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The Hidden Costs of Outsourcing

Last Updated: Apr 16, 2012 01:39PM EDT

by Alex James, CFO

One of the biggest business trends of the late 1990s was the outsourcing of accounting and service jobs to low-cost providers. As globalization became the buzzword, companies rushed to offshore payables, receivables, contract processing, and any other function that involved mundane tasks such as data entry, basic accounting, or – heaven forbid – talking to customers.

The battle cry was labor arbitrage: why pay someone in Manhattan when Mumbai could put a well-spoken PhD in the position for $10,000 a year? Better yet, with outsourcing, companies didn’t even have to manage the process. Just sign a service level agreement (SLA) and a team of ambitious junior executives would map your process, reroute your servers, and promise your firm world-class service for 10 cents on the dollar. And, yes, it was too good to be true.

The problem was that nearly every company turned to outsourcing at the same time, which resulted in rising costs, complexity, and competition in regions commonly used as landing pads for “unwanted” jobs. This challenge did not deter the ambitious. They cased new low-cost locations around the globe, built new centers, and found new service providers, all the while fixated on price. But price is only one facet of a very complicated decision.

The cost of outsourcing a service versus keeping it in house is a simple measurement of success, and to the financially minded it’s the most obvious metric. However, the reality is that outsourcers face a variety of potential hidden costs. While well outsourced processes have brought huge benefits to a wide variety of American companies, here’s a look at some of the challenges we’ve seen in the marketplace, followed by recommendations to help keep your eye on the ball.

  • A rental equipment company outsourced collections to a service provider in India. While the provider originally staffed the account with college graduates, it struggled with retention and gradually turned to lower-quality employees. The college graduates who stayed were promoted to other areas of the firm, while our client’s account was backfilled with high school graduates who had basic bookkeeping skills. Fortunately, the SLA took into account traditional accounts receivable metrics like days to collect and bad debt write-offs, and the rental equipment company did measure the provider’s performance against these metrics. Unfortunately, the rather desperate provider resorted to tricks such as writing credit memos, which reduced days to pay while keeping write-offs off the bad debt radar screen. This practice went on for some time before analysis showed that credit memos were on the rise and action needed to be taken.
  • A large retail grocer outsourced customer service calls regarding gift cards to an offshore provider. The SLA called for paying the provider for total call minutes handled on a monthly basis but did not allow good visibility into the actual call center metrics. As expenses to the grocer continued to rise, the provider insisted that call volume was going up and that the client needed to add more resources to the account. Our analysis showed that the grocer’s call center was one of the smallest accounts within the outsourcing provider and that it was being used as a training ground for larger, more lucrative accounts. Call volume was not rising; rather, call duration was rising and first-call resolution was dropping as the quality and experience of the managers and reps was deteriorating. The grocer was paying for training new employees and getting poorer service quality as its return.

Five key takeaways from our client work in outsourcing:

1. Look beyond price when calculating the true cost of outsourcing. While price is certainly the most critical consideration in any outsourcing decision, it is not the only metric that management must track.

2. Use risk assessment tools to ferret out hidden problems. Use these tools not only during the transfer process, but also to determine what hidden risks may arise once the outsourced process is up and running. Build these findings into your service agreements.

3. Out of sight should not be out of mind. Outsourced processes need to be managed like any other portion of the business. Some of our clients expanded managerial roles after FTEs were moved offshore. The managers lost focus of the distant processes they were supposed to be managing and focused instead on managing what was in their own backyard.

4. Look to make process improvements before you outsource. There are at least two good reasons for this. First, you may find that improving in-house processes eliminate the need to outsource by capturing significant cost reductions while improving customer service. Second, the outsourcing provider will strive to lower the costs of your process yet is unlikely to pass those benefits through to you.

5. Consider low-cost providers closer to home. Many smaller call centers are finding success in the U.S., delivering lower “Midwest” pricing along with high customer satisfaction and fewer hidden management dangers.

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