J. Seward, eds.,
Warren Gorham & Lamont Handbook of Modern Finance, South-Western
College Publishing, Ohio.
For periodicals
Griffiths, W., Judge, G., 1992, ‘Testing and estimating location vectors
when the error covariance matrix is unknown’, Journal of Econometrics
54, 121-138.
For unpublished material
Gillan, S., and L. Starks. Relationship Investing and Shareholder Activism
by Institutional Investors. Working Paper, University of Texas (1995).
JOURNAL 8 -v3
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Page 131
Request for Papers — Deadline September 26th, 2003
The world of finance has undergone tremendous change in recent years.
Physical barriers have come down and organizations are finding it harder
to maintain competitive advantage within today’s truly global market
place. This paradigm shift has forced managers to identify new ways to
manage their operations and finances. The managers of tomorrow will,
therefore, need completely different skill sets to succeed.
It is in response to this growing need that Capco is pleased to announce
the launch of the ‘journal of financial transformation.’ A journal dedicated
to the advancement of leading thinking in the field of applied finance.
The journal, which provides a unique linkage between scholarly
research and business experience, aims to be the main source of
thought leadership in this discipline for senior executives, management
consultants, academics, researchers, and students. This objective can
only be achieved through relentless pursuit of scholarly integrity and
advancement. It is for this reason that we have invited some of the
world’s most renowned experts from academia and business to join our
editorial board. It is their responsibility to ensure that we succeed in
establishing a truly independent forum for leading thinking in this new
discipline.
You can also contribute to the advancement of this field by submitting
your thought leadership to the journal.
We hope that you will join us on our journey of discovery and help shape
the future of finance.
Shahin Shojai
Editor@capco.com
For more info, see page 130
© 2003 The Capital Markets Company. VU: Shahin Shojai,
Prins Boudewijnlaan 43, B-2650 Antwerp
All rights reserved. All product names, company names and registered trademarks in
this document remain the property of their respective owners.
131
JOURNAL 8 -v3
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Page 132
Design, production, and coordination: Cypres — Lode Vandermeulen and Pieter Vereertbrugghen
© 2003 The Capital Markets Company, N.V.
Photography: Gangway — Mathilda by Wolfgang Winter & Berthold Hörbelt
All rights reserved. This journal may not be duplicated in any way without the express
written consent of the publisher except in the form of brief excerpts or quotations for review
purposes. Making copies of this journal or any portion there of for any purpose other than your
own is a violation of copyright law.
Mexican flowers. Perfected by the Dutch.
Private Wealth Management.
Perfected by Deutsche Bank.
Van Gogh sought perfection, combining
powerful imagination with outstanding
technical skills. And transformed simple
sunflowers into a masterpiece.
At Deutsche Bank, we’ve built our reputation
in much the same way. We begin with a
highly personal, perceptive understanding
of your needs. Which we creatively link
with financial products that only a worldclass bank can offer.
A unique blend. And results that speak
for themselves.
Talent.
Leading to results.
www.db-privatebanking.com
www.capco.com
Antwerp T +32 3 740 10 00
Boston T +1 617 262 1135
Frankfurt T +49 69 9760 9000
London T +44 20 7367 1000
New York T +1 212 284 8600
Paris T +33 1 47 55 30 90
San Francisco T +1 415 445 0968
Singapore T +65 6395 6998

Offshoring

Transcription

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