Today’s BTO initiatives are moving beyond information technology (IT) hosting and non-strategic business function outsourcing to transformational outsourcing designed to provide more sustained impacts on a company’s financial performance.
THE HISTORY OF OUTSOURCING IN THE UTILITY INDUSTRY
The earliest widespread adoption of outsourcing for utilities took the form of IT hosting. Utility companies recognised that although IT hosting was not core to their business, it required a specialised skilled labour force and high capital expenditures. IT hosting organisations were able to offer the required skills and platforms, together with cost savings through better management and economies of scale. Further, through contract negotiation, specific service-level agreements on the available environment could be defined, thus greatly reducing the risk of IT hosting to the utility. As the hosting market matured, companies began to examine other areas for potential technology outsourcing opportunities such as maintenance, support and enhancements of IT applications.
IT was not the only area that was being outsourced. Chartwell indicates that approximately 40% of US utilities outsourced business functions such as bill printing, collections, call overflow, and remittance processing. This type of business process outsourcing was typically for non-strategic functions or activities that could be mass performed or produced. This model yielded cost savings, but without outsourcing the end-to-end business process, utilities were not able to take advantage of the integration of technology, organisational change and business process improvements.
This historical outsourcing model is quickly changing; industry and global trends show that the use of outsourcing is becoming a key component of shareholder value creation. Momentum is building to move beyond incremental improvements in outsourcing to full end-to-end business transformational outsourcing, where costs can be reduced by 30%-40% while improving customer service and employee satisfaction. The table opposite outlines key differences between traditional and transformational outsourcing.
THE STRATEGIC VALUE OF BTO FOR UTILITIES
BTO service providers use the latest advances in business process design, measurement, and information technology to fundamentally change business processes in a given functional area, the systems that support the processes, and how the processes are fulfilled. In many cases the BTO provider will acquire the assets, employees, risk and responsibility associated with the specific operational area, in order to transform and manage processes over a long-term contract.
The benefits to the utility of transforming operations and outsourcing include a dramatic reduction in cost, reduced regulatory and financial risks, and improved performance. Following is a list of some of the key strategic benefits of transforming and outsourcing your operations:
Ability to take advantage of new competitive opportunities.
Many utilities today are trying to knit together a patchwork of overlapping and outdated IT and customer care capabilities, often created through distribution company mergers and acquisitions. Synergy cost savings are not enough if produced by an inflexible operating model. Utilities must be able to grow their businesses in step with the market requirements of competition and the new requirements of re-regulation. This requires flexibility and responsiveness throughout the organisation, as well as an IT strategy and infrastructure that can adapt to these changes and enable new growth. With a strong BTO partner, utilities can quickly increase or decrease their infrastructure needs as their business changes. There is no longer a need to have excess IT capacity or delay business decisions due to infrastructure constraints.
Potential for improved cash flow, realisation of asset values.
Lower economic growth, combined with the collapse of the merchant power market, creates a more urgent emphasis on earnings and cash flow. Reducing non-essential IT budgets and new investments will increase cash flow, but not without consequences for the longer term. In addition, a ‘less is more’ strategy does not consider the potentially greater value of your IT assets and operational processes to a transformational outsourcing provider. With a BTO partnership, the provider is constantly looking for ways to reduce costs while meeting service level agreements. This process of continuous improvement will have a positive impact on costs and customer service.
More efficient operations.
The utility industry’s recovery from its current retrenchment will be marked by the emergence of the companies that have best prepared themselves – through cost improvements, portfolio optimisation, re-capitalisation and better asset management – to compete for capital. Many utilities with the most focused operations and means of integrating new acquisitions will continue or re-start their M&A programmes. Utilities that have outsourced non-core parts of their operation will be more able to focus executives’ attention on targeting and integrating acquisitions.
In addition, utilities will have guaranteed operational costs that will allow for less risk in the bid – which translates to a higher price and a greater chance of winning. An outsourcing relationship will also allow more effective integration of the newly acquired operations, as the outsourcer should have the experience to integrate operations from many different platforms. In a BTO partnership the utility can leverage the infrastructure of the provider and avoid massive new capital investments in technology. The operating platform will change and evolve and reduce the risk of obsolescence.
FACTORS TO CONSIDER WHEN ANALYSING BTO
The first step for utilities wishing to pursue BTO is to define the corporate strategy and the non-core functions to be included in the outsource offering. Outsourcing service providers have developed flexible business models that meet the needs of individual utilities, yet are able to deliver the economies of scale needed to make the business viable. In identifying a BTO partner, it is critically important to ensure that their solution meets certain solution design principles:
- Experience and strength of BTO provider. It is important to select a BTO partner that is financially strong and has substantial experience in outsourcing. With a BTO arrangement, the provider is your partner. Before any other factors can be fully analysed, the utility must be confident that transformational outsourcing is a strategic endeavour for the BTO provider and that the organisation is able to provide long-term support to the utility.
- On-demand capability. Utilities should pay only for the technology and services they are currently using. By providing services‘on-demand’, the outsourcer commits to charging most fees through a variable price structure that can accommodate future growth or reduction. Many businesses have found that the goal of ‘on-demand’ service acts as a catalyst to promote other changes in related process areas, especially serving to promote efficiency and stronger matching of costs to business volumes. To support ‘on- demand’ service, the BTO provider should be able to provide additional infrastructure and/or services as the business changes.
- Build for scale. Necessary efficiencies are gained by spreading fixed costs and resources across an outsourcing service provider’s operations. To aggressively lower costs, the outsourced operations must be deployed around a highly scalable infrastructure.
- Leverage the combined capabilities of the partnership. Client managers should provide guidance and unique perspectives on their customer base, interfaces with other operational areas, and information on the utility’s long-term strategic direction. An outsourcer should bring a variety of industry and ‘good practice’ capabilities that complement management’s expertise; a proven ability for seamless execution, combined with best-in-class partners; a ready infrastructure to deliver immediate financial impact; creative contracting, risk-sharing, and financing options; and research capabilities to develop new technologies.
- Technology. Technological advances will enable cost savings through increasingly sophisticated automation of operational processes and delivery ‘on demand’. Automation will make operations more responsive to business changes and customer needs; more resistant to security vulnerabilities and hardware failures integrated with systems in other functional areas; and more flexible through the provisioning of new information technology. A significant benefit of BTO is that the outsourcer will have substantial economies of scale relative to any individual utility. As a result, the outsourcer will be able to justify investments in advanced technology more quickly than most utilities, ensuring that its clients are provided with the latest technology while being able to avoid significant up-front investments.
- Variable pricing considerations. A utility should be paying a variable rate for the work actually being done by the outsourcer. In addition, an outsourcer whose results have a substantial impact on utility financial performance should be paid based on pre- determined service level agreements (SLAs) or business value agreements (BVAs).
- Continuous transformation. Outsourcers and clients must aggressively pull apart, innovate, and re-engineer the client’s operation and methods of doing business. Any changes should involve minimal disruptions to customers and utility operations.
- Use of global labour pool. There are many areas in the world with a well-educated, multi-lingual population and infrastructure capable of providing excellent service at much lower costs than in the US. Countries outside the US also possess superior application development and programming skills to deliver many of the system components needed for outsourced IT.
- Balanced scorecard. A balanced scorecard approach to
performance management is an effective way to measure,
communicate, and provide the basis for continuously improving delivery. This approach provides a clear linkage between the strategic intent or direction of a business (or function) and its operational execution.
The next one to two years represent substantial opportunities for utilities with the right strategy, operations, financial capabilities, management, and business partners. Utilities with a strong portfolio of physical, financial, and intellectual assets, and the foresight to proceed with the right transformation initiatives, will be best positioned to compete for capital and increase shareholder value. An important first step is to partner with a firm with substantial outsourcing expertise to explore transformational outsourcing of their operations.