The transformative benefits of knowledge process outsourcing has led many organizations to offshore their core functions to high-talent, low-cost locations like India, the Philippines, China, Eastern Europe and Latin America. Cost reduction remains an important driver of all outsourcing activities, but strategic benefits and value take precedence for those looking to outsource and gain knowledge process outsourcing benefits.
Potential Cost Savings of Outsourcing Knowledge Processes
Companies can save as much as 40 to 50 percent by offshoring knowledge-intensive activities to a third party in a low-cost location. A study in 2006 revealed that India, China and Russia produce massive numbers of STEM professionals and even PhDs receiving annual salaries that are about one tenth of their Western counterparts. The cost difference can range between $60,000 to $80,0000 per year for science and engineering PhDs, for example.
According to a 2005 study, the cost breakdown for a typical U.S.-based management consulting firm is 20 percent fixed cost, 60 percent variable cost and 20 percent profit margins. After outsourcing, the cost breakdown is 18 percent fixed cost, 30 percent variable cost and 20 percent profit margins. This translates to a 32 percent value creation for buyers of KPO services.
KPO offers significant potential cost savings in absolute terms, because the average cost of knowledge process resources is higher than IT or BPO resource costs. An example is financial services modeling in India performed by professionals with 1-2 years of experience. The total annual compensation for the Indian employee would be about $150,0000, including annual salary, bonus, social security and medical benefits. On the other hand, the compensation for a U.S.-based professional with the same skills and qualifications would total about $200-250,000 a year, including office space, HR and admin overheads, database lease and other infrastructure.
Similar cost savings can be seen in the automotive sector. Many companies have offshored research and development and certain design tasks to professionals offshore who have master's degrees or doctoral degrees in engineering, computer and materials science, metallurgy, and polymer science. In the U.S. these roles are performed by tenured employees with annual salaries of about $200,000.
KPO services providers further lower costs, charging about $50,000 to $60,000 a year for chartered accountants, financial analysts and MBAs with 1-2 years of experience, according to a 2008 study. Even lower labor costs can be found in the Philippines, Chile and Mexico as these countries increase competition and drive prices down (Outsourcing: Its Benefits, Drawbacks and Other Related Issues, Journal of American Academy of Business, Cambridge 2006).
Access to Highly Specialized Labor with KPO
The KPO industry relies on the availability of differentiated talent as much as the availability of talent. A specialized educational background and in-depth understanding of the client's industry are required because in-house training of recruits without experience is expensive and time-consuming.
A 2010 study predicted that demand will outpace supply of skilled labor in the U.S., with excess demand of 5.6 million. Offshoring is expected to fill the gap partially by contributing 1.3 million jobs. As developed countries face shortage skills in knowledge-intensive activities like financial risk management, research and development, design, IT, and engineering, KPO becomes an even more attractive proposition.
Because domain expertise is the key factor in KPO, strong contenders are those locations that produce large numbers of physicians, lawyers, engineers, STEM graduates and post-graduates, MBAs, certified financial analysts, certified public accountants, and other knowledge-intensive professions. For example, India produces about 441, 000 technical graduates and over 300, 000 post-graduates every year, which makes up about 30 percent of the available talent supply in all low-cost countries (NASSCOM and McKinsey, 2005). Besides India, key KPO destinations include China, Russia, Poland, the Philippines, Hungary, and many areas in the Soviet Union.
Better Human Resource Management
Companies that have one or more offshore centers dedicated to knowledge-intensive or core processes have more flexibility in terms of time and human resource management. KPO enables companies to tailor their workforce to changing business needs and avoid the monetary and emotional costs of laying off in-house employees. KPO also allows 24/7 production and collaboration between local and offshore teams due to time differences across the globe.
Limited Economies of Scale
According to a recent study, 75 percent of financial services KPO firms have less than 500 resources, and 40 percent of financial services KPO firms have less than 100 resources. KPO firms in other verticals tend to have similar small, niche capabilities. Large-scale KPO operations are thus unlikely to be the norm, limiting economies of scale that are easily achievable in the IT-BPO sector that employs thousands of people. Most KPO services are also fragmented within departments in an organization and across different geographies. This makes it difficult to consolidate processes and further limits the scale and the scope of services that can be offshored.
Limited Process Portability
Knowledge processes are usually fragmented within an organization and business groups, making it more difficult to break down KP activities and bundle them into segments. Service providers must have offshoring maturity and sophisticated frameworks to support an efficient KPO model.
Security and Intellectual Property Issues
Due to the strategic nature of knowledge-intensive processes, intellectual property protection is even more important. Retaining core activities in-house mean better control of sensitive information and equipment protection. Offshoring core activities can increase security risks if the third party does not provide ISO certified or qualified professionals. Organizations also risk low-quality work and delays if the quality of employees is poor, thus forfeiting the main benefit of KPO, which is intellectual arbitrage.
Knowledge Process Outsourcing in the Philippines
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