Yet most will miss the potential impact of service globalization through sub-optimal activity scoping.

by Michel Janssen, Wayne Mincey

Global options in business process sourcing are having a significant impact on executive decisions in this area. The Hackett Group’s work with clients fully leveraging global labor markets for their selling, general, and administrative (SGA) activities reflect average, fully loaded labor rate savings of more than 70 percent. Our research further indicates that the average Fortune 500 firm could realize annualized savings of more than $116 million by fully leveraging a globalization strategy.

The cost and quality benefits available through service globalization is driving a fundamental mindset change. Not only is the prospect of leveraging low-cost labor markets affecting decisions on business models and the placement of planned centralized transactional activities, but it is also forcing a reexamination of fundamental decisions about which processes should be considered for centralization. Simply put, potential cost savings, combined with the quality and capability of talent available in these markets, are helping to change the entire business process sourcing analysis.

While many of the standard considerations about business models remain in place—including linkage with and requirements for proximity to the client—the impact of disaggregation and the possibilities for process elimination through redesign exists. Nevertheless, maturation of capabilities in many low-cost countries, combined with potential savings, will alter what are often the most fundamental business process transformation decisions: Where should the work be performed, and what is the scope of processes included?

Today’s C-level executives exist in a business environment that forces an across- the-board examination of every dollar spent, whether in front- or back-office processes. New options for service delivery leveraging low-cost labor markets and third-party providers are requiring management to rethink the models used to make these decisions (Fig. 1).

In the world of sourcing decisions for business processes, a historical best-practice model would require:

• A full understanding of the business requirements of a particular process or sub-process;
• A thorough analysis of the organizational structure of where this work should be performed (decentralized vs. centralized). This would typically lead to the business model question of whether this function should be retained in-house or outsourced.
• A choice of exact location with the primary considerations including long-term cost optimization, availability of sufficient talent, location infrastructure, and cultural compatibility.

However, there is a fundamental problem with the decision flow outlined above. It significantly underestimates the true ROI associated with determining what is in and what is out of scope from centralization or location optimization perspective.Executives cannot look at this ROI decision through the historical lens of 15 to 30 percent process cost improvement from centralized support structure. Why? Because this thinking was framed through experience with driving cost out primarily through a combination of process improvement (15 to 20 percent) and domestic labor market optimization (5 to 15 percent) in shared-services environments. The latter part of that equation, in the era of globalization, approaches 70 percent!

If executives do not analyze their process optimization opportunities using what is possible through globalization, they might grossly underestimate the potential value of activity centralization and therefore make poor decisions on process strategy. Executives must alter the traditional model for evaluating the structure and design of future process execution to reflect the global market for labor and services.

Like aspects of a complex business environment, the decision framework for business process sourcing must reflect the unique nature of each firm’s strategy and business model. The Hackett Group’s research and experience since it began its SGA benchmark studies in 1992 has helped create a model which provides visibility into the key drivers of the business process sourcing decision and the flexibility to appropriately weight these factors for the unique circumstances of the business.

These drivers are critical to understand, particularly from the most senior levels of the business. Dangerously, they can be influenced by myth as much as reality. Organizations that have traditionally operated under significant decentralization often perceive the necessity of placing nearly every support activity “close to the client and business operations.” In rare cases, this may be true, but more often this perception is a reflection of a desire for control rather than a truly objective view of the customers’ needs.

SETTING A HIGH BAR
Business leaders must set a high bar for allowing decentralization of processes that lend themselves to superior performance in centers of excellence or other modes of consolidation. Why must this activity be close to the client? What is the real impact on client intimacy? Is the activity core to the business? Obtaining clear, unbiased answers is a prerequisite for ensuring that all appropriate processes are centralized, absent a demonstrable business case for doing otherwise.

Other and more strategic questions that must be addressed at this level include the future of a particular business within the company’s portfolio. While any process can be disaggregated over time, consolidating business support functions can pose a near-term barrier to divestiture. Additionally, one should not underestimate the influence that local relationships have on key clients and partners.

Taking an end-to-end view of business processes is a key consideration. When making decisions about business process sourcing, there is no good alternative to detailed and specific knowledge of the transactions or services under consideration. This includes everything from volumes to the nature of the source transaction and variability across the business. Also critical are the business interface elements and the
existence of logical process segmentation points. There can be unforeseen consequences of process desegregation if the processes are not fully understood from an end-to-end perspective.

Now we come to where the many executives may reach faulty conclusions from the return on investment (ROI) perspective. First, however, let’s be sure we are clear on why calculating ROI is critical. Make no mistake about it: shifting processes from a decentralized model to some form of centralized or remote model comes at a cost, including costs to redesign processes, costs to rationalize workforces, costs to establish new infrastructure and, most importantly, the potentially heavy costs of disruption. In addition, many processes, when removed from the point of transaction or disaggregated, create frictional costs. So businesses will only pursue such initiatives in the face of quantifiable and sustainable ROI.

When projects fail to produce a reasonable ROI, they are abandoned altogether or, in many cases, scaled back to encompass only those processes with the least risk and most obvious ROI. Accordingly, if ROI is underestimated, executives will fail to realize the maximum benefit of sourcing opportunities. Why are executives underestimating their potential? By focusing on historical gains from such efforts and not fully including the potential scope of activity centralization for inclusion within a service globalization strategy.

How much of an impact could an organization expect to see from global sourcing? Preliminary results from The Hackett Group’s 2006 study on globalization suggest that the average Fortune 500 organization could see a potential benefit of $116 million across the SGA functions. These potential savings will not necessarily be achievable overnight, but a well-executed business process sourcing strategy could achieve a good portion of these benefits within a three-to-five-year horizon.

MYRIAD OPTIONS
Clearly, location is critical, but in sourcing, cost is key. Savvy executives, however, will look beyond current costs to longer-term prospects for a stable and educated workforce, predictable political environment, language compatibility, and infrastructure.

It is critical to identify viable resources in the form of mature service providers, either internal or third parties. Many companies have moved toward adopting centers of excellence or shared services and are well prepared to expand their centralization footprint through inclusion of additional processes. Many of these have also ventured into global markets to tap into lower-cost structures and skilled workers. In most process areas, there are also mature third-party providers with deep capabilities and experience in traditional support functions.

When it comes to venturing into the global sourcing market, executives must consider their own level of preparedness. Firms with existing operations in global markets are better positioned to leverage their investments and knowledge for expansion into SGA support activities. Management should be careful, however, not to underestimate the challenges of creating support organizations that require significantly different skills than what their current operations utilize. Also, the locations for global operating centers may be quite different from the optimum location for SGA services.

Organizations without an existing global footprint to leverage should instead work with a proven service provider that can bring a combination of experience in the global market, enabling technology, and methodology that support the complex and all-important transition of service delivery to a third party. Whether leveraging internal capability or proven external providers, the bottom line is there exist viable paths that nearly every company can leverage.

The importance of evaluating and managing risk in global business process sourcing cannot be overemphasized. The establishment of an offshore operating unit or the entrustment of processes to a viable service provider in a foreign location comes with risk. Firms must evaluate all potential types of risk, from political instability to environmental and cultural risk. More important, they must adopt a mindset that embraces contingency planning, always being prepared to answer the question: How will we operate if…?

EFFECTS OF GLOBAL SOURCING
In our experience, CFOs at companies we have empirically defined as world-class take a view of the finance function’s strategy that balances efficiency (cost) with effectiveness (business return), in accordance with the overall goals of the company.

It doesn’t take an advanced accounting degree to detect the linkage between globalization and the efficiency side of the equation, as demonstrated in direct labor cost savings. However, companies with the most successful globalization of business processes are looking well beyond cost savings. They are tapping into highly educated and motivated workforces that can drive substantial improvements in business impact and effectiveness.

GLOBALIZATION FOR THE MASSES
Should globalization be a strategy pursued only by a select few? Our research (Fig. 3) reveals that there is a broad planned adoption of globalization strategies among leaders in the finance community. The Hackett Group’s 2005 survey of business process sourcing trends shows a doubling of the anticipated use of low-cost countries either in an insourcing or outsourcing model, albeit from a current low adoption base.

While data confirming absolute adoption rates remains elusive at this point, there is clear evidence that the interest in FAO is at an all-time high. As senior executives evaluate the opportunities afforded by a globalization strategy, they must make the additional decision of whether to go it alone or to engage an outsourcing partner. This decision must be made based on a number of key factors.

The implementation of a globalization strategy requires a tremendous amount of time, investment of resources (both financial and human), and most of all, management attention. Many organizations will find that they are better served by focusing on the desired end-state and leveraging a relationship with an outsourcing partner to implement their globalization strategy.

There is an ever-increasing number of qualified service providers improving their FAO capabilities to address almost every imaginable type of business model. Ultimately, what counts are business results, and the evaluation of the globalization strategy may be an opportune time to reevaluate the potential to rid an organization of transactional and non-core work to better focus on those efforts that truly add value.

An often-asked question is whether FAO is purely a cost-driven solution. The resounding answer is no. FAO is not just about labor arbitrage; it is also about improving quality. Among the capabilities increasingly offered by many providers is strength in compliance management and management reporting—both top-of-mind issues for CFOs and CEOs. Additionally, FAO providers’ ability to leverage technology and advanced analytical tools can instantly provide capabilities that otherwise would take significant time and capital to develop internally.

IN A "FLAT" WORLD
There is no doubt that the rise of globalization is changing the corporate landscape. Investigations of globalization may well begin with CFOs simply looking to reduce costs. But irrespective of whether they choose insourcing or outsourcing, the odds are that they will soon seek to expand the benefits of that decision. It is then that a need emerges for guidance in the form of a model or framework to illustrate what is possible, the tradeoffs that result from changes in operating models, and the impact of risk.

The ultimate goal for all involved—advisors, service providers, and the executives themselves—is to reach sound conclusions that will help them achieve the goals of the client organization.

That said, missteps or ineffective execution will prove damaging to all parties. Conversely, as the number of executives who make well-informed decisions increases, globalization and FAO capabilities will expand, to the benefit of all.

Wayne Mincey is president and Michel Janssen is managing director at the Hackett Group, a global strategic advisory firm.