The best way to measure the benefits of quality is to define and quantify a “Total Cost of Errors” (TCE). For transactional Business Process Outsourcing (such as claims processing, application processing, HR recordkeeping, etc.), BeyondCore defines this as the per transaction average costs specifically incurred due to errors in the output of the back-office process. For example, in a credit card application processing scenario, costs may be incurred to detect and correct errors in the applications processed by the vendor; errors in an application may prevent straight through processing at the customer side and force expensive manual processing; errors may remain undetected and affect end-customers who generate expensive customer support calls. All of these costs would not be incurred if the processing was completely error-free.  These costs, depicted in the figure below, constitute the TCE which has four major components:

• Quality Control Costs: Costs of QC systems/staff to detect and correct errors. This cost is usually included in the price charged by the outsourcing vendor but is ultimately borne by the customer. Some customers also engage in-house staff to sample and confirm the quality of the BPO vendors’ output.
• Downstream Error Costs: Costs incurred by BPO customer in downstream processes because of errors caught and corrected before the end-customer is affected. One S&P 500 bank’s loan officers spent 25% of their time catching and fixing data-entry errors. Due to errors, a midsize healthcare services company has to manually process approximately 5 to 10% of the transactions data-entered by its BPO vendor.
• Uncaught Error Costs: Costs incurred in remediation steps once an end-customer is affected by one or more errors. For example, if an incorrect loan document is issued, the customer may call in to complain about the mistakes. The expenses for each customer service call, as well as the cost of reissuing a corrected loan document would be included in the TCE. A mid-sized insurer found that due to data entry errors in its new application process, up to 10% of its customers received incorrect documents and made multiple calls to the customer service center before the errors were corrected. In fact, almost 1% of the applications required three or more customer service calls before all the data entry errors were corrected. 
• Soft Costs: Hard-to-quantify and not immediately evident costs that are incurred because of back-office errors. Soft costs may include: lost revenues due to low customer satisfaction, operational losses due to bad decision-making based on erroneous data, or regulatory risk caused by incorrect processing or recordkeeping.

 TCE: Adding up the true cost of back office errors [click for larger image]

 Simplified TCE Example Based on Global 1000 Bank Data: 

	Quality Control Costs	Downstream Error Costs	Uncaught Error Costs	Soft Costs
Average Error Rate	5%	2%	0.5%	Hard to quantify. Customer ballpark estimated $5 based on historic experiences.
Average Error Cost	$20	$75	$400
TCE Component	$1	$1.50	$2	$5

 Thus, for this process, the per-document Hard TCE is $1.00+$1.50+$2.00=$4.50, while the per-document TCE including Soft Costs is $9.50. The per-document Direct Cost of Operations (DCO) for this process was only $1. Thus, Hard TCE was 4.5 times greater than the DCO. In other words, for every $1 this firm spent on this back-office process, it spent $4.50 on hard costs related to back-office errors generated in this process.

 

While each company’s TCE ratio is unique, TCE is almost always several times larger than DCO.  What does this mean for the importance of quality versus costs, especially in the case of Business Process Outsourcing? First, if TCE is greater than DCO, then quality is more important than processing costs. Second, if outsourcing increases your error rate even slightly, it can wipe out significant reductions in processing costs.  This is because traditional outsourcing only affects DCO and Quality Control Costs, and does not affect the other components of TCE. Thus, in an outsourcing situation the TCE to DCO ratio actually increases, making quality relatively even more important.

 

© 2006, BeyondCore, Inc.

 

 

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