Sunday, May 16, 2004


The Myth of Lowest Bid = Lowest Cost
A large number of companies in the insurance sector, today, are driven by the "lowest bid" mentality. Many have gotten it down to a science in terms of their purchasing departments literally dictating the price points for different services. Such practices do work well for routine, time and material consulting situations. These consulting engagement are "retail" by nature and are tactical steps towards lowering overall consulting expenditures. Further, these engagements usually do not require high-end services management or well-defined service level agreements, which are core features of strategic outsourcing. But the trend is now towards the outsourcing of knowledge-centric business processes and IT applications which require development / maintenance of complex solutions and experimentation with new ideas than just hiring bodies. Applying the same "retail" yardstick to outsourcing is detrimental to deriving greater value out of each dollar that is spent. Thus, for knowledge centric and strategic outsourcing ventures, it really comes down not to costs alone but the value that the end-user must benefit from in terms of real financial savings, customer satisfaction, certainty of outcome, scalability, predictability, deployment of competent staff and velocity.

Based on my experience and observation, many organizations tend to take a narrow view of costs in terms of dollars only. The fact of the matter is that real costs are a function of time and dollars that an organization is willing to invest or spend in improving its revenues or profitability. Akin to the "total cost of sale" for a vendor, clients also need to put a value to the time that is spent right from preparations for outsourcing to a steady state of affairs.

The Importance of Customer Satisfaction

Smart organizations have a strong desire to derive a high level of customer satisfaction from their outsourcing activities. Consider your own personal lives. How many times you have been willing to pay more for goods or services because you experienced a high level of customer satisfaction? Well, the same applies to insurance companies, as well. The level of attention that buyers get, dictates their behavior. Good examples to see are the CEOs of several successful, large offshore outsourcing vendors who have been in the forefront selling their services to CXOs. Clients also have to do the same internally. They must take a "customer-centric" view and insist upon the outsourcing providing giving you the same commitment - at no extra cost.

Defining the SLA and measuring it

Defining service level agreement and measuring how it is being met may sound basic and obvious. Even with the maturation that offshore outsourcing enjoys today, one is surprised to see the obvious being omitted with frightening regularity. Without the right metrics and measurement of SLAs, any outsourcing venture is bound to fail resulting in cost over-runs. Clients have to see themselves as enablers for exceeding customer expectations. It is only then that they will get more value for each dollar that is spent for outsourcing activities.

Watch Out for the Pitfalls

In most cases, offshore outsourcing is a financially compelling and prudent alternative to providing services in-house. Let us say that reducing cost year over year is a key measure. It is critical that the outsourcing partnership is crafted in such a manner that the provider has the incentive to help you meet your goals.

Like most companies, the provider's goals are to grow their revenues with existing clients and increase profitability. For existing relationships, changing the mode into year-on-year cost reduction is difficult to achieve. The first reaction from vendors will be to rotate out their more experienced and marketable staff leading to service degradation and no prizes for guessing, potentially increased costs to the client!

Vendors' failure to scale is another potential pitfall related to costs. Your outsourced provider's ability to scale is critical to your changing business needs. Inspite of claims to the contrary, vendors are loath to carry an on demand "bench" of skills that the client can pick from at will. If they do, I can guarantee you that the client is paying for it in some hidden costs. The inability of the vendor to scale can affect your time-to-market for products or services and result in lost revenue opportunities.

Key Best Practices

Fashioning multi-year, multi-million dollar spends with outsourcing vendors is a smart way to ensure predictability of costs for the client. It is good for the provider, too, since they can count upon these revenues year-on-year. Several application management outsourcing (AMO) contracts signed between insurance companies and providers in the US and the UK are good examples of cost predictability.

Large insurers like AIG have found the offshore outsourcing model financially compelling. Not too long ago, went in for a "Build, Operate, Transfer" (BOT) model, acquired the staff from their offshore provider and set up large captive units. These units are now providing new, value-added services to other global entities within the parent corporation.

New grounds are being broken daily by smart outsourcers. Large and even medium-sized Insurance companies now see intelligent outsourcing as an important lever to reduce costs. Claims processing, claims adjudication, travel and expenses and several other business processes have been successfully outsourced to offshore providers. Many of the new business process outsourcing pilots that have been proven to be successful are now being scaled into full production mode resulting in significant cost savings and increasing the profitability of insurance companies in Europe and the US.

Reaction to Change

Finally, a key aspect of cost is an outsourcing venture is "velocity" - that is, it's ability to react to change in business conditions. Events like terrorism, wars, political disturbances and weather (hurricanes, storms, etc.) have a direct and measurable impact on the business of insurance companies. Outsourcing partnerships must be able to react to such changes in business swiftly and effect dramatic (and sometimes, traumatic) corrections in scale of operations. The build-up of cost structures for outsourcing ventures should allow for flexibility on both sides to increase or reduce the size and scale of the venture.

Remember, that these are your systems that are being built. It is all about the money - and yet not about it only!

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