Rewind-to February 2004. Outsourcing, in particular offshore outsourcing, was a bad word in the American lexicon. Merely one year later--with the presidential campaign over and President Bush still in office, it's not such a bad word anymore. In fact, industry sources say, outsourcing-even offshore outsourcing-has actually been growing, even while it was under fire. What's more, they say, "global sourcing" is here to stay."Outsourcing captured so much attention around the world in 2004," notes Lorrie Scardino, research director, at Stamford, Conn.-based Gartner Inc., during a recent teleconference. "A lot of people would say there was a lot of political rhetoric and attention that kept outsourcing at top of mind in many industry sectors-especially the IT sector, while others would say there were a lot of economic issues that kept it top of mind," she says. "But the reality is: Outsourcing in the IT services sector is a mainstream business practice."

In fact, in 2003, outsourcing captured 26% of total IT services spending across industries, according to Gartner. By 2008, that number will grow to 33%. Forty-seven percent of insurers are using or plan to use outsourcing within the next 18 month--and the insurance sector alone spent $6.26 billion on IT outsourcing in 2003--a figure Gartner predicts will grow to $10.3 billion by 2008.

In addition, Scardino says, "global sourcing" is an irreversible mega-trend. That's the term used to describe the practice of finding the right skills in the right regions of the world at the right price, and it includes using what Gartner calls a four-tiered delivery model-of on-site, off-site, nearshore and offshore resources.

"You would think in 2004 with a lot of the political pressure on offshore outsourcing that there would have been some slowdown of contracts awarded that included some component of offshore delivery-and specifically the Indian offshore companies," Scardino says. "But even with all that pressure, there was no slowdown in contract signing."

One example is Tata Consultancy Services (TCS), an India-based IT and BPO services provider, which has continued to grow despite the bursting of the tech bubble five years ago as well as the recent controversy over offshore outsourcing.

Sixty percent of TCS's revenues come from North American companies, according to Victor Chayet, director of U.S. corporate communications for the company. And, although TCS has been challenged to communicate the value of global sourcing of IT services and business processing, the company's average annual revenue grew 27% to 30% over the past five years, with year-over-year profit-before-tax increases of 53% per year.

"We've sustained growth over what may been considered the most difficult five years in technology," Chayet says. Even over the past year, TCS's revenues grew nearly 50%.

"Offshore outsourcing is only one part of our value to customers," he says. "In many cases, we come in, deliver services, and leave behind trained people and the technology assets they're going to manage." And, while many TCS contracts contain an offshore component, that offshore component is diverse, he says. "It can come from Uruguay or China or Hungary or Sidney or Buffalo or Toronto. Those are all development locations of ours," he adds.

In fact, although offshore outsourcing has been the focus of the most criticism, it accounts for only about 4% of insurers' total IT services spending-and 3% of IT services spending across industries, according to Gartner.

Yet, even with the offshore component of IT services spending so much smaller than might be expected, sources say geography is playing a role in how companies complete an IT project. "It could be nearsite, nearshore, offshore-anywhere-depending on how sophisticated your IT staff is," Chayet says. "Across the board, everyone is considering where to do things as much as what to do and how to do it."

That's primarily because outsourcing promises to save money. No doubt about it: The main reason companies outsource is to reduce costs. Like U.S. manufacturers who moved factories to regions of the world where the labor rate was much lower and where developing countries offered tax advantages, the services sector is following suit--a few decades later.

It's no longer acceptable for companies to have a fixed location in a high-priced area of the world, Gartner's Scardino says. "And it's no longer acceptable to have an external service provider deliver all of its services from one U.S. location."

That was the thinking behind the recent decision by Document Sciences Corp. to acquire Objectiva Software Solutions Inc. The acquisition, which was completed in July, resulted in a team of insurance, document processing, and enterprise software development experts from the United States and China.

Having this diverse team is enabling Document Sciences, a Carlsbad, Calif.-based document management firm, to offer its customers more competitive rates for enterprise software and services.

In fact, Document Sciences currently is working with one large U.S. insurer on a multi-million dollar contract to consolidate systems and re-brand the insurance company after a recent merger, according to Doug Winter, general manager of technical operations at Document Sciences. "This is a huge project with a huge labor content," he says, declining to name the company.

But because Document Sciences is tapping into the development center that Objectiva established in Bejing, the provider has been able to charge this large insurance client a "blended" rate for software development services that is less than half that of U.S. labor, according to Winter.

"From Day One, we were a U.S.-Chinese company," he says. Winter co-founded Objectiva in 1999 in Encitas, Calif., with his Chinese-American business partner Tao Ye, who still runs the development center in China.

To be sure, Indian, Chinese, and Eastern European software programmers earn far less than their U.S. counterparts-and they're highly skilled. As a result, cost has been and will continue to be a focus for IT outsourcing-unless wages even out. "You can't get away from the focus on cost with outsourcing," says Gartner's Scardino.

This year, however, outsourcing is beginning to take an interesting turn-in the sense that executives are beginning to look beyond cost for other benefits of farming work out to third parties.

"If we look at the priorities companies had when they outsourced IT infrastructure in 2001 and 2003, it was to reduce operating costs," Scardino says. In 2005, however, the top driver is to transform their infrastructure and align it with the business."

This is a significant change, she says. "Clients are looking to external service providers-the vendors-to introduce change in their environment and make them more flexible and adaptable."

More flexibility

Document Sciences' Winter concurs. "Cost for cost's sake isn't the only advantage of outsourcing." Lower cost produces flexibility, he says, which is enabling Document Sciences to go after enterprise software business that requires a lot of customization. "This model gives us more resources to work with than we would otherwise have with operations in the U.S. alone."

In addition, he says, because Document Sciences has a development facility in Bejing, the company has gained access to the Chinese insurance market-a market that is growing at 25% to 30% a year.

That's because Objectiva has enabled Document Sciences to design its product for Asian characters, and the development center in Bejing provides local support for customers in that region.

Similar findings about the value of outsourcing beyond cost savings resulted from research by New York-based PricewaterhouseCoopers.

In its fall Management Barometer Survey of 151 U.S. senior executives across industries, PwC found that many companies are not even reaping the cost savings they had expected from their outsourcing ventures.

Even so, the majority still plan to continue the practice-primarily because they believe it will contribute to profitable growth within the next two years.

According to PwC, 77% of U.S. companies used outsourcing or shared services for financial functions-which includes payroll, billing, IT systems support, and human resources. But only 47% believe their company is saving a great deal or a moderate amount by outsourcing these functions. Twenty-nine percent said they had limited or very little savings, 9% were breaking even, and 5% were actually losing money.

Nonetheless, companies see the value of outsourcing, says Dan DiFilippo, PwC's global leader for performance improvement, and U.S. leader for governance, risk and compliance. "They're just having more implementation issues than they would have expected. Down the road they plan to continue to expand this activity."

Some of the implementation issues cited by PwC survey respondents include performance problems and difficulty dealing with complexity. For example, only 36% of U.S. executives surveyed feel their outsourcer is dealing with complex issues in a highly effective manner, 37% believe their outsourcer is providing quality performance, and 32% indicated that learning curves were higher than expected.

Even so, 55% of the same group plan to continue the same amount of outsourcing over the next two years, and 30% plan to increase it.

Companies that were losing money or breaking even seem to believe these issues are controllable, says DiFilippo. They admitted they could benefit from using more accurate up-front feasibility studies and cost-benefit analyses (43%), as well as regular monitoring of process improvement with the outsourcer (64%), he says.

Skills are needed

Outsourcing is by no means a cure-all for expense issues, says Craig Weber, a senior analyst with Boston-based Celent Communications Inc. In fact, he says, when a company hires a third party to perform IT or business processing functions, the project usually requires more measurements and a more rigorous process. "And that costs money," he says.

Insurers that outsource have to build the right skills to manage their outsourcing programs, sources say. Those skills include understanding the contracting process, controls, measurements and service-level agreements.

"You need to have people inside who are skilled at managing external resources-communicating, and setting up and managing projects," Weber says. "You can't leave it to chance that your outsourced projects will be managed."

Despite the obstacles, however, the carriers Weber talks to believe they are getting value from outsourcing. "My sense is the market is sold on the outsourcing model," he says.

Unity Life of Canada is certainly sold on the outsourcing model-because it has enabled the 104-year-old, Toronto-based mutual life insurer to grow from $2 million to $50 million in settled premium in only four years. The company has been transformed from a struggling life insurance company into an innovative provider of unique insurance products through unique distribution channels.

"About five years ago, we decided if we were going to survive and prosper in an environment where the larger mutuals had de-mutualized and there were mergers and acquisitions going on, we had to do something significantly different," says Tony Poole, senior vice president of sales and marketing at Unity Life.

Different business model

So Unity Life management decided to create a virtual insurance company, spinning off its back-office operations into a separate company, now called Genisys.

"We recognized this was a completely different business model," Poole says. "It would free us up to really do what we do best-our core competency-which is the manufacturing and distribution of products."

The idea was to transform Unity Life's back office from being an expense-driven operating division of a life insurance company into a revenue generator, Poole says. With Unity Life as its original customer, Genisys-an end-to-end business processing outsourcer (BPO) to the life insurance industry-has since attracted several more customers including CIBC, BMO Life, Gerber Life Insurance Co., and Manulife Financial.

Free from the day-to-day back-office operations, Unity Life also outsourced human resources and legal services, as well as valuation and actuarial services.

"We said, 'What is our core expertise? It's manufacturing, marketing and distribution of products,'" Poole says. By outsourcing the valuation and actuarial functions, Unity Life obtained best-of-breed talent that it otherwise couldn't afford as a small insurer, he says.

Business process outsourcing captured a lot of attention in 2004, notes Gartner's Scardino. "It's a very hot term-a very hot topic," she says. "And when we talk to clients about BPO, their No. 1 reason for considering it is to focus on their core business."

BPO seems particularly suited to markets characterized by commodity products, tight margins and industry consolidation, says Mike McGuin, senior marketing specialist at Toronto-based Genisys. Because of these pressures on the life insurance industry, life insurance BPO will account for more than 65% of total U.S. BPO by 2006, according Datamonitor, a New York-based research and advisory firm.

"When you look at the landscape, insurance companies need to redefine their core competencies to continue to be viable going down the road," McGuin says. "That's why outsourcing is an option they should look at-to reduce expenses, redefine their processes, and leverage best-of-breed technology that they not be able to afford otherwise."

BPO moving slowly

Because of its potential benefits, carriers have been curious about BPO-but adoption is moving more slowly than most pundits have predicted, says Celent's Weber.

Insurers have grown more comfortable with IT outsourcing and they have an established history with using third-party administrators (TPAs) for discrete services such as first-notice-of-loss (see "When Insourcing Makes Sense," page 26). But they're still wary of outsourcing core business processes, such as policy and claims administration, sources say.

"Clients are afraid of losing too much control of their processes and in-house expertise," says Gartner's Scardino. They also have difficulty determining exactly which processes are the ones that differentiate them-which they should retain and which they should consider outsourcing, she says.

Even with insurers' caution, however, Celent predicts BPO in insurance will grow over the next several years-from $2.5 billion in 2004 to nearly $3 billion in 2006-with TPAs accounting for about 60% of that revenue. BPO hasn't exploded in growth as some people predicted, says Weber. "But it is coming. This is one of those trends that isn't going to go away. And the enthusiasm of vendors is justified."

When insourcing makes sense

Outsourcing has received a lot of attention as a way to reduce costs and improve operational flexibility. Sometimes, however, the best decision a company can make may be to keep the work in-house or to bring it back in-house.

The latter is what happened to OneBeacon Insurance Group when the Boston-based subsidiary of White Mountains Insurance Group hired Opus Group LLC to evaluate and redesign its disparate underwriting processes.

After Opus Group re-engineered the insurer's workflow and aggregated data from several underwriting systems into one central repository, the carrier consolidated its call centers, which included bringing an outsourced first-notice-of-loss call center operation back in-house.

"Opus Group has done a lot to help us understand the work flows in the offices-and they've brought a certain level of standardization to managing our internal processing," says Mike Murray, vice president of finance at OneBeacon.

As part of its analysis, Opus Group discovered the insurer had excess capacity in-house. Those resources could be redeployed to a first-notice-of-loss operation, which OneBeacon could operate at a lower unit cost than it was paying its outsourcing provider.

"We always say, 'Before outsourcing, fix the process here first,'" says Mike Callaghan, CEO of Opus Group, a Chicago-based call center performance management software provider. "There's always a way for an organization to be more efficient," he says.

"Don't give that efficiency over to an outsourcer. Get as efficient as you possibly can before you calculate what you can save by outsourcing."

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