June 01, 2009

By John Varricchio

This article is the first in a series highlighting a four-step process (concept, plan, execute, monitor) for alternative sourcing.

Thinking about outsourcing When most insurance executives think about alternative sourcing, they think first of the potentially huge cost savings of moving finance or IT processes to low-cost countries. They may also think about how outsourcing frees up management to focus on core, strategic work instead of low-value transactional tasks.

However, executives with experience in alternative sourcing are more likely to think about the trade-offs between cost and quality, the tricky decision of "fixing" and consolidating processes before moving them, and the need for clear alignment with business strategy and senior management support. They may also consider the risks that prevent companies from achieving sourcing goals such as choosing the wrong processes or functions to outsource, selecting the wrong vendor or outsourcing model, the rapid rise of wages and turnover-related expenses in "low-cost" destinations, IT infrastructure and business continuity challenges, cultural issues and project management difficulties.Collectively, these risks point to the need to develop a "concept" to determine whether alternative sourcing is right for their company and which processes or functions are appropriate for outsourcing. A concept should look beyond simplistic cost metrics to take into account strategic, brand and transformational dimensions. Further, concepts serve as the foundation for a full and accurate business case - an imperative for insurers looking to outsource a single process or function.

Asking the right questions Concepts result from an internally-focused, pre-planning process that asks simple, but highly useful questions:

• Will new sourcing models align to core corporate strategies and/or transformation initiatives? • What are the guiding principles of sourcing programs? • How efficient and effective are current operations? • Which processes or functions should be considered for outsourcing? • Are all short- and long-term costs understood?

These questions are closely related, and difficult to answer in isolation. But the concept effort enables insurers to craft a framework well suited to their needs.

What's the strategic link? Effective sourcing starts with a clear assessment of strategic implications asking how alternative sourcing will further or hinder core strategies. Companies should also shape a vision for specific support functions.

If "best in class" customer service is a differentiator, then policyholder expectations and cultural challenges must be considered carefully before call centers are moved offshore. Similarly, if claims management transformation plans call for shorter cycles, time zone differences may dictate where resources are located. These are issues that are often overlooked in the race to cut labor costs.

What are the guiding principles? Guiding principles clarify sourcing goals some of which are not cost-related. For instance, organizations focused on operational excellence may be able to outsource transactional work, provided quality metrics and service level agreements (SLAs) specify performance thresholds. Further, guiding principles foster strategic alignment by defining how sourcing models fulfill the vision for specific functions.

Where are you today? Visibility into current costs and performance is another essential ingredient in sourcing concepts. At a minimum, companies need baseline costs-per-transaction and end-to-end costs for any process or function that may be outsourced, including shared services. The ability to accurately forecast costs and volumes is a distinct advantage.

It's critical to consider quality. Linking quality metrics (e.g., cycle times, error rates) to cost profiles quantifies both the value created by internal operations and the financial impact of poor quality. The cost vs. quality trade-offs can be a make-or-break factor in sourcing decisions.

What to outsource? Early adopters have outsourced "factory" processes in finance (AP and billing) and IT (software development), before moving on to higher-value, but still non-core tasks, like reporting or claims processing. But a careful examination of the process portfolio may point toward a different course. The key is to rank processes across a few criteria, including strategic import (core vs. non-core) and relative costs then break them down through activity-based costing - important steps in concepting.

Yes, it takes time, but the effort will pay off in realistic savings targets and a stronger overall business case.

Do we understand all the costs? In our experience, insurers overemphasize labor cost savings and greatly underestimate immediate and long-term indirect and transition costs in building the business case for outsourcing. These expenses can easily add up to 30% of the overall project costs.

Concepting in context In our view, concepting is about internal due diligence, and asking "Why should we outsource?" and "How will alternative sourcing help us achieve our strategic goals?" Certainly it helps answer the most popular outsourcing question "How much can we save?" But, most importantly a strategically developed concept helps you realize those savings.

John P. Varricchio is a Principal in the insurance sector of Ernst & Young LLP's Financial Services Office. He is based in New York City and can be reached at +1 212 773 7645.Concepting is about internal due diligence, and asking "Why should we outsource?" and "How will alternative sourcing help us achieve our strategic goals?" Certainly it helps answer the most popular outsourcing question "How much can we save?" But, most importantly a strategically developed concept helps you realize those savings.

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