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ISEF Conference Addresses Business Process Issues

4/21/2003 --

As companies increasingly turn over key business processes to vendors, including those operating in low-wage countries such as India, they often fail to adequately assess the potential risks and costs.

This was a primary conclusion of the U-M Information Systems Executive Forum (ISEF) spring meeting, which took place March 28 at the Business School’s Executive Residence. The forum, titled “The Future of Corporate Information Systems Organizations,” featured presentations from university and industry experts.

And corporate IS departments are dramatically affected when companies outsource information technology services and back-office processes which rely on IT --– such as human resources, accounting and customer support.

Companies are doing just that at an accelerating rate. Financial services firms have outsourced $8 billion worth of business processes – including $4 billion in IT work -- to India in the past five years, according to one of the presenters, C.K. Prahalad, the Harvey C. Fruehoff Professor of Business Administration and professor of corporate strategy and international business.

Market research firm Giga Information Group predicts IT outsourcing to India will increase 25 percent in 2003, and Forrester Research says 3.3 million U.S. jobs will shift to India, Russia, China, and the Philippines over the next 15 years as companies outsource business processes.

Domestic companies are turning to offshore suppliers, Prahalad said, because they offer high quality, a large talent pool, and cost savings.

“This is gaining momentum and does not seem to have an end in sight,” ISEF Director Jerry Peterson told forum participants. “It’s not the same old outsourcing.”

Potential pitfalls

Despite the potential benefits, business process outsourcing is fraught with pitfalls, said Tom Criste, a partner at Deloitte and Touche. “I’ve seen more disappointments than . . . raving successes,” he warned. “We have trouble getting people to look at the entire package.”

Criste identified these potential land mines:

  • Companies that cut back or eliminate a department when work is outsourced often absorb those workers elsewhere in the organization – so anticipated savings are not realized. That’s not the only hidden cost. Companies often have to allocate additional project management resources to oversee the outsourced work, for example, and change orders can drive up contractual costs. These budget blows are hard to pin down – and managers who advocated outsourcing have no incentive to do so. “It’s a very difficult thing to measure,” Criste said, “and more difficult to find people who want to measure it accurately and realistically.”
  • Outsourcing a company’s financial reporting creates a tangible risk for corporate leaders who, as a result of post-Enron regulatory reforms, are personally liable for the veracity of financial statements and controls.
  • Outsourcing contracts often fail to detail precisely what the vendor is responsible and accountable for, which creates incongruous expectations. As a result, the client company may believe it is entitled to certain services – ERP support, say, or Internet security safeguards – while the outsourcer contends the services were not explicitly contracted for. “You run into this constantly,” Criste said. “The relationship deteriorates from there.”
  • A company may damage its corporate culture and skewer morale if it sheds staff and moves work offshore.
  • Companies must carefully consider what type of work to outsource and how to structure these arrangements – because its reputation is on the line. Can a company maintain exemplary customer service, for example, if its “help desk” operation is run by a vendor? “That’s a pretty strategic thing to hand over to a third party,” Criste said.
  • It can be difficult to structure the client-supplier relationship like a partnership – which is necessary to optimize results. “If you’re not going to treat them like a partner, don’t expect a lot of innovations and best practices,” Criste said. “They’re not going to run to you with ideas.”
  • It can be difficult to align incentives so the client and the vendor are pursuing the same objectives. This sometimes is addressed by instituting a gain-sharing arrangement, in which case it is important to determine which gains to share and how they will be measured. “It absolutely has to get done right,” he said, “and it seldom is.”

Offshore vendors can improve the likelihood of success, Prahalad added, by addressing the perception that it’s risky to do business with them, building expertise in specific markets such as financial services or retail, delivering on projects so clients are confident to move to umbrella agreements, and maintaining a strong U.S. presence.

Procter and Gamble weighs in

Consumer packaged goods giant Procter and Gamble recently considered a massive $8 billion business process outsourcing initiative to lower costs, increase quality and allow the company to focus on its core competencies.

Robert Scott, vice president for information technology in the global market development unit at Procter and Gamble, told the forum his company evaluated a plan to spin off 30 back-office services – including accounting, finance, office management, non-strategic purchasing, and some data warehouse management and IT applications support.

After careful study, Scott said, Procter and Gamble concluded the plan would generate a significant return – as well as an unacceptable risk.

The company’s concerns included the following:

  • Procter and Gamble could easily identify some in-house “commodities” appropriate for outsourcing, such as payroll services, but was less certain about others, such as customer call centers. “And today’s commodity can be tomorrow’s strategic advantage,” Scott said.
  • Company leaders did not want to place such a large part of their enterprise in the hands of a supplier whose viability they did not control.
  • Given the Enron debacle and other corporate scandals, Procter and Gamble did not want to relax its control of corporate governance and oversight.
That’s not to say the company is turning its back on outsourcing altogether. It abandoned the $8 billion mega-deal, but will still undertake selective outsourcing, Scott said. Today, 30 to 40 percent of Proctor and Gamble’s IT work is outsourced to low-wage nations such as India, Philippines and Poland.

Ford and DTE Energy remain skeptical

The explosive interest in IT outsourcing reminds Ford Motor Company CIO Marv Adams of the hysteria surrounding e-business a few years ago. “Outsourcing has been a similar hype,” he said.

Adams primary concern with IT outsourcing is the potential loss of learning within the company’s IS organization – which could create a competitive disadvantage. “You have to be in the game in a serious way to keep up,” he said.

Lynne Ellyn, CIO for DTE Energy, questioned the value of outsourcing and said it’s a mistake to relinquish corporate control when companies are being held to stricter standards for financial reporting and cyber-security.

“It doesn’t matter who I have pulling wire through the walls,” Ellyn said. “But if I outsource the thinking about how to integrate the business there will be consequences.”

IS organizations have not traditionally been seen as a strategic weapon, said Prahalad, but that is changing. “What I find fascinating is how critical technology has become to strategy,” he said.

For more information, contact:
Bernie DeGroat
Phone: 734.936.2150