“Business Processes Are Moving from the West to Other Parts of the

World”

Long before he became a professor of information and operations

management at the Wharton School of the University of Pennsylvania,
Ravi Aron worked in the product development group of Citicorp in New
Delhi. Memorably, his boss at the time told him to forget what he had
learned about marketing at the Indian Institute of Management, Bangalore
– because “in a highly service intensive industry like ours, marketing
basically means information management.” Aron realized he was right:
Almost everyone at Citicorp was busy collecting, analyzing, aggregating
and disseminating information. “I realized that information was our stock-
in-trade – our input and our output,” Aron recalls. “I began to look for
emerging themes, and realized that service essentially means collecting
information about the context of the buyer.”
That realization, coupled with a desire to understand it more deeply, prompted
Aron – who has worked as a consultant in Malaysia – to pursue a Ph.D. degree at
New York University’s Stern Business School. Since joining Wharton in 1999 his
research has focused on various aspects of information management, including the
pricing of information-rich services and the efficiency of business-to-business
markets and online auctions.
These days Aron, in collaboration with Jitendra Singh, a professor of management
at Wharton, is studying the outsourcing of business processes such as call centers
from the U.S. and other Western countries to India and other parts of the world.
Despite the general slowdown that dogs the tech industry, business process
outsourcing (or BPO) continues to be regarded as a hot market. Gartner, a tech
consulting firm, reckons that the global BPO market will be worth more than $240
billion by 2005. In a recent conversation with Knowledge@Wharton, Aron discussed
his findings about the potential and risks of this emerging phenomenon. Wharton's
Mack Center for Technological Innovation and the Wharton e-Business Initiative
(WeBI) have helped support this research.
Knowledge@Wharton:You have been studying the outsourcing of services such
as call centers to India. What have you found so far?
Aron: I am studying the supply chain of expertise; call centers are one aspect of
that phenomenon. A call center can be driven by the fact that the cost of human
labor intervention is much lower in India than in the U.S. and other Western
countries. The orders of magnitude are one-eighth, one-tenth or one-twelfth,
depending on the kind of work. But call centers represent just the most visible
component. In three to four years, you will see that the supply chain of expertise
that connects the West to India, the Philippines, Brazil or Malaysia will not be about
call centers but about other things.
Knowledge@Wharton:What do you mean by the supply chain of expertise?
Aron: Many things that are done inside firms are labor intensive. I’m not referring
to physical assembly-line labor; I mean the kind of work where human beings have
to intervene in a process and use decision-making skills – such as interpretation,
validation, translation, transliteration or transformation. For example, when a
dealer is given an 8.5% rebate, does that mean 8.5% of the package price or the
promotional price? Computers can’t make such decisions. Computers are good at
sorting and manipulating large data sets and executing instructions. But when it
comes to making judgment calls, you need people. Human beings are good at
making meaning out of one medium and translating it into terms that computers
can understand. Such processes are called back-office processes, and they are
rapidly migrating from the U.S. and other Western countries to India, Singapore,
Brazil and other parts of the world.
Consider some examples. In the call-center industry, companies like Daksh (which
has the Amazon account), Spectramind (which works for Dell), and Tracmail
provide call-center support and telemarketing services to clients. But that is just
the beginning. British Airways has moved its back offices to India, as has the World
Bank. At these offices people have to look at vouchers and other documents, make
decisions about what they mean, and convert information into a format that can be
aggregated or manipulated by computer – which is typical of back-office work.
From a research standpoint, what is interesting is that things that were once
internal to a firm are no longer so. The boundary of the firm in some ways is being
compressed, while in other ways it is being expanded.
Knowledge@Wharton:How does this happen?
Aron: When Dell tells Spectramind to handle certain services in exchange for a fee,
it means what was once being handled inside the firm has now become a market
transaction. As a result, the boundary of the firm is compacted. But a different
phenomenon also is underway. An extended organizational form is emerging in
which firms relinquish control in return for monitoring.
For instance, let’s say I have a company and I move my back office to Chennai. I
stop exercising control; I don’t tell an employee, “I want you to be in the office at
8:30 a.m.” But I do look at the number of errors per 1,000 documents processed
and control that quality. In addition, I randomly sample phone calls to monitor the
quality of the marketing. Consider DirectTV, whose call center has gone live in New
Delhi. If someone were to do telemarketing for me from that call center, I would
not tell them how to do their jobs, but we would agree on the outcomes and I
would pay them depending on the number of deals they closed for me. So the
extended organizational form is one in which you relinquish local control – it is
another firm that actually hires the employees – but you monitor those employees.
This is a very different model from traditional supply chains. A company like
Johnson Controls might supply automobile components to GM, but there’s no
question of control or monitoring by GM – these employees are Johnson Controls
employees.
There’s a big difference between the supply of materials and the supply of
expertise. This is because IT enables deep linkages to be established between
organizations. These linkages are much richer than when you are supplying car
seats or windshields. It is reasonable to expect that DirectTV’s customer service (or
telemarketing) representatives have to be able to see the same version of customer
information in Delhi as those at DirectTV’s headquarters. This establishes very deep
information-based linkages between the two outfits. So at one level, these are two
companies engaged in a market-based transaction, but at another level you could
view this as an extended organization.
Knowledge@Wharton:How have such extended organizations – and business
process outsourcing in general – evolved?
Aron: Business process outsourcing began with the setting up of captive service
centers by large transnational corporations. These centers, such as the ones set up
by Citicorp and American Express in India, began by executing enterprise-wide
operations that involved the conversion of data from one medium (such as
documents) to another (digitized data in corporate databases). Companies such as
American Express and Citicorp started moving more and more of their information
extraction and reporting tasks overseas. Two factors that made this possible was
the convergence in corporate computing platforms and the rapid advances made in
communications technology. As corporations standardized a few enterprise wide
platforms (such as Relational Databases, networking standards etc.) and with the
availability of software tools that made it easy to port large data sets between
dispersed information systems, the flow of data and information between
geographically dispersed branches of the same corporation became a viable and
nearly costless option.
Knowledge@Wharton:What difference did this change make?
Aron: As the flow of data between computers that talked to each other increased,
so did the extent of human intervention and the degree of expertise required of the
information worker to transform data into information. As a result, the costs of
providing accurate and timely information to support middle management decision
making increased by orders of magnitude. Corporations were faced with a two-
pronged cost escalation – they had to hire more information workers and at the
same time ramp up the expertise levels of existing information workers who
provided operational support to the managers. The move to a centralized
operations factory in a lower-cost labor regime was an obvious response to the cost
frontier faced by these corporations. Hong Kong Shanghai Bank Corp., for instance,
has an office in India handling back-office work which employs about 1,000
information workers, and HSBC plans to triple this office size in the near future.
America Online’s customer service operations are supported from India. Initial
reports suggest that some firms benefit to the tune of up to 60% cost savings in
these lower wage markets.
Knowledge@Wharton:On what specific aspects of this phenomenon does your
research focus?
Aron: I’m studying at least three issues. Let’s place this in its theoretical context –
there are two theories that broadly explain the existence of the firm: the
transaction cost and the principal-agent theories. If you look at the extended
organizational form, you can argue that people are sending work out to places like
India for cost gains. But that also increases the transaction cost. What if the firm
behaves opportunistically? So one of the things I’m studying is, what kind of
information is shared between organizations?
Secondly, I’m looking at questions such as, what tradeoffs take place between
monitoring and control; what are the metrics of performance and who agrees on
them; what is efficiency and effectiveness and how are these measured; and how
do you align the incentives of firms that ship out the work with those to whom it is
sent? In addition, I am studying the so-called KIF problem or the knowledge-
intensive firm. These include firms in industries such as insurance, banking,
financial services, brokerage, health care – these are now huge and sprawling
organizations. Firms have no reason to be that big, and they are starting to unravel
to some extent. Ford Motor realized back in 1915 that there was no reason for it to
own rubber plantations in the Amazon so that it could make its own tires; someone
else could make the tires. In the same way, health care firms, insurance firms and
brokerages are beginning to recognize that they don’t need to have all these back-
end processes going on within their organizations. That expertise could be acquired
much better and cheaper from someone else.
The third issue I’m studying is pricing: contracts, fee systems, etc. Also, I’m
looking into whether pricing defines the employees’ behavior in some way. If you
take your back office and make it someone else’s front office, what sort of pricing
structures do you use? Out of 50 or 60 things that you can study, these are the
three I’m focusing on.
Knowledge@Wharton:Have you reached any preliminary conclusions?
Aron: I’m looking closely at these relationships in the financial services industry.
Early results show that initially, as the process of organizational unraveling begins,
firms look at the most easily definable tasks such as document reconciliation or call
centers. After that, they look at a factor I call revenue distance.
The concept of revenue distance is simple: The point at which a financial services
firm captures revenue – where a customer works through its doors and agrees to
buy a credit card or another service – is the point at which its revenue distance is
zero. It is a final and visible process that leads to the sale, but supporting that is a
series of processes that run behind it. If you take one step back, before you call a
customer to sell him a credit card or another service, you may have looked at his
profile, your existing relationship with him, and so on. You may have sifted through
a list of 10,000 people and found 1,500 potential prospects. That’s a back-end
process. If you take yet another step back, you may have acquired that list of
10,000 names from a credit rating company or some other vendor. As you take
more steps away from the point of revenue capture, your revenue distance
increases.
Initially companies ship out back-end processes that have really long revenue
distance. At that point, their main motivation is cost. But by the time the
relationship starts deepening, they realize that costs are relatively unimportant.
Many back-end jobs in the U.S. are manned by people who are under-qualified and
bored. Attrition rates in call centers in the U.S. range from 70% to 120%. It takes a
month and a half to train a person so that he or she can hit the ground running,
and then three months later that person is gone.
In contrast, in India, at its worst, the attrition rate is between 12% and 35%. A
back-end job in the U.S. is a serious job for someone in India because it pays
serious money. This applies all the more as you move away from call centers into
other back office processes in financial services and other industries. Pentamedia
Graphics is a great example. It is a large animation shop, which also has a U.S.
office that does business development. Just as you can find talented engineers and
software writers in India you can find talented animators. So you can argue that
initially U.S. companies outsource operations to India for cost reasons, but by the
time the relationship deepens, it’s driven by anything but costs.
Knowledge@Wharton:What are the main drivers in addition to costs?
Aron: Cost benefits usually just open the doors. You may start by saying that your
call center or back office operations are very expensive, and you want to look for
other options. Thereafter you discover some interesting things. Consider quality.
You might believe that if you are willing to throw money at quality in the U.S., you
will get it. That’s not true. You’ll have to pay anything from a 40% to 80% cost
premium (in direct wages alone) to get the kind of quality you could get in India.
Inaltus, a processes outsourcing company based in Britain which specializes in F&A
services (Finance and Accounting), estimates that premium in Britain to be upwards
of 80%. In many cases, they point out that the quality is simply not available in the
labor pool that competes for these positions in the UK (and several other Western
countries). Many of the people in the U.S. who have talent and education don’t
want to do back office jobs. In the U.S. there is a serious mismatch between the
kind of skills and temperament that delivers quality and the kind of people that are
needed to deliver them. That mismatch doesn’t exist in India. So even though a
company may enter into a relationship with an Indian firm because of costs, it
discovers that it gets much better quality than it had expected.
Moreover, companies that outsource back-office operations to India discover other
intangible benefits. At one financial services firm, the back office in India started
making suggestions about how processes could be streamlined in Europe and the
U.S. That not only led to productivity gains, but also made for much faster
customer processing and proximity. Earlier, if you wanted to cross-sell an insurance
product to someone who had already bought a credit card or mortgage, it took six
to 12 days to turn that around. You can now do that in 24 hours. You can find really
smart people who are willing to make a career of this in India.
So companies start out for cost, stay on for quality, and then realize that they get a
lot of managerial initiative. It takes a lot of headaches off their hands and allows
them to stay focused on their core competence – and to remain close to their ideal
customers and serve them.
Knowledge@Wharton:What are the implications of your research for developing
countries to which the supply chain of expertise extends?
Aron: Initially many companies looked at setting up back-office operations in
Ireland and Canada; now the cost advantages have gone away in those markets.
Ireland has a small population, and back-office operations are a sunset industry
there. Malaysia and Singapore are trying to get in on the action. They have the
infrastructure, unlike India. Getting your telecom infrastructure set up in India is
like a doing a root canal without Novocain. You don’t have this problem in
Singapore; it’s amazingly agile. In 48 hours you can get full connectivity.
You might also see hybrid situations where more skill- and labor-intensive jobs
might migrate to India and parts of Malaysia, and and as a second tier, jobs which
carry higher managerial content – which require more Western management
techniques and human GUI (graphics user interface) and more of a professional
touch – such as offshore CRM services - those might migrate to Singapore.
Knowledge@Wharton:Have you seen any examples so far?
Aron: Architecture offers a good example. There’s a large firm which does a lot of
work in Indonesia, but this is how it works: the Australian firm ships out part of its
work to Singapore, where the cost differential is very high (in fact, they have many
Indian architects working there), and this relationship is managed out of the
Sydney office. This allows the firm to be in the region and yet not part of the same
cost regime. So you might find middle offices move to countries like Singapore,
Thailand or the Philippines. The single biggest advantage India has over these
countries is the existence of a large, math-friendly, English-speaking population.
Knowledge@Wharton:What about risks? How should companies deal with the risk
of intellectual property being poached as a result of outsourcing arrangements?
Aron: The principal risks are what my Wharton colleague Eric Clemons calls PSOR –
poaching, shirking and opportunistic renegotiation. These are very early days, and
so most of the time you find companies under-committing and over-delivering.
These risks can come up when the market matures, but right now it’s still in the
expansion phase.
Still, you have to be careful in a couple of areas. First, if the firm to which you have
outsourced work takes ownership of your customer information, that greatly
increases its bargaining leverage. Outsourcing firms that have this information can
start renegotiating prices or contracts.
Secondly, there is the issue of lock in. When people think about lock in, they
usually think about information technology. This is a minor part of lock-in; in fact,
there is a great deal of standardization with web services. The greater risk is
process-level lock-in. If employees get used to seeing the same screens and doing
the same things while someone supports them from a back office, it’s a tremendous
bargaining advantage for outsourcing companies (the providers) vis-ŕ-vis the
principals (the users). Even if the outsourcing firm increases its fees, it becomes
difficult for the principal to discontinue operations or change the way things are
done. The human level lock-in – of the person, the process, and the information
manipulating system – is much more dangerous and costly. Disruption of those
processes is usually unaffordable; and that gives the outsourcing firms tremendous
advantages.
There are of course ways to guard against these risks. One is to distribute risk. The
other is to have a dummy standby mechanism for every process. And going back to
the notion of revenue distance, as you come closer and closer to the point where
revenue is captured, for those processes you should keep a skeleton back up, which
might let you operate for two weeks without interruption if your supply is disrupted.
That skeleton backup is enough because it changes your bargaining power.
Knowledge@Wharton:What opportunities do you see in health care? Medical
transcription is being outsourced, but do you see other opportunities as well?
Aron: In the next four to eight years, the U.S. is going to see three important
trends in health care. One is boutique medical care: For those who are able to pay,
there will be a level of service that goes beyond what is now provided by medical
care firms. Every time you hear the term, “high quality service,” it means there is a
great deal of information manipulation. So boutique medical care is likely to take
off – and this will aim at providing health services priced at $60,000 a year to
$400,000 a year. There are more than 1 million millionaires in the U.S., so this is
not a tiny market.
Since not everyone is going to get the same suite of health care services, other
parts of the industry will segment themselves into groups that make more
intelligent use of customer information. In the U.S., some of this will be aimed at
better capacity utilization. If, for example, a hospital such as the Columbia
Presbyterian Hospital is accepted by 20 health care providers, you might want to
make the case that it should be accepted by 200 of them. You can do several levels
of fine segmentation, and decide how those costs are going to be covered among
the providers.
The finer you price your services, the better it is for people at the lower end. If
someone who costs $500 a month to service pays a premium of $250, and
someone who costs $50 a month to service also pays a premium of $250, if you
can make the premium reflect the risk status a little better, you might be able to
reduce the number of the 40 million uninsured in the U.S. Finer segmentation
means faster information throughput and movement in the back office. Two very
large players in the health care business are already looking for outsourcing
opportunities in this area.