Unlike traditional outsourcers, BPOs can connect processes in new, efficient ways that their clients never dreamed of. But once you turn over an entire business function to a third party, it's hard to turn back if the outsourcer doesn't meet your expectations.

As new ways of doing business come and go, expert advice on how to keep up with the changes can be a real competitive advantage. That, basically, is what business process outsourcers (BPOs) claim to offer: ways to perform business functions better and generate more overall value than a company can create by itself. That attractive proposition has helped make business process outsourcing one of the fastest-growing areas within the outsourcing field. Gartner Inc. estimates that BPOs' revenues will grow from $106.7 billion in 1999 to $301 billion by 2004.

The primary distinctions between a traditional outsourcer and a BPO revolve around the amount of freedom a BPO is given and the scope of its responsibilities. BPOs can twist a client's process, discard it, reinvent it or combine components of it with new ways of working, all in an effort to improve the client's value. They can even help the business create a process where none existed before. Outsourcers have historically been more limited in scope, not looking as much at the big picture but focusing primarily on cost savings through greater economies of scale.

"BPOs can show companies how processes can connect together in ways they never imagined," says Charles Gibbons, North American business development leader at PricewaterhouseCoopers in Stamford, Conn. "BPOs add value often by inserting a technological innovation into the process. For example, a BPO could offer a company a Web-based, self-service capability that enables employees to not only input their own human resources information, but also handle their own procurement needs using the same technology," he says.

While the reasons companies switch to outsourcers almost always focus on saving money, BPOs provide additional benefits, such as faster time to market, greater productivity, access to expert strategic thinking, higher customer satisfaction ratings and an increase in market share. "BPOs save clients between 10 percent and 15 percent on average, but cost reduction isn't the number one reason to seek one out; process improvement should be the primary objective," says Michael F. Corbett, president and CEO of Michael F. Corbett & Associates in LaGrangeville, N.Y., which provides research and training on outsourcing and BPOs.

BPOs typically handle business processes essential to the company's health, such as supply chain management, logistics, telemarketing sales, customer relationship management (CRM), manufacturing operations, research and development, risk management, human resources, finance, general accounting, procurement, and education. Management of these processes requires specialized skills and expertise. For that reason, a BPO is not just a vendor. It is more like a business partner.

The largest BPO deals tend to occur in the manufacturing operations area, particularly within the auto industry, according to Rebecca Scholl, senior analyst at Gartner Dataquest, a division of Gartner Inc. in Mountain View, Calif. "Aside from that, the business administration processes, such as human resources, are the fastest-growing areas for BPO growth," Scholl says.

The first noteworthy deal to come down the BPO pike was BP Amoco PLC agreeing to outsource a number of its processes in a $1 billion deal with PricewaterhouseCoopers. That was about four years ago, according to Rudy Hirschheim, professor of information systems in the Bauer College of Business at the University of Houston. "When other companies realized that this deal was working, they began to think more seriously about outsourcing their processes to a BPO," says Hirschheim. "Some BPOs got their start by taking over ERP [enterprise resource planning] systems for companies that didn't have the in-house expertise to develop those systems."

Dealing With the Risks

Giving an outsider access to confidential data makes some companies uneasy. That reticence is assuaged, however, when they realize that deals with BPOs haven't led to widespread exposure of company secrets, thanks to provisions in the contracts which help ensure confidentiality.

But turning over an entire process to an outsider can cause bigger problems. For instance, if you want to bring that process back in-house at some point in the future, you could have quite a chore on your hands. "It can be hard to get back into running the process if you no longer want a BPO to do it," says Bill Hall, president of Columbus, Ohio-based Pretium Partners Inc., a consulting company that trains outsourcing providers to sell their services. "For instance, suppose you've invested a lot of time in training your people to run the process. If you turn it over to the BPO, those people will likely leave, and you may even sell the physical assets you used to run the process. Later on, if you become dissatisfied and want to bring the process back in-house, what do you do — go out and hire and train an additional group of in-house people? Buy back the equipment you need?"

Those questions have no easy answers. And other fears can plague a company, as well. Cisco Systems, for example, committed itself to providing a certain amount of business to electronics manufacturing BPOs, but Cisco's business forecasts were overly rosy. As a result, the BPOs didn't receive as much business from Cisco as they were promised. "When predictions of business volume going to those BPOs came up short, the BPOs were stuck holding huge volumes of inventory," which Cisco was responsible for, says Hall.

How do you control scenarios like those? The relationship need not be irreversible or inflexible. "The BPO should be able to scale up or down depending upon the level of business its client is doing," says Scholl. "The BPO should agree, in effect, to benefit more or less depending on the level of its client's business."

That's how BPO deals are structured at PricewaterhouseCoopers, according to Gibbons. "For example, if you have to reduce your sales force by 50 percent, we'll build in provisions to reduce our costs [and fees] by the same percentage," he says. "Of course, we're expecting to receive a minimum amount of revenue from our client, but in a multiprocess deal, there are more opportunities for cost reduction than there would be if we were handling just one process."

A Start-up Boost

One popular niche for BPOs these days is assisting start-up businesses. Rather than hiring an internal staff, which runs up costs, they hire a BPO, which can often get the job done faster and with more expertise. Aleks Rabrenovich, director of finance and operations at Covalent, a Web infrastructure services firm in San Francisco, chose to outsource his company's entire accounting function to a BPO.

"When you're in a start-up, the board of directors looks at your head count and ways you're reducing administrative costs. The BPO helps us on both counts," says Rabrenovich. "We're month-to-month with our BPO. If it isn't working after six months into the relationship, we can always bring the whole accounting function back in-house."

Covisint, an online business-to-business marketplace in Southfield, Mich., serving the auto industry and owned jointly by Ford Motor Co., DaimlerChrysler, General Motors and Nissan, couldn't hire finance people until it was approved by the Federal Trade Commission. But it wanted to be ready to conduct business as soon as approval was granted, so it hired a BPO. "We needed a BPO who could prepare the accounts payable, accounts receivable and general ledger processes for us, as well as our expense reporting and revenue recognition processes, so we could start using those processes as soon as we received approval from the FTC," says Rick Stephenson, the company's treasurer. "The BPO's role has been to establish these processes for us. Then once everything is up and running smoothly, we'll turn those functions over to a low-cost transaction outsourcer."

Contract Essentials

Businesses dictate the terms of a BPO relationship through the contract. Negotiating an effective contract can make the difference between a flexible relationship that the client can control and a relationship that controls the client. Organizations shopping around should consider hiring a consultant to help analyze the details of the contract, and avoid standard, canned agreements.

"Three main ingredients in a good contract are tiered pricing, so you don't have to renegotiate pricing when business volume changes; meaningful service levels, including performance-based rewards and penalties built in; and shared continuous improvement, which means if you receive some benefits such as cost savings, you pass some of those cost savings along to the BPO," says Liz Secor, practice manager at Parson Group LLC, a consultancy located in Troy, Mich., that specializes in BPOs. "In addition, you can test out a BPO by giving them just a piece of a process to see how they perform. You don't have to commit the entire process to them all at once."

Performance-based and outcome-based contracts are essential. Building in penalties for performance that falls below the service level agreement is a way for clients to see that they get what they're paying for. "For instance, if your goal is a 15 percent improvement in customer satisfaction, then tie the BPO's compensation to hitting that business goal," says Corbett.

Exit clauses should be included in case the relationship goes sour. "If service levels are dropping or you want to go with a lower-cost BPO, there are certain provisions in the contract that can allow you to terminate the relationship, but you may have to pay a termination fee," says Hirschheim.

Companies replace their BPOs for a variety of reasons. Sometimes a new management team wants to use a different outsourcer or bring the process in-house. In other instances, the business can't afford to pay the BPO any longer. Or an organization might decide to go global and realize its BPO has a regional scope.

When negotiating contracts, companies must make sure to clearly define the terms of exiting the relationship, recommends Bill Bierce, founder and principal of Bierce & Kenerson PC, a law firm in New York City that focuses on outsourcing, IT and e-business. "Can you get out on day one of the relationship, or day 365? How much notice do you have to give? How much do you have to pay in penalties to get out? All these things need to be spelled out in the contract," Bierce says. "Most of all, the client should know exactly what they want from the relationship before entering into the contract, including how it's going to be measured, rewarded, compensated and terminated."

A consultant can help not only in constructing the contract, but also in choosing which BPO is the best fit and in pinning down the fees. "BPO fees vary widely, depending on what kind of shape the process is in and what level of service you expect, but usually they charge on a per-something basis — that is, on a per product unit or per employee basis," says Corbett. "That way, the fee structure is flexible, so you just pay for what you're using."

Once the relationship is established, several rules of thumb can help it progress smoothly: First, don't dictate how the BPO should do its work or limit it to certain legacies your company has always lived by. You're hiring the outsourcer presumably because it has better ways of getting the job done, so focus on the outcomes, not on how it reaches them. Down the line, if things aren't going well, take a closer look at the BPO's methods. And keep the big picture in mind. Outsourcing is about more than just cost reduction; it's about process improvement and building shareholder value. Relationships that deliver those kinds of benefits deserve careful nurturing.

10 Tips for Successful BPO Relationships

Turning over an entire process to an outside party requires careful consideration. As you go through the process of choosing a BPO, keep these guidelines in mind:

1. Look beyond cost reduction. Focus on a candidate's history of improving client shareholder value. Larger, more established BPOs are less likely to go out of business. Talk to clients who have used the BPO you're considering.

2. "Test drive" a BPO, turning over just a piece of one process to see how well the outsourcer handles it.

3. Consider allowing the BPO's experts to work on your process in-house to ease the transition of transferring the process over to them.

4. Agree in the contract about where the BPO's responsibilities begin and end. Determine how much authority you will have over the relationship.

5. Discuss shared liability risks. Determine how much the BPO should be liable if your company is damaged as a result of the relationship. Ask a lawyer to help pin down potential liability issues.

6. Build in a flexible fee structure that enables you to pay the BPO less if your business declines.

7. Identify expected performance levels in the contract, and develop easy-to-understand metrics for evaluating the BPO's performance.

8. Let the BPO conduct its own business, but monitor its performance at least monthly throughout the term of the relationship.

9. Establish rewards for performance above agreed-upon levels, as well as penalties for underperformance.

10. Hire a consultant to help you formulate the contract, set service level agreements and establish performance metrics.