The Future of Outsourcing Unveiled by ITO and BPO Analysis

Part of the IDC Outsourcing Forum Midwest Report

IDC-main-grfx2IDC analysts Brian Bingham and Barry Rubenstein cited extensive IDC research to describe how outsourcing is developing as a business practice. Although they didn’t explicitly delve into adoption itself, their treatment of ITO (IT outsourcing) and BPO (business process outsourcing) provided significant insight into how outsourcing is being adopted by global enterprises. ITO is several years ahead of BPO for several reasons, namely that IT has traditionally been managed as a support function and cost center in most enterprises and, as such, it has been a textbook candidate for outsourcing. BPO is often more intertwined with the business’s core competencies; in addition, it almost always requires sophisticated IT support. Clearly, ITO had well publicized failures in the early 2000s, but this proved to be part of the normal learning curve, and ITO successes have emboldened buyers and providers to push further into the business. This contrast between ITO and BPO patterns is particularly instructive.

The Growing Strategic Importance of Outsourcing

Outsourcing is clearly gaining recognition as a strategic opportunity for driving operational efficiency and agility. Bingham and Rubenstein outlined C-level executives’ priorities and showed how outsourcing is addressing them, referring to IDC End-User Research (2004-2005):

  • Cost control—the hyper-competitive business climate mandates relentless focus on cost control, and outsourcing has a growing track record at delivering cost savings.
  • Margins and risk assessment—savings are attractive because they fall to the bottom line; executives want to mitigate risk through driving up the performance of IT.
  • Compliance—complying with government-mandated security and customer expectations is getting more difficult every day; outsourcing providers are proving themselves to be creative at addressing this need.
  • Resources/Talent—a talent shortage looms in many areas, echoing the technology boom, and outsourcing is a compelling means to address it. Enterprises and providers are getting better at creating value, and enterprises realize that they have the experience and processes to source talent far more flexibly than ever before.
  • Consolidation/Competition—mergers and acquisitions introduce complexity to business systems and processes, and outsourcing can be an effective means to simplify systems and processes.
  • Customer focus—customer demand is increasingly volatile, and product life cycles are shrinking. High quality is a must, and unprecedented agility is required.
  • Globalization—IT is now sourced globally; outsourcing isn’t about choosing the “right” country or site. Increasingly, teams are located in several countries.
  • Timeliness—time to market and flexibility are more critical than ever, and outsourcing can significantly enhance both; in IT, outsourcing can help to turn the balance of IT costs toward new development, away from maintenance.

ITO and BPO Drivers and Goals

ITO and BPO adoption by enterprises offers insight into the future direction of outsourcing. ITO began with a clear mandate to save costs in the early 2000s, which wasn’t a new idea by any means but profound changes in IT throughout the e-business boom provided more opportunities (Web-enabled infrastructures and applications are more flexible). Citing the IDC IT Outsourcing Survey 2006, Bingham showed that reducing operational costs had fallen to fourth on CIOs’ priority lists; it trailed modernizing legacy systems (#3), maximizing ROI (#2) and improving system performance (#1). In 2006, the top five ITO drivers—for firms in general—were cost savings (#1), resource constraints, quality of service, lack of internal knowledge and focus on core competency (#5).

For manufacturers, ITO drivers were cost savings (#1), lack of resources, focus on core competency, lack of internal knowledge and new regulations (#5). Bingham made the point that manufacturers were accustomed to managing supply chains and were therefore more open to the concept of outsourcing when compared to some other sectors. They are adept at managing their places within their value chains by focusing on their core competencies. Like other industries, they are coping with the added pressure of compliance. They are open to sourcing knowledge that they lack via outsourcing partners, especially in the areas of compliance and the emerging area of RFID (Radio Frequency IDentification, electronic tagging), which is being mandated by Wal-Mart and the Department of Defense.

The top BPO initiatives in 2006 have been reducing operational costs (#1), followed by increasing revenue, integrating key business partners, improving employee productivity, and expanding into new areas (#5). Enterprises have learned from their ITO experience and are applying this learning to business processes. As in ITO, their first goal is reducing cost, but it’s easy to predict a rapidly expanding scope as they learn how to succeed with BPO (and their outsourcing partners learn and enhance their offerings).

ITO and BPO Deals

Bingham and Rubenstein next described the state of the market, drawing conclusions from their analysis of recent ITO and BPO deals. ITO is far more mature because the top vendors have built out the breadth of their offerings, which enables them to address all aspects of large, complex deals. The top five vendors own 50% of the value of the top 100 ITO deals by revenue. However, their share of the top deals is falling as new players emerge. Notably, the large Indian firms are continuing to grow their offerings to address a broader part of the value chain, and they are increasingly effective at competing with the top five. In 2006, although they have yet to earn permission to manage the largest strategic outsourcing deals, the tide is beginning to shift: Rubenstein cited TCS’s (Tata Consulting Services) $847 BPO win with the Pearl Group last year. Another key development in ITO is the growing preeminence of the global sourcing model: providers need to be able to deliver IT services from any part of the world as part of a seamless integrated global offering. In addition, note that manufacturing is a heavy adopter of all ITO services, consistently ahead of the norm.

What Buyers Are Outsourcing—ITO
All industries Manufacturing The biggest ITO deals of 2005
  • Desktop outsourcing (34%)‡
  • Network outsourcing (30.5%)‡
  • Application outsourcing (29%)‡
  • Help desk outsourcing (27%)‡
  • Data center outsourcing (24.5%)‡
  • Disaster recovery services (24.5%)‡
  • Network and desktop outsourcing (21%)‡
  • Total IT outsourcing (18%)‡
  • Desktop outsourcing (39%)‡
  • Network outsourcing (32.5%)‡
  • Application outsourcing (34%)‡
  • Help desk outsourcing (45%)‡
  • Data center outsourcing (32.5%)‡
  • Disaster recovery services (28%)‡
  • Network and desktop outsourcing (33%)‡
  • Total IT outsourcing (23%)‡
  • UK Ministry of Defence and EDS—$4.4 billion total ITO
  • Reuters and BT—$3.0 billion network outsourcing
  • Volkswagen and T-Systems—$3.0 billion total ITO
  • Fiat and IBM—$2.2 billion data center outsourcing
  • State of NY and Tyco—$2.0 billion network outsourcing
  • UK Ministry of Defence and BT—$2.0 billion network outsourcing
  • State of Virginia and Northrop—$2.0 billion IT infrastructure
  • FAA and Lockheed Martin—$1.9 billion network outsourcing
  • ABN Amro and IBM—$1.9 billion data center/desktop outsourcing
  • DuPont and CSC—$1.8 billion total ITO
‡ Source: IDC 2006 IT Outsourcing Survey (numbers rounded) Source: IDC 2006 IT Outsourcing Survey

BPO deals are becoming more comprehensive. The key trend here is that deals are integrating several parts of the business process value chain such as procure to pay or order to cash.

Previously vendors would provide outbound collections calling services, where they are now risk sharing and helping the client manage cash flow. In addition, ITO is often bundled into the BPO offering, including hosting, IT professional services consulting and BPO. Deal length is expanding as well: five to seven years is now the norm, and the number of ten year deals is growing. The number of one to three year deals is falling. These are all signs of the maturation of BPO as a business practice. Regarding BPO deals by industry, government led with 22%, just edging out manufacturing’s 21.9%. They were followed by financial services (19.7%), communications and media (10.5%) and services with 8.8%.

Interestingly, the number of mega-deals, as defined as $1 billion or more, will probably tie 2003’s record by the end of 2006. Conventional wisdom in some quarters had held that big, complex deals failed too often to be viable. This year’s numbers may prove that wisdom wrong.

What Buyers Are Outsourcing—BPO
All industries Manufacturing
  • Human resources (22%)
  • Customer care (11%)
  • Logistics (10%)
  • Procurement (6%)
  • Finance & accounting (6%)
  • Other horizontals (15%)
  • Vertical industry processes (22%)
  • Multiprocess (7%)
  • Human resources (30%)
  • Customer care (2%)
  • Logistics (24%)
  • Procurement (18%)
  • Finance & accounting (6%)
  • Other horizontals (12%)
  • Vertical industry processes (2%)
  • Multiprocess (6%)
Source: IDC Services Contracts Database (numbers rounded)

Bingham and Rubenstein discussed enterprises’ “preferred vendor characteristics” for ITO and BPO, which sheds more light on the adoption of each practice. Note that BPO buyers, in an early stage of adoption relative to ITO, desire vendors to provide a vision and roadmap for BPO. They are looking for true partners to help them manage their businesses better. Due to the successes in ITO, executives realize that outsourcing can be a strategic enabler, and many are placing significant bets on outsourcing. Also note that buyers rate “lowest cost” fifth as a preferred characteristic for ITO vendors, and it doesn’t even make the list for BPO.

Preferred Vendor Characteristics
ITO BPO
  • Ability to collaborate (31%)
  • IT talent/knowledge (15%)
  • Ability to reduce operational risk (14%)
  • Advanced technologies/innovation (10%)
  • Lowest cost (8%)
  • Industry expertise (8%)
  • Transformational capabilities (7%)
  • Offshore capabilities (4%)
  • Ability to provide vision/roadmap (35%)
  • Flexibility in contracting (15%)
  • Ability to reduce operational risk (18%)
  • Commitment to innovation (15%)
  • Global scale/resources (10%)
  • Focus on relationship (7%)
Source: IDC 2006 IT Outsourcing Survey Source: IDC BPO Buyer Trends, 2006

Trends in Sourcing Models

They also briefly discussed sourcing models, namely multisourcing and single sourcing. Gartner especially has been promoting the idea of multisourcing (having multiple vendors providing the same/similar service) as a means to pursue a “best of breed” approach, decrease dependency on one vendor and to wrest attractive terms from vendors by having them compete for the business. According to the 2006 IDC Outsourcing Survey, 43% of respondents single source outsourcing while 32% multisource. Reasons for multisourcing are cost reduction (68%), best of breed (60%), risk mitigation (45%), transformation to new technologies (40%), alignment with internal structure (30%). GM’s 2006 deal is often cited and was again here; they had intended to multisource and ended up giving 43% of it to EDS. Obviously, multisourcing increases management costs significantly and the need for governance. Bundling ITO and BPO is a growing trend; buyers want true partners to share the risk and reward of their outsourcing deals. The 2006 IDC Outsourcing Survey shows that 51% of respondents would bundle ITO and BPO, while 43% would insist on stand-alone ITO.

IDC Advice

Bingham and Rubenstein wrapped with these key success factors:

  • Don’t rush the due diligence process, and have a dedicated champion or team manage all phases of the project.
  • Line up internal buy-in; understand and overcome objections to the proposed scope and purpose of outsourcing; get senior executive endorsement.
  • Vendor selection is best done by conducting short consulting projects with finalists to experience them in action. Insist on assessing the vendor’s performance in similar engagements with other clients. Keep contracts flexible, clearly define roles and responsibilities, and establish metrics to gauge progress.
  • Have a well-structured governance process and team. Empower the vendor with the information and access needed to succeed with their role.

Analysis and Conclusions

  • The adoption of ITO and BPO clearly show patterns for outsourcing in general. Cost-cutting is an early goal, but it subsequently falls in importance as both buyers and providers gain experience and success with outsourcing. They learn how to outsource while pursuing cost reduction, and they reuse the competencies to address other goals later such as quality of service, agility and time to market.
  • In the early stages of ITO adoption, aggressive deals were signed, and there were many well publicized mistakes that many (see Deloitte and PwC) construed as serious limitations to outsourcing as a business practice. However, this is a normal part of the adoption curve; what will be interesting is will the BPO learning curve be dampened by its ITO progenitor? I predict that it will be, and there will be fewer BPO failures.
  • Buyers’ and providers’ growing proficiency with collaboration and outsourcing is enabling outsourcing to become more strategic. For example, now that enterprises and their partners are succeeding with managing flexible work processes, they can increasingly provide talent in synch with market demand. They no longer must exclusively use the employee model, and they can source expertise externally while they build internal capabilities.
  • An interesting sub-plot the ITO-BPO bundling story is how the emerging SOA (service-oriented architecture) and Web services infrastructure enables outsourcing. At a very high and simplistic level, SOA is transforming enterprise software by reorganizing its functionality into modules that provide and request (information) services to and from each other via standardized interfaces (i.e. Web services). All vendors of import are standardizing on SOA, which means that software can increasingly plug and play. Competency with SOA is a valuable indicator for buyers’ and providers’ readiness for BPO that requires sophisticated IT support. Also see The Revolution in Enterprise Software: Why It’s Key to Outsourcing.
  • The multisourcing vs. single-sourcing debate is most interesting when seen from the perspective of collaboration. Both models are optimal for various circumstances, but the oft-cited advantage of multisourcing that pressures vendors into cut-throat competition is short-sighted because it prevents true collaboration, which implies willing knowledge sharing and interdependent working relationships. Collaboration calls for the cooperation of independent parties, and it must be mutually rewarding to work. Multisourcing will become more viable when providers and buyers evolve their proficiency in governance and diminish its cost. Innovation in this area will be a key area to watch because it can change the rules and make multisourcing more viable. Two examples: 1) having a key provider serve as the master contract holder that manages subcontractors (i.e. cascading accountability); 2) sophisticated technologies that pinpoint the root cause of failures will make multisourcing more viable; at present, multiple vendors often point to each other as the cause of failure. One example, for software and networks, is EMC Smarts Software.
  • This talk didn’t address pursuing outsourcing to increase innovation and drive the revenue line. As I have written extensively, innovation will drive most of the value in the years ahead, and I predict that innovation will increasingly be the target for outsourcing, once buyers and providers have exhausted the BPO opportunity. Collaborating for innovation will present a higher challenge because there is less of an established process; it’s not a question of transferring an established process (say, accounts receivable) to a provider; innovation is a challenging undertaking in itself because it involves significant risk and reward, and it’s aim is to create and take to market an offering that results from discontinuous thinking. Among others, see How the Knowledge Economy Will Transform Markets and the Producer/Consumer Relationship or 21st Century Drivers for Innovation and Collaboration.

1 comment to The Future of Outsourcing Unveiled by ITO and BPO Analysis

  • Great article! I am very optimistic that the outsourcing industry will still continue to boom in the next few years and will be one of the significant driving forces for economic growth for both US and the outsourcing countries like here in the Philippines.

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