Outsourcing: art or science?

You've just read the recommendations of the outsourcing committee and you are wondering, "Are outsourcing and sanity mutually exclusive?" From those who have changed outsourcing from an art to a science, varying observations may shed light on the subject.

The groundwork for mortgage

banking outsourcing was laid in the '70s with the availability of data processing via service bureaus and payment processing via lockbox. The pace slowed substantially until the late '80s when advances were made in real estate owned (REO), insurance and tax tracking and some related functions. Outsourcing, like Total Quality Management (TQM) or Management by Objectives (MBO), was another management foray set out to improve quality and service, with the definition of "success" difficult to assign.

By the early '90s, some mortgage entities began looking at outsourcing as a strategic tool for business process redesign, adding dimension to the finances of outsourcing, performance metrics and control -- and challenges for the suppliers. Wholesale outsourcing of insurance and tax departments occurred, followed by foreclosure, bankruptcy and loss mitigation functions. The pace only quickened. Success became measurable in dollars, service, and value-added -- for both the outsourcer and the supplier. What changed?

Many first entered the outsourcing cycle by attempting to differentiate whether the process under consideration was a strategic advantage or a commodity that did not differentiate them from the competition. Conceptually, that makes sense. But for an industry known for rapid change and unpredictable turns, your objective should be to maximize economic and operational flexibility and control in order to pursue different options as you learn more or as the business changes. So the first change was a clarification of objectives.

Others entered the cycle under duress, with a broken or outdated process desperately in need of triage. They quickly learned a hard lesson: Outsourcing problems can cost a fortune. Success is more likely when you achieve stability before entering the outsourcing process. Stability also provides a base set o metrics for further evaluation, a discipline that will benefit all departments.

Typically, your cranky processes are the ones most likely to benefit from something new and frequently are identified as processes that could benefit from someone else's investment in capital equipment, innovation and training. When evaluated and benchmarked against competitive and suppliers' metrics, several attributes of your process are clarified, including risk, economics, service, training and culture.

If you're not convinced that outsourcing the process is strategic, go back to your business plan and review it for short-term, intermediate and long-term change objectives. For successful outsourcing ventures, an outsourcing evaluation and a business plan dovetail not only in objectives but also in their timing and priorities as well.

With a tentative outsourcing decision made, a convergence of activities occurs: Priorities are set, change actions are identified, management buy-in is sought, and a new infrastructure for outsourcing is designed. With contracts completed and implementation under way, the most difficult part of outsourcing begins: relationship management. More a strategic alliance, the balancing of technical needs, complex relationships and external and internal factors while moving ahead in a competitive industry becomes the true measure of success.

Although the cycle is well documented in various forms and formats, it is the paradigm shift -- contract management, new relationship complexities and your supplier is now the expert -- that is hard to capture on paper. Recognizing that outsourcing is a partnership, where each entity has a stake in the success of the relationship, is a responsible approach. It's the management of the "business onus" that can make you crazy.

As always, knowing where the risks are is essential. The due diligence process is an excellent opportunity to identify the qualitative aspects of information from a potential supplier. For example, supplier culture, business strategy, human resource policies, service philosophy and quality incentives are critical pieces of information. Is this a new, expanded service of the supplier or a tried-and-true older service? Are you operating under the "halo effect" of their other products and assuming that things are there that aren't?

As you get closer to selecting a supplier, you may also wish to consider entrepreneurial tone, service orientation and history of cost reductions as a means of differentiating one supplier from another. Remember, the objective is to hedge against change and uncertainty in the industry, not a cost transfer of the status quo.

Pick the right negotiating team. Experience suggests that the best contracts are drawn up by a team of at least three: the individual in-house expert, with a deep understanding of the company's requirements; an outsourcing consultant who can objectively translate in-house requirements to suppliers' requirements; and an attorney who specializes in the function to be outsourced and is aware of the company's risk profile. Team members may all be in-house, but successful ventures suggest a different team for each negotiation may be appropriate.

Successful contracts are direct and maximize your primary objective -- to be flexible and in control. Recognize that your different channels of business (flow, bulk or loan-by-loan) require different pricing. Degree of invisibility to the customer is another pricing issue. Cost, service delivery, options, common terminology, renegotiation conditions and exit clauses are well defined. Successful outsourcing is highly personalized, not standard. A standard contract is probably not desirable.

One way to hedge against uncertainty and change is to create a measurable partnership, where goals and even profits from a new undertaking are shared. Another control tool is the shorter-term contract, on the assumption that technology and improvements could bring the price down overall in two to three years. Other industries have been known to outsource only part of the process to one vendor or split the contracts between sites to hedge against uncertainty.

To optimize your contract, a contract management infrastructure is essential. This go-between role is crucial, balancing contract management skills, functional knowledge and the ability to manage complex relationships. Since few contracts contain incentives for suppliers to work with other suppliers, the contract manager may be found in the middle of in-house business management, several suppliers, compliance and risk mitigation issues. Think through this structure carefully.

Perspective is everything. Suppliers serve businesses. You deal with borrowers and investors. Perspectives on customer service can be quite different. A two-week supplier notice is not unusual; for your borrowers, it is debacle. "Year-end" for a supplier may mean December 31; for a servicer, it means in advance of the year-end processing cycle. Every successful outsourcer has been surprised once or twice by semantics, and this is one reason service-level delivery definition has vastly improved.

In the outsourcing decision, relationship management and performance management go hand in hand. Hold regular and formal meetings with your supplier. In the first generation of measuring, you will probably develop your own version of management reporting tools in addition to those defined in the contract and supplied by the supplier. To what standards did they commit? Are they doing it? Is it getting communicated? What percent of delivery is met and what is exceeded? Are you keeping a recap of open issues, including those handled over the phone and in memo form? Discuss expectations and continually clarify roles. Remember, this relationship is a partnership.

While carefully monitoring cost, remember that it cannot be the only factor. Responsiveness, customer service and quality are key issues. What is their speed of change in the form of special reports? What is the cost of special requests? What is their expected turnaround? How are vendor dollars for the project being spent (i.e., how many dollars are paid in penalties? Why and where? )

Second-generation measurement should involve the measurement of value-added. Give the vendor points for innovation, business process improvement, financial management, customer focus and organizational learning. Share in the benefits and costs of jointly developed initiatives. Recognize that you add value to the supplier, who in all likelihood will ask to use your name when approaching other clients.

Continue to conduct benchmarking of the outsourced function against your competition and those of the suppliers. For outsourced departments, consider customer satisfaction surveys of your borrowers on a periodic basis.

The way to maximize flexibility and control is to maximize competition. The decision to outsource is not a one-time decision. Instead, your approach is to ensure potential suppliers always are attempting to improve their services.

So what's next in outsourcing? Other industries plan on outsourcing up to 50 percent of their current functions. AT&T not only won a Baldrige Award for its customer service outsourcing business, American Transtech, but also is building part of its three-pronged future around the trend. And American Transtech outsources the customer service representative staffing and training to Accustaff, the temporary agency.

For the mortgage banking industry, the dark cloud of capital investment looms. Human resources, fixed plant, training and technology changes produce frightening capital implications. The move from fixed to variable cost is imperative. Automated underwriting, property evaluations, quality control, audit, computerized loan originations (CLOs) and brokers are all forms of outsourcing. Size, once a constraint, is now addressed by suppliers in consortia arrangements. The next wave of outsourcing may include telemarketing, collections, management reporting and data base (cross) marketing.

The ultimate outsourcing arrangement, subservicing, was introduced in the '80s and is a thriving business today. In 1995, its origination complement was initiated by several large outsourced production pacts. Competitiveness comes from the ability to manage change. If you are optimizing your outsourcing option, you may be one leg up on your competition. And that could be considered an art and a science.