Until 2004, business-process outsourcing was commonly practiced but rarely preached. Discreet applications such as payroll or other forms of third-party financial-transaction processing didn’t garner much media attention. But as we begin to forecast developments in 2005, the impact of BPO is much more substantial and pervasive.

BPO is the fastest-growing type of outsourcing, as measured both by size of the contracts and the number of deals. We are witnessing growth of approximately 20% per year in the number of contracts overall and in the number of contracts with values of $100 million or more. Average BPO contract values are also increasing. Over the past 12 months, we have seen on average the value of each BPO contract increase by 18%, while in the top 20 contracts and the top 50 contracts we are witnessing even higher increases in average contract value, with increases of approximately 40%.

On a year-over-year basis, BPO contract value awarded globally has increased by 43%, compared to just 3% in IT-outsourcing contract value. Overall, BPO now accounts for 36% of global outsourcing contract value, compared to 29% over the same period of 2003. Indeed, the impact of BPO has been even more pronounced in North America, where during the first half of 2004 BPO contract value awarded exceeded IT-outsourcing contract value.

Why is this happening? Well, it isn’t due to a fundamental change in the service mix, though the continuing emergence of transformational customer-management-services contracts is certainly one factor. Overall, it shows that organizations are becoming more comfortable with BPO and that the scope of BPO contracts is increasing, and there is no reason to believe that this trend will not continue well into 2005.

Let’s look at how BPO is likely to continue its maturation process in 2005:

Atlantic Crossings

The pattern of BPO activity by sector has been increasingly diverging between North America and Europe during 2004.

A year ago, the government market, particularly the state and local government sector, was the most important BPO market in both North America and Europe. However, while the state and local government sector has retained its importance in North America, the level of BPO contract activity has fallen away sharply in U.K. local government over the past 12 months. The BPO market within U.K. central government is moving to fill this gap, and there are emerging opportunities in back-office processes and in document and case management in U.K. central government. The trend for 2005 is that central and federal BPO activity will grow in strength and begin to overtake the level of activity in local government worldwide.

However, in North America the major growth in BPO contract activity in 2004 has been in the utilities and telecom operator sectors. This increased contract activity was driven by a need for transformation of customer-care services within the major utilities and telecoms operators. High-profile contracts include those at TXU in the utilities sector and at Sprint and Nextel in the telecom sector. In 2005, it is time for transformational customer-care projects to further penetrate the North American market.

In Europe, the pattern of growth in 2004 was dominated by considerable increases in BPO contract activity in the financial services and manufacturing sectors. The BPO activity in the European financial-services sector is predominantly concentrated around middle-office service silos, with high activity in the outsourcing of policy-services administration by life-insurance companies. However, it is the banking sector, rather than the insurance sector, that accounted for 65% of European financial-services BPO contract value awarded over the past 12 months. This growth will continue in 2005, as some of the key European retail banks are studying how to apply BPO to achieve service transformation.

The basic profile of the BPO market by service type has remained relatively static during 2004, with the market continuing to be dominated by front-office and industry-specific services rather than back-office support functions such as HR outsourcing and finance and accounting services. However, this masks a fundamental shift in requirement. The market for traditional, standalone, customer-management services is being replaced by a requirement for customer-management services to become more industry-specific and reach deeper into the client organization. Hence, there is a corresponding shift in the market in favor of industry-specific, middle-office services that include an element of customer-handling capability combined with industry-specific processing services.

Again, there is still a difference in emphasis between North America and Europe by service type, with back-office BPO accounting for 29% of contract activity in North America, compared to just 16% in Europe.

In addition, while back-office BPO activity is still more important in North America than in Europe, there are signs of industry-specific BPO contract activity becoming more important in North America. Middle office was the fastest-growing area of the North American BPO market over the past 12 months, which leads us to suspect that front- and middle-office industry-specific BPO will increase in importance in North America during 2005.

HR outsourcing will remain a key growth opportunity in 2005 in both the U.S. and European markets. HR outsourcing adoption is led by the manufacturing, retail, and financial-services sectors, followed by government and transportation. The level of F&A (finance and accounting) outsourcing has shown some growth in North America during 2004, but it remains relatively disappointing in Europe and overall. Nonetheless, we are seeing increasing vendor activity in particular niches within F&A, such as collections, which often has a strong offshore delivery component, and this area will strengthen during 2005, though the overall adoption of full-scope F&A outsourcing may continue to disappoint.

Rise Of Multi-BPO

So far we’ve looked mainly at the major BPO opportunities. However, there are also other areas that show potential in the medium term, as indicated by a key contract signing or by a number of relatively low-value contracts at present.

First, there is the question of the multiprocess back-office covering HR and F&A and, in some instances, indirect-procurement BPO. So far, organizations have been very reticent to outsource multiple back-office processes to a single supplier, preferring to minimize risk through a best-of-breed approach. However, it’s possible that Exult’s letter of intent for a combination of HR and F&A outsourcing services from Grupo Semco in Brazil could be the start of a wider willingness to adopt multiple back-office services from a single supplier during 2005. Nonetheless, this trend is still in the earliest stages.

In addition, indirect procurement services, albeit from a small base, are now growing more rapidly than HR outsourcing or F&A outsourcing. Examples of indirect-procurement BPO contracts in the last quarter include:
- An employee travel procurement contract between EDS and the U.S. Department of Agriculture
- An extended procurement contract between Xchanging and BAE Systems in Europe.

Within HR, outsourcing pan-European payroll has been slow to take off, but in the last quarter there have been several pan-European payroll contract wins by Ceridian, and this service is finally starting to be adopted on a more significant scale.

While there traditionally has been and continues to be a high level of healthcare-related activity in the U.S. in the form of Medicare and Medicaid administration services, more direct forms of healthcare delivery are also promised. Intellicare’s contract for telephone triage services could be the start of developments in this area during 2005.

The sectors showing the highest BPO contract value growth over the past 12 months differ between North America and Europe, with customer-care transformation in the utilities and telecoms sectors driving contract growth in North America, while industry-specific services in the financial-services sector and back-office processing in the manufacturing sector are driving growth in Europe. In 2005, we expect to see customer-care transformations becoming more commonplace, while the financial-services sector will continue to be the dominant sector for BPO in Europe.

Within HR outsourcing, the pattern of activity by sector has been relatively well established for some time, but the retail sector has emerged as a major new source of demand over the past year. Elsewhere in back-office services, indirect-procurement BPO is proving to be a solid market from small beginnings, pan-European payroll services are showing increasing uptake, and Exult has recently been awarded a contract for combined HR and F&A outsourcing services, which may show that some organizations are finally prepared to outsource combinations of back-office services.

The BPO Mix

So, what have been the developments in use of offshore and nearshore BPO delivery patterns during 2004 and how will these change in 2005? Offshore BPO delivery still accounts for approximately 2% of global BPO-market delivery by value and is dominated by contact-center services. Elsewhere, processes delivered from offshore tend to be limited sub-processes rather than major end-to-end services.

This is unlikely to change dramatically in 2005, though there are two factors that are increasing the move of services offshore. First, some of the early industry-specific BPO deals have now matured to a stage after four or five years where significant proportions of these processes can be transferred offshore. Second, some of the major captive BPO service centers in India are beginning to change hands, and as these delivery vehicles become available to vendors, they will assist them in implementing a step-change in the sophistication of their offshore-delivery capability, making these offerings more attractive to buyers by the end of 2005.

Similarly, onshore shared-services centers will increasingly be outsourced as organizations seek to invigorate existing in-house shared-services centers. Initially the delivery capability will remain onshore, but over the coming years there will be a tendency for these centers to become part of multishore delivery vehicles serving a range of clients. Nearshore centers increasingly will be important in areas such as HR outsourcing in delivering pan-European services.

However, it is important for new clients to bear in mind that it may not be a good idea to jump straight to a multishore or offshore model in the case of major BPO contracts. Instead, they may be best served by adopting a model of continuous service improvement off-site, followed by a more gradual transfer to a multishore model. The early BPO contracts may be ready to do this, and more sophisticated offshore BPO delivery capability is certain to come in 2005, but clients should be careful to move at a pace that guarantees ongoing customer-service improvements as well as process-cost improvement.

If you’re preparing BPO RFPs, make sure to emphasize that improved customer service takes precedence over the cost reductions in excess of 20% that you are certain to achieve. Good luck in 2005.