The New, New Thing in India: Software + BPO,
The Next Generation Outsourcing Model
The last couple of years have been a real test of resilience for the Indian IT and BPO (Business Process Outsourcing) industry. The supply side has taken a hit due to skill shortages and attrition rates of 18-24 percent, and salary inflation at 12-13 percent. The demand side has taken a hit due to the effects of the slowing US economy and the weakening US Dollar vs. the Indian Rupee. Despite these factors, the Indian outsourcing sector continues to grow by double digits, re-validating its strong and sustainable value proposition. Industry watchers seem to agree: “Positive market indicators and a proven track record strongly support the optimism of the industry in achieving its aspired target of $60 Billion in software services exports and $73-75 Billion in overall software and services revenues by 2010.” [Nasscom (National Association of Software and Services Companies) Report 2008].
The industry is transitioning into its next phase of maturity and will undergo some positive advances:
- India is increasingly becoming the “go-to” destination for more value-added services, with global companies setting up operations and technology hubs in India to build talent and know how.
- Company operations are tightly integrated with technology, resulting in a shift away from IT and BPO only services to the outsourcing of complete end-to-end operations that are being delivered via Software + BPO Services.
- The early adopters of outsourcing are continuing to lead the foray into the Software + BPO Services model: Banking and Capital Markets, Fund Administration, Healthcare, Insurance and Airlines.
- Outsourcing is finding its place in a global company’s strategic plan because it provides advantages beyond just cost savings by building revenue enhancements and product development capabilities. The other big advantage is that India’s local economy is growing at GDP +7% which provides the incentive of being present in India as an access point to one of the most attractive emerging markets in the world.
So What is Software + BPO Services?
The best way to understand the model is by way of an example. Here is a case study of a company that transformed its Finance and Accounting (F&A) operations by adopting the software + BPO Services model. The Company is a $7 Billion global contract manufacturer that was looking to outsource their accounts payable process as part of their overall BPO strategy. They had two options: (i) keep their F&A system and outsource the people part to a low cost geography, or (ii) outsource the entire software + people part to a vendor. The total headcount supporting the accounts payable process was 75 FTEs with an average annual transaction volume of 800,000 invoices.
The accounts payable department had numerous challenges:
- Utilizing obsolete technology which was integrated to multiple ERP systems and interfaces. Due to the cost pressures on the business the company could not afford to upgrade its technology in a 2-3 year timeframe
- Lack of visibility into service levels
- De-centralized procurement process with many inefficiencies
- Labour-intensive accounts payable process with low levels of automation
- High costs incurred due to duplicate invoices
The Solution
The outsourced service provider replaced the Company’s F&A system with their best in class customized Software + BPO Services solution that gave the Company benefits in the areas of automation, process improvement and labour costs.
Some of the features of the solution were:
- Eliminated future technology investments
- Process, technology and people solution:
- Took over the mail room functions and automated 70% of the functions (e.g. scanning of invoices)
- Implemented a workflow routing and approval process
- Implemented a tool to consolidate and unify data entry from multiple ERP systems
- Provided consolidated MIS reporting from the multiple ERP systems
- Improved the client services and support function and moved it to a low cost location
- Implemented a vendor Web portal that further reduced redundant manual intervention
- Improved the audit and control processes to best in class
- Continuous technology and process improvement through Six Sigma initiatives
- Year-on-year productivity gain
- Risk mitigation through complete solution transition methodology and processes
- Transparent SLA management and improvement
- Robust governance structure and real-time process improvement visibility
If the customer were to have continued with their disparate F&A systems and outsourced only the manual BPO Services to the vendor, they would not have been as successful. They would have benefited from labour cost advantage and minor process improvements, but those would have been limited by the inflexibility of their internal F&A system.
Business Benefit
The solution provided over 65% cost reduction due to reduction in labour costs, automation and process improvements. All future investments in technology have been eliminated. All pricing was done on a per-transaction basis. The Company still has the benefit of control through partnership transparency, risk and reward metrics to promote continuous improvement, Web-based tools that track utilization and SLA achievement metrics.
Repeatable Processes Lead to a New Business Model
India’s dominance as the premier location to outsource IT and BPO has led to a build-up of a talent pool that is well positioned to offer Software + BPO Services. Teams have come to understand that they can now patent repeatable processes and package into offerings consisting of a software platform and extended services. This was done successfully in the US by companies like ADP (payroll processing) and Exult (HR processing). A repeatable process was transformed into the combination of industry best practices, services IP, and an existing software platform. This service was offered to the customer on a per-transaction basis which could be easily benchmarked and tracked against internal processes and other third party solutions.
Further, global R&D spends are showing indications of supporting this trend of outsourcing. Cumulative US R&D related investments internationally are growing at over 15% annually. The annual incremental increases are also growing rapidly. While the investments are fairly divided among different countries, India and China still stand out. 10% of the $40 Billion increase during 2006 went to these two countries.
The Software + BPO Services model has the following advantages:
- Opens up new channels of revenue enhancement and Gross and EBITDA margin improvements through software plus services synergies
- Mitigates the risk of customer-side technology obsolescence
- Mitigates company-side labor and technology maintenance overheads
- Converts Company fixed costs into variable costs
How Does Transaction or Variable Pricing Work?
*Chart by iGATE
- The Software + BPO Services provider prices the offering based on demand forecasting of the Company’s volume requirements. Volume bands at set prices are determined and agreed with the customer.
- One price to the customer results in a fixed margin to the service provider. The margin cost components are labor, technology and process. The margin flow through to the bottom line can be directly influenced based on further optimization and automation to the existing process as well as technology development and maintenance. SLA compliance makes sure quality is maintained at all levels.
Some Early Adopters: Financial Services
The Software + BPO Services model is being adopted in various forms depending on the core skill set of the service provider. Software product companies are most often using their existing platform to launch services. In the case of IT services companies, they end up either acquiring a product or licensing it and investing in the infrastructure and hosting environment.
However, the adoption of Software + BPO Services has been slower than expected due to the fact that higher value-added services tend to involve core operations where customers prefer to take the more conservative approach to outsourcing (i.e., handover one process at a time).
The early successful adopters of this model have been the bulge bracket investment banks that used the Software + BPO Services model within their captive centers in India. One of the critical success factors was the transparency by which costs were attributed per process. Hence the benefits after benchmarking to the original operation could be determined more accurately. The comparison has proven more difficult to do in the case of 3rd party Software + BPO Services providers.
A good example of a successful captive case study is large German Investment Bank. The bank set up a captive facility in Mumbai a couple of years back where they recruited an India-based team of traders that used the Bank’s proprietary equities analytics platform to conduct trades for the New York, London and Hong Kong desks. In other words, a “follow-the-sun” model at a fraction of the costs. This trading team further recruited a team of engineers that maintained and hosted the platform in India and interfaced with product development engineers in Russia.
The Fund Administration sector has adopted the Software + BPO Services model as well. The global hedge fund market is approximately US$2.9 Trillion in assets. In spite of the financial market turmoil in the last six months — where hedge funds were the worst hit — single manager hedge fund assets rose from $2.4 Trillion to $2.9 Trillion AUA (Assets under Administration) which is an annualized growth of 20%. Quality of Service is an important differentiator in this sector and is driven by software, skill (calculations based on complex trade strategies), and availability of a 24/7 service window.
Historically, Fund Administration [of which Hedge Fund Administration (HFA) is a part] was done out of high cost locations such as the US, Ireland and Luxemburg. The Euro’s appreciation against the US Dollar has impacted the cost of operations in these locations and it is now shifting to Asia (primarily Singapore and India). Tougher industry guidelines have forced fund managers to demonstrate their ability to effectively manage risk, provide accurate and auditable net asset value calculations, and provide the required level of investor reporting and transparency. Privacy concerns are being traded for more cost-effective outsourcing solutions. Commercially, HFAs are pricing their services as a percentage of AUA. Other administrators are pricing per transaction, or a monthly/quarterly subscription fee for direct usage of the software Software + BPO Services as opposed to costly up-front licensing fees and on-going annual maintenance charges.
The travel industry is the other sector which has transitioned to this outsourcing model. However, one could argue the adoption has been slower than expected. Due to the higher price of fuel, airlines are being forced to outsource their Revenue Accounting operations to 3rd party Software + BPO Services companies either piecemeal or end-to-end. An example of this sector transition is a leading Middle Eastern airline outsourced its entire Revenue Accounting function (150 FTE) to an Indian Software + BPO Services company. The Indian Software + BPO Services company has a total of 70-80 FTEs running this operation for the airline. The airline’s Revenue Accounting staff has been reduced to 4-5 employees who now log into the outsourced revenue accounting platform directly. The rest of the 145 FTEs have been successfully re-deployed to other functions within the company.
Where Do We Go From Here?
The companies that were first to adopt this model all took similar paths — bold steps — transitioning from rudimentary transactional processing to true innovation over time. However, it is important to note that while the path was similar, the time-frames were not. The investment banks have been at it for the last 9-10 years while the airline sector has adopted the service in the last 5 years. And the Fund administrators have been at it only in the last 2 years.
But the companies also shared several characteristics: They were committed over a long period of time. They were clear that the key business driver had changed from cost and skilled capacity to world-class talent and innovation output over time. And they saw that the outsourcing centers’ key competencies were now cutting-edge knowledge that would enable them to become centers of excellence and global hubs.
We believe that the model is showing signs of acceptance and will become mainstream in the next 24-30 months. This shift is a real opportunity for Indian pure play BPO and IT Services companies to develop their vertical solutions around Software + BPO Services offerings. We believe this will be an interesting avenue for investment into the outsourcing sector in India and result in the promotion of IP creation in the end.
If you would like to discuss this topic or have an interesting company that fits this model, please contact me at gautam@battery.com.
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