Mid-market firms face a host of challenges in business process outsourcing

By Ian Springsteel

With the pressure on executives to protect the bottom line in the midst of a struggling economic recovery, it’s little wonder that there is an explosion of interest in the potential benefits of business process outsourcing, or BPO.

That means handing over activities like accounting, human resources, and information technology management to outside vendors. The practice promises many rewards, including reduced costs, improved information flow, simplified management of processes and technology, andaÍbest of allaÍmore senior management time to focus on the real profit drivers of a company.

Many of the world’s largest companies, such as BP America, American Express, J.P. Morgan and Lockheed Martin, embraced outsourcing in a major way because the benefits can be huge. By hiring the biggest accounting, IT and HR services firms to do work like general accounting and financial reporting, benefits administration and IT management, major corporations are slashing their overhead and paperwork, enabling them to reduce overall costs for many processes by 10% to 40%, which translates into hundreds of millions of dollars in saved expenses at each company.

These financial savings are luring one Fortune 500 firm after another into outsourcing agreements. Globally, the finance and accounting outsourcing segment alone hit $40 billion in billables in 2002, and is projected to blossom into a $65 billion industry in just the next three years, according to IDC Corp., an IT and BPO research and advisory firm. And in the U.S., end-to-end HR outsourcing, which has so far only been pursued by large companies, is reported to be at $8 billion in billings in 2002, and may very well triple by 2006, according to TPI, a Houston-based outsourcing advisory firm.

Now there are indications that middle market companies are also getting on board the BPO bandwagon. This mid-tier of companiesc�those with 100 to 1,000 employees, and revenues under $2 billionc�represents a massive piece of the American business pie. To compete for more shelf space, the best employees and the cheapest capital, middle market firms know they have to do everything they can to lower their costs and focus on the main event–their core business.

Relatively few mid-tier firms outsource entire functions like finance and accounting, internal audit, HR or IT at the same scale that their behemoth competitors have over the last few years. Rather, middle market firms are taking?well, the middle road, and increasingly warming up to farming out these functions.

In a recent Gartner Group survey, 73% of mid-tier firms indicated they outsource some piece of their enterprise business processes. But, keep in mind that, 89% of those firms included some piece of HR in that mix, with the well-worn category of payroll outsourcing claimed by 89% of those respondents.

More than half outsource some benefits administration, which includes aspects of commonly shipped out 401(k) administration. And there is still much room to grow, since 76% of large firms say they outsource some piece of benefits administration.

In addition, 25% of middle market firms say they use BPO services, such as financial and accounting services, which includes easy-to-outsource tax management, versus 38% of large companies.

And there is still much room to grow. For example, just 14% use outsourced demand management processes, like customer call centers, compared to 23% of large firms; and only 13% use supply management services, such as logistics outsourcing with a shipping firm, compared with 30% of large companies.

Those differences may narrow soon, as the survey shows that middle market firms plan to use outsourcing much more aggressively in the next few years. For instance, while 43% of mid-tier firms now outsource at least some of their education and training needs, 89% say they will do so by 2005. Similarly, while just 7% of such firms use accounts payable BPO services today, 20% say they will use such services within two years.

Why did outsourcing take so long to catch on among mid-sized companies? One key reason is the lack of stable, sizable outsourcing partners focused on the middle market. Big consulting firms like Accenture, Cap Gemini Ernst & Young, Exult, Mellon HR Solutions and EDS are largely focused on the biggest firms, and usually can’t justify bidding on outsourcing contracts of companies with just a few hundred employees, given the cost of selling the service, high set-up expenses and the shorter contract lengths on which many smaller firms insist.

Plus, several Internet-driven firms focused on small and medium-sized businesses that started up during the dot-com boom found themselves victims of the dot-com bust. Hot young outsourcing firms like Ledgent and LeapSource ran out of cash, and subsequently out of business, after just a brief run, leaving clients to bring the processes back in house or find another provider. Then there is the plethora of smaller, thinly capitalized operations–often CPA and HR consulting firms–that cover just one city or region.

“It’s hard for mid-tier companies to find outsourcing partners with the right scalability, particularly if they need services on site in a number of locations,” says Robert Brown, an analyst of the BPO industry with Gartner Group, in San Francisco.

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