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The Three Dimensions of Value

Value in Outsourcing

Don't Skip on the Details

Outsourcing: Dynamo for Transformation

Outsourcing Allows the Little Guys to Play in the Big Leagues

Rx for Secure Patient Data Collection

Change Without Pain - An Alternative Model for Year One of Outsourcing Agreements

Integrated People + Processes + Tools = Best-of-Breed Service Delivery

Ask Before You Outsource: Ten Critical Questions to Put to Potential Service Providers

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The primary benefit of outsourcing is creating value. To paraphrase George Orwell, not all value is created equal. The knowledge of which kind of value your outsourcing relationship is creating is mission critical information because the impact on your organization differs wildly.

Everest consultants, who have completed hundreds of outsourcing transactions, are closely examining the outsourcing process to understand how and where outsourcing creates value. What we're observing is this: each new component of value builds on the results of what came before, improving and changing ever increasing areas of the organization until outsourcing addresses the company's deepest concerns. There, outsourcing unlocks the greatest value.

The Core Component: Cutting Costs

Most buyers initially decide to outsource an important but non-core process to save money. Understandably, cost reduction sits at the center of most outsourcing arrangements.

The value outsourcing creates is relatively easy to quantify when all you are concerned about is cutting costs. A company that outsources a data center and achieves a 15 percent cost reduction can identify a 15 percent creation of value.

Outsourcing, however, promises more than just reducing costs. Outsourcing often improves the quality of the service delivered at the same time, or at a minimum, doesn't decrease it. Suppliers can perform this magic because they have advantages that individual buyers don't have.

Value creation is possible because suppliers use leverage. The critical leverage points include:

• Economies of scale. This is a tremendous leverage point that works to the advantage of both buyer and supplier.
  
  For example, Exult, an Irvine, California supplier, has been able to generate real economies of scale by building a human resources (HR) transaction engine that generates real and sustainable economies of scale that individual companies cannot match. The resulting leverage benefits Exult's customers like BP, Bank of America and International Paper with better service at much lower cost.



• Access to cheaper labor resources. In today's global economy, the ability to take advantage of cheaper labor pools is a powerful leverage tool for suppliers. These lower cost workers can be found in smaller American cities as well as offshore. Major IT players like EDS and ACS have facilities overseas, in India and Ghana, respectively. Suppliers are able to recruit top talent to provide high-quality service and still lower their labor costs by as much as 80 percent. Labor becomes a lucrative leverage point.



• Capital investment. The ability to spend other people's money is a powerful leverage point in today's competitive, global economy. Companies, carefully husbanding their resources, typically channel their capital investments into their core areas that help them compete in the marketplace. This leaves little or no funds for non-core processes, which suffer as technology changes. Quality and service from these less fortunate business functions deteriorate over time because of this lack of investment. Outsourcing becomes the best way to provide a sustained investment in these non-core processes.
  
  A compelling example is Barclay's Bank in London. The bank realized it needed to have image technology to process its checks. This technology takes a photo of the check at the presenting bank and sends the image around the banking system, not the physical check itself. However, bank researchers reported check volumes were falling five percent per annum due to the popularity of bank debit cards. Management was unwilling to spend the large sums necessary to purchase the new technology.
  
  Barclay's joined with another big London bank, Lloyd's; together they outsourced their check processing to iPSL, a Unisys company in which they bought a stake. IPSL was willing to make the huge investment in image technology because it was able to process 67 percent of the UK's checks. Of course, Barclay's price per item fell, thanks to the new technology.
  
  Capital investment is increasingly becoming the core driver in many outsourcing solutions.



• Process expertise. Suppliers are often more competent and further down the learning curve in the areas where they provide service than their customers. This is because suppliers are monomaniacal about their processes, and customers are just not as focused on them. Outsourcing suppliers also are able to attract and retain the best of the best because the career path is better for these employees.
  
  For example, many companies have dabbled in managing a server environment. Getronics, an Amsterdam, the Netherlands supplier with U.S. regional offices in Boston, Massachusetts, and Washington, D.C., has world-class processes and expertise in this area. For that reason, Getronics can manage a server environment more efficiently than its customers can.

These four leverage points allow suppliers to lower the cost and improve the quality of a particular process.

Typically, our research shows outsourcing value ranges from 10 to 25 percent when the focus is on cost savings. The savings vary, depending on the number of leverage points applicable.

Suppliers can create value when they earn a fair profit from the outsourcing transaction. These profits provide the capital necessary for the supplier to make an on-going investment in the outsourced process. If the supplier cannot generate a profit, the relationship becomes a one-time transaction. That result benefits neither party.

Assessing the Business Impact of Outsourcing

Once you understand how to reduce costs through outsourcing, you can see how outsourcing also impacts other services, related processes and different constituencies within the company.

For example, one of our clients outsourced its IT function, which included implementing a new inventory control system. Soon information produced by this system allowed the company to reduce the inventory it needed to keep in its warehouse. In addition to saving money, this happy result rippled throughout the rest of the organization.

An effective IT strategy allowed the company to reduce its inventory costs. At the same time, the company reengineered the entire inventory process. Both pieces had a greater influence than just direct cost reduction.

We have consulted on many Enterprise Resource Planning (ERP) system implementations. An ERP system like SAP gives a company better financial control, creating value everywhere. Combining IT with business process outsourcing often creates more value to an organization.

Outsourcing definitely produces more value, but quantifying it is the tricky part. Often, the supplier is only partially responsible for the benefits that accrue. In some situations, both parties claim credit for these benefits, not realizing there is plenty of praise to go around. In particular, the buyer doesn't want to give credit to the supplier because it doesn't want to pay extra for the additional services needed. So both parties tend to ignore the value created by the business impact of outsourcing.

This is a very shortsighted view. The fairest way to give the supplier credit is to develop objective metrics to determine exactly which benefits are generated from the outsourcing relationship. Once the metrics have isolated that value, the buyer should provide a modest (in relation to the value created) incentive back to the supplier. This incentive encourages the supplier to continue providing this additional value and even find ways to provide new benefits.

Everest Group is currently conducting research to document the components of value creation. One goal of this research project, called Total Value Equation (TVE)^SM, is to define objective metrics and mechanisms that allow buyers to objectively and fairly measure - and then compensate - the supplier for this added value. Currently, the TVE research is focusing on value creation in the healthcare industry in a project sponsored by ACS, Eclipsys, ExNet, First Consulting Group, SAIC and Schlumberger.

Impacting Strategic Drivers

The final component of value creation has the potential to create the most value for an organization since it impacts the company's core drivers. For example, one of our clients, a hospital, outsourced the implementation of a computerized physician's order entry system. The new system fundamentally changed the way the hospital was able to conduct its core business. The order entry system improved the:

• Quality of patient care.
• Patient satisfaction.
• Relationship with physicians.
• Cash flow.

All are strategic drivers of business success at this hospital. Of course, the outsourcing supplier has only partial influence on these drivers. However, the effects of outsourcing radiated out in waves to wash over them. Outsourcing that addresses these vital signs will fundamentally improve the operation and financial health of a hospital, creating the deepest and most long-lasting value.

When a buyer understands these different components of value and their respective importance and power, it can create an outsourcing relationship that aligns its interests with those of its supplier. Understanding how value is created helps buyers shape solutions that are the most effective.

Lessons from the Outsourcing Journal:

• Cutting direct costs forms the core of most outsourcing relationships. Outsourcing can cut costs up to 25 percent depending on the leverage factors of the supplier.
• Outsourcing can have a positive business impact on an organization when it improves processes and services throughout the organization. Corporate reengineering usually occurs at the same time. Creating value in this way is harder to quantify.
• Outsourcing can also impact strategic drivers, creating the most value for an organization.
• Suppliers must earn a fair profit on their outsourcing transactions so they have the capital to invest in their processes.

Publish Date: April 2002

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Copyright © 2002 - Everest Partners, L.P.

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