Bridging the Outsourcing Value Gap

Capturing the Elusive Value Beyond the Business Case

Despite the seemingly continuous change the outsourcing industry has experienced over the last 40 years, one constant question lingers: “Is the client realizing the value it expected from its service provider?” That this question remains present speaks not only to the challenges of extracting long-term and sustainable value from a complex, multiyear relationship, but also the quickened pace of change and the impact that digital has added.

Clients have historically realized operational cost savings by shifting roles to an offshore outsourcing model, possibly assisted by automation. Some organizations also realized cost savings associated with eliminating redundant technology, facilities or other overhead, or even soft savings resulting from better service and agility. The bulk of the financial business case, however, has always been labor related.

Those labor savings are and will continue to be a minimum requirement for any first-generation or multigeneration outsourcing deal. The availability and acceleration of digital tools – along with increasing competition for quality talent, current economic conditions, and increasing demands from the business for accurate and timely insights – are fundamentally changing the role that business process outsourcing (BPO) needs to play. It is more important than ever to extract additional or downstream value from an outsourcing contract through transformation and innovation.

With the path to closing a deal typically highly focused on labor savings, the other aspects of potential value (service quality, global delivery capabilities, innovation, business outcome, etc.) become relegated to the back burner – and often stay there. For many outsourcing clients, this creates a gap between the value ultimately realized and the greater potential downstream value associated with continuous improvement, service evolution, optimization, and transformation that is promised in the sales process. The Hackett Group refers to this as the “value gap.”

Outsourcing creates tangible value beyond cost

The Hackett Group’s 2022 Business Process Outsourcing Study examined the value that clients realize from current outsourcing arrangements – cost and otherwise – relative to their expectations.

We found that after a modest, single-digit cost reduction in the initial year of the relationship, year-on-year savings rose to 10% after the initial period and are projected to increase over the remaining term. The ongoing impact of transformation and other performance improvement factors can be key to accelerating the scale of predicted cost savings over the contract life cycle.

On the other side of the value equation, outsourcing clients reported modest initial improvements in cycle time, service quality and customer satisfaction, but much more significant annual gains in subsequent years as they optimize the relationship.

Transformation increases in importance for next-generation contracts

The study also assessed the value drivers that clients are seeking in their next BPO contracts. Several transformation-related objectives – particularly digital and process transformation and the ability to extract data-driven insight – rose significantly in the ranking of anticipated importance for the next contract relative to their importance for current contracts, while emphasis on traditional value drivers such as cost reduction dropped. This shows that clients are looking for business value and looking to their BPO partners to be the agents of change.

Supporting this insight, in our Digital World Class Matrix™ report Finance and Accounting Outsourcing (FAO) Solution Provider Perspective, nearly 53% of customer respondents listed cost reduction as their original objective for the current BPO contract, with only 28% focused originally on transformation capability. When comparing qualified service providers, differentiating factors will likely include alignment of capabilities and characteristics for the prospective partners with each client’s unique business objectives and needs.

Outsourcing meets business expectations for most value drivers

Though contracts are delivering value against traditional expectations, there is an important message in these findings: what is defined, contracted and measured is what gets delivered. Legacy BPO contracts have customarily focused too heavily on transactional objectives such as cost reduction and not enough (if at all) on value-based or digital transformation objectives. Part of the reason those contracts fall short of expectations for digital transformation is that they were never set up to deliver it in the first place.

Service providers not meeting digital transformation expectations

Most companies are satisfied with their efforts to modernize, migrate or consolidate core transactional business applications. But nearly two-thirds said that smart automation technologies adopted through their outsourcing vendors failed to meet business expectations. Over one-half were not satisfied with the ability to use data to drive insight and improve decision-making.

Implementation of smart automation – including early attempts at artificial intelligence (AI) and advanced analytics solutions – is maturing, though. As that happens, we expect clients to begin seeing greater value from these capabilities. For example, The Hackett Group recently studied the potential impact of generative AI on more than 80 selling, general and administrative (SG&A) business processes. The analysis concluded that adoption could reduce SG&A costs by 40% and full-time equivalent (FTE) staff requirements also by 40% over the next five to seven years as the technology evolves and organizations learn how best to apply it.

Getting to the heart of the value gap

From the BPO Performance Study results, it is clear some companies are successfully bridging the value gap, while others are not. The potential for transformational value exists, but clients and their service providers must work together to mine maximum value from the relationship. There are various barriers to unlocking transformational business value from an outsourcing relationship. In our experience, the root cause for much of the value gap falls into two areas: the contract and governance.

Incentivizing transformation in contracts

Services and performance standards should be contracted in a manner that is truly integrated with the commercial model, aligns with the value that the client organization expects to achieve and recognizes the environment within which those services will be consumed. For example, if the commercial model is tied to FTEs, then the contract should not only specify year-over-year FTE reductions, but also describe the initiatives, accountability for investments and key dependencies that enable those annual reductions. Beyond those contracted reductions, the contract should provide effective mechanisms to incentivize the service provider to not only continue driving efficiency and productivity, but also identify and deliver other tangible business value opportunities.

Traditional FTE-based pricing is still the primary pricing mechanism for current outsourcing relationships. It will remain the most significant pricing mechanism for the foreseeable future – but its emphasis will drop as use of outcome-oriented pricing models increase. FTE-based models offer greater transparency and ease of benchmarking, but they do not reflect the increasing demand for relationships that link suppliers’ objectives more closely to those of their clients.

There are many other examples of pitfalls in contracts that can impact or limit transformation, including:

• The service provider negotiated the ability to baseline performance following transition, and ultimately set the performance bar too low because there was no historical data to substantiate current performance.
• The service provider included an annual pool of innovation hours in the deal – but these are being used for day-to-day projects and backlogs, if at all, and not for transformational initiatives.
• The contract includes a gainsharing clause that requires both parties to agree on details that are not yet known and stipulates that if there is no agreement, then the parties will follow a governance process that perhaps was never designed or implemented.

The overall approach to pricing outsourcing services and shaping effective commercial mechanisms to incentivize performance is complicated and beyond the scope of this paper, but the point is this: a contract and its pricing mechanisms may be contributing to a value gap. Unless a contract specifically stipulates and incentivizes transformation, it is often treated as something to address later – after the transition and stabilization period – which typically consumes both parties for some time.

Governance

A value gap can almost always be traced to insufficient, poorly defined or poorly executed governance – that is, the management of the relationship and performance. The Hackett Group’s BPO Performance Study shows that executives recognize the importance of governance, with 69% of participants surveyed rating establishing clear governance and accountabilities as highly important for the next planned contract renewal or sourcing model change – a higher percentage than for other areas studied such as executive engagement, funding and program management.

Day-to-day operational governance is generally successful

Clients and services providers typically do a good job at the tactical day-to-day governance required to manage the outsourcing relationship, including basics such as issue and risk management, service performance management, change control, demand management, and contract management. These are focused on achieving the original business case – ensuring services are performed at a contracted level of quality for an agreed price.

Governance involves conflict resolution and difficult conversations, with the goal being to drive accountability on both sides of the relationship. It is human nature to want to avoid conflict on a day-to-day basis, so it is important to have the right people in governance roles.

Governance is more critical as the relationship moves up the value chain

It’s the more strategic aspects where governance often falls short, contributing not only to value leakage of the original business case but also a value gap. Clients and service providers should have a governance process specifically for service evolution, innovation, and transformation. Many do have one, but it isn’t robust enough. Without robust governance focused on long-term continuous improvement and transformation, clients tend to wait for the service provider to bring innovation to them – or they look for it elsewhere.

All too often innovation is a “check the box” exercise that involves bringing in an expert to a quarterly meeting to share what the provider is doing with other clients. This can fall flat and lack the actionable content that clients need. While the transformation described is real, it may not apply to the client’s operations, is not relevant to the executives in attendance, or has not been approached from a pragmatic and actionable perspective.

Governance is not just the responsibility of the client

Both the service provider and client are responsible for executing governance, and both can be culpable. Clients often blame the service provider for lack of innovation, but sometimes this is the direct result of the client not involving the service provider in strategic discussions about the technology road map, major initiatives, or goals and objectives for the function(s) involved. A service provider cannot bring forward meaningful transformation without the right context and a seat at the table for strategic discussions. This is particularly true when disruptive technologies enter the market because current applications of AI technology are in many industries.

Establishing a governance model and processes that go beyond tactical, day-to-day operations is essential – but it is easier said than done.

The foundation for successful transformation

An effective approach to innovation in outsourcing requires three pillars: define, fund and enable.

Define: Distinguish clearly between service evolution (continuous improvement) and transformation – and treat them differently. Ongoing service evolution that tracks what others are introducing as standard across the BPO industry – in both process and technology – is table stakes. Transformation is a step change – specific projects with clear objectives, outcomes, responsibilities and business cases.

To be truly successful and close the value gap, future BPO relationships need to take a broader approach to enabling transformation. A multilayered approach creates the structure for driving people, process and technology transformation.

Fund: Transformation and innovation don’t happen in a vacuum. They require investment. The right investment mechanisms, targets, and incentives are key to driving the collaborative and challenging behaviors that are fundamental to successful innovation and value creation.

Enable: Transformation and innovation require a flexible and enabling framework, a culture that encourages mutual ideation, and a top-down business and relationship environment that rewards success – building momentum for change.

If any one of these is weak or missing, efforts to derive value from innovation will struggle.

Look beyond capabilities when approaching the next contract

When approaching a new contract – whether a next-generation contract with the current service provider or initial contract with a new provider – it is important to consider the degree to which solution providers and offerings are producing tangible performance improvement and measurable business impact.

For example, The Hackett Group assesses offerings based on two dimensions – capability breadth and market penetration, and business value and impact – by gathering performance and experience data from solution provider surveys and strategy sessions, buyer reference checks, and client surveys. From this, we position service providers in one of five categories:

• Enterprise leaders are offerings with high capability and broad reach.
• Innovators are more specialized offerings that may produce market-leading results but are more limited in breadth or other areas such as integration with other solutions.
• Challengers are offerings that are moving toward greater value realization and capability breadth but are not yet fully established.
• Emerging offerings are still developing and defining their capabilities and go-to-market strengths with limited market share but are showing signs of growth.
• Digital World Class^® offerings have high capability and proven results that move companies toward upper-quartile performance in both operational excellence and business value.

Don’t wait to start bridging the value gap

There is real value for the taking that does not require dragging an organization through a retendering or potential switch in providers. Across industries, outsourcing relationships exist where clients and service providers are aligned contractually, operationally and strategically. In a perfect world, you properly structure the deal and contract to incentivize both parties on the front end and put in place transformation-specific governance capabilities for long-term value capture. But if you’re already a couple of years or more into a contract and looking to bridge the value gap, know that there are stepping stones just below the surface that can help you close the gap.

Are you ready to realize greater value from your outsourcing contracts?

The Hackett Group, a leading global strategy and operations consulting firm, offers advanced outsourcing consulting services that set us apart from conventional sourcing advisors through:

• Broader focus: We aim to optimize process performance rather than simply getting the best price.
• Innovation: Most outsourcing arrangements focus on static service levels over time. We strive to build innovation and continuous process improvement into our clients’ outsourcing contracts.
• Proprietary insight: We leverage our renowned benchmarking and business best practices database to target measurable improvements in process efficiency and effectiveness.
• Experience: We combine deep sourcing strategy and implementation experience with complementary expertise in process transformation and core business functions. We have advised on hundreds of transactions, with billions spent in the past five years.

Contact The Hackett Group to start your journey toward bridging the value gap.