Tag: location optimization

The Curious Case of Currency Trends and Cost Competitiveness | Sherpas in Blue Shirts

While cost arbitrage for global services delivery is impacted by numerous factors, e.g., wage and rental cost inflation, currency fluctuations are often the ignored wild card.

Most currencies have varied significantly in the past few years (see the graphic below). For example, in Asia-Pacific, the Indian rupee has depreciated considerably compared to the U.S. dollar, with an average yearly decline of 5.4 percent in the last three years. On the other hand, the Philippine peso has appreciated substantially against the dollar, recently reaching a four-year high. The currencies from major outsourcing locations in Latin America and Europe have also been volatile in recent months.

Currency Trends

While one would have expected the large currency variations to have a big impact on delivery costs, a closer analysis reveals that the relative cost rankings of locations in 2013 have remained nearly the same as in 2010 (see the graphic below). This counter-intuitive result is because the currencies in most global services delivery destinations have depreciated over the last few years. In addition, all these locations have experienced moderate-to-high wage inflation, thus having a similar net impact on cost across locations.

Cost Rankings

Further, the interplay of wage inflation and exchange rates is leading to interesting trends in absolute value of operating costs among locations. Let’s look at two extreme examples to understand this phenomenon:

  • The cost differential for customer service operations between Argentina and Colombia has decreased given the interplay of wage inflation and exchange rates resulting in comparable rankings (see the graphic above)
  • India and the Philippines are competing locations for most transactional processes. While the costs for English voice services in these two countries were quite similar in 2010, costs in the Philippines are now 18-20 percent higher than in India (see the graphic below). This significant cost differential was driven by a combination of moderate wage inflation (10-15 percent per year) and the appreciation of the peso.

Operating Cost Gap

It is important to note that these cost changes among competing locations for similar type of work has not resulted in changes in work distribution. For example, India has not gained greater share of contact center voice work relative to the Philippines. This is because while cost is an important factor, location selection and work placement decisions are dependent on several other factors, e.g., talent availability and scalability, niche skills, risk considerations, and the organization’s existing footprint. Short-term currency changes may result in companies optimizing some work among locations in their portfolio, but this alone is not likely to significantly change the role and standing of locations in their portfolio.

Is Costa Rica’s Magic Beginning to Fade? | Sherpas in Blue Shirts

Recent news announcements on several third party service providers’ pullouts from Costa Rica may lead people to believe that the country is losing its luster as a sourcing destination for outsourcers and global in-house centers (GICs). But, before jumping to any conclusions, let’s gain some perspective on these announcements.

HP

HP in February 2013 announced it was scaling back the English-language customer support team in its Global Services Center by 400 employees. However:

  1. HP has nearly 6,500 employees in Costa Rica, spread over multiple sites and processes/functional areas, and this move affects only 400 working in just one of the company’s 20 different units operating in the country
  2. This particular reduction in headcount was part of a global restructuring plan announced in May 2012 by CEO Meg Whitman
  3. Most of these 400 employees will be given the opportunity to apply for one of the 300 new jobs being created in the other 19 units
  4. HP is planning to hire 150 employees into the Global Engineering Services unit it opened late in 2012

Rather than signaling that HP’s confidence in Costa Rica is shaken, this move indicates a strategic shift in how the company plans to utilize the location, and that the kind of work supported in the country may be moving up the value chain.

Stream and Teletech

Reportedly driven by rising wages and other operational costs, TeleTech is expected to cut ~ 160 of its 1,250 positions in Costa Rica. And while Stream Global Services recently shuttered its 700-750 FTE operations in the country, it opened a new center in Honduras with a capacity of 750 FTEs.

Everest Group believes these developments are the result of the providers’ evolving location portfolio strategies to control/optimize service delivery costs with rebalanced footprints.

Costa Rica Facts

While the country has traditionally been, on average, 30-40 percent more expensive than other less-developed locations in Central America for delivery of bilingual (Spanish-English) voice-based BPO services, it is still fairly attractive due to its:

  • High cultural affinity and solid English language skills
  • Geopolitical stability, and relative safety and security
  • Well- established depth and breadth of ITO/BPO service offerings
  • Opportunities to support European languages per its ability to attract people from countries in Latin America and Europe

And although wage inflation and attrition levels increased steadily over time, and are now at levels that make its cost profile less attractive than lower-cost and lesser-developed options in Latin America (Managua, Guatemala City, San Salvador, Tegucigalpa, Santo Domingo, Peru, and Colombia) and the Caribbean, sourcing activity in the country has not slowed down for third party providers or GICs.

In fact, Costa Rica experienced record delivery center establishment activity in 2012, on par with China, and behind only India (see Exhibit 1). Amazon and Bridgestone are among the most notable companies that setup GIC operations in Costa Rica last year.

Exhibit 1

Costa Rica delivery center setups

Moreover, as depicted in Exhibit 2, it has dominated center set-up activity in Latin America for the past three years.

Exhibit 2

LATAM delivery center setups

Costa Rica clearly continues to present an attractive mix of skills and opportunities, and these often outweigh the higher cost of operations in service providers’ and GICs’ tradeoff analyses.

So what’s in Costa Rica’s future as a sourcing destination? Everest Group predicts the market will continue to mature across multiple dimensions, and will exhibit the following major shifts/trends:

  1. It will increasingly be leveraged for up-the-value-chain, more complex work, not just in business processes such as F&A, but also in areas including knowledge processes, IT, and creative media. This will be driven primarily by a maturing talent market, synergies with customer service work, and efforts by companies to optimize facility costs
  2. Wage inflation and attrition for bi-lingual (English-Spanish) professionals will plateau in the next 18 months, driven by a moderate slowdown of growth
  3. Call center players will rebalance their Latin American portfolio footprints, and transactional contact center work, especially that requiring a medium level of English proficiency or monolingual Spanish delivery, will move to emerging locations
  4. Large new investments in the contact center space, or existing players scaling to more than 1,500-2,000 in the country, are unlikely. There will be a gradual decrease in size of new centers as companies start to support higher-order work that is less FTE-intensive
  5. Players will continue to leverage some unique talent and operating models to continue operations/grow in the country. These will include tapping into pools from areas adjacent to the Greater Metropolitan Area (GMA), leveraging part-time students and diploma holders, and even opening satellite centers outside the GMA
  6. GICs will continue to play a significant part in the increasing maturity of Costa Rica. They will find value in expanding the depth and breadth of services supported from Costa Rica, in part to better utilize their sunk costs

While we do not expect Costa Rica’s magic to fade away anytime soon, some of its charm will shift from some specific areas, especially English-Spanish voice delivery, to emerging areas of work such as  IT, knowledge processes and F&A. Moreover, the recent developments in Costa Rica are an inevitable part of the natural evolution/maturation of a delivery location; we’ve seen, and continue to see, similar trends in other sourcing destinations such as India and the Philippines.

For a deeper analysis of the GIC landscape in Costa Rica, please refer to our recently-released report, Global In-house Center (GIC) Landscape in Costa Rica and Trends in Offshore GIC Market

Leverage Points in Global Services for India, China, and Philippines | Sherpas in Blue Shirts

India, China, and Philippines are often lumped together in regard to their roles in global services delivery. The reasons are not hard to fathom – these three geographies are consistently featured as leading locations for global services delivery (both new centers and expansions). In addition, their common availability of large talent pools coupled with low-cost operations make them highly relevant in global services delivery discussions.

However, a deeper analysis of the source markets served by these countries reveals some country-specific findings that are relevant for incumbents as well as new players with plans for these geographies. The chart below provides the distribution of IT-BPO services revenue in these countries in terms of source geographies served.

IT BPO Services Revenue

More than four-fifths of the global services delivery in China is focused on the domestic market with a limited scale of global delivery to North America and Europe. The availability of an English-speaking workforce continues to be a concern for global organizations as are perceptions related to IP / data protection regulations. There is a distinct value proposition for China to serve  its regional markets (e.g., Japan and South Korea) given factors such as time zone similarity, cultural affinity, and language availability.

In contrast, the Philippines is almost exclusively leveraged to serve the United States. Voice BPO has been the traditional growth engine for the Philippines, given cultural affinity and a large English-speaking workforce. However, of late, the Philippines market has also seen traction in BPO functions (particularly industry-specific non-voice BPO) and IT services, indicating diversification of service portfolio beyond voice.

And lastly, India has a distinctive value proposition around serving both the domestic and global markets. Leading players have multi-function scaled operations for global delivery to North America and Europe. In addition, India also sees large demand from the domestic market, particularly for technology and voice operation, and players typically leverage multiple cities within the country (including tier-2/3 cities) for serving this demand. However, unlike China, a very small proportion of service delivery from India is targeted towards the Asia Pacific market primarily due to the constraints around East Asian languages.

Global adopters are increasingly accepting a multi-location approach towards building their portfolios. As they think about their location strategy for Asia, they would be wise to consider roles for India, China, and Philippines based on their unique factors related to source markets and functions for delivery.

Recognizing and Reducing Offshore Location Selection Risks | Sherpas in Blue Shirts

A recent article in BusinessWeek, Argentina Tries the Chavez Way, triggered my thinking about the increased role of geopolitical risk in location selection and overall risk mitigation. In the last decade, Argentina became the “darling” of global services given considerably lower resource prices than in neighboring Brazil, a stable society with deeply rooted democratic principles, etc. But the country’s geopolitical risk profile substantially changed recently. Its economy has stagnated from defaulting on its national debt, pseudo-populist movement groups are promising “quick and easy” fixes to the existing problems, and the trend of nationalizing privately owned businesses is expected to continue, given the views of the current political leadership. None of this yet puts Argentina’s geopolitical risk profile outside of the acceptable range. But we’ve seen from examples around the world that, in the absence of more efficient measures, it may be very tempting for a government to divert public attention from internal problems to some newly introduced external threat. For instance, consider what would happen to the country’s business environment if something similar to the almost forgotten conflict over the Falkland Islands suddenly escalated.

Now think about Colombia, whose geopolitical risk is moving in the opposite direction. While 15 years ago it couldn’t have bought a place on the global services location map, for the last two years its stock market gained an impressive ~50 percent due to various successful measures against FARC, drug cartels and other instability factors. Now, BPO and IT delivery centers are mushrooming in Colombia, driven by an abundance of relatively inexpensive but highly qualified labor resources. Given the large size of the young population in Colombia, as well as steady adherence to open market principles, it is believed the country will continue gaining attractiveness as a global services hub. And it is already considered the second largest IT services market in Latin America.

The point of this blog is not to discuss specific country’s risk profiles, but rather to remind readers that such wild swings must be factored into location analyses, similar to how attorneys approach terms and conditions from a worst-case scenario.

Although labor arbitrage was the primary driver – and continues to be important – in offshoring location decisions, typical global firms are becoming increasingly ready to exploit economies of scale. If a company’s offshore delivery is currently split among several locations – say, Argentina, Philippines, and Romania, each serving a respective region – it is quite tempting to consider some consolidation initiative through formation of a mega-large shared services center, and that’s where increased exposure to specific location risk kicks in as a decision factor.

Obviously, increased volatility in geopolitical risk is just one of many aspects an organization should factor into cost/benefit analysis, and the analysis must be tailored to each organization’s specific situation. That said, here are several general thoughts to consider:

  • There’s no question that it’s very difficult to walk away from an opportunity to reduce your annual cost by, say, US$20-50 million through aggressive optimization of your delivery footprint. But all those savings could get wiped out by billion dollar losses if something goes wrong and disruptions cascade throughout the entire value chain. Therefore, it makes sense to “hedge” such optimization opportunities by developing a customized risk mitigation framework that includes maintaining some “cold” and “warm” alternative sites, and a relocation strategy.
  • Level of acceptable location selection risk varies from company to company, and depends in part on whether the goal is just to achieve cost parity with industry peers, or if a lighter cost structure is expected to become the source of competitive advantage. But remember that any company implementing a low cost competitive strategy must take on some degree of risk.
  • You can reduce some of your risk by using a reputable third party service provider instead of building your offshore presence from scratch, as managing location risk is one of providers’ core competencies, and global providers operate multiple delivery centers across the globe. With properly structured terms and conditions, your outsourcing provider will monitor and proactively manage your risk exposure, including geopolitical concerns.

Philippines: From Voice Services to a Broad-based Global Sourcing Destination? | Sherpas in Blue Shirts

The Philippines, which is already giving competition in voice-based services to the leading offshoring destinations in Asia, is now eyeing to further up the ante. The country continues to see robust growth in its voice segment and credible activity in non-voice services.

Several positives…

With its sizeable graduate pool, low-cost of operations, and English language advantage, the Philippines offers an attractive proposition for organizations looking for destinations to offshore services. The Philippines IT-BPO industry registered US$11 billion in 2011 on the back of successful expansion in services and increased geographic diversity. The sector is generating 640,000 direct jobs and another 1.5 million indirect jobs. Given the robust growth, the Philippines is likely to achieve its target of US$25 billion in revenues and generate 1.3 million direct by 2016 as per the IT-BPO Road Map 2016 developed by Everest Group.

The country is also seeing an increase in the share of non-voice work (including IT/ESO) which now contributes about 30% to the industry and there is evidence of credible activity in complex processes, e.g., legal, analytics, although their scale remains small. This is largely because buyers are now looking to diversify their delivery operations beyond established markets and are witnessing satisfactory experience from country’s non-voice services. Geographic diversification beyond the United States is also gaining traction and focus on multi-lingual services is increasing.

Philippines IT-BPO Services Revenue by Service Segments

One of the key reasons behind this success is government’s commitment to the sector which is working to position the country as an attractive destination for diversified services with the target to double share of revenue from other service lines. Continuing in this direction, the government and BPAP are initiating steps to enhance country’s value proposition at segment level (e.g., ESO, animation), with a significant attention on non-voice services.

…however, some concerns remain

Activity in Next Wave CitiesTM is evolving at slow pace. Analysis of the delivery location pattern of top 20 service providers and Forbes 2000 companies reveals that of the 35 centers set-up in the Philippines in last three years, only three were located outside Metro Manila and Cebu. Clearly, Philippines has its task cut out in order to position these cities as alternative locations beyond Metro Manila and Cebu and widen the talent base to ease the supply of talent and address high attrition.

Location Distribution of Centers Set-up in the Philippines

Moreover, ITO and Engineering Services are still not prevalent. The country also needs to continue to increase its alignment towards the United Kingdom and Europe, which are the biggest growth markets after United States. In addition, the country has a high risk of natural disasters. The most recent example is the typhoon activity in 2011, which led to power cuts and disruption of daily activity in Manila. Companies are, therefore, mindful of business continuity plans when they evaluate the Philippines for expansion of their delivery network.

While the government and industry associations are striving to enhance the attractiveness of Philippines IT-BPO sector, it remains to be seen how much the country can get players to think of itself for considerations beyond the arbitrage in voice-based services and more as a broad-based global sourcing destination.

For more details on the Philippines global sourcing market, refer to the recently released reports by Everest Group:

The Less than Great Divide: Onshoring Gaining Ground | Sherpas in Blue Shirts

When conducting outsourcing cost/benefit analyses for clients, a typical comparison includes the existing internal total cost of process ownership and the hypothetical future state cost structure, consisting of retained sub-processes, governance overlays, and externally provided services. The externally provided services often assume a certain offshore component, as labor arbitrage has historically been one of the most powerful cost optimization strategies. But this is no longer necessarily true. In fact, our clients are increasingly asking us to analyze domestic labor arbitrage opportunities, and there are cases in which we advise a client heavily leaning toward an offshore solution to take a closer look at onshoring or nearshoring options, as they may reveal healthy cost savings potential without any change in risk exposure.

For example, here are a few of my recent client engagements:

Call center operations of a Canadian client – relocation of its operations from the Greater Toronto area to New Brunswick or Prince Edward Island may deliver as much as 20 percent savings on the basis of the fully loaded FTE cost.

IT applications maintenance and development – a risk-averse Chicago-based client can reduce its blended operating cost per FTE from ~$140,000 to $110,000 annually by relocating its IT support to Springfield, IL or Sioux Falls, SD. In these alternative locations it will still maintain access to a four-digit annual pool of college graduates with relevant degrees.

F&A functional support for the Brazilian operations of a large international conglomerate – offshoring of selective F&A functions from Sao Paolo to, say, Monterrey, Mexico, can generate 50 percent savings per fully loaded FTE cost. However, as the import of services in Brazil is subject to draconian duties, the entire cost savings potential is essentially eroded. However, relocation of its operations to low cost cities in northern Brazil, such as Belo Horizonte or Belem, can generate almost equal savings

I attribute all this increased interest in onshoring to a number of factors.

First, geopolitical/location risks have substantially increased in the last couple of years…think Arab Spring, drug trade-driven violence in Mexico, and numerous natural disasters in Latin America and Southeast Asia. Changed perceptions and realities require a more sophisticated risk mitigation strategy, which obviously adds to the governance cost in traditional offshore delivery models.

Second, most global firms have already addressed their secondary, non-critical processes via some outsourcing and/or offshoring frameworks. However, continuous cost pressures and increased levels of competition are forcing them to look at their retained cost components, which typically include more critical processes, and that’s where domestic labor arbitrage reveals its full potential.

Third, increased regulatory requirements in banking, healthcare, and other industries have imposed incremental solution constraints, making internal/domestic scenarios more attractive.

Fourth, fast growing economic centers are now facing talent pool shortages, with demand exceeding supply due to the extreme concentration of business activity in a single geography. As such, establishing a regional presence in such cities as Sao Paolo, Shanghai, or Moscow comes at a two to five times cost premium compared to other cities in their parent countries.

Finally, the overall slowdown of the world economy is positively contributing to domestic labor arbitrage trends. Offshoring to India or Philippines has been historically driven not only by ultra low cost opportunities but also by the abundance of local labor resources. And although there is interdependency between the cost of resources and their availability, increased unemployment rates have pushed the resource pools in various low cost domestic locations above the minimally required size, justifying a more detailed location analysis.

All in all, onshoring is evolving as a viable sourcing option, and along with traditional offshoring scenarios – externally sourced or captive – should be included in any location analysis.

Cost Savings: Does It Trump All other Outsourcing Considerations? | Sherpas in Blue Shirts

One of our clients recently asked our Location Optimization practice to validate its intention to relocate certain back-office support from one Latin American country to another. As the client’s primary driver was cost savings, we used that as the initial analysis point. Our preliminary analysis found that on the basis of the fully loaded operating cost per FTE, the relocation could result in as much as a 50 percent cost reduction. Further investigating into this issue we also found that the local currency in the outbound country appreciated almost 50 percent during the last decade, while the local currency in the inbound country depreciated by 50 percent within the same timeframe. While our complete assessment of this offshoring opportunity returned many additional pros and cons, the main conclusion was that the overall upside economics of this relocation could potentially erode or completely evaporate if the local currencies significantly shifted in the opposite direction over time, which of course is a distinct possibility in today’s globally disrupted economic environment.

This client engagement was atypical for a couple of reasons. First, when offshoring a labor-intensive back-office function within the same region, potential savings of such great magnitude are not very common and they typically come at the cost of increased geopolitical risk, e.g., when a Japanese company establishes a captive somewhere in Southeastern Asia. Second, while risk associated with local currency must always be an integral part of any location analysis, it typically is never the most important evaluation criterion. Traditionally, offshoring has been utilized for relocating operations from high cost, developed countries, which entails dealing with relatively stable currency at least for the outbound location. And despite the high probability of wild inbound location currency fluctuations, the overall economics of the deal are not threatened by this factor alone, because offshored cost is typically just a fraction of the initial cost.

Speaking about possible risk mitigation strategy, in our opinion, any currency hedging may help only in the short- to medium-term, while offshoring is typically targeting a longer timeline because it entails substantial transition cost, which can be recovered only over extended period. And as any type of measures related to relocation of operations are quite traumatic, including the risk of operational disruptions, they are therefore not something a company wants to do repeatedly.

However, this client engagement example demonstrates the emergence of a new class of short-term opportunities that can be exploited by cost-conscious companies, especially when these opportunities are limited to secondary, non-critical processes. An increasing number of external service providers are developing “instant capacity building” tools and offerings that are modular and discrete. Essentially, utilizing these “country in a box” type of solutions, a company can minimize the time/risk of getting in and out of a country while simultaneously achieving significant cost savings.

Granted, the short-term value of such an approach is appealing, but any decision on location optimization should not be driven solely by labor arbitrage considerations. Attractive economics should be complimented by various benefits beyond cost savings, be they access to the wider pool of resources, conversion of fixed to variable costs, a more sustainable delivery footprint requiring less governance effort, etc.

Genpact’s Partnership with a City Government in China – A Move to Learn from! | Sherpas in Blue Shirts

On November 16, 2011, Genpact signed a five-year strategic partnership agreement with the government of Qingdao to help foster the globalization of Chinese corporations. According to the agreement, Genpact will set up a global process innovation center, and the local government will facilitate establishment of partnerships between Genpact and domestic multinational enterprises. Genpact will provide high-end services and business models to these companies from the center by leveraging its global expertise and implementing industry best practices

Qingdao ChinaQingdao is a relatively new face in China’s global services arena, and has not really experienced notable market activity from ITO-BPO services providers and buyers (captives). Before we talk about the implications of Genpact’s foray into Qingdao, let’s take a quick look at this city located in the Eastern part of China.

Qingdao is a major seaport, naval base, and industrial center in the Shandong province in China. Key industries in the city include household electrical appliances and electronics, petrochemicals, and automotive components.

As an important trading port in the province, Qingdao has witnessed significant foreign investment and international trade. In particular, South Korea and Japan have made extensive investment in the city. According to estimates, Qingdao has the second largest population of Koreans in China – approximately 100,000 – bested only by Beijing.

Coming back to this strategic partnership, it helps Genpact make further inroads into China by expanding its existing six-city presence as part of a journey that started in 2000, including its proactive establishment of delivery centers in the Tier-2 cities of Changchun, Foshan and Kunshan. In addition to the benefits of lower operating costs, access to additional talent pools, and a toe hold in the domestic outsourcing sector, governments in Tier-2 cities are often more flexible in offering incentives. These considerations are likely to have played a pivotal role in Genpact’s investment decision, and has helped place Qingdao on China’s global services map.

For the local Qingdao government, having one of the large global BPO players open a center in their city is a welcome move. It will not only bring process expertise to domestic companies, but also lead to notable job creation in the region. Moreover, it will help build Qingdao’s credentials as a delivery base for global services, enabling the city to find a place on the radar of other global services investors on the lookout for new locations.

This agreement is also evidence to the fact that there is a strong push from government at all levels in China to develop the global services sector. In fact, as part of Everest Group’s Market Vista Q3 2011, we talked about the role the Chinese government is playing through its “1,000-100-10” project to provide thrust to its global services industry and attract investments in the sector.

China's 1000-100-10 Project
Click to Enlarge | Source: Everest Group Captives Database; Everest Group analysis

The Genpact-Qingdao government partnership also underlines important characteristics of China’s global services sector, and presents lessons for broader global services stakeholders:

  • Tier-2 cities in China are becoming important evaluation candidates for service providers and captives. Indeed, Chinese Tier-2 cities already have a significant share among the service provider and captive set-ups, and a higher share than Tier-2 cities in other countries such as India and the Philippines. This has been enabled to a large extent by the wider reach of the government’s incentive programs, and the cities’ robust infrastructure growth.
  • The domestic global services sector opportunity in China is huge. Everest Group estimated the domestic opportunity for global services to be US$20 billion in 2010 (for more details read Everest Group’s Global Locations Compass – China). This is driven both by Chinese enterprises’ need to remain globally competitive and the government’s impetus on outsourcing.
  • Service providers often adopt a partnership model while framing their China go-to-market strategy. This construct involving collaboration with a local partner helps get the plans off the ground quickly, aids in learning the rules of the (local) game, and mitigates risk. In this case, Genpact’s partnership with local government will help it collaborate with domestic multinationals like Haier, Tsingtao Beer, and Hisense in Qingdao. This agreement is potentially a win-win strategy for Genpact, the Qingdao government, and domestic companies alike.

In summary, the Genpact-Qingdao partnership epitomizes the key nuances of China’s global services sector, and reiterates the fact that China can be leveraged not only as an offshoring destination but also a location in which third-party providers can serve the domestic market. It also demonstrates that Tier-2 cities in China are a must to keep an eye on!

No Crystal Ball for Service Delivery Location Risk, so Plan for Your own Appetite | Sherpas in Blue Shirts

Rapid evolution of global sourcing has allowed multinational corporations to gain access to a much broader pool of resources and to maximize the benefits of service delivery from low-cost locations. However, these incremental benefits have come at certain intangible cost, as now the overall value chain for any global industry is much more vulnerable to a variety of global risks. As increased pressures for cost containment are forcing large corporations to accept the risks associated with delivery from low-cost offshore sites, the focus is shifting from risk avoidance to risk mitigation. Generally, global companies approach risk mitigation in three ways:

  • Rigorous location selection/optimization analyses are conducted simultaneously with the sourcing decision so the business case typically captures not only cost savings benefits but also the probability of various risk factors associated with each location option
  • Risk monitoring frameworks are constantly refined so that even a slight shift in risk exposure is identified very early on, ideally providing the opportunity for some proactive measures rather than reactive responses
  • Disaster recovery and business continuity plans are developed to minimize disruptive consequences if risk situations materialize

Given Fortune 1000 companies’ magnitude of global sourcing activity and the fact that a worst-case scenario may entail billion dollar losses, it is not surprising to see rising interest in development and use of risk monitoring tools. There is no doubt that this activity, if conducted properly, can add considerable value to the overall risk mitigation process. However, in the recent months I have seen multiple attempts and claims to push these measures to unrealistic levels of event forecasting based on some early indicators. To be fair, these attempts are primarily limited to political types of risk, as conventional science is not able to predict natural disasters such as earthquakes or tsunamis. However, even for political risks, some “experts” believe that proper interpretation of early signs of threat can allow global firms to relocate their delivery hubs to safer locations.

For example, these experts point to the “Jasmine Revolution” in Tunisia, which began in December 2010, and now in hindsight they claim it was obvious that the Tunisian revolution would trigger a chain reaction across the entire region. So, per these experts, only completely oblivious companies didn’t pull out from Egypt ahead of time. Really?! In the same mindset, all global firms should have pulled out of India and shut down their Indian captives in 2008 after the Mumbai bombing. Similarly, the 2009 spike in criminal activity on the Mexican border due to the drug wars should have led to an immediate assumption that the danger would spread throughout the country driving an immediate need to relocate operations to a safer location.

Tracking risk changes is quite feasible, but 100 percent accurate prediction of major political disruptions is a complete utopia, and I believe that such wishful thinking may work to an organization’s detriment by creating a false feeling of security in believing it possesses a universal prediction tool. The reality is that a reliable crystal ball has yet to be invented, a shift in risk distribution still leaves multiple scenarios possible, and all that can be done is perform an accurate probability analysis.

Then, as probability of risk is just an input, actual interpretation of and decisions made per that input must be based on each specific organization’s risk appetite. For example, one company may choose to ignore a very high probability of a catastrophic event because it views doing so as a “better off” scenario than the prohibitive cost of relocating a mission-critical process. On the other hand, even a slight increase in hypothetical risk exposure may force a risk-sensitive client to take some proactive measures. The right approach for every organization is the establishment of a comprehensive set of risk thresholds and predetermined measures. For example,  if the probability of major disruption reaches, say, 25 percent, the firm should keep passports and invitation letters ready for business continuity staff. If the probability of disruption increased to 75 percent, then the company must relocate 50 percent of its business continuity staff to the extraction location.

I do believe there is significant benefit in tracking risk, performing scenario analyses and constantly refining your mitigation approach, but accurate prediction of the future is impossible. Think about it this way: had there been a reliable framework to forecast the wave of revolutions around the Arab world, I am sure that all dictators would have identified this risk at the very early stage and attempted to preempt it.

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