Why Offshore or Outsource when Lean 6 Sigma will deliver large cost savings and significant customer service improvements? Kevin Dilton-Hill 1
Forget outsourcing - go for the bone! Although business levels have improved considerably over the last year, in many companies the cost pressures have not gone away and the demands of doing even more with less are becoming relentless. Even where a business feels it can recruit, skills shortages have materialised quickly and salary inflation has begun again, in some cases at an alarming rate. Every business wants to reduce costs, or at least slow the rate of increase. Outsourcing, Offshoring and Lean 6 Sigma can all deliver impressive cost savings. But the drawback to fashionable outsourcing and offshoring is that they can be copied relatively easily by competitors, and control over the cost base is handed over to a third party. The key thing about the third way, Lean 6 Sigma, is that one keeps control over the cost base. This enables the firm to achieve additional cost savings year after year a tremendous competitive advantage. In the few reported instances where these Lean 6 Sigma methodologies have been used in financial services the results have been stunning. (For example, The Lean Service Machine, Harvard Business Review, October 2003). Jack Welsh, former head of General Electric was an early proponent of outsourcing and offshoring. He espoused a 70:70:70 rule; 70% of GE s internal processes should be outsourced; 70% of these should be offshored; and of that, 70% should be done in India. In financial services proponents of outsourcing claim they make 10-20% cost savings. Proponents of offshoring point to 30-40% cost savings. However, there seems to be consensus that only 20%-40% of the cost base is available for these initiatives. Are these techniques the only ways to achieve these levels of savings? And what can be done about the remaining 60%-80% of the cost base that cannot be attacked by outsourcing or offshoring? Toyota and Dell have been winning against relentless cost pressures using approaches generally known as Lean methods. The combination of these with the 6 Sigma methods made famous by Motorola and GE created Lean 6 Sigma. JSK Solutions has over ten years experience using Lean 6 Sigma across the range of financial services businesses. In our experience cost savings of around 30% can be extracted out of most financial service processes using Lean 6 Sigma, and we also see significant improvements in customer experience. 2
Outsourcing Outsourcing is now reasonably sophisticated in financial services. What is outsourced ranges from one activity within a process through to the end-to-end business process including all related activities from a number of departments. An example of one activity being outsourced is payments processing which is often done because the cost of the technology is prohibitive. An example of an outsourced end-to-end process in fund management is where sales, customer account management, and the daily transfer of the net cash position to or from the fund manager is outsourced to a fund distributor. In summary, the advantages of outsourcing are: Cost cost reduction and cost certainty. Cost reduction is seen as coming from economies of scale and greater efficiencies. Against these must be offset the profit margin for the provider. Cost certainty is obtained from a price list. Service is defined and measured in terms of service level agreements and the idea is that these performance measures improve service Technology risk this covers the risk of implementing new technology to provide a service and the costs associated with keeping up to date with technological advances. Capital using it for the mainstream business rather than the technology necessary to support it. Management - their time and effort is focused on the core business. However, the disadvantages of outsourcing are less well known. These are discussed next. Although outsource agreements often have cost reduction targets, the benefits are usually shared. Also, it is difficult to specify the components of competitiveness in terms of performance measures that could be used in service level agreements. JP Morgan Chase announced that it was reversing an outsourcing deal with IBM. The CIO stated: "We believe managing our own technology infrastructure is best for the long-term growth and success of our company. Our new capabilities (from the Banc One merger) will give us competitive advantages, accelerate innovation, and enable us to become more streamlined and efficient." (JP Morgan Chase press release, 2004). Outsourcing has problems because costs and the level of service may not be competitive despite being within the service level agreement. Irrespective of the formal justification for outsourcing, the initial motivation often comes from management asserting that the area concerned is more trouble than it s worth. At that point the reality is often a scramble to get rid of that area as fast as possible. It is this scramble to get rid of an underperforming area that leads to the major disadvantages of outsourcing it seems to be a success but there is a massive underperformance relative to what competitors can achieve. This occurs because the outsourcing is often not well organised. At the start the costs are too high and the performance too low. Outsourcers win significant 3
benefits by merely achieving average! As for being close to world class, benchmarking studies in finance function, for example, show that outsource service providers (OSPs) seldom achieve top quartile cost or performance. If average is good enough, fine. If not, then a company needs to strengthen weak areas before embarking on outsourcing, so that the starting cost and performance benefits are OK. Performance levels specified in service level agreements can also create problems if they are not consistent with the company s business objectives. This issue is not limited to outsourced activity but is often exacerbated if outsourced. The most obvious examples of this are in call centres where measures are usually internally focused rather than customer focused. In one instance one of JSK s insurance clients had outsourced the handling of claims, but the service levels were appalling. Claims were taking six weeks on average to settle. This was having a big negative impact on sales because the sales people were not keen to sell a product that created such a high level of complaints. One of the key suggestions that JSK made to improve things was to settle simple claims over the phone. The outsourced service provider (OSP) strongly resisted this suggestion because this would increase the average call length significantly. When eventually the OSP was forced to settle claims via the phone, a quarter of all claims were settled this way and the backlog was eliminated. This took less than six months to do, with no extra staff. Their key performance measure, average call lengths, had focused management and staff on the wrong issue. The key issue was the timely resolution of a claim. The call centre had focused on the measure that appeared to drive costs rather than measures that drive customer satisfaction and, ultimately, revenues. The greater the number of customer contact or service points that are outsourced the more difficult it is for the company to ensure that the customer experience it wants is delivered. Not long ago a bank was featured on the back pages of the Sunday newspapers financial sections for an embarrassingly long time because of continuing customer complaints. The company executives had to spend inordinate amounts of time handling the PR disaster despite the fact that the product was outsourced. The potential risk to reputation which remains with the company may be too great for it to give up control. Compliance can cause problems for a company wishing to outsource because responsibility for compliance failure cannot be outsourced. The challenge is how to ensure that the OSP has appropriate controls and risk management systems to keep compliance risk at levels that are acceptable to the company. A company has to decide whether to send its compliance people to check over the OSP or to trust the OSP s staff to report effectively. 4
Outsourcing disadvantages: Competitiveness - the costs and performance of the OSP may be far from the level required by the business to compete Behaviour service level agreement performance measures may induce behaviour that is not aligned with the company s strategy Customer experience the service may not deliver what customers want Reputational risk this risk cannot be outsourced Compliance risk this risk cannot be outsourced. Offshoring Offshoring is the movement of activity to a business entity in a foreign country that is controlled by the company. Offshoring started with the move of IT programming to India. The success of these initiatives coupled with the growing capability of global communications meant that more and more IT functions followed, and the list of other business processes being offshored is growing. The big benefit of offshoring is cost savings of 30% to 40%. There seems to be consensus that 20% to 40% of the cost base is available for these initiatives, thus enabling financial service businesses to cut costs by up to 15%. A Deloitte study states that the top end of these gains is only achievable by financial institutions with a market capitalisation in excess of $10 billion (The Titans Take Hold - How offshoring has changed the competitive dynamic for global financial services institutions, Deloitte.com research paper, 2004). Smaller financial service companies, in its view, would lose most of the benefits through operational complexity and the overhead costs (excluding IT) associated with offshoring. 5
Proponents of offshoring also point to the high skills levels that are available for the low costs. For example it was recently reported that some hedge funds had offshored their financial and statistical analysis work to India (FTfm, 18 October 2004) The difficult thing about offshoring is management having to manage from a distance. Most of the companies that pioneered offshoring were multinationals which already had that experience. The response for those that do not have this experience may be to hire another organisation to do the foreign management, i.e. outsource the offshoring. Does this cut or compound the risks? In Bubble s experience all hand-offs increase risk; whether from one employee to another in the same office or to another person in a foreign country. This can only be minimised if the hand-off point is carefully selected and the handoff of the transaction properly controlled. (see below). There is reputational risk associated with offshoring as politicians try to capitalise on the loss of jobs. However, McKinsey argue that far from damaging the economy of the United States, offshoring should enable its companies to direct resources to next-generation technologies and ideas if public policy doesn't get in the way (Exploding the myths of offshoring, The McKinsey Quarterly, July 2004). communication problems when dealing with offshore call centres. This culture gap with some offshore service providers threatens the extent to which a firm can up-sell and cross-sell to its customers. As Jane Simms notes (The Director, August 2004) companies are pouring money into ensuring their staff understand, engage with and project the corporate brand values The problem is, no matter how much training staff get, nor how intelligent they are, the vast differences between Occidental and Oriental perspectives on life, culture and service make it extremely difficult for Indians to understand, interpret and translate a western brand for a western audience. The advantages of offshoring are : Cost Cost savings in the range of 30% to 40% from lower labour costs Skills Technical skills can be as good or better than in the developed world at a lower price The disadvantages are : Distance the problems of managing from a distance, and control may be lost over time Culture the cultural differences between the domestic customer and the foreign staff may put off the former The biggest potential backlash from offshoring comes from the company s customers. It is only the customer experience that differentiates financial service businesses. We have all suffered 6
Lean 6 Sigma Using Lean 6 Sigma has a dramatic impact. Jaguar s Halewood factory on the Merseyside has implemented Lean 6 Sigma and has become Ford s top facility worldwide. In comparison, Landrover s Solihull site has faced many closure threats by Ford; the latest threat prompted calls to introduce Lean 6 Sigma. Dell s plant in Limerick, Ireland, has been able to deliver productivity improvements year-in, year-out. It uses Lean 6 Sigma methods to increase productivity by 3%- 4% each quarter. Consequently, it has been able to stave off relocation to a lower-cost site, and is now the only plant controlled by a major multinational electronics maker that still produces personal computers in Europe. The use of Lean 6 Sigma methodologies by companies such as Toyota and Dell has been so successful that they have fundamentally altered their cost base as well as customer service expectations in their respective industries. The introduction of Lean 6 Sigma into a company can be traumatic, particularly in financial services, because it needs a totally different way of thinking (a new mind set ), and working. The magnitude of the first change is huge and then it is followed by continuous improvement. Lean 6 Sigma can be great because its impact is to simplify the business so as to cut costs and improve customer experience. The skill comes in managing staff through the change. Lean 6 Sigma - advantages: Customer experience it is crucial that it is reliable; that promises are kept. Processes based on Lean 6 Sigma are repeatable they do what they say. They have minimum time delays and minimum error. Staff are heavily involved in the process thus minimizing the chances the change not working Cost JSK Solutions typically delivers productivity improvements of around 30%. Minimum IT most changes focus on work practices rather than new IT. This means that improvement projects are more affordable and changes can be implemented more quickly Lean 6 Sigma disadvantages: Change - It is not asking someone else to do the work; it is about change management; it is asking staff to change. JSK Solutions has more than 10 years experience in implementing Lean 6 Sigma across most financial service sectors and has developed great expertise in change management and helping staff accept change. 7
Things to think about before choosing a route Lean 6 Sigma can be applied to all areas of the business: from the banking hall and call centre, through transaction processing to preparing monthly accounts. In both outsourcing and offshoring, the question remains about what one can do with the majority of the business that cannot be moved out or offshore. This is particularly so when there does not appear to be a next big automation idea to remove further costs. Lean 6 Sigma is about a detailed review of everything to strip out waste and to ensure that the company gets the customer experience it wants. Outsourcing, offshoring and Lean 6 Sigma all have their challenges, but if it were that easy to cut costs by upwards of 15%, everyone would be doing it. There are many parts of the company that cannot be outsourced or offshored so Lean 6 Sigma is probably the only way of achieving sustainable large cost reductions in these parts. In those cases where there are alternatives (including combinations; for example, applying Lean 6 Sigma prior to outsourcing or outsourcing offshore), and each approach could yield acceptable cost savings, it is necessary to develop a decision tool to help evaluate each approach. An example is given in the table below. First, one needs to score the importance of each dimension out of five. These are the key dimensions noted above in discussions about the advantages and disadvantages of each approach. Then one needs to judge the score out of 5 for each approach for the specific area under consideration. The score depends on how successful the approach could be in achieving the objectives of the dimension when implemented properly. The score for importance is then multiplied by the score for effectiveness to give a total score by which to rank the three approaches. Dimensions Importance Outsource Offshore Lean 6σ Cost 5 3 = 15 5 = 25 4 = 20 Customer experience 5 3 = 15 2 = 10 5 = 25 Staff 4 3 = 12 2 = 8 2 = 8 Risk 3 3 = 9 2 = 6 5 = 15 Capital 1 5 = 5 5 = 5 1 = 1 Management focus 2 3 = 6 3 = 6 4 = 8 Total score 62 60 77 8
In many instances the impact on customer experience and on the company s people could be the deciding factors. The impact on customer experience should be evaluated formally for each service point. JSK Solutions uses a type of hierarchy of needs model to do this evaluation because it recognises that customer requirements from each service point vary depending on the type of service and the type of customer. For example, a particular credit card may be valued for its cachet in a social situation such as a restaurant but will generate annoyance when a retailer will not accept it for payment because they say the charges are too high. Customers who are technically savvy may want to whiz through a website to buy an insurance product but others may need considerable support and guidance to understand what they are doing. Assessing the readiness for change in a company is a classic part of change management and includes issues such as: Deepening staff understanding of outcomes Increasing staff involvement and commitment Preparing staff for change and diluting perceived threats Gathering ideas from staff to ensure project success Identifying good people for project teams Identifying obstacles to reengineering Anticipating points of resistance Lessons It is possible to assess how the company s people will cope with a big change by comparing their behaviour profile to that of the new process. Performance will be maximised if the behavioural profile of the new roles closely match those of the people who will use that process. It s important to understand fully the impact of the chosen approach on the business i.e. customer experience, staff, the risks and cost base. Are you after a quick win and not really concerned about being locked into an increasingly uncompetitive situation? Or, do you really need to keep control over the area to ensure continuing cost reduction and better competitive opportunities? In JSK Solutions opinion ineffective and inefficient processes should not be outsourced or offshored because the company may be giving away the benefits that come with Lean 6 Sigma. If the move is a significant business decision, moving broken processes will result in costs which will grow bigger over time. Once one has applied Lean 6 Sigma to the processes there may no longer be a need to outsource or offshore. JSK Solutions is experienced at estimating the benefits of implementing Lean 6 Sigma. We will be able to determine whether the targeted savings will be sufficient and, if not, where changes should be made before implementation. 9
If the company is going to outsource or offshore some work, the key issue from a process perspective is to determine where the work of the company stops and the service supplier starts (i.e. the hand-off point). The risks of a hand-off are the same as in a relay race it is where things generally go wrong. The England 2004 Olympic men s 100m relay team won gold because the faster USA team botched a baton change. In processes it is the knowledge that is needed by the receiver of the hand-off that causes the problems. Minimise the knowledge transfer and minimise the problem. Essential to managing the outsourced or offshored area is to select the correct performance measures those which are in line with the desired customer experience. Focus on the measures that matter, avoid detail. Unlike offshoring and outsourcing, Lean 6 Sigma leaves the company in control. Companies like Toyota and Dell have demonstrated that Lean 6 Sigma can deliver substantial additional cost savings year-in, year-out. Intrigued by Lean 6 Sigma? Find out more by calling JSK Solutions. Why not give it a try? Contact Kevin Dilton-Hill on +44 7767 406309 or kevin.dilton-hill@jsk-solutions.com 10