Outsourcing: Get a grip on all the links in the chain

By Paul J Davies

ARCHIVED 2005

Outsourcing and offshoring have become a mainstream strategic option for many corporations looking to cut costs. Hundreds of thousands of IT jobs have been exported from western Europe and the US to countries such as India, while tens of thousands of call centre jobs have gone from the UK alone. But the ever increasing popularity of such moves belies the considerable risks involved.

According to Sam Samaratunga, a partner in Risk Assurance Services at PwC, 25 per cent of IT outsourcing contracts fail within the first two years with the rate rising to 50 per cent over five years - and this includes domestic outsourcing.

When companies send contracts offshore the risks are compounded. Offshoring risks range from the large political event threats such as terrorism, political violence and war to the more subtle, including political discrimination, regulatory considerations and cultural issues.

Matthew Strong, a partner at Jardine Lloyd Thomson, the insurance broker and risk consultancy, says few countries will unilaterally confiscate company assets, but unexpected renegotiation of a licence to operate remains a danger. China and India are among the most popular of offshoring destinations due to an abundance of well-educated but cheap labour.

However, their relative modernity and stability is far from assured, says Charles Keville, a director of Aon Crisis Management, a unit of Aon insurance brokers. “Very recently, China said it could declare war on Taiwan while two years ago everyone thought there could be imminent nuclear war between India and Pakistan," he says. Sure enough, just as the countries agree on a peaceful bus route through Kashmir, trouble has flared again.

For the apocalyptic situations insurance is the only safety net but, according to Strong, losses are still likely. Coverage for asset confiscation, for example, is capped at about £1bn, he says, although companies can still mitigate losses by arranging cover with a number of providers. "Cultural problems are both common and hard to mitigate, especially in customer-facing operations" The more common threats, where insurance is also an option, involve a whole gamut of service interruptions.

Depending on your company, these will be more or less important to your business, says Mr Keville. For an online travel company with IT services abroad, a long interruption would be likely to cause a painful loss of business, not just at the time but when affected customers are considering which site to visit in the future. However, the same kind of interruption is not likely to be nearly as sensitive for an online directories business.

One of the most important things, whether you are concerned about serious peril or just a hiccup, is to have good contingency planning in place. When it comes to insurance, most companies will take out a policy to cover the costs of re-establishing operations quickly, whether that be back at home or at another offshore site. Mr Keville says that, because of this, it may only take a policy for £5m or £10m to protect a business. But while you can insure against errors, continuity of service, even fraud, there are plenty of risks that are far harder to quantify and so very difficult to insure.

Cultural risks are both incredibly common and hard to mitigate, especially when it comes to customer facing operations. Capital One, the credit card company, found this to its cost when it cancelled a telemarketing deal with an Indian call centre company because it discovered that workers had misled customers with spurious offers of credit. Dell was also forced to reverse its policy and shift a number of customer support jobs back to the US because a significant number of customers complained that they had difficulty understanding Indian accents. As Mr Samaratunga says: “If you've broken down in Aylesbury and end up speaking to someone in India there's a good chance they are not going to be able to relate to you or your situation very well."

Customer frustration can lead easily to customer loss. But if outsourcing is pursued with phased implementation of contracts that have been well prepared with a proper understanding of the rationale for pursuing the move and a firmly established cost base, many problems can be avoided. Companies need to understand all the links in the chain of outsourcing, Mr Samaratunga says.

Outsourcing contractors can delegate some elements further to a subcontractor and a company needs to ensure that all elements of the chain will be contractually obliged to it. Another problem, particularly with IT contracts, is the hidden costs that a company can realise too late have previously been absorbed by departments other than the internal IT department but then can crop up as part of the outsourcing contract. But one of the biggest reasons for failure is that companies underestimate the amount of effort and control that is needed to ensure that outsourced service agreements are fulfilled.

A call centre strategy that works

Aviva, the UK's largest insurer has been one of the leaders in attempting to cut costs by offshoring call centre jobs to India, along with Prudential, HSBC and others. It has created 3,700 jobs in India already and plans to increase this to about 7,000 by the end of 2007. While it may have aroused the ire of Amicus, the UK union for white collar workers, the strategy has not yet run into any serious problems or caused an exodus of customers. Simon Machell, director of customer service, says the group began researching possibilities for offshoring call centres in 2002 and quickly decided not to open a new location itself in some faraway place.

The company decided on a three stage model in which it would find a partner to build the business and operate it with an option for Aviva to bring it under the group umbrella at a later date if it progressed well. This approach was a good way to minimise the cultural risk because it provided a cheap escape route if Aviva's customers did not take to the service or if the contracts were not fulfilled to the group's satisfaction.

“If we had set it all up ourselves and in one or two years had to unwind it because it wasn't working, it would have been very expensive, Mr Machell says. He says the group spoke to about 70 different companies in India before choosing, ranging from individual entrepreneurs who would be starting almost from scratch, to very large companies. “We chose a company called EXL the first time. They had done similar stuff with large US insurance companies and so had the knowledge of the industry as well as the capacity. The contracts are set so that a company such as EXL can run the business for a minimum of three years, allowing it time for to make a return on its investments but, after that period, Aviva can effectively take the operations back when it wants, Mr Machell says.

Mr Machell adds that the business continuity risks it faces in India are slightly more complex, but essentially much the same as it would face with a domestic call centre.