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Best Practices in Offshore Outsourcing: Strategies for Transition, Attrition, Communication, and Bridging the Cultural Gap

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Transformational Offshoring: Why and How?

Guidelines For IT Management: Planning for Offshore Outsourcing

Outsourcing to India: Key Legal and Tax Considerations for U.S. Financial Institutions

At Everest Group, we first encountered the term "global hub-and-spoke delivery model" about five years ago. A service provider told us that it wanted to create a global hub-and-spoke service delivery model to serve large global clients. The goal was to have in each geographic region either a regional or country presence to serve local needs and a global hub to serve as a large-scale transaction engine for all work that that was location independent. At the time, the idea sounded revolutionary, the work of true visionaries.

Now every service provider we speak with either has a global hub-and-spoke model, is in the process of implementing one, or is looking for the right global client deal to get them there. The service providers understand both the operational benefits and the client value-add of this model.

Suppliers use spokes for work that needs to remain local, and the definition is constantly shifting; that is, each year companies are getting more and more comfortable sending work to far-away locations. In our July 2007 article "How 1937 Economic Theory, Which Won a Nobel Prize, Helps Offshore Buyers Today," we discussed the drivers and enablers behind the movement of work to far-away locations. The primary enablers are automation and language independence.

What Work Must Remain Local?

For finance and accounting outsourcing (FAO), the work remaining in the spokes tends to be one of two types:

1. Local Language - Some work requires local language support; and some of the languages, primarily non-English languages, are difficult to staff in remote locations. Local language requirements are often present when buyers outsource non-transactional work such as decision-support work. Buyers sometimes associate local language requirements with transactional work, such as requirements for contact with local vendors (accounts payable), employees (payroll), or customers (accounts receivable).
2. On-site Requirements - Some work, by its very nature, requires an on-site presence or frequent on-site visits. A good example is internal audit and SOX compliance. Some day all processes may be fully automated and totally paperless, but we have not yet reached that day. When that day comes, it may be possible to perform all audits and controls testing remotely; but today this work still requires some level of site visits.

Are FAO Offshore Hubs Different from Other BPO Offshore Hubs?

All offshored processes have one thing in common: they are located where there is an opportunity for labor arbitrage. For finance and accounting (F&A) work, India has emerged as the leader with the largest number of scaled FAO centers. Bangalore is the hub of F&A outsourcing in India, with almost one-third of the F&A workforce of third-party service providers. Chennai, Pune, Mumbai, and the National Capital Region have also emerged as preferred Tier-1 locations for delivery of F&A services. Service providers are also opening centers in Tier-2 Indian cities like Jaipur, Nasik, Kochi, and Kolkata, which are relatively lower cost than Tier-1 locations.

Figure 1

Other factors beyond labor arbitrage also create a unique value proposition for FAO global hubs. In fact, the global hub-and-spoke model is arguably better suited to finance and accounting than other processes due to three factors: standardization, scale, and location independence.

Standardization: F&A processes are more standardized than many other processes due to regulation and rules such as SOX and US GAAP. SOX and GAAP rules have impacts well beyond the US borders; every company listed on US exchanges must follow these rules. There is also a convergence taking place between US GAAP and International Accounting Standards Board Standards. This convergence will only further strengthen the value proposition for FAO global hubs. There are no comparable governing bodies and rules for the majority of the other BPO processes.

Scale: Much of the outsourced F&A work is transaction processing, and transaction processing is very responsive to scale. Creating a global hub in a low-cost location purely for labor arbitrage is not a guarantee of long-term success. As the demand for low-cost labor increases, the price of labor increases. Labor arbitrage in low-cost countries will last for many years. However, the labor arbitrage benefits are slowly diminishing. Processes that respond strongly to scale will retain value; as service providers add scale, the scale benefits will act to offset the decline in labor arbitrage.

Scale allows:

• Greater resource utilization by smoothing the peaks and valleys associated with varying demand cycles, which creates productivity gains by allowing fewer people to perform a given volume of work
• Greater individual productivity due to the ability to spread software, best-practice research, and reengineering investments across more volume
• Increased ability to specialize by matching the right skilled person to the required activity to optimize the skills mix
• Increased throughput. More than many other business processes, F&A transactional work lends itself to an assembly-line production model, and assembly lines by their nature are responsive to scale--assembly lines yield lower cost per unit of output as volumes increase

Location Independence: Much of the F&A work outsourced is location independent (again see http://www.outsourcing-journal.com/jul2007-everest.html); therefore, the ratio of what needs to stay in the spoke versus what can be moved to the global hub is favorable versus the spoke-to-hub ratio for many other processes.

Why are Providers Adopting the Hub-and-Spoke Model?

Three key drivers continue to push service providers to adopt the global hub-and-spoke model:

Scope Expansion: Five years ago, the majority of buyers of outsourced F&A services purchased only basic transactional services; today, buyers continue to move up the mountain with the outsourcing of reporting, compliance, and other key processes (see Figure 2). As both service providers and buyers become more comfortable moving work to the global offshore hubs, buyers outsource new work (key processes) that they prefer to hold near shore, thereby creating an ongoing need for the local presence, creating an ongoing need for the hubs.

Figure 2

Competitive Pressures: A number of Tier-2 FAO service providers are pushing aggressively to take market share from the Tier-1 providers. These competitive pressures, along with rising wages in India and other hub countries, are putting pressures on service providers to be operationally excellent. Placing the maximum amount of work in the low-cost hub helps the service provider to reduce cost.

Scale Benefits: FAO processes respond well to scale. Placing the maximum amount of work in the low-cost hub helps the service provider increase productivity and thereby reduce cost.

Lessons from the Outsourcing Journal:

• Over the past five years, the global hub-and-spoke model has evolved from visionary idea to standard and growing best practice.
• FAO processes are perhaps best suited for the global hub-and-spoke model.
• There are factors driving the need and growth for both the hubs and the spokes. Operational excellence is driving the need for hubs because they create scale and enable standardization. The scope of FAO deals continues to expand into more complex processes which create language and proximity requirements.

Publish Date: October 2007

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Copyright © 2007 - Everest Partners, L.P.

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