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Strategies To Maximize Value And Minimize Risks In BPO
Daniel A. Masur & Sonia Baldia
Friday, June 27, 2008
BUSINESS PROCESS OUTSOURCING (BPO) IS A burgeoning business market—it is predicted to grow to over $300 billion by 2004. The potential of BPO is impressive, with cost savings measured in some instances as high as 60%, not to mention the improved service levels that can go along with it.

BPO carries with it not only substantial opportunities, but also certain risks and uncertainties. These risks can be managed, however, so as to minimize them. This article identifies some of those risks and addresses how they can be managed so that the enormous potential benefits of BPO can be realized.

Growing Offshore Component in BPO—Risks and Opportunities
BPO service delivery solutions increasingly involve lower-cost “offshore” locations, such as India, China, the Philippines, Russia, Costa Rica and the Far East, as well as “near-shore” locations, such as Canada, Mexico and Latin America. The Internet and dramatic advances in telecommunications have helped U.S.-based customers tap seamlessly and inexpensively into the highly-skilled, lower cost workforce these countries offer.

Because of the unique legal and operational challenges associated with offshore outsourcing and the customer fear associated with outsourcing critical business functions to the other side of the globe, the majority of BPO deals to date have involved offshore vendors in subcontracting roles to traditional U.S. providers. This approach permits even the most timid BPO customer to reap at least some of the benefits of having work moved offshore while keeping the risk and responsibility of that work in the hands of the primary domestic vendor. However, as customers have grown more familiar and comfortable with offshore outsourcing, the number of customers contracting directly with offshore providers has increased significantly.

Contracting directly permits customers with a greater risk tolerance to achieve even greater cost savings. Of course, to understand and properly allocate the transaction risks, a potential BPO customer must in either case identify the risks particular to the specific offshore location and perform detailed due diligence regarding, among other things, the offshore country’s local economic, political and legal environment, data privacy and security laws, export control laws, intellectual property laws, tax laws, currency fluctuations, and infrastructure, such as business continuity capability, electric power and telecommunications etc.

India is one offshore location that has enjoyed phenomenal success in attracting outsourcing opportunities precisely because it offers lower operational costs combined with a globally recognized, highly skilled workforce fluent in English. As the demand for offshore outsourcing continues to grow, countries like China, Russia, the Philippines and other venues are competing for offshore business with Indian companies . To maintain their leading edge, Indian vendors will have to broaden their service offerings beyond application development and maintenance and high-volume/low-margin data processing and call center operations. In addition, to enable Indian vendors to reach their full potential in the IT-enabled BPO services market, India will have to fully deregulate its telecommunications sector, strengthen its intellectual property regime and establish an effective framework for data security and protection.

Applying ITO Lessons to BPO
BPO is an outgrowth of the success of ITO and BPO transactions are very similar to ITO transactions in many respects. There are, however, additional considerations and important differences that BPO customers and vendors must be aware of:

•By definition, BPO is much broader and more strategic in scope than ITO because it involves the outsourcing of the business processes themselves, not just the technical infrastructure enabling such processes, such as the data center or desktop operations.
•Because of the perceived importance of finance/accounting and other business processes, BPO transactions attract far greater scrutiny from senior corporate management—this is especially true in the wake of the Enron accounting scandal and the enactment of Sarbanes-Oxley.
•The BPO market is less mature than the ITO market and thus service delivery tools and strategies, pricing models and methodologies, and service quality measures are still evolving.
•Unlike ITO, the BPO market is not commodity based (i.e., number of CPUs provided, MIPs consumed or help desk calls answered). Because the objective of BPO is value creation for the customer, pricing is based on benefit/risk sharing and therefore involves more complex pricing structures
•BPO requires intense collaboration between the customer and vendor as it rests on meshing the customer’s processes, technology base and skills with the vendor’s offerings.
•In addition, because of the perceived importance of the outsourcing functions and the associated risk and uncertainty, there is an even greater need for customer/vendor trust, confidence and chemistry.
•BPO functional areas are often subject to greater legal, regulatory and accounting requirements such as GAAP/GAAS, HIPAA, Gramm-Leach-Bliley, EU Privacy regulations, and Sarbanes-Oxley requirements, to name a few

Because of the nature of BPO, potential BPO customers must overcome the natural and understandable hesitation to relinquish control over the outsourced processes. The business processes and associated data are often critical and companies have legitimate concerns about security, quality assurance, support, regulatory compliance, and cost, to name just a few concerns. Vendors typically derive their economies of scale by providing the same set of services to multiple customers, thereby creating concern about whether valuable and sensitive information is being sufficiently protected. BPO-related risks can be managed, however, with thorough due diligence, objective vendor selection and the careful negotiation of a contract that memorializes all underlying business terms and provides real and practical protections and enforcement mechanisms.

Implementing an Effective Vendor Selection Process
One of the most important aspects of a successful BPO transaction is vendor selection. It is critical to the success of the BPO transaction that a customer:
•Develop comprehensive and precise vendor selection criteria up-front and perform substantial vendor due diligence, including investigating the vendor’s technical expertise in the areas at issue, its track record in the market, and its financial position
•Utilize a competitive RFP selection process unless, after thorough and careful evaluation, sole sourcing makes more sense—the RFP process is by far the preferred method of selecting a vendor absent exceptional circumstances
•Require the vendor to take full, end-to-end responsibility for delivering the services.

Structuring a Comprehensive Contract
Successful outsourcing starts with a comprehensive and carefully negotiated contract. A BPO contract, like an ITO contract, must •memorialize the business terms (i.e., the allocation of legal, financial and operational responsibility and risk), • address all known and foreseeable issues, and • provide a workable framework to manage the relationship, address future change and resolve disputes. From the customer’s perspective, a BPO contract must be crafter to provide the customer with the tools to:
•Retain leverage and flexibility and manage change. Business processes constantly change and require continuous optimization. Also, the cost of technology inevitably diminishes with time and customer demands and usage may vary significantly over the life of the contract in response to market dynamics. The customer must be able to modify the scope of services and service volumes based on changing business needs and market conditions.
•Ensure competitive pricing and promised cost savings. Pricing is a critical but challenging aspect of a BPO transaction. Unlike ITO pricing which is largely commodity-based, BPO vendors are still struggling to create reliable pricing models and methodologies and there is little history regarding the evaluation and pricing of perceived risk. The market expectation is that BPO pricing will decline in the coming years as the industry matures. BPO customers must therefore build pricing flexibility into the contract that will allow them to evaluate, adjust and even re-negotiate the pricing from time to time.
•Monitor and manage service quality. To ensure service quality, the customer must establish meaningful service levels for every measurable component of an outsourced business process, a mechanism for regularly measuring and evaluating the vendor’s performance and strict monetary penalties for any failure to meet the defined service levels. Because BPO-eligible business processes are often heavily regulated, the customer can minimize its risk and exposure to regulatory requirements by tying services levels to vendor’s compliance with such requirements. Unlike the IT industry, the tools and methodologies used to deliver BPO are still evolving and vendors are understandably uncertain as to the service quality commitments they can comfortably make. As with pricing, the market expectation is that, as the BPO marketplace continues to evolve, better practices and efficiencies will emerge. To take advantage of the enhanced service levels associated with such emerging practices and efficiencies, it is important that the customer build in the flexibility and right to add, modify and delete service levels. This protects against measuring service levels that have become obsolete or are no longer critical.
•Protect its intellectual property. Unlike with ITO, issues relating to ownership of intellectual property can be complex in a BPO deal with few established best practices to rely on. For example, a vendor using its proprietary expertise and skills to reengineer a customer’s business process will strongly resist relinquishing or even sharing any intellectual property it creates or modifies, and if forced to relinquish or share, may not be motivated to add the value it is capable of adding. To protect its interests and ensure that it does not end up being precluded from using its own proprietary software or customer data in the process of outsourcing its business function, the customer must clearly address who owns what and what happens to those ownership rights after the relationship is terminated.
•Establish governance procedures to effectively manage the vendor relationship. The contract must provide an effective means to govern the critical and often complex relationship between the parties. The governance processes must provide an effective means to review and manage vendor performance, manage the touch points and interdependencies of outsourced and retained functions, escalate issues and disagreements, and resolve the inevitable disputes. This is especially true where the customer has already outsourced portions of its IT and business process environment to other providers.

BPO is a new and exciting means of streamlining business functions that can yield enormous cost savings, increased efficiencies and improved service quality. The market is still relatively immature, however, the challenges and perceived risks of BPO can be effectively managed and the promise of BPO cannot be ignored.

Daniel A. Masur is a partner in the Outsourcing Practice of Mayer, Brown, Rowe & Maw. From 1994 to 1997, Masur served as Vice President and General Counsel of I-NET, Inc., a rapidly growing provider of information technology, telecommunications services and outsourcing services. Prior to I-NET, Masur was a partner in Reed Smith Shaw and McClay.

Sonia Baldia is an associate in the Outsourcing Practice as well as the Intellectual Property Practice of Mayer, Brown, Rowe & Maw. She has been a consultant to the U.S. Agency for International Development and the U.S. Department of Commerce. Baldia has served as Adjunct Faculty in IP law at the George Washington University Law School and as a fellow at the Max Planck Institute in Munich, Germany.
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