How to Manage and Mitigate Offshore Outsourcing Risks - Operational

What are the real risks in offshore outsourcing both ITO and BPO work? Ravi Aron, assistant professor, Carey Business School, Johns Hopkins University and a research partner with the Wipro Council for Industry Research, says understanding those risks helps buyers set up procedures to mitigate them, making their offshore engagements more successful.

Aron, who is also a Senior Fellow at the Phyllis Mack Center for Technology and Innovation at the Wharton School of Business, The University of Pennsylvania, says there are three types of risks buyers must worry about:

Operational risk: The propensity of a process to break down and result in less than acceptable quality of work
Strategic risk: Losses that result when the offshore supplier behaves opportunistically
Composite risk: Risk that arises over time from a combination of factors like erosion of competence and loss of flexibility.

Operational risk

Aron says operational risk is simply "getting output you don't like. The quality is not there." The output has too many errors, mistakes, and defects.

For example, in ITO, the application does not have all the functionalities that the buyer asked for. Or the code has bugs. Or there could be cost overruns or delays in delivering the system.

Turning to BPO, there could be mistakes in underwriting in insurance work. In call center outsourcing, the offshore provider of services does not achieve first-call resolution metrics; the buyer wants 80 percent but the supplier can manage only 60 percent. In supply chain outsourcing, the accounts receivable/accounts payment closures have too many errors.

"In all cases, the supplier's quality is less than what's mandated in the service level agreements (SLAs)," explains Aron.

The causes of operational risk

Source: Ravi Aron

Aron says the principal reason this risk exists is "because of the complexity of work. It takes a while for the offshore organization to understand what the buyer wants."

Another reason operational risk occurs is because of business unfamiliarity. "I think the risk of cultural context unfamiliarity is overstated and the risk of business context unfamiliarity is understated," says Aron. The professor says you can teach Indians why Americans love Halloween. "But few buyers estimate the real hazards of trying to transfer the business context."

He gives an example. The offshore company manages the back-office corporate treasury function for a bank. The bank instructs the provider of services to reconcile the various invoices and then make payments to a corporate customer (a large retailer). The amount in question is about US$60 million of business receipts for the retailer. The bank has a reputation for speedy and accurate reconciliation, which helps in improving the float for its customers. This is a part of the bank's value proposition: to help its customers get better working-capital management through improved management of its float.

However, the offshore supplier doesn't understand the concept of float or why it's important to these customers. So it transfers the $60 million a couple of days later than usual, causing the customers to lose the float on that amount. The bank's customers are angry. The supplier just didn't understand why a two-day delay was so much of a problem. "Business unfamiliarity can be a serious issue," says Aron.

Managing operational risk

How do you manage operational risk? Aron says there are four ways to do this:

Knowledge transfer and management. The professor says North Americans and Europeans typically "under invest in knowledge transfer." The Japanese, on the other hand, take this matter seriously. "When a Japanese company outsources its back office to a Chinese supplier, say in Dalian, China, its knowledge transfer investment greatly diminishes the problem of business continuity and transfer of business context," says Aron.

He says buyers shouldn't assume "the supplier will understand." And he insists "there is no such thing as too much training." He also suggests creating joint knowledge repositories and deploying collaboration mechanisms such as wikis, blogs, and RSS feeds via corporate intranets.

Metrics. Aron says metrics "have a huge impact on operational risk." He says buyers must make suppliers understand their definition of quality.

According to the professor, "through well-defined metrics the supplier can easily understand and greatly reduce operational risk." He suggests SLAs should identify key factors of process quality. Then, buyers should measure continuously and in great detail. He points out VelociQ, a mechanism Wipro designed to track an elaborate system of metrics for BPO and ITO projects, "is very granular. It allows a company in Manhattan to see what's going on in Mumbai in real time," he explains. Chennai, India-based OfficeTiger (acquired by RR Donnelley in 2006) has a similar mechanism.

Transition management. "Buyers sign a contract, fly to India, take photos in front of the Taj Mahal, give everyone T-shirts and coffee mugs, then go home," he says. That's not how he suggests handling transition management.

The professor says the first couple of months typically go well, because the problems revolve around clarification. Difficulties generally don't crop up until later. "That's when real problems of output or quality appear. That's when the rubber meets the road," says Aron.
The message here is "don't overlook transition management because it can reduce operational errors by up to 15 percent," he reports.

Monitoring versus control. "Don't over control and under monitor," says Aron. Controlling is telling them how to do their work. With monitoring, buyers establish objectives (what to do) but leave the "how" to the provider's managers. Buyers can safely delegate if they verify. However, they need a granular system of metrics and a mechanism to track SLAs (like Wipro's VelociQ) so they can verify from the earliest moment.

Unfortunately, companies either do not monitor enough or "the metrics can be too skimpy or not well understood," he says. He quotes Ronald Reagan who said "Trust but verify."
Publish Date: June 2009 outsourcing-offshore.com

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