Optimizing Global Service Delivery Models in the Current Environment

The economic environment has changed the decision-making process and criteria weighting for enterprises selecting between onshore shared services, offshore captives, and outsourcing alternatives. While there is extensive political discussion around bringing processes back to the United States, most of the examples cited in the media are exceptions, and our research demonstrates that companies are increasingly looking to leverage offshore labor opportunities.

Offshoring activities have been hotly debated in political and business communities, but the continued growth shows that offshoring is a trend that is not likely to be reversed. The preliminary results  from our latest Offshoring Research Network (ORN)  service provider survey, conducted in February 2009, reveal that over 70 percent of service providers have plans to expand the scale of the service activity or expand into new locations (see Exhibit 1). This reflects the growing opportunities in the outsourcing service industry despite the turmoil in the global economy. Increasing cost pressure due to the economic environment has made companies consider service delivery transformation where incremental cost reduction and efficiency improvements cannot deliver the scale of cost-cutting required. Many companies are rethinking their operating models on a global scale. Hence, shared services and outsourcing scenarios that were developed in the past (but somehow didn't seem to be that compelling at the time for political and emotional reasons) are now being dusted off and reconsidered.
 
Exhibit 1: Future Plan for the Next 18–36 Months Indicated by Service Providers

Transformation of Service Delivery
Shared Services centers for back-office and routinized functions, including IT, application development, finance and accounting, customer service, and human resources, have been around for decades and have delivered significant savings for the companies that were able to manage the risk of such major change programs. The enormous savings potential eventually led to an emergence of a new service provider industry focused on consolidating clients' processes, systems, and people in low-cost locations. While it has grown quickly, the service provider industry has matured and become more sophisticated in managing the risks of such endeavors, leading to consistently higher returns and overall better outcomes for clients. Nevertheless, some companies are concerned that their company-specific processes are too critical to outsource because of the company’s size or the proprietary, unique, and complex nature of the processes. These companies have therefore opted to execute company-specific processes on their own by developing "captive" centers onshore or offshore in developing geographies. Exhibit 2 illustrates the findings from the ORN annual corporate client surveys showing that, for American companies, India, China, and the Philippines are the most popular destinations for captive back-office operations.  Eastern Europe and Latin America also show up as the emerging destinations for several back-office functions. In many cases, captive decisions can have the complementary benefit of accessing the market in these countries by establishing a footprint in support of the growth of their customer-facing business in those developing nations.

Exhibit 2: Captive Locations By Offshoring Function
 
  

By far, the biggest consideration for companies deciding whether to outsource or make the investment to develop captive shared services is the savings from labor arbitrage. Our research shows that savings in excess of 50 percent have been achieved, but require companies to significantly transform the enterprise and implement a disciplined approach through the entire planning, design, transition, and operating lifecycle. Many companies that have moved activities offshore are large global enterprises in highly competitive industries. Most of them had no choice but to leverage their global operating model, as their direct competitors grabbed the headlines of investor magazines with the next mega-deal or the successful implementation of a global (business) services delivery organization. Smaller companies, or companies that preferred to stay away from such a drastic move, still managed to capture important cost savings by implementing their shared services centers in the United States. Consolidation of activities, standardizing processes on a single ERP platform, and a solid performance management framework still enable companies to reduce their cost by 5 to 15 percent, but obviously still leaves a lot of money on the table.

Exhibit 3: The Savings Opportunity

 

Shared Service and Outsourcing in the Current Economic Environment
Both research  and industry data suggest that none of these opportunities has changed with the current economic downturn. If anything, the business case for planning and implementing a significant transformation and being positioned for better economic times with a leaner and more efficient service delivery model has become even more strategically important. That said, the decision-making dynamics have changed with the maturation of the service provider industry and the downturn in the economy. The increasing expertise of service providers and the pressure on cost and efficiency emphasize the attractiveness of outsourcing these processes to service providers who can offer a higher quality at a lower cost, often with lower or no up-front investments. The argument is strongly supported by the findings from the ORN corporate client surveys, suggesting that companies are looking for both cost savings and access to qualified personnel in their offshoring decisions (see Exhibit 4). However, this fast-paced growth in outsourcing relies on the assumption that the company can implement appropriate governance practices to mitigate the opportunistic behaviors of service providers and inherent geographic risks. The majority of companies find that they achieve not only significant savings, but also an improvement in their process performance (e.g., reduced cycle times, reduced error rates, new coordination capabilities).

Exhibit 4: Underlying Drivers of Back-Office Processes Offshoring

Captive Shared Service or Outsource?
Many companies are just not well-suited to establishing and operating remotely located shared service centers in developing countries, even in cases where they have current operations in that part of the world. Shared services centers require skill sets, systems, training, and infrastructure that present a plethora of challenges, which often makes companies turn to the established service providers who can achieve scale and return on investment in facilities, systems, tools, and training across a broad set of clients. In our experience, while the business case may initially seem attractive, significant scale (i.e., headcount and volume) is typically required to make the benefits of an offshore captive outweigh the risks and challenges associated with transition and management. Still, considering shared service as a lower-risk approach, many companies take the shared service path as an intermediate step toward outsourcing at a later date. Since there are one-time costs associated with both transitions, this two-step path can often dilute the majority of the financial benefits.

While many companies struggle with the decision of whether to move to shared services or outsource their processes, they find the choice more complex given the global recession. This complexity involves understanding what processes are critical to retain at the local level, the location choice, and whether to keep them in-house or outsource. The decision requires companies to diligently maintain a balance between keeping costs down while maintaining their capabilities (i.e., knowledge and skills) in performing their core activities. Therefore, companies need to carefully consider which processes are core and which are non-differentiating, and therefore could be good candidates for consolidating and moving to low-cost offshore locations.

Consistent with this thinking, the results from the ORN corporate client surveys that show the proportion of firms pursuing captive shared services and outsourcing by function reveal that companies tend to retain high-value activities (i.e., legal services, engineering, R&D, and product design) within the firm boundary—as captive shared services—while they are more likely to outsource peripheral activities such as call centers, software development, and IT. We further suggest that companies also need to use a fact-based approach to consider whether they would be better off to develop and operate their own captive center or to outsource the processes, freeing up management time to focus on the core operations.

Exhibit 5: Percentage of Service Delivery Model by Function

Conclusion

To increase operational competitiveness and be well-positioned for the economic turnaround, American companies need to be able to leverage their global capability and source their back-office services from those countries and providers where they are performed most efficiently. It suggests the rising need for companies to be adaptive to the changing environment and capable of selecting an appropriate service delivery model that allows them to optimize performance, flexibility, and scalability. While cutting costs has long been the most significant factor in offshoring and outsourcing decisions, the changing economic environment is pressuring companies to aim not merely for cost and efficiency, but also to gain access to knowledge and expertise of the service providers.

When an activity is mission-critical to a company's business, launching a captive shared service center can serve as the first step for companies before moving to an outsourced model. Captive shared services also allow the capability to be retained in-house. On the other hand, as the supplier market matures and service providers can offer services at a higher quality with more efficiency compared to in-house, outsourcing appears to be a worthy consideration.

© 2009 PricewaterhouseCoopers LLP. All rights reserved. "PricewaterhouseCoopers" refers to PricewaterhouseCoopers LLP, a Delaware limited liability partnership, or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity.  This document is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.

1. The estimates are based on preliminary data from the ORN service provider survey 2009
2. The Offshoring Research Network (ORN), as part of Duke University’s Center for International Business  Education and Research (CIBER), is a multi-year initiative focused on understanding the relationship between offshoring and firm competitiveness. To learn more about the ORN and Duke CIBER, visit https://offshoring.fuqua.duke.edu
3. Back-office operations included in the analysis are specified as finance and accounting, human resources, engineering services, IT, and software development. 
4. "Getting Serious about Offshoring in a Struggling Economy" published in February 2009 issue of Shared Service News, part of the Shared Service & Outsourcing Network.