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Offshoring and Process Transformation

November 9th, 2003 · No Comments

McKinsey Quarterly (via News.com) takes a closer look at the business-process offshoring that is moving jobs from the US to countries like India, arguing that:

Companies are leaving billions of dollars in savings behind when they “offshore” back-office functions and service jobs. Such companies are merely replicating what they do at home, where labor is expensive and capital is relatively cheap, in countries in which the reverse is true.

What is needed? Nothing less than a total transformation of business processes to harness the new environments potential. And by undertaking such a transformation, many companies will find that the resulting lower cost structure releases massive new revenue opportunities even more valuable than the savings.

Merely replicating processes developed at home, however, is not the way to realize offshorings full potential. Wages represent 70 percent of call-center costs in the United States, for instance, so these operations are designed to minimize labor by using all available technology. But in low-wage India, that makes little sense, since wages represent only 30 percent of costs, and capital equipment (to provide telecom bandwidth, for example) is often more expensive than it is at home.

The way to reduce the cost of offshore operations even further is to reorganize and reengineer operations to take full advantage of these differences. In a low-wage country, the capital infrastructureincluding office space, telecommunications lines, and computer hardware and softwareshould be used as intensively as possible. For a call center, this approach can reduce costs by an additional 30 percent to 40 percent, boosting total savings to as much as 70 percent of the cost of onshore operations. The potential value for other functions moved offshore, like data entry, payroll processing and financial accounting, is similar.

Companies can boost their capital productivity in low-wage environments in three ways:

– Round-the-clock shifts
– Cheaper capital equipment
– Reduced automation

One of the examples given is from the Indian auto sector:

In India, domestic car companies have reduced the need for automation throughout the manufacturing process: They use more manual labor to load and change dies in pressing, to weld bodies, handle materials and do other functionswhile suffering no discernible loss of quality in the finished product. In this way, these companies manage to cut their assembly costs by 4 percent to 5 percent or even more and save themselves millions of dollars annually.

The new cost position can also be used to develop cheaper products for consumers in emerging markets. Consider the experience of one of India’s own local companies. The Indian automaker Tata Motors (formerly Telco) designed the low-cost Indica car for the domestic market. The Indica sells for roughly 10 percent less than cars from global OEMs and breaks even on a volume of 150,000 units, a fraction of the number global companies need. That Indicas have fewer features accounts for a small part of the cost savings.

Most of the savings come from a lower level of automation in assembly, a reengineered process, and the use of very low cost local labor to develop the car (at a quarter of what a global OEM would have spent to develop something similar). As a result, the company has grown from virtually nothing to capture a quarter of the Indian market in its segment during the past four yearsdisplacing Suzuki Motor, Hyundai and other global brandsand is now under contract to export 100,000 Indicas to the United Kingdom and Continental Europe.

This is what IBM calls “business transformation outsourcing”. In a story on IBM, Barrons takes a closer look at IBM’s approach:

The consulting piece of IBM’s services grew by nearly 50% with the acquisition of PricewaterhouseCoopers. Management consultants in that unit help demonstrate to customers the connection between computing and business outcomes. “There’s been a shift in this industry,” says Ginni Rometty, who runs IBM’s consulting business. “Customers are not just looking for advice but for business results, and they’re holding their partners accountable for showing business results.”

A direct way of showing results is to take over the business itself — or at least a piece of it. One of Rometty’s fastest-growing initiatives is “business transformation outsourcing,” IBM argot for a deal in which a customer outsources departments other than info technology. So far, IBM is offering to take over finance, procurement, human resources and customer call centers.

Tags: Enterprise Software

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