What are the real risks in offshore outsourcing
both ITO and BPO work? Ravi Aron, assistant
professor, Carey Business School, Johns Hopkins
University and a research partner with the
Wipro Council for Industry Research, says understanding
those risks helps buyers set up procedures
to mitigate them, making their offshore engagements
Aron, who is also a Senior Fellow at the Phyllis
Mack Center for Technology and Innovation at
the Wharton School of Business, The University
of Pennsylvania, says there are three types
of risks buyers must worry about:
· Operational risk: The
propensity of a process to break down and result
in less than acceptable quality of work
· Strategic risk: Losses that
result when the offshore supplier behaves opportunistically
· Composite risk: Risk that arises
over time from a combination of factors like
erosion of competence and loss of flexibility.
Aron says operational risk is simply "getting
output you don't like. The quality is not there." The
output has too many errors, mistakes, and defects.
For example, in ITO, the application does not have
all the functionalities that the buyer asked for.
Or the code has bugs. Or there could be cost overruns
or delays in delivering the system.
Turning to BPO, there could be mistakes in underwriting
in insurance work. In call center outsourcing, the
offshore provider of services does not achieve first-call
resolution metrics; the buyer wants 80 percent but
the supplier can manage only 60 percent. In supply
chain outsourcing, the accounts receivable/accounts
payment closures have too many errors.
"In all cases, the supplier's quality is less
than what's mandated in the service level agreements
(SLAs)," explains Aron.
The causes of operational risk
Source: Ravi Aron
Aron says the principal reason
this risk exists is "because of the
complexity of work. It takes a while for
the offshore organization to understand what
the buyer wants."
Another reason operational risk occurs is
because of business unfamiliarity. "I
think the risk of cultural context unfamiliarity
is overstated and the risk of business context
unfamiliarity is understated," says
Aron. The professor says you can teach Indians
why Americans love Halloween. "But few
buyers estimate the real hazards of trying
to transfer the business context."
He gives an example. The offshore company
manages the back-office corporate treasury
function for a bank. The bank instructs the
provider of services to reconcile the various
invoices and then make payments to a corporate
customer (a large retailer). The amount in
question is about US$60 million of business
receipts for the retailer. The bank has a
reputation for speedy and accurate reconciliation,
which helps in improving the float for its
customers. This is a part of the bank's value
proposition: to help its customers get better
working-capital management through improved
management of its float.
However, the offshore supplier doesn't understand
the concept of float or why it's important to these
customers. So it transfers the $60 million a couple
of days later than usual, causing the customers to
lose the float on that amount. The bank's customers
are angry. The supplier just didn't understand why
a two-day delay was so much of a problem. "Business
unfamiliarity can be a serious issue," says
Managing operational risk
How do you manage operational risk? Aron
says there are four ways to do this:
- Knowledge transfer and management. The
professor says North Americans and Europeans
typically "under invest in knowledge
transfer." The Japanese, on the other
hand, take this matter seriously. "When
a Japanese company outsources its back office
to a Chinese supplier, say in Dalian, China,
its knowledge transfer investment greatly
diminishes the problem of business continuity
and transfer of business context," says
He says buyers shouldn't assume "the
supplier will understand." And he insists "there
is no such thing as too much training." He
also suggests creating joint knowledge repositories
and deploying collaboration mechanisms such
as wikis, blogs, and RSS feeds via corporate
- Metrics. Aron says metrics "have
a huge impact on operational risk." He
says buyers must make suppliers understand
their definition of quality.
According to the professor, "through
well-defined metrics the supplier can easily
understand and greatly reduce operational risk." He
suggests SLAs should identify key factors of
process quality. Then, buyers should measure
continuously and in great detail. He points
out VelociQ, a mechanism Wipro designed to
track an elaborate system of metrics for BPO
and ITO projects, "is very granular. It
allows a company in Manhattan to see what's
going on in Mumbai in real time," he explains.
Chennai, India-based OfficeTiger (acquired
by RR Donnelley in 2006) has a similar mechanism.
- Transition management. "Buyers
sign a contract, fly to India, take photos
in front of the Taj Mahal, give everyone
T-shirts and coffee mugs, then go home," he
says. That's not how he suggests handling
The professor says the first couple of months
typically go well, because the problems revolve around
clarification. Difficulties generally don't crop
up until later. "That's when real problems of
output or quality appear. That's when the rubber
meets the road," says Aron.
The message here is "don't overlook transition management because it can
reduce operational errors by up to 15 percent," he reports.
- Monitoring versus control. "Don't
over control and under monitor," says Aron.
Controlling is telling them how to do their work.
With monitoring, buyers establish objectives (what
to do) but leave the "how" to the provider's
managers. Buyers can safely delegate if they verify.
However, they need a granular system of metrics
and a mechanism to track SLAs (like Wipro's VelociQ)
so they can verify from the earliest moment.
Unfortunately, companies either do not monitor enough
or "the metrics can be too skimpy or not well
understood," he says. He quotes Ronald Reagan
who said "Trust but verify."
Publish Date: June 2009 outsourcing-offshore.com