Research

How relationships improve business process outsourcing

Trying to cover every contingency in a contract for long-term business process outsourcing is a challenge for CIOs, but research by Rob Hornyak, an assistant professor of information systems, shows that there are relationship mechanisms that can stand in for contract specificity in delivering BPO alliances with strong client satisfaction.

2015-02-18

Here’s the assignment: forecast everything that’s going to happen on the job where you work — every project you’ll need to handle, every problem that will crop up and all the new market forces that will impact your organization over the next three years. If you can’t do this, you’re not alone. It really can’t be done, according to Rob Hornyak, a professor of Information Systems at the W. P. Carey School of Business.

And, because forecasting every conceivable influence over a business and its processes is so difficult, Hornyak sees the exercise of trying to cover every contingency in a contract for long-term BPO as an exercise in futility. Fortunately, his research shows that there are relationship mechanisms that can stand in for contract specificity in delivering BPO alliances with strong client satisfaction.

“All contracts are incomplete,” Hornyak says. “And, when contractual controls break down, they can be substituted by relational controls.” The insights Hornyak uncovers open up new possibilities for CIOs who have been managing BPO at their companies for more than 20 years. Applying relational controls means that BPO can deliver far more value than simply cost savings.

Leaking greatness

What is the nature of BPO and how does it differ from other outsourcing, like that used for information technology provisioning? IT outsourcing generally comes into play to cut costs or allow in-house staff to focus on core competencies. It’s limited in scope and targeted toward task completion.

BPO is broader in scope. It could cover core business processes, such as customer service, financial activities, human resources and other key functions. It also generally comes into play to achieve a wide range of goals — including cost savings, innovation and business transformation — and it’s long-term, typically lasting several years and often including contract renewals.

“BPO contracts require that the partner understand something about the business context and not just the IT enablement part. Sometimes processes being outsourced are customer facing, so it’s important that the partner is doing things as your business would,” Hornyak says.

Put another way, BPO requires both the vendor and the client firm to integrate their own spin on the processes into one cohesive whole, unlike IT outsourcing, which requires coordination, but not as much merged activity. Hornyak started looking at BPO initially because it’s a huge industry — worth some $2.7 trillion in 2013 and growing at a rate of 16 percent or more annually, according to researchers at the Everest Group. But it’s also an industry awash in failure.

Industry watchers estimate that between one-third and two-thirds of the potential value of BPO contracts goes unrealized, Hornyak say. Part of this is mere numbers play by accountants, but there are true opportunities and real dollars getting left on the table, too. “What typically happens in these contracts is that they’re managed by the sourcing and procurement department, and those people are technically focused on the cost of the contract, not the relationship,” he explains.

He admits that cost cutting sits at the foundation of most BPO relationships, but “there’s also the need for innovation, strategic growth and market responsiveness. If you’re focused only on costs, you’re not focused on growing the business and investing in the business or innovation. That’s where companies see value leakage in BPO contracts.”

As an example of the innovation and growth companies might miss, Hornyak points to the field of package delivery. Initially, that all companies like FedEx or UPS cared about was delivering a package in the specified period of time. But consumers are a curious lot, and we want to know where our packages are, whether they’ll arrive on time and, if possible, when they might cross the destination threshold.

So delivery companies started adding package tracking and other services, like text messages letting senders know when the package has arrived at its endpoint. “If you’re waiting for an auto part and trying to manage a fleet of vehicles, it’s important to know if your package is due to arrive on Tuesday at 10 a.m. or Wednesday at 4 p.m. ,” Hornyak notes. “Companies like UPS and FedEx invest in systems to deliver this type of information. It’s a differentiator. Those are the types of things that are being lost in some BPO relationships.”

Satisfaction guaranteed

So how do companies get all the value a BPO arrangement can deliver? Often, they try to guarantee it with a contract and service-level agreements. That approach could fall short, according to Hornyak’s research findings. “Well-written contracts are the foundation for governing BPO relationships but, over time, the business environment changes,” Hornyak explains.

New government regulations may crop up, new technology for service delivery or other innovations might evolve, but if the contract is written to the old way of doing things, problems arise. “One way to deal with this is to continue to write more and more specific contracts,” Hornyak continues. “Many businesses have found that this is very costly and, in a dynamic business environment, there is a time lag between when action is needed and when the contract is completed. Sometimes, it’s too little, too late.”

What’s more, detailed contracts impede flexibility, a key attribute for successful BPO delivery. In fact, overly detailed and rigid contracts can thwart a BPO vendor’s impetus for initiative. If the client firm is focused only on costs, why bother coming up with new, innovative ideas that will likely get shot down? If contracts aren’t the answer, Hornyak knows something that is.

“Relational mechanisms: trust, information exchange and conflict resolution,” he says. When managers focus on fostering these attributes in a BPO relationship, inadequate contracts won’t matter. The relational factors can still bring client satisfaction and successful outcomes.

Trust, a higher power

Working with three other researchers in the U.S. and Europe, Hornyak tested his theories that relational mechanisms would substitute for contractual ones in bringing about satisfaction among BPO client firms. The research team surveyed managers at 215 German banks engaged in 335 BPO ventures.

For the contract piece of it, the scholars examined three contractual governance factors: goal expectations or the main purpose behind the contract; activity expectation or the performance metrics to be met through the contract and contractual flexibility, or the ability to modify the contract to meet changing needs and circumstances.

Client satisfaction served as the measurement of contract success because, as Hornyak says, “Satisfaction reflects the decision maker’s view of how things are going and maybe even is an indication of how likely he or she is to continue the relationship.” Pitted against each of these contractual governance mechanisms, the researchers found relational factors could substitute for the contract provisions and, in many ways, outperform them.

“You want your partner to make good decisions for the relationship when you can’t micro-manage everything,” Hornyak explains. Conflict resolution, for instance, could be more beneficial to a relationship than any contractually obligated mediation or legal means to resolve disputes.

“With contracts, you can specify procedures for conflict resolution and escalation processes. What isn’t specified is how to use those processes for a fair, equitable outcome,” Hornyak says. “Going through the motions specified in the contract doesn’t always guarantee you’ll come up with a solution that works well for both partners.” That said, some of the relational factors Hornyak sees as engendering trust would facilitate those equitable outcomes.

“Being forthright, considering the interest of your partner: those are the kinds of behaviors that lead to trust in the relationship,” he says. Things like information exchange — face to-face meetings — and trust that help manage the relationship where the contract breaks down.” The researchers compared relational factors against contractual ones in a variety of circumstance and, in each combination, relational factors proved every bit as strong as contracts in bringing about client satisfaction.

So, how do managers foster these relational factors as BPO governance tools? Formal approaches, such as reports and regular meetings, can strengthen information exchange and comradeship. Or, companies may employ informal approaches, such as consistent check-in calls and site visits. Hornyak also recommends that BPO partners “make small bets on each other over the course of time.”

Little things add up, he says, like returning calls promptly and delivering information when promised. And, most important, commitment comes into play. Managers need to make developing strong relationships a priority. Will the effort pay off? “Relationships develop over time, and you can’t simply will a great relationship into existence, so contracts are still important,” Hornyak says.

Still, his research argues that a hybrid approach combining both contracts and relational governance mechanisms leads to greater satisfaction with BPO relationships overall. And, a good place to start building the relationship is to start building trust. “Trust pretty much substitutes for everything,” Hornyak concludes. “In creating a successful BPO partnership, it’s definitely the heavyweight factor.”

Bottom line:

• Business process outsourcing (BPO) engagements typically differ from other outsourcing gigs in their length and complexity.
• Because BPO arrangement lasts multiple years and covers broad and critical business processes, contracts generally fail to account for all the events and changes that will occur during the engagement.
• Relational factors such as trust, information exchange and conflict resolution can substitute for contractual agreements and still bring about high client satisfaction, according to recent research.
• Managers should focus on both relationship-building and contract terms in governing BPO arrangements.

Information Economics and Strategy Managing IT