Offshore Outsourcing: A Primer Dr. Kevin D. Stringer June 7, 2011 1
Agenda What is offshore outsourcing? Why offshoring? Offshoring strategies and business approach Sample locations India, Poland, the Philippines Directed questions 2
SECTION 1 What is Offshore Outsourcing? GEN0190n.ppt 3
What is offshore outsourcing? Outsourcing refers to the transfer of business processes from inside an organization to outside an organization. The people who conduct the business processes change from internal employees to professionals outside the organization. Offshore Outsourcing refers to the cross-border transfer of business processes to a provider located outside a firm s home country of operations and typically in a location with greater available talent and lower cost. Other terms: Nearshoring, Bestshoring, Backshoring There are 4 general types of offshoring models: External company (vendor) Internal team of employees (captive) Hybrid (mixture of vendor and captive models) New legal entity between a vendor and captive (Joint venture) Vendor Captive Joint Venture 12% 37% 2% Hybrid 49% Financial Institutions Breakdown 2009 4
Sourcing (out, in, off, near) Company Operations 5
The original outsourcing gurus Adam Smith David Ricardo 6
Outsourcing based on competitive (dis)-advantage considerations Competitive Disadvantage Production costs Procure from Market In-house production 7 7 7
Another guru Ronald Coase, Nobel Prize in Economics, 1991 8
Outsourcing based upon competitive advantage and transaction costs Transaction costs Outsourcing losses Production costs Procure from Market In-house production 9
Examples of transaction costs (1) Resources spent on guarding against opportunistic behaviour by vendors Finding reliable vendors Drafting contracts Enforcing contracts Dispute resolution Monitoring mechanisms 10
Examples of transaction costs (2) Resources spent on managing transitioning, and interactions with a (remote) vendor that would have occurred naturally in-house Travel (Tele) communications Coordination mistakes Knowledge acquisition and transfer 11
3 main types of offshoring Business Process Offshoring (BPO) BPO is the offshoring of a specific business process task, which often involves executing standardized and transactional processes Sample BPO functions includes back-office work, billing, purchasing, payroll and administration, trade processing (OTC, FX, securities, etc) Knowledge Process Offshoring (KPO) KPO is the offshoring of processes that demand research, analytical and decision-making / judgement skills. Sample KPO work includes MIS reporting, data mining, equity and fixed income business research, data analysis and financial modelling / analysis IT Offshoring (ITO) ITO is the offshoring of IT applications and infrastructure functions Sample ITO work includes application development, prototyping, testing and maintenance BPO, KPO and ITO are the three most established types of offshoring in the industry 12
Activities being offshored (complexity) Research Services Content development Product design services CAD / CAM services High Knowledge Services Customer analytics Portfolio & risk management Equity research Wealth management research Complexity Medium Low Back Office Fin. & Acctg., HR, Procurement shared services Technology support Operational transaction processing Contact Services Inbound customer relations & helpdesk Outbound telemarketing Collections Data Processing Basic data entry Transaction processing Document management 13 13 13
Headlines on industry trends KPO industry is expected to grow at 45% a year and to top $17 billion by 2010. Onshore, Nearshore, Offshore: Unsure, 2010 The global BPO industry, currently estimated at $26-29 billion, has grown at 35 per cent over the last few years and will be worth $450 billion by 2012. The banking, capital insurance and manufacturing verticals will constitute 70 per cent of this global BPO market. Everest Group, 2008 In 2008, the ITO market was estimated to be worth $250 billion, with annual growth rates of 6-9%. LSE Outsourcing Unit Report, 2009 GEN0190n.ppt 14
What are the preferred locations? Canada Ireland Eastern Europe Russia China Near shore Toronto Dublin Moscow Warsaw Budapest Shanghai Malaysia Location Mexico % of companies with offshore presence Share of offshore headcount Mexico City India Delhi Hyderabad Manila Mumbai Bangalore Chennai Kuala Lumpur Singapore Philippines India 100% 72% Sydney Philippines 19% 3% China 16% 4% Near shore 13% 2% Ireland 9% 1% Respondents allowed multiple choice Source: Deloitte and Gartner Singapore Australia 15
Ireland a pioneer 16
SECTION 2 Why Outsource to Offshore locations? 17
Potential benefits of offshoring A wide variety of benefits may make offshoring appropriate in several business situations Reduce costs Address open positions/ skill shortages to grow Access to a large pool of qualified employees at a lower cost Follow the sun operations (up to 7 x 24 h) Extend working hours Offer additional service Enhance quality and controls Focus on client service 18
Why are banks offshoring? Cost reduction is still a main driver to move offshore Achieve Cost Savings Improve Quality Improve Time to Market Gain Technical Skillsets Forced Strategy Cost Predictability Penetrate Market Gain Industry Experience 0 10 20 30 40 50 60 70 80 Source: Ventoro Offshore 2007 and Gartner, 2008-09 % of respondents GEN0190n.ppt 19
And the broader industry sample set? For CFOs and CIOs, access to skill-sets seems to be more important Business transformation Focus on core business Impact competitive advantage Gain 3rd party expertise Free internal resources Access innovation Cost reduction Access Skill sets 0 10 20 30 40 50 60 70 80 Source: Cognizant and Warwick Business School Research, 2009 % of respondents GEN0190n.ppt 20
SECTION 3 Offshoring strategy and business approach 21
What should an offshoring strategy do? Create differentiation Create greater business value Reconfigure value chain or contribute to value shop development Cost savings alone is not sustainable! Imitating competitors is dangerous! 22
Which approach to offshoring? Company culture and politics.. Centralized Top down targets No exceptions Holistic view to the company operating model Company leverage towards vendors and scale and scope increases Desire to change business model Decentralized Sub-units define targets Lots of exceptions No firm-wide view Fragmented leverage Vendor s gain arbitrage opportunities Cost savings is often main catalyst..will have a big impact on the approach taken 23
Example: DB Global Transaction Banking NY LO FRA Competence Centers Dublin Frankfurt Bangalore Processing Centers 24
SECTION 4 Sample locations India, Poland, the Philippines 25
Gross cost comparisons: India - Europe Personnel Ongoing infrastructure costs Total onshore cost Business Process Offshoring (BPO) Thousands 300 250 200 Knowledge Process Offshoring (KPO) Thousands 300 250 200 150 150 300 100 50 0 150 22 15 100 50 0 24 38 Onshore Offshore Onshore Off shore 75% overall savings 79% overall savings E.g., back-office work, administration etc. E.g., research and other tasks requiring specialist knowledge GEN0190n.ppt 26
Ex. Goldman Sachs in Bangalore Goldman Sachs offshoring research to India Small Cap research team was created to assist in completing the initial research work required to cover companies. This significantly increased the amount of companies covered by the Equity Research Dept. Offshore Quantum team (team of 12, compensation between ~8,500 USD and 27,000 USD p.a. per person) reduced number of onshore contracted Grant Thornton accountants saving approximately 4.5 million dollars on a 12 million dollar contract Bangalore Portfolio Business Analyst (compensation was ~27,000 USD p.a.) took on a project usually outsourced to Grant Thornton accountants that cost 28,000 USD per quarter GEN0190n.ppt 27
But consider the risks in India Inequality within a rising population Water shortages High oil prices Global protectionism Climate change Infectious diseases Source: Victor Mallet, The utopian myth of India s double dividend, FT, December 6, 2007 28
Social instability India has a small part of the population with the GDP of Mexico and the rest with a GDP of sub-saharan Africa Home-grown Maoists (Naxalites) have exploited resentment over official corruption and the widening gap between rich and poor to control large swaths of rural India. Maoist insurgency in 172 of India s 600 districts 29
Social issues As Palaniappan Chidambaram, erstwhile Indian trade minister noted in a conversation with Financial Times, Do you know what the population of Finland is, he asked? 5 million. We have 5 million blind people in India alone. Source: Gideon Rachman, For nations, small is beautiful, Financial Times, Dec 4, 2007, 13. 30
GINI Coefficient Report 2009 This is the most commonly used measure of inequality. The coefficient varies between 0, which reflects complete equality and 1, which indicates complete inequality (one person has all the income or consumption, all others have none) 31
GINI Coefficient Report 2009 32
Resource scarcity India imports 70% of its oil from the Middle East and has no strategic reserves The Indian government subsidy on food, oil, and fertilizer is equivalent to the entire collection on income tax India has 18% of the world s population but only 4% of its freshwater and just over 2% of its land area 33
Numbers can be deceiving With a population of 1.1 billion India has the highest absolute numbers of people receiving hardly any education Literacy rate is a low 61% About 2% of India s existing workforce has skills training compared to 96% in Korea, 75% in Germany, and 68% in the USA Source: Goldman Sachs Global Economics Paper, 169, June 16, 2008 and India s Borderless Workforce, Manpower, 2008 34
Talent is not always at the same level Only 13 percent of the university graduates from 28 low-wage nations are suitable for jobs in most multinational companies. Regionally, the differences are more marked. So while 50% of the engineers in Hungary or Poland could work for multinational companies, only 10 % and 25 % of those in China and India, respectively could do so. Source: Diana Farrell, ed. Offshoring: Understanding the Emerging Global Labor Market, McKinsey Global Institute 2006. 35
Poland 36
Poland s talent pool Largest working population in Central Europe and one of the youngest populations on the continent 50% of the Polish society is under the age of 34 35% is below the age of 25 POLAND Over 2 million students enrolled at universities Almost 400,000 graduates/year 126 higher education academies, including 35 universities Foreign language skills: English, German, French, Italian, Spanish, Russian 37
University graduates per year in Poland 21 000 25 000 30 000 14 000 76 000 33 000 44 000 41 000 27 000 20 000 34 000 GEN0190n.ppt 38
Poland cost comparisons Typical onshore/offshore salary cost comparison 2010 Business Process Offshoring (BPO) Thousands Knowledge Process Offshoring (KPO) Thousands 300 250 200 150 100 50 0 150 Onshore Poland 300 250 200 150 100 50 0 275 33 45 Onshore Poland e.g. Back-office work, Administration etc. e.g. Research and other tasks requiring specialist knowledge Ca. 60% overall savings Ca. 83% overall savings Source: Grafton Recruitment, 2010. GEN0190n.ppt 39
BPO Szczecin Gdansk Olsztyn Poznan Warszawa Lodz Wroclaw Lublin Katowice Czestochowa Bielsko Biala Krakow GEN0190n.ppt 40
IT or Call Centers Gdansk Olsztyn Szczecin Bydgoszcz Poznan Warszawa Lodz Wroclaw Kielce Katowice Krakow GEN0190n.ppt 41
Fewer risks European Union member NATO member Closely connected to US and Europe Cultural fit Nevertheless. 42
Corruption Index 2010 Rank (09) 1 (1) 8 (5) 20 (17) 22 (19) 25 (24) 41 (49) 78 (79) 87 (84) 178 (178) Country New Zealand Switzerland United Kingdom United States France Poland China India Somalia Score 9.3 8.7 7.6 7.1 6.8 5.3 3.5 3.3 1.1 Source: Transparency International, Corruption Index 2010 43
Case: State Street in Poland Challenges: Increased demand for fund services Competition (BONY, Northern Trust) Limited capacity in existing locations (Luxembourg,Ireland) Solution: Krakow captive culture, quality, value proposition Krakow costs when benchmarked across Europe at an 8% salary spiral take ca. 20 years to reach average But, not as productive as other European locations. Needs 2 years or more. India was not a choice.why? 44
Case: State Street in Poland (2) Focused business - fund accounting Top Management targets, support, and buyin Goal to move the Poland operation up the value chain from simple to complex funds administration When does it just become another European office? 45
The Philippines 46
Philippine IT-BPO: excellence in voice / growing non-voice capability 47
Growth Business One of the fastest-growing industries in the country Major contact centers in the Philippines: 218 Total full-time employees: 280,000 Estimated revenues in 2009: US$5 billion Revenue growth from 2008: 30% Key Players in the Country Third-party providers: Convergys, TeleTech, Stream Global Services, Sykes Asia, Aegis PeopleSupport, Teleperformance, Sitel, CyberCity Teleservices, Telus, epldt Ventus, Sutherland, ACS, HTMT, IBM Daksh, KGB, Transcomm, eperformax, Link2Support, Genpact Captives: HSBC, Dell, Shell, AIG, Siemens, Verizon, Citigroup, Six Continents Intercon Hotels, Henkel Financial Services, GE Money, Trend Micro, Oracle Technology, Western Union, Ford (Percepta), DHL 2009 Offshoring Destination of the Year National Outsourcing Association, UK 48
The Philippine value proposition Comparison of direct operating cost 1 per FTE for transactional F&A work 2008; US$ thousand per annum 75-85 65-75 ~75% savings ~70% savings 40-45 34-39 19-21 18-20 1 Operating cost includes salary, facilities, equipment, telecom, training, and attrition cost Source: Everest Research Institute (2008) and BPAP (Manila costs) 49
Qualitative challenges & solutions There are a number of challenges which are typically faced when working with offshore teams Challenges Solution Work with different cultures Maintaining high quality standards Cultural training Personal interaction through visits Onshore training for team leads Coaching "Shadow" key outputs in both locations in initial phase Regular structured feedback both ways Efficiently utilizing capacity Involve offshore managers in departmental resource allocation meetings Clearly designed process for assigning work offshore Managing different time zones (US) Ensure overlap Retaining Staff Integration into onshore team Onshore travel Clearly defined career path GEN0190n.ppt 50
SECTION 5 Directed Questions and Answers The Larger Offshoring Challenge 51
Concerns Economic Social Issues Political GEN0190n.ppt 52
Directed large group questions For developed countries, how do you maintain a comparative advantage? How do you reengineer your work force or industries in countries like Switzerland, Germany, USA, UK, etc.? For offshore locations how do you address the asymmetric economic and social development problem? What do you do about the cross-border issue of client data and overall reputational risks? 53
Last thoughts! Offshoring is one tool among many. It needs to be evaluated carefully. There are successes, but cross-sector, every 5th firm reverses an offshoring project after 2 years. Very few managers are trained to lead and manage offshore and onshore organizations well. Beware consultants with offshore operational units. 54
Selected Further Reading Outsourcing, Understanding the Emerging Global Labor Market, Farrell, 2006 Why Are Companies Offshoring Innovation? The Emerging Global Race for Talent, Lewin, Massini, Peters, 2008 Globalization of White Collar Work, Duke/BAH report, 2006 Offshore Nation, Strategies for Success in Global Outsourcing and Offshoring, Vashistha and Vashistha, 2006 India and China May Not be the Answer, Strategy +Business, Stringer, 2010 55
Summary and Discussion Your views and takeaways! 56