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  1. Analysis
July 11, 2007

Is outsourcing really the ‘magic bullet’?

The need for economies of scale and cost efficiency has led many card issuers to outsource their processing to third parties Francesco Burelli and Anthony Louw, principal consultants at global strategy consultancy Capco, look at the points organisations need to consider when choosing to outsource. Since the late 1990s, more and more card issuers have followed the blazing trail to India for business process outsourcing (BPO)

By Verdict Staff

The need for economies of scale and cost efficiency has led many card issuers to outsource their processing to third parties. Francesco Burelli and Anthony Louw, principal consultants at global strategy consultancy Capco, look at the points organisations need to consider when choosing to outsource.

Since the late 1990s, more and more card issuers have followed the blazing trail to India for business process outsourcing (BPO). With US processors now breaking into the European market, many European card issuers are outsourcing their processing to them.

Outsourcing and offshoring are seen as the answer to the challenges of cost reduction and increasing complexity, as well as increasing levels of regulation such as the Single Euro Payments Area, which is enforcing standardisation within Europe. But is outsourcing the ‘magic bullet’?

History

The early adopters of offshoring and out-sourcing in the cards arena included American Express, Citigroup and HSBC, most with captive centres (see Figure 1). Late adopters in the UK included Barclaycard, which has only recently started moving certain functions offshore to the Barclays captive centre Intelenet.

The leading global BPO service provider in which Barclays held a 50 percent stake, was acquired by private equity firm The Blackstone Group in June 2007.

Results have been mixed even for the mega issuers. In 2004, Capital One pulled out of India on a credit card telemarketing venture with India’s full-spectrum outsourcer Wipro Spectramind, citing quality of service as the key reason. Citibank was also in the media in the same year when approximately $425,000 was fraudulently transferred from US customers’ accounts. In March 2007, Lloyds TSB announced that it was closing its Indian call centres, and making direct calls to UK branches possible.

Card issuers, offshored operations, systems selection

What is it worth?

What has been undeniably achieved with offshoring has been cost reduction. The average reported savings tend to be in the 30 to 40 percent range, with some companies reporting a significant increase in service levels and cost savings (see Figure 2). In our experience, the benefits achieved can be further enhanced by re-engineering the business process and offshoring simultaneously, but the cost reduction gained through offshoring has not been without its consequences.

In 2005, a report by research and advisory company Gartner revealed that four out of five outsourcing deals would be renegotiated within the lifetime of the contract, as short-term cost cutting had come at the expense of flexibility and the ability to cater for changing needs.

Often, the cost savings originating from offshoring have come at the expense of customer satisfaction. For example, in the UK, a number of banks have had customers migrating accounts due to dissatisfaction with offshore call centres. The most common reason stated is difficulty in understanding accents. Certain UK-based companies are now taking advantage of having onshore call centres and are making this known to prospective customers through aggressive advertising.

Outsourcing and offshoring are considered to be the solution to the quest for lower-cost operations, but for how long will this approach will be sustainable? In India, the number one destination for offshored processes, rising wage costs of between 12 and 14 percent in the major Indian outsourcing centres have caused companies to seek either lower-cost cities in India such as Calcutta (now known as Kolkata) or lower-cost countries. Some projections show that India will no longer be a cost-effective option within the next five years, although a more conservative approach predicts 20 years, due to the large arbitrage gap between India and most European countries.

Moreover, outsourced operations are starting to experience similar challenges to onshore operations. The National Association of Software and Services Companies, the trade association for the Indian software industry, estimates that contract attrition is currently in the 35 to 40 percent range in India, but industry experts place it higher at 65 to 75 percent. In addition to this, of the major outsourcing destinations such as India, the Philippines and China, few have strong political stability and those that have it typically do not have the infrastructure required.

In spite of all these concerns, for card issuers with margins under pressure, one of the primary remaining options is to reduce costs through outsourcing and wherever possible to offshore. The question for most is not if they should outsource or offshore, but rather what to outsource and offshore, and to whom.

 

Cost reduction benefit scale

Functions

Although the selection of functions to offshore should be driven by the strategy and criteria set by an organisation, over the past years common trends have started to emerge among global card issuers.

After the offshoring of simple processing such as application data capture, most organisations, particularly those providing customer services and outbound telesales, moved their call centre operations offshore. Functions that generally continue to remain in-house are those that set the rules for operational functions such as risk strategies, collection strategies and pricing.

The organisations that have offshored have been forced to enhance what had previously been seen as important capabilities and functions but which were small in size, such as governance and supplier management, in order to effectively manage their offshored operations and ensure that service is commensurate with the customer expectations.

Best practice phasing

Best practice in terms of the sequencing of offshored functions is shown in Figure 3.  The model allows issuers to typically start with low-complexity, well-defined and hence low-risk functions that require little or no customer interaction, and as they build confidence and capability in the offshored facilities, to move higher up the value chain.

Assuming a company has decided to investigate offshoring, the question arises as to what should be done to guarantee the expected results. Learning from what has been done successfully before, the broad steps are:

In-house versus outsource The first step is to define what processes are seen as having a strategic advantage for the company. These processes are the ones that the company will want to retain the greatest flexibility and control over and hence retain in-house. To ensure a full definition of what is seen as strategic, an agreement for what defines strategic advantage in terms of business processes should be made by the board as a whole and not simply seen as the responsibility of one director.

Pick the process to meet the objectives of offshoring Based upon the reason(s) for offshoring, the criteria for making the process selection must be defined. These criteria will allow an organisation to rank in terms of eligibility those processes most suited. There are a number of typical criteria for this selection, including, for example, the numbers of full-time equivalent personnel per process (where the objective is cost reduction), whether direct customer contact requires onshore culture, language, complexity of the process, infrastructure, system constraints, and so on.

Select offshore country destination This selection will largely be driven by the criteria set in step two, but additional criteria may include skills availability, average cost of resources and expected inflation, and whether the country has a mature market in the processes that are being sought.

Once the appropriate country has been selected, the next major decision will be which model to follow. The choice of model will be affected by the decision on whether to outsource the process or keep it in-house. If in-house, the company has the choice to either set up a wholly owned captive processing centre or to purchase a controlling stake in a processing centre. The time-span within  which the objectives must be achieved will often drive this decision. The longest and most complex model to establish is the setting-up of a new captive centre. For processes that have been deemed eligible for outsourcing, a joint venture (JV) or the selection of a third party (the quickest option) will be the primary options.

If the model chosen is a purchase, JV or outsource, the next step is to go through a partner selection process.

Systems or system vendors selection (if using an outsourced offshore provider) A further consideration in evaluating onshore against offshore and outsource against in-house is which systems to use to support the processes. If a company wishes to retain greater flexibility and to be able to create innovative products that cannot quickly be imitated by competitors, then an in-house system or a licensed external system maintained in-house would provide the best choice.

If, however, the product offering or business process is seen as highly commoditised and flexibility of change is not seen as a differentiator, then the preferred option would be to use an external processor.

Another primary consideration will be the speed at which the benefits are to be obtained. The quickest option will be to utilise the systems that the company currently uses (external if licences allow, or internal). The longest and most complex option, but the one with potentially the highest financial benefit, would be to utilise the same systems as the BPO provider, if applicable. This will free the company of responsibility for any maintenance that is required with the normal technical standards upgrades, as the vendor will have to guarantee compliance.

Furthermore, if the contractual model is based upon the mutually beneficial gain share arrangement, it will fall upon the partner to constantly improve productivity and make the system changes or enhancements required.

 

Offshoring model: Best practice phasing

Conclusions

For outsourcing or offshoring, a major consideration must be what the desired outcome is. For example, cost reduction, improvement of service level agreements (SLAs), providing scarce skills, etc, each have very different implications for the outsourcing decision.  Organisations should fully consider the implications at the strategic level pre- and post-execution.

Finally, specific attention should be paid to the selection of a partner and the set-up of governance and procedures for the management of vendors and offshored operations.

Needless to say, the implications at the strategic, operational, people management and core competitive positioning levels cannot be underestimated, especially the risk of very costly mistakes.

Preference should be given to the gain share model, whereby both the company and the offshore supplier share the benefits of a joint operation. SLAs and key performance indicators based on mutual success should be made part of the contractual relationship.

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