Outsourcing takes place when an organization transfers the ownership of a business process to a supplier. The key to this definition is the aspect of transfer of control. This definition differentiates outsourcing from business relationships in which the buyer retains control of the process or, in other words, tells the supplier how to do the work. It is the transfer of ownership that defines outsourcing and often makes it such a challenging, painful process. In outsourcing, the buyer does not instruct the supplier how to perform its task but, instead, focuses on communicating what results it wants to buy; it leaves the process of accomplishing those results to the supplier.
2. What exactly is BPO?
BPO is a term that has evolved over the years, and each time it evolves further, its definition has changed. Some people have not kept up with its evolution and, therefore, refer from time to time to old definitions or descriptions of BPO. It is not simply another term for outsourcing. In BPO, strategic value through outsourcing (see an explanation for outsourcing in FAQ #1) is created by creatively examining the process and changing the way it is actually performed. It is more than just changing who is performing the process. In BPO, the supplier not only takes on the responsibility to take over the function or business process, but it also reengineers the way it is done. That will include either putting in new technology to accomplish the process, or applying the existing technology in a new way to improve the process. In BPO, something about the way the process is currently being done gets fundamentally changed. Often it involves taking into consideration how a particular process in the buyer's company affects and interacts with other departments and functions in the company. BPO often increases a company's shareholder value.
3. Is "contracting" or "contracting out" just different terminology for "outsourcing?"
These two terms are often confused, but they are not the same at all. Contracting is when a company (buyer) purchases goods or services from another company (supplier or vendor). In this situation, the buyer "owns" and controls the process. In other words, the buyer tells the supplier exactly what it wants and how it wants the supplier to perform those services. The supplier cannot vary from the buyer's instructions in any way. The buyer can replace the supplier quite easily by breaking the contract. In outsourcing, the buyer turns over the control ("ownership") of the process to the supplier. The buyer tells the supplier what results it wants the supplier to achieve, but the supplier decides how to accomplish those results. In outsourcing, the supplier has expertise in a certain process (such as desktop, or human resources, or logistics, etc.), and it has economies of scale. If the buyer were to dictate to the supplier how to do the job (as happens in contracting), the buyer would be destroying an important aspect that makes outsourcing work - the value that is created by using the supplier's expertise and economies of scale. Telling the supplier how to do the job also eliminates accountability on the part of the supplier, and this is an important element in successful outsourcing relationships. Here is an example of printing services that are outsourced and that are contracted. Contracted: The buyer says it wants 500 copies of the product. The buyer tells the supplier what kind and weight of paper to use, what method to use in binding the product (staple, glue, clips, brads, etc.), how many people should be working on the project, etc.. Outsourced: The buyer says it wants 500 copies of the product and it needs to be first-rate quality, bound, produced at a cost that is lower than what it costs the buyer to do it in-house, and accomplished faster than it could be done by the buyer in-house. Then the supplier decides how to accomplish the quality, lower cost, speed, what type of paper and binder to use, etc.
4. Why is outsourcing sometimes not successful?
Outsourcing is based upon fundamental principles and, if those are applied at the outset of a relationship, the parties will most likely have an effective, successful relationship. If the parties enter into an agreement that is not based on those principles, the result will be an unsatisfactory relationship and, probably, an early termination of the contract. The first of these basic principles is for the buyer to determine the scope of services and the metrics (for the performance levels) it wants from the supplier. This is the only way a buyer can achieve a comfort level with turning over its process to the supplier and ensuring that it gets what it pays for. This is the only way to ensure accountability from the supplier. It must be done up-front, before the contract is signed. A certain cause for failure in an outsourcing relationship is for the buyer to let the supplier dictate what the services and performance levels will be. Another sure cause for failure is for the buyer not to completely describe the scope and boundaries of every component of the service. (This can lead to a supplier providing something that was not agreed upon and then charging a premium for it or the supplier not providing something the buyer assumed it would be getting for the price it is paying.) For example, in an outsourced human resources function, the buyer must adequately describe the scope of services the supplier is to provide (does it include payroll, administration of benefits, procurement of new benefit options, recruiting, retirement benefits, etc.?).
5. I need to know how outsourcing transactions are priced?.
The structure of the pricing for the outsourcing contract can be one of the following: (1) Cost Plus. This approach pays the supplier for its actual costs, plus a predetermined profit percentage. This plan allow little or no flexibility when business objectives and technology change during the life of the contract, nor does it give any incentive for the supplier to perform more effectively. (2) Unit Pricing. This is a set rate determined by the supplier for a particular level of service, and the client pays based on its usage. Paying for desktop maintenance based on the number of users is an example of this approach. (3) Fixed Price. Some buyers think this is the best approach, because they know exactly what the supplier's price will be, even in the future. But the problem with this approach is that if the buyer does not adequately define the scope of the process and design effective metrics before signing the contract, too often the result will be that the supplier claims a particular service or service level is beyond the scope of the contract and then charges a premium for it. (4) Variable Pricing. This plan involves use of a fixed price at the low end of the supplier's service, with variances based on higher service levels. Its effectiveness, again, depends on adequately defining scope of process and metrics. (5) Incentive-based (or performance-based) pricing. Here, the buyer provides incentives to encourage the supplier to perform at peak level (or complete a one-time project ahead of time, for example) by offering a bonus reward if the supplier performs well. This same plan works in ensuring that the supplier must pay a penalty if it does not perform to at least the "satisfactory" service level designated in the agreement. This plan is the one to use to ensure the supplier's excellence in performance. (6) Risk/reward sharing. Here, the buyer and supplier each have an amount of money at risk and each stand to gain a percentage of the profits if the supplier's performance is optimum and achieves the buyer's objectives. The buyer will select a supplier using a pricing model that best fits the business objectives the buyer is trying to accomplish by outsourcing.
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