Out Growth

Insurance companies today are battling a number of issues, including sinking margins, competitive pressures, globalization, sweeping regulatory changes, and product commoditization. To react to the changing landscape, they have had to alter the risk-averse mentality that has traditionally driven their business. As part of a plan to break from the past, insurance executives must create leaner, more nimble organizations and be willing to take calculated risks.

In todays context, this plan often includes the use of offshore labor for business process management and information technology. The advantages of using offshore labor are well documented and highly compelling. Labor-related IT and back-office administration costs amount to a significant portion of an insurance companys operating expenses. Programmers, claims processors, underwriters, and a slew of other re-source types generally are hired full-time and paid prevailing U.S. wages. In an offshore country, not only can you find the skills required to perform these job functions in abundance, but also the wage rates will be significantly lower. In most cases, companies can realize a savings within a one-year time frame of 30 percent to 50 percent by outsourcing to India. Because IT outsourcing is a mature industry in countries such as India, skilled resources and vendor choices are more abundant relative to the newer areas of business process outsourcing (BPO) and call center outsourcing. However, this issue can easily be overcome with the appropriate emphasis placed on training and process development.

The offshore outsourcing decision process generally focuses on four key topics: cost, control, quality, and risks. Can I save on operating expenses to the extent it will have a direct impact on my bottom line? Will I lose control of the processes that may adversely impact my core business? Can I maintain or exceed current quality levels by using offshore labor? What are the risks involved, and am I willing to take those risks? To address these questions, a structured road map to offshore outsourcing should be developed. Broadly speaking, this roadmap should include three high-level components: country selection, delivery model definition, and vendor selection.

Country Selection
Developing countries across the world are in a battle to become the preferred destination for offshore outsourcing. Some countries have emerged as early leaders, including the Philippines, Malaysia, and South Africa. Each country has its own particular strengths and weaknesses. Countries should be evaluated across several variables, including: cost, size of labor pool, political stability, culture, business environment, availability of vendors, and infrastructure.

However, no single country has been more successful in the outsourcing market than India, which currently owns about 80 percent of the offshore IT outsourcing market and is positioned to capture a majority of the BPO market as well.

Several key factors are responsible for the growth of the outsourcing industry in India. First, India has a large, highly skilled labor pool that is available at a relatively low labor cost. With over four million engineers, India ranks second only to the United States as the country with the largest population of English-speaking technical personnel. This sizable pool of IT talent in India is available to companies worldwide at relatively low labor costs.

A second key factor driving the market is the educational system in India. The origin of the present-day Indian educational system can be traced to the countrys roots as a British colony. The British in-sisted on the establishment of education based on Western standards and the use of English language. As a result, the Indian educational system today is a global leader in areas such as science, technology, and management, and graduates from the Indian Institutes of Management (IIMs), Indian Institutes of Technology (IITs), and the Indian Institute of Science (IIS) are highly sought after by corporations across the world.

A third key factor driving the Indian IT market is that of quality. On a global basis, Indian IT firms own the majority of CMM level 4 and 5 certifications, with 51 and 27, respectively. Although the BPO and call center industries still are in their early stages, executives from the Customer Operations Performance Center (COPC) have very positive comments about India. Several Indian delivery centers already have achieved COPC certification. In many respects, quality has become synonymous with India in the offshore outsourcing marketplace.

Fourth, differences in time zones allow work to be carried on by Indian teams on a 24-hour basis, shortening cycle times and improving productivity and service quality. The approximate 10- to 12-hour time difference between India and the United States is a considerable advantage for India-based operations. For customer contact functions that require real-time interaction with customers during U.S. business hours, Indian companies are more than happy to establish nighttime shifts to accommodate the demands of U.S. clients.

Finally, the Indian government has recognized the importance of the outsourcing sector to the Indian economy. Government policy has created a favorable atmosphere for Indian businesses through tax relief and infrastructure support for companies operating in Govern-ment Software Technology Parks. Gov-ernment policy toward the industry also is being driven by the desire of the central government to encourage exports to generate foreign currency reserves.

Because of the population and the established educational system, India will keep its leadership position for the next five to 10 years. Skilled talent in the areas of IT and business always will be readily available at lower costs than in the U.S. And because of its early leadership position, other countries will find it hard to catch up, especially in the areas of quality, acclimation with U.S. business practices, and overall brand recognition.

Delivery Model Definition
After a country has been selected, the next question for insurance executives is how the offshore delivery center should be structured. There are essentially five basic choices, all with their own benefits and risks:

Captive delivery center. This is the preferred model for companies that are completely committed to an offshore strategy and are willing to invest the necessary financial resources to build their own subsidiary from the ground up. The key advantages of such a model are long-term cost savings and control. Although the strategy involves significant upfront capital commitments, in the long run companies are able to maximize their cost savings as a vendors profit margin does not need to be paid. From a control perspective, the offshore delivery center will be committed to its parent without competing interests. This model works well when organizations move from piecemeal outsourcing to a comprehensive outsourcing strategy. One disadvantage of this model is companies are not able to learn processes from an offshore vendor, especially in the case of software development where process rigor is important. Another downside is companies must learn to build and operate a business in a foreign country. The challenges of doing this can be quite significant.

Build-Operate-Transfer (BOT). This is a model that is becoming popular for U.S. companies because it takes on characteristics of a captive center and, at the same time, mitigates a portion of the start-up risks. Using this model, U.S. clients engage an offshore vendor to build a dedicated delivery facility and manage it for a specific period of time, ranging from one to five years. After this time period, the company has the option to buy the offshore center for a predetermined price. The vendor puts up the capital to build the center and assists with developing the operational pro-cesses. The advantages of this model for U.S. companies are it lessens the initial capital requirements and it gives access to a vendors processes. However, vendors are not inclined to make as much money under this model relative to an outsourcing contract. Thus, the hourly offshore bill rates and eventual purchase price of the entity may be high. Some larger offshore vendors are not interested in this model because they eventually lose the business once it is transferred.

Offshore Development Center (ODC). This model has gained popularity over the last three years, especially for larger companies. ODCalong with captive center and BOTis not suitable for companies that wish to take a project-by-project approach. With the ODC model, a U.S. company establishes a dedicated center separate (virtually and often physically) from a vendors main business. The vendor manages the offshore center on behalf of the client. There is no buyout option of an ODC as is the case with BOT. The client has dedicated resources that cannot be moved to other parts of the vendors business. The benefits of an ODC are numerous: knowledge retention, improved rate negotiation, increased productivity, faster ramp-up time, and consistency in delivery quality. The offshore workers often feel as if they are employees of the U.S. company and thus have a certain loyalty to the job. The disadvantages of such a model are that a company loses some of the benefits of outsourcing, specifically those allowing it to have variable costing instead of fixed costing. Regardless of resource utilization under the ODC model, companies will pay the offshore vendor the same amount on a monthly basis.

Joint Venture (JV). This model has been used with limited success. Depend-ing on whom you ask, failure rates of offshore joint ventures can range from 60 percent to 90 percent. In this model, a separate legal entity is structured in the offshore country, and equity is split between the offshore vendor and the U.S. client. The advantage of this model is the U.S. company and vendor can start with a clean slate and structure the JV in any fashion that makes sense. Often, start-up capital comes from both parties. However, the JV eventually will take on a life of its own and often conflict with its parents interests. There are several documented case studies that have shown this model to be less effective relative to other options.

Outsourcing. This model is best for companies that are new to offshore outsourcing and those that want an ex-tremely quick path to cost savings. There is minimal long-term commitment under this model for companies, and it is a good way to test the waters. The relationship is defined contractually through service levels and hourly rates for offshore resources. With outsourcing, companies often complain they lose control of the outsourced work. Moreover, cost savings are not as high as with other models because the vendor needs to support its profit margin, which can range from 25 percent to 50 percent.

Vendor Selection
The final phase of the offshore outsourcing process is selecting the vendor. Selection strategies can be quite complex, as several factors need to be taken into consideration. Best practices in vendor selection demonstrate the use of a weighting and scoring systemcustomized for client-specific requirementsto create a short-list of three to five vendors. The final selection of the vendor should be based on softer issues assessed during a series of site visits to the vendors facilities. These issues include cultural compatibility, alignment of goals and objectives, and commitment from senior management.

For the more initial scoring system, however, the vendor should demonstrate proven competence in its field. Breadth and depth of capabilities should be balanced by a commitment to quality, delivery, integrity, and innovation. Flexi-bility, efficiency, and cost savings also are important criteria. Overall, the vendor should demonstrate a proactive and responsive management style that supports a customer-focused approach. In offshore context, reliable information about vendors is hard to come by, which further complicates the process.

Once the vendor has been selected, key to success will be a well-managed relationship between the vendor and the client organization. Commitment to the relationship and development of a shared vision ultimately will create the greatest value for both businesses. Risks and rewards need to be shared, and clear communication mechanisms need to be such that decision-making is based on transparent information.

Conclusions
Like many companies facing shrinking profit margins, in-surers have to extract as much efficiency as they can out of their operations. The industry as a whole has been relatively slow to adopt offshore outsourcing, but the time for action may be now. The ad-vantages are many, and the risks can be properly controlled through a disciplined approach. Offshore outsourcing is here to stay and will eventually become a necessary element for survival.

Shailen Gupta is president of Renodis, which specializes in the rapidly expanding offshore outsourcing market. He can be reached at sgupta@renodis.com.

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Worldwide IT Services Market Revenue Estimates by Region (Millions of U.S. Dollars)