Seventeen of the world's leading outsourcing providers put aside their differences to discuss challenges facing the industry and how they can deliver better value for their clients through: greater alignment of expectations, collaborative dialogue between the parties and post-contract change management.

On May 24, 2007 more than 40 senior executives representing 17 of the outsourcing industry's leading ITO and BPO service providers gathered in Dallas, Texas at the Intercontinental Hotel to participate in the Outsourcing Leadership Forum's 2007 Provider Conference, sponsored by Alsbridge, Inc.

One of the innovations that Alsbridge has brought to the sourcing industry is the company's Sourcing Alignment SessionsT (SAS) process. The Alsbridge team used this collaborative tool to gather viewpoints from the provider executives in attendance. Participants were asked to identify the most significant challenges facing the outsourcing industry as seen through the eyes of the industry's largest and most influential service providers.

In a larger group setting individual views are often missed due to time constraints, reticence to speak and/or the inherent nature of group dynamics. By separating the provider executives into sub-groups that represented a cross section of service providers we were able to gain insight from each individual. Each sub-group was then guided to reach agreement and a common understanding of the challenges they had identified and the ramifications thereof. Next, the groups were brought back together and each sub-group presented their findings to the larger group as a whole, which then refined and agreed upon the conclusions.

This report documents the key findings from the collaborative workshop including how the identified challenges are impacting both the buyers and providers of outsourcing services as well as the steps that need to be taken to address them.

Participating outsourcing service providers included:

Executive Summary

While a mature industry with established players, the rapid global expansion and ever-changing dynamics of the outsourcing industry are causing some growing pains for both the buyers and providers of BPO and ITO services.

When brought together and guided through an all-day collaborative session, representatives from the leading outsourcing providers identified over 70 unique challenges facing the industry. Foremost among these challenges were the lack of innovation in the industry and the currently en vogue, transaction oriented sourcing process. While definitively separate challenges, there is a compounding effect where each challenge feeds the existence of the other to the detriment of all the parties involved. Given the top two challenges facing the industry, the third should come as no surprise: relationships characterized by a "lack of trust" and "arms length" negotiations.

Even worse than the staggering number of challenges facing the industry is the fact that a clear majority of them have a negative impact on both the buyers' business and the providers' profitability. If the buyers aren't getting what they paid for and the providers aren't able to make a profit, who is winning? The answer is that both are playing a zero sum game that no one is winning. Outsourcing relationships not only should be win-win situations - they must be.

The results concluded that addressing these challenges is essential to the overall health of the outsourcing industry and that each player - buyer, provider and advisor - must take steps in order to do so. The providers candidly admitted their own shortcomings and accepted the burden for better aligning expectations during the sourcing process. They expressed a desire for buyers to be open to innovative solutions that leverage the providers' expertise, and to focus more on business issues and less on the mechanics of an outsourcing transaction. Finally, they expressed the view that third party advisors could accelerate and enhance these changes by facilitating more open, collaborative dialogue between the buyers and providers.

In short, we all know the opportunity is there for the taking - buyers can greatly enhance their businesses while allowing for the providers to make a sensible profit. Open collaboration between all three players in the industry will make that opportunity a reality.

Industry Challenges

Participants were assigned to one of six break-out groups representing a cross section of service providers from the global outsourcing industry. Each team was asked to identify significant challenges facing the industry and, through facilitated discussion, move to a common understanding of their meaning within the context of today's outsourcing business environment.

Over 70 unique challenges were identified and then grouped into ten categories to examine commonalities and draw conclusions about the nature of the challenges. Chart 1 below displays the categories and how often they were mentioned across the break out groups of participants.

By a margin of more than 4 to 1, the inability to fund and apply innovation to client requirements ranked as the number one challenge facing the outsourcing industry today. Working in tandem with the dearth of innovation is the second ranked challenge - a transaction oriented sourcing process that is overly focused on cost reduction and risk shifting at the expense of solving the buyer's business problems.

From the buyer's business side, providers hear talk about innovation, yet the reality of the sourcing process and selection criteria fails to bear it out. Providers revealed that buyers routinely push toward commoditized solutions and use "level playing field" approaches to procurement that directly inhibit innovation. Across the groups, providers complained of common buyer behaviors that inhibit innovation:

• Requests for service levels that are not focused on achieving business objectives
  
  
• Lack of C-level attention essential for consideration of innovative solutions.
  
  
• Governance approaches that are wrong-sized or focused on activities over results.
  
  
• An inadequate internal change management activity after the deal is signed.

This latter fact rubs against the additional observation that when providers do include change management services in their offers, they are frequently forced to remove them from scope in order to win the deal.

In addition to the buyer behaviors that inhibit innovation, the providers were very candid about their own limitations:

• The struggle to keep pace with technology changes.
  
  
• Meeting the global demand for highly trained and skilled resources.
  
  
• Turnover and lack of experienced talent at the client-facing, account management level.

Results of the collaborative session with the providers brought fresh insight and added depth to prior research conducted by Alsbridge published in Q1 2007. That research report, The Outsourcing Innovation Crisis, took a look at the evolution of the outsourcing industry, evaluated the operating margins of leading outsourcing providers over three decades and concluded that the impact of declining margins and slowing revenue streams has pushed providers to a breaking point.

As Chart 2 indicates, revenue growth rates declined from almost 25 percent between 1974 and 1987, to less than 10 percent between 1996 and 2005. Operating margins declined even more sharply from an average of just over 14 percent to roughly 6 percent over the same time period. As margins dropped below 10 percent, providers lost the ability to hire and retain the best people and were forced to significantly decrease their investment in research and development, which ultimately made it impossible to fund innovation and apply it to their clients' businesses.

Other significant challenges identified by participants include the need for stronger, more collaborative relationships and the need to close gaps in expectations between the parties involved in defining, executing and delivering outsourcing solutions. Participants specifically pointed to provider/client relationships as characterized by a general "lack of trust" between the parties. Similarly, they pointed to the sizeable gaps that often exist between the client's, provider's and advisor's views of specific technical, business, and delivery requirements due in part to the "arms length" nature of the procurement process.

Impact on Buyers and Providers

So we know that challenges exist, but what impact are they having on the industry? Once specific challenges were identified and discussed, each break-out group positioned individual challenges on a matrix reflecting their relative impact (from low/negative to high/positive) on the buyer's business and provider's profitability. Rankings for each challenge were developed from the plot points provided by individual break-out groups.

Certainly a challenge might favor one player at the expense of another (i.e., a challenge for the provider might be an advantage for the buyer). And while the results did indeed show this to be true, it was in a minority of the cases. Looking across all 71 industry challenges, a clear majority of them were identified by participants as having a "neutral to negative" impact on both the buyer's business and the provider's profitability as indicated in Charts 3 and 4 below.

Although the two categories - buyer business and provider profitability - may at first glance seem disparate, they are inextricably linked. If the buyers fail to see a positive impact to their business, then the providers are hardly in a position to demand higher profit margins. Conversely, if the providers are unable to make a sensible profit, then they will be in no position to provide value to the buyers.

Providers stated that clients expect and need more innovation but that in today's outsourcing environment it is sorely lacking. Meanwhile, provider margins continue to shrink leaving little capacity to fund innovative solutions for the buyers. While admitting that much of the burden for improving their profitability lies with them, participants spoke very pointedly about the nature and scope of the sourcing process as a significant area needing improvement from the buyer side.

Using standard procurement processes may be fine when buying certain types of true commodity product, but cannot work when buying complex services which will be delivered over a period of years to a changing client in an ever-changing world. Doing so results in the buyer receiving a sub-optimal solution because the wider knowledge and expertise of the market is not exploited. Better by far for the buyer to define their current state, objectives, what the results should look like, and any constraints or complications, and let the providers propose the best solution - they, after all, have the expertise to do this best. Of course, this makes direct cost comparisons between proposals more difficult because the solutions proposed will vary - but that is a small price to pay for getting a solution that actually solves the buyer's problem or achieves their business objectives.

Even worse than getting "lowest common denominator" solutions, current sourcing processes are setting up outsourcing deals to fail altogether. If the buyer negotiates a deal where the pricing does not reflect the real, underlying economics of the work involved - i.e., the buyer appears to be getting "something for nothing" - then it is going to be uneconomic for the provider and therefore unsustainable. In that case, only two things can happen:

• Either the provider will find ways to increase its prices (generally through change control) to make up the shortfall, in which case the client will pay more than they expected.
  
  
• Or the provider will cut back on the services it delivers for the price, in which case the client gets less for its money than it expected.

In either case the deal is failing, and it has to fail - no provider can afford to keep delivering on a loss-making contract. The cost of continuous re-negotiation - or in the worst case termination - is likely to far outweigh the benefits of the "low price" negotiated up front.

Addressing the Challenges

Providers readily accepted the burden for improving the alignment of expectations during the sourcing process; however, they told us that advisors can accelerate much needed change by encouraging more open dialog and discussion between a wider range of provider and client executives. Providers made it clear that they want to see changes in the sourcing process that provide for:

• Greater alignment of expectations across advisors, buyers and providers.
  
  
• A more collaborative environment allowing greater dialogue between the parties.
  
  
• Better frameworks for effective post-contract change management.

In short, providers want a process that costs less, moves faster, and focuses more on business issues and less on the mechanics of an outsourcing transaction. They expressed a desire for buyers to become less risk averse and more open to new solution approaches by including requirements for more innovation in the sourcing process. Further, they ask that the buyers be willing to accept at least some of the burden of funding innovation through a willingness to consider more value added pricing in the offers they consider.

In conclusion, if each party - buyer, provider and advisor - will acknowledge and address these challenges, then outsourcing deals will begin to consistently deliver on their promise. Open cooperation and collaboration in the sourcing process will generate greater value to the benefit of all the parties involved.