The answer clearly depends on the perspective of the person asking the question.   But with some basic assumptions, one can, I believe, come up with an analytical perspective that makes some sense.

Let me begin by making some basic assumptions (assumptions that many will disagree with, but I believe are reasonable and defensible).   First, the political right identifies primarily with shareholder and ownership rights - in the US often tied closely to private property rights.   As such, that which is good for the “owners” - which include diverse shareholders - is viewed as good for the country and the economy.

The left takes a somewhat different approach, looking at what is good for stakeholders.   These stakeholders include the communities, employees and environments of the companies - as well as the shareholders.   Depending on the gradation of left, ownership rights can be equally to slightly more important than stakeholder rights - or substantially subservient to the rights of the other stakeholders.

Analyzing outsourcing in this manner, one can easily see how one group - the outsourcing companies, the C-level large company executives and the major shareholder groups would be aligned to support a pro-outsourcing position.   After all, it is good for the bottom lines of these companies, good for the shareholders and good from the economic perspective of these players.

The other group, including labor unions, many community governments, local service providers and local businesses, aligns against outsourcing.   Why?   Because it adversely affects their micro-economies - either directly or indirectly.

Because there are so many pundit talking about outsourcing - and since Mr. Obama is making it a political issue, this is a debate that will likely last through the election.   Understanding the underlying perspective will, therefore, be useful in any policy analysis.   Hopefully, this short post will help explain the seemingly opposite positions.

The link can be found here.

While this approach is good for legal fee generation, it does not facilitate dealmaking, nor does it engender trust in the upcoming relationship.  All too often, clauses are simply swapped wholesale - a process that can go on for several cycles until the parties develop a compromise.

With that compromise, both parties walk away partially bloodied and partially triumphant.  Lawyers, when they compare notes, talk about the great limitation of liability provision they got with X supplier or Y customer.  They retain defenses against the potential malpractice suit - “I recommended X, but the client settled for Y.”  But oftentimes, little actual thought is put into these.

It is, perhaps, time to take a more nuanced approach to risk allocation.  Instead of walking in with extreme positions (whether or not identified as “reasonable”), the parties should commit to developing commercially reasonable risk allocation profiles prior to negotiation - instead of just reacting to extreme langauge.  There are a million ways to accomplish this goal, but doing so would reduce the transactions cost involved in significant outsourcing and services deals.

What makes these companies great?  Top quality products, for sure, but there is something else beyond the quality of their products that comes into play.  It’s a sense of fit-and-finish to their products, I think, that takes them to the next level.

Apple is legendary for this.  An Apple product simply works well - it is consistent, has a great look-and-feel, and allows the underlying product to become an appliance that fosters creativity.  It is truly amazing how their products are engineered to allow the customer to better enjoy the media that runs through them.

Southwest is also legendary for producing a product, in this case air travel, that is a cut above the other carriers - at least for me.  Because I’m not a €œPlatinum Level Frequent Traveler, I don’t often get to enjoy the higher-end service that used to be offered by the domestic carriers.  However, what I don’t enjo€ is the feeling of being a second-class citizen on their aircraft, crammed into seats that are too tightly packed, treated rudely by gate staff and in-plane staff, etc.  On Southwest, I’ve never had that feeling - and sitting here at the airport in Las Vegas - I still don’t.  Southwest has always been a class act - and in these days of troubled times, their class is shining through.

Toyota has been dominating car quality and popularity statistics for years.  Why?  I think, honestly, it is because their products - from the lowly Yaris to the Lexus LS - feel like they’ve actually had someone look at the product after design was complete and smooth out the rough edges.  U.S. designed vehicles have rarely had that feeling, with options either bolted, or vast areas of plastic switch covers which remind you that the options aren’t there.  Remember the old Chevy Bel Air from the 60’s?  It was like an Impala, but instead of three light taillight clusters (two running/stop, one reverse),  it had two light clusters.  Get behind a Bel Air and you knew that the driver opted for the €œcheapo€ version.

What are the commonalities?  In my mind, Apple and Toyota spend that extra time post-engineering their solutions - making sure that the pieces fit together as a coherent whole.  Southwest and Toyota avoid blatant class distinctions - while still maintaining some stratification.  Apple and Southwest excel in focusing on the user experience - clearly evaluating their products and cultures from their customer’s perspective.

What does this have to do with outsourcing?  Each company outsources large percentages of its activities - Apple products are made in China, Southwest’s jets are maintained in Latin America and Toyota offshores to the US to build a large percentage of its products.  It is clear that outsourced production can, if guided correctly, produce quality results.  The trick is that guidance - and it is the standard that we must all strive for.

Once companies begin to build that level of quality into their operations, be them insourced or outsourced, the true value of outsourcing - which is bringing the best and brightest minds to work on business problems - will begin to be seen.  Until then, we may continue to feel like the companies we deal with treat us like second-class citizens or worse.

More interesting was the presentation given by Malcolm Frank, the chief strategy officer of Cognizant, which asserted that the days of “Offshore-R-Us” is over, and that €œ[s]ubject matter expertise is really important to [customers]. In retail, you want a company with point-of-sale experience. In pharmaceuticals, you want a company that has experience with clinical trials.

If this assertion is true, the door may open for boutique organizations that can develop specific expertise.  However, the counterpoint is that it will become more difficult for new companies to enter the offshoring market and existing companies to grow into new, unrelated, lines of business.

On the other hand, the article points out that market saturation for Indian outsourcing is 10% in the U.S. and only 1% in Europe.  If these markets can be encouraged to grow, there may be room for new entrants.

For more on the article, click this link.

These regulations have also had another, less positive (in my mind) effect.  They have made most public companies in the US extraordinarily risk averse.  Sure, avoiding unnecessary risk should be a cornerstone of most corporate decision-making, however what began as an avoidance of unnecessary risk has seemed to evolve into an aversion to any kind of risk at all.

Domestically, this factor has increased the entrepreneurial gulf between private and public companies.  Free from much of the compliance regulation that public companies tolerate, private companies can take advantage of opportunities that are all-but-foreclosed from the public company marketplace.  As a result, innovation is lagging, investment is declining, and companies are forced to increase profitability by scaling back on the expense side rather than scaling up on the investment side.

In short, many public companies are now, for all intents and purposes, run by their accountants and lawyers - neither profession known as a dynamic center for growth or innovation.

This approach has, no doubt, been good for portions of my profession (law) and for the CFO class (and their minions).  However, I think we must begin to ask whether or not we’ve regulated ourselves into a hole where innovation and creativity is simply too risky for public companies to chance.  Furthermore, with recent revelations about the mortgage industry, and recent apparent abuse of the oil commodities sector, it isn’t clear to me that the regulations are accomplishing their goal which, in my mind, is simply making it more difficult for the cheaters to cheat.

Asian countries, with their history of free markets, and, no doubt, with their history of heinous labor practices, are relatively free to innovate.  Even in a controlled economy, like China’s, it seems as if innovation is prized and encouraged, at least to a certain extent and in certain places.  Yet the U.S. has a unique competitive advantage - diversity - in its workforce, in its customer base and in its creative minds.  If it makes it here, it has a good chance of making it anywhere.

I’m not suggesting that we scuttle regulations and encourage a laissez-faire approach to regulation, but instead am suggesting that we revise our regulatory scheme to reward innovation at least as much as we reward accountability.   Until we do that, and begin to benefit from the innovation marketplace, I fear that we will continue to loose ground to those countries who prize and reward innovation.

While I agree with Mr. Santos at a macro level, I also think that the article fails to explore methods for retaining, or even increasing, customer leverage by using LOI’s. Furthermore, Mr. Santos offers suggestions, such as build in enough time and educate stakeholders, as solutions to a problem that is far more complex.

Why do outsourcing deals bog down? Several reasons, but primary to them is the complexity brought to the dealmaking process by the outside consultants and lawyers who feed on such complexity. Instead of focusing on the line of demarcation and necessary business terms, outsourcing negotiations get bogged down in counting every server and turning over every leaf? This is also one of the main reasons that outsourcing deals are obsolete when signed.

A more nuanced approach to outsourcing looks to the inputs and outputs - the lines of demarkation - and builds a structure that allows for the analysis of business issues as they arise. Does that lead to some ambiguities occasionally? Certainly, but at the same time, it creates a deal that can robustly handle the ebbs and flows of business.

But that is an aside. The real question is what to do when the deal bogs down. At that point, particularly if there are proposed staff reduction, the deal is probably well-known throughout the company (very few pledges of secrecy actually work). The “good people” are looking for new jobs. The HR department is beginning to study retention bonuses, etc. A delay at this point will jeopardize the company, as the replacement services are really needed.

In this instance, an LOI makes sense. There are usually enough steps in a transition that an LOI can actually help keep projects on their timeline. But there are pitfalls, too, with leverage and “hunger” being only two of them. Those risks fall to both parties, and both parties should undertake efforts to mitigate them.

So how does one balance the equities? There are several approaches. First, it is important to make sure that the supplier has some “skin” remaining in the game with regard to loss-of-contract risk. An LOI should never be fully compensatory - a significant portion of the costs should be part of the initial contract payment, but only if a contract is ultimately signed. This approach insures that the vendor stays “interested” throughout the dealmaking process.

Second, segment the work so that generally useful portions are front-loaded, and insure that the customer has the ability to use that work or subcontract it elsewhere. No doubt, vendors will complain that this leaves their IP at risk, but that can be addressed contractually. The important piece here is that the customer should try to get something of value from the relationship - even if the deal fails. This also creates benefits for a client who changes approaches or vendors mid-stream.

Third, keep the “person-out-of-the-room” involved. Someone who can pull the plug on the entire project if it is going awry. Until the final contract is signed, the deal maintains a large amount of uncertainty.

Fourth, limit the LOI’s scope, duration and dollar value severely. While this creates some additional administrative overhead, it also keeps the parties interested in moving the deal forward - and reminds everyone that the deal is not yet done. This approach is particularly useful as quarter- and year-end periods approach, as the threat of not being able to book the initial revenue tends to light a fire under many supplier deal teams.

Finally, consider a multi-vendor procurement. Let each of the vendors work with you for a while before making final award. They will see some revenue, the customer will gain lots of insights into the operations of their prospective outsourcers, and leverage will be maintained through the competitive bidding process.

While I agree with Mr. Santos that, in an ideal world, those doing outsourcing deals would not resort to LOIs, I have seen very few “ideal world” scenarios. I would even venture that LOIs, done correctly, can create leverage for the customer that can be beneficial as deals get near closing. Instead of being a tool of the vendor - to be avoided at all costs by the customer - an LOI should be viewed as a tool that, when used appropriately, can offer many benefits.

 

I got to the Apple Store about 20 minutes early and waited around.  Anyone who has visited a “Genius Bar” at an Apple Store would understand my experience – smart agents working with customers to solve their problems.  Few mentions of “policy” or “we can’t do that.”  It was about 1:25 when my name was called, 10 minutes after the appointed time.  The agent looked at my computer, attempted to boot it (it failed), listened to my suggestion to re-seat the drive (also to no avail), then quickly checked and found out that my computer could be repaired in a couple of hours.

 

Guess what.  Three hours later, my MacBook was up and running (with a new hard drive).  Now, the fun part – restoring my data.  I had purchased a Time Capsule for just this kind of scenario, but still my palms were sweating.  Would it work?  But now, about four hours later, my MacBook is up and running, my drive is restored fully and I’m typing this article.  Kudo’s to Apple.

 

What does this have to do with outsourcing?  After all, Apple’s support was 100% in-house.  Clearly, they train and they care.  That being said, there are many things that any outsourcing customer or vendor can learn from my experience. 

• A vendor who provides outsourced customer service can set a higher bar for their agents.  This should be viewed as a necessity, not an expense to recover.  “Black belt” agents will draw customers.
• A customer who empowers their agents to solve customer’s problems (as opposed to pushing customers away) will engender customer loyalty.
• A well-designed quality product – one that is thought through from the customer’s perspective, needs to be at the base of it all.
• Make the basic service good – and offer a premium service for those who need it.  Not “luxury” service – but instead a little bit of preferential care for a little bit of extra money.  But no separate entrances, no red carpets, no classism.

Quality customer care is about one thing – caring.  It does not matter where the agents are or how much they are paid.  It does, however, matter how much they are trained to care.  Apple has learned this – it is time for the rest of the customer care industry to learn it, too.

No doubt, these are all significant factors in the market.  However, I think that the Indian IT market may be selling a product that it’s US consumers are beginning look away from.  Why?  Several reasons.

First, even two years ago, when the market was chugging along just fine, companies were beginning to be concerned about the value proposition promised by outsourcing.  Actual costs ran above budgets, management expenses were higher than expected and, worse yet, internal customer satisfaction plummeted.  Aside from those simply focused on “this year’s budget,” outsourcing, even two years ago, was becoming a less attractive proposition.

Second, the deals represented a snapshot-in-time approach to the outsourcing - the infrastructure was, for all intents and purposes, frozen at the time of the deal.  Changes, which in prior years would be done internally and “for free,” were now subject to a change request and discreet cost.  Now, no one really believes that internal changes were “free,” but the costs were, in fact, buried in and under layers of bureaucracy.  No one really saw them.  Now, every change is accompanied by a cost, a budget change and requires financial review.

I am going to boldly suggest that this approach did little but empower the accounting and finance department in many corporations, not just permitting them, but almost requiring them, to micro-manage every little aspect of IT infrastructure.  IT management (and IT workers) generally dislike being managed by either finance or legal departments.  Instead, I believe that they long for the day that they simply had a budget to manage and annually had to go and ask forgiveness when it was exceeded.

Finally, IT outsourcers made the mistake of underpricing during bids, expecting to make their margin through the change process.  No doubt, it was viewed as necessary to earn the business in a price-sensitive segment.  This approach, however, also created a very unpleasant business dynamic which I call “change order hell.”  In change order hell, every picayune change requires a form, several layers of approval and a payment.  They failed to recognize that American managers, particularly in IT, tend not to want to get nickeled and dimed to death - and would much prefer a simple price for services.

So, what is the answer?

First, IT outsourcers must begin to view their services as “products,” creating an identity for them that distinguishes them from their competitors and offers something extra to their consumers.  Right now, nothing distinguishes one IT outsourcer from another, not even price or reputation.

Second, they must focus on being easy-to-manage.  What does that mean?  Getting one step ahead of your customer - by anticipating their needs.  Being proactive about problem solving.  Not pointing fingers.  Not charging for every little thing.  In short, making the outsourcing process easier and better than insourcing.

Third, like their American customers, they will have to tighten their belts a bit - maybe loose a little money.  But they can, perhaps, do it a bit better than we do by not squandering their talent through massive, knee-jerk layoffs.  Instead, they should take the time to invest in their talent - so that when the market turns, they will be better off than we are.

Finally, stop looking at the election as causing a sea change.  It is unlikely that any of the candidates will do much about the offshoring issue in the main.  Instead, it is far more likely - and historically supported - that a change that bolsters the American economy will come from a large infrastructure investment - the kind of investment that creates jobs in the local, not the global, economy. 

No doubt, this is a difficult time for both American companies and their service providers.  It is a time that will, however, end.  Examining the faults in this market, however, is not all that helpful - they are pretty obvious.  Examining the mistakes that were made when business was good, however, can really shed some light on how to improve.

 

Ultimately, the problem is one of management - the same affliction faced by many outsourcing deals.  Whether it is “one throat to choke” or many “moles to whack,” the bane of most outsourcing deals - and the reason for their relative failure - is inconsistent and often poor management by the customer combined with opportunistic behavior on the part of the vendor.  In my opinion, however, large “aircraft carrier” deals do not solve the management problem - high-quality management does.

Management starts at the beginning and at the top - with clear understanding and a focused, transparent mission.  Why is a company doing the deal?  What to they expect to get out of the deal?  What is the value of the deal?

The Challenges

One challenge that enterprises face in their outsourcing is that they often have a poor understanding of internal cost of a function.  Disaster Recovery is a perfect example.  Many companies have great DR plans - but often they are just that - plans.  When a company outsources the work and actually requires the vendor to perform services that meet the plan, costs can quickly escalate.

In addition, there is a certain amount of duplicity in the justification of many company’s outsourcing initiatives.  Cost is the most oft-cited reason for outsourcing, but historical evidence shows that cost savings are, in many cases, illusory.  Transformation is an often-cited goal as well, and in certain instances (such as GM’s), it is.  But most of the time, the deals and their management do not facilitate transformational sourcing.  Flexibility is also mentioned, but the current state of outsourcing agreements show little tolerance for flexibility - either on the customer or vendor side. 

So Why Outsource?

So why do companies outsource?  I believe that there are several reasons.  First among them is budget concerns (which are separate from cost concerns).  This is the classic case of it being easier to ask forgiveness than permission.  By moving to an outsourced relationship, budget numbers are shifted around (think desk chairs on the Titanic), reducing costs in certain categories and in immediately following years but increasing costs in later years. 

Second, companies outsource because their competitors are.  Back office operations across companies and industries are remarkably similar.  Outsourcing over the past few years, while not reaching the level of network economics, has reached a tipping point of acceptance among corporate managers and, yes, even employees. 

Third, and counterintuitively, control plays into the outsourcing equation.  Over the past couple of decades, control of many corporations has shifted from sales and operations to accounting and finance.  Accounting and finance thrive on numbers and statistics, but in many cases, the value of an employee is very difficult to quantify.  Yes, it is easy to figure out how much an employee costs, those numbers are readily available.  However, it is very difficult to figure out the value of that employee - most employees perform more than their defined functions.  When measured solely against their defined function, however employees seem expensive especially when compared to outside resources.

With accounting and finance taking center-stage in many organizations, this lack of predictable value becomes a liability - it simply makes the numbers less reliable.  Outsourced relationships, on the other hand, have very clear cost metrics and functional outcomes - and are much easier to account for.  Thus, you will often see justifications for outsourcing include a line that states “control costs.”  

A Better Approach

As I said above, I do not agree with the assertion that an “aircraft carrier” deal offers either better savings or better control in most instances.  Instead, separation of the functions into logical units - with clearly defined interfaces - is better suited for success.  By breaking the work into logical units, managers will very often gain flexibility, manageability and clarity.  Whether or not the logical units are provided to multiple vendors, a single vendor or a hybrid of vendor and in-house personnel is irrelevant - the clarity gained by breaking the problem into manageable units will go farthest to facilitate manageability and, ultimately, success.

The Institute for Global Challenges and the Law at Boalt Hall in Berkeley is sponsoring a conference called: 

 

THE INTERNATIONAL OUTSOURCING OF THE LEGAL PROFESSION 

 

On Friday, April 25, 2008, in Berkeley, California 

 

Registration can be found here

The Problem With Metrics

The concept of using metrics as THE management tool has several significant faults. The biggest of these is that metrics are, by their nature, an ex post measurement. The customer managing to metrics possess little insight into the day-to-day operations of their outsourcer, and may only be learning about problems — potentially significant problems — 30-60 days after they occur. By that time, the problem has extended into the next reporting period and remediation, if necessary, is at its early stages. By the time remediation is in place, significant damage may have been done already — and the cost of remediation — in time, effort and money — has risen exponentially.

Metrics also present an incomplete picture of the services being rendered. Aggregated over 30 day periods, they often fail to measure the performance during important peaks and valleys in the business cycle, but instead average it over the entire thirty day period. In addition, since they are hard, measurement-based numbers, they fail to capture many important factors that are subsumed within the high-level measurement points.

Finally, metrics are often set arbitrarily, either too low if set by the vendor, or too high if set by the customer. For example, vendors often offer uptime metrics of between 90 and 95 percent, when server uptime in a well managed environment generally reaches 99% or better. With metrics like these, only a force majeure event (which is generally otherwise excused) would cause a Service Level failure. Similarly, customers often set transaction processing metrics at a level far exceeding any level they were able to reach with internal staff, putting vendors in a near constant state of breach all under the guise of “continuous improvement.”

Certainly, customers are faced with regulatory and business commitments that tie to performance metrics — and these must be both reported and met. Beyond that, however, metrics should be viewed as one of, but neither the only nor primary, tools to manage an outsourcing agreement.

Other Management Tools

Perhaps the best management tool is sophisticated, comprehensive and cooperative communication between the customer and vendor. Not just single-point communication — where individual personalities can affect communications, but team communications that are regular and non-adversarial.

Too many conversations between customer and vendor become either (a) drubbing contests, where the customer reads a laundry list of what is wrong with the vendor and their performance under the agreement, or (b) finger-pointing exercises by the vendor meant to ensure that they face no blame for their poor performance. Neither type of conversation is particularly useful.

Instead, the conversations should be “how can we make this better for both of us.” After all, many issues can be addressed easily and at low cost. Looking for areas of synergy — where both parties benefit from a change — can really help move the process along and create an environment that encourages quality and innovation. Furthermore, with the right environment, problems can be brought forth early and solutions developed quickly, without fear of the “hammer” coming down on either party.

Transparency

In addition to communication, transparency is essential for both parties. Insights into each others’ businesses can create opportunities to, once again, expand the pie for both companies. Of course, each company must maintain its certain business priorities and secrets, but the “Kimono” can be opened quite a bit more than it generally is without giving away crown-jewel secrets.

Customers, for example, often distrust vendor pricing — particularly during the term of the deal. Without any reasonable insight into costs, and often without the ability to use the competitive bidding process to build integrity into pricing, customers are left feeling, most of the time, like they are being overcharged for many items.

Vendors, on the other hand, look suspiciously at customer performance edicts, knowing full well that service levels demanded by customers are, at best, aspirational, and at worst, a scheme intended to keep a Sword of Damocles over their heads.

Simple transparency helps alleviate these fears — and puts some integrity into each party’s position. After all, an outsourcing deal is a long-term, high-touch arrangement — not a “one night stand” — and should be treated accordingly.

Flexibility

Another important aspect is some reasonable flexibility in management. Vendors will miss properly set service levels from time to time, customers will need last-minute changes to meet business, legal or regulatory demands. Instead of using these situations as opportunities to gain additional concessions or revenue, being understanding and flexible can go a long way toward building a good relationship.

Does that mean that a company shouldn’t collect service credits? That a vendor shouldn’t exercise its rights under change control? No. Proper management calls for businesses to properly exercise and protect their rights. However, the approach to protecting these rights can vary — and an approach that includes compassion and forgiveness, rather than anger and threats, is generally beneficial to the relationship.

Marriage Counseling?

A lot of what I’ve said in this article sounds like marriage counseling — and that is intentional. Marriages that measure their success not by metrics, but by the overall quality of the relationship, are far more likely to succeed as long-term, satisfying partnerships. The same is true of outsourcing agreements.

After all, the critical factors for outsourcing success are not a laundry list of metrics — nor endless meetings full of table pounding about them. Instead, instead are trust, respect and communication form the basis of these good business relationships. It is time for customers and vendors alike to put renewed energy into developing these “soft” skills — energy that will move them forward as successful business partners.

For Outsourcing Customers

1) I will dedicate adequate resources to managing my outsourcing deal.

2) I will send out RFP’s only to vendors with a chance of earning the business.

3) I will set service levels that reflect my true business needs, not pie-in-the sky service levels that cannot ever be met.

4) I will avoid the end-of-year search for pricing concessions to cover up my own bad budgeting.

5) I will listen to my outsourcing vendors for ways that I can improve my business and its interface with my outsourcing vendors.

6) I will pay regular attention to my outsourcing deals and proactively work with my vendor to solve problems.

7) I’ll refrain from blaming the vendor for things that are my company’s fault, but I will be honest with my vendor when it is their fault.

… And for Outsourcing Suppliers

1) I will make quality customer service my highest priority.

2) I will only offer pricing that is fair - and will not sell outsourcing services as loss-leaders with the expectation of “making it up later.”

3) I will accept responsibility for my actions when performing the services.

4) I will resist the urge to overdiscount.

5) I will listen to my customers for ways by which I can improve my services.

6) I will manage my outsourcing deals to optimize customer service, not short-term revenue.

7) I will take real measures to reduce turnover and keep my workforce happy and interested in the work.

… And for Outsourcing Advisors

1) I will reduce the complexity of deal structure.

2) I won’t “ride” deals to maximize my profitability (at the expense of my client).

3) I will actually watch expenses and costs.

4) I will “think outside of the box” to help my clients develop flexible deals that will bend without breaking.

5) I will reign in runaway projects an keep my staff under reasonable control.

6) I won’t make hyperbolic, self-serving public statements about future trends.

7) I will provide my customers with deal summaries and other information that will help them manage their deals.

And for all of us…

Let’s drop the hype and focus on real business and real deals! 2008 will be as good as we make it!

I would like to suggest that they are missing the point here. Many customers dealing with any of the Big Three express frustrations linked to inflexibility, top-heavy bureaucracy, and difficult, tedious negotiations. Certainly, that has been my experience with them.

Contrast this to doing a deal with an Indian outsourcer - even a large one - and one of the main differences come clearly to light. It is much easier to get into a relationship with an Indian outsourcer than it is an American one. Much easier.

Furthermore, the management strategies of the big three fail to differentiate themselves during the ongoing contract and relationship management cycles. The deals are not generally easier than Indian deals for customers to manage, nor are they substantially more effective in purpose than Indian deals. It isn’t that the quality or customer service offered by the big three is inherently worse than that of the Indian vendors - its that it isn’t substantially better.

Finally, these U.S. companies do not offer their services at the lowest price. They are rarely the lowest-cost bidder, and while prices are coming closer together, they still charge a premium for the services that they render.

The combination of these three factors - difficult deal-making process, failure to differentiate themselves by offering better quality and customer service, and a premium price make the big three’s offerings somewhat less compelling in the open market. As Indian firms become more savvy in the U.S. market - something that comes with experience - this problem can only get worse.

We have experienced this cycle once before - in the auto industry. Japan entered the market with cars that were small and cheap - and not up to the quality standards of American vehicles. Detroit, instead of pushing quality and the customer experience, competed on price - a strategy that was doomed for failure from the start. The Japanese automakers understood that, once they got their toehold, they could push the envelope on quality and service, and still retain a price advantage (albeit smaller). Now, tables are turned and Japanese cars are perceived as quality and value leaders - and are competing on price only in the luxury segments.

Ultimately, to turn this trend around, the big three companies, like all American outsourcing companies, will need to become more fanatic about quality and customer service than of the quarterly revenue cycle. More fanatic - much more fanatic - than their Indian counterparts. Moving the debate from cost to quality, customer service and value will play to such company’s inherent advantages - proximity, common culture and a better understanding of the underlying business. Failing to recognize this simple fact creates a Detroit-sized risk for American IT outsourcing firms.

While I agree with the implication that American’s generally will not pay for better customer service (although Apple, with it’s Genius Bar, is a marked exception), I disagree with the implication that domestic service is by definition better than offshore service. I know that many will disagree with me, pointing to research that concludes just the opposite, but I believe that is due to other factors.

When a company looks to offshore customer service, those at the head of the initiative are often the same folks who are looking to scrape the last bit of living tissue off of the company bones. Done as a pure cost cutting exercise - often in a hostile manner disrespectful of the current employees - the solely-cost-driven process of outsourcing customer service often renders quality customer service impossible.

It doesn’t have to be that way. Customers can get the benefit of lower cost (although perhaps not “lowest cost”) by focusing on quality as much, if not more, than price and by working with their vendors to continuously improve customer satisfaction. Certain financial services companies have taken this approach, and there telephonically delivered customer service (wherever delivered) is a competitive asset. Most companies, however, look to reduce the non-customer focused criteria, such as throughput or staffing levels.

Certainly, nothing can fully replace a high-quality, face-to-face customer service interaction. But high-quality service, delivered telephonically, can be a good ambassador for your company. For this to happen, quality must truly share top billing in the company’s customer service priorities.

Part of the problem is that outsourcing hasn’t, in the main, created real value for those who partake in it. Certainly, lower costs have occasionally occurred - although these have often been offset by higher administrative costs and quality problems - but true value has been elusive, at best.

There are a world of opinions as to why this is the case, but I would submit that the entities who outsourced were primarily at fault. Why? Because they weren’t seeking or allowing for the creation of true business value. From the inside, it isn’t even clear that lower costs (on a transaction basis) was the underlying reason, either. Sure, “cost cutting” and budgets were talked about liberally in outsourcing plans, but in many cases, little effort was expended to create internal infrastructures to mange the outsourcing deals to ensure that cost reductions were realized.

So is the end near for the outsourcing craze? Will U.S. jobs be safe from the outsourcing cleaver? No. However, organizations (at least some of them) will get smarter about outsourcing and get smarter about managing their existing relationships. At that point, it will finally be possible for entities to use outsourcing to do more than simply cut costs - they will be able to use outsourcing to create value.

How will they get there? They will begin by creating an “outsourcing framework” - a standardized set of policies, procedures, quality requirements, and management techniques to ensure that their outsourcing efforts are coordinated. Then, they will look to their outsourcers to work together to create a “networked” operation - so that additional, high cost functions, such as business continuity, can be augmented within their vendor communities.

Those companies that move in this direction will have the upper hand - both in cost profile and in innovation. They will be better able to utilize the unique skill sets that exist in both their internal and vendor work forces.

So, maybe “the end of outsourcing” may, instead, be the beginning of better outsourcing. This may be bad news for consulting firms and law firms - smarter outsourcing will require smarter, less purely adversarial relationships - and few with established old-line practices in either the legal or consulting arenas have shown much ability to “think outside of the box.” So ultimately, it will be the responsibility of organizations that are undertaking outsourcing initiatives to develop better contracting, management and deal life-cycle methodologies and to develop the staff to properly manage these ultimately strategic relationships.

Outsourcing of legal services is not a new concept. It is, however, just beginning its exponential growth. Fed in part by the undisciplined increase in firm fees, in part by industries growing comfort with outsourcing and in part because of improving skills and capabilities in the marketplace, high growth in this market is a given. Full exploitation of these capabilities, however, has been delayed by several factors, including in-house counsel reluctance and perverse incentives for law firms. As processes and methodologies improve, in-house reluctance will ultimately decrease and in-house counsel will, for economic reasons, lead the charge to offshore services.

Still, far too many companies are not yet taking advantage of these great, high-value, but relatively low cost services. Certainly, a company may be cautious about exposing its innermost legal secrets to outsiders – particularly ones that are thousands of miles away. Yet those same companies have little concern about sending their customer data to the four corners of the earth. Also, most lawyers (including this author) will claim that what they do is somehow unique or special. While there is certain truth to this, the simple fact is that many facets of a law practice are neither unique nor special. It is these tasks that are ripe for LPO services. That LPO services has remained a relatively small, but consistently growing trend, indicates that certain market forces must be effectively retarding the growth of LPO services.

Ultimately, I believe that the reluctance comes from two discreet, but related areas: law department management shortcomings and law firm reluctance. The combined forces of these two factors has kept companies from realizing significant savings in their receipt of legal services and facilitated the unfettered rise in overall legal fees, even while the economy is slowing.

Historically, lawyers have not made the best managers. Many times, those elevated to management positions in organizations, while often brilliant lawyers, have had little formal management training. In addition, and unlike most business management, law department managers are still lawyers first and managers second. The number and complexity of matters dealt with by a senior attorney in any given day can vary greatly, and rarely is there sufficient time to clear one’s calendar to deal with internal management tasks.

Staff counsel are reluctant to promote outsourcing as well. Law, like all professions, operates with a little mystique – mystique that will be potentially compromised if the same work can be done at one-fifth the cost offshore. Furthermore, after seeing outsourcing related reductions-in-force throughout their organizations, staff counsel are reasonably concerned about keeping their jobs.

Still, the average in-house law department is significantly understaffed given the workload that they face. However, budget constraints discourage the use of expensive outside resources, meaning that long hours and unfinished work are more the norm than the exception. In these situations, LPO services can significantly add value to the in-house law department.

Lowering litigation costs offers another benefit to a law department. Litigation is often seen as a wildcard in the budgeting process – after all, one never knows when costly, complex litigation will strike. Employing lower-cost offshore resources in support roles can decrease the amplitude of litigation costs and add more predictability to the budgeting process.

Law firms present another roadblock to a company using LPO services. It is simply not in a law firm’s best interest to outsource less-complex, but highly profitable services to offshore locations. Many years ago, law firms justified the use of high-cost junior associates as necessary to the training and apprenticeship process. Unfortunately, due to high associate attrition rates (some studies show that between about 20-50% of junior associates leave their position within the first three years); the value of this training may be severely compromised.

A modern law firm operates under a model that represents a very steep pyramid. At the top are the equity partners with the largest “books of business.” Under that are lesser equity partners, non-equity partners, of counsel (basically, non partner-track attorneys) and associates (effectively, an apprentice pool). It is the equity partners’ charge to keep these other, rather expensive people busy – very busy – and to weed out, at an alarmingly high rate, those deemed not to have “equity partner potential.”

It is a simple fact that law firms make the most money on their junior- to mid-level associates. These people are kept busy doing a variety of tasks, some complex, but many very simple. With rates of first-year attorneys’ at large firms now at $300 or more, and with work goals of about 1,900 – 2,100 hours per year/per associate, the economics become clear. A first year associate may be worth $600,000 or more in revenue during his or her first year of service. Yet the fully loaded cost of such an associate is around $275,000 or so. Keeping these people busy – at the client’s expense – is among the highest of priorities within a major law firm.

Interestingly, many of those lower- to mid-level tasks can be outsourced or offshored to substantially lower-cost resources. However, doing so could remove these highly profitable workers from the mix, drastically cutting into a firms profits-per-partner, particularly in jurisdictions requiring disclosure of fee sharing and subcontracting arrangements (California, for instance). It is no wonder why most major firms have been reluctant to embrace outsourcing.

Given that the firms are disincentivized from outsourcing and that most law departments do not have the resources to manage outsourcing, it is no wonder that LPO services are just beginning their upward thrust. The economics, however, are staggering – and will drive more and more companies to these cost-effective options.

Most LPO’s tend to focus on relatively straightforward matters, such as document review, legal research, due diligence, patent searching, document coding and transcription. Except for transcription and document coding, these tasks are often assigned to young associates – at nearly $300/hour. Large deals and large litigations, where substantial due diligence and document review often occur, are literally gold-mines for major law firms, offering substantial opportunities to staff large numbers of associates on relatively low-value, but high-profit work. It is clear that a law firm has little incentive to move work offshore!

Given the incentives, it is ultimately up to the law departments of commercial clients to encourage and manage LPO relationships. To do so, law departments will have to become more skilled at management – and may even need to hire a skilled vendor manager to properly allocate and control the workflow. It will then be up to the law department to insist that their outside law firms use the contracted offshore resources.

While this may seem to be a significant and difficult task, the financial and services benefits can be great. With lower personnel costs, offshore resources could be deployed to assist various business units within the organization, doing more to support their clients for less money. Furthermore, the peaks and valleys of work could be evened out a bit, allowing in-house attorneys to take a more strategic role as business partner with their clients.

At the end of the day, it will be up to the client, not the law firm, to compel the use of these less expensive options. It is time for them to do so.

Let me start by saying that I honestly believe that there are portions of a relationship that defy measurement. This is true in a marriage, in a friendship, in an employer-employee situation and in an outsourcing. But these things are often the “mortar” that hold the relationships together – they are neither discreet nor clearly measurable. Certainly, I can look at a building and count the number of bricks used to build it with efficient precision. However, determining the amount of mortar that is holding those bricks together is a little more difficult.

Certainly, the Forrester process shows promise. Like most methodologies, however, it fails to recognize that some things cannot be measured. Missed expectations are a great example. Missed expectations are one of the most significant reasons for outsourcing unhappiness. Because of company dynamics, outsourcing deals are often oversold – both by vendors and internal constituencies. These deals are often presented as magic bullets intended to stem escalating costs, provide comprehensive solutions and work perfectly. This puffery, however, is not easily measurable.

It is, however, possible to create organizational discipline within a company, discipline that would discourage creating internal puffery or accepting a vendor’s puffery. The discipline to recognize that the deal will neither save the company from further cutbacks, nor put a company’s customer satisfaction scores in “JD Powers’” territory overnight. What it can do is save some money, open up resources to more high-value work and offer greater ability to meet business peaks-and-valleys.

Second, outsourced vendors are easy to blame in the event of problems. Certainly, problems are often caused by the vendor. However, many problems are also created by the customer for the vendor as a result of antiquated processes, broken or barely functioning systems and good old-fashioned blame shifting. After all, it is much easier to blame a vendor than it is to take personal responsibility for a problem or fault within the organization. Frankly, the only way to combat this problem is for a company to measure its own performance and for it to be honest in its evaluation of its own processes and people.

Third, these relationships are sometimes overwhelmed by the need to measure something. SLAs are the obvious measurement and, without question, well crafted SLAs do offer great opportunities to measure results. The problem is that SLAs are rarely crafted to measure the customer’s true needs – nor do they tend to align themselves with the customer’s real pain points. Instead, laundry lists of statistics, often with little bearing on the real business at hand, are measured. In many cases, I would recommend replacing existing SLAs with SLAs that are more nuanced and better aligned with the customer’s true needs. Then I would measure them regularly, carefully and thoroughly.

Fourth, as an attorney, the word “partnership” makes me queasy, I do believe that the nature of the customer-vendor relationship is different in successful outsourcing. Instead of the traditional “us versus them” approach that many managers take, I have come to believe an “us and us versus them” approach would be more effective. As a close business ally, an outsourcing vendor and its customer should be encouraged to assist each other in the competitive marketplace. This is not a “partnership,” either legal or otherwise, but instead a recognition that each party will prosper if the other one does. Aligning the customer’s and vendor’s interest – at least when it comes to facing the rest of the world – can enhance the esprit de corps of the relationship – and make all involved parties feel as if they have something to gain.

Finally, take the “temperature” of the relationship. Informally. How a company’s employees and customers feel about their outsourced vendor is critical to that vendor’s success or failure. If the SLAs are great, but the customer satisfaction ratings are low, there is clearly something wrong with the relationship. If your employees are constantly complaining about having to deal with your vendor, there is clearly something wrong with the relationship. On the other hand, if customer satisfaction is up, if your employees enjoy their relationship with your vendor, then recognize that your vendor is likely a valuable business ally, and treat them accordingly.

As business becomes more and more driven by metrics, it is important to remember that there are still things out there that defy clear measurement. However, many of these things are the mortar of a successful relationship. Like in a building, where the bricks and the mortar are critical components, an outsourcing’s measurable and immeasurable results are vital, in combination, to ensure satisfaction.

The article described four reasons for this trend: tightening timelines at a cost lower than offered by vendors; bringing recovery centers closer to customers’ data centers; inflexible, long term contracts; and inflexible testing options and environments. While there is certainly truth in each of these, I believe that there are two unmentioned reasons, both more compelling than those above, that were overlooked by this article.

First among these is that companies have often bought disaster recovery on an al la carte basis. One system is outsourced, along with the DR requirements for that system, followed by another system – maybe to a different vendor. A company can wind up outsourcing multiple processes under multiple agreements to multiple vendors – with each deal providing DR services separately.

Like going to a retail store and purchasing an extended warranty on specific, individual products, buying DR on an a la carte basis is a very expensive way to purchase these kinds of services. And like a smart consumer who makes the risk-reward calculation and then declines such extended warranties, companies will, when possible, say “no” to such extra costs.

Second and more cynically, is that an outsourced DR process is very difficult to de-fund. A vendor knows that it must meet its service levels – and often there is enhanced liability for failing to meet DR requirements. Doing so, and accepting that risk, is a very expensive proposition (and also a source for some windfall profits). Some vendors even try, contractually, to limit a company’s ability to provide thier own DR services by limiting that company’s ability to have extra, operational instances of software and systems. On the other hand, an in-house DR process can be cut – often drastically – by a company which determines that the risk-reward calculus simply does not warrant the investment required by a true, company-wide DR investment.

Companies cut costs by only providing partial DR for their own systems. Major systems are often tested separately, allowing companies to boast quick recovery of disasters on such systems, but hiding from themselves, their management and their shareholders the inability to recover from a company-wide, multi-system disaster. They cannot do this with outsourced services – as the contract calls for all systems to be available within certain timeframes – and the true liability risk is borne by the vendors.

It is important to remember that DR is, in fact, an extra cost related only to the expense-side of a business. No one (except for vendors providing DR) makes a cent on any dollar spent on DR. Companies looking to reduce costs have been ruthless about cutting the expense-side (rather than the revenue side) of their businesses – and, frankly, in-house DR is among the easiest of these targets. It is simply a meta-expense. Even after the tragedies of 9/11 and Hurricane Katrina, no major company has failed (or even suffered substantially) due to a failure in its DR procedures.

Of course, there are ways to solve this conundrum. Foremost of these is to move business continuity issues into a separate budget area controlled by the company’s risk manager, not its CIO. CIO’s are constantly faced with tough budget choices and, because of the “black box” nature of many of their projects, in-house DR is often the victim of such budget choices (can’t do this with outsourced DR!). Treating DR like insurance, on the other hand, would allow for more rational, transparent behavior.

Second, eliminate the a la carte DR approach. While it often seems easier and cheaper up front, the cost over time is much higher than a centralized, organized and coordinated DR infrastructure. Doing this may require extra staff and expertise to manage, but it can lead to extraordinary savings and extra security – and higher quality DR.

Third, look for ways to have your vendors work together on DR. If your company has several outsourcing vendors providing similar services (say, BPO, ITO, call centers), develop in your contract requirements that would have each vendor act as DR providers for your other vendors. Of course, many vendors will squawk about “proprietary processes” and will be reluctant to agree to work with other vendors, but at the end of the day, an honest look at what is (and is not) the secret sauce of a company or vendor can reduce this concern dramatically.

Finally, be honest about the costs of true DR – and what a company is truly willing to spend and provide internally. Critical systems – particularly in certain industries – may require hot sites, mirrored storage, extra staff, etc. Other systems may be able to tolerate disruptions of 24 hours or longer. Match your DR standards to your true requirements – and pay only for what you need.

Disaster recovery is an important responsibility of every company. Like commercial general liability insurance, no company should be without it. However, unlike CGL, where needs are well understood by management and a rational market has developed, disaster recovery remains another IT “black-box,” and remains subject to the whims of the ever-more-ruthless budget cycle. Maybe it is time to move disaster recovery out of the shadows and treat it, like insurance, as a truly necessary expense.

Frankly, outsourced vendors have done a poor job of singing their own praises in the U.S. press. Of course, the trade journals are full of “so-and-so is ranked in the top 10 of all HRO outsourcing providers,” but these surveys are neither particularly credible nor widely read. Furthermore, customers’ desire to hide their outsourcing initiatives makes the success stories unknown – effectively ceding the field to the naysayers. In the public’s mind, there are no outsourcing successes – only failures – and any organization who outsources is simply trying to line their own pockets at the expense of their customers.

Maybe it is time for the likes of Wipro, Infosys and Tata, among others, to begin to invest in changing public opinion in the U.S. Many industries – including some generally seen as “pariahs” – spend a lot of money and energy garnering the good will of consumers – whether or not they sell consumer products. One can look to examples including BP’s recent “green” campaigns, BASF’s recent – “We don’t make the product, we make it better” series and Pharma’s Partnership for Prescription Assistance initiative, as campaigns that have taken relatively unpopular industries – big oil, big chemicals, and big pharmaceuticals – and put a positive spin on their efforts (and note that neither BP nor BASF are U.S.-based companies).

One could imagine a public television series on India, a museum traveling exhibition, full-page advertisements in large-circulation papers, and other fairly common public-relations techniques being employed by these companies. Maybe sponsor a clinic in a low-income area, create information and technology for schools or develop some cross-border media ties. Any of a number of things could raise both the profile and the public opinion of the industry. The key is to make the campaigns look less like long commercials and more like “giving back” to the communities that use their services.

This is, no doubt, new ground for outsourcing companies. But it is one that has been well-paved by Japanese, and now Korean, auto manufacturers, European chemical and pharmaceutical companies, global oil companies, etc. While opinions aren’t changed overnight, they can slowly be changed – and, at least, the shrill, one-sided criticism can be blunted a bit. While little can be done to affect certain disadvantages of offshore outsourcing, including time zone differences and currency fluctuations, something can be done to affect public opinion in their target markets.

Of course, everyone would like to move past the labor-arbitrage model – and away from a pure cost-based measurement. Doing so would allow suppliers more flexibility in operating their model and offer, customers, theoretically, the outcomes that they desire. But moving to an outcome-based measurement can be difficult for companies who are focused on reducing their administrative expenses by next quarter.

Also, as hard as costs are to estimate accurately, they can often be measured with some level of precision. Developing outcome criteria, let alone measuring the results, can be a very difficult exercise at best. Furthermore, even the successful outcomes must be folded back into the value model so that the investment can be recouped.

A focus on outcomes can be dangerous for managers within an organization. If, for example, I outsource a process to get better results than I had from in-house staff, am I not commenting on my own organization’s and internal management’s weakness in dealing with a process and the people supporting it? Outsourcing for pure labor-arbitrage avoids those difficult issues by placing the underlying foundation on price, not skills.

I have, for years, counseled clients to look beyond the immediate bottom line and seek service and process improvements from their outsourcers. After all, a company that provides similar services across a range of customer likely has developed expertise and skill that comes from a broad base of experience. Unfortunately, this advice is rarely followed. Furthermore, legitimate concerns about proprietary processes are misused and too broadly interpreted by clients and their organizations, creating irrational lock-downs of information.

Ultimately, I do agree with Peter – that the only way to get the real value of outsourcing is to focus on outcome targets rather than labor arbitrage. However, a client must ask why those same outcomes were not looked at while the process was in-house and whether, given transactions costs and training costs, the end result will present savings significant enough to warrant the loss of skills and institutional knowledge. This remains the seminal question in outsourcing – the question that every organization will ultimately have to answer.

Differentiation seems to be the direction that most are taking. The big attraction offshore used to be lower cost. Today, that is not good enough because they themselves are facing increased inflation in labor, real estate and infrastructure cost. Even countries like India have to think about what else they can do to be successful.

While I tend to agree – participants in crowded marketplaces always look for differentiation – I wonder what the effect such differentiation and segmentation will have on the marketplace in general. After all is said and done, the effort involved in entering into and managing an outsourcing relationship can be costly, and requires distinct, measurable benefits over non-outsourced environments.

Generally, benefits tend to align themselves in three broad areas: costs, scalability and capability. While many, including this author, have suggested that focusing on areas aside from cost is imperative for a successful relationship, one can also make the argument that, without cost benefits, the outsourcing model contains some serious flaws.

Why? First, analysts often fail to consider transactions costs. However, transactions costs are both real dollars (in the case of advisors and lawyers) and lost productivity (in the case of analysis and management), and can adversely affect the cost-benefit analysis. As deals get shorter and smaller, transactions costs eat up a larger portion of the deal value. Put simply, if a company invests the same time and money in building its own staff that it would in building an outsourced relationship, it may be able to secure excellent results within its own four walls. Without a significant cost benefit, offshoring can become a less attractive option.

Second, if one takes cost out of the equation, it is possible to address scalability and capability in most domestic markets without changing the delivery model. While there may be specific labor shortages in specific markets, many needs can be met through hiring and training in local markets. Furthermore, popular offshoring destinations are experiencing labor issues (including shortages and turnover) themselves. Such issues adversely affect markets ability to scale significantly. Without a significant cost benefit, offshoring again becomes less desirable.

By raising the internal governance costs, differentiation and market segmentation also work to make offshoring less attractive. It is cheaper (although perhaps not more successful) for a company to manage one or two large, long-term deals than it is for that same company to manage ten specialized, short term deals. As a customer’s transactions costs and governance costs increase, the cost-benefit of offshoring, by their nature, decrease.

Finally, developing a market based on capability is no easy task. Unlike cost and scalability, a capability-based market is a reputation-based market. For a variety of reasons, executives tend to believe that outsourcing – particularly offshoring – is inferior to, but cheaper than, domestic services. Like many back-office services, executives are far more likely to notice and talk about failures than they are about successes – and the successes often do little to polish the public reputation of an outsourcing vendor. This is not a good foundation for a capability-based market. Furthermore, the nature of offshoring deals – and most customers’ desire to keep them from public view – does not tend to offer the type of repeated positive customer contact and press necessary to build a good reputation.

“Top-ten” lists (and there seem to be many) do little to ameliorate this problem. They are simply not believable measures of how Vendor X will handle your problem. Advisors and lawyers can offer some assistance, but all too often, such parties are only involved in the deal-making and dispute resolution processes, not the governance process, and their knowledge of Vendor’s actual capabilities are, in fact, limited.

Cost, on the other hand, is easily estimated and believable – even though cost estimates have proven remarkably inaccurate and deal value has proven elusive. The often-false objectivity offered by a set of number on a spreadsheet – and the many gates generally provided by a customer’s finance and legal organizations offer security to the outsourcing executive that is not offered by claims of scalability and capability. In addition, one could make the argument (and I will in a later article) that outsourcing reduces the cost risk to an organization (even if it increases the process risk) by reducing the size of the domestic workforce and, therefore, the risks of benefit mandates and accelerating benefit costs.

Like domestic companies looking to offshore, offshore vendors are going to have to look into ways to make their organizations leaner and more efficient. Ultimately, cost will remain a key differentiator – and one that is facially more objective than other measures.

I do think that it is important to look at the reasons why the process is “broken” in the first place and, for those championing outsourcing deals, to understand, with a healthy dose of realism, what characteristics led to the breakdown.

Frequently, a broken process is simply too old to be fixed. Old legacy IT systems, maintained for over twenty, are the classic example. While these may be able to be “fixed” with Herculean efforts (and Titanic expense), they may just be too broken to make it worth the trouble.

Other times, an organization changes too rapidly – through multiple reorganizations, management reshuffles, etc. While many say that “change is the only constant,” too often organizations change for the sake of change. Organizational behavior that encourages internal instability also encourages self-preserving behavior amongst middle-level managers and technologists – and, therefore, inflexible, arcane and, ultimately “broken” processes.

Both of the above scenarios seem ready candidates for outsourcing the solution. While that approach often makes sense, it is not without risks. The most significant, in either case, is the difficulty that the vendor will have in divining the appropriate business rules from the broken processes. In the first instance, the detail-level rules will be tied up in code that is likely poorly documented, patched repeatedly and subject to unknown manual workarounds. Detail-level knowledge may not exist within the company at all, and solutioning without in-house expertise may be nearly impossible.

In the second instance, gathering business rules from employees facing an inevitable reduction-in-force may prove difficult, at best. Furthermore, job-saving incentives may encourage behavior that further obfuscates the business rules, making the outsourced vendor’s job more difficult and costly.

On the other hand, some processes are broken simply because management has failed to invest in its processes and its people. These broken processes languish from insufficient resources, lack of institutional commitment and weak planning.

Still others become “broken” because the customer changes. New products are created and old ones discontinued. Companies go through major organizational changes (merger/acquisition, bankruptcy, etc.). Processes no longer fit the business – and therefore become “broken.”

In these two cases, investments in internal solutioning seem like obvious solutions. In the first instance, what could be better than finally investing in your people? It is an obvious and apparently enlightened solution. However, an organization that systematically under-invests in its people has likely already lost its best-and-brightest – and the remaining skill set may be insufficient to successfully fix the process.

In the second instance, major corporate changes are often the cause of fear, instability and self-protective behavior. One way to overcome this is to invest in its people – and give them a big solutioning project. While this may calm certain fears, it also sets the stage for turf battles at all levels. In this instance, going outside, for both perspective and impartiality, may offer the better solution.

The scenarios are just a few examples of the considerations that should go into the decision to fix a broken process before or after an outsourcing. An impartial consideration of both sides of the question is critical, and decisions should be tested carefully within the organization before selecting one approach over the other.

It is also important to remember that your vendor likely cannot work miracles (I’ll hear from the vendor community on this one). A “broken” process may, in fact, be impossible to fix – and may require replacement. Depending on the centrality of the broken process, replacement, itself, may prove costly, painful and disruptive. However, it may be necessary. Knowing, and understanding fully, the decision making process, and the pros and cons of each approach, will help a customer through these very difficult times.

While fairly straightforward, claims processing does present specific, unique issues for both the Customer and Vendor.  The Customer may face regulatory scrutiny, customer abrasion, undue expense and privacy risks.  Vendors, on the other hand, may face diminishing volume, undue regulatory risk and impossible customer satisfaction goals.

Customer-side Concerns

In many industries, timeliness and accuracy of claims processing is subject to regulation and/or government scrutiny.  Obviously, the elapsed time to process a claim is the sum of the time taken for the Vendor and the Customer to perform necessary processes.  Delays, particularly systematic ones, can be costly – and can lead regulatory action or lawsuits.

Undue denials, by their nature, create customer abrasion.  While claims processing is generally governed by business rules, the internal communication between initial adjudication and claims reexamination may be lost – and insured parties may be subject to undue procedural burdens that may erode customer loyalty and company reputation.

Undue approvals, on the other hand, lead to the obvious problem of too much money being paid out.  Again, losing the informal knowledge and network that often exists within a claims processing organization can lead to these errors – as more processes are done “by the book,” without regard to the quality of the “book.”

Privacy concerns must also be taken into account.  Claims generally contain non-public financial information (regulated by the Gramm-Leach-Bliley Act) and may contain protected health information (regulated by HIPAA).  Also, given that many (but not most or all) claims require manual processing – exposure of such information to Vendor staff is going to be more frequent and all-encompassing.

Finally, process mobility may prove to be more difficult than originally believed.  With an outsourcing usually comes an exodus of Customer’s qualified staff – and their knowledge.  Bringing the process back in-house or to another vendor may prove difficult, costly and time consuming.

Vendor-side Concerns

As mentioned above, Vendors face risks in claims outsourcing as well.  Insurance claims are generally subject to some automatic adjudication process (known as “auto-adjudication”).  Insurance companies are constantly trying to improve their auto-adjudication rates through improved software and analysis tools.  As auto-adjudication rates increase, the number of claims that require manual processing will, naturally, decrease, reducing the volume of claims being processed by the Vendor.  A significant reduction in volume can substantially affect Vendor margins.  Thus, pricing should take into account the likelihood of improved auto-adjudication rates.

Many potential outsourcing Customer’s attempt to push significant regulatory risk onto their outsourcing vendors.  This is facially troublesome, as Customers are generally in the best position to understand regulatory schemes that affect their business.  It sometimes even goes so far as to state that the Customer must approve all changes (without regard to reason), while making the Vendor responsible for regulatory actions and fines – even if the Customer does not allow the change.  While it is fair and reasonable to expect the Vendor to take responsibility for its own actions – including delays and inaccuracies caused by its processes, pushing compliance risk to the Vendor, without the corresponding authority to meet compliance responsibilities, is patently unreasonable and should be avoided.

Oftentimes, internal Customer claims processing metrics do not translate cleanly to an outsourced environment.  Sometimes, in fact, the internal metrics are wholly inaccurate or engineered to meet specific internal goals.  Domestic agents may wear multiple hats, making their productivity difficult to measure, may have significant company experience (oftentimes as long-term employees) and have generally learned how to deal with the “warts” that exist in any automated system.  Offshore vendors, with more accurate measurements, more significant turnover issues and less significant Customer-specific experience, may find it difficult to meet these unrealistic metrics.

Solutions

Although there are no magic bullets, I believe that clear lines of demarcation is the first and most significant driver to success in outsourced claims processing relationships (and, for that matter, in all outsourced relationships).  Knowing clearly where the line between Customer and Vendor responsibility is drawn and building “interfaces” to hand off the procedures eliminates much of the confusion and difficulty in these relationships.  These interface points are also a natural location for service level measurement – and creating service levels at these handoff points can help ensure that the incentives remain aligned between Customer and Vendor.

Developing (and improving) processes and procedures is another key driver to claims processing success.  While it may be impossible to capture every nuance in a specifications manual, clarity within the captured nuances is a must.  Claims processing rules are often overly complex – and not permitting process improvement through an outsourcing will maintain such undue complexity.  Thus, an outsourcing may be an opportune moment for some process reengineering – with Vendor participation.

Using a reasonable pilot procedure to determine accurate service levels can address incompatibilities in the service delivery model and be used to better determine service levels.  However, this should be done with both Customer and Vendor employees where possible – as doing so will balance the incentives to create beneficial inaccuracies.

Risks should be fairly shared, too.  While customers and vendors often disagree on what a fair risk allocation is, I would suggest that each party should be responsible for its actions and areas of expertise under the agreement.  Thus, I would argue that the Customer is responsible for developing compliant procedures – and should be held responsible if the procedures are not compliant.  The Vendor, then, is responsible for executing such procedures – and should be held responsible for its failure to do so accurately.  With respect to protected health information – often a stumbling block in negotiations for health care outsourcing – the Customer should be responsible for, again, developing compliant processing and for reasonable mitigation of disclosures, while the Vendor should be responsibl