Managing Risks in Offshore Outsourcing

As the new waves of outsourcing trends emerge, it is also important to take a pause and analyze the risks that come with such virtual domain. An understanding of such risks and ways to mitigate them would help small and medium business enterprises to have a successful off shoring engagement.

According to Aron, assistant professor, Carey Business School, Johns Hopkins University and a research partner with the Wipro Council for Industry Research, there are three kinds of outsourcing risks that buyers should take into consideration while venturing into off shoring arrangement.

They are:

(A)Operational risk:

What?

The propensity of a process to break down and result in less than acceptable quality of work. Here the output of work has too many errors and defects. Like while engaging in FAO, in the supply chain outsourcing, the accounts receivable/accounts payment closures have too many errors.

Why?

This kind of risks mainly originates "because of the complexity of work. It takes a while for the offshore organization to understand what the buyer wants." Another reason is "business unfamiliarity".

How to manage?

According to Aron, who is also a Senior Fellow at the Phyllis Mack Center for Technology and Innovation at the Wharton School of Business, The University of Pennsylvania, there are four definite ways to deal with such risks.

• Knowledge transfer and Management:

  In this it is important never to take it for granted that "your suppliers will understand". The suppliers need training to understand how your business works in your country. Added care should be taken to make them understand the terms and processes. The professor suggests creating joint knowledge repositories and deploying collaboration mechanisms such as wikis, blogs, and RSS feeds via corporate intranets

• Metrics:

  The metrics "have a huge impact on operational risk". It is important for the buyers to make sure that the suppliers understand their standards and definition of quality. According to the professor, "through well-defined metrics the supplier can easily understand and greatly reduce operational risk"

• Transition Management:

  It is very important that extra care and time is given while transitioning the work. This is as it establishes a clear understanding of work flow during the off shoring process. Mr. Aron says that, "don't overlook transition management because it can reduce operational errors by up to 15 percent"

• Monitoring versus Control:

  It is important to have some monitoring ways in place while not controlling too much on the work flow

(B)Strategic risk:

What?

Losses that result when the offshore supplier behaves opportunistically.

According to Mr. Aron there are three ways the suppliers do this. They are:

• Deliberate underperformance or shirking
• Poaching or the deliberate misappropriation of information
• Opportunistic renegotiation of the contract or other opportunistic behaviour

How to manage?

• Build transition service clauses into the contract:

  This clause gives an opportunity to find a new supplier in case of a sudden termination of the contract from the supplier's side

• Use multiple suppliers:

  This can cover strategic risks as in case of breach from one supplier, the work can be diverted to another one with disrupting the business process

• Retain residual capacity:

  The professor says, "Retaining strategic residual capacity also gives buyers the comfort they can immediately take important tasks back in house if the supplier starts misbehaving."

• Monitor and control:

  The professor says, "Continuously monitoring what's happening will go a long way in stopping the provider from taking liberties, shirking, or deliberately underperforming. It's a great deterrent."

(C)Composite risk:

What?

This kind of risk arises over time from a combination of factors like erosion of competence and loss of flexibility.

EOF

The extended organizational form (EOF) "contains in great measure all three risks." The EOF "bridges the strengths of both organizations" by letting the provider's employees report to the buyer's management. While there is no direct employee relationship between the buyer and the provider's employees, this allows the buyer to divest financial control while retaining operational control.

"Surprisingly, it also provides operational benefits to the supplier," says Mr. Aron. Over a period of time the provider's costs fall without compromising the quality of work. Another benefit of this is to deal with a possible legislation that would discourage US- based companies from off shoring by not allowing tax deductions for their captive centres off shore.

Mr. Aron says, "In these difficult economic times, it provides a compelling rationale for offshore services. Combining the EOF with careful use of CSS criteria in contracts allows buyers to move towards transforming their offshore service providers into strategic partners."

The understanding of the types of risks and taking appropriate measures from the beginning would help in the comfortable off shore transactions. The best way is to get it all covered in the contract...