October 15, 2013
In the global services industry, cost benchmarking is a method enterprises use to compare their outsourcing cost competitiveness against those of similar organizations. Yet, in Everest Group’s experience and observations, businesses all too often erroneously view salary benchmarking as indicative of overall expenditures.
While salaries constitute the biggest component (60-70 percent) of operating costs, salary benchmarks fall short of providing the requisite insights, as higher salaries don’t necessarily mean higher overall costs. There are multiple other factors driving costs. The top three factors driving outsourcing operating costs, other than salaries, are:
- Pyramid and talent model
- Scope of work
- Non-compensation cost
These factors are specific to companies’ context and typically depend on their positioning. In addition, there are market-driven forces impacting costs, such as attrition, wage inflation, and the exchange rate in different countries.
A typical benchmarking exercise takes all these factors, and others, into consideration.
Following are three cost benchmarking best practices.
Best practices of cost benchmarking
Take a holistic view
Cost benchmarking should consider a comprehensive set of factors effecting cost. Everest Group classifies these components into three broad buckets:
- Compensation-linked costs (e.g., salaries, benefits)
- Non-compensation costs (e.g., real estate, technology, support staff, transportation, recruitment, and training)
- Policy levers (e.g., delivery pyramid, support staff leverage, and space usage)
An ideal cost benchmarking takes a holistic view across all three categories.
Identify underlying cost drivers
By definition, cost benchmarking determines differences within the market. However, on their own, these differences offer limited insights. To discover opportunity areas for cost optimization and subsequent calibration, enterprises need to identify the underlying drivers of differences.
For example, if an organization’s real estate costs are higher than the market average, benchmarking should identify whether it is due to rentals, space per seat, seat utilization, or a combination of these factors. Similarly, for companies with higher support staff costs, benchmarking should identify if it is driven by higher support staff salaries, skewed support staff ratios, or both. There are multiple such costs elements (e.g., transportation, recruitment, training) for which benchmarking could help identify the underlying drivers for calibration.
Even in situations where cost drivers are identified, it is critical to ensure like-to-like comparisons in order to derive meaningful conclusions. For illustration, in the real estate example above, economies of scale can result in different real estate costs for a 100 seat center and a 1,000 seat center.
Thus, organizations should normalize data along key dimensions impacting the cost. Typical dimensions to normalize include:
- Locations (e.g., onshore/offshore, Tier-I/II/III)
- Scope of work (e.g., ITO/BPO, front office, back office)
- Nature of work (e.g., transactional, complex)
- Player type (e.g., GIC, service provider, specialist)
- Scale (e.g., mid-size, large scale)
Cost benchmarking is not an easy, close your eyes and toss the dart exercise. Benchmarking that fails to take a comprehensive view of cost, identify underlying drivers, and normalize data runs the risk of making misleading comparisons that may lead to flawed results.