Business Case Fundamentals: Steps for Assessing a BPO Opportunity

Business Case Fundamentals: Steps for Assessing a BPO Opportunity
Start: August 17, 2011
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At a time when companies are seeking new ways to bring high performance by controlling costs, reducing risk and increasing transparency, the use of Business Process Outsourcing (BPO) is growing among executives.

One might assume that the steps to outsource a business process are well defined and easy to follow. Unfortunately, this is not the case. In comparison to strategic sourcing for more commoditized goods or services, such as IT hardware or office supplies, each step in a BPO initiative has additional complexities and nuances, often with far-reaching business implications. More importantly, the returns achieved through a BPO initiative are strongly related to the organization’s ability to effectively execute several specific steps related to a BPO assessment.

Develop a Detailed Business Case

To ensure a BPO initiative commences with as great a chance for success as possible, it is critical to build a strong and detailed business case. While a business case is a fundamental prerequisite for any corporate endeavor, BPO business cases typically contain high volumes of inputs and variables and an extensive set of critical decisions, assumptions and modeled results. Examples of decisions relative to a BPO initiative that need to be made include determining:

whether the organization will consider an off-shore delivery model (if on-shore delivery is a requirement, it can significantly impact labor related savings);

the expected size and complexity (and therefore the cost) of the retained organization that will manage the vendor relationship, as well as perform activities outside the outsourcer’s scope;

the extent to which the outsourcer will re-badge employees (e.g., a “lift and shift” approach) and the timing of such a re-badging (impacting the expected volume and timing of severance costs); and whether to bundle associated technology within the outsourcing scope (which can impact accounting related to existing assets, the overall costs related to management personnel, and the productivity commitments to which the outsourcer may be willing to agree).

Specialized Requirements and ‘As-Is’ Costs

Depending on the specific business processes under consideration as outsourcing candidates, there are significant regulatory impacts, currency exchange implications, and third party termination/exit fees (for external services that may be replaced by an outsourcer) that may need to be evaluated. Identifying and understanding these will be critical in enabling the organization to fully understand and construct a strong “as-is” cost model.

This baseline cost model should include the sum total of all existing costs associated with the business process under consideration, including the impacts of costs associated with specialized requirements or regulatory needs and will act as a ceiling for any outsourcer’s cost proposal. Building such a baseline also supports the analysis of internal optimization initiatives that the organization may be weighing as an alternative to outsourcing.

Calculate Transition Costs

BPO business cases must not overlook transition costs. There are often upfront costs that must be accounted for in the migration of an internal business process to an outsourcer. These costs typically range between 10 to 25 percent of the overall BPO deal value and, in some cases, may be greater.

While it is possible to spread these costs over durations of up to 24 months via mutually agreed milestone payments (and depending on the type of transaction), the bulk of the transition costs are typically weighted towards the initial months of the service migration.

These costs include labor, technology, infrastructure implementation, and outsourcer personnel ramp-up, but may also cover costs associated with parallel, or “shadow,” operations for a period of time until the outsourced business process is proven.

Analyze Net Present Value

Finally, given that BPO deal terms generally range from five to eight or more years, it is key to calculate the potential costs and total savings from a net present value perspective. Such a calculation allows the enterprise to truly grasp the potential upside (or downside) of pursuing business process outsourcing.

While a superficial analysis of deal economics may appear to favor a BPO transaction, a net present value calculation frequently demonstrates that the upfront costs of establishing the arrangement leads to a solution with a total cost greater than current state operations. While a net present value calculation implicitly incorporates a margin of error due to uncertainty regarding future economic conditions, such a calculation is highly recommended as a means to validate a BPO opportunity business case.

While assessing a potential BPO opportunity is complex, and may seem daunting, approaching the process with all of the facts is critical to beginning a BPO endeavor on solid footing and will help ensure the effort’s long term success.

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