A US Financial Services company outsourced a data-entry process to a leading Business Process Outsourcing (BPO) vendor. The BPO vendor met all of its SLA targets and reduced the processing costs by 30%. However, the BPO customer soon found that its overall operational costs had actually increased after the process was outsourced. Eventually, the customer brought the process back in-house.  This turn of events is not rare: In an October-December 2004 Deloitte Consulting Outsourcing Study, 64% of respondents stated that they had brought some outsourced services back in-house.

 

The following simplified disguised case highlights the importance of quality in BPO engagements. In this insurance claims scenario, the client’s cost of processing each claim was $1, but the average downstream cost due to errors in a claim was $300.  The $300 average downstream costs included manual exception handling costs, costs of customer support calls initiated due to errors in claims, and costs of reissuing corrected documents for any claims processed incorrectly the first time. The customer also faced significant soft costs from regulatory risk, lost revenues due to low customer satisfaction, and costs of overpayment on claims due to claims processing errors. These soft costs were not included in the $300 number.  The scenario faced by the customer was as follows:

 

This client only outsourced the back-office processing. All of the downstream activities which constituted the “average cost to the company due to 1 incorrectly processed document” remained in-house and thus this cost was not affected by outsourcing. Because the cost of correcting errors is so much higher than the cost of processing a document, the error rate of the vendor became the true determining factor for the Total Cost of Ownership (TCO). Unfortunately, far greater focus had been placed on ensuring the greatest reduction in unit processing cost. As a result, the firm managed to reduce their direct processing costs, but the TCO remained unchanged, or even became worse than before.

 In this scenario, just one-tenth of a percentage point increase in errors wipes out the benefits of a 30% point reduction in processing cost! On the other hand, if the financial goal was to save $30 million, the company could have achieved the same goal at lower risk by decreasing their error rate by just one-tenth of a percentage point.

 

Outsourcing vendor quality and business process costs vary widely, thus, careful examination of the TCO is critical in any outsourcing decision. The best outsourcing firms deploy the latest technologies, invest heavily in best practices, and thus often provide significantly better quality. In their case, the value created due to outsourcing is severely underestimated if we do not consider the TCO. For example, for the previous scenario if a BPO vendor reduces the error rate to 0.5% but reduces direct costs by only 15%, the TCO benefits created are 11 times greater than the difference in direct costs. Thus, traditional measures of outsourcing benefits would underestimate the benefits of such an outsourcing relationship by an order of magnitude. However, many upstart BPO firms are focusing merely on cost reductions and are ill-serving their customers as a result. We need to explicitly and aggressively shift the outsourcing debate to focus on quality. This focus on quality would offer American workers a fairer competition, and a game that they have a chance of winning. At the same time, the focus on quality would actually give the best outsourcing firms a competitive edge and increase the benefits their customers gain from outsourcing.

 

© 2006, BeyondCore, Inc.

 

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