Outsourcing Economics

The main reason why companies outsource processes they can reasonably perform in-house is to save money. There are some direct apples to apples comparisons that can be made. There are also hidden costs that need some consideration. Let’s design a model that can be used for cost comparison.

The true cost of labor
A typical clerical person in the New York Metropolitan area earns between $14 and $16 per hour. What is his/her hourly cost? This is not a trick question. Here are a set of calculations.

Hours in a year: (52 weeks times 40 hours)                                                             2,080

Gross Compensation at average rate of $15 per hour-                                       $31,200

Payroll taxes and benefits (estimated at 20%)-                                                     $6,240

Total Annual Compensation before overhead,which we’ll discuss below   $37,420.

In this example, we’re paying for 2,080 hours. How many hours are actually worked? Here are some additional calculations.

Gross paid hours-                                                                                                                 2,080

Less vacation and sick time (assume 2 weeks), and holidays (assume 2 weeks)- 160

Actual hours worked-                                                                                                           1,920

Actual hourly compensation is $37,420 divided by 1,920, or approximately $19.50 per hour.

After accounting for vacation, sick time, taxes, and benefits, the fully absorbed cost of an offshore employee, with US and overseas supervision is between $7 and $9 per hour. Assuming an $8 average, the difference is about $11.50 per hour, or $22,000 per employee annually. Outsourcing costs also include overhead.

Overhead and its relevance
When calculating traditional unit costs of production, attention is paid to overhead costs. These costs include administrative, IT, HR, rent, office supplies, professional services, and other items that are not direct labor. Many of these costs are fixed, regardless of where the work is performed, and therefore should be excluded from any comparative calculations. On the other hand, certain cost items can figure in substantially. Hiring 25 additional people in an existing business requires space. A typical employee requires 100-300 square feet of space, including supporting areas such as restrooms, snack/dining areas, conference rooms, corridors, hallways, etc. If these workers were employed in Midtown, the effective hourly cost per employee would rise substantially, up to $10 an hour or more for rent, utilities, office supplies, computers, depreciation on furniture and renovations, etc.

If a business expects to expand, overhead costs, which come into play when structural issues are being considered, can be a major factor in the decision-making process.

In evaluating potential savings from an outsourcing initiative, a business should perform a comprehensive review of all current spending to get a clearer picture of the financial impact. Many outsourcing initiatives result in substantial reductions to the ancillary costs of doing business.

Other costs related to outsourcing
Some companies may not be structurally ready for the outsourcing process. The biggest structural cost related to an outsourcing project is becoming paperless. This mean documents must be scanned and stored online. Then they must be viewed on a computer side-by-side with work performed. Employees who work with offshore employees will generally be more productive using computer systems using 2 monitors. There will also be investments required for scanning equipment and the labor to do the scanning. On the other hand, going paperless cuts costs in many ways beyond the discussion of outsourcing. Businesses free up large amounts of expensive space by going paperless. They also increase productivity if they set up their online document “cabinets” intelligently, enabling employees faster access and more productive usage of electronic documents than the old paper ones.

Training remote employees takes more time than in those where management and the employees reside in the same space, since trainers can’t stand over the trainees. For most jobs, it takes more training for a remote employer than one who is sitting near your desk.

When planning an outside project, all of the above should be taken into consideration. All responsible outsourcing companies will work with you on these calculations to come up with a viable, responsible plan. As economic benefits are the primary drivers of outsourcing decisions, proper planning and accounting for the relevant costs should be carefully considered as part of the decision process

Effects
While the above may be all well with Medicare, DME suppliers are suffering. Medicare accounts for 65% of their reimbursements. Many are losing bids and literally going out of business. The suppliers who win have other issues. From talking to our DME provider clients and prospects, I realize that here are some of the challenges the industry faces.

– Companies who lost the bids are losing most of their referral sources and payer reimbursements.
– Companies that win don’t have the infrastructure to handle the workload and are backlogged and running inefficiently.
– Winners have narrower margins and find it difficult to be profitable.
– Winners are not delivering proper service to patients outside of their original territory.
– Audits are more frequent, requiring proper documentation, and causing more overhead.

Solutions
Upheaval calls for creativity and innovation. There are a few ways of dealing with this predicament. Either generate more revenue, cut costs, or both. Here are some methods I’ve observed that DME companies are adopting to cope with the crisis.

– Merging together to combine resources and referral sources.
– Stopping the acceptance of insurance and switching to e-commerce.
– More automated and paperless processes.
– Pursuing smaller claims instead of writing them off.
– Expanding into new bid categories with the hope of winning.
– Outsourcing billing/ordering functions to cut cost dramatically and increase efficiency.

Any company not implementing some or all of the above changes faces extinction. Any one of these changes can fundamentally alter the economics of a business.

In my obviously biased opinion, the method that seems to make the most impact is outsourcing specific functions in the ordering/billing processes. In the NY metropolitan area, DME companies who outsource tasks such as charge entry, eligibility checking, denial processing, or other functions, save at least $20,000 annually per employee. This allows them to cut overhead costs, go after claims that might not have been worth it previously, and shift more resources into sales and customer service.

I hope this perspective has been thought provoking. I welcome all your comments.

OUTSOURCING AND EMPLOYEE MORALE
You have a 100 employee company and are experiencing steady growth. 20 employees perform low to midlevel clerical tasks. These positions are ideal candidates for outsourcing. You have calculated potential annual savings of $400-600,000. However, if you outsource, there will be resistance from existing employees, including those not in the affected job slots. What should you do?

The answer to this question, based on the experiences of my company, will surprise you. If you own a profitable company, where there is movement of people to positions of more responsibility, there is one path to an easy YES answer that depends on two quantifiable numbers within your organization:

– Your company’s rate of hiring growth and
– Your company’s annual rate of employee turnover.

If your company’s employment needs are growing at 10 percent per year and your annual turnover is 10 percent or more, you should be able to implement the 20-job program with no negative impact on employee morale. Over the next year, approximately 10 people will leave and 10 new positions will be created. A carefully crafted outsourcing plan will result in no layoffs, yet achieve most or all of the needed savings. Some people will move to positions of higher responsibility. Others can continue in the same position, even if the outsourcing goals are being realized. Some undesirable employees will just leave.

What happens to the dynamics of a company when outsourcing enters the picture?

For employees in good standing, who do their jobs competently, and have been treated properly by their management, there will be no effect on morale if they don’t feel threatened. These employees need to know their company-

– has no compelling need to squeeze every dollar of labor savings through a switch to outsourcing,
– is reassuring its employees, through deeds more than words, that they will not be outsourced, even if some of their duties will be, and
– is creating opportunities to move existing solid employees to duties with greater responsibility and higher compensation.

For employees that have performance, attendance, or behavioral issues, the outsourcing threat is real. Many will oppose outsourcing and, when realizing what is happening, may leave. Others will passively accept the situation with no improvement in performance or attitude. A few will improve themselves in the name of job preservation. Losing employees who can’t or don’t want to perform is not a negative.

Forcing employees to improve performance and attitude is a definite positive.

What should an employer do in this scenario?
#1- Be honest and open about everything you tell your employees
Any change in business practices that impacts on employees creates confusion, followed by nervousness. If employees detect any deviation from the truth, resumes will fly out the door. Fast. The better people will always leave first.

#2- Explain the program accurately, the underlying reasons for the program, and how employees jobs are affected.
Employees fully understand that businesses are operated to maximize long-term profits. They just need to know how it affects them. If certain jobs descriptions are changing in major ways, they must be carefully explained. Most of the following issues are worthy of discussion with employees:

Converting to a paperless environment, which facilitates outsourcing, requires major changes in how people get things done.
Working with people in another country, with a very different culture and perspective, often requires employees to reevaluate their own perspectives and prejudices.

Often, when outsourcing, work is allocated in different ways from the past to separate the verbal language responsibilities from other functions. Specifically inform your employees that anyone who is able to take on different, often higher-paying responsibilities, has nothing to worry about. Weaker employees will derive a different message from the good ones. Some will leave.

#3- Meet with each good employee one-on-one
Make sure he/she understands where they are headed, jobwise, with respect to the outsourcing program. Explain all changes in responsibilities and the underlying reasoning behind those changes. Give reassurance. Explain the upsides. For growth-oriented employees, outline career paths that will result in specific forward progress for the employee.

#4- Turn some employees into winners from the program

Employees who take on more responsible duties should be promoted and recognized publicly as soon as possible. Nothing is better for morale than promoting good and deserving employees.

Outsourcing works most smoothly when companies are profitable and growing, when there is enough time to implement carefully and gradually, and when employees are kept in the loop, with a substantial number coming out ahead.

Profitable companies should have at least a small program in place as soon as it is practical. You will understand why when you consider the next scenario.

You’re a service company with 50 employees and not growing. Your biggest customer, which accounts for half of your business, gives you sixty days’ notice to cut your price by 35% or lose the business. The threat seems very credible. You crunch your numbers and realize that you can keep the customer and remain viable by replacing 20 people with an outsourcing program. What do you do now?

Your company is at serious risk. To save it, you need to implement an outsourcing program that will cause a major disruption in your operation. There is no escaping the reality. While this, in itself, is risky, you have no choice. There is no way of avoiding a major drop in overall employee morale.

Recognizing this, the steps are similar to the above, with one critical exception. You must immediately inform employees that you absolutely must retain in order to survive, what is happening. You gather them in a group after hours and lay it out. Then you meet with each one individually and tell them how this will play out for them. Then you follow a modified version of the four steps above.

– You remain honest and forthright
– You announce what’s happening and why.
– You meet with each employee in a one-on-one meeting.

For good employees you know you need to terminate, you let them know their termination date. Offer a bonus on top of severance pay if they stay until the last day they are needed. Allow them time off for job interviews.

For good employees at risk of losing their jobs, depending on who else leaves, tell them the truth. Give them their termination dates, and offer bonuses for those who stay until they are no longer needed, if their presence is required. For those employees who are sub-par, inform them of their severance package and let them know how much notice they need to give you in order to collect it. They should also be given time off for interviews.

The last few paragraphs above contain a blunt discussion of what a business in trouble needs to do in order to survive. In these circumstances, execution must be perfect. However, sometimes perfect execution becomes impossible with just a few words from management that exacerbates the panic.

Outsourcing work overseas for a company in trouble is much more complicated and fraught with risk than for growing companies. In these uncertain times, companies are best off continuously keeping costs at a minimum while building a stable business with happy employees. Happy U.S. employees and employees overseas are not mutually contradictory concepts. In fact, they can be complementary, if everyone stands to gain from the experience. For this reason, the best time to outsource is when a company is growing and profitable.

Outsourcing: How and Why

Today’s business markets are faster moving and becoming more competitive than ever.  Businesses are under relentless pressure to improve their offerings and keep costs low.  For most businesses, labor costs and the supporting overhead constitute the largest portion of business expenses.

Many companies are using process outsourcing to cut costs and improve the quality of their outputs.  Functions that require processing of data, but not physical handling of goods, are largely location‑independent and can be moved, albeit with some challenges, to lower-cost locations to realize substantial savings.

What underlies those challenges?  Businesses usually need to change mindsets and structure to enable an optimal outsourcing program.  The biggest problem, as with any major undertaking, is getting from Point A to Point B.

Why Outsource?

Substantial Cost Savings

A competent clerical worker in New York City earns between $14.00 and $20.00 per hour.  Payroll taxes and benefits increase this cost 10 to-30% or more.   After factoring in paid vacations, holidays, and sick time, a typical clerical worker will cost most businesses well in excess of $20 per hour.  Moving New York‑ area work offshore will save most businesses at least 60%, often substantially more, on fully‑absorbed labor costs.

Scalability

For growing companies, constantly adding employees frequently requires changing locations, upgrading computer networks, and adding supporting overhead that slows down growth and increases unit costs.  Scaling up outsourced processes moves this burden to the outsourcing service provider, enabling companies to grow faster and more economically.

Standardized Processes

Outsourcing usually forces businesses to adopt standardized processes for all transactions, with documentation of procedures.  In the long run, this transition usually makes businesses more efficient.

Skillset Acquisition

Companies will often find that an outsourcing company has more in-depth capabilities in certain non‑core functions.  Working with an outsourcing company enables businesses to learn through watching the processes being performed on their behalf.

The competition is already doing it

Most companies, at almost any size, are either outsourcing some process or giving the idea serious consideration.  Keeping up with the competition requires looking at all the possibilities.

The Challenges

Location-based Thinking

Many managers feel the need to walk over and talk face-to-face with employees to obtain the feedback and interaction necessary to “manage”.  Managing employees in a distant location requires analytical substitutes to the face-to-face encounters.  Managers control outsourced processes through measurements and controls, such as error rates, throughput rates, balancing totals, and other metrics that substitute for the constant hands-on interactions.  Outsourced processes are more likely to be managed by the numbers.

Training Lag

It does takes a little longer to train an employee at a distance, than it does face-to-face.  Most standard processes, even if easily documented, have many exceptions to the rules.  In a face-to-face environment, it is easier to teach processes that are heavy with exceptions.

Culture Gaps

People from different cultures and countries think and respond differently to communications.  Because of this, there are often misunderstandings about expectations and deadlines for completions of work.  Thinks do get lost in translation if preventative measures are not taken in the early stages.

Time Differences

When handled properly, time differences can help keep businesses operating around the clock on time‑sensitive jobs.  However, some companies experience difficulty maintaining communications among employees with different work-days.

Resentment of existing employees

Using offshore workers can be seen as a threat to job security.  There can be a certain disdain among US employees for work done by foreigners, even when competence is demonstrated.

Implementing an outsourcing program

Because of the compelling economics, outsourcing can be a game-changing strategy for many companies.  However, it must be done carefully to mitigate many of the challenges we have described.  Here are some things to think about.

Figure out what work is truly location based

The cashiers in retail stores are tied to its location, as they deal face-to-face with customers. Order processors in a web-based business are not.  Every business function should be analyzed as to where it really needs to be performed.  Many companies redesign job duties and responsibilities to enable more functions to be moved.

Pick a simple process as a test

If possible, look for something that requires relatively little training.  Watch the process carefully with the goal of improving implementation procedures with each process that is moved.

Go paperless

Besides enabling outsourcing, paperless processing improves efficiency and cuts cost in many ways, from storage to slowdowns due to missing papers, to copying costs, etc.  Any professional outsourcing company will help you go paperless.  However, even if you decide not to outsource, you will eventually need to go paperless to maintain profitability.

Pick a company that speaks your language and understands your processes

Your client manager should be experienced, US-based, and available to you.  Arrange site visits prior to selecting a vendor.  Ask specific questions about methodology and timing.  Discuss the challenges described above with the vendor. Get comfortable.

Outsourcing works best when there is no dire need for it

When times are good and people feel secure, there is little resistance to outsourcing processes. When times are tough, employees will resist anything that looks like a threat to their jobs. Outsourcing works best when companies leverage the capabilities of their existing employee base through the addition of low cost new hires. Growing companies are ideal candidates for outsourcing.

In Summary

In the current business environment, the use of outsourcing can strengthen your company’s bottom line and competitive position.  While there are challenges, you can succeed if you are careful and do it right.