Backward Integration Vs Business Process Outsourcing

In this month's strategy debate, industry leaders discuss the merits and demerits of...

BPO

Jerry Rao
Chairman and CEO,
MphasiS

Indian IT companies have had a good run. They are now recognised around the world not just as low-cost code-writers but as high-quality designers, architects and developers "" a superstructure built on solid cost advantages and world-class project management experience.

Within a few years, IT has become more than a business story...it has become a source of patriotic pride.

The question as always is "what next?" The answer "" more of the same. Dramatic growth fuelled by major global acquisitions, backward integration into hardware and riding on the back of our IT strengths into areas like business process outsourcing. I rise to support the "BPO Case".

Quite frankly, remote BPO from India is currently happening and will continue to take place in future. The developments in the telecom and workflow fields have enabled processing and customer contact services to be done remotely.

From data entry and call centres to tax returns and development services, work is constantly moving to India. 250 of the Fortune 1,000 companies already outsource their services to India.

The number of firms using offshore providers will grow by 50 per cent in the next two years. Budgets will more than double. The economic case in favour of outsourcing to India is so compelling that market forces will ensure this move.

Unless, in a fit of irrationality, we choose to shoot ourselves in the foot, India will emerge as a major BPO hub of the world.

The only question that now remains to be answered is whether IT companies should enter BPO. My response to that is that entering BPO is the right choice for "some" IT companies just as backward integration may be the right choice for some others.

BPO rides on the crest of a new wave in the underlying technologies of how we work in service industries. Telecom developments and secure IP have reduced the cost, improved the quality and robustness of remote access and remote processing.

Workflow and imaging software are making it possible to chop up work into smaller bits and move tasks around the world.

Indian IT companies have a track record of doing software development, testing, installation and maintenance on a remote basis. They have a reputation for quality "" a hard-earned one.

They have excellent customer bases "" the biggest corporations of the world. They have demonstrated their ability to leverage India's highly talented English speaking work force.

BPO simply demands a repeat of all these. Hence, why not go for it?

Here is an opportunity to exploit the current momentum and go for global scale and world-class operations.

Indian IT companies have healthy balance sheets with little or no debt. The opportunity is there. At least some, if not all, must and will grab it.

At MphasiS, we have successfully managed to leverage our combined strengths in software development and offshore IT services expertise to provide integrated, end-to-end solutions and services to our clients.

Are there risks? Yes, there are. Businesses leverage similar strengths, but they are not identical. But that's not the only issue.

To my mind, scale issues in BPO are far more mind-boggling than in IT. In my own firm, in a short time MsourcE "" the BPO arm "" employs 100 per cent more people than the older IT services business.

Quite frankly, we are learning the challenges of scaling at this killing pace in real time. Does it give us sleepless nights? Of course. Would we have it any other way? No way. The overdose of adrenalin suits us.

Raman Roy
Chairman and managing director,
Wipro Spectramind

If you look at backward integration the way I do, it implies starting everything from scratch.

It takes us back to the Stone Age, where we ignore commercialisation, the existence of currency and industrialisation that has brought us into an era of super-specialisation that allows people to focus on their core strengths and on sheer scale.

Scale is a key factor to any manufacturing decision. Whether it's the manufacturing sector or services, there are certain core strengths to any company.

Then there are the non-core aspects where the advantages of scale and skill matter. It is the scale and skill that determine whether a particular manufacturing or services needs to be done by one corporation or the other.

Wherever there is enough skill and scale, backward integration makes sense. But where it lacks skill or scale and can be purchased without denigrating the end-product to the customer, it makes sense to go for outsourcing.

Today, the needs of a corporation are so diverse that creating capability, competency, skill and scale is not economically viable. Therefore, it makes sense to make an end-product that is a mix of what is done in-house and what is outsourced.

Take the example of Boeing which builds aircraft. It does not make aircraft engines, the seats, the panels, the wings or the steel.

All this is made by manufacturers that specialise in each category. Boeing buys them in a cost-effective manner and puts them together.

Technology, communication and transportation have made the world a global village. Distances don't matter anymore and geography is history. Therefore, the ability to tap resources is on a global platform.

If you look at the manufacturing sector, countries like India and China "" where both labour and technology inputs are high and there is also abundance of natural resources "" have tremendous potential.

Why sell iron ore, when we can sell iron and steel, and further components or intermediate products made out of them?

There is skill available, there is managerial capability available and technology can be purchased to build those factories.

India has the intellectual capital and servicing is a natural competency and capability. We have demonstrated our skills in the services arena.

And as a country, we need to build on this competency to become truly global in terms of quality and costs, which is the value that the customer is looking for to become a natural choice wherever an outsourcing decision is taken. Can we do it?

Yes. We have a lot of distance to cover to create the size, skill and scale for us to become a natural choice globally.

As told to Amit Ranjan Rai

BACKWARD INTEGRATION

V Sumantran
Executive director,
passenger car business unit,
engineering and research centre,
Tata Motors

I hate to be painted in a "for or against" posture, because my natural instinct is to talk about a balance. But within that balance, there are both advantages and disadvantages that accrue to backward integration.

Going back to the Indica project, the Rs 1,700 crore it cost to put up a plant on a literally greenfield project is a price tag fourth of what western or eastern automakers would find cost effective.

We not only built a car, but also designed test fixtures and operations. There was a tremendous amount of value that that the company was able to unlock out of its assets "" a compelling reason to say backward integration can work.

Now, does backward integration work all the time? Absolutely not. The primary disadvantage is that one must make every element of the operations competitive. But sometimes, the model does not force that degree of competitiveness all along.

I spent a large fraction of my career with General Motors, which, when I joined, was a backward integrated company to the point where the company even did research on the ceramics for the spark plugs that go in engines of the vehicles sold.

Over time, there were disadvantages and that led to the spin-off of auto component manufacturing companies like Delphi that now courts business from GM and several other automakers.

However, it is difficult to come up with a formula on how companies can decide on what to make and what to outsource. Everything depends on the context and size of the company, the areas of focus, the depth of resources and the availability of alternatives for sourcing.

It may not be true that backward integration never worked and it may be false that disintegration is always the best thing to do. Even successful companies like Honda build their own machine tools and aligned automation equipment.

Backward integration makes more sense where there is a dependence on critical skills and there are fewer alternatives to supply or deliver the results you are looking for.

And in areas where there are freely available solutions and the barriers for entry are low, backward integration may not be the answer.

As told to Prasad Sangameshwaran

K Venkataramanan
Member of board and president-operations,
Larsen & Toubro

There is no one answer for whether backward integration is better, or if BPO is a wiser option.

To make the right choice, assess the critical performance drivers for your business. Check what is vital in terms of proprietary knowledge that you possess.

If everybody gets access to your proprietary knowledge, then your differentiation goes away.

BPO is a good option where the information is not so vital to your competitive business edge and does not interfere with your proprietary tools or your USP. It is useful for routine work, which is basically driven by cost and manpower.

But for our business concepts like sourcing are critical. They are not the functions that are amenable to BPO. We have to ensure that we have the skills to not only create, but also sustain the backward integration over a period of time.

Every industry has areas where backward integration is necessary and some areas where BPO can be done. It's a question of you identifying where those processes are. For that, you need to take a closer look at the value chain in your business.

In our business, it starts from sourcing and technology, identifying customers, getting prequalified, quoting, getting orders, engineering and so on.

You must know the areas that control profitability and prequalifications. There are certain areas that are a must-have to prequalify for bids.

For example, if we do not have engineering skills in-house, we will not be prequalified. Similarly, procurement makes up 60 per cent of our costs. What will distinguish us from the competition is our ability to procure better.

For the engineering and construction division of L&T, backward integration has helped because these areas are new for outsourcing service providers too and everyone is in the learning stage.

So do we want to make a service provider learn at our cost, or do we learn at our own cost?

And if we have the competence to do as well or better than the service provider, then why not integrate backwards?

At this point of time, do you really believe that somebody else can do it better than you, because they too are learning and do not even have the domain that you have.

But ensure that even if something is not too critical to your organisation, be sure that it is mature and the outsourcing service provider does the same task as well as you do it.

As told to Prasad Sangameshwaran