Senior executives in corporations, contend that outsourcing is not strictly a cost-cutting exercise; it is a business-value creator. If they implement it properly, they can even point to stock price gains to prove their point. Sometime back, that would have settled the debate. For more than three decades, business-value creation has meant short-term stock price gains. For a CEO, that meant playing to the stock analysts’ gallery. And analysts love cost-cutting exercises. From GE’s Jack Welch to JP Morgan’s Jamie Dimon — CEOs focused on cutting fat have garnered much applause. For all practical purposes, value creation was cost reduction.
That is in all likelihood changing. The new thinking, exemplified most notably by Jeffrey Immelt, Jack Welch’s successor, is simply this: Don’t play to the stock market’s whims; focus long-term.
Most outsourcing rules and best practices of today may not directly fit into the new business requirements. Increasingly, experts see signs of some outsourcing deals going astray, citing the possible culprits as problems with a service providers’ capabilities (or the lack of it), lack of governance models, offshoring challenges, cultural issues and so on. Yet, the real reason is perhaps this: Organizations are trying to achieve tomorrow’s business goals with yesterday’s principles.
When Efficiency was the Objective
The traditional cost centers such as HR, finance and accounting and some low-value, high-volume customer-facing functions have been the most frequently outsourced activities. In such services, reducing cost has been the objective, though the means of achieving that have evolved over time.
Customers are trying to achieve tomorrow’s business goals with yesterday’s principles.
Initially, the business models were built on simple manpower replacement. This led to a pricing model that compared directly with what it replaced: The cost to the company per employee. In third-party outsourcing, this was translated into pricing per Full-Time-Equivalent (FTE).
A pattern was established where service providers delivered the promised cost savings. But this method of pricing for the input — rather than output or quality — did not spur service providers to gain efficiency.
That, in turn, led to the practice of paying the service provider for the smallest unit of work, usually per transaction. “Pricing models have evolved over the years from being labor arbitrage focused to efficiency focused,” says Anurag Jain, Head, BPO Business, Perot Systems.
The model — the much-touted transaction-based pricing model — is the result (and iteratively, the cause) of a series of improvements such as process simplification, application of technology, standardization and finally a combination of all these leading to what is called platform BPO.
Transaction-based pricing offers significant advantages over the variations of Time and Material (T&M) based pricing where service providers charge for manpower employed per unit of time. In transaction-based pricing, since the service provider is paid for quantity of work, it breeds efficiency. It also helps the customer, as iGate’s CEO Phaneesh Murthy points out, “to compare the service providers better.”
A Change of Approach
“The math of transaction-based pricing is not merely about dividing an FTE cost by the production per year — it is a whole different way of looking at managing delivery,” says Perot Systems’ Jain. “It is about accurate forecasting, staffing, shift management, productivity and production management,” he adds. It requires a far more structured approach to managing the business.
Whether it is process consulting, applying the right application of technology, or improving productivity — these steps offer enhancements in discrete processes. That helps a service provider trim its cost per transaction, and in turn to offer its customers a better per-transaction price.
In many noncore, support activities — the cost centers — being efficient is synonymous with being effective. Not surprisingly, this pricing is till in vogue and will remain so for these activities.
“There is a greater desire to try out innovative pricing models like gain sharing, though in reality there are very few contracts signed today with [it].”
— Robert Finkel, Attorney, Milbank, Tweed, Hadley & Mcloy LLP
“In HR outsourcing, there is a tendency to follow transaction-based pricing,” says Robert M. Finkel, New York-based Partner in the outsourcing practice at Milbank, Tweed, Hadley & McCloy.
Ultimately, transaction-based pricing (and the focus on per-transaction cost by the service providers) helps providers (and in turn their customers) achieve better process efficiency and nothing more.
