Strategic Global Outsourcing and Offshoring

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pa rt I Making a Sourcing Decision

Oshri, I., Kotlarsky, J., & Willcocks, L. P. (2015). The handbook of global outsourcing and offshoring 3rd edition. Retrieved from http://ebookcentral.proquest.com Created from aston on 2019-03-13 14:34:05.

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ch ap te r1 Overview of the Global Sourcing Marketplace

With the advent of globalisation and heightened levels of competition, many organisations are having considerable difficulties in developing and maintaining the range of expertise and skills they need to compete effec- tively. The emergence of American, European, Japanese and other Asian multinationals has created a competitive environment requiring the glob- alisation, or at least semiglobalisation, of corporate strategy. Moreover, with developments in information and communication technologies (ICT), firms do not have to be large multinationals to compete globally. These developments have led many companies to turn to various sourcing strate- gies such as outsourcing, offshoring, offshore outsourcing, nearshoring and onshoring. Therefore, this chapter focuses on:

The key terminologies used in the sourcing literature The background of global sourcing The key drivers, benefits and risks of global sourcing Market trends and future developments in global sourcing.

Definitions Sourcing is the act through which work is contracted or delegated to an external or internal entity that could be physically located any- where. It encompasses various insourcing (keeping work in-house) and outsourcing arrangements such as offshore outsourcing, captive offshoring, nearshoring and onshoring.

7 Oshri, I., Kotlarsky, J., & Willcocks, L. P. (2015). The handbook of global outsourcing and offshoring 3rd edition. Retrieved from http://ebookcentral.proquest.com Created from aston on 2019-03-13 14:34:05.

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8 Making a Sourcing Decision

Outsourcing is defined as contracting with a third-party supplier for the management and completion of a certain amount of work, for a specified length of time, cost and level of service. Offshoring refers to the relocation of organisational activities (e.g., infor- mation technology, finance and accounting, back office and human resources) to a wholly owned subsidiary or an independent service provider in another country. This definition illuminates the importance of distinguishing whether the offshored work is performed by the same organisation or by a third party. When the work is offshored to a centre owned by the organisation, we refer to a captive model of service deliv- ery. When the work is offshored to an independent third party, we refer to an offshore outsourcing model of service delivery. And when organisational activities are relocated to a neighbouring country (e.g., US organisations relocating their work to Canada or Mexico), we use the term nearshoring.

These definitions include various sourcing models: for example, staff aug- mentation, domestic and rural sourcing, crowdsourcing, cloud services, microsourcing, bundled services, out-tasking and shared services (terms explained in Chapter 2). In addition, there are various common buzzwords such as best-sourcing (or best-shoring, right-shoring and far-shoring (as opposed to nearshoring), usually coined and used by supplier companies. Finally, there is also the backsourcing trend, which implies bringing work back in-house.

Global Sourcing Background

The global IT outsourcing (ITO) market has increased each year since 1989, when global ITO was only a US$10 billion market. On conserva- tive estimates, by the end of 2013, the global outsourcing contract value for business and IT services was about US$648 billion (business process outsourcing (BPO) US$304 billion, ITO US$344 billion) and by the end of 2014 exceeded US$700 billion. On some estimates the market will see a 4.8% compound annual growth through to the end of 2018 as more is out- sourced and new service lines and delivery locations are added (Bhimani and Willcocks, 2014).

Looking at the global BPO and IT services market by region, in 2013 North America was 42% of the market, Europe, Middle East and Africa (EMEA)

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Overview of the Global Sourcing Marketplace 9

34%, Japan 10%, the rest of Asia Pacific 9% and Latin America 5%. How- ever, for the first time, in 2014 growth in outsourcing services in Europe exceeded growth in the USA.

Not surprisingly, spending on IT consulting topped any other function out- sourced by leading multinationals in Western economies when working with a third-party service provider. Figure 1.1 depicts the distribution of expenditures in 2014 by the leading 150 multinationals in the UK and the USA on various ITO and BPO functions when working with suppliers.

While outsourcing has accelerated, we have also seen growth in the area of shared services and captive centres. Figure 1.2 depicts the distribution of outsourcing expenditure on shared services per function in 2014.

The main driver for outsourcing is still cost reduction; however, we have witnessed growing attention by client firms to other objectives such as access to skills and flexibility in how human capital is utilised. Figure 1.3 offers an insight into the drivers for outsourcing in 2014.

While, during 2014, manywondered whether automation and backsourcing (also known as re-shoring) would see the erosion of offshore outsourcing, in practice offshore outsourcing has been growing worldwide. Within the overall outsourcing figures cited above, offshore outsourcing exceeded US$100 billion in revenues in 2013 and is estimated to grow at 8–12%

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FIGURE 1.1 Distribution of outsourcing expenditures by ITO and BPO functions when working with suppliers Source: Survey by Loughborough Centre for Global Sourcing and Service, 2014.

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10 Making a Sourcing Decision

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FIGURE 1.2 Distribution of outsourcing expenditures by ITO and BPO functions when working with shared service centres and captives Source: Survey by Loughborough Centre for Global Sourcing and Service, 2014.

Reduce costs OthersOvercome internal

politics and resistance to

change

Gain access to cutting-edge

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resource is utilised

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FIGURE 1.3 Main drivers of outsourcing Source: Survey by Loughborough Centre for Global Sourcing and Service, 2014.

per year from 2013 to 2018 (Willcocks et al., 2015). This strategy has always appeared promising in terms of the reduction of costs as cer- tain organisational activities would be moved to an independent service provider in a country with favourable conditions. In more recent years,

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Overview of the Global Sourcing Marketplace 11

clients have pursued a cost-plus agenda when offshore outsourcing, and for large multinationals, offshore outsourcing increasingly has to fit into a larger global sourcing strategy that mitigates risk and links different sourcing options in a coordinated manner. The USA is a major player in the offshore outsourcing of IT and business-process applications. However, offshore outsourcing has appeared to be gaining momentum in Europe, where the UK is the lead consumer of such services. We cover offshore outsourcing in more details in Chapters 2 and 3.

Drivers, Benefits and Risks of Global Sourcing

The growth of global sourcing has been attributed to many factors. First, technological advances in the telecommunications industry and the Inter- net have shrunk space and time and have enabled the coordination of organisational activities at the global level. Other reasons are as follows: the supply of skilled yet low-cost labour in countries such as India and the Philippines and subsequently now over 125 further locations; investments in infrastructure; an improved business, economic and political climate in a number of developing countries; and the standardisation of IT pro- cesses and communication protocols that contribute to the efficiency of inter-organisational activities.

Along these lines, many countries have invested heavily in improving their telecommunications infrastructure, which is essential for electron- ically transmitted services. For example, Barbados has had a fully dig- italised communications system with direct international dialling since the beginning of the 1990s. Jamaica constructed its Digiport, with a 20,000-telephone-line capacity and speeds of 1.5 Mbps. Furthermore, many countries have provided tax advantages to attract offshoring. For example, Bulgaria offers a 10% flat enterprise tax rate that is dropping to 0% in areas with high unemployment. In Jamaica the Digiport BPO free trade zones are tax free. South Africa offers government and provincial grants for job creation through attracting offshore work to the country and in 2014 made its immigration laws more supportive of the industry. Other countries like China, Morocco, Egypt and Kenya have invested heav- ily in business parks and in ways of supporting offshore industry growth. Chapter 3 deals with such issues in more detail.

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12 Making a Sourcing Decision

Global sourcing may offer several benefits associated with the advantages of outsourcing in general. A company may reap significant cost advan- tages through the creation of economies of scale, access to the unique expertise of a third party and the reduction or stabilisation of overhead costs. In addition, a company may benefit from outsourcing by concen- trating on core activities, organisational specialisations, or by focusing on achieving key strategic objectives. More specifically, a strategy of build- ing core competencies and outsourcing the rest may enable a company to focus its resources on a relatively few knowledge-based core competencies where it can develop best-in-the-world capabilities (Quinn and Hilmer, 1994; Lacity and Willcocks, 2012). Concentration on a core business may allow a company to exploit distinctive competencies that will lead to a significant competitive advantage.

Another major benefit of outsourcing is that it can give the organisation access to the supplier’s capabilities and innovative abilities, which may be expensive or impossible for the company to develop in-house (Quinn and Hilmer, 1994).

Even more important, a network of suppliers can provide any organisation with the ability to quickly adjust the scale and scope of its produc- tion capability upwards or downwards, at a lower cost, in response to changing demand. In this way, outsourcing can provide greater flexi- bility (McCarthy and Anagnostou, 2003). Furthermore, outsourcing can decrease the product or process design cycle time if the client uses multiple best-in-class suppliers that work simultaneously on individual compo- nents of the system, as each supplier can contribute greater depth and sophisticated knowledge in specialised areas and thus offer higher qual- ity inputs than any individual supplier or client can (Quinn and Hilmer, 1994). On this basis, having several offshore centres can provide around- the-clock workdays. In other words, development and production can take place constantly by exploiting the time difference between different countries.

While firms seek to reduce costs and access skills and ideas from outsourcing engagements, it is not always clear whether value is appro- priated from such relationships. Oshri and Kotlarsky (2009) examined value in outsourcing to conclude that the vast majority of client firms

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Overview of the Global Sourcing Marketplace 13

are in the dark when trying to measure and quantify the return on their outsourcing investments. In fact, less than half of the firms studied (43%) have attempted to calculate the financial impact of outsourcing to their bottom line, indicating that the financial benefits are difficult to quantify (51%). When asked about cutting back or bringing back operations in- house, executives sited ‘unclear value for money’ as the main driver (see Figure 1.4).

Adopting sourcing strategies poses several other disadvantages. Loss of critical skills or overdependence on an outside organisation for carrying out important business functions may evolve into significant threats to a company’s well-being. Also, security and confidentiality of data can become major issues for many companies. Another major issue is los- ing control over the timing and quality of outputs since these will be undertaken by an outside supplier: the result may be a poorer qual- ity of the final product or service, and this may sully a company’s image.

The following case illustrates the challenges companies such as BSkyB face when pursuing a sourcing strategy. It highlights the responsibility both client and supplier hold when signing an outsourcing contract and the implications for both parties when things go wrong.

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FIGURE 1.4 Main drivers for cutting back or bringing back outsourced services Source: Oshri and Kotlarsky, 2009.

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14 Making a Sourcing Decision

C A S E S T U D Y

BSkyB: The Bumpy Road of Outsourcing

In 1983, Rupert Murdoch purchased Satellite Television, a com-

pany founded in 1981 by Brian Haynes, and renamed it Sky.

After years of competition between British Satellite Broadcast-

ing (BSB) and Sky, the two companies merged on 30 October

1990, to formBSkyB. By 2007, BSkyB had become theUK’s largest

independent broadcasting operation, supplying a broad range

of programmes, channels and services to more than ten million

people around the world.

In 2000, BSkyB was looking for a company that would redesign

and implement a new Customer Relationship Management

(CRM) system for that would be the heart of its business. The

system needed to be built around Chordiant Software and run

on Sun Microsystems hardware. BSkyB’s contact centres in

Livingston and Dunfermline in Scotland would use the new

CRM system.

To achieve this objective, BSkyB conducted a competitive ten-

der exercise to find a supplier that would be able to meet its

criteria. Several bidders emerged during the tendering process,

including PricewaterhouseCoopers and Electronic Data Systems

(EDS). In the end, EDS was chosen as the supplier for the CRM

system.

EDS had been founded in 1962 by Henry Ross Perot, a former

salesman from IBM who came up with the idea that besides

delivering computer equipment, IBM should also deliver elec-

tronic data processing services to its customers. When IBM

rejected the idea, Perot resigned and founded his own company,

EDS. In 2008, Hewlett-Packard (HP) acquired EDS, which now

delivered a broad range of infrastructure technology, applica-

tions and BPO services. In 2009, EDS changed its name to HP

Enterprise Services.

The initial idea was that EDS would provide BSkyB with a tech-

nically advanced solution that would make a valuable contri-

bution to BSkyB’s drive to lead innovation in customer service

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Overview of the Global Sourcing Marketplace 15

and maintain Sky Digital’s industry-leading levels of customer

retention. BSkyB’s customers would be able to access account,

billing and other information and services by phone, the Web or

the television service itself.

On 30 November 2000, BSkyB and EDS signed a contract esti-

mated at a value of £48 million. As there was uncertainty about

the cost of this work (due to the uncertainty regarding the

amount of work that needed to be done), BSkyB employed

EDS on a time-and-materials basis. EDS stated that it would

be able to go live in nine months and complete delivery in

18 months. However, just five months later, in March 2002,

BSkyB terminated its relationship with EDS because, accord-

ing to BSkyB, EDS did not fulfil its contractual obligations.

BSkyB switched to in-house development, and the residual

work was taken over by BSkyB’s subsidiary, Sky Subscribers

Services Ltd.

By 2004, BSkyB had invested over £170 million; in addition, its

IT department had budgeted £50million over the next four years

to complete the implementation. By March 2006, BSkyB had

successfully completed the project after spending £265 million.

Back in 2004, BSkyB initiated legal action against EDS, citing that

EDS had not been honest during the competitive tender about its

resources, technology and the methodology it planned to use in

order to deliver the system within the defined time frame and

within budget. BSkyB claimed that it would have probably cho-

sen PricewaterhouseCoopers for the work if EDS had not given

a false sales pitch in which it overestimated its capabilities. EDS,

for its part, claimed that the most critical element in this project

was that BSkyB did not specify the project properly and that it

did not know exactly what BSkyB wanted or needed. In October

2007, the trial started at the High Court in London and was con-

cluded in July 2008. On 26 January 2010, 18months after the end

of the trial, the High Court ruled on the dispute between BSkyB

and EDS (now part of HP). It found that EDS had been deceit-

ful when it claimed that it had carried out an accurate analysis of

the time needed to complete the delivery and go live andwhen it

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16 Making a Sourcing Decision

claimed that it was able to deliver the system within the agreed-

to schedule. According to the Court, the CRM manager for EDS

had known that it was not possible to finish the project accord-

ing to schedule and that there had not been an accurate analysis

of what needed to be done. In addition, BSkyB proved that EDS

had violated the contract. BSkyB was, therefore, awarded dam-

ages up to the liability cap set out in the contract. In addition, the

Court stated that the responsibilities for deceitful misrepresenta-

tions that were not described in the contract were not accurately

excluded by the same contract.

One major outcome from this trial was that BSkyB was able to

prove that EDS had made a deceitful sales pitch, so the liability

cap was not applicable. On 3 February 2010, the Technology and

Construction Court ordered EDS to pay an interim payment of

£200 million for damages.

Additional outsourcing risks are associated with organisational changes. For example, outsourcing is usually followed by changes in organisational structure with redundancies and layoffs. Research and experience indicate that outsourcing effectively signals to employees their employer’s inten- tion to initiate a change that may involve deskilling and redundancies (Kakabadse and Kakabadse, 2000). Such initiatives can generate internal fears and employee resistance.

Moreover, as Hendry (1995) highlights, outsourcing can be associ- ated with problems related to the company’s ability to learn because it can increase insecurity among the workforce and decrease its motivation, reducing employees’ willingness to question and experi- ment. There are fears as well that interactions among skilled peo- ple in different functional activities, which often lead to unexpected new insights or solutions, will become less likely (Quinn and Hilmer, 1994).

With regard to offshore outsourcing, Rottman and Lacity (2006) offer a comprehensive list of risks associated with such ventures. These include different kinds of business, legal, political, workforce, social and logistical risks (see Table 1.1).

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Overview of the Global Sourcing Marketplace 17

TABLE 1.1 Offshore outsourcing risks

Risk category Sample risks

Business No overall cost savings Poor quality Late deliverables

Legal Inefficient or ineffective judicial system at offshore locale Intellectual property rights infringement Export restrictions Inflexible labour laws Difficulty obtaining visas Changes in tax laws that could significantly erode savings Inflexible contracts Breach in security or privacy

Political Backlash from internal IT staff Perceived as unpatriotic Politicians’ threats to tax US companies that source offshore Political instability within offshore country Political instability between USA and offshore country

Workforce Supplier employee turnover Supplier employee burnout Inexperienced supplier employees Poor communication skills of supplier employees

Social Cultural differences Holiday and religious calendar differences

Logistical Time-zone challenges Managing remote teams Coordination of travel

Source: Adapted from Willcocks and Lacity, 2006.

The Future of Outsourcing and Offshoring

Drawing on a number of the authors’ research streams, we can identify ten trends for the future of global sourcing markets.

Trend 1: Spending will continue to rise in all global sourcing markets, but BPO will overtake ITO We have already seen how, following the long-term growth trend, ITO and BPO expenditure is set to rise continually in the 2012–2018 period. The interesting feature is that BPO is and will grow at a faster rate than ITO, with BPO expenditures rising across the board in areas such as the human resources function, procurement, back-office administration, call

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18 Making a Sourcing Decision

centres, legal, finance and accounting, customer-facing operations and asset management.

BPO is outpacing ITO because many executives recognise that they under- manage their back offices and do not wish to invest in back-office innova- tions. Suppliers are rapidly building capabilities to reap the benefits from improving inefficient processes and functions. IT provides major underpin- ning for, and pay-off from, reformed business processes. Thus, many of the BPO deals will encompass back-office IT systems. This is also evidenced by the shift in strategy of traditional IT suppliers like IBM and HP to provide more business-process services. Suppliers will increasingly replace clients’ disparate back-office IT systems with Web-enabled, self-serve portals.

There have been some high-profile backsourcing (i.e., returning services in-house) cases in recent years: Sainsbury in 2005, Santander in 2012 and General Motors in 2013, for example. Although these cases have drawn the attention of the media, they have never represented a dominant trend towards backsourcing. The most common course of action at the end of a contract continues to be contract renewal with the same supplier. The typical pattern seems to be that a quarter of contracts are retendered and awarded to new suppliers, and only a few are backsourced.

Trend 2: The ITO and BPO outsourcing markets will continue to grow through multisourcing Although ITO and BPO spending is increasing, the average size of indi- vidual contracts and the duration of contracts has been decreasing. For example, the Everest Group found that, among the ITO contracts signed in 1998, 24% of contracts were worth more than US$400 million and 33% of contracts were worth between US$50 and US$100 million. In 2005, only 11% of contracts were worth more than US$400 million and 57% were worth between US$50 and US$100 million. Concerning contract dura- tion, the Everest Group found that 37% of contracts signed in 1998 were more than nine years in duration compared to 18% in 2005 (Tisnovsky, 2006). According to a Gartner report from December 2009, in 2009 only six megadeals (contracts with a total reported contract value exceeding US$1 billion) were signed, with an average term of seven years, which is lower than the nine-year-average term in 12 megadeals signed in 2008. These trends continued across the 2008–2014 period, initially as responses

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Overview of the Global Sourcing Marketplace 19

to the recessionary climate but then as part of long-term trends in buy- ing behaviour, which includes a reduction in the number of suppliers while pursuing the advantages of multisourcing.

Multisourcing is becoming the dominant practice, and its overall growth is driven by client organisations that are signing more contracts with more suppliers. Although multisourcing helps clients access the best suppli- ers and mitigates the risks of relying on a single supplier, it also means increased transaction costs because clients must manage more suppliers. In addition, suppliers themselves incur more transaction costs: they must bid more frequently because their contracts are shorter; they face more competition because smaller deals mean that more suppliers qualify to bid, and they need to attract more customers in order to meet growth targets.

Trend 3: Global clients will view India primarily as a destination for excellence rather than a way to lower costs Many US and UK clients initially engaged Indian suppliers to provide technical services such as programming and platform upgrades. As these relationships matured, US clients assigned more challenging work to their Indian suppliers. For example, a US retailer first engaged an Indian sup- plier to help with Y2K compliance. As the relationship matured, the retailer assigned development and support tasks for critical business applications to the supplier. This retailer and other satisfied clients said, ‘We went to India for lower costs, but we stayed for quality.’

Indian suppliers have also been taking actions to move themselves up the BPO value chain into complex BPO work and management consulting activities. At the same time, this has become a critical strategic move as the cost advantages India enjoyed in the early 2000s have eroded in the face of labour cost rises, higher labour attrition rates (by 2014 running at 25% or higher in many outsourcing arrangements) and increasing competition from cheaper locations (see Chapters 3 and 4).

We believe that India will remain the ITO and BPO powerhouse and will continue to have 65% or more of the global market over the next five years. However, Indian suppliers are going to have to work hard to be recognised among the top suppliers of higher added value areas of complex BPO and consulting.

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20 Making a Sourcing Decision

Trend 4: China’s investment in ITO and BPO services signals promise . . . China invested US$142.3 billion in ICT in 2006, which it hoped would pay off in terms of its ability to compete globally in the offshore services mar- ket. Its long-term ITO and BPO future is expected to be strong (Lacity et al., 2010). The ITO and BPO supplier landscape is changing quickly with some of the suppliers finally setting global footprints, such as Pactera.

C A S E S T U D Y

Pactera Technology International: An Emerging Global

Chinese Player

by Ken Schulz

Pactera was formed in 2012 with a Merger of Equals (MOE)

between leading China-based software outsourcing firms

VanceInfo Technologies Inc and HiSoft International Ltd. This

created the largest IT services and outsourcing firm headquar-

tered in China with over 23,000 employees.

China Pioneers: 1995–2010

Prior to the MOE, VanceInfo already had a 17-year history, hav-

ing been launched in 1995 by Chris Chen with 25 employees.

VanceInfo secured IBM as its first major client by helping Big

Blue localise its OS/2 operating system for the China mar-

ket. VanceInfo began work for Microsoft in 1997 and in 2001

acquired Fuji Xerox as a client. As China’s economy contin-

ued to expand, VanceInfo established multiple client-dedicated

offshore development centres, investing together with clients

in IT-product development and software R&D services, forging

long-term partner relationships.

Current Pactera President David Chen joined Chris Chen to lead

VanceInfo forward, and following ten years of steady growth to

nearly 1,000 employees in 2005, the firm received funding from

Silicon Valley VC Doll Capital Management and local VC Legend

Capital in 2005, with another Silicon Valley firm, Sequoia Capital,

joining a second round in 2006. The VC expertise and capital

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Overview of the Global Sourcing Marketplace 21

fuelled growth for the company, leading VanceInfo to list on the

New York Stock Exchange in 2007.

Newly listed companyVanceInfo grew to becomeChina’s largest

software outsourcing company focused on the US and EU mar-

kets, with a marquee client base including Citigroup, Microsoft,

IBM, Oracle, HP, Expedia, TIBCO and many other leading For-

tune 1,000 companies.

HiSoft International Ltd was founded in Dalian, China, in 1996.

Before 2006, HiSoft generated most of its revenues from clients

in Japan. HiSoft’s strategy was to leverage demand for China-

based outsourced IT services from multinational and domes-

tic corporations in China. Approximately one third of HiSoft’s

clients were Fortune 500 companies, representing over half

of the company’s revenue. Of its clients, 60% were from the

USA and Europe, 30% from Japan and 10% from China.

HiSoft’s first overseas subsidiary was established in Tokyo in

August 2002. The same year, it established a US presence in

Atlanta and New York. From 2007 to mid-2012, HiSoft success-

fully expanded to serve clients in the USA, Europe, China and

Australia, helped by a series of overseas acquisitions.

HiSoft raised US$74 million during its IPO on NASDAQ in 2010.

Around the time the company was planning to go public, it

recruited a former executive of Hewlett-Packard China as its

CEO: Tiak Koon Loh, still serving as the current Pactera CEO.

Market Consolidation: 2010–2014

One of HiSoft’s primary strategies was to increase business for

existing clients while building business with Chinese compa-

nies. With fresh capital from the IPO, HiSoft’s geographic expan-

sion and onshore capabilities upgrade strategy continued with

the purchase of IT consulting firms NouvEON in the USA and

BearingPoint in Australia.

VanceInfo held similar aspirations to move up the IT services

value chain. Most Chinese domestic ITO companies operate at

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22 Making a Sourcing Decision

the lower end of the value chain, employed in coding, testing

and other low-end value-added sectors. This lower end has

smaller barriers to entry, as projects can be completed with

lesser experienced employees including lower cost new gradu-

ates. At this low end of the chain, competition is fierce and profit

margins have become increasingly tight.

At the other end of the spectrum, higher-end IT services and

software outsourcing are subject to higher entry barriers. Com-

petition is less crucial in thismarket, and it is oftenmore a case of

not finding sufficiently experienced personnel than competing

with other foreign and domestic firms.

The importance of offering a full spectrum of services by

addressing the high end of themarket in addition to services tar-

geted at the lower end was one of the factors driving VanceInfo

and HiSoft to combine in late 2012 to form Pactera. Pactera

believed there to be a lot of space for development at the high

end, particularly in certain industry verticals and dependent on

the ability to seize first-mover advantage in China. The company

believed that players with a clear vision, international focus,

innovation and a strong high-end business would grow fastest,

and their market share would continue to expand.

The company is now positioned to benefit over the next decade,

not just in the outsourcing industry but also in IT consult-

ing services as China’s economy continues to expand rapidly

and companies seek more sophisticated IT systems to support

growth. For example, Pactera supported Microsoft by helping to

launch the Azure cloud platform in China.

Pactera is currently heavily reliant on its overseas client base,

with nearly 40% of its revenue coming from USA-based cus-

tomers and another 20% from Europe and overseas Asia-Pacific-

based clients, while seeking to develop its relations with China

domestic companies.

In servicing clients, the drive to increase quality while

simultaneously lowering costs is also pushing Pactera to

diversify the location of service delivery centres and offices. The

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Overview of the Global Sourcing Marketplace 23

strategy for the company emerged from the ground up, with

government support being a significant factor. As ITO grew,

national conferences were held and local governments gave

financial support and other benefits, thus lowering costs to the

company.

Going Global: The Future Outlook

In March 2014, a consortium led by US private-equity giant

Blackstone Group acquired Pactera for around US$600 million.

The Blackstone Group acquisition of Pactera was widely thought

to be due to several key factors including the following: Pactera’s

relatively international management team that aligned well with

the Blackstone Group; Pactera’s ability to quickly enhance its

growth rate by merging; and Pactera’s position as the largest

software outsourcing company in China and leading IT service

provider in a rapidly developing and promising market.

Goals for Pactera following privatisation include becoming

a leading global IT service enterprise with the largest scale

in China while maintaining the leading position in China’s

outsourcing services. With competitive large-scale Chinese

enterprises targeting multiple markets beginning to expand

globally, the company also seeks to become the number one

IT partner for Chinese customers expanding into international

markets.

Privatisation might also help Pactera to complete its strate-

gic transformation from an outsourcing service provider to

an IT services player that provides a fuller spectrum of offer-

ings including consulting, solutions and outsourcing services.

Transformation requires time, money and resource support to

balance short- and long-term development.

Privatisation is also expected to help accelerate the pace of

the company’s vertical transformation, as Pactera also seeks to

focus on key industry verticals such as Banking, Financial Ser-

vices and Insurance (BFSI), travel and technology, with strong

aspirations to become the top-ranked service provider in the

Chinese domestic banking IT solutions market by 2015.

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24 Making a Sourcing Decision

The Chinese service outsourcing sector is still facing major challenges. Even in 2014, language barriers, cultural barriers and fears over losing intellectual property remained obstacles for the executives, who often preferred to access the vast Chinese talent by setting up captives and shared services (Oshri, 2014). The Chinese government and Chinese busi- ness sectors are well aware of these barriers and are seeking ways to address them. For example, the Chinese government invested US$5 billion in English-language training to target the ITO and BPO markets. Sub- sequently the Chinese national and provincial governments have made additional investments to develop the services industry. Given their sim- ilar size of populations, India and China have remarkably different records on offshore outsourcing, with India, attracting over ten times more than China in the global revenues. Unlike India, China does not have one focused marketing body for the country and relatively little assistance for would-be investors.

Trend 5: Developing countries beyond India and China will become important players in the global business and IT services market In 2014, there were over 125 countries with operational ITO or BPO offshore sectors, and we see this number rising, albeit slowly, over the next five years. We also see a deepening and widening of services at many of these locations, as they seek competitive advantage in the global marketplace. Many US clients already use Central American suppliers for Spanish-speaking business processes such as help desks, patient scheduling and data entry. Synchronous time zones are another favourable factor for US firms looking to Central or South America for sourcing.

In Western Europe, organisations will increasingly source IT and business services to suppliers located in Eastern Europe. For example, the Visegrad- Four countries (Czech Republic, Hungary, Poland and Slovakia) offer Western European firms closer proximity, fewer time-zone differences and lower transaction costs than Asian alternatives.

In Africa too, many countries are actively seeking to become players in the global ITO and BPO markets. North Africa already exports IT services to Europe. One interesting study examined five Moroccan IT suppliers that provided services to clients in France as early as 2003 (Bruno et al., 2004). The common language, similar time zone and cultural capability make

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Overview of the Global Sourcing Marketplace 25

Morocco attractive for French organisations seeking to outsource. South Africa is also exporting IT and BP services, primarily to UK-based clients. South Africa appeals primarily to UK-based clients because of the simi- lar time zone, cultural similarities, English-speaking capabilities and good infrastructure. Even some sub-Saharan countries are building part of their future economies on IT (Willcocks et al., 2015).

Trend 6: Large companies will give application service provision a very strong second look, as it becomes cloud services Many thought that application service provision (ASP) had died with the dot-com bust. But through cloud computing, small and medium enter- prises (SMEs) and large organisations are increasingly buying into the proposition of renting applications software, infrastructure, applications, services and storage over the Internet. A few large multinationals, for example, Proctor & Gamble and Johnson & Johnson, have been leading the way in developing cloud-ready policies and developing and harnessing their own and service-provider capability to move to the cloud. By 2014, many SMEs, especially those ‘born in the cloud’ had adopted various forms of cloud computing services. Many large organisations want Net-native applications (proprietary applications designed and delivered specifically for Internet delivery) that are available only through software as a ser- vice (SaaS) delivery (e.g., Salesforce.com). Large organisations may also finally be ready to abandon their expensive proprietary suites for cheaper SaaS and cloud alternatives. Furthermore, SaaS providers may well have got the message by 2015 that clients want customised services, even if the products are standardised. The need for customised services actually increases the service providers’ viability because they can generate profits by charging for value-added services.

Trend 7: Outsourcing will help insourcing . . . to an extent As organisations become smarter at outsourcing, they also become smarter at insourcing. In-house operations are facing tough competition in nearly every area and can no longer assume they will retain their monopoly status with the organisation. As a result, in-house operations are adopt- ing the techniques of the market. While this book is about outsourcing and offshoring, it should be recalled that about 60% of IT work and about 80% of back-office service work is still managed in-house. Clearly

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26 Making a Sourcing Decision

there is still plenty of room for outsourcing expansion. And, also clearly, in-house operations will need to become much more competitive in their service offerings against what the burgeoning services market can offer.

Nevertheless during the 2013–2014 period, against the outsourcing growth trend we pointed to earlier, there were increasing examples of moving some work back in-house. Automation may help this trend much more over the next five years. However, such insourcing will be impeded by a supply shortage of talent within developed countries, particularly for IT skills. The USA is not alone in this. Nearly every research report sug- gests that other developed countries will suffer a shortage of domestic IT workers within the next five to eight years. The shortages in devel- oped countries will be caused by the gap between a strong demand for domestic IT workers and a dwindling supply due to the lingering effects of declining enrolments into IT education and the future effects of the retirement of the ‘baby boomers’. At the moment, however, it is not clear how the numbers will work out. Certainly the demographics suggest that the supply of IT and back-office workers will be much higher in what the USA and European countries would consider offshore outsourcing loca- tions; though, of course, multinationals also have the option of building offshore captive sites there. The development of offshore locations and their labour pools could also help and is already supporting the growth of in-house captives (see Chapters 3 and 4).

Trend 8: Nearshoring will become more prevalent Compared to offshoring to remote locations, the benefits of nearshoring include lower travel costs, fewer time-zone differences and closer cultural compatibility. The economic and management logics suggest a lot more nearshoring. The transaction costs for offshoring are not always obvious, but when they come to be noticeably large, then nearshoring becomes an obvious alternative. Nearshoring is about proximity not just in terms of geography but also culture, institutions, time zone, languages, religion and ethics. For these reasons for the UK, for example, South Africa could be considered almost a nearshore location, despite the two countries being over 11 hours apart in flight time. More conventionally, Canada, for exam- ple, is a significant nearshore destination for US clients. Some analysts

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Overview of the Global Sourcing Marketplace 27

argue that US clients could have lower total costs with nearshoring to Canada than with offshoring to India.

The Czech Republic, Poland and Hungary are significant nearshore desti- nations for Western Europe. Clients in Western Europe are attracted to Central and Eastern European suppliers for many of the same reasons that the USA is attracted to Canadian suppliers: familiarity with language, cul- tural understanding, minimal time-zone differences and low labour costs. However, Central and Eastern Europe may be more attractive for BPO than ITO because, while these countries provide an excellent general educa- tion, at the moment there are far less IT and engineering graduates than in India.

Nearshoring will also become more prevalent as part of client and supplier strategies to ‘best-shore’, that is, to find the optimal mix of locations for the dynamic portfolio of work they need to carry out.

Trend 9: More companies will sell their captive centres or create virtual captive centres While it is widely recognised that Western companies are setting up sites offshore, there is an emerging trend that might be called ‘The GE Effect’. General Electric (GE) may not have been the first US footprint in India, but certainly Jack Welch’s enthusiasm for India made it acceptable for other CEOs to locate back offices there. GE established General Electric Capital International Services (GECIS) as a captive centre in India in 1997. In the winter of 2004, it sold off 60% of GECIS to two equity companies: Oak Hill Capital Partners and General Atlantic Partners. A year later, the name was changed to Genpact, and it is now one of the top ten BPO or ITO suppliers in India. Some have called GE’s approach ‘the virtual captive centre’ because GE still maintains primary equity holding. With a virtual captive centre, the company owns the physical operations, but staff are employed by a third-party supplier. Presumably the virtual cap- tive centre offers the best of both worlds: the client investor maintains strategic control while the supplier attracts, develops and retains local talent.

Among US clients there have been several examples of organisations sell- ing their captive centres. Beyond the anecdotes, in 2007 the Brown-Wilson Group conducted a survey of 18,272 clients, which found that selling

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28 Making a Sourcing Decision

captive centres may be a significant trend. Respondents from large organ- isations were more likely than those in mid-sized businesses to investigate selling. The main reasons for selling captive centres were as follows:

The captive centre was built to protect data and intellectual property, which is no longer viewed as a threat if provided by a third-party supplier Senior executives are no longer committed to captive centres It is no longer necessary to keep decision-making authority in-house Third parties are now able to handle complex processes.

There is a difference between the ITO and BPO captive centres: companies are much more likely to set up captive centres for BPO than ITO. Accord- ing to Oshri and van Uhm (2012), what has been happening to captives is quite dynamic – both in selling and setting up a new one. We expect this trend to continue over the next five years. In 2010, there were nearly 500 captive centres in 34 countries, employing over 440,000 professionals (Oshri and van Uhm, 2012). Since then client companies have sought to build global business services (GBS) – a dominant trend during 2014 – and this development has boosted the interest in establishing captives offshore, as part of their hybrid global sourcing portfolio (Willcocks et al., 2015).

Trend 10: SMAC impacts outsourcing . . . in the longer run We are regularly asked about the likely timing and impact of digital inno- vations such as social media, mobile Internet, business analytics and cloud (SMAC) on outsourcing. Taking a broad view, we predict that, in combina- tion and together with advanced robotics, the Internet of things and the automation of knowledge work, these technologies will lead to the found- ing by 2025 of most organisations as fundamentally digital operations and significant reliance on the cloud. But how do these developments affect outsourcing over the next five years?

As we have seen, outsourcing will continue to grow, and the embed- dedness of existing contracts signed for anything between three and ten years will slow down the new technology impact. But outsourcing will increasingly change its character, as suppliers themselves adopt these technologies and build and offer services based on them. We will see a

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Overview of the Global Sourcing Marketplace 29

number of disruptors impact the traditional outsourcing scene more force- fully. Cloud platform suppliers like Amazon, Google, Microsoft and IBM will move up the value chain with more automated platforms. Software- as-a-service could become a dominant sourcing model in certain areas such as employee performance management, indirect procurement, payroll and benefits administration, as clients move to self-help through managed services.

Automation (also known as robotic process automation) will have signif- icant impact on outsourcing industry. Generally speaking, work can be classified into four types: routine manual, routine cognitive, non-routine manual and non-routine cognitive. Of these, it is believed that routine manual work could be automated in the near future and routine cognitive work follows suit. Non-routine cognitive work is likely to be automated through the application of Big Data and business analytics, and non- routine cognitive work is also somewhat automated with the use of algorithms. What does this add up to? A recent study suggests that, just looking at the USA, about 47% of jobs are under serious threat of automa- tion over the next ten years (Frey and Osborne, 2013). If this scenario is correct, then client companies will be able to significantly reduce the number of employees, for example, not by outsourcing but by automat- ing. Meanwhile outsourcing suppliers may try to combat this by offering cheaper automated solutions of their own. The likely outcome over the next ten years is to see a slowing down of outsourcing growth among ser- vice providers, who will be moving increasingly from labour arbitrage to automated service offerings.

Summary

In this chapter, we have explained the key terminology relating to global sourcing and provided an extensive review of past, current and future trends in global sourcing. It is clear that more and more firms have intro- duced business solutions relating to global sourcing to access scarce skills, reduce costs and streamline operations. Furthermore, interest has been growing rapidly in outsourcing business processes. The success rate of outsourcing has been mixed, because outsourcing benefits are not easily

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30 Making a Sourcing Decision

won and managements on both client and supplier sides face multiple risks and challenges on the path to successful outcomes. Meanwhile SMAC and related technologies are going to have a long-term significant impact on outsourcing, which will see outsourcing still grow but make more automated service propositions.

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ch ap te r2 Sourcing Models: What and When to Outsource or Offshore

Clients are facing a large variety of alternatives to choose from when mak- ing sourcing decisions, which means that they need to take into account a number of considerations to be able to make the right decision. This chapter focuses on sourcing models for client firms and how to make sourcing decisions. In particular, it covers the following topics:

Sourcing models Factors to consider when making a decision about outsourcing and offshoring The most suitable processes for outsourcing and offshoring.

Overview of Sourcing Models

Various types of global sourcing models have emerged. The major distinc- tion among these models lies in whether the function is performed by a subsidiary business unit (BU) of the firm or an external supplier (or by both, as a joint effort) and also whether the function is performed on the firm’s premises (i.e., on-site) or off-site, which can be onshore (in the country where the organisation is located), nearshore (in a neighbouring country) or in an offshore location. Figure 2.1 provides an overview of the most popular sourcing models, which is followed by a more detailed explanation.

31 Oshri, I., Kotlarsky, J., & Willcocks, L. P. (2015). The handbook of global outsourcing and offshoring 3rd edition. Retrieved from http://ebookcentral.proquest.com Created from aston on 2019-03-13 14:34:05.

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32 Making a Sourcing Decision

Location

Off-site On-site

Internal delivery

Co-sourcing

Captive centre (e.g., R&D); Captive shared services

Offshore/nearshore development centre Build-operate- transfer

Offshore/nearshore outsourcing Foreign supplier

Onshore outsourcing Domestic supplier, ‘rural sourcing’

Shared services

Insourcing Staff augmentation

Onshore (same country)

Nearshore/offshore

In-house

Joint venture

Third party

O w

n er

sh ip

Make

Hybrid

Buy

FIGURE 2.1 Overview of sourcing models

Insourcing: This sourcing model is based on managing the provision of ser- vices internally, through buying in skills that are not available in-house, on a temporary basis. This is usually achieved through staff augmenta- tion (also referred to as body-shopping), a sourcing model that implies that staff are supplied to clients on demand, at a pre-agreed rate. Most large outsourcing suppliers and management consultancies offer staff augmentation services.

Domestic outsourcing: This is based on contracting with a third party situ- ated in the same country as the client organisation for the completion of a certain amount of work, for a specified length of time and at a certain cost and level of service. Domestic outsourcing implies that the supplier is in close proximity to the client. Alternative terms for this sourcing model are home-shoring or rural outsourcing, which involves sending the work to lower wage, usually rural, regions within the home country. This trend is popular in the USA, Israel, India and several other countries.

Offshore-outsourcing: This model implies contracting with suppliers based at an offshore location (which usually means in a developing country and separated from the client by an ocean).

Impact sourcing: This is a new sourcing model that is based on divid- ing work into small tasks (‘micro-work’) and sending it to centres in

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Sourcing Models and Sourcing Decisions 33

developing regions where employees complete it. It aims to promote economic growth in developing regions (Gino and Staats, 2012).

Out-tasking: This is outsourcing on a small scale. It usually implies ongoing management of and support for selected packaged applications. Out- tasking is popular with local suppliers; however, it can also be provided from offshore locations (in particular, if the supplier is a global company such as IBM).

Captive or in-house sourcing: A strategic choice to locate organisational activities within a wholly owned subsidiary in another country. Captive sourcing models offer basic, shared, hybrid and divested captive options (these are discussed in detail in Chapter 11).

Build–operate–transfer (BOT) models: The client contracts with an offshore or nearshore service provider to execute an outsourcing arrange- ment whereby the supplier will build and operate the service centre (e.g., a call centre or any other business process) for an extended period of time. The client retains the right to take over the operation under certain conditions and certain financial arrangements.

Joint venture in the outsourcing or offshoring context: This is a partnership between a client firm and an offshore supplier whereby the parties con- tribute resources to the new venture. Many of the offshoring joint ventures have a BOT component built into the agreement.

Shared services: This is an operational approach of centralising administra- tive and business processes that were once carried out in separate divisions or locations, for example, finance, procurement, human resources and IT. A shared service centre can be a captive centre or outsourced to a third party. With the increasing popularity of the shared services model, we believe it deserves a more detailed explanation.

Shared services imply the consolidation of support functions from several departments into a stand-alone organisational entity whose objective is to provide services as efficiently and effectively as possible. When managed well, shared services can reduce costs, improve services and even generate revenue. A shared service can take various forms of commercial structure such as unitary, lead department or joint initiatives. Unitary refers to a sin- gle organisation that consolidates and centralises a business service, and a lead department is an organisation that is consolidating and centralising a

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34 Making a Sourcing Decision

business service to share with other organisations. Joint initiatives are set up by two or more organisations that have reached an agreement to build and operate shared services. Similar to outsourcing arrangements, shared services can be run onshore, nearshore or offshore. More about shared services can be found in Chapter 11.

Sourcing Models Based on Internet Delivery

Sourcing models based on Internet delivery of products or services that are becoming increasingly popular are cloud services and crowdsourcing. In practice, each of these high-level sourcing models can be implemented in different ways, in terms of specific operational and commercial aspects of service provision. Below we describe the key principles of these two Internet-based sourcing models and give examples of how these models have been adopted by client firms.

Cloud computing services Cloud computing is defined as a ‘model for enabling ubiquitous, con- venient, on-demand network access to a shared pool of configurable computing resources (e.g., networks, servers, storage, applications and services) that can be rapidly provisioned and released with minimal man- agement effort or service provider interaction’ (Mell and Grance, 2011). In the global sourcing marketplace, cloud computing has taken the form of cloud services (or cloud computing services) such as IT resources, busi- ness applications, infrastructures or platforms which are delivered on demand, using public, community, private or hybrid infrastructures. The metaphor of the cloud draws on how the Internet is depicted in computer network diagrams and represents an abstraction of the complex infrastruc- ture it conceals. In other words, cloud computing allows users to access technology-enabled services on the Internet without having to know or understand the technology infrastructure that supports them. Nor do they have much control over it.

The key benefit of cloud computing is that it provides on-demand access to supercomputer-level power, even from a smartphone or laptop. Enabling massively scalable services characterises cloud computing. For example, those who log on to Facebook or search for flights online are taking

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Sourcing Models and Sourcing Decisions 35

advantage of cloud computing. They are connecting to large volumes of data stored in remote clusters or networks of computers. Google is another example of cloud computing.

The key properties of cloud services are as follows (Armbrust et al., 2009):

Pay-as-you-go usage of the IT service The service is on-demand, able to scale up and scale down Access to applications and information from any access point Abstraction of the infrastructure so applications are not locked into devices or locations The ability to create the illusion of infinite capacity.

Cloud services can be hosted and configured for single or multiple client organisations and even hosted privately within the organisation or pro- vided over a virtual private network (VPN). There are four basic types of cloud infrastructures1 that characterise cloud-deployment strategies:

Private clouds, which are operated solely for the use of a single organ- isation servicing multiple consumers (e.g., business units) within the organisation Community clouds, which are operated for the exclusive use of a spe- cific group from organisations that have shared concerns (e.g., mission, security requirements, policy and/or compliance considerations) Public clouds, which use cloud infrastructure available for the use of the general public (i.e., referred to as public network) Hybrid clouds, which combine the infrastructure of two or more clouds (public, community and private) that remain unique entities but are connected in such a way that enables data and application portability.

The main distinction between cloud infrastructures is in the restrictions regarding the specific group of consumers who can access the cloud (i.e., one organisation, cross-organisational community or public). In terms of the ownership of the infrastructure, any type of cloud may be owned, managed and operated by a business, academic or government organisa- tion, a third party, or some combination of these, and it may exist on or off premises (NICT, 2011).

While many organisations were initially reluctant to use cloud services, the general public have embraced them in the form of social media platforms,

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36 Making a Sourcing Decision

such as Facebook, Twitter, LinkedIn, Pinterest and YouTube, among oth- ers. Consumer demand for easy-to-use, intuitive, accessible applications – accessed via a browser – has spread upwards through many organisations as employees expect the same ease of use from their employer’s in-house systems.

In recent years, ongoing economic challenges and the need to improve efficiency, streamline operations and cut costs have prompted the large- enterprise world to pay serious attention to cloud computing, even those that previously believed cloud services to be the preserve of smaller and medium-sized organisations.

While the primary driver for corporates to investigate cloud computing has tended to be cost savings, many have come to realise that the cloud promises a lot more in the form of operational efficiency, reduced waste and increased business agility, partly because clients can begin to unbur- den themselves of the onerous on-premise software and hardware upgrade cycle.

Cloud services also rely to a large extent on virtualisation, and this breaking apart of monolithic on-premise infrastructures and dispersing them across networks in the form of hosted solutions and virtualised systems carries its own economic advantages, even if some dyed-in-the-wool IT strategists feel threatened by the reduction in their personal domains.

That said, legitimate concerns remain, especially around data security and public cloud infrastructures. At the root of the problem is the misleading terminology. Rather than being somehow ‘out there’ worldwide, cloud ser- vices actually reside in hardware – data centres – that are located on land and are, therefore, subject to national laws, including those laws concern- ing data hosting, processing and transfer in both the client and supplier territories. Therefore, privacy and confidentiality become a concern, espe- cially when clients use service providers in a different country, where the local law may allow the government of that country to access certain data stored on hosted servers.

These issues have become particularly relevant in the wake of the Snowden case and other revelations concerning the National Security Agency moni- toring data and communications. Various countries, including the USA and India, mandate government oversight of data that are hosted, processed

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Sourcing Models and Sourcing Decisions 37

or transferred within national borders, under national security regulations (such as the US Patriot Act).

There are also security implications of a different kind inherent in sup- plier lock-in. Being reliant on any single supplier to host data remotely and, potentially, also computing platforms and core business applications means being a hostage to that supplier’s fortunes, good customer relations, employees and internal security regime.

But with the growth in cloud services, it has become evident that there is increased demand for enterprise cloud solutions among clients that might once have only considered traditional outsourcing options. The enterprise cloud solution market has entered a high-growth phase and holds considerable potential for enterprises and suppliers alike. But in order to capitalise on that potential and ensure the delivery of true busi- ness value, client organisations need to learn more about the following points:

The maturity of the IT industry in its support of enterprise cloud solutions The attractiveness of the cloud-based market for suppliers The factors enabling and influencing the adoption of cloud over tradi- tional on-premise solutions How enterprise solution suppliers add value – and plan to add value – to customers through their cloud-based offerings.

Furthermore, it is important to consider who the different actors are and their roles in the cloud marketplace. The National Institute of Standards and Technology (NIST) has developed the NIST cloud computing refer- ence architecture (Mell and Grance, 2011) that distinguishes between five major actors and specifies their roles in the delivery and consumption of cloud services. These roles (described in Figure 2.2) can be used as a tool for discussing the requirements, structures and operations of cloud computing.

Cloud-based sourcing models

In terms of commercial sourcing models, what is generally known is that cloud services are far from being a single-template solution. Typically, there are three main forms: Platform as a Service (PaaS), Infrastructure as a Service (IaaS) and Software as a Service (SaaS). These can be delivered

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38 Making a Sourcing Decision

Cloud consumer

Person, or organisation that maintains a

business relationship with, and uses service from Cloud providers

Cloud provider Person,

organisation or entity

responsible for making a service

avaiable to Cloud consumers

Cloud broker

An entity that manages the use, performance and delivery of cloud

services, and negotiates

relationships between Cloud providers and

Cloud consumers

Cloud auditor A party that can

conduct independent assessment of cloud services, information system operations, performance and

security of the cloud implementation

Cloud carrier The interdmediary that provides connectivity and trasport of cloud services

from Cloud providers to Cloud consumers

FIGURE 2.2 Actors in the NIST cloud computing reference architecture Source: Mell and Grange, 2011.

over public, community, private or hybrid infrastructures and can also be combined to create various forms of Business Platform as a Service (BPaaS) offerings.

PaaS provides a development platform for developing end-user solu- tions. Google’s App Engine and Microsoft Azure are examples of this. IaaS supplies storage and processing capabilities as services over the net- work. Capacity is pooled and made available to handle workloads that range from application components to high-performance applications. Amazon’s cloud is an example of an IaaS platform. SaaS, meanwhile, provides a complete application as a service on demand. The software runs in a/the cloud and may service multiple end users or client organisations. The most widely known example, and a pioneer of the model, is Salesforce.com; although, it now also provides a platform and an ecosystem of hosted business applications. A number of other solutions like Microsoft Office 365 and Google Apps offer a range of day-to-day business applications. Apple’s own walled- garden approach offers an alternative ecosystem, used by millions of consumers. Many types of software are well suited to the SaaS model

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Sourcing Models and Sourcing Decisions 39

for customers with little interest or capability in software deployment but with substantial computing needs. The model can be applied within different segments of the market. At the higher end of the market, suppliers may offer applications such as Enterprise Resource Planning (ERP), CRM, and e-commerce, as well as selective industry-specific solu- tions. Low-end applications include solutions for small and medium enterprises that the users can easily configure.

Different commercial cloud models offer different types of cloud services which can be consumed in multiple ways. Some examples of the ser- vices requested under different models and usage scenarios are included in Table 2.1.

On-premise vs. cloud solutions

With the growing maturity of cloud services, most organisations face a dilemma about whether to continue investing in on-premise solutions. One of the main challenges is technology legacy and the internal sup- port structures that have grown up around it over many years. Many senior IT strategists now accept that, given the opportunity to start from scratch, many would do things very differently. The challenge for those IT strategists, therefore, is to become more business and information focused.

A key differentiator between traditional on-premise solutions and cloud computing is control. On-premise solutions give clients complete control over their assets – licensing issues aside – while leaving them with capi- tal outlay and support headaches. By contrast, the cloud model demands a different mindset by expecting the client to relinquish some control and potentially share assets in exchange for greater scalability, more rapid deployment and reduced costs. Lock-in is an issue here, as has already been explored.

Some organisations adopt a hybrid approach where the solution spans both on-premise and cloud elements. Many organisations retain core/ critical systems and applications in-house, while pushing non-critical and replicable business process tasks outside of the organisation. In this way, cloud services are analogous to many clients’ attitudes to outsourcing. Other organisations preserve their current IT assets on premise while investing for their future needs in the cloud.

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40 Making a Sourcing Decision

TABLE 2.1 Cloud consumer and cloud provider activities

Service models Examples of services available

Cloud consumer activities

Provider activities

SaaS ERP, billing, sales, CRM, collaboration, HR, email and office productivity, content management, social networks, financials, document management

Uses application/service for business process operations

Installs, manages, maintains and supports the software application on a cloud infrastructure

PaaS Business intelligence, application deployment, database, integration, development and testing

Develops, tests, deploys, and manages applications hosted in a cloud system

Provisions and manages cloud infrastructure and middleware for the platform consumers; provides development, deployment, and administration tools to platform consumers

IaaS Service management, platform hosting, storage, compute, backup and recovery

Creates/installs, manages and monitors services for IT infrastructure operations

Provisions and manages the physical processing, storage, networking, and the hosting environment and cloud infrastructure for IaaS consumers

Source: Based on Mell and Grance, 2011.

Maturity of cloud solutions: Client and supplier perspectives

Oshri and Kavari (2013) interviewed 32 users and 34 suppliers of enter- prise cloud solutions to establish their views about the maturity of the market, their satisfaction with the range of services and the value gained from them. Understanding the interviewees’ views about each of the cloud computing models was of particular interest.

Maturity and satisfaction Firms were asked to identify the current cloud market maturity level within each of the main service models to determine if they were mature

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Sourcing Models and Sourcing Decisions 41

enough to be used in an enterprise environment. The findings demonstrate that the level of maturity varies depending on the service model.

Over 98% of respondents indicated that they believed SaaS to be above the ‘infancy’ stage, with 55% positioning it as mature. Approximately 88% of respondents positioned IaaS above the infancy stage, with a major- ity (61.5%) indicating that it was still in the growth phase and was not mature as yet. PaaS was voted the most immature of the three, with over one quarter (26%) of respondents believing it still to be in its infancy.

Client organisations were overwhelmingly satisfied with their SaaS solu- tions, with over 90% of them describing themselves as ‘Satisfied’ or ‘Very satisfied’. Both IaaS and PaaS received about 60% ‘Satisfied’ or ‘Very satis- fied’ ratings. This implies that the perceived level of maturity has a direct impact on the supply and consumption of cloud services in the enterprise market – not surprisingly, perhaps. Put another way, organisations seem healthily resistant to hype.

Business, data and financial factors Client organisations were asked to rate how business and financial fac- tors influenced their choice of cloud-based enterprise solutions. Generally speaking, client organisations and suppliers shared the same perspec- tives on most business and financial considerations. However, the research showed that while suppliers believed that scalability was one of the key influences on the adoption of enterprise cloud services, client organisations did not share this view very strongly.

Firms were asked to rate the other business factors enabling and hindering the adoption of enterprise cloud solutions. Both client organisations and suppliers rated cost management as one of the key influencers of the adop- tion of cloud solutions. Interestingly, while clients perceived productivity to be a key element, suppliers did not share this view. The top factor hin- dering enterprise cloud adoption was information security, while the least important factor was performance.

Firms were then asked to rate the factors that added value. The research revealed that suppliers overestimated the importance of experimenting with new ideas; client organisations needed persuading that hard business outcomes would be delivered.

It is understandable why suppliers might choose to focus on obvious enterprise concerns like cost and innovation during the initial stages of

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42 Making a Sourcing Decision

cloud adoption. However, the enterprise cloud market has matured to a stage where other business drivers have equal, if not more, weight in an enterprise’s decision-making process. Suppliers need to refocus their mar- keting efforts to better align with these changes in customer attitudes and behaviour.

On security, suppliers need to be open and honest about the security regimes they provide. Due diligence is essential for clients, who should also discuss with potential suppliers what both sides can do to implement bet- ter data security. And on supplier credibility, suppliers need to move away from the use of generic references to bolster their credibility. It has become clear that enterprises need recommendations from a trusted source.

Organisations that plan to include cloud as part of their IT portfolio need to have a comprehensive IT and business strategy in place to deal with the differences that they will encounter on their journey to the cloud. The whole organisation will need to be trained to adopt best practices on ensuring data security.

Since security and lack of confidence in the supplier are the two main factors hindering cloud adoption, client organisations need to have a robust vetting and selection process where they review and validate the credentials of their potential cloud services supplier.

The following case discusses the various challenges faced and approached by Global Pharma with regard to their cloud computing strategy.

C A S E S T U D Y

A Global Operating Model That Exploits Cloud

Computing Services2

by Mark Skilton

The global pharmaceutical market is a multibillion-dollar

dynamic worldwide business ranging from consumer health-

care products to advanced medical devices and biotechnology

research.Many aspects of themarketplace are interconnected by

the need for constant research and rapid market trials through

to dynamic scaling up and down of collaborative product man-

ufacturing and diverse distribution supply chains to deliver

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Sourcing Models and Sourcing Decisions 43

to residential, wholesale and retail marketplaces. The indus-

try is regulated through regional and global governance stan-

dards, ranging from patent laws for products and drug licensing

through to compliance standards including the US Food and

Drug Administration (FDA), as well as specific health data pro-

tection laws such as the US Health Insurance Portability and

Accountability Act.

The Global Pharma company competes in these conditions

through awide and expansive organisational structure spanning

100,000 direct employees; 250 BUs operating in the Americas,

Europe, Middle East, Asia Pacific and South American markets;

and a wide partner channel ecosystem network. Its products

span consumer health care, medical devices design, manufac-

ture, distribution and biomedical product research and commer-

cialisation.

The following operational capabilities are essential to Global

Pharma:

The ability of front-end business operations to adapt and

offer products and services quickly in response to market and

consumer demand

The ability to create research patents and rapidly move

research to market test trials

The ability to build operational cost efficiencies into the

infrastructure through shared services

Rapid movement of existing and new business operations

and resources to locations that would enable (i) flexible mar-

ket entry and withdrawal, (ii) to build and expand capacity

and shrink and remove capacity as needed and (iii) to pursue

market opportunities

Strong security and compliance partitioning and controls

over BUs

Partner networks to enable effective collaboration and yet

guard security compliance and corporate societal values

The development of brands and pricing strategies across

diverse market geographies to exploit patents and market

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44 Making a Sourcing Decision

buying behaviours for long-term shareholder value in the

brand and revenue share.

Global Pharma’s IT hardware and software assets and staff are

consolidated into regional data centres connected by a corporate

global network. A small central corporate IT function coordi-

nates policy and strategy, which is largely distributed down to

the BU-based IT functions to meet local market and business

service requirements. The use and development of the business

applications and infrastructure are focused onshore by region.

Large-scale corporate systems are developed in each data centre,

and some are replicated across other regional data centres. Sig-

nificant investment in virtualisation has addressed the oper-

ational efficiencies of the data centre as the pharmaceutical

market environment continues to change rapidly. At present,

because of the cultural and organisational diversity, regional

BUs own IT strategy and delivery.

Steps Towards Adopting Cloud Computing

In 2009, the Global Pharma IT board saw that many of pharma-

ceutical industry characteristics aligned well with the capabili-

ties found in cloud computing. This resulted in a cloud strategy

plan and assessment of current investments in data centres and

a number of strategic pilots to test public, private, and hybrid

cloud solutions and to learn more about cloud technology and

businessmodels. By themiddle of 2010, these investigations had

focused on a complete global private cloud and recommended

developing pilots to accelerate the design of the private cloud

data-centre solution.

In terms of an operating model, moving to cloud computing

redefines the need for each region and BU to develop certain

types of IT service onshore. Common services hosted in a secure

private cloud-based data centre provide the possibility for many

BUs to move to an offshore shared model that Global Pharma

saw as an opportunity to improve its organisational efficiency.

While agility in individual markets and BUs was still essential

to competitiveness in Global Pharma’s specific markets, Global

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Sourcing Models and Sourcing Decisions 45

Pharma sought to support this by targeting cloud computing

services for specific business activity needs.

Global Pharma developed a vision of an operating model using

cloud computing:

Flexible front-end IT services to enable the IT function to

support rapid business demand in disparate dynamic markets

Alignment of IT modernisation programmes of data centres,

networks and applications to become on demand and with

shared cost efficiencies

Coordinated modular data centres and service centres for

operating efficiencies from a one-to-many service for BUs.

Defining the Right Type of Cloud Operating Model

Given the strategic decision tomove to private cloud computing,

Global Pharma had already invested extensively in infrastruc-

ture virtualisation technology and a global data centre network.

Cloud computing, however, introduced the need for a mod-

ular infrastructure. The plan of work by the end 2010 was to

modernise the infrastructure with modular data centres and

networks, enabling a new operating model for IT resources

and software applications to align with business capacity needs

across the global operation and to deploy to meet specific BUs.

In the distributed user groups in Global Pharma’s BUs, there was

a range of business processes that could be supported by com-

mon administration services such as email, storage and collabo-

ration. These were candidates for shared services. Other specific

services defined for each BU or as strategic platforms were mis-

sion critical and differentiating for the company. Hosting these

business activities required cloud infrastructure services to be

dedicated to these services and the potential assembly of specific

application services to be put together to meet differentiated

service levels.

Thus, in parallel with themodular data-centre concept, the anal-

ysis of corporate and BU enterprise software applications hosted

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46 Making a Sourcing Decision

in the modular data centre identified different types of business

activities that were grouped into portfolios of cloud computing

services that could be moved to a cloud computing environ-

ment. Business activities that represented commodity services

acrossmany user groups in one-to-many fashion (such as email

and content management) and did not require much data stor-

age and consumption of computing power were grouped into

horizontal cloud services. Specific high-resource intensive busi-

ness activities (with high computing power and data storage

consumption) that included both one-to-many and one-to-one

niche-specific services for markets were grouped into vertical

cloud services. Business activities that involved collaborative

business transactions that were common across BUs but more

complex and more resource intensive than commodity services

(e.g., the general functionality of customer relationshipmanage-

ment and enterprise resource planning) were grouped together

as candidates for a shared service cloud-based computing envi-

ronment:

Business activities for horizontal cloud services (one-to-

many): email, market trial tests, storage, enterprise portals,

content management and human capital management

Business activities for vertical cloud services (one-to-one and

one-to-many): engineering, research simulation and process-

ing, business intelligence, niche enterprise resource planning,

customer relationship management (industry specific) and

supply chain management (planning and scheduling)

Business activities for shared cloud services (one-to-many):

global enterprise resource planning, customer relationship

management (online stores), supplier relationship manage-

ment, product life-cyclemanagement and global supply chain

management.

Impact of Cloud Services on Global Pharma

As a result of themodular approach that created data centres and

services for common cross-BU services, specific high-resource

intensive business activities and specific business capability

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Sourcing Models and Sourcing Decisions 47

platforms hosted in the cloud were given to alternative data

centres. To manage these cloud services, Global Pharma created

employer competency centres for skills, training and investment

programmes. Other competency groups were set up to support

common shared services around specific technologies such as

Microsoft, Oracle and SAP.

Furthermore, the movement to modular data centres and the

grouping of business activities into classes of cloud application

services enabled support for business activities to be managed

between onshore and offshore cloud data centres, where per-

mitted. Moreover, the migration of existing applications and

services to cloud-based data centres required changes in service

management practices. Existing service centre operations dedi-

cated to specific BUs needed to develop cross-BU cloud services

and align to specific cloud platform service support needs.

Because compliance issues related to data movements across

borders prohibited the use of offshore cloud data centre services,

Global Pharma faced difficulties in using public cloud.

Issues Hampering Forward Movement for Global Pharma

Global Pharma faced a number of issues related to cloud com-

puting. At the strategic level, Global Pharma needed to amend

its business strategy to maximise the benefits from cloud

computing and incorporate cloud computing strategy into the

business strategy. At the operational level, Global Pharma strug-

gled to decide what operations and business processes should

be moved to public, private or hybrid cloud options, and how

the global operating model needed to change to get the benefits

of cloud computing. In addressing these issues, Global Pharma

identified specific challenges:

Managing multiple clouds and required capabilities: If Global

Pharma chose a private cloud, it needed to recognise that

running a cloud service as a supplier was different from con-

suming a cloud service. The skills required for the transfor-

mation are more complex, because an understanding of all

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48 Making a Sourcing Decision

of the components of cloud architecture does not typically

reside in just one supplier. The BU stakeholders also needed

to identify generic services (those used across different func-

tions and BUs) to build the one-to-many usage patterns to

enable a return on the investment from the cloud and avoid

fragmentation and multiple clouds.

Offshoring in the cloud: Global Pharma was already operat-

ing in an onshore and offshore distributed model enabled

through its data centres. However, the move to distributed

cloud-hosted business services enabled one location to dis-

tribute a business activity to another region. Locations of

business activities that became business services still needed

to be controlled for compliance and security management for

the regional and BU.

Security and operational concerns: Specific security and

compliance issues for the US FDA and data controls such

as Safeharbor Knowledge Solutions, which prohibits med-

ical data movement off-premise and offshore, and Feder-

ation of Security access to supplier partner networks that

need multiple identity and authentication control had to be

handled appropriately. Partitioning specific business activ-

ities for FDA security compliance into specific data centre

domains was one approach to contain a dedicated cloud

resource to focus performance and security controls of crit-

ical systems. This required specific cloud rules for control

and access. Alternatively, Global Pharma could consider par-

titioning applications into different cloud services types – for

example, an FDA application cloud, an ERP cloud, a Microsoft

cloud, or anOracle cloud to support specific supplier licensing

and performance issues.

Outsourcing, in-house or hybrid service delivery: With a pri-

vate cloud, Global Pharma would become a service provider

delivering on-demand services to its own BUs. An alternative

to doing everything in-housewould be the use of third parties.

However, it was not clear how these third parties could par-

ticipate as alternative private clouds. In particular, how would

third-party outsourcers with cloud data centres be certified

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Sourcing Models and Sourcing Decisions 49

for pharmaceutical company use? And how would external

private clouds be integrated with internal company private

clouds?

Payment structure and licence reengineering: The licens-

ing issue was not clear. The use of pay-as-you-go con-

sumptionmodels of applications and infrastructure resources

would not necessarily be compatible with existing licens-

ing based on usage per user instance. If this is virtualised

and not specific to a physical instance of hardware, the

software licence model breaks down. Alternatives might be

found through reseller licence models or licence pooling

for the corporation. How would individual suppliers need to

be handled on a case-by-case basis? How would umbrella

contract agreements for existing supplier software licences

be affected if they are moved to a cloud-based hosted

environment?

Stakeholder engagement: In distributed user groups in the

Global Pharma BUs, a range of cloud services needed to be

defined for each BU and market-facing operation. Focusing

on common services versus variations of service required

the involvement of many different stakeholders from these

groups to build the one-to-many opportunities that cloud can

support.

The cloud service provider also had to address some issues. If

Global Pharma decided to create a private cloud, the internal unit

delivering the cloud services and any third parties had to clarify

the following issues:

Alignment of modular business services with demand: The

use of modular business activity (service) hosted in specific

data centres required control and demand forecast plan-

ning of capacity availability. Demand aggregation and request

management processes needed to accommodate a shift to

a catalogue-style provisioning model. This included a por-

tal strategy for self-service. From Global Pharma’s perspective,

the cloud provider (or the internal unit providing services in

the private cloud) had to be able to forecast shifts in demand

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50 Making a Sourcing Decision

in order to meet that demand. From the cloud provider’s per-

spective, the ability to forecast demand capacity is essential to

ensure the service was able to meet operational demands.

Alignment with modular business services and supply capac-

ity: The standard operating environments hosted as various

templates for cloud resources needed to be aligned with the

types of applications and usage patterns for the allocated

capacity. This introduced new operating practices for traffic

and load balancing.

Power efficiencies and facilities certification: Efficiency of

power consumption in cloud computing can be affected by

a large-scale burst in demand. In certain circumstances, the

power demand in the cloud data centre needed to be planned

to be available to prevent insufficient energy to support oper-

ations. And efficient green energy and certification of ser-

vices are as essential in cloud operations as in conventionally

managed hosting.

Crowdsourcing Crowdsourcing is the act of taking a job traditionally performed by employ- ees and outsourcing it to an undefined, generally large group of people in the form of an ‘open call’ (Howe, 2008). This sourcing model has been widely adopted in the open innovation movement (e.g., by Innocentive, TekScout, IdeaConnection, and many other open innovation marketplaces and communities). A large number of new business ventures have emerged through crowdsourcing, mainly by creating an opportunity for anybody to submit an idea (examples are products such as photos to iStockphoto.com or T-shirt designs to Threadless.com) and let the community of users or potential buyers decide whether a particular creation is worth buying. Crowdsourcing projects rely on the contributions of individuals or a collec- tive of people who are not necessarily motivated by monetary incentives. Psychological motivations, such as self-fulfilment, sense of contribution and the pleasure of solving problems are other motivation factors, no less important than monetary rewards. The following case study describes the crowdsourcing phenomenon and provides examples of crowdsourcing firms.

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Sourcing Models and Sourcing Decisions 51

C A S E S T U D Y

Crowdsourcing

by Onook Oh and Rajiv Kishore

The Crowdsourcing Phenomenon

With the development of Web 2.0 technologies, entrepreneurs

are continually creating and experimenting with innovative e-

business models. One of the recent e-business models that

has gained popularity and recognition in a short span is

crowdsourcing. This business model harnesses the potential of

a heterogeneous and globally dispersed online crowd to meet

a variety of business needs. As with any new major business

development, crowdsourcing has spawned a new and emerg-

ing vocabulary including terms such as ‘prosumers’ (producers

+ consumers) or ‘produsage’ (production + usage). A key impli-

cation of these new coinages is that consumers are no longer

passive buyers who simply consume end products. Rather, they

are active ‘prosumers’ who directly or indirectly participate in

co-creating the goods and services they consume. As a result,

the line between producer and consumer indeed becomes blurry

in the crowdsourcing phenomenon.

Crowdsourcing may be best understood as a variant of the

outsourcing phenomenon, in that both sourcing mechanisms

utilise resources from outside the organisational boundaries

to meet internal business needs. However, a major difference

between the two sourcing mechanisms is that, while traditional

outsourcing relies predominantly on a handful of established

professional services firms, crowdsourcing turns to a much

larger heterogeneous, online crowd of individuals to meet their

internal business needs. The main driver that made reaching

to a multitude of potential virtual workers and crowdsourcing

possible is the collection of Web 2.0 technologies that enable

individuals to actively participate and engage in co-creation

activities through the 24/7 interconnected virtual technolog-

ical environment. Furthermore, a crowd of individuals that

is highly connected through this technological environment

makes it possible for organisations to aggregate individual

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52 Making a Sourcing Decision

profiles and create a large virtual workforce of varied skills

sets that they can search and match for meeting specific busi-

ness needs and then contract with specific individuals all in

real time.

Examples of Crowdsourcing Firms

InnoCentive: The Oil Spill Recovery Institute (OSRI) was formed

to find ways to remove oil from contaminated areas in response

to the catastrophic 1989 Exxon Valdez oil spill in Alaska, and

it continues to be engaged in cleaning up all the remaining

oil from affected areas. While dozens of barges have diligently

pumped oil from iceberg cracks into barge tanks, the mixture of

pumped water and oil quickly freezes to a sticky state, making it

difficult to separate oil from water. In 2007, OSRI posted a chal-

lenge on the InnoCentive website. Within two weeks, a cement

expert, John Davis, came up with a simple solution that sur-

prised OSRI scientists. John applied tools and techniques widely

used in the concrete industry. The concrete industry uses a

vibration tool to keep cement from becoming solid during mas-

sive cement pours. John’s solution was to attach a long pole and

insert it into the oil recovery tanks and to vibrate this pole to

prevent oil and water from freezing. Using this simple vibrating

tool, OSRI could remove oil fromwater, and the challenge solver,

John, was rewarded US$20,00.

The InnoCentive website is comprised of seekers and solvers.

Seekers – corporations or non-profit organisations – can

post their Research and Development (R&D) challenges to

InnoCentive’s open innovation marketplace website. Each chal-

lenge has a solution submission deadline and is assigned a cash

reward ranging from US$5,000 to more than US$1 million. Any

registered InnoCentive solver can enter the online project room

to gain access to the posted challenges and work on any project

that he or she may want to solve. The seeker reviews submit-

ted solutions after the deadline, awards the announced cash

reward to the best solver and pays an agreed commission to

InnoCentive.

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Sourcing Models and Sourcing Decisions 53

Launched in 2001, InnoCentive has posted more than 1,650

external challenges and achieves a premium challenge success

rate of 85%, using the above-described crowdsourcing model.

In contrast to technology services firms working with a hand-

ful of highly skilled scientists and researchers, InnoCentive

is working with 300,000 anonymous solvers from nearly 200

countries.3 To solve problems, InnoCentive is using the crowd’s

collective creativity and the power of scale of the knowledge

community. InnoCentive counts Proctor & Gamble, Boeing,

DuPont, LG and other large and famous brand names as its

seeker customers.

Cambrian House: Michael Sikorsky raised US$10.1 million from

2006 to 2007 for his new venture firm, Cambrian House Inc. As a

Web 2.0 platform-based crowdsourcing start-up, his vision was

to create ‘low-cost software quickly’.

The first video game, Gwabs, took a volunteer team six months

from concept to finished product and cost US$200,000. Produc-

ing it with in-house staff, says Sikorsky, ‘would have taken 50%

longer and cost three times as much’.4

In the initial phase of its growth, Cambrian House hosted

and developed a mass crowdsourcing community. During that

period, Cambrian House mixed an open-source software devel-

opment model with a traditional company format and was able

to attract about 50,000 members and more than 7,000 ideas

from the crowd.5 Cambrian outsourced market research, prod-

uct design and development to this community and focused

only on project management, sales and marketing. With trans-

parent compensation schemes and respect for its community

members, Cambrian utilised the collective knowledge of online

community members in a creative and cost-effective way.

The product development process at Cambrian worked as

follows6: any individual could submit his or her idea for a fresh,

new software to CambrianHouse.com. Then Cambrian com-

munity members discussed, researched and voted on that idea.

On a regular basis, Cambrian issued 100 Cambros (Cambrian’s

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54 Making a Sourcing Decision

virtual money) to the individual who submitted the best idea.

This individual could form a project team using Cambrian

community members. Cambrian on its part created a demo

website for the selected idea and conducted market research

using Google’s pay-per-click advertising. Using Google ana-

lytic tools, Cambrian analysed market demand by gathering

statistical information: ‘How many people are searching for

your idea right now?’, ‘How many visit your site?’, ‘Do they

ask for more information?’, ‘Would they pre-order your prod-

uct?’. If the idea showed market demand, they invested in the

project themselves, otherwise they cancelled it. Once the project

was completed and was put into production for public use,

Cambrian took 50% of the revenue generated for project man-

agement, sales and marketing. Each contributor to the project

received ‘royalty points’ for as long as the product generated

revenue.

Cambrian had been developing a crowdsourcing technology

platform since its launch to enable its own crowdsourcing

model. It shifted its strategy around 2008 and started offer-

ing its crowdsourcing technology platform named Chaordix™as

‘crowdsourcing technology in a box’ to new industries and

enterprises wishing to bring crowdsourcing to their own busi-

nesses. The Chaordix platform provides much more enhanced

functionality for crowdsourcing than just in the area of software

development, and Cambrian partners can now use this platform

for generating team insights, product innovation, brand inno-

vation and business model innovation through business-to-

business collaboration.7

OhMyNews: For many newspaper companies, the web is sim-

ply another channel to deliver and/or sell their news con-

tent created by professional journalists. Launched in February

2000, a Korean online newsmedia company, OhMyNews (www.

ohmynews.com8), innovated the way in which news content is

created and delivered to consumers. As an online newspaper,

this company finds and generates news content through vol-

untary citizen reporters instead of professional journalists. The

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Sourcing Models and Sourcing Decisions 55

founder, Yeonho Oh, says that he ‘wanted to start a tradition

free of newspaper company elitism where news items are eval-

uated based on quality, regardless of whether it came from a

major newspaper, a local reporter, an educated journalist, or a

neighbourhood housewife’.9

Starting in 2000with 727 voluntary citizen reporters, OhMyNews

had more than 40,000 citizen reporters in 2005 and more than

78,000 in 2014 out of South Korea’s total population of 46 mil-

lion. Typical citizen reporters write a story or two per week. Once

the story is submitted online, it remains as a ‘Saengnamu’ article

before being accepted by the OhMyNews copyeditor team. Dur-

ing this period, intensive screening takes place, such as for

sentence construction, checking for factual errors and the value

of the news and the copyediting process by professional inter-

nal editors. When an article is approved, citizen reporters can

monitor the number of readers’ clicks or comments and collect

monetary rewards in a virtual ‘tip jar’.

In the OhMyNews business model, readers are not passive con-

sumers of news content. They are both active producers and

consumers. This citizen reporter model turned out to be quite

effective, as it can deliver the same news content much faster

and with a unique perspective. However, high-quality news

content does not come for nothing. OhMyNews has designed

and implemented unique quality management programmes to

produce high-quality news contents. To enhance their news

quality, OhMyNews actively involves its citizen reporters in

online conversations. For citizen reporters’ news to be placed

as a headline, they have to persuade OhMyNew’s frontline

copyeditors. Also, OhMyNews organises regular seminars for

citizen reporters to help write high-quality news and to give

nearly 70 citizen reporters contracted to write books. In May

2006, OhMyNews was invited as a special guest to Google’s

Zeitgeist media forum in London, along with world-renowned

media companies such as Reuters and Le Monde. This model

of citizen reporting is now being adopted by mainstream news

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56 Making a Sourcing Decision

media organisations owing to its unique value proposition. CNN

has developed a community of iReporters (http://ireport.cnn.

com), who provide first-person accounts of breaking news in

areas where it does not have its own professional reporters at

the time.

Online crowdsourcing environments and marketplaces10

Similar to the emergence of large numbers of business-to-customer and customer-to-customer online marketplaces that bring together buyers and sellers (e.g., Amazon and eBay), online marketplaces for sourcing customised products and services have emerged. Such marketplaces allow customers to contract a supplier (an individual or a company) to develop and deliver a product or service based on the customer’s specific needs. Different from online auctions such as eBay and uBid and e-malls like Amazon, which sell ready goods, sourcing marketplaces provide clients a suitable supplier for a product or service delivery. Marketplaces such as Freelancer, Elance, Guru and oDesk11 serve as intermediaries that pro- vide legal and project management support in the form of standard contracts that include copyright protection, payment protection and basic project management stages to facilitate interactions between clients and suppliers who are essentially members of the crowd. Registered crowd members can be individuals or firms. This sourcing model is usually suit- able for relatively small and well-defined tasks such as website design, the development of specialised applications or software development to implement small product features, proofreading or indexing. Clients and suppliers rely exclusively on online interactions and usually never meet face-to-face.

Online crowdsourcing represents a somewhat unknown slice of the global sourcing landscape. Online sourcing environments (OSE) are online spaces where buyers and suppliers of services can meet, offer and apply for jobs; carry out project-related tasks; and conduct financial transactions.

All OSEs have three main stakeholders: buyers, suppliers who form the ‘crowd’ and (online) platforms. Buyers are companies or individuals who come to OSEs because they are interested in outsourcing a part of their workload. Historically most OSE buyers have been small – usually

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entrepreneurs and small firms with fewer than 100 employees, mostly from English-speaking countries. Suppliers are also represented primarily by small service firms and individuals, with the latter being either moon- lighters or independent professionals. They participate in OSEs to market their skills and services to potential buyers. The population of suppli- ers is more geographically distributed than that of buyers, yet the USA still contributes a significant portion. In addition, certain countries have become somewhat specialised in specific project types – for example, India, Romania and Pakistan dominate the IT category. The third stakeholder is the intermediary, the marketplace itself, which takes the shape of an online platform. These are the websites that provide an environment where buyers and suppliers can interact.

A new project in an OSE usually starts with the buyer formalising its work needs and converting them into project requirements. These requirements are then communicated to suppliers typically in the form of a job, project (a request for bid) or competition announcement. The buyer selects a sup- plier to work on the project. This may be done on the basis of proposals (bids) submitted by suppliers or an actual project deliverable submitted as a part of a competition or contest. Once the job is awarded, the buyer over- sees its completion and, when the final deliverable is deemed acceptable, pays the supplier for services rendered. The final step in the buyer work- flow is to rate the supplier and, sometimes, provide additional qualitative feedback on the project.

Suppliers register with OSEs by building a personal profile. Most OSEs today allow rich supplier profiles that include personal and contact infor- mation, educational and employment history, job history on the platform and, in many cases, skill evaluation data (tested or self-reported). Once the profile is in place, the supplier can start searching and applying for relevant job or project announcements.

The mechanics of the application process may vary from one online sourcing marketplace platform to another, but usually it is set up as either a reverse auction or a competition. Once selected, the supplier starts work- ing on the project. The work is usually facilitated by the platform, which provides communication, collaboration and project management tools. Once the job is completed, the supplier collects the payment and provides feedback on the buyer.

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58 Making a Sourcing Decision

We distinguish three main types of OSEs: directories, which provide list- ings of projects, supplier profiles and contact information, but where deals are usually done offline; marketplaces, which connect buyers and sup- pliers and facilitate their interaction throughout the entire sourcing life cycle; and communities, which aim to build a network of talented and skilled individuals in a particular field, such as creative design or computer programming. Their key characteristics are summarised in Table 2.2.

Boundaries among the three OSE types often blur or change over time. For example, a platformmay start out as a directory, but over time, features are added with the objective of gradually evolving into a marketplace. Simi- larly, some platforms in the marketplace category are starting to adopt elements from the community category. For example, marketplace plat- forms Elance and oDesk have made significant efforts to engage with and foster the community of suppliers (e.g., both platforms maintain blogs and are active on Twitter).

Kaganer et al. (2012) summarise four major types of crowdsourcing plat- forms that provide financial incentives: facilitator, arbitrator, aggregator and governor models. The facilitator refers to crowdsourcing platforms (e.g., Elance and Freelancer) that provide relatively transparent mech- anisms for both project initiators and suppliers (crowd members) to view each other’s expertise, credibility and past experience in order to make decisions. In a facilitator contract, usually the client is expected to select one supplier who can be an individual or a firm. The fees are agreed between the client and the supplier in advance, before the supplier commences the project. With respect to the arbitrator model, suppliers compete with each other and provide deliverables that they decide to submit without an advanced promise of a payment (e.g., crowdSPRING). The project initiator only selects one deliverable that best fulfils its need and only the wining supplier gets paid. The aggregator model usually engages with a large number of suppliers to deliver a huge amount of simple, repetitive tasks and there is no coordination need among suppli- ers (e.g., CrowdFlower). For each supplier, the payment procedure is the same as with the facilitator model. In the governor model (e.g., Trada), the crowdsourcing platform provides project governance by employing a combination of human project managers and a sophisticated software- enabled framework for monitoring and coordinating individual tasks. Governor platforms provide a thicker layer of project governance, including

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TABLE 2.2 Characteristics of online sourcing environments

Directories Marketplaces Communities

Main focus or objective

Help buyers discover suppliers by providing supplier listings with profile and contact information

Connects buyers and suppliers of services throughout all stages of the workflow

Helps members (i.e., suppliers) develop professionally through community interaction and paid client (i.e., buyer) engagements

Nature or structure of deals

Deals are done offline; the platform is not involved

Deals are done online, usually through a reverse-auction type of process; the platform is involved in both legal and financial aspects of the deal

Deals are done online and usually structured as contests or competitions; the platform is involved in both legal and financial aspects of the deal

Platform’s role in facilitating buyer–supplier interaction

No buyer–supplier interaction takes place on the platform; buyers may have an option of posting projects online, but all the ensuing activities take place outside of the platform

The platform facilitates buyer–supplier interaction with a focus on project completion

The platform facilitates buyer–supplier interaction with a focus on learning and community building

Revenue model Advertising, sponsorship

Project commission paid by suppliers; buyers and suppliers may sign up for premium membership

Project commission/fee paid by buyers

Platform examples

Infolancer, Chinasourcing

Elance, Guru, oDesk, Freelancer

crowdSPRING, TopCoder (Direct)

collecting project requirements from the client, breaking them up into micro-tasks, coordinating completion and sequencing individual tasks, conducting supplier certification and ensuring the quality of the final deliverable (Kaganer et al., 2013). Furthermore, there is the campaign

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60 Making a Sourcing Decision

model which refers to those firm-initiated campaigns engaging exter- nal workforces to achieve particular business purposes (e.g., Bonabeau, 2009; Whitla, 2009). Usually the firm creates a dedicated online space (supported by a crowdsourcing platform) for the campaign. The crowd gets involved in the campaign in the form of competitions. Unlike the arbitrator model, there are usually multiple ranked winners getting the rewards. For example, LEGO®learns from consumers’ creativity through maintaining its own platform CUUSOO to invite players to design their own toys. Such a model is frequently used for marketing, R&D and customer-research-related business purposes (Whitla, 2009).

Why do buyers come to OSEs?

OSEs afford buyers instant global reach. Neither buyers in search of tal- ented people nor suppliers are bounded by their region or country. Buyers benefit from low costs that result from global supplier competition. The differences in bids submitted to the same project description are usually due to lower wages and costs in the supplier countries or regions. OSE programmers in India, Bangladesh and Pakistan usually submit bids that are much lower than those by their competitors in wealthy nations.

Another advantage OSEs offer to buyers is the ability to quickly launch and scale up projects. Once a buyer posts a project, it is common to get 20–30 proposals from suppliers within the first two or three days. For larger projects, OSEs can help buyers mobilise the supplier commu- nity to start working in parallel on the individual tasks comprising the project. Community-type platforms like crowdSPRING and TopCoder do an especially good job at that.

Finally, buyers can take advantage of an established framework provided by OSEs for initiating and managing the sourcing projects (i.e., a com- prehensive suite of online tools and services that help buyers manage all aspects of the sourcing relationship).

What challenges do OSE buyers face?

Trust is key to any successful buyer–supplier relationship, especially in OSEs that lack personal contact and face-to-face interaction, with cross-cultural and language differences creating additional obstacles. A buyer needs to have confidence that the supplier it selects will complete the project on time and that the final deliverable will be of acceptable quality. The buyer

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also needs to be assured that, in case problems arise, effective mechanisms are available within the platform to address the issue. Thus, trust must be established at two levels: the supplier level and the platform level.

At the supplier level, the general strategy has been to make the OSEs more transparent, to open up communication channels between the buyer and supplier and to provide tools to monitor project progress. For exam- ple, in the early years of OSEs, suppliers had anonymous user profiles and aliases instead of real names. Over time, OSEs realised that this approach was counterproductive in terms of helping the parties build trusting relationships. Today most platforms allow suppliers to build rich profiles providing detailed personal and contact information, educational and employment history, skill evaluation scores and often a portfolio of previous work. In addition, to make up for the lack of personal recom- mendations common in traditional offline environments, platforms have introduced sophisticated rating systems and feedback mechanisms. Buyers can also see a complete history of projects the supplier has worked on, along with earnings and project completion statistics.

With respect to opening up communication channels, platforms like Elance and oDesk offer built-in online communication services, including chat, discussion forums, Web conferencing and phone integration. These tools can be used to interview a supplier at the selection phase or facilitate collaboration between the two parties throughout the project. Similarly, many platforms now offer project management tools enabling buyers to establish milestones and link payments to milestone completion.

Fostering trust at the platform level is based on the idea that since it is virtually impossible to ensure the trustworthiness of each individual sup- plier in a global context, the platform itself should become the guarantor that buyers will trust. Two primary mechanisms are used to accomplish this goal. The first includes initiatives seeking to reduce the perception of risk for the buyer. Escrow accounts (the project payment is held by the platform until the work is completed and approved by the buyer), arbitra- tion services and mandatory intellectual property agreements for suppliers provide the most common examples.

The second mechanism focuses on grooming the supplier pool. Here, the rationale is that by weeding out poor suppliers and promoting high-quality ones, the platform will build up a trustworthy reputation for itself. For

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62 Making a Sourcing Decision

example, Elance encourages all buyers to take advantage of its project management module. Once the critical mass of projects goes through the module to create some benchmark history, a platform-wide monitoring system can be established to identify and warn suppliers who regularly underperform.

Can outsourcing suppliers benefit from crowdsourcing?

Crowdsourcing offers several potential benefits to outsourcing suppliers, among them an alternative to the on-site-offshore model. This next gen- eration of outsourcing which is associated with the ‘human cloud’, a virtual, on-demand workforce (Kaganer et al., 2012), is enabled through crowdsourcing platforms. As large companies such as Microsoft,12 IBM,13

GE14 and Google15 have started experimenting with crowdsourcing, its growing popularity has stimulated a range of mixed reactions in the outsourcing community. Some established suppliers are ignoring the fact that an ‘unknown workforce’ is delivering jobs that could have been contracted to them. Others realise the increasing competition and are attempting to utilise this virtual on-demand workforce for their benefit. In particular, during the economic downturn, when reducing headcount across global delivery centres was seen as one of the obvious solutions to reduce costs, especially fixed costs, a possibility to tap into a global talent pool and employ required skills on demand created an interesting proposition for established service providers.

While the expected economic benefits of this proposition are signifi- cant, it is not clear what effort is required from established IT service providers to be able to successfully leverage crowdsourcing. Kaganer et al. (2012) suggest, for example, that the organisational challenges associ- ated with the human cloud require new management models and skills from the contracting organisation (the buyer). Putting this perspective into the outsourcing context, Nevo and Kotlarsky (2014) argue that ser- vice providers engaging in crowdsourcing need to develop new capabilities to successfully utilise crowdsourcing in delivering services to their clients. Based on data collected from focus groups with crowdsourcing leaders at a large multinational technology organisation, the new capabilities that were identified stem from the need of the traditional service provider to assume a ‘client’ role in the crowdsourcing context, while still acting as a ‘supplier’

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in providing services to the end-client (for a detailed discussion of new capabilities, see Nevo and Kotlarsky (2014)). Overall, the combination of ‘client’ and ‘supplier’ capabilities would enable a primary supplier to manage the three stakeholder groups that play an important role in crowdsourced projects:

1. The clientwho is ultimately the most important stakeholder, with client buy-in needed to ensure their satisfaction. Not all clients that con- tract a specific organisation may agree to have (parts of) their work crowdsourced.

2. Internal team members who need to design, facilitate and manage crowdsourced work, as well as integrate the crowdsourced deliverable into the services delivered to the end-client.

3. The crowd who need to have appropriate support (e.g., infrastructure) from the primary service provider, and feel motivated to respond to crowdsourcing calls.

Considerations for Outsourcing and Offshoring

An activity can be sourced as an overall set of processes or as smaller parts of it. The tasks and business processes that can be outsourced or offshored vary. In order of increasing complexity, they are as follows:

Low-cost simple back-office functions such as infrastructure and data management Customer-facing services such as call centres or help desks and telemar- keting Business functions such as human resources, finance, and accounting, and procurement Strategic knowledge-intensive processes, such as business intelligence, market research, and various R&D activities.

Using the scope of outsourcing as a criterion (i.e., the degree to which a process is managed internally or by a third party), we distinguish three models:

Total outsourcing, which refers to transferring more than 80% of a function’s operating budget to external providers

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64 Making a Sourcing Decision

Total in-house sourcing, which refers to retaining the management and provision of more than 80% of the function’s operating budget within the organisation

Selective outsourcing, which refers to sourcing selected functions to exter- nal parties while managing 20–80% of the function’s operating budget internally.

Along these lines, Metters (2008) suggests that offshoring and outsourcing decisions should be seen as a spectrum rather than as dis- tinct categories. With regard to the offshoring decision, Metters explains that, initially, it may appear categorical as a process performed either in the home country or offshore. However, Metters also emphasises degrees to the level of offshoring that are related to the amount of risk a firm undertakes. For example, we could consider a US firm that would like to lower the costs of a back-office process related to keying in handwritten English text to a computer system. Modern information and communi- cation technologies enable the performance of this process from various remote locations in a more cost-effective way. In the decision relating to where to offshore, a number of factors may play significant roles, depending on the company’s business model. Metters focuses on the case of electronically transferrable services and identifies labour costs, cultural distance from the data source and quality of infrastructure as some of the most important factors to consider when making offshoring decisions.

If we take into account the labour costs of clerical workers, the most favourable cost alternative is offshoring the process of keying hand- written English text to a computer system to China. As illustrated in Figure 2.3, China is the most attractive destination for a US customer

Canada Rural U.S. Urban U.S.China India Barbados Ireland

Low

High Low

High

Labour cost

Cultural distance from data source

Infrastructure quality

FIGURE 2.3 Spectrum of single-facility offshoring choices for a US customer Source: Metters, 2008.

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in terms of labour costs. However, non-English-speaking Chinese work- ers use character recognition rather than understanding English as a language. For this reason, undertaking this process would require two or even more employees to independently key characters and ensure that the process is performed correctly. Another choice might be India, where English-speaking Indians would perform the keying. This choice would entail higher wages than in China, but only one-fifth the level of US wages. Furthermore, this choice would entail a relatively lower level of language and cultural barriers between the client and the sup- plier organisation. An even more expensive option might be to offshore the process to Barbados, where English is the prevalent spoken language and salaries are 20–50% of the US levels. Another option might be to offshore (more precisely, to nearshore) the work to Canada, where wages are lower relative to the USA yet higher than the other destinations men- tioned. A further option might be using homeshoring or rural outsourcing by sending the work to lower-wage rural regions within the US. Finally, the firm can engage in offshoring to multiple destinations and perform the same process within different facilities around the world. On this basis, the cost of labour, the cultural distance and the quality of infras- tructure are the most relevant factors in the choice of an offshoring option.

In contrast to electronically transmitted services, viewing offshoring options as a spectrum is more complex if we consider non-electronically transmitted services such as manufacturing. For such processes, factors such as tax regimes, tariffs and government regulations make costs highly specific rather than general.

Identifying the Right Processes for Outsourcing and Offshoring

Factors influencing the suitability of processes for outsourcing and offshoring Understanding the core of each sourcing model and what it has to offer is of vital significance for engaging in effective sourcing strategies. How- ever, in the case of outsourcing and offshoring, it is of equal importance to identify which processes should be transferred to another supplier

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(domestic or offshore) or another country as part of the business of a captive centre.

According to Metters (2008), firms typically consider activities for outsourcing or offshoring that are not critical for the company’s opera- tions or holding on to its competitive advantage. The reason is that when a task is being outsourced, the institutional knowledge concerning the task is also leaving.

The scale of the process is also important in deciding if outsourcing is an appropriate solution. The costs associated with searching and select- ing an appropriate supplier, establishing service-level metrics, creating and managing the contract, monitoring the ongoing outsourcing relationship and enforcing the contract may be significant. In the case of offshoring, these costs are even more significant because of the complexity of these ventures. However, a process can also be too large for outsourcing to be effective. When a process is too large, outsourcing may represent only an additional layer of management, thus complicating operations and adding costs.

Processes that are being influenced by rapidly changing technologies con- stitute good candidates for outsourcing, unless they are critical to the company’s business model and operations. The reason is that small in- house units have a relatively limited capability to keep up with the rapidly changing technological environment. Firms that dedicate them- selves to these activities (such as IBM, Accenture, Infosys and Tata Consultancy Services) can be more innovative because they specialise in this business.

Furthermore, outsourcing (or insourcing) is appropriate for activities that have a high degree of variance – for example, an activity which requires 50 people one day and only ten the next. Hiring 50 people for this activ- ity when they are only occasionally needed constitutes a significant cost for the firm. An outsourcer can mitigate this variance by serving several countercyclical clients.

With regard to offshoring, Aron and Singh (2005) note that most com- panies do not make decisions systematically and rigorously enough and in fact repeatedly make at least one of three fundamental mistakes. First, although many companies spend time choosing countries, cities

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and suppliers and put significant effort into negotiations, they do not spend time evaluating which processes should go offshore and which should not. It appears that most companies have difficulty in distinguish- ing core processes that they must control, critical processes that they must buy from expert suppliers, and commodity processes that they can outsource.

Second, most organisations do not fully consider the risks associated with offshoring. Financial managers and senior executives make calculations in relation to the costs and benefits of offshoring without taking into account that, after signing the deal, the supplier might gain an upper hand. Most outsourcing customers appear to disregard any risks related to the power relation between the two partners and make choices that eliminate the savings from outsourcing.

Third, a number of companies do not understand that outsourcing is not an all-or-nothing choice; rather, there is a range of sourcing models that they can follow.

Metters (2008) suggests that processes that require substantial levels of communication between the client and the supplier do not constitute good candidates for offshoring. Time-zone differences, language and other sorts of communication barriers can shrink the benefits of offshoring. However, Aron and Singh (2005) appear to be more concerned with how processes are ranked in terms of their value to the organisation. They suggest that there must be a careful consideration between business pro- cesses that constitute good candidates for offshoring and those that do not. Processes that are important for the creation of value should not be offshored.

Along these lines, Aron and Singh (2005) suggest that executives should rank organisational processes along two dimensions: their poten- tial for value creation and for value capture. More specifically, executives should consider how crucial a process is in the creation of customer value compared to other processes. Furthermore, they should consider the extent to which each process enables the organisation to capture some of the value created for customers. For the processes that are ranked high, such as working capital management and cash-flow fore- casting, offshoring is not suggested. Processes that are ranked lower (e.g.,

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payment authorisation and invoice verification) appear better candidates for offshoring.

It is important to note that one of the two dimensions can be more impor- tant for certain industries or specific companies. In this case, rankings must be calculated taking into account the relative weight of each of these dimensions. Ranking all of the company’s processes creates a value hier- archy that reflects which processes should go offshore and which should not. The higher the rank of a process is, the more crucial its role is to the company’s strategy, and thus the less it should be considered for offshoring or outsourcing.

Having identified activities that are outsourcing candidates, Willcocks et al. (2002) suggest evaluating whether the market can service the requirement. If the market is not cheap, capable or mature enough, then the organisation will need to seek a largely in-house solution. Table 2.3 captures the major elements for consideration and plots the cost efficien- cies and capabilities the market can offer against carrying out the activity internally.

TABLE 2.3 Strategic sourcing by market comparison

Outsource

Activities and roles

Market superior

Market inferior

In-house

COST

Market cost efficiencies

vs. internal

• Expertise

• Management practices

• Experience curve effects

• BUT NOTE: transaction costs

• Lower labour costs

• Economies of scale

• Service, speed • Complementarity

CAPABILITY

Market capability vs. internal

‘Buy-in’ for critical

Cheap source for non- critical

activities and roles

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Sourcing Models and Sourcing Decisions 69

Where the market can carry out a task cheaper and better, then outsourcing is the obvious decision. As an example, Federal Express provides customer delivery for Dell. Where the market offers an inferior cost and capability, then in-house sourcing will be the best alternative. Where the market offers a better cost deal, then this should be taken, but only for processes that are not critical for value creation and value cap- ture. Where the market offers superior capability but at a premium price above what the in-house cost might be, there may still be good reasons for buying in or close partnering with the third party, not least to leverage and learn from their expertise, and apply it to processes with higher potential for value creation and value capture.

Impact of operational and structural risks on outsourcing and offshoring decisions Another aspect to consider while deciding which processes can be off- shored or outsourced is related to two major types of risk that companies face: operational risk, which refers to the danger that processes will not function properly and operate smoothly after offshoring, and structural risk, which refers to the danger that the relationship between clients and suppliers may not work as expected.With regard to operational risk, it is of great significance to evaluate the extent to which processes can be codified and measured. Aron and Singh (2005) distinguish transparent, codifiable, opaque and non-codifiable processes.

Transparent processes (e.g., transaction processing, telecollection and technical support) can be clearly measured in terms of quality and are the tasks that can be fully codified. Consequently, the operational risk of offshoring and outsourcing in this case is very low. Codifiable processes can be measured to some extent in terms of the quality of their execution, and most of the work can be codified. If firms can measure the quality of the final outcome to a satisfactory extent (e.g., for customer service and account management), then the oper- ational risk of offshoring and outsourcing becomes more manageable. However, if measuring the final outcome is not possible (e.g., for pro- cesses such as equity research, yield analysis and litigation support), then the operational risk becomes very high.

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70 Making a Sourcing Decision

Opaque processes can be codified in terms of the work being done, but the quality of the process outputs is difficult to measure (e.g., for processes such as insurance underwriting, invoice management, and cash flow forecasting). Although the risks of offshoring these processes are moderate, companies can monitor the work being done and inspect samples to ensure that the outcome meets their expectations. This, however, could be rather troublesome and expensive. If a company can specify how the supplier should do the work, it can lower the risk of offshoring by establishing a performance-based reward system and penalties. Non-codifiable processes, as the term implies, cannot be codified; exam- ples are supply chain coordination and customer data analysis. In addi- tion, often they cannot be measured in terms of the quality being achieved (such as pricing and working capital management). For this reason, such processes usually carry a high amount of operational risk. If an organisation chooses to outsource such processes, it should closely supervise the supplier’s work.

The ability to monitor work and the precision of metrics used to mea- sure process quality define the degree of structural risk that outsourcing presents to a client firm (Aron and Singh, 2005). For example, transaction processing and insurance claims processing are typically easy to monitor, with precise metrics to measure their quality. Therefore, these activities present low structural risk. Activities like product design and research and development are high risk, because it is difficult to monitor outcomes and challenging to define a precise quality metric.

While engaging in an outsourcing relationship, most companies assume that their supplier will behave in a collaborative way. This is not necessar- ily true, however, even in the case of companies that are buying services from captive centres that they own. For example, structural risk may arise because a supplier does not update the processes of performing certain tasks, does not invest in employee training and does not hire the most qualified people. Another problem is that service providers often exert much less effort in getting the work done than they originally agreed to. Structural risk also arises when contractual terms are altered after clients have handed over processes to suppliers. Once a company has handed a set of processes to a supplier, it is not easy to take it back in-house at short

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Sourcing Models and Sourcing Decisions 71

notice. Suppliers are aware of this and thus may use their power position to demand higher prices.

It is also important to consider that when firms source processes that require the transfer of a large amount of knowledge, they have to invest time and effort to pass this knowledge on to the supplier’s employees. Furthermore, some processes take a long time to stabilise when they are offshored. In both cases, the cost of switching suppliers is very high.

Nonetheless, structural risk can be mitigated in a number of ways. First, firms must establish contractual clauses that will impose on the supplier the obligation to continue to deliver the service at a certain price after the contract’s expiration date. Usually this period is 150% of the time that it would take for the supplier to deliver output that matches the organisation’s requirements and quality standards. Furthermore, compa- nies should try to split their business between two or more suppliers. Working with multiple suppliers provides a strong element of power for a company for at least two reasons. First, if a supplier underperforms, it becomes easier to transfer the work to another supplier that is already executing the same processes. Second, working with multiple suppliers will generate a competitive climate among them that, if managed care- fully, can become very beneficial for the client in terms of price and the quality of service delivered. (We discuss sourcing models that use multiple suppliers in Chapter 5.)

Aron and Singh (2005) suggest that firms should base their outsourcing and offshoring decisions on the assessment of operational and structural risks. For activities that present high operational and structural risks such as corporate planning, they recommend executing such activities in-house and onshore. For activities that present moderate operational and struc- tural risks such as supply chain coordination, they suggest outsourcing carefully, using extended organisation offshore, and monitor closely in real time. (Extended organisation is a hybrid organisational form where the client company specifies the quality of services it wants and works closely alongside suppliers to get that quality by managing the sup- pliers carefully and monitoring the agents’ work to ensure that things are done properly.) Activities with low operational and structural risks such as transaction processing are suitable for outsourcing to offshore service providers. Table 2.4 provides the full spectrum of organisational

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72 Making a Sourcing Decision

TABLE 2.4 Choosing location and organisational form

HIGH Outsource to service provider located nearby (nearshore) Litigation support

Set up captive centre nearby or onshore R&D, design

Execute process in house and onshore Pricing, corporate planning

O pe ra tio

na lr isk

MODERATE Oursource to offshore service provider over time Insurance claims processing, customer support

Oursource carefully, using ‘extended organisation’ offshore, and monitor closely in real time Supply chain coordination

Set up captive centre offshore Equity research

LOW Outsource to offshore service provider Data entry, transaction processing

Outsource carefully, using ‘extended organisation’ offshore Telecollection, technical support

Outsource carefully, using ‘extended organisation’ offshore, and conduct frequent process audits Customer data analysis market research analysis

LOW MODERATE HIGH

Structural risk

Source: Aron and Singh, 2005.

forms and locations and several examples of activities suitable for each combination of operational and structural risks (each being low, moderate and high).

Complex and problematic business processes In addition to the value-creation and value-capture criteria that certain processes present, as well as the relative operational and structural risks in outsourcing, Aron and Clemons (2004) suggest that the complexity of pro- cesses plays a significant role in offshoring decisions. They provide a useful

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Sourcing Models and Sourcing Decisions 73

set of criteria for evaluating process complexity that can help executives make appropriate sourcing decisions:

1. The codifiability of the data that must be transferred so that the pro- cess can be performed by the external party in a reliable way and with adherence to the required quality standards

2. The amount of training that must be provided to the employees of the supplier so that they become competent in performing the work

3. The cost of monitoring performance levels 4. The difficulty in assessing managers’ level of confidence that their

quality assessments will be accurate and reliable 5. The desired educational level for the employees of the supplier 6. Revenue per supplier working on the assigned task 7. Number of sub-tasks associated with the task 8. A single overall measure of task complexity used to assess the accuracy

of ratings and the weight associated with different factors.

Taking a different perspective, Puryear and Detrick (2006) suggest that the main problem with offshoring is that many managers regard it as a panacea for operational processes. Instead of diagnosing and correct- ing deficiencies, many managers seek to move the problems somewhere else. In most cases, however, this tactic is counterproductive. For this rea- son, the authors suggest that before considering offshoring, firms should determine the factors that inhibit performance. To address such inhibitors, they suggest the following three strategies:

1. Revamp business processes. Increased complexity is a fundamental factor causing organisational deficiencies and poor performance. Offshoring is not always an answer to the problem. Managing complexity and elimi- nating unnecessary complications can bring significant cost reductions, without engaging in the risks of offshoring. This is what the Brother International Corporation did when dealing with its problematic front- line call centre operations. The company received approximately 1.8 mil- lion calls on an annual basis, which took too long to process. To make matters worse, customer profiles were lost in online databases, and rep- resentatives were able to resolve fewer than half of the queries from new customers. However, instead of misdiagnosing the problem as a

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74 Making a Sourcing Decision

simple customer service problem that could be solved by offshoring it to an external cost-efficient party, executives tried to ‘dig deeper’. They discovered that solving the issue of managing customer com- plaints could actually benefit the organisation if the insights gained with regard to their customers’ profiles and tastes could be shared and used to improve marketing and product design. For this reason, they did not consider offshoring call centre operations, but instead decided to improve them. The division consolidated paper manuals into an online directory and integrated its records into a CRM database. Within a year, product returns had dropped by one third and the time needed to resolve customer problems dropped by 43 seconds on average. The new CRM enabled the company to capture insights with regard to its customers that it used in the development of its new products and marketing strategies.

2. Reinforce credibility and trust. Sourcing strategies often mask dysfunc- tional relationships between departments and BUs. For this reason, it is important to make sure that different divisions and units within an organisation are collaborating effectively and that their goals are aligned. For example, at the brokerage firm Charles Schwab, IT had long been viewed as a source of competitive advantage. But while the IT bud- get remained strong, pressure to deliver new applications meant less spending to update infrastructure and reduce complexity. Over time, the firm’s IT efforts drifted.When a major two-year initiative to develop a new portfolio management system failed, trust in IT plummeted. In response, the company launched a business-led IT project in 2004 geared to restructuring the IT infrastructure. The alliance and collabora- tion between the business and the IT department was fundamental for the effective execution of the project.

3. Find the scale-economy sweet spot. Contemporary organisations can benefit significantly from the consolidation of activities to the regional or global level. For example, one global financial services company reduced its cost structure significantly by consolidating its scattered customer service centres. The company had to deal with a host of incon- sistent procedures across its centres. However, the standardisation of the technology and the connection between the locations by a routing software boosted both efficiency and customer satisfaction. The overall savings of the company reached US$200 million.

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Sourcing Models and Sourcing Decisions 75

Summary

This chapter reviewed key models for making decisions regarding outsourcing and offshoring. Although many dimensions must be consid- ered, firms are mainly concerned with the following: which parts of the business to outsource and to what locations. This chapter brings together the considerations regarding these two questions, to offer a comprehensive analysis of the options available for firms.

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ch ap te r3 Country Attractiveness for Sourcing

This chapter discusses the maturity of various geographical locations worldwide and the factors that clients and suppliers take into account when deciding on their offshoring and offshore-outsourcing strategies. We focus on the following aspects:

An overview of sourcing destinations Criteria for selecting locations The advantages of nearshoring as a sourcing option.

An Overview of Sourcing Destinations

Both clients and suppliers consider sourcing destinations but with differ- ent goals in mind. Suppliers are interested in locations where they can set up global delivery centres. Client companies are interested in outsourcing a range of possible activities, or in setting up captive facilities abroad, typ- ically for R&D, shared services or customer support to service their own organisation or their customers.

Together with India, which currently attracts over 65% of ITO and over 43% of the BPO market (Willcocks et al., 2015), Brazil, Russia and China (referred to as BRIC economies) are considered the most attractive (tier 1) sourcing destinations for ITO and BPO. This is mainly because of the scale of services, available skills and the maturity achieved with regard to sourcing activities. Suppliers as well as captive centres based

76 Oshri, I., Kotlarsky, J., & Willcocks, L. P. (2015). The handbook of global outsourcing and offshoring 3rd edition. Retrieved from http://ebookcentral.proquest.com Created from aston on 2019-03-13 14:34:05.

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Country Attractiveness for Sourcing 77

in these countries, in particular in India, tend to move up the value chain, departing from specific and repetitive tasks that are usually cap- tured by new entrants – the so-called tier 2 and tier 3 countries. By 2015, over 125 offshore locations have been providing ITO and BPO ser- vices for more than five years and are seeking to mature their service capabilities.

A range of reports suggested the BRIC offshore ITO/BPO market share as 65% to 70% for India, and the rest almost equally divided between China, Russia and Brazil. According to NASSCOM (2012), ITO/BPO export rev- enue (excluding hardware) for India would exceed US$69 billion in 2013, serviced by about a 2.2 million workforce. This represented a growth of 16.3% on 2011. The BPO segment was expected to grow by 12% to reach US$16 billion in 2012 (NASSCOM, 2012). Brazil was next as the most frequent nearshore destination, mainly for US-based large compa- nies. However, Brazil and China could have done more to leverage their potential, while Russia, despite a lack of government support, was suc- ceeding in finding high value but niche work. This still remained true as of 2014 (Willcocks et al., 2015).

Reports concerning non-BRIC countries suggested global market share of around 15% in 2012. In BPO, the Philippines BPO industry earned US$11 billion in 2011 (Punongbayan & Araullo Report, 2012). In the same year, the Philippines ITO/BPO industry employed 638,000 full-time employees representing a 22% increase from 2010. Non-BRIC locations vary in areas of specialisation and offering. Some non-BRIC locations offer nearshoring opportunities; for example, the Czech Republic for Germany or Mexico for the USA. Further, India and China, between 2012 and 2015, have been turning to non-BRIC locations for some solutions, for example to secure lower costs or labour availability. As at 2015, among the top contenders globally and for different markets were Romania, Bulgaria, Poland, Slovakia, the Czech Republic, Belarus, Morocco, Tunisia, Costa Rica, Mexico, Venezuela, Vietnam, Egypt (despite the 2011 ‘rev- olution’) and the Philippines. Non-BRIC locations also offer different risk-reward ratios, and, given Indian dominance, have sought to iden- tify niche offerings – by service, geography or industry. For example, South Africa has gone down the niche route, leveraging not only con- tact centres as an area of specialty but also multiple location attractiveness factors.

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78 Making a Sourcing Decision

The relative attractiveness of BRIC and non-BRIC countries as sourcing destinations is dynamic. Their attractiveness needs to be understood in the context of long-term global sourcing trends and the current global economic climate. In this regard, spending will continue to rise in all global sourcing markets through recessionary as well as growth periods, but spending on BPO will overtake spending on ITO within the next five years. BPO expenditures will be in areas such as the human-resource func- tion, procurement, back-office administration, call centres, legal, finance and accounting, customer-facing operations and asset management. In line with this trend, a highly competitive global services market presents opportunities for countries that can offer the right mix of costs, skills and reliable service (see the trends in Chapter 1).

Emerging sourcing destinations are trying to differentiate their offerings from BRIC countries and from their tier 2 and tier 3 rivals when compet- ing for a contract. For example, Egypt has promoted itself as a low-cost destination for call centres that specialise in European languages. Dubai and Singapore present their IT security systems and legal systems as an advantage, particularly with regard to the outsourcing of high-security and business-continuity services. South Africa stresses its reputation for services in contact centres and hopes to transfer this into more complex BPO work. The Philippines, a former US colony, stresses its long cultural ties with the USA and the excellent English skills of its population to attract English-speaking call centres. Morocco is trying to attract French-speaking European clients to set up call centres, while Central and South American Spanish-speaking countries seek to establish call centres that can provide services to the Hispanic market in the USA (Reinhardt et al., 2006). In fact, recent studies have shown that some non-BRIC destinations have sought to, and have been successful in, competing with BRIC by positioning their specialised skills sets in particular areas and often by offering lower costs than other potential destinations (Kotlarsky and Oshri, 2008; Willcocks et al., 2015).

While second- and third-tier outsourcing destinations are improving their position, India has continued to gain volume in the area of ITO and BPO services over the 2011–2015 period. Many global clients (large multi- national corporations) view India as a centre of excellence for ITO and BPO and not merely as a low-cost destination. Many US and European clients initially engaged Indian suppliers to provide technical services such

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Country Attractiveness for Sourcing 79

as programming and platform upgrades (e.g., to help with compliance at the turn of the century). However, as these relationships matured, Western clients assigned more challenging work to Indian suppliers, such as development and support tasks for critical business applications.

However, India and, to a lesser extent, China, Brazil and Russia have now, for a number of years, been experiencing upward pressure on wages, com- bined with rising, and sometimes high, labour attrition. There is in fact a war for talent within each of the BRIC countries, which suppresses the key factors that made these countries attractive destinations for outsourcing in the first place. For example, many firms from India and China have relo- cated offshore activities from these countries to more attractive locations. And major Indian suppliers such as Tata Consultancy Services (TCS) are setting up global delivery centres in China, mainly because the supply of engineering skills and the proficiency in English has significantly improved in recent years in China.

To put these views into context, China’s US$142.3 billion investment in ICT in 2006 aimed at improving its competitive position in the offshoring ser- vice market. Willcocks and Lacity (2009) predicted that China’s ITO and BPO service capabilities would become strong, and by 2014 its ITO/BPO revenues probably exceeded US$7 billion. However, the main ITO and BPO suppliers in China are either large US-based suppliers like Accenture, Capgemini, Dell, HP and IBM or large India-based suppliers like Genpact, Infosys and TCS. Still, similar to the development of the Indian services sup- ply base, many Chinese suppliers do not want to compete solely in terms of low-level technical skills. Now they are trying to address the full range of the service value chain, such as Pactera, featured in Chapter 1.

Nevertheless, many client organisations are cautious of China’s ITO and BPO services because of language and cultural barriers and fears over losing intellectual property (IP). The Chinese government and business sectors are well aware of these barriers and are seeking ways to address them. For example, the Chinese government is investing US$5 billion in English-language training to improve the marketability of the ITO and BPO services from China. In 2009, the Chinese government redressed the lack of attention to the services outsourcing industry by establishing 23 service outsourcing cities and numerous outsourcing hubs such as Henan Outsourcing Park (Oshri, 2014).

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80 Making a Sourcing Decision

Developing countries other than India and China are becoming players in the IT services market. Many US clients already use Central American sup- pliers for Spanish-speaking business processes such as help desks, patient scheduling and data entry. Synchronous time zones are one of the drivers for US firms that outsource work to Central or South America. Further- more, access to skills and scale are two factors that clients consider in their assessment of attractive locations. In this regard, Brazil has the advantage of a large population, the innovative creativity of its engi- neers and government programmes supporting the outsourcing industry; while Chile and Uruguay, for example, have exploited their time-zone advantages, back-office proficiencies and government incentives to attract outsourcing work.

While South America is emerging as an attractive destination for offshoring and offshore outsourcing, today organisations from Western Europe are increasingly sourcing IT and businesses services to suppli- ers located in Central Eastern Europe (CEE). Among the key drivers of such a trend are the closer proximity to the supplier, limited time- zone differences and lower transaction costs than those incurred through using Asian alternatives. Furthermore, research on captives (Oshri, 2011; Oshri and van Uhm, 2012) shows that the CEE region is becom- ing a popular nearshore captive destination for Western European clients. In particular, Bulgaria, the Czech Republic and Hungary have attracted large numbers of R&D centres, making them a hub for business innovation and high-value, knowledge-intensive professional services.

In sub-Saharan Africa, several countries are actively seeking to become players in the global ITO and BPO markets. These countries, for exam- ple, Botswana and Kenya, have quickly established their economies partly on the competitiveness of IT and IT services. Another exam- ple is South Africa, which is exporting IT and business services pri- marily to UK-based clients, because of similar time zones, cultural similarities, English-speaking capabilities and a good infrastructure. Mediterranean North Africa already exports IT services to Europe. For example, Moroccan IT suppliers are attractive for clients in France because of the common language, similar time zone and cultural capability.

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Country Attractiveness for Sourcing 81

Criteria for Selecting Locations

Selecting a location is one of the major challenges organisations face when making offshoring and outsourcing decisions. A decision to relo- cate a business function or set up a new captive facility (for clients) or delivery centre (for suppliers) abroad is based to a great extent on the attractiveness of the sourcing location. Several frameworks for select- ing offshoring and offshore-outsourcing destinations are set out in the academic and professional literature to help managers assess the attrac- tiveness of countries and regions. All of these frameworks consider costs, business environment, availability of labour resources and specific skills. Some frameworks (e.g., Carmel, 2003; Farrell, 2006) are more detailed than others (e.g., A.T. Kearney’s three factors) in terms of the factors they consider when comparing potential sourcing locations. We compared and combined factors identified in several offshore destination evalua- tion frameworks, primarily developed in practitioner-oriented literature, to define criteria we are using for evaluating country attractiveness (Kotlarsky et al., 2013). We describe these factors in Table 3.1 and discuss them in detail below, providing an example of how each of these factors can be used to compare the attractiveness of several non-BRIC tier 2 countries for the sourcing of IT services and BPO. Examples in this chapter are based on the recent ten-country study by Willcocks et al. (2015) covering India, Philippines, South Africa, Poland, Morocco, Malaysia, Kenya, Sri Lanka, Egypt and Northern Ireland. (More examples related to the attractiveness of Western countries based on research by Oshri and Ravishenkar (2014) are included in Chapter 4.)

Factor 1: Costs Companies considering outsourcing IT or business processes typically compare a range of costs, including labour costs (average wages for skilled workers and managers), infrastructure costs (unit costs for tele- com networks, Internet access and power, office rent) and corporate taxes (tax breaks and regulations and other incentives for local invest- ment), across potential outsourcing locations. In addition, they are now also looking at value-added dimensions for how they might benefit over time.

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TA BL

E 3. 1

Fa ct or sf or

as se ss in g co un

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TA BL

E 3. 1

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84 Making a Sourcing Decision

EXAMPLE: Comparing Costs

Cost is invariably in the top three reasons cited by clients for offshoring. However, cost is not a simple equation. One commonly used measure is the direct operating cost per full-time employee. In the 2014 study of nine countries in direct competition with South Africa, India, the Philippines, Malaysia and Egypt led, while, in 2012, only Poland and Northern Ireland were more costly than South Africa across its selected skills base (Willcocks et al., 2015). However, the declining value of the Rand had made South Africa increasingly less expensive in 2013, 2014 and 2015. For the African locations, in 2014, labour costs in Morocco were higher than Egypt and Kenya but lower than in Europe and about half the labour costs in its major market of France. However, all ten locations were subsidised to some degree through tax allowances and government/regional incentives for inward investment. A further factor is infrastructure. Here, espe- cially in telecommunications, historically South Africa had lagged behind its major competitors, but the gap has narrowed considerably over the last four years.

On cost comparison, several other factors are pertinent. The first is cost dynamism. India and the Philippines have been experienc- ing erosion in their cost advantage due to scale and accelerating demand, creating skills shortages that drive up labour costs. One result is these countries outsourcing and offshoring work them- selves, for example to Egypt, Sri Lanka and China in order to stabilise labour costs. Another response is the rise of cheaper second-tier locations (e.g., Katowice, Poznan and Wroclaw in Poland; Davao, Sta. Rosa, Cebu, Pasig, Quezon and Mandaluyong City in the Philippines).

A further factor is hidden costs. For example, there was a widespread shortage of middle management and team leadership skills on the supplier side in many of the ten locations studied in 2014. The point here is that dealing with such shortages costs time, money and sometimes productivity. Clients also often fail to factor into their

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cost equations the cost of their own management of offshoring arrangements. On one analysis, the management costs of domes- tic outsourcing fall between 4% and 8% of contract value, but this moves to 12–16% with offshoring arrangements.

Factor 2: Skills This factor encompasses the skill pool (the size of labour pool with required skills) and the supplier landscape (the size of the local sector providing IT services and other business functions). Required skills may include technical and business knowledge, management skills, languages and the ability to learn new concepts and to innovate.

Labour resources

The scalability of labour resources in the long term (i.e., the ability to sup- ply sufficient labour resources to handle growing demand) is a major issue to consider while deciding on a sourcing destination. An indication of the scalability of labour resources is the growth in the number of graduates with desired skills that the country is able to produce each year – for exam- ple, technical and business knowledge, management skills, languages and the ability to learn new concepts and innovate. Countries that offer scala- bility of labour resources are also more likely to keep wages relatively low due to a constant supply of graduates.

For companies considering expansion to offshore or nearshore loca- tions, it is important to evaluate the gap between desired and available skills. Furthermore, these companies should assess the efforts by vari- ous stakeholders to bridge such skill gaps, for example, through various specialised in-house training programmes.

Supplier landscape

Clients looking to outsource IT or business processes must evaluate the sup- plier landscape in terms of the skills set (or capabilities) and competencies of suppliers. In this regard, clients should assess each supplier’s ability to respond to their ongoing needs (a delivery competency), radically improve service in terms of quality and cost (a transformation competency) and be willing and able to align its business model to their values, goals and needs

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(a relational competency). Countries that have suppliers able to demon- strate such competencies to clients are in a better position to attract those looking to outsource high-value, complex, knowledge-intensive and strate- gic activities. The supplier landscape combines both local and international suppliers that have a presence in the country (e.g., have set up a delivery centre). The maturity of suppliers in a country can be assessed based on 12 capabilities that are grouped into three key areas of competencies: rela- tionship, transformation and delivery (mentioned above and discussed in further detail in Chapter 5).

EXAMPLE: Comparing Availability of Skills

Skill pools can be difficult to assess, and numbers can be confusing. Poland and Northern Ireland have well-developed education sys- tems and are generally strong in sciences, technology, engineering and business, and accessible to the vast majority of the indige- nous population. This contrasts with less accessibility and the lower levels of English/other language proficiency in several African and Asian countries we studied. Thus, while Poland’s population is much smaller than, for example Egypt, the Philippines and Morocco, the percentage of the population being educated and becoming a highly skilled workforce is much higher. However, graduate numbers still do not compare with India, the Philippines and Egypt. The labour pools of Poland and Northern Ireland remain limited and could come under pressure quite quickly in the face of growing demand, though Northern Ireland was actually losing BPO work in recessionary conditions through 2011–2013.

The scalability of labour resources in the longer term is a major issue for client companies to consider when deciding on an offshore and outsourcing destination. Countries that offer scalability of labour resources are more likely to relieve pressure on skills shortages and rising wages through taking active measures to provide a constant supply of school leavers and graduates.

The number of graduates produced annually by any country is one indicator of how scalable the labour pool for the country will be

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in the long run. India is the offshore powerhouse in terms of ITO, BPO back office and voice and is trying to gain major traction on higher value BPOwork. India’s universities produced 4.4 million new graduates in 2012, with almost 16% focusing on science and tech- nology. These figures were even higher for 2013 and 2014. However, reports by McKinsey and NASSCOM suggest that only around 30% of graduates are readily employable. For this reason, in the last six years major suppliers like Infosys and TCS have set up and run very large pre-employment training programmes. India has a prevalence of English-language skills (on some estimates 20% of the popula- tion in 2014), but accent and quality are mixed. Adult literacy runs at 54% of the population. In 2012, India added 230,000 employees to its 2.8 million ITO/BPO workforce, still more again in 2013 and 2014. Pressure on skills and wages are pushing Indian suppliers and captives to second-tier locations, and also to other cheaper locations abroad. On call centres, India has an 800,000 workforce but has seen some repatriation to the UK and USA in the last three years over service quality issues, changes in the cost equation and some moves to other offshore locations.

The study of the Chinese economy skills-base by Oshri (2014) reported that China produced 6.8 million graduates in 2013 with about 65% in science and engineering but only 16% in busi- ness studies. This research led to the conclusion that the lack of management skills in the Chinese ITO and BPO sector hinders its internationalisation.

Egypt has over 330,000 graduates (from all disciplines) every year and 31,000 of these have degrees in technology, science or engi- neering. Egypt has ‘multi-linguinity’, with over 25,000 graduates annually from Cairo alone able to speak English and other major European languages. Like several other locations, however, Egypt has struggled to build requisite middle-management BPO skills.

In South Africa, the annual supply of high-school leavers exceeds 227,000. Graduates and post-graduates have exceeded 140,000 annually in recent years, with 51% in science, engineering technol- ogy and business, the rest in humanities and social sciences. South Africa added 370,000 proficient English speakers to the workforce

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in 2011, compared to 4.4 million in India and 450,000 in the Philippines. Other locations had smaller additions, the next in size being Malaysia with 160,000 and Egypt with 70,000. South Africa is also strong in legal, accounting and business skills, which support offshored legal-process and financial-service operations.

For the Philippines 82% of work is voice contact, primarily to the USA (though it has services offered in 18 languages). The rest of ITO/BPO services include finance, accounting, medical transcription, human resources and IT. Filipino residents are considered to speak a more ‘American-style’ version of English than their Indian counter- parts. In 2011, the Philippines officially overtook India as the world’s offshore call centre capital. By 2014, the BPO industry employed over 640,000 people and the figure is expected to rise eventually to 1.3 million, provided the key skill creation challenges are addressed. Like India, the Philippines, as a mature, large destination experienc- ing growing demand, faces challenges in skills shortages, retention of talent, as well as rising labour costs. Some government action has been taken to address the skills issues.

Sri Lanka has an adult literacy rate of 91%. Sri Lanka uses English as a unifying language, primarily in government. English is spoken by about 10% of the population. With few skills problems, BPO resources in Sri Lanka are very affordable. Junior non-voice work- ers with limited experience collect just 7% of what a comparable employee would earn in the USA. More skilled employees, with five to nine years’ experience can expect to earn US$8,300, 15% of US wages. Historically Sri Lanka has provided skills and expertise in IT development, accounting and some legal back-office work. Given the strong educational standards in legal and accounting qualifica- tions, there are real opportunities to increase the scale of operations and grow the offshore accounting and legal-process outsourcing market, especially with the cost competitiveness Sri Lanka can offer against its neighbour, India. Sri Lanka is particularly well endowed in IT skills with over 120 software development firms, with estimated exports exceeding US$75 million by 2014. Sri Lanka is emerging and quickly gaining momentum in the outsourcing market because of its proximity to India. Its labour pool is exponentially smaller

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than India’s, but Sri Lanka aimed to create 30,000 new jobs in the ITO/BPO industry between 2013 and 2018.

Kenya is at a relatively early stage in development as an offshore location but has satisfactory skills in IT, English and to some extent certain forms of knowledge process to support further foreign investment in its ITO/BPO growing industry.

Morocco is providing skills to support nearshore operations for European-based companies such as Dell, Deloitte, HP and Attento. Morocco offers well-trained human resources, and for voice BPO has strong capability in French and Spanish, as well as English. For offshore development, Morocco is positioned well to get a good share of the European offshoring IT market. It has a large pool of skilled human resources in the region where banks, computer and insurance companies could become major clients. Its business parks host more than 100 multinationals, and its policies, private sector and government target growing a workforce of more than 90,000 people by 2017 in the outsourcing field, concentrating on shared service centres, non-voice BPO, voice BPO and ITO.

Malaysia has a literacy rate of 92%, a workforce size of over 12 million, with over 180,000 graduates entering the labour market annually, 54% with science and technology backgrounds. English speakers make up 28% of the population. Its education and train- ing programmes support IT, financial and accounting and general back-office process outsourcing activity.

Finally, the ten-country study found widespread shortages of middle-management and team-leadership skills on the supplier side in offshore locations. This was also as true in the more mature locations such as the Philippines, India and Sri Lanka (though not Northern Ireland and Poland) as in the emerging locations of Kenya and Egypt.

Factor 3: Business and living environment This factor considers governance support (policy on foreign investment, labour laws, bureaucratic and regulatory burden, level of corruption), the business environment (compatibility with prevailing business culture and

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ethics), the living environment (overall quality of life, prevalence of HIV infection, serious crime per capita) and accessibility (travel time, flight frequency, time difference).

EXAMPLE: Comparing Business and Living Environment

The governments of all ten comparison countries favoured foreign investment, relaxed labour laws to some extent and tried to reduce some of the regulatory and bureaucratic burden. Corruption is per- ceived by clients as an issue in some countries, including China. Most governments understand that and some have pursued strong action to eradicate this, in order to support an emerging or mature BPO industry. However, particularly in developing countries with- out strong detection and regulatory agencies, corruption is not always easy to police. The Transparency International’s Corruption Perceptions Index regularly reports on this issue, but if you look at these from 2009 to 2014, they show a somewhat changing pic- ture almost from year to year. Generally Northern Ireland, Malaysia, Poland and South Africa tend to score better; India andMorocco less so, while the Philippines, Egypt, Sri Lanka and Kenya less so again. However, these are general country indicators rather than specifi- cally for the BPO sector in the country where governments need to attract inward investment and choose to act more strictly.

Following this last point, business environments can be made com- patible with foreign clients’ standards and culture through setting up carefully controlled business environments in which to operate. We see this with India’s and Morocco’s business parks, for example. Egypt has made great efforts to develop such business environ- ments around several of its major cities. As business environments, Malaysia, South Africa, Northern Ireland and Poland tend to bemore compatible with their target markets. Sri Lanka, like India, has some strong cultural compatibilities with its UK market historically.

On living environment, South Africa, Northern Ireland, Malaysia, then India and the Philippines were perceived as most attractive, and Kenya the least attractive. Of course, accessibility – in terms of travel

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time, accessibility and time difference – depends on the client. From a UK perspective, South Africa has great accessibility, a compatible time zone and tolerable travel time: the same is true for Poland and Northern Ireland. South Africa is still attractive from an Australian perspective, but not for the USA. Countries like Morocco and Egypt play into smaller nearshore niches that give them advantages on accessibility. Meanwhile, India has so many diverse customers around the globe, inevitably there are going to be trade-offs on accessibility. Not surprisingly, the Philippines scores more highly on accessibility with its mainly US-based customers.

Factor 4: Quality of infrastructure Quality of infrastructure includes telecommunication and IT (network downtime, speed of service restoration, connectivity), real estate (availabil- ity and quality), transportation (scale and quality of road and rail network) and power (reliability of power supply).

EXAMPLE: Comparing Quality of Infrastructure

All ten locations claimed high-quality infrastructure, but in practice there are large variations across the sample. On telecoms and IT, it is difficult to run an offshore location as a business proposition without reliable, fast, relatively cheap technology with low down- time, fast restoration of service and good connectivity. Most popular outsourcing sites (cities) in India and Philippines have achieved this as have several locations in Morocco, Malaysia, South Africa, North- ern Ireland and Poland. Sri Lanka has a relatively good record, while Kenya is still building its capability but now has good access to a steady telecom connectivity. In Poland and Northern Ireland, quality of telecoms and IT infrastructure is comparable with that found in the UK and France. Malaysia has advanced IT and telecom facilities. In our other North African and Asian countries, it is common to find an advanced IT infrastructure in business parks and large cities but a very limited IT infrastructure in rural areas – or none at all. The

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92 Making a Sourcing Decision

Philippines stands out as having a particularly good telecoms infras- tructure with a reliable domestic and inter-island service because of the US military bases there.

The cost of real estate can be an unpleasant surprise in some offshore locations. Mumbai and Bangalore in India, for example, are no longer cheap. In practice, renting commercial space in Mumbai can cost higher than in downtown New York. As a country, and specific cities therein, grows their offshore market, inevitably real-estate prices rise, as is recently happening with Poland. The Philippines still has low real-estate costs (Manila is ranked second lowest in Asia after Djakarta) and also has special economic zones in several cities. Real- estate costs do vary across the other locations, withMalaysia, Poland and Northern Ireland being at the higher end, followed by South Africa which is in fact cheaper than the Philippines. Sri Lanka and Kenya are at the lowest end, and Egypt and Morocco are protected somewhat when business parks are utilised.

Transportation and power tend to be at their most efficient and reli- able in Poland, South Africa, Northern Ireland and Malaysia. There are variations in the Indian experience depending on the city loca- tion. Road and transportation generally in the Philippines is fairly low quality, on a par with, for example, former Russian states, as is the reliability of power supply; though, as in India, in some cases the BPO sector operates in protected conditions created by ser- vice providers themselves. Morocco tends to have better transport and power facilities than Egypt, though Egypt has been upgrading extensively over the last three years. Of our ten locations, Sri Lanka and Kenya are at the bottom end on these factors.

Factor 5: Risk profile This factor assesses security issues (risks to personal security and property- related issues, such as fraud, crime and terrorism), disruptive events (risk of labour uprising, political unrest, natural disasters), regulatory risks (sta- bility, fairness, efficiency of legal framework), macroeconomic risks (cost inflation, currency fluctuation and capital freedom) and IP risk (strength of data and IP protection regime).

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EXAMPLE: Comparing Risk Profile

When making offshoring decisions, companies have been typically driven primarily by cost, skills availability and service factors. But since 2008, and through the Arab Spring and after, risk has taken on a heightened significance in their BPO calculations. Events have driven this, for example: Egypt’s BPO activity being stalled by unexpected political and social events and natural disasters affect- ing Bangkok’s business attractiveness. Suppliers are also aware that clients in recessionary USA and Western Europe cannot be guaran- teed. By establishing a presence in new offshore locations, a supplier can improve the cost and skills proposition, making it more compet- itive in its existing markets. But the supplier can also spread risk by establishing a local presence to seek secondary markets within the new region.

Risks can be on a country scale but can also be limited to specific locales within a nation. Terrorism has had a high profile in India, Sri Lanka, Egypt, Northern Ireland and more recently Kenya. But much of this has been historical, and surprisingly small in scale despite media magnification. Except for Sri Lanka, which has recently ended a 30-year long civil strife in its north-west region, it would be pos- sible to point to similar levels of terrorism in the UK and Spain, for example. More critical are risks to personal security from fraud and crime, and this tends to vary by region and city within each country, and also by neighbourhood within each city. In our ten locations at least, the BPO industries tend to be located in quite well-protected areas.

Some countries are more prone to natural disasters than others and this can affect location attractiveness. Japan, for example, regu- larly experiences earthquakes, and Mumbai has seasonal torrential rain. Less anticipatable are political risks: Egypt followed by Kenya and Sri Lanka being the highest risk countries. Malaysia, Northern Ireland and Poland are countries with the lowest disruptive-event risk among the ten countries studied. Morocco remained largely unaffected by the Arab Spring of 2011, while South Africa’s labour unrest in 2012–2013 should be put in the context of a relatively

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94 Making a Sourcing Decision

stable democratic state and economy. India and the Philippines are also considered relatively stable political entities for BPO purposes.

On regulatory risks, Northern Ireland, Poland and Malaysia have the best profiles; Kenya, and Egypt the worst, followed by Sri Lanka. India received some adverse comments on legal inefficiencies; while the Philippines, South Africa and Morocco are generally rated as meeting requirements. IP risk is rated as at its worst in Sri Lanka, Kenya and Egypt, followed by Morocco. There is divided opinion on India and the Philippines which may reflect their large market sizes, thus offering a diverse range of experiences on this issue. Northern Ireland and Poland are rated as better than requirement on this issue, likewise (though with a lower mark) South Africa and Malaysia.

Factor 6: Market potential Market potential can be assessed based on the attractiveness of the local market (current gross domestic product and gross domestic prod- uct growth rate) and access to nearby markets (in the host country and adjacent regions). This may take one or more forms:

Whether the local market is attractive for setting up a captive oper- ation (client consideration) or delivery centre (supplier consideration) that would use local labour, infrastructure and resources Whether the local market is populated with sophisticated local service suppliers (client and supplier consideration) Whether the local or nearby market have the demand for outsourcing services (supplier consideration for setting up a service centre).

EXAMPLE: Comparing Market Potential

In terms of scale and range of services, India with a US$70 billion plus ITO/BPO annual revenue is easily number one in the captive and offshore-outsourcing market but is not so strong on supply to the host and nearby region. The Philippines is next with US$11 billion in revenues, and by 2012 had overtaken India as the biggest con- tact centre location by number of seats. From 2012 to 2013 there

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have been some moves away from India on call centres, but it still attracts such work and remains second in size and revenues. These countries now have major offshore industries and will use this as a basis to accelerate their growth over the next five years. Neither country will slow down. Indian suppliers are increasingly providing best-shoring models, mixing skills onshore (close to the customer), offshore and ‘anyshore’ in the search for optimal price points and labour skills pools. Both are attempting to move higher up the value chain into complex BPO, with India, indeed, seeking to rebrand itself as a business-process services country.

Given these advantages, the other eight countries tend to seek ser- vice niches in order to differentiate, gain new business and build momentum and scale. Sri Lanka gains ‘overload’ work from its neigh- bour India at a lower price point, but in 2014 was offering and gaining further momentum in software development, accounting and legal-processing services. Morocco will continue to be a rela- tively small but growing market, mainly nearshoring into Western Europe. Egypt has voice captives, and a small but growing IT ser- vices and BPO market, but its offshore future is temporarily on hold while political and economic instabilities work their way through. Malaysia is a second-tier outsourcing location with good cost com- petitiveness and English and technical skills. It looks to grow itself as an ITO/BPO location, has good infrastructure for captive operations but is still looking for its precise focus and market(s).

Through 2012–2014, Poland grew fast as a destination, especially for nearshore work from West Europe and large global suppliers. Its education dividend in technical and engineering skills and employ- able workforce gives it leverage in complex ITO/BPO work as well as more commoditised services. In time, cost pressures will emerge as a ‘problem of success,’ as we have already seen in India. Northern Ireland also has a strong employable ITO/BPO workforce and a less attractive price point and is likely to regain momentum in less reces- sionary conditions, taking advantage of its nearshore positioning with Europe and links with the USA.

The African countries in the 2014 sample were South Africa and Kenya. South Africa emerged as a rising offshore location with

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strongly differentiated services, high-quality contact capability, but still underplaying its potential strengths in financial services and legal process outsourcing and accounting. Kenya was still a start-up location with limited scale, able to deliver on IT and voice and some commodity back-office work, but needing several years of sustained investment and marketing to achieve the scale of any of the other locations.

C A S E S T U D Y

The Giant Awakens: Sheen Software Systems Considers China

for Offshore IT Outsourcing

by Erran Carmel

Frank Xin, the founder of Sheen-USA and his friend Zhang

Chang were ordering dinner at M on the Bund, the stylish eatery

overlooking the dazzling Shanghai riverfront. ‘I’m bullish on

China and particularly on Shanghai,’ said Xin. His friend, Chang,

a vice-president of Information Systems at a major Shanghai

bank, was more careful.

Look, Xin, as a friend, I think you’re taking somemajor risks

in setting up shop across the ocean. And this stuff about

lightweight methodologies seems lightweight to me.

Frank Xin Goes to China

Xin had made up his mind that China was where his offshore-

outsourcing unit would be located. He hadmonitored the recent

emergence of the offshore-outsourcing industry in China. His

deliberation was only on where and what form his Chinese

operations would take. He considered Shanghai because of the

buzz and because of some family ties in the city. Shanghai is a

good strategic point to grow, he thought. And in answer to his

own hesitations, he thought: ‘If Shanghai itself continues to get

expensive, I canmove to one of the nearby cities with tech parks

such as Suzhou or Hangzhou’ [Each is 12 hours by train from

Shanghai.].

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Country Attractiveness for Sourcing 97

Operations

Xin wasn’t sure how to set up his China operations. He saw two

options: setting up his own captive office that would be a sub-

sidiary of Sheen-USA or partnering with an existing firm. In that

arrangement, he would sign an agreement with a Shanghai

firm whereby the Shanghai firm would allocate some of its staff

to Sheen. Xin saw advantages to each. If he decided to lease

an office, he had a number of choices. His first interest was

in the software park in Pudang, a newly built area in eastern

Shanghai. But the facility was already full. Pudang costs were

very low for Shanghai, at 55 cents per square metre versus

about 70 to 80 cents in the rest of the city. Being a member

of the software park, even if Xin did not reside there, having

a subsidiary in China would give his company other financial

benefits: a tax holiday for the first three years (on profits) and

a 50% reduction on taxes in the subsequent five years. Xin was

not sure what profits would be allocated to his Shanghai office,

though.

Xin began planning his offshore strategy by attending the 2003

Global IT outsourcing summit1 in downtown Shanghai a few

minutes’ walk from the Bund. The two-day conference was one

of the first in China that focused on offshore outsourcing. It was

organised by the Shanghai Municipal Foreign Economic Rela-

tions and Trade Commission, the Shanghai Municipal and For-

malisation Commission, the Shanghai Software Industry Asso-

ciation and several other organisations.

At the conference, the vice-mayor of Shanghai welcomed the

attendees. About 200 people attended the conference, most of

them from Chinese software companies. Several foreign firms

had sent their representatives, including ADP-Asia and Siemens.

Conference speeches included those by the heads of Microsoft

China and Shanda (a leading computer-game maker based in

Shanghai) and the CTO ofWebEx, an American firmwith R&D in

Shanghai. The summit was covered in the next day’s English-

language Shanghai Daily with the headline, ‘China’s software

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98 Making a Sourcing Decision

outsourcing industry is expected to shorten its gap with India

in about three years’.

By 2003, the China software market had been growing at a

fast pace for several years. Unlike the Indian industry, which

most see as itsmain competitor, China’s industry enjoyed strong

demand domestically from an economy that had been growing

over the past decade at double-digit compound annual growth

rate. Beginning roughly in 2000, Chinese firms had begun to

set their sights on augmenting the domestic demand with for-

eign markets. In 2003, China was expected to export roughly

US$1 billion in software and software services. The Shanghai

metropolitan area accounted for roughly 12% of the total soft-

ware exports. Shanghai was also home to software R&D centres

for HP and Ericsson, as well as support centres and localisation

centres for Microsoft and other multinationals.

Xin and His Company Sheen

Frank Xin was reflective of many global software entrepreneurs:

as an ‘overseas Chinese’, he was able to bridge East and West.

His home had been in Los Angeles for 15 years. Having grown

up in Taiwan, he spoke Mandarin and could be understood in

Shanghai, though he was having to master the local Chinese

dialect. Prior to founding Sheen, he was at PeopleSoft.

Xin founded Sheen in 2000 to provide customised solutions

for the business and entertainment industries. His large clients

included Disney and 20th Century Fox, but most of his clients

were small- and medium-sized enterprises. In all cases, the

development teams assigned to projects were small and nim-

ble – usually three to six technical staff. Most of his clients were

local, but some were based elsewhere in California and the USA.

Sheen had four permanent employees and a dozen regular con-

sultants and contractors brought inwhenneeded. He ran a small,

lean shop that relied on the combined technical abilities and

sales abilities of the principals. ‘My strategy is to grow,’ said Xin,

‘to capitalise on our strengths and the strengths of the Chinese.’

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Country Attractiveness for Sourcing 99

In Sheen’s client engagements, the firm used its own adaptation

of agile methodologies, also known as ‘lightweight methodolo-

gies’, the most famous of which is Extreme Programming (XP).

The ‘agile movement’ is a reaction to the ‘heavy’ methodologies

exemplified by the Software Engineering Institute’s Capability

Maturity Model (CMM), which emphasise controls and docu-

mentation, both of which are anathema to independent-minded

programmers.

Xin said, ‘We’ve found that most clients don’t have the band-

width to do full-blown systems analysis and design, so agile

methodologies are better suited. Agile approaches aremuch bet-

ter suited tomore and better communication between client and

developers with lots of end-user participation and small, nimble

teams of developers. By working closer with the developer, the

client gets over the xenophobia of working with the foreigner,

the unknown.’

The other part of Xin’s strategy was to use the strength of the

Chinese. While the Indian outsourcing industry had mastered

the factory approach of software production, the Chinese soft-

ware industry was only slowly, and perhaps reluctantly, follow-

ing that lead. About 20 Indian firms had attained the highest

process standards of software development: CMM level 5. India’s

success was all the more noteworthy because its firms repre-

sented roughly 50% of all global firms that have attained this

standard. ‘When we bid against CMM level 5 Indian firms,

how do we beat them? We have to offer something different,’

reflected Xin.

Chinese programmers are educated in computer science pro-

grammes with a tradition of theory and algorithm development.

Students coming out of this educational system are not inter-

ested in working in factory environments in which they are

handed specifications. They want to work with the customer

to solve problems. ‘Agile programming is a much better fit to

Chinese work culture than the stifling procedures embedded in

the CMM,’ said Xin.

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10 0

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One of the cornerstones of agile methodologies is tight team-

work and close interactions between client and developer.

Sheen’s approach to teamwork was to place people at the client

site as much as possible. Sometimes this could be for as much as

half of the project duration. When the client wanted the team

at its site for longer periods of time, this added to the project

cost, and Sheen passes the cost to the client. ‘In China, every-

one wants to be their own boss, people are less conformative; so

when you use agile methods, you allow everyone on the team to

give feedback.’

The A. T. Kearney Global Services Location Index (2011), shown in Table 3.2, illustrates a different approach to assessing the attractiveness of a location for outsourcing and offshoring. Its approach provides a score for each factor (financial attractiveness, people skills and availabil- ity, and business environment), which are added up to create a final score. We believe that a qualitative assessment should be combined with a quantified approach to decide on the attractiveness of a location for outsourcing.

Finally, those who are comparing potential sourcing destinations must con- sider the influence of certain cities on such a decision. The rationale for this is that costs, availability of skills and infrastructure may vary significantly across cities within the same country. Even factors such as the environ- ment, risk profile and market potential can present varying results when examined in each city of the same country. The Global Services Tholons Report (Vashistha and Khan, 2008) shows that comparing countries is superficial because ‘no two cities of a country would be at the same level of skills maturity or offer the same cost advantage’. For example, some cities graduate more engineers; others more accountants. Therefore, sourcing decisions can be more accurate if the attractiveness of potential locations such as cities are assessed, rather than countries.

One approach to assessing the attractiveness of cities for outsourcing is that proposed by Farrell (2006), in which the scale and quality of workforce, business catalyst, cost, infrastructure, risk profile and quality of life are among the more critical factors. According to 2014 Tholons

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TABLE 3.2 A.T. Kearney Global Services Location IndexTM, 2011

Rank Country Financial attractiveness

People skills and availability

Business environment

Total score

1 India 3.11 2.76 1.14 7.01

2 China 2.62 2.55 1.31 6.49

3 Malaysia 2.78 1.38 1.83 5.99

4 Egypt 3.10 1.36 1.35 5.81

5 Indonesia 3.24 1.53 1.01 5.78

6 Mexico 2.68 1.60 1.44 5.72

7 Thailand 3.05 1.38 1.29 5.72

8 Vietnam 3.27 1.19 1.24 5.69

9 Philippines 3.18 1.31 1.16 5.65

10 Chile 2.44 1.27 1.82 5.52

11 Estonia 2.31 0.95 2.24 5.51

12 Brazil 2.02 2.07 1.38 5.48

13 Latvia 2.56 0.93 1.96 5.46

14 Lithuania 2.48 0.93 2.02 5.43

15 United Arab Emirates

2.41 0.94 2.05 5.41

16 United Kingdom

0.91 2.26 2.23 5.41

17 Bulgaria 2.82 0.88 1.67 5.37

18 United States

0.45 2.88 2.01 5.35

19 Costa Rica 2.84 0.94 1.56 5.34

20 Russia 2.48 1.79 1.07 5.34

21 Sri Lanka 3.20 0.95 1.11 5.26

22 Jordon 2.97 0.77 1.49 5.23

23 Tunisia 3.05 0.81 1.37 5.23

24 Poland 2.14 1.27 1.81 5.23

25 Romania 2.54 1.03 1.65 5.21

26 Germany 0.76 2.17 2.27 5.20

(continued)

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TABLE 3.2 Continued

Rank Country Financial attractiveness

People skills and availability

Business environment

Total score

27 Ghana 3.12 0.69 1.28 5.18

28 Pakistan 3.23 1.16 0.76 5.15

29 Senegal 3.23 0.78 1.11 5.12

30 Argentina 2.45 1.58 1.09 5.12

31 Hungary 2.05 1.24 1.82 5.11

32 Singapore 1.00 1.66 2.40 5.06

33 Jamaica 2.81 0.86 1.34 5.01

34 Panama 2.77 0.72 1.49 4.98

35 Czech Republic

1.81 1.14 2.03 4.98

36 Mauritius 2.41 0.87 1.70 4.98

37 Morocco 2.83 0.87 1.26 4.96

38 Ukarine 2.86 1.07 1.02 4.95

39 Canada 0.56 2.14 2.25 4.95

40 Slovakia 2.33 0.93 1.65 4.91

41 Uruguay 2.42 0.91 1.42 4.75

42 Spain 0.81 2.06 1.88 4.75

43 Colombia 2.34 1.20 1.18 4.72

44 France 0.38 2.12 2.11 4.61

45 South Africa

2.27 0.93 1.37 4.57

46 Australia 0.51 1.80 2.13 4.44

47 Israel 1.45 1.35 1.64 4.4448

48 Turkey 1.87 1.29 1.17 4.33

49 Ireland 0.42 1.74 2.08 2.24

50 Portugal 1.21 1.09 1.85 4.15

Note: The weight distribution for three categories is 40:30:30. Financial attractiveness is rated on a scale of 0 to 4, and the categories for people skills and availability, and business environ- ment are on a scale of 0 to 3. Source: A.T. Kearney Global Services Location Index™, 2011.

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Country Attractiveness for Sourcing 10 3

Top 100 Outsourcing Destinations Ranking among the top ten global outsourcing cities: six are in India and the others are Manila and Cebu City in the Philippines, Kraków in Poland (number eight) and Dublin in Ireland (number ten). It is interesting to think through how quickly this ranking is changing and ponder how dynamic the global sourcing environ- ment has been – and will be. For example, in 2010 Kraków was among the top five emerging cities according to Tholons ranking of emerging desti- nations and in 2014 it is among the established destinations list. In a few years we will see several locations in Central and Eastern Europe that might well be promoted, but others demoted for running into cost and skills challenges.

Nearshoring and Beyond

Nearshoring is an activity in which a client outsources work to a sup- plier located in a foreign low-wage country and yet the supplier is close in distance and in terms of time-zone differences. Compared to offshore outsourcing, the benefits of nearshoring include lower travel costs, fewer time-zone differences and closer cultural compatibility. Canada, for exam- ple, is a significant nearshore destination for US clients. Indeed, some analysts argue that US clients can have lower costs when nearshoring work to Canada as compared with the strategy to offshore-outsource to India.

However, the question which remains is the degree to which distance mat- ters (or not) in nearshoring, in comparison to the alternative to offshore. In their study of nearshoring, Carmel and Abbott (2007) argue that dis- tance still matters and point to customers choosing the nearshore option to gain benefit from one or more of the following constructs of prox- imity: geographical, temporal, cultural, linguistic, economic, political and historical linkages.

Nearshoring represents a major way in which non-BRIC countries can com- pete with India for market share. The top Indian firms now offer a variety of location choices to their clients, which mitigates some of the currency costs incurred in uncertain markets. For example, India-based TCS can offer its British clients services that are ‘farshore’ (India), nearshore (Budapest, Hungary) and onshore from their offices in London, Nottingham or else- where. Another Indian firm, Infosys, has ‘proximity development centres’

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10 4

Making a Sourcing Decision

and like other Indian firms has also refined its internal processes in mitigating time-zone difficulties (Carmel and Abbott, 2007).

Nearshoring may be part of a more complex outsourcing arrangement, in particular when the client firm is a multinational company that requires a supplier with a global presence to deliver services to business units based in different geographies. This can be illustrated through the example of the outsourcing contract between TCS and ABN AMRO (Oshri et al., 2007a). In this contract, TCS provided IT services to the bank from offshore locations (Mumbai and São Paulo), from nearshore locations (Budapest and Luxembourg) and from an onshore location (Amsterdam). The client and the supplier assessed the most appropriate location to provide ser- vices based on some of the criteria outlined above (e.g., availability of skills, language and cost). Our research suggests that clients and suppli- ers are increasingly moving to such an arrangement for either insourced or outsourced IT and business services (Oshri et al., 2007a).

Nearshoring is less likely to dominate the offshoring strategy in the coming years; however, it is going to be one component within the best- shoring strategy. According to numerous reports in the media, several regions have emerged recently as attractive for nearshoring such as Cen- tral and Eastern Europe (to Western Europe), Northern Africa (for French and Arabic speaking countries), the Caribbeans (to the USA east-coast), Southeastern China (to Japan and South Korea) and Central and South America (to North America).

Summary

This chapter has provided an extensive review of the factors that affect country attractiveness for outsourcing and offshoring. Through examples, the chapter has illustrated the comparative advantage of certain locations within the context of the nature of the function outsourced. As such con- texts change, the attractiveness of a location may change as well. Country attractiveness also needs to be combined with a more granular analysis of city and regional attractiveness within each country.

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ch ap te r4 The Attractiveness of Western Countries for Outsourcing Services and Backsourcing

In this chapter, we continue the examination of country attractiveness, however, by focusing on the characteristics ofWestern countries. We build on the country attractiveness framework presented in Chapter 3 which is generally suitable for the evaluation of developing countries and revise it to accommodate the value proposition of Western countries. We illus- trate the use of this Talent-based, Value-adding and Advanced Sourcing (TAVAAS) framework based on the analysis of the UK. The attractiveness of Western countries for outsourcing services has become an important component in the firm’s global business service portfolio as some services are provided from onshore or in some other cases services are brought back in-house from an offshore location. In this chapter, we therefore focus on the following aspects:

A framework to analyse the attractiveness of Western economies for outsourcing services: the UK case A decision matrix to assess firm’s propensity to invest in a Western economy Backsourcing IT and Business Processes.

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10 6

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The Attractiveness of a Western Economy for Outsourcing Services

Outsourcing: A new competitive regime Outsourcing is in a new era: an era of value-adding services, innovation and transformation. An era that shifts competition to skills and expertise and that shapes the firm’s strategic objectives on business transformation rather than technical solutions. As the outsourcing landscape is changing, so competition between countries for outsourcing work is reconstructing. It is no longer competition for low costs but a search for superior skills, both technical and managerial, that provide the strategic guidance and operational excellence needed in the 21st century.

As the outsourcing industry of ITO and BPO enters its fourth decade, a shift has taken place in terms of the value expected from large global players. Firms are shifting their attention from a single one-off cost reduc- tion to seek ongoing value delivered through partnership and close ties. As part of this major shift in the outsourcing arena, firms are now paying more attention to the ability to work closely with the supplier on techni- cal and business challenges and deliver innovation and transformational programmes as a key supplier selection criterion. Such changes in the outsourcing landscape offer great opportunities for countries that devel- oped their outsourcing offerings around high-quality and value-adding ser- vices that are customer-centric enabled by advanced sourcing capabilities.

While such a strategic shift in the outsourcing landscape has been observed in the last five years, the tools to assess the attractiveness of high- talent and advanced sourcing capabilities of countries have not been updated. Indeed, several frameworks for country attractiveness have been offered in the existing academic and professional literature (summarised in Table 3.1 in Chapter 3); however, these tools have been designed to assist managers to assess the attractiveness of mainly low-cost countries with a highly specialising workforce. Oshri and Ravishankar (2014) mod- ified the Farrell (2006) framework to fit the challenges that talent-based, value-adding countries such as the UK is facing in attracting outsourcing investments.

In the global sourcing marketplace, the UK has long been perceived as a lucrative outsourcing market. It is considered to be the second largest

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Attractiveness of Western Countries and Backsourcing 10 7

consumer of outsourcing services and a hub for leading global suppliers that provide end-to-end BPO and ITO services to UK- and Europe-based customers. However, the shift in value sought from outsourcing engage- ment is now positioning the UK as a contender for high-value outsourcing destinations.

We examine the UK position in light of the following three trends (reported in Oshri and Ravishankar, 2014):

1. The maturity of the outsourcing industry will drive more and more client firms to seek impact on business and strategic performance from their suppliers.

2. Client firms and suppliers will deploy complex sourcing models that will increase the importance of sourcing managerial capabili- ties, such as relationship management, against technical and delivery capabilities.

3. As growth through outsourcing is becoming a key strategic driver for partnership, locations with promising entry points to lucrative markets will become more attractive for outsourcing investments, such as the UK market as an entry point to the US market.

These trends change the nature of competition in the outsourcing industry, placing greater importance on the knowledge-base of the country, both technical and managerial skills, and on the trade opportunities a country may offer as entry points to other lucrative markets.

Talent-based, Value-adding and Advanced Sourcing (TAVAAS) capabilities country attractiveness framework In order to assess the attractiveness of TAVAAS countries, such as the UK, the USA and Germany, we propose the following factors and their respective weights (Table 4.1).

In developing the weights per factor, both the demand and supply side of outsourcing services were considered. For example, we assert that client firms that seek high-quality service based on an advanced platform of sourcing capabilities are likely to consider costs as a less important fac- tor than the availability and quality of skills. Similarly, supplier firms that invest in TAVAAS countries are more likely to attribute high importance to growth opportunities over the cost-base of the country.

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TABLE 4.1 TAVAAS countries attractiveness framework

Factor Categories Weight

Costs 15%

Average wage per skilled employee and manager

Average rental office space per square metre (�/m2/yr)

Cost of telecom, Internet access (US$ per month)

Cost of power (Kw/H)

Availability of skills 30%

Size of the labour market

Quality of relevant delivery skills indicator

Quality of relevant sourcing management skills

Environment 15%

Corruption index

Quality of life index

Serious crime index

Accessibility to the country indicator

Corporate tax

Quality of infrastructure

10%

Network downtime

Availability of housing indicator

Quality of roads and rails indicator

Risk profile 10%

Personal security index

Natural disasters index

Political unrest index

Cost inflation index

Intellectual property indicator

Market potential 20%

Attractiveness of local market index

Leverage to promising markets indicator

Total 100%

Source: Oshri and Ravishankar, 2014.

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Attractiveness of Western Countries and Backsourcing 10 9

Based on data collected from various sources including interviews with key informants from leading suppliers and client firms, we have devel- oped a perceptual map of the attractiveness of seven countries in Europe: the UK, Ireland, Germany, France, the Netherlands, Czech Republic and Poland (for a more detailed comparative analysis about these countries please see Appendix A). We report on data collected from various public sources and also offer expert opinion regarding some of the factors, in par- ticular where public information was not available (included below in the example box).

EXAMPLE: UK Attractiveness Analysis

Cost The UK is certainly positioned as a high-cost location, in particu- lar as compared with the Czech Republic and Poland. However, the UK cost base is not significantly more expensive than Germany and Ireland. For example, the average wage per skilled employee in the UK is US$33,513 compared with US$41,170 in Ireland. The cost of telecommunications and power in the UK is lower than Ireland; however, corporate tax in Ireland (12.5%) is lower than the UK (20–24%) (Figures 4.1 and 4.2).

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Average wage per skilled employee and managers (US$) (OECD)

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d UK

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

FIGURE 4.1 Average wage per skilled employee and managers (US$)

Source: Oshri and Ravishankar, 2014.

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11 0

Making a Sourcing Decision

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Cz ec

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d UK

UK L

on do

n 0

200

400

600

800

1000

Average rental office space per square metre ( /sp.m/yr)

FIGURE 4.2 Average rental office space per square metre

Source: Oshri and Ravishankar, 2014.

Availability of skills The UK is offering a highly skilled and well-rounded workforce that is capable of both managing and delivering outsourcing services. The supply of both technical and management talent from UK uni- versities, combined with the extensive experience in outsourcing, positions the UK ahead of any other country in Europe. There is evidence that recent investment in the UK is mainly motivated by the highly skilled outsourcing management talent available in various parts of the country including the North East, Wales and Scotland. Further, the supplier landscape in the UK in terms of pres- ence and scope of services has developed far more than in any other European country, reflecting the interest that suppliers express in making significant investments in the UK (Figure 4.3).

Environment The environment in the UK is also attractive, mainly because of low levels of corruption, good quality of life and low levels of crime com- pared with other European countries. With 462 airports, the UK has one of the highest number of airports per capita in Europe, a positive indicator of country accessibility (Figure 4.4).1

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Attractiveness of Western Countries and Backsourcing 11 1

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d UK

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

Size of the local vendor market indicator Quality of delivery skills indicator Quality of sourcing management skills indicator

FIGURE 4.3 Availability of skills

Source: Oshri and Ravishankar, 2014.

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Accessibility to the country indicator

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Po lan

d UK

100

FIGURE 4.4 Accessibility to countries

Source: Oshri and Ravishankar, 2014.

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11 2

Making a Sourcing Decision

Infrastructure The quality of the UK’s infrastructure is moderate but well ahead of Poland and the Czech Republic and not too distant from other European countries. For example, the availability of real estate in the UK has scored 93.7 compared with only 65.9 in Ireland and 84.7 in Germany. While network downtime performance is below industry standards, the quality of housing in the UK is among the best in these European countries. The UK government has recently acknowledged the shortcomings with regard to broadband access and has massively invested in improving technological capabilities such as an upgrade to 4G and 5G technologies and the expansion of broadband usage across the UK (Figure 4.5).2

Risk The UK offers a low risk profile (along with Ireland, Germany, France and the Netherlands); however, the UK’s personal security indica- tor (80.2) is far better than Ireland (62.3) and nearly the same as Germany (86.6). The UK enjoys a moderate to low score on risk of labour strikes, on a par with Ireland but slightly better than the risk in Germany (Figure 4.6).

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FIGURE 4.5 Quality of overall infrastructure

Source: Oshri and Ravishankar, 2014.

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Attractiveness of Western Countries and Backsourcing 11 3

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d Sp

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d UK

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

FIGURE 4.6 Access to nearby markets

Source: Oshri and Ravishankar, 2014.

Market The UK has the strongest market entry point in Europe. Among the reasons identified for the strong market attractiveness are the high service mentality and delivery system, the availability of language skills and the strong trade ties with the USA, which are considered leverage for many of the suppliers investing in the UK (Figure 4.7).

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d UK

0.5

1.5

2.5

3.5

Cost of living inflation

FIGURE 4.7 Cost of living inflation

Source: Oshri and Ravishankar, 2014.

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The Outsourcing Services Value Proposition of Western Economies

As the outsourcing of IT and business processes enters its fourth decade, a significant change has taken place. Client firms now seek to benefit from value-adding services and access to unique skills in their engage- ments with outsourcing suppliers. Innovation and business transforma- tion have come to the fore when client firms and suppliers negotiate a contract, and success is assessed based on both operational excel- lence and strategic transformation. Talent management and supply of skilled employees capable of engaging in business solutions delivered through cutting-edge technology have become a critical source of com- petitiveness for suppliers. These critical skills are hard to develop and exploit, in particular in countries that have emerged only recently as attractive locations for outsourcing, such as Poland, the Czech Repub- lic, Hungary, Spain, Egypt, South Africa and Morocco. Other locations, such as Brazil, Russia and China, have not managed to develop strong business innovation capabilities. As the outsourcing competitive land- scape is changing towards higher value services, the traditional offshoring location will continue to compete on cost in an ever-search for cost reduction through automation and relocation to cheaper locations. How- ever, countries with a strong talent position combined with an inno- vative and nimble economy will shift their value proposition towards value-adding services that command premium fees for higher value services.

The UK outsourcing landscape, as an example, is at the heart of this change. Being the second largest outsourcing market in the world, popu- lated with sophisticated consumers of outsourcing services and a supply of technical and managerial talent, the UK has attracted top-tier suppliers to set up delivery centres and sales offices around the country. In this regard, Western economies such as the UK offer value proposition for suppliers and client firms around the following:

A premium service mentality Large-scale, sophisticated outsourcing economy Supply of linguistic, technical and managerial talent Flexible workforce distributed around the country.

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Attractiveness of Western Countries and Backsourcing 11 5

Opportunities for growth in Western economies such as the UK are also attractive. The UK ITO sector is one of the largest in the world and its BPO sector is growing fast. In particular, the contact centre sector has been attracting investments in recent years as client firms sought to ben- efit from access to talent in more affordable locations, such as the North of England, and in some cases have brought back their operations from offshore locations to the UK to improve customer experience.

Without doubt, the USA, the UK and Germany have maintained their competitive position in the outsourcing industry despite their disadvanta- geous cost position. While some European countries may be seen as more attractive on the cost side, other factors play a far more important role.

There are also opportunities for client firms to benefit from the Western economies outsourcing proposition. Client firms with extensive outsourcing experience that have developed a strong retained IT function (discussed in Chapter 6) and a sophisticated internal sourcing unit may consider backsourcing (also known as re-shoring or insourcing) part or an entire outsourced function. (We discuss backsourcing in depth in the following section.)

Making an investment decision is complex. To guide suppliers in their decision-making to invest in Western economies such as the UK, the USA or Germany, we offer a decision tool that considers the key factors affecting outsourcing FDI and a three-step assessment process.

Are you Prone to Consume or Provide Outsourcing Services in a Western Economy? A Decision-Making Tool

Step 1: Assess your Propensity to Invest in the UK

Using the decision matrix, please keep track of your score by care- fully answering the questions below. If your answer falls within the description provided under ‘Tend to invest in a Western economy’, then you score the maximum points for this question. If your answer falls within the description provided under ‘Do not tend to invest in a Western economy’, then your score is zero. If your answer is somewhere between the two answers, please make a judgement

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Making a Sourcing Decision

regarding your score. For example, if your answer for the first ques- tion ‘What is my value proposition?’ is a combination of high-value services that drive innovation and cost reductions, then your score should be 4 or above (Table 4.2).

TABLE 4.2 A decision matrix to assess your propensity to invest in a Western economy

What is my . . . Tend to invest in a Western economy

Do not tend to invest in a Western economy

. . . value proposition? (7%)

High-value services that deliver innovation

Mainly cost reductions

. . . service mentality? (15%)

High quality, working closely with my clients

Mainly driven by SLAs, offshore-based

. . . governance philosophy? (6%)

Combination of transactional and relational approaches

Mainly transactional

. . . strategy to remain relevant in my market? (8%)

Innovate my business models and technological platforms

Mainly innovate my technological platforms

. . . strategy to growth? (10%)

Enter competitive and demanding markets to improve service quality as test-bed for more challenging markets

Avoid competitive and demanding markets; mainly focus on existing markets

. . . philosophy towards competition in the market? (5%)

Competition drives innovation and creates opportunities to differentiate

Competition destroys value and ability to command margins

. . . strategy to acquire global clients? (9%)

Set up global centres of excellence

Set up regional delivery centres

. . . strategy to acquire talent? (10%)

Talent comes at cost Talent is cheaper in offshore locations

. . . strategy to talent management? (5%)

Offer a career path Offer a job

. . . sourcing models strategy? (8%)

A combination of sourcing models to arrive in an optimal utilisation of assets

The application of those sourcing models that drive operational excellence

. . . risk mitigation strategy? (7%)

Investments in both high- and low-risk locations

Investments in mainly high-risk locations

. . . strategy to select a location to set up a new centre of excellence? (10%)

Evaluate multiple factors that weigh in growth opportunities, costs, infrastructure and risk

Mainly focus on costs

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Attractiveness of Western Countries and Backsourcing 11 7

Step 2: Sum Up Your Score

Having scored each factor, total the scores to make a single score out of 100.

Step 3: Assess Your Propensity to Invest in a Western Economy

A score between 66 and 100 is past the tipping point to invest in the UK as a destination for outsourcing services. A score below 33 signals that you are unlikely to benefit from investing in aWestern economy as a destination for outsourcing services. A score between 34 and 65 is in the area that requires additional analysis to understand your tendency to shift strategy and operations to deliver higher value, talent-based outsourcing services; however, without aligning the strategic vision with the operational strategy (Figure 4.8).

Tipping point

Tending not to invest

Tending to invest

Unlikely to invest

0 33 50 66 100

Tipping point

Very likely to invest

FIGURE 4.8 A decision matrix to consider propensity to invest in a Western economy Source: Oshri and Ravishankar, 2014.

Backsourcing of IT and Business Processes

Backsourcing concerns with bringing back in-house previously outsourced services. It is the reversal of a pre-existing outsourcing strategy and a re-aggregation of previously disintegrated internal capabilities (Wong, 2008). This sourcing strategy differs from insourcing where organisations

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retain the management and provision of services internally after care- fully evaluating the external service market (Hirscheim and Lacity, 2000). Backsourcing may take different forms. For instance, backsourcing can range from bringing back a single business function such as helpdesk or call centre to a complete reversal of an entire business function such as R&D. The latter would be larger in scale, budget and more complex in nature than the former. The backsourcing process presents major chal- lenges to organisations which include managing organisational change, re-transferring knowledge and other resources to develop new capabilities and competency (Ejodame and Oshri, 2014).

In the public’s mind, backsourcing is often synonymous with the so-called ‘re-shoring’ of jobs that have been outsourced to offshore locations. In par- ticular, public dissatisfaction with offshore call centres is well known, and there have been demands from the customers of a number of companies for onshore-only services.

But there is much more to backsourcing than public irritation with those companies that appear to favour cost-cutting over customer service. Indeed, backsourcing goes far beyond customer contact roles and into the heart of IT and business process outsourcing.

Pulling back work: Background In 2013, Oshri surveyed 200 large consumers of outsourcing services based in the UK and the USA. The study revealed that 44% of the sample has brought back services at one point or another (Oshri, 2014). Yet despite the fact that many client firms brought back some services, there has surprisingly been little academic research into backsourcing.

Indeed, the list of companies that have backsourced in over last 20 years is certainly getting longer. Among notable examples is that of American Airlines, which brought back its IT infrastructure from IBM in 2007 and JPMorgan Chase, which terminated its US$5 billion (£3.3 billion) contract with IBM in 2004, two years after signing it.

Others have followed suit. In 2005, Sainsbury’s terminated an outsourcing contract with Accenture after five years of service; while McDermott Inter- national dropped what was supposed to be a ten-year global outsourcing deal with AT&T’s professional services wing, taking back responsibility for the design, implementation and management of its IT.

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Attractiveness of Western Countries and Backsourcing 11 9

More recently, both Santander and General Motors announced that they were repatriating work that had been offshored to India. Santander was one of many companies to be criticised for offshoring its customer service centres, leading customers to feel as though their loyalty was being deval- ued by the opportunity to cut costs. Table 4.3 provides an overview of major backsourcing cases and the reasons for the backsourcing.

The prevailing view of backsourcing has been that an informed decision was made after evaluating the facts, based on a desire for lower costs, higher value and/or better control and service. However, research shows that most organisations backsource as a passive reaction to a short-term problem rather than as a positive and considered sourcing strategy for the longer term.

Customer rebellion aside, pursuing backsourcing as a reactive, remedial strategy is risky. Some organisations should certainly consider backsourcing if they have made significant improvements to their internal capabilities, but others should avoid it if their in-house functions have not improved since outsourcing.

C A S E S T U D Y

Backsourcing Cheque-Checking Services

Any cheque the bank receives needs to go through a cheque-

clearing process. As part of the cheque clearing, there is a man-

ual process in which a specialist checks whether the cheque

has been tampered with by a fraudster. What kind of spe-

cialty would be needed to check cheques? (Think Leonardo de

Caprio and the movie Catch Me if You Can). Just the same as

many other Banks, EnglishBank needed to provide a complete

cheque-clearing process. While some parts of the clearing pro-

cess were kept in-house, the cheque checking was outsourced

to GermanSupplier back in 2001. GermanSupplier built the capa-

bility to check cheques by manually examining the EnglishBank

cheques and assuring EnglishBank that no fraudulent activ-

ity was suspected. In 2010, EnglishBank decided to backsource

this function in-house. The main reasons for backsourcing the

cheque-checking function was a consequence of an overall

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12 0

Making a Sourcing Decision

decision to bring core services back in-house, based on a per-

ception that services performed in-house have a better customer

satisfaction rate.

EnglishBank proceeded with the backsourcing process swiftly

by applying its well-developed process-oriented skills to ensure

that cheque checking could be done in-house. However, the

bank stumbled when it came to a rather simple question: how

do you recruit people who are capable of checking cheques?

EnglishBank thought this through and realised that it would not

be possible to advertise a job description to perfectly describe the

set of skills required. The approach taken in bringing back the

function in-house and rebuilding this capability was based on

the assumption that such skills could not be acquired from the

market. Instead, the talent recruited for these positions should

be carefully trained by setting up criteria as to when minimum

proficiency in detecting fraud activity has been developed by an

individual.

And this is what EnglishBank did. Indeed, new recruits under-

went training in which a two-tier checking panel was created.

Cheques were delivered to the first specialist, who carefully

examined the cheques and filled out a report whether these

cheques had been tampered with by a fraudster. Then, the same

cheques were passed on to the second specialist, who examined

the cheques, not knowing the opinion of first expert. As the spe-

cialists were checking the cheques, EnglishBank set up certain

indicators to sense whether they had reached the proficiency

needed in the long term. For example, EnglishBank recorded

average levels of fraud the specialist detected and kept track

on those to see if they changed over time. EnglishBank also

paired specialists to check each other’s outcomes and recorded

those incidents when the first specialist failed to detect a cheque

which was tampered with. Further, the bank recorded the over-

all incidents in which the first check of a fraud cheque went

unnoticed and the trend over time. EnglishBank continued with

this training until both the first- and second-tier specialists

were in agreement with regard to fraud activity in the checked

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Attractiveness of Western Countries and Backsourcing 12 1

cheques, and the average number of mistakes had stabilised

to an acceptable figure according to bank regulations. At this

point in time, EnglishBank completed rebuilding the capability

in-house, a process that took several months and some unusual

approaches for training.

The main drivers for backsourcing There are three major categories of reasons to backsource: contract prob- lems, opportunities arising from organisational change and opportunities from external factors in the business environment. Cost considerations have been critical in some decisions, of course, as has the quality of the outsourced relationship, service or product. However, these last two fac- tors suggest that due diligence may not have been properly carried out pre-contract.

One common reason to backsource is when the costs associated with outsourcing are substantially higher than originally planned, sometimes because of hidden costs that accumulate over time. Cost savings may also have been overestimated by the buyer at the outset or can disappear as the client ramps up outsourcing activities and its expectations of the outcome.

Another reason may be a gap between expected and actual service lev- els. However, recent studies show that organisations that backsource generally experience lower service levels and quality than those that switch outsourcing suppliers instead. In other words, the failure of one outsourcing relationship should not be interpreted as the failure of the outsourcing model.

A critical factor in some backsourcing decisions is the client’s loss of con- trol over functions that had previously helped create strategic value – for example, an in-house IT function that is later identified as having been a contributor to gaining or maintaining a sustained advantage in the mar- ketplace. Several studies find that losing a competitive edge is the driver behind about 25% of cases.

Sometimes this loss of control makes client firms realise that they are locked into an outsourcing relationship with a supplier that ‘knows better’

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Attractiveness of Western Countries and Backsourcing 12 5

or which does not fully understand the client or the market it operates in. Either case may drive client firms to disengage and backsource.

Sometimes, both client and provider may see the wisdom of the deci- sion. In 1996, for example, Continental Airlines ended collaboration with its outsourcing partner, EDS, after four years of successful work together. Continental wanted to improve its reservation system to enable more efficient fleet capacity usage and better ticket pricing. Since EDS was nei- ther familiar with the air-travel industry nor with Continental’s customers, Continental decided to run the project in-house. In this way, Continental re- evaluated the strategic importance of its outsourced IT functions and built an innovative online business on its own – one that improved user satis- faction and attracted new customers, all without the aid of a third-party supplier.

The management angle

Internal management changes at the client company generally lead to shifts in power. Research finds that when companies bring new execu- tives onboard, the new members are three times more likely to make changes. In particular, new CIOs and CEOs may reconsider the value of an IT outsourcing deal and identify new strategic importance in those outsourced activities. This may persuade them to backsource.

Of course, internal changes are often triggered by external influences and most organisations report structural changes immediately before a backsourcing decision is made. These changes include mergers, divest- ments and acquisitions – another factor in the JPMorgan Chase case study (in Chapter 6, p. 173) after its takeover of Bank One brought new man- agement onboard. The refreshed leadership team strongly influenced the decision to bring IT back in-house.

The Halifax Building Society’s merger with the Bank of Scotland is another example of external structural changes prompting a decision to back- source. In the wake of the merger, the Halifax cancelled a ten-year IT services contract with IBM, worth over £700,000.

So when are client firms most likely to backsource? It might be assumed that it is in the final stages of a failed relationship; but ongoing research at Loughborough Centre for Global Sourcing and Services (CGSS) (e.g., sur- vey by Oshri, 2013; Ejodame and Oshri, 2014) shows that not all clients

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bring back services at the end of such a deal. In fact, recent examples show that backsourcing often happens in the earlier stages of a project, once sufficient information has been gathered by the client as to whether outsourcing is likely to work.

That said, few outsourcing projects offer instant payback, and the quest for immediate, unrealistic costs savings is often the root cause of outsourcing failure. Firms that consider backsourcing at the end of a project may be able to assess their internal capabilities far more realisti- cally against those of the supplier, in addition to evaluating the contract’s true value over its course.

The human angle

There may be other repercussions of backsourcing, tactically and reac- tively rather than as a carefully planned sourcing strategy. For exam- ple, backsourcing is rarely something that happens in isolation; it is likely to involve managing organisational change and knowledge re- integration, rebuilding capabilities and re-coordinating expertise with administrative functions. All of that costs time, money and human resources.

Knowledge re-integration, in particular, is not a process for which most client firms have developed a methodology. This is because ‘knowledge re- integration’ is really people re-integration and may have negative impacts on morale, productivity and trust.

This was also demonstrated in the JPMorgan Chase case (see Chapter 6). When the bank outsourced IT services to IBM in 2002, some 4,000 staff transferred to the supplier. When the new management team came onboard from Bank One two years later, most of the outsourced IT staff were brought back to their old employers. That sort of upheaval and lack of management continuity will create an uncertain and unstable working environment in any organisation, and the costs of that may be impossible to estimate until it is too late.

Whatever the long-term advantages of backsourcing might have been, JPMorgan Chase incurred significant costs, including its outsourcing fees, the premature contract termination with IBM, its reinvestment in thou- sands of skilled IT staff and also in the hardware and software needed for the newly backsourced department.

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Attractiveness of Western Countries and Backsourcing 12 7

In all, analyst firm Gartner estimates that the total cost of backsourcing is typically around 15% of annual contract cost. In short, the switching costs are high. This is particularly true in knowledge-intensive functions such as R&D, product development and engineering services. Indeed, CGSS research finds that switching suppliers may be preferable to backsourcing if there is an internal human-resources cost or a significant transfer of knowledge.

Based on the business drivers described above, nearly any client firm could be considered a candidate for backsourcing. However, the decision to backsource cannot be based on those drivers alone, especially if it is taken ‘in anger’. More than anything, executives should be mindful of the challenges involved and attempt to mitigate them by developing critical capabilities and a clear path forward.

Critical success factors for backsourcing3

Bhagwatwar et al. (2011) examined two backsourcing JP Morgan and Sainsbury in their study and developed a framework which stresses the importance of knowledge transfer in such undertaking. The process of knowledge transfer is very complex since it contains both explicit and implicit knowledge and therefore requires frequent communication and inter-personal interactions (Szulanski, 1996). Furthermore, barriers such as distance, language, management differences, beliefs and cultural norms, and lack of incentives, can all hinder a smooth re-transition of knowledge (Bhagwatwar et al., 2011). These barriers can also be equally associated with outsourcing. To overcome them, Bhagwatwar et al. (2011) formu- lated lessons learned which could be considered to be critical success factors at backsourcing decisions.

First of all, once the decision of backsourcing has been taken, the client firm should immediately inform the supplier in order to prepare for con- tract termination and any financial and relational implications. Indeed, the decision to backsource must not be connected with an abrupt termination of the relationship. Instead, the collaboration needs to continue to secure knowledge transfer and re-integration from the supplier to the client firm (Warner and Brown, 2005). Another critical success factor is the compo- sition of a capable backsourcing project team with ‘executives, managers and technical staff from the client side as well as from the outsourcing ser- vice provider side’ (Bhagwatwar et al., 2011). The teams should agree on a

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plan, make stakeholders aware of the activities and timeline and ensure a clear and functional backsourcing governance for this project. The supplier should be committed to provide support and information until the success- ful re-integration of the service. As part of re-integration knowledge and services, the client firm should consider re-transferring employees from the supplier to the client’s organisation. Client firms with little capacity for sig- nificant backsourcing should consider piloting the repatriation of part of the service prior to commencing with the re-shoring of the entire service.

Summary

In this chapter, we discussed how to examine the attractiveness ofWestern countries for outsourcing services and the option of bringing back oper- ations onshore from offshore locations. It is our contention that while offshoring remains a strong proposition, multinationals will consider all options, including setting up delivery centres onshore and, in some cases, will repatriate work under the appropriate conditions.

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