How to Navigate the 'Outsourcing or Shared Services' Maze

SSON News and Analysis
Posted: 07/09/2012

Impact of Globalization

Globalization is driving change within organizations at unprecedented levels as global networks of customers and suppliers are forcing companies to review how services are delivered. As a result, the debate over whether operations should be captive or outsourced is gaining momentum. New markets, customers and hyper-competition mean that organizations must look at how best to source their operations. In today's environment, more companies are getting away from the traditional "core" and "non-core" thought processes and are gravitating more towards "how can services be delivered better, faster and cheaper". What traditionally might have been considered non-core or overhead functions are now the competitive edge for many organizations. This debate needs to be an integral part of the overall organizational strategy.

Developing a new strategy is challenging as showcased in PwC's Eleventh Annual CEO Survey, which was released in January this year at the World Economic Forum in Davos, Switzerland. With more than a thousand CEOs from around the world participating in the survey, it showed a marked shift in the thinking around globalization.  The survey showed that as companies become more global, the process of developing a new strategy to meet the challenges of globalization is becoming more complex.

 The survey also showed:

  • There is a lot to do as globalization is still a force in transition. Many organizations are thinking about trans-border but still headquartered based
  • Mergers and acquisition activity is a major force in globalization with half of the CEOs responding that they are involved in cross-border mergers and acquisitions
  • Leadership in society indicates a priority on building a sustainable business that acts responsibly on a global scale, and that winners will be those who can learn to operate on a global scale

Operating on a global scale is difficult, with the management of new customers, markets, products, and employees becoming a priority. Adopting a strategy and business model to the new global realities can be daunting. It is, however, an opportunity to identify and capture organizational efficiencies through the leverage available to companies operating on a global scale. By acting globally, a company broadens the options for how and where to source a particular activity or service, thereby providing access to the best, fastest and cheapest services   The need to look and act globally should be one of the mantras driving any company reviewing  their sourcing options.

Global Challenges via Sourcing Models

The organization's service delivery model should be completely aligned with the organizational strategy. For example, if core operations are part of the organizational strategy so should the back office operations. Misalignment between corporate and sourcing strategy drastically increases an organization's risk profile and may result in failure. The decision to choose the right operating model is difficult, one which takes organizations through a web of multi-dimensional and cross-functional variables.  These, coupled with personal and political agendas, add to the complexity.

Sourcing Models

The process of developing the model of how a company will source key back office functions can be overwhelming. Given the multitude of sourcing options available to an organization, determining what models to use is becoming a vital and competitive differentiator.

1. Shared Services (captive)

Shared services or a captive is the consolidation of dispersed resources performing similar functions into one or multiple centers that serve multiple internal customers with similar needs. The shared service organization (SSO) is the internal service provider for the organization. Best practices dictate that this organization should be run as an independent business with focus on global service delivery.

ProsCons
 Ensures standardization and complete controls Needs high initial investment
 Protects intellectual property Requires strong brand power and corporate reputation
 Creates a metric-driven organization Creates staffing challenges

 

2. Outsourcing: 

This is the contracting of work, previously conducted in-house by a company's employees, to a third party. New trends indicate that relationships in outsourcing are evolving from cost focused to collaborative relationships with the vendor becoming a true business partner. At its best, these third party, outsource, relationships are leveraged to deliver a faster go-to-market strategy and build a more flexible and scalable service delivery model. Within the realm of outsourcing, two models are becoming more prevalent:

Build Own Transfer (BOT) - outsource and then captive
In this model, the customer outsources the build of the center and the operations to a service provider who, after operations are stabilized, transfers all the assets and operations back to the customer. This is a viable option for organizations that:

  • are not looking to make big investments into building operations
  • don't have the skills and the know how to do this internally
  • lack the knowledge around local laws and culture
  • lack the initial critical mass to justify the investment of financial and management resources in building a captive center

Joint Venture 
In this model, the customer creates a new entity with the service provider where both parties have equity in the new entity. These models are optimum for organizations whose strategy is to become market facing. Joint Ventures are difficult to manage and the relationship between the customer and the service provider must be very strong for it to be a success.

ProsCons
 Partners with reputed global service providers Sacrifices a degree of control
 Leverages proven technologies Encounters governance issues
 Moves to variable cost models Weakens intellectual property protection

 Hybrid:

 Mixture of SSC and Outsourcing
This model is becoming prevalent in the industry as captive organizations are moving up the value chain and are outsourcing low value activities like data entry functions. Even as organizations outsource functions, creating a shared service environment for the retained organization generates value.

ProsCons
 Shares risks and financial burdens between parties Increases administrative and legal complexity
 Ensures internal controls (not external) Induces business and cultural challenges
 Protects intellectual property under the new entity Poses regulatory challenges, e.g., issues such as confidential client data sharing between the two entities

 

 All the models above can be set up onshore, nearshore, or offshore.

How It Is Done

Prior to deciding the "who", "how" and "where", management must ensure that the sourcing strategy is aligned with the organization's overall vision and drivers, such as:

  • How can sourcing increase process effectiveness? What automations, innovations and process improvements may be implemented?
  • Will the organization be entering or expanding into new markets?
  • With future growth expectations, will the sourcing model have the ability to expand quickly and with a minimal capital investment i.e. is your model scaleable and flexible?
  • What impact will this have on the industry and competitors?
  • Is the organization balancing what’s vitally urgent for today with what’s keenly important for tomorrow?
  • Will the workforce be in line with the organization's skill sets?
  • What impact will this have on employee morale? Is there risk of losing key people?

The answer to these questions requires insight into all levels of the organizations

Get a holistic view of your current (As-Is) organization

The biggest challenge for many organizations is to get out of the silo way of thinking. Getting a holistic view of the current organization is more difficult in a decentralized environment. The nature of decentralized organizations encourages redundancies in operations. Cross leveragability becomes difficult as there is little incentive for business units to identify these areas.  Some of these mandates should be driven by the corporate management to drive efficiencies in the organization.  It's important to know all aspects of operations across the organization with regards to people, processes and technology. Some things to look for:

  • Are there areas for gaining operating leverages? For example, there may be other business units that are involved in a current outsourcing or shared service model as well the possibility of some operations already being done offshore. Better economies of scale and standardization will benefit the organization's bottom line.
  • Is there enough critical mass to justify an investment for a captive or gain the interest of a service provider?
  • Can critical mass be gained by onboarding multiple business units to the new sourcing model?
  • What does the technology landscape look like? Consolidated platforms, especially in a Shared Services environment, will be more effective than an environment with multiple technologies and platforms.  Many organizations look at Outsourcing if the investment to upgrade the technology is high.
  • Is there a potential to gain better scale in outsourcing if IT and BPO are bundled together?

Align the sourcing strategy with organizational strategy

One of the most important pre-requisites for this kind of initiative is not only executive management buy-in but also their involvement in the decision making process. These initiatives may drastically change the operating model and the C-Suite has to be onboard with the new direction. These executives have the responsibility to communicate the vision, drivers and the future strategy of the organization. Once the direction is clearly understood, the options may have to be reviewed.

Some of the elements that you may have to analyze against each model are:

  1. Global Tax
    Which model will allow the organization to set up the optimum investment structure? Is transfer pricing involved in setting up the model? For offshore locations, what are the issues around profit repatriation?
  2. Legal & Regulatory
    Understand the legal and regulatory issues with the model change. This includes understanding of the laws and regulations of the home country or the offshore location. Identify the impact of non-compliance. What are the IP and data privacy laws?
  3. Geo-political
    Evaluate the geo political risks. How stable is the political landscape? What is the economic forecast? How is the law and order situation? Is the government part of the international organization, like WTO?
  4. Organizational Structure
    Depending on the model, the organization may have to be restructured to facilitate the new model. This may require additional investments in resources and technology.  For example, for a shared services organization, more service delivery skills including account management are required to accommodate the new model. On the other hand, in an outsourcing scenario, more vendor and project management skills are required.
  5. Facilities & Infrastructure
    Facilities and infrastructure are assets that require significant investment. In a shared services model, the option is to choose between a Greenfield and a Brownfield site. Both require investments in building or leasing facilities. In addition, organizations have to invest in all the infrastructure related assets like phone systems, office supplies, etc. These investments are worth if the assets are appropriately utilized over a period of 7-10 years. If there is a risk that a location might not be valid in 2-3 years, investing in this type of infrastructure is not worth the effort and money. Additionally, investment in physical security and disaster recovery will be required. On the other hand, Outsourcing requires minimal upfront investment in facilities and infrastructure and the service providers may be able to offer comprehensive security and disaster recovery services.
  6. Systems & Technology
    Will the new operating model require investment in systems and technology? For example, a shared services center will require performance management, time and attendance, workforce management, ACD/IVR, remote access, and monitoring tools. Additionally, considerable investments may be required to standardize and consolidate systems. In decentralized organizations, Shared Services can act as a change enabler by centralizing the control of the system and standardization of processes before the organization ventures into an expensive transformation projects. On the other hand, Outsourcing will require little upfront investment.
  7. People and Culture
    People and culture should be high on the criteria list. In a shared services environment, the charge of hiring and retaining the right skills falls solely on the organization. Regardless of the model, the organization will have to put a strong change management program in place and ensure proper transfer/transition of people and knowledge takes place. It is important to highlight the need for organizations to assess the impact to people and the need for a change management program to mitigate risk.
  8. Benefit Realization
    For most organizations, cost is the main reason to implement Shared Services or get into an outsourcing contract. Either way, both models require initial investment and benefits may not be realized for a number of years. In outsourcing, the benefit realization may happen sooner as compared to the captive model.
  9. Service Delivery Model
    Designing the right Service Delivery model is imperative for a Shared Services Organization.  Best practices dictate that a shared service organization should be run like an independent unit, with clear contractual relationship and service level agreements. Additionally, a transparent cost allocation model is imperative for successful service delivery. Regardless of the model, a comprehensive governance model across all layers of the organization is imperative for success.

Conclusion

The process of deciding on a specific service delivery model can be daunting and time consuming. If an organization approaches the task prepared with an understanding of its strategy and how back office services support success, it need not be.  A comprehensive understanding of the current state, analyzing the potential opportunities and risks against the baseline and aligning the service delivery model with the overall organizational strategy will make the process easier. As globalization increases, organizations are evolving into more of a hybrid model where operations are split between captive and outsourced operations. Certain organizations may outsource international support; other may outsource low value activities while keeping the higher activities in the value chain internal. Regardless of the model, patience and proper diligence are pre-requisites for success.

About the Author

Tarun Kakar
Advisory
PricewaterhouseCoopers LLP

tarun.kakar@us.pwc.com

SSON News and Analysis
Posted: 07/09/2012

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