Equasiis Market Assessment, Outsourcing Governance Operational Efficiency, May 2009 (e2002)
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EquaSiis Market Assessment Data, Research and Analysis on the Global Business and IT Services Markets
Effective Governance Yields Outsourcing Value Mike Beals, Vice President, EquaSiis Enterprise Stan Lepeak, Managing Director, EquaSiis Global Research The value and importance of outsourcing governance in an outsourcing effort is in many ways self-evident and intuitive. Outsourcing governance is the vehicle through which buyers can ensure the benefit is achieved. Given the increasingly complex nature (e.g., multi-sourced, multitower, multi-geography) of outsourcing today, good governance is more important than ever. EquaTerra continues to find, however, that many buyers struggle with their outsourcing governance efforts. This is due to inadequate resources, skills, processes and tools. It is also due to the lack of information or inability to build a solid business case required to make the investment to improve these capabilities. One aspect of developing such a business case is clearly assessing and understanding current state governance capabilities and efficiencies or inefficiencies as the case may be. This Market Assessment paper reviews the results from recent EquaTerra research that assesses and measures the operational performance characteristics of buyers managing major outsourcing efforts.
The Details Outsourcing Governance Overview EquaTerra has long stressed the role and importance of outsourcing governance to the success of outsourcing efforts. EquaTerra‟s direct client experience and market research studies have found a direct correlation between the quantity and quality of governance investments and the success and satisfaction of outsourcing efforts. This is not to imply that the more a buyer spends on governance, they happier they become. Rather it means that there is a minimum investment threshold needed to ensure that buyers can field and support adequate and skilled outsourcing governance resources, processes and tools. EquaTerra has identified six key capabilities that enable outsourcing governance success. These capabilities can be categorized further and are mapped to the competing priorities that buyers must balance in their governance efforts: risk mitigation against desires for value realization. These categories are highlighted below. Risk Mitigation Finance and commercial management: the ability to ensure contractual obligations are being met by both parties and verifying the invoice reflects the service quality received and provisioned Compliance management: ensuring effective compliance with regulatory, safety and privacy requirements Issue and problem management: appropriate mitigation of issues and resolution
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Value Realization Change and program management: manage demand for services as well as leverage and focus on service provider capabilities Service quality management: create optimization through standardization, defined performance and satisfaction levels Communication management: business requirements and relationship alignment Both risk mitigation and value realization are critical to outsourcing success. Outsourcing buyers tend to focus on the risk mitigation issues spending much of their time and energy on contractual or financial issues leaving very little time or focus on the areas that create the most value. Failure to perform either well will lead to value “leakage” in the outsourcing effort. This leakage can take the form of dollars spent unnecessarily in governance, missed cost savings opportunities, or the failure to achieve broader business case goals like process improvement and innovation. Figure 1 illustrates the potential value leakage from poor or inadequate outsourcing governance.
Figure 1 – Potential Value Leakage from Poor Outsourcing Governance
Minimizing leakage is critical. Effective risk mitigation can help ensure that costs remain in line with projected usage and costs. Creating efficiencies in the risk management function can reduce the cost of outsourcing governance itself. These cost savings can flow to the bottom line or buyers can reinvest them in improving outsourcing governance capabilities. It is easier to measure the “hard dollar” (or € or £) costs and benefits of good governance than its impact on value creation. Ensuring outsourcing achieves the intended savings or the projected business case will also resonate with financial and executive management outside of the governance organization.
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Gaining the support of these constituencies is needed to get the approval for the investments in governance and tools required to improve outsourcing governance capabilities and ultimately the value achieved from outsourcing. Seeking to better quantify the potential benefits from effective governance, EquaTerra launched a market research study (see Figure 2) to complement and extend findings from its own client outsourcing governance experiences. The balance of this paper will review and interpret the results of that study. For more information on general outsourcing governance best practices, please refer to the following Perspective paper as well as to the EquaTerra Library. EquaTerra conducted this market study in the first quarter of 2008. It surveyed over 300 North American buyers actively engaged in governing and managing their organizations’ information technology and business process outsourcing efforts. Seventy-nine percent of respondents were director or manager level, with the balance in vice-president or executive management roles. Twenty-six percent of respondents were from organizations with $100M to $1B in annual revenues with the rest coming from larger firms. Twenty-nine percent of respondents were from firms with revenues in excess of $25B annually. All major industries were represented led by banking, financial services and insurance (18 percent of respondents) and manufacturing (13 percent). Figure 2 – Study Method & Demographics
Market Study Findings Some level of outsourcing governance inefficiencies will exist in any organization. The magnitude depends both on the scope and scale of the outsourcing effort and the sophistication of the buyer‟s outsourcing governance capabilities. The market study assessed outsourcing governance activities in ITO and BPO (see Figure 3). Average total contract value (TCV) under management by study respondents was in excess of $100M. Outsourced
Outsourced
In the process
No plans to
2+ years
< 2 years
of outsourcing
outsource
Information Technology
59%
17%
10%
14%
Finance, Accounting & Administration
24%
12%
9%
55%
Human Resources
23%
10%
13%
54%
Procurement
15%
11%
17%
56%
Customer Care/Call Center
37%
16%
14%
33%
Industry Specific Services
35%
16%
10%
39%
Functional Area
Figure 3 – Levels of Outsourcing
Prior EquaTerra research and client experiences have found that buyers tend to invest more in outsourcing governance, or minimally make better investment choices, after they have been in outsourcing efforts for more than two years. Outsourcing satisfaction levels also tend to rise after
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two years. Market study respondents included a mix of buyers who had outsourced both greater and less than a two year time frame. Respondents had reasonable though not exceptional success in achieving the benefits sought from outsourcing. On a scale of one to five, where one represented benefits not at all achieved and five represented fully achieved, responses ranged between 3.1 and 3.6. Benefits sought included the usual mix of cost reduction, cost avoidance, process improvement and seeking to redirect focus to more strategic activities. Most respondents planned to expand their existing outsourcing efforts either in the same or new functional areas or into new business units and geographies. Twenty-two percent planned to maintain current levels of outsourcing while just four percent planned to curtail or eliminate their outsourcing efforts. Arguably, the buyer sample measured in this market study represents “typical” outsourcing users in today‟s market. Outsourcing governance spend levels fell within the ranges EquaTerra typically finds in outsourcing efforts of this profile (see Figure 4). Forty-one percent of respondents estimated their outsourcing governance spend at three to five percent of TCV annually. A full 20 percent of respondents did not know their annual spend levels or spend was not tracked. Given the potentially large size of outsourcing governance spend (basic math shows that three percent of a $100M contract equates to $3M spent annually) buyers that do not know or do not track outsourcing governance spend are in the dark around the details of a large annual expenditure. Minimally, these outsourcing governance spend numbers highlight the volume of potential leakage that can occur in a typical ITO or BPO effort – not to mention the savings often sought in a contract of this magnitude. While measuring total outsourcing governance spend is important, it is more valuable to understand where the funds are spent and tracking the value of that spend. As with all business functions, there is much administrative work, or transaction-type work, in outsourcing governance. The degree to which buyers can streamline or limit the time and effort spent on these tasks determines how much they can focus on more strategic aspects of outsourcing governance – activities to support value creation – while simultaneously maintaining or lowering cost levels. Buyers need to assess the costs associated with these administrative tasks as well as their performance levels. As the outsourcing governance marketplace matures, buyers will be able to comparatively assess or “benchmark” their cost and performance levels against those of their peers EquaTerra has developed assessment diagnostic for outsourcing governance to help buyers better assess their performance against those of their peers.
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Figure 4 – Outsourcing Governance Annual Spend as Percent of TCV
There are a number of key operational metrics associated with outsourcing governance administration. EquaTerra reviews these metrics when helping clients assess the efficiency of their governance operations. They include the following: Number of FTE‟s in the outsourcing governance organization and their fully loaded costs Number of service providers and service provider relationships being managed Invoices received monthly from outsourcing service providers Estimated percentage of invoices that are inaccurate or wrong Time spent per month in hours and/or FTE‟s on invoice verification and recovery/reconciliation Percentage of invoices received: Electronically with summary information Electronically with detail level information Non-electronic or paper-based Time spent per month in hours to calculate chargebacks (when programs are in place) Estimated percentage of service provider service level credits that are wrong or inaccurate
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Time spent per month in hours to manage service level credit programs (when programs are in place) Time spent per month in hours dealing with contractual issues (e.g., researching the contract for specific deliverables, affirming scope, definitions, language, etc.) Time spent per month in hours dealing with or “rehashing” issues dealt with previously (e.g., re-addressing the same contractual problems, looking for the same information) Most of these are relatively “hard” metrics. The issue often is whether the governance organization has the information and/or time to capture and verify the metrics. Once the metrics are in hand, the governance team can perform a benefits calculation on potential performance improvements. As part of this it is also important to understand how much improvement is realistic to expect. There are no broad industry accepted outsourcing governance performance “benchmarks” available in the market. Invoice verification is a time consuming process for most outsourcing buyers, yet the magnitude of these projects warrant careful review of work performed and money spent with service providers. EquaTerra has captured cost and performance levels for these outsourcing governance operational metrics shown in Figure 5 during several years of client engagements. The recent market study findings add broader market context and validation to those findings. Both are represented below. Outsourcing governance metric
Level found in market study
Percent inaccurate/wrong invoices
9%
Invoices – electronic summary
33%
Invoices – electronic detail
40%
Invoices – non-electronic
27%
Percent inaccurate service level credits
11%
FTE equivalent staff in governance team
9
Hours spent verifying invoices/month
35
Hours spent to calculate chargebacks/month
41
Hours spent on contract review/month
44
Hours spent “rehashing”/month
34
Figure 5 – Common Outsourcing Governance Performance Metrics
Dealing with inaccurate invoices may seem a normal cost of doing business. In an outsourcing effort with a short-staffed outsourcing governance team, however, dealing with these inaccuracies can prove a huge and costly headache. The following is a typical scenario. First buyers have to expend a fair amount of effort to identify any potential discrepancies. When a discrepancy is found, supporting detail will determine if they should pay or dispute the invoice.
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Even if the supporting detail is provided electronically with the invoice, it usually involves reentering this information into spreadsheets to verify correct calculations. This can take weeks to investigate and resolve, and many times the service provider has to manually query their operational and billing systems for the information. Further complicating this issue, many outsourcing service providers negotiate a provision into client agreements stating that the buyer has a limited amount of time to dispute an invoice and to recover fees that were incorrectly paid (that is, 30 days to dispute, and 60 days to recover). After the specified time period, the money reverts back to the service providers, so the timeliness of information is critical. When making the decision to live with or fix these types of inefficiencies buyers need to understand the potential benefits from fixing them or at least lessening them. EquaTerra finds buyers often underestimate potential impact of invoice errors and missed service level credits. To help illustrate the potential benefits EquaTerra has developed an outsourcing governance benefits calculator (see Figure 6).
Figure 6 – EquaTerra Outsourcing Governance Benefits Calculator
The scenario represented in Figure 6 is a buyer with outsourcing relationships totaling $250M TCV over five years with three service providers. Using average numbers from the market study, assume the buyer has a total of nine FTE staff in the outsourcing governance team, with two
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focused on invoice verification and processing. Average invoicing accuracy is 91 percent. The buyer‟s goal is to reduce invoice errors by two percent and reduce service level credit errors by one percent. Because of those reductions, the buyer wants to redeploy staff previously remediating those errors and achieve a labor reduction of productivity improvement gain or 10 percent. If the buyer is able to achieve these relatively modest goals, the monthly bottom line savings exceed $130,000 and total potential savings exceeds $8M. This clearly illustrates the hard dollar value of improved outsourcing governance operational efficiency.
How are Governance Organizations Responding? Targeting lucrative cost savings and cost recovery from improved outsourcing governance efficiency is a laudable goal. The challenge is successful execution. EquaTerra finds that more outsourcing buyers appreciate the value of good governance, especially those in second generation or later outsourcing efforts. This was borne out in the results of a separate market study on global outsourcing trends that EquaTerra conducted 1Q08. This study found that the governance model was cited as the top critical success factor in next generation outsourcing efforts (see Figure 7). Buyers that recognize the importance of good governance are also dedicating more, or at least more skilled, resources to outsourcing governance efforts. More importantly they are looking at how to improve outsourcing governance capabilities rather than just devoting more bodies to its support.
Figure 7 – "Next Generation" Outsourcing's Critical Success Factors
There are many ways buyers can improve outsourcing governance capabilities. The most obvious is ensuring skilled and experienced staff are placed in key roles. Outsourcing governance must
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become a valued role and career path, not a transitory position or home of last resort to former members of outsourced functions. Buyers must also define clear roles for outsourcing governance team members and processes for outsourcing governance activities. Ad-hoc processes and roles are a prime cause of inefficiencies. To maximize cost savings, buyers must minimize the time and effort spent on administrative outsourcing governance activities while simultaneously improving the efficiency. A key means to do this is through process automation. EquaTerra finds that too much outsourcing governance work today is performed manually with the usual associated high levels of inaccuracies and overhead. Automation of outsourcing governance activities through the greater use of dedicated software tools (beyond Excel) offer some of the greatest potential long-term opportunities to improve efficiency and to help reduce costs. At the more strategic level buyers must ensure their outsourcing governance investment matches the intent of the outsourcing efforts being supported. A relatively straightforward “lift and shift” outsourcing effort focused on maximizing cost reduction does not require a large or complex outsourcing governance to support it. More strategic or transformational outsourcing focused on process improvement and innovation requires higher skills and deeper outsourcing governance capabilities.
How are Outsourcing Service Providers Responding? In some respects outsourcing service providers face competing goals when supporting their side of a buyer‟s outsourcing governance effort. From one perspective there is money to be made if a buyer is lax around tasks like invoice verification. If the client is unaware that an outsourcing service provider is not meeting its contractual obligations due to weak governance capabilities, the service provider does not have a strong, immediate incentive to point out the shortcomings. In this case no news is good news. Strategically, however, it is in the outsourcing service providers‟ best interests to work with clients that are skilled in outsourcing governance. When the service provider is held accountable the buyer is in a much better position to understand the value and benefits the service provider is delivering. Both sides are better able to proactively identify problems and work to remediate them before they grow and threaten the long term viability of outsourcing. As the scale, scope and complexity of outsourcing efforts grow this becomes even more critical. Service providers continue to improve the software applications and tools they use to support outsourcing governance. This benefits buyers but does not detract from the need for buyers to invest in their own outsourcing governance audit and automation. Minimally, provider tools do not support other provider tools. And, provider tools are not ideal to audit service level credits and verify invoices. The service providers‟ ability to automate and streamline the transmission of key operational data to the buyer will benefit both the buyer and the provider.
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The Advisor Perspective – Critical Points to Consider EquaTerra continues to find that poor or inadequately supported outsourcing governance are a root cause in underperforming outsourcing engagements. EquaTerra advisors polled in the 1Q08 EquaTerra Pulse survey offered the following advice to buyers on how to improve their outsourcing governance capabilities. “Continually check to ensure the two parties are aligned. Regularly assess the capability of your governance team and audit the level of adherence to the governance processes. Do you have the right people with the right skills?” “Buyers must remember they are not outsourcing their accountability. They have to find that line between „managing‟ and „governing‟ (oversight) – a difficult mandate for line managers who are thrust into governance.” “Don‟t force fit individuals into governance roles - identify the required skills and enlist resources appropriately.” “Service credits are not a punitive mechanism. Relationships should not be adversarial. Rather, you should be looking to encourage the right behaviors through a „win-win‟ approach.” “Don‟t over-engineer governance. Make governance something that is real, practical, and can be implemented. Focus your resources on the biggest impact areas by using experienced resources and advisors. Use automated tools to accelerate your governance resources.” “Go for a more integrated approach and a true partnership, instead of only mentioning partnership but managing the relationship as a traditional buyer/seller situation.” “Make sure to implement state-of-the art technology to support governance as this will not only increase effectiveness but also reduce governance expenses and thus positively impact the baseline of the outsourcing initiative.” Relative to the last point, buyers need to leverage outsourcing governance software tools and applications to assess their outsourcing governance operations. Scenarios presented above show the tangible cost savings buyers can gain from improving the efficiency of administrative tasks. More importantly, improving outsourcing governance capabilities creates a foundation for improving the more strategic and critical aspects of outsourcing governance around relationship management and value realization.
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Figure 8 – Mapping the Work of the Outsourcing Governance Organization
Figure 8 illustrates the totality of outsourcing governance work. EquaTerra estimates that 50 percent of governance work falls in this lower left/transactional quadrant and that it is possible to automate up to 40 percent of that work. Automating invoice verification, calculating service level credits, and collecting information and reporting accounts for much of this automation. Of the remaining 50 percent of governance work, EquaTerra believes that another 40 percent is consultative and 10 percent strategic. There is also the opportunity to automate some amount of this work by providing scorecards to highlight issues and document repositories for quick reference. This will also aid in helping buyers perform more rapid and quality decision making. There are important benefits buyers can gain once they have automated the transactional tasks and focused more on consultative and strategic work. One is to address the issue of consumption management. Regardless of whether a buyer has to deal with base service fees with additional resource charges (ARCs) and reduced resource credits (RRCs), the buyer will pay more if it consumes more resources from the service provider. Most organizations outsource to get to a „future state‟ often with a targeted cost reduction. This means that buyers want to shift the delivery of services from old, manual delivery mechanisms to self-service, and automated delivery mechanisms. The outsourcing business case is based on a set of assumptions around consumption patterns, and more specifically, the adoption of the new services (e.g., HR self-service applications, improved help desk support, access to new knowledge based services). Buyers that do not have adequate consumption management processes and tools in place – and therefore visibility into actual consumption levels of services are flying blind. If new services offered are improved, users are naturally likely to consume more of them, driving up outsourcing costs.
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Using invoice verification as an example, even if the buyer receives the invoice and consumption detail that supports fees charged, it will not know which resources are out of variance with business case assumptions. It will also not know which users or business units are the culprit. This highlights that the more a deal depends on transformation and the adoption of new services, the more critical it is to have demand forecasting and consumption management tools in place. Buyers are increasingly developing higher-level relationships with their outsourcing service providers for the purpose of transforming their back-office functions. The implication for service provider relationships is that buyers must select a service provider not only for its operational effectiveness to cut costs, but as a strategic business partner who understands the industry and the key to help you achieve your business objectives. Instead of telling its service provider what to do and how to do it, buyers inform the providers of their business objectives and let the service provider use its recommended approach, given its expertise and knowledge of best practices. So what does this mean from a governance capability perspective? It means that buyer skill sets have to include things like program management, change management and strong communications capabilities. It also means that buyers will need to facilitate regular, structured joint-planning sessions between the collaborative provider(s), the retained organizations, and its business units, in order to create value. If the buyer‟s governance team has the wrong skill set, or is totally bogged down doing work such as verifying invoices and performance reports, it will not have the skills, or time to effectively facilitate the innovation necessary to accomplish transformational objectives. EquaTerra typically sees a relatively small amount of savings from operational efficiencies and many millions of dollars in benefit expected from arriving at that future state.
Conclusion As typical buyers expand their outsourcing efforts in terms of function, scope, scale, number of service providers and global delivery, good outsourcing governance is more important than ever to outsourcing success. While EquaTerra sees a growing appreciation of the importance of governance to outsourcing success, it still finds that many buyers struggle to deploy the adequate resources needed to support outsourcing governance efforts. Buyers must build a stronger business case to garner the investment required to improve capabilities, but must also enhance the performance of current operations. Focusing on improving the efficiency and effectiveness of administrative outsourcing governance operations is one area where buyers can both save money and free up resources for more strategic governance. Buyers should review their options to improve capabilities in these areas, including the greater use of process automation through support software applications and solutions.
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About EquaSiis
Media Contacts
EquaSiis, an EquaTerra company, provides software and services that
Ron Walker, EquaSiis
improve the business support services lifestyle for shared services,
+1 858 486 6035
outsourcing practitioners and service providers. The software,
[email protected]
EquaSiis Workbench and EquaSiis Enterprise, is a framework for collaboration used during the service delivery assessment and sourcing process to assist in analysis and decision making for shared services or outsourcing. EquaSiis provides intelligence and
Lee Ann Moore, EquaTerra +1 713 669 9292 [email protected]
optimization for the delivery of business support services across the entire organization. The company also offers service providers market intelligence, research, customer satisfaction and trending data through its Insights group. For more details about EquaSiis‟ research offerings, please contact Stan Lepeak, [email protected]. www.equasiis.com
Copyright © EquaTerra 2009. All rights reserved. The prior written permission of EquaTerra is required to reproduce all or any part of this document, in any form whether physical or electronic, for any purpose.
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Effective Governance Yields Outsourcing Value Mike Beals, Vice President, EquaSiis Enterprise Stan Lepeak, Managing Director, EquaSiis Global Research The value and importance of outsourcing governance in an outsourcing effort is in many ways self-evident and intuitive. Outsourcing governance is the vehicle through which buyers can ensure the benefit is achieved. Given the increasingly complex nature (e.g., multi-sourced, multitower, multi-geography) of outsourcing today, good governance is more important than ever. EquaTerra continues to find, however, that many buyers struggle with their outsourcing governance efforts. This is due to inadequate resources, skills, processes and tools. It is also due to the lack of information or inability to build a solid business case required to make the investment to improve these capabilities. One aspect of developing such a business case is clearly assessing and understanding current state governance capabilities and efficiencies or inefficiencies as the case may be. This Market Assessment paper reviews the results from recent EquaTerra research that assesses and measures the operational performance characteristics of buyers managing major outsourcing efforts.
The Details Outsourcing Governance Overview EquaTerra has long stressed the role and importance of outsourcing governance to the success of outsourcing efforts. EquaTerra‟s direct client experience and market research studies have found a direct correlation between the quantity and quality of governance investments and the success and satisfaction of outsourcing efforts. This is not to imply that the more a buyer spends on governance, they happier they become. Rather it means that there is a minimum investment threshold needed to ensure that buyers can field and support adequate and skilled outsourcing governance resources, processes and tools. EquaTerra has identified six key capabilities that enable outsourcing governance success. These capabilities can be categorized further and are mapped to the competing priorities that buyers must balance in their governance efforts: risk mitigation against desires for value realization. These categories are highlighted below. Risk Mitigation Finance and commercial management: the ability to ensure contractual obligations are being met by both parties and verifying the invoice reflects the service quality received and provisioned Compliance management: ensuring effective compliance with regulatory, safety and privacy requirements Issue and problem management: appropriate mitigation of issues and resolution
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Value Realization Change and program management: manage demand for services as well as leverage and focus on service provider capabilities Service quality management: create optimization through standardization, defined performance and satisfaction levels Communication management: business requirements and relationship alignment Both risk mitigation and value realization are critical to outsourcing success. Outsourcing buyers tend to focus on the risk mitigation issues spending much of their time and energy on contractual or financial issues leaving very little time or focus on the areas that create the most value. Failure to perform either well will lead to value “leakage” in the outsourcing effort. This leakage can take the form of dollars spent unnecessarily in governance, missed cost savings opportunities, or the failure to achieve broader business case goals like process improvement and innovation. Figure 1 illustrates the potential value leakage from poor or inadequate outsourcing governance.
Figure 1 – Potential Value Leakage from Poor Outsourcing Governance
Minimizing leakage is critical. Effective risk mitigation can help ensure that costs remain in line with projected usage and costs. Creating efficiencies in the risk management function can reduce the cost of outsourcing governance itself. These cost savings can flow to the bottom line or buyers can reinvest them in improving outsourcing governance capabilities. It is easier to measure the “hard dollar” (or € or £) costs and benefits of good governance than its impact on value creation. Ensuring outsourcing achieves the intended savings or the projected business case will also resonate with financial and executive management outside of the governance organization.
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Gaining the support of these constituencies is needed to get the approval for the investments in governance and tools required to improve outsourcing governance capabilities and ultimately the value achieved from outsourcing. Seeking to better quantify the potential benefits from effective governance, EquaTerra launched a market research study (see Figure 2) to complement and extend findings from its own client outsourcing governance experiences. The balance of this paper will review and interpret the results of that study. For more information on general outsourcing governance best practices, please refer to the following Perspective paper as well as to the EquaTerra Library. EquaTerra conducted this market study in the first quarter of 2008. It surveyed over 300 North American buyers actively engaged in governing and managing their organizations’ information technology and business process outsourcing efforts. Seventy-nine percent of respondents were director or manager level, with the balance in vice-president or executive management roles. Twenty-six percent of respondents were from organizations with $100M to $1B in annual revenues with the rest coming from larger firms. Twenty-nine percent of respondents were from firms with revenues in excess of $25B annually. All major industries were represented led by banking, financial services and insurance (18 percent of respondents) and manufacturing (13 percent). Figure 2 – Study Method & Demographics
Market Study Findings Some level of outsourcing governance inefficiencies will exist in any organization. The magnitude depends both on the scope and scale of the outsourcing effort and the sophistication of the buyer‟s outsourcing governance capabilities. The market study assessed outsourcing governance activities in ITO and BPO (see Figure 3). Average total contract value (TCV) under management by study respondents was in excess of $100M. Outsourced
Outsourced
In the process
No plans to
2+ years
< 2 years
of outsourcing
outsource
Information Technology
59%
17%
10%
14%
Finance, Accounting & Administration
24%
12%
9%
55%
Human Resources
23%
10%
13%
54%
Procurement
15%
11%
17%
56%
Customer Care/Call Center
37%
16%
14%
33%
Industry Specific Services
35%
16%
10%
39%
Functional Area
Figure 3 – Levels of Outsourcing
Prior EquaTerra research and client experiences have found that buyers tend to invest more in outsourcing governance, or minimally make better investment choices, after they have been in outsourcing efforts for more than two years. Outsourcing satisfaction levels also tend to rise after
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two years. Market study respondents included a mix of buyers who had outsourced both greater and less than a two year time frame. Respondents had reasonable though not exceptional success in achieving the benefits sought from outsourcing. On a scale of one to five, where one represented benefits not at all achieved and five represented fully achieved, responses ranged between 3.1 and 3.6. Benefits sought included the usual mix of cost reduction, cost avoidance, process improvement and seeking to redirect focus to more strategic activities. Most respondents planned to expand their existing outsourcing efforts either in the same or new functional areas or into new business units and geographies. Twenty-two percent planned to maintain current levels of outsourcing while just four percent planned to curtail or eliminate their outsourcing efforts. Arguably, the buyer sample measured in this market study represents “typical” outsourcing users in today‟s market. Outsourcing governance spend levels fell within the ranges EquaTerra typically finds in outsourcing efforts of this profile (see Figure 4). Forty-one percent of respondents estimated their outsourcing governance spend at three to five percent of TCV annually. A full 20 percent of respondents did not know their annual spend levels or spend was not tracked. Given the potentially large size of outsourcing governance spend (basic math shows that three percent of a $100M contract equates to $3M spent annually) buyers that do not know or do not track outsourcing governance spend are in the dark around the details of a large annual expenditure. Minimally, these outsourcing governance spend numbers highlight the volume of potential leakage that can occur in a typical ITO or BPO effort – not to mention the savings often sought in a contract of this magnitude. While measuring total outsourcing governance spend is important, it is more valuable to understand where the funds are spent and tracking the value of that spend. As with all business functions, there is much administrative work, or transaction-type work, in outsourcing governance. The degree to which buyers can streamline or limit the time and effort spent on these tasks determines how much they can focus on more strategic aspects of outsourcing governance – activities to support value creation – while simultaneously maintaining or lowering cost levels. Buyers need to assess the costs associated with these administrative tasks as well as their performance levels. As the outsourcing governance marketplace matures, buyers will be able to comparatively assess or “benchmark” their cost and performance levels against those of their peers EquaTerra has developed assessment diagnostic for outsourcing governance to help buyers better assess their performance against those of their peers.
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Figure 4 – Outsourcing Governance Annual Spend as Percent of TCV
There are a number of key operational metrics associated with outsourcing governance administration. EquaTerra reviews these metrics when helping clients assess the efficiency of their governance operations. They include the following: Number of FTE‟s in the outsourcing governance organization and their fully loaded costs Number of service providers and service provider relationships being managed Invoices received monthly from outsourcing service providers Estimated percentage of invoices that are inaccurate or wrong Time spent per month in hours and/or FTE‟s on invoice verification and recovery/reconciliation Percentage of invoices received: Electronically with summary information Electronically with detail level information Non-electronic or paper-based Time spent per month in hours to calculate chargebacks (when programs are in place) Estimated percentage of service provider service level credits that are wrong or inaccurate
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Time spent per month in hours to manage service level credit programs (when programs are in place) Time spent per month in hours dealing with contractual issues (e.g., researching the contract for specific deliverables, affirming scope, definitions, language, etc.) Time spent per month in hours dealing with or “rehashing” issues dealt with previously (e.g., re-addressing the same contractual problems, looking for the same information) Most of these are relatively “hard” metrics. The issue often is whether the governance organization has the information and/or time to capture and verify the metrics. Once the metrics are in hand, the governance team can perform a benefits calculation on potential performance improvements. As part of this it is also important to understand how much improvement is realistic to expect. There are no broad industry accepted outsourcing governance performance “benchmarks” available in the market. Invoice verification is a time consuming process for most outsourcing buyers, yet the magnitude of these projects warrant careful review of work performed and money spent with service providers. EquaTerra has captured cost and performance levels for these outsourcing governance operational metrics shown in Figure 5 during several years of client engagements. The recent market study findings add broader market context and validation to those findings. Both are represented below. Outsourcing governance metric
Level found in market study
Percent inaccurate/wrong invoices
9%
Invoices – electronic summary
33%
Invoices – electronic detail
40%
Invoices – non-electronic
27%
Percent inaccurate service level credits
11%
FTE equivalent staff in governance team
9
Hours spent verifying invoices/month
35
Hours spent to calculate chargebacks/month
41
Hours spent on contract review/month
44
Hours spent “rehashing”/month
34
Figure 5 – Common Outsourcing Governance Performance Metrics
Dealing with inaccurate invoices may seem a normal cost of doing business. In an outsourcing effort with a short-staffed outsourcing governance team, however, dealing with these inaccuracies can prove a huge and costly headache. The following is a typical scenario. First buyers have to expend a fair amount of effort to identify any potential discrepancies. When a discrepancy is found, supporting detail will determine if they should pay or dispute the invoice.
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Even if the supporting detail is provided electronically with the invoice, it usually involves reentering this information into spreadsheets to verify correct calculations. This can take weeks to investigate and resolve, and many times the service provider has to manually query their operational and billing systems for the information. Further complicating this issue, many outsourcing service providers negotiate a provision into client agreements stating that the buyer has a limited amount of time to dispute an invoice and to recover fees that were incorrectly paid (that is, 30 days to dispute, and 60 days to recover). After the specified time period, the money reverts back to the service providers, so the timeliness of information is critical. When making the decision to live with or fix these types of inefficiencies buyers need to understand the potential benefits from fixing them or at least lessening them. EquaTerra finds buyers often underestimate potential impact of invoice errors and missed service level credits. To help illustrate the potential benefits EquaTerra has developed an outsourcing governance benefits calculator (see Figure 6).
Figure 6 – EquaTerra Outsourcing Governance Benefits Calculator
The scenario represented in Figure 6 is a buyer with outsourcing relationships totaling $250M TCV over five years with three service providers. Using average numbers from the market study, assume the buyer has a total of nine FTE staff in the outsourcing governance team, with two
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focused on invoice verification and processing. Average invoicing accuracy is 91 percent. The buyer‟s goal is to reduce invoice errors by two percent and reduce service level credit errors by one percent. Because of those reductions, the buyer wants to redeploy staff previously remediating those errors and achieve a labor reduction of productivity improvement gain or 10 percent. If the buyer is able to achieve these relatively modest goals, the monthly bottom line savings exceed $130,000 and total potential savings exceeds $8M. This clearly illustrates the hard dollar value of improved outsourcing governance operational efficiency.
How are Governance Organizations Responding? Targeting lucrative cost savings and cost recovery from improved outsourcing governance efficiency is a laudable goal. The challenge is successful execution. EquaTerra finds that more outsourcing buyers appreciate the value of good governance, especially those in second generation or later outsourcing efforts. This was borne out in the results of a separate market study on global outsourcing trends that EquaTerra conducted 1Q08. This study found that the governance model was cited as the top critical success factor in next generation outsourcing efforts (see Figure 7). Buyers that recognize the importance of good governance are also dedicating more, or at least more skilled, resources to outsourcing governance efforts. More importantly they are looking at how to improve outsourcing governance capabilities rather than just devoting more bodies to its support.
Figure 7 – "Next Generation" Outsourcing's Critical Success Factors
There are many ways buyers can improve outsourcing governance capabilities. The most obvious is ensuring skilled and experienced staff are placed in key roles. Outsourcing governance must
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become a valued role and career path, not a transitory position or home of last resort to former members of outsourced functions. Buyers must also define clear roles for outsourcing governance team members and processes for outsourcing governance activities. Ad-hoc processes and roles are a prime cause of inefficiencies. To maximize cost savings, buyers must minimize the time and effort spent on administrative outsourcing governance activities while simultaneously improving the efficiency. A key means to do this is through process automation. EquaTerra finds that too much outsourcing governance work today is performed manually with the usual associated high levels of inaccuracies and overhead. Automation of outsourcing governance activities through the greater use of dedicated software tools (beyond Excel) offer some of the greatest potential long-term opportunities to improve efficiency and to help reduce costs. At the more strategic level buyers must ensure their outsourcing governance investment matches the intent of the outsourcing efforts being supported. A relatively straightforward “lift and shift” outsourcing effort focused on maximizing cost reduction does not require a large or complex outsourcing governance to support it. More strategic or transformational outsourcing focused on process improvement and innovation requires higher skills and deeper outsourcing governance capabilities.
How are Outsourcing Service Providers Responding? In some respects outsourcing service providers face competing goals when supporting their side of a buyer‟s outsourcing governance effort. From one perspective there is money to be made if a buyer is lax around tasks like invoice verification. If the client is unaware that an outsourcing service provider is not meeting its contractual obligations due to weak governance capabilities, the service provider does not have a strong, immediate incentive to point out the shortcomings. In this case no news is good news. Strategically, however, it is in the outsourcing service providers‟ best interests to work with clients that are skilled in outsourcing governance. When the service provider is held accountable the buyer is in a much better position to understand the value and benefits the service provider is delivering. Both sides are better able to proactively identify problems and work to remediate them before they grow and threaten the long term viability of outsourcing. As the scale, scope and complexity of outsourcing efforts grow this becomes even more critical. Service providers continue to improve the software applications and tools they use to support outsourcing governance. This benefits buyers but does not detract from the need for buyers to invest in their own outsourcing governance audit and automation. Minimally, provider tools do not support other provider tools. And, provider tools are not ideal to audit service level credits and verify invoices. The service providers‟ ability to automate and streamline the transmission of key operational data to the buyer will benefit both the buyer and the provider.
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The Advisor Perspective – Critical Points to Consider EquaTerra continues to find that poor or inadequately supported outsourcing governance are a root cause in underperforming outsourcing engagements. EquaTerra advisors polled in the 1Q08 EquaTerra Pulse survey offered the following advice to buyers on how to improve their outsourcing governance capabilities. “Continually check to ensure the two parties are aligned. Regularly assess the capability of your governance team and audit the level of adherence to the governance processes. Do you have the right people with the right skills?” “Buyers must remember they are not outsourcing their accountability. They have to find that line between „managing‟ and „governing‟ (oversight) – a difficult mandate for line managers who are thrust into governance.” “Don‟t force fit individuals into governance roles - identify the required skills and enlist resources appropriately.” “Service credits are not a punitive mechanism. Relationships should not be adversarial. Rather, you should be looking to encourage the right behaviors through a „win-win‟ approach.” “Don‟t over-engineer governance. Make governance something that is real, practical, and can be implemented. Focus your resources on the biggest impact areas by using experienced resources and advisors. Use automated tools to accelerate your governance resources.” “Go for a more integrated approach and a true partnership, instead of only mentioning partnership but managing the relationship as a traditional buyer/seller situation.” “Make sure to implement state-of-the art technology to support governance as this will not only increase effectiveness but also reduce governance expenses and thus positively impact the baseline of the outsourcing initiative.” Relative to the last point, buyers need to leverage outsourcing governance software tools and applications to assess their outsourcing governance operations. Scenarios presented above show the tangible cost savings buyers can gain from improving the efficiency of administrative tasks. More importantly, improving outsourcing governance capabilities creates a foundation for improving the more strategic and critical aspects of outsourcing governance around relationship management and value realization.
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Figure 8 – Mapping the Work of the Outsourcing Governance Organization
Figure 8 illustrates the totality of outsourcing governance work. EquaTerra estimates that 50 percent of governance work falls in this lower left/transactional quadrant and that it is possible to automate up to 40 percent of that work. Automating invoice verification, calculating service level credits, and collecting information and reporting accounts for much of this automation. Of the remaining 50 percent of governance work, EquaTerra believes that another 40 percent is consultative and 10 percent strategic. There is also the opportunity to automate some amount of this work by providing scorecards to highlight issues and document repositories for quick reference. This will also aid in helping buyers perform more rapid and quality decision making. There are important benefits buyers can gain once they have automated the transactional tasks and focused more on consultative and strategic work. One is to address the issue of consumption management. Regardless of whether a buyer has to deal with base service fees with additional resource charges (ARCs) and reduced resource credits (RRCs), the buyer will pay more if it consumes more resources from the service provider. Most organizations outsource to get to a „future state‟ often with a targeted cost reduction. This means that buyers want to shift the delivery of services from old, manual delivery mechanisms to self-service, and automated delivery mechanisms. The outsourcing business case is based on a set of assumptions around consumption patterns, and more specifically, the adoption of the new services (e.g., HR self-service applications, improved help desk support, access to new knowledge based services). Buyers that do not have adequate consumption management processes and tools in place – and therefore visibility into actual consumption levels of services are flying blind. If new services offered are improved, users are naturally likely to consume more of them, driving up outsourcing costs.
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Using invoice verification as an example, even if the buyer receives the invoice and consumption detail that supports fees charged, it will not know which resources are out of variance with business case assumptions. It will also not know which users or business units are the culprit. This highlights that the more a deal depends on transformation and the adoption of new services, the more critical it is to have demand forecasting and consumption management tools in place. Buyers are increasingly developing higher-level relationships with their outsourcing service providers for the purpose of transforming their back-office functions. The implication for service provider relationships is that buyers must select a service provider not only for its operational effectiveness to cut costs, but as a strategic business partner who understands the industry and the key to help you achieve your business objectives. Instead of telling its service provider what to do and how to do it, buyers inform the providers of their business objectives and let the service provider use its recommended approach, given its expertise and knowledge of best practices. So what does this mean from a governance capability perspective? It means that buyer skill sets have to include things like program management, change management and strong communications capabilities. It also means that buyers will need to facilitate regular, structured joint-planning sessions between the collaborative provider(s), the retained organizations, and its business units, in order to create value. If the buyer‟s governance team has the wrong skill set, or is totally bogged down doing work such as verifying invoices and performance reports, it will not have the skills, or time to effectively facilitate the innovation necessary to accomplish transformational objectives. EquaTerra typically sees a relatively small amount of savings from operational efficiencies and many millions of dollars in benefit expected from arriving at that future state.
Conclusion As typical buyers expand their outsourcing efforts in terms of function, scope, scale, number of service providers and global delivery, good outsourcing governance is more important than ever to outsourcing success. While EquaTerra sees a growing appreciation of the importance of governance to outsourcing success, it still finds that many buyers struggle to deploy the adequate resources needed to support outsourcing governance efforts. Buyers must build a stronger business case to garner the investment required to improve capabilities, but must also enhance the performance of current operations. Focusing on improving the efficiency and effectiveness of administrative outsourcing governance operations is one area where buyers can both save money and free up resources for more strategic governance. Buyers should review their options to improve capabilities in these areas, including the greater use of process automation through support software applications and solutions.
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About EquaSiis
Media Contacts
EquaSiis, an EquaTerra company, provides software and services that
Ron Walker, EquaSiis
improve the business support services lifestyle for shared services,
+1 858 486 6035
outsourcing practitioners and service providers. The software,
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EquaSiis Workbench and EquaSiis Enterprise, is a framework for collaboration used during the service delivery assessment and sourcing process to assist in analysis and decision making for shared services or outsourcing. EquaSiis provides intelligence and
Lee Ann Moore, EquaTerra +1 713 669 9292 [email protected]
optimization for the delivery of business support services across the entire organization. The company also offers service providers market intelligence, research, customer satisfaction and trending data through its Insights group. For more details about EquaSiis‟ research offerings, please contact Stan Lepeak, [email protected]. www.equasiis.com
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