Each sourcing conference brings a new set of countries marketing themselves as the next big thing in offshoring. China, India, Ireland, Malta and South Africa all have active marketing campaigns underway.
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Yet senior executives who offload problematic operations in the hope that they will improve in another climate are likely to be disappointed. A more compelling area for managers to focus on is confirming to what extent the savings promised by offshore service providers are realistic, sustainable and whether they will enhance the experience for internal stakeholders or external customers.
Analysis of mature offshoring operations by Compass Management Consulting is uncovering examples of organizations locked into long-term agreements, deteriorating service levels and higher costs than anticipated. Specifically, over the long term, service levels are being compromised and changes in volumes and labor costs mean that the offshoring decision is failing to deliver the level of savings anticipated. In short, we are seeing organizations facing the double whammy of service quality being compromised and a failure to deliver the level of savings anticipated.
Despite extensive evidence emerging from early offshoring contracts, organizations continue to regard the practice as an easy way to reduce costs and remove troublesome operations to faraway postcodes. This ‘lift and shift’ approach prioritizes moving the operation offshore as soon as possible in order to take advantage of lower labor costs.
In this scenario, managers rarely pause to undertake a root and branch review of the operation in order to optimize processes and solve inefficiencies ahead of the offshoring. Rather, the freedom to avoid confronting such issues is often seen as an attractive by-product of the offshoring decision. The expectation is that lower wages in the offshore location will mean that additional personnel can be assigned to the process to iron out problems at little cost. Compass has seen organizations reducing operational costs by up to 20% in the first year using this approach.
Yet simply changing the location of an inefficient operation or broken set of processes does not solve business problems in the long term.
Instead, the seductive simplicity of the lift and shift approach masks a series of operational issues that can become major business problems over time.
Analysis of onshore and offshore environments by Compass has shown that substantial increases in processing volumes is the main driver of cost increases over time, regardless of location.
At the same time, we are seeing rises in personnel costs of up to 15% per annum in countries such as India. These two factors combined — high rates of growth in processing volumes and increased labor costs — will quickly reduce the price advantages of offshoring over time.
In the example below, the chart confirms that the cost benefits of offshoring decrease substantially over time. It also illustrates Compass’ findings that some organizations are able to achieve the cost savings of lift and shift offshoring by simply improving the performance of their existing onshore operations.
The ACME (prior) column shows the costs of a bank’s existing onshore operational costs per application processed, broken down into an IT and personnel component. The ACME (offshore) column shows the cost reduction achieved through lift and shift offshoring. The onshore best performers column shows the cost achieved by the best performing onshore operations while the offshore best performers shows the reduction that can be achieved for an operation through a performance improvement program prior to offshoring.
The contrast between ACME (prior) and onshore best performers is the potential saving that can be achieved through a performance improvement program ahead of any decision on sourcing.
So instead of mulling over which country would be ‘best’, the first step in any offshoring decision should be a thorough analysis of existing operations in order to understand the drivers of business performance and cost.
Compass analysis of high-performing organizations has shown that an optimized blend of onshore and offshore operations delivers the best long-term returns to the business. This blending, or ‘fix and mix’ approach, involves analyzing the efficiency of existing processes onshore, identifying precise and quantifiable opportunities for improvement (normally against a reference group of high performing peer organizations) and implementing a performance improvement program.
Different elements of the improved and more efficient operational processes or infrastructure can then be either kept onshore or selectively packaged offshore to take advantage of competitive labor costs. This approach may seem less glamorous than being fêted on country visits but will deliver more enduring business benefits.
Geraldine Fox is an analyst at Compass Management Consulting
