Chapter 19 – Lowering Costs For Your Extended Enterprise

Your Board of Directors has mandated that back office expenses must decrease in proportion to product development and customer facing costs as your Company grows.  How will you design your organization to simultaneously provide customer satisfaction, scale with the business, and lower costs without introducing risks such as interruptions to business continuity, employee defections, inability to meet quality targets, and reduced levels of service?

Most founders of technology companies have psychological and intellectual difficulties with outsourcing.  They are reluctant to share product, personnel, funding, or other information with anyone outside their organization.  Yet they accept that resources, to produce results, must be allocated to customer facing efforts.  A company that wants successful economic results has to deliver real value. Unless efforts are directed to revenue-producing activities, costs will drift towards what is difficult rather than what produces value.  Instead of efforts to cut across all functions of a business, effective cost controls must be concentrated on activities not directly tied to value generating activities (such as sales or product development).  A strategy that reduces the amount of attention and resources directed to back-office activities (e.g., finance, accounting, human resources, facilities, supply chain, internal technology, etc.) in proportion to the attention managers devote to development, sales, and marketing is the most effective cost control.   

Why Should Employers Outsource Instead of Hiring Teams in Low Cost Locations?

Regardless of the psychological hang-ups founders or managers may have about outsourcing, their efforts to minimize costs will eventually lead down the path to a barbell strategy, which is as follows:  If they know that the company’s value proposition via competitors is vulnerable to rising costs, and if they accept that that most cost control efforts must be directed at back-office functions, their strategy must be to aggressively outsource the routine, transactional activities performed by these functions to low cost locations. The other side of the barbell, work that requires intensive interactive service for issues of internal management of the organization or senior management of a support function, must be retained at headquarters.   

Why should organizations outsource routine work instead of moving employees to low cost locations or hiring them at headquarters?  Paying employees six figure salaries to do transactional back-office activities such as payroll or general accounting is idiotic when you can hire someone in a low cost location for less than half the cost.  

Should You Outsource Your Back Office Services?

The more difficult question is whether or not to outsource.  I am biased towards outsourcing. Outsourcing firms compete to provide value in a specific domain.  For example, an outsourced payroll providers whole existence is predicated on delivering better payroll services at a lower price than its competitors, including its potential customer’s internal teams.  Its resources are concentrated on hiring the best personnel, developing the best processes and implementing the best systems needed to provide payroll services. Payroll processors are the breadwinners for the provider.  They generate its revenue. Compare them to an internal payroll team at a tech company. The internal team is a back-office cost center. They are not winning any “bread.” Rather, they are picking up the crumbs left over after product development, marketing, sales, and almost every other piece of an organization is allocated a budget.  They have the same goal as the outsourced firm, produce the best results with the least input of effort and expense. But they almost never receive breadwinner level resources to achieve that goal.

How to Effectively Start Outsourcing Routine or Transactional Work

How should one go about outsourcing routine or transactional work?  Treat the process like you are picking a partner. Outsourced back-office activities affect not only back-office employees but everybody in an organization. Because these partners will function as an extension of the company, managing the relationship with them matters.    Are candidates’ current customers satisfied with their service? Do they outsource their work to another party? How do they protect customer data and keep it private? Is their infrastructure and capitalization scalable? Do they have a business continuity plan? What are their employee retention rates?   As you go about these evaluations, focus on aligning objectives between the people from the firm and your organization’s key stakeholders. Pick a competent partner that shares your values and culture.

Once you pick a partner, be sure to engage key internal stakeholders to hammer out the terms of your partnership.  Have your teams develop an aggressive but realistic timeline to transition work. Design the goals and strategies of the relationship.  Write a contract that not only addresses scope adjustments, escalation processes, extraordinary activity (e.g., acquisitions) and changes in volume, scope or activity, but also incentivizes process, policy and technology innovation.  Identify a project team that can set essential metrics that focus on what is right for the customers of the outsourced services. How they go about doing this is critical. The “soft stuff,” building relationships, confronting problems without playing the blame game, and using facts to address “noise” around performance, helps to build a trusting relationship.  

The transition from internally managed activities to externally managed activity is never easy.  Don’t fall into the trap of going live without a plan to manage the transitional risks. Every organizational redesign carries risks such as interruptions to business continuity, employee defections, a lack of stakeholder engagement, and poor implementation. Your teams can mitigate the damage by identifying key risks early and monitoring them after the redesign goes live. Initially, regular daily monitoring is essential to diagnose what has gone wrong, what contributed to the root cause of the problem, and how to solve the problem.  Make sure that surprises are rare. Integrate your plans so that expectations and responsibilities are clearly and formally acknowledged by both partners. Make sure that your plan includes design elements that can change in response to evolving markets and new strategic directions.

Extending your team to include an outsourced partner is harder than it sounds.  During each phase of an outsourcing agreement, from diligence to maturity of the transitioned services, both partners must use principles and mechanisms of engagement that promote shared success rather than adversarial negotiations. Collaborative behavior is the guiding principle of engagement. The most important mechanism is a Master Service Agreement that is clear on the “aspirational” components of the relationship. The best way to avoid damage to the Company’s reputation or the loss of customers due to poor customer service, processing delays, errors, or fraud is to set two-way service levels. Behaving collaboratively means communicating frequently, and working together to meet these service level objectives. Jointly developed metrics allow both parties to focus on problem solving without laying blame. Frequent communication enables partners to avoid surprises and repetition of problems.  

Takeaway questions:

• Is your headquarters located in a high cost urban area?  If so, are back office tasks performed at headquarters?

• Have you performed an analysis of which routine and repetitive back office tasks could be performed off-site?

• Have you performed a make versus buy analysis for tasks that could be moved to a low cost site?  If so, does the analysis include bids from multiple external service providers?

• If tasks have been moved to a low cost site, has a two-way service agreement been created that clearly sets aspirational goals for the teams?