Originally published 12 February 2010
Keywords: KPO, ITO, BPO, cost reductions, India, China
A new form of global outsourcing to India, known as "knowledge process outsourcing," or KPO, is following on the heels of the remarkably successful Indian market for information technology outsourcing (ITO) and business process outsourcing (BPO). Like ITO and BPO, knowledge process outsourcing allows client companies to realize substantial cost reductions by offshoring domestic business functions to lower-cost foreign venues. KPO differs, however, in terms of its potentially value-adding proposition: effectively structured and implemented, it can help companies gain strategic advantage over competitors by virtue of the types of offshored processes and functions it incorporates.
Knowledge process outsourcing offers its clients a very real possibility of significant benefit. But it also raises a number of key issues and risks that must be carefully evaluated when considering a KPO transaction in India. KPO involves the offshore outsourcing of knowledge-driven or "high-end" processes that require specialized domain expertise. Examples of these processes include research and development (R&D), insurance underwriting and risk assessment, financial analysis, data mining, investment research, statistical analysis, tax preparation, engineering and design, animation, graphics simulation, medical services, clinical trials, legal services and more.
The ITO and BPO market sectors create cost savings by leveraging
economies of scale and rules-based process expertise. In contrast,
KPO accesses the global talent pool to carry out processes that
demand specialized analytical and technical skills, as well as the
exercise of informed judgment and decision-making. The strategic
driver for KPO is to add value by providing high-quality business
expertise and superior productivity through improved time to
market, in addition to realizing the traditional cost reductions
through arbitrage of labor markets that have made ITO and BPO so
There are vast first-mover benefits to US and European participants in KPO. But meaningful challenges exist that must be addressed and navigated knowledgeably in order to achieve and maximize the strategic incentives offered by the KPO model.
Potential KPO customers must overcome the natural and understandable hesitation to relinquish control over the outsourced processes. These processes and their associated data are often critical, and companies have legitimate concerns about data security, intellectual property protection, quality assurance, regulatory compliance and cost, to name just a few.
By definition, moreover, KPO involves an investment by the customer in the host country's educated workforce and a dependence on that workforce that far exceeds BPO and ITO. In addition, KPO customers are far more dependent on the stability and predictability of the host country's underlying political and social structures. As a result, a deeper understanding of the host country's business, regulatory and legal framework becomes imperative.
Attraction of India's "Knowledge Class" for KPO and First-Mover Advantage
A successfully implemented KPO can deliver truly enormous rewards. The global KPO market is poised to grow by more than 45 percent annually – to $17 billion in 2010.1 India is emerging as the global KPO leader and is expected to capture over 70 percent of the market share going forward. The major KPO domains expected to grow in India over the next five years and their respective estimated value pie distribution are reflected in the chart below.2
India has a large reservoir of English-speaking, knowledge-based professionals who are available at extremely competitive salaries. The nation also offers a rapidly evolving legal and regulatory environment that is based on a western model and that is increasingly friendly to foreign investment.3
ITO and BPO are almost exclusively cost-based; they benefit from a virtually unlimited, relatively quickly trainable labor pool in developing countries such as India and China. In contrast, KPO depends on a more limited – albeit currently vast – supply of highly skilled, educated workers. These workers, over time, will certainly demand more economically rewarding compensation packages as competition for their skills increases.4
Successful KPO participants, accordingly, should not only leverage existing resources but should also consider investing and visibly participating in education and training systems to assure a predictable future supply of highly skilled workers and to develop first-mover brand recognition in Indian society.5 Many companies, such as Microsoft, GE and American Express, are already acting to do so. Because of this market timing consideration inherent in tapping into India's increasingly developing worker base, first mover considerations are therefore not insignificant with respect to KPO strategy.
The future prospects for KPO in India are immense because KPO is applicable to multiple industry sectors in which India's highly skilled workers and technically educated professionals have developed specialized expertise. These sectors include (but are not limited to) finance, pharmaceuticals, healthcare, biotechnology, insurance, electronics, software, aerospace, automotive, textiles, industrial machinery, entertainment, media and publishing, education, law and engineering. Many US businesses have already made successful forays into the KPO domain in India to leverage India's knowledge class. Among them are leading American corporations such as GE, IBM, Microsoft, HP, Intel, Oracle, Cisco, Texas Instruments, Sun Microsystems, Philips, Motorola, JP Morgan, Citigroup, McKinsey, Goldman Sachs, Reuters, Morgan Stanley, United Airlines, Ford, General Motors and Caterpillar. Many of these businesses are projected to expand their KPO operations in India, and it is likely that a host of new entrants will join them in seeking to leverage India's growing KPO sector.
Two examples of KPO in India – the pharmaceutical and financial services sectors – are worth noting. In the pharmaceutical industry, global producers such as AstraZeneca, GlaxoSmithKline, Pfizer, Novartis and Eli Lilly have moved portions of their clinical drug testing operations to India in an effort to leverage the nation's vast and diverse population and its pool of highly skilled, relatively low-cost scientists. This strategy can significantly accelerate the trial time and time to market for new drugs, and it offers potential savings of 40 percent to 60 percent compared to US costs. India's vibrant local pharmaceutical sector and its recently amended patent laws granting patent protection to drugs and chemical products, coupled with its history of process protection, have also attracted global pharmaceutical companies to offshore R&D to India.6
India's attractiveness as an offshore destination for clinical research is further enhanced by investment incentive policies ranging from tax holidays to duty exemptions and by its acceptance of the International Conference on Harmonization Guidelines for Good Clinical Practices. With the cost of bringing new drugs to market continuing to escalate in the United States (current estimates approach US$1 billion per product), the possibility of halving the cost of clinical trials and drug discovery by moving those processes offshore cannot be ignored.7 Increasing pressure on pharmaceutical companies to improve productivity and profitability without sacrificing quality to sustain competitive advantage makes KPO a compelling strategic route.
Similarly, KPO initiatives within the financial services sector have seen tremendous growth in India as global financial institutions such as JP Morgan, Citigroup, Prudential, Goldman Sachs and ABN AMRO continue offshoring high-end work, either through delivery by affiliated legal entities in India or by unaffiliated, pure-play third-party vendors. Most of these businesses originally outsourced IT-enabled common finance and accounting processes that were transactional in nature, such as accounts payable, accounts receivable and payroll. But many have gradually migrated to offshoring high-end financial processes, such as equity research, business intelligence, credit risk analysis and insurance claims processing.
When it comes to the KPO delivery model, one size does not fit all. Currently, three key KPO delivery models exist. These include:
- offshoring through affiliated legal entities in India, which can be thought of as "captive KPO" ;
- contracting with unaffiliated third-party vendors, or what can be called "third-party KPO"; and
- partnering with local entities to share control of local operations used for delivery of KPO services, or "joint venture KPO".
Each model has its own advantages and risks, and each should be evaluated carefully in order to identify and assess the relative pros and cons for a particular KPO strategy. Businesses should adopt different delivery models for different situations, taking into account variables such as the nature and scope of the activities to be offshored, previous offshoring experience, concerns about security and control of intellectual property (IP), risk tolerance, tax considerations and budgetary constraints.
For example, third party KPO can be more quickly implemented and often can offer greater flexibility in access to talent, scalability and cost structure. But it also yields to the third party more control over day-to-day operations and the handling of sensitive data and IP, and it creates more reliance on the foreign host country's legal regime and the timely enforcement of contracts.
In comparison, a captive KPO model usually requires more time to implement and provides less flexibility to ramp up or down quickly. However, it ensures substantially more customer control over management of the offshore operations and the company's sensitive data and IP and less dependence on foreign enforcement of contract rights. A KPO customer should consider adopting the captive KPO strategy if the outsourcing's scope involves a substantial transfer to India of critical proprietary technology, IP or data and if the enterprise cost of possibly losing control over some meaningful component of those assets is high.
In India, KPO initially took hold in captive centers through the establishment of local subsidiaries, and estimates suggest that over 50 percent of offshore business in India is currently captive KPO. But as the Indian KPO market matures and the business, legal and regulatory environment there continues to advance and stabilize, customers can be expected to increasingly leverage third party KPO in light of that model's advantages relative to flexibility, scalability and range of expertise.
Regardless of the delivery model, KPO invariably requires the customer to disclose and share knowledge-intensive processes with the offshore provider. This knowledge may take the form of proprietary technology, software, chemical entities, specifications, product designs, business processes, methodologies, drug formulations or other sensitive data. Accordingly, the substantial benefits that KPO in India offers must be seen as "hand in hand" with the unique and heightened risks inherent in the transfer of customer-owned knowledge to India. These risks must be carefully considered upfront, and they must be diligently mitigated to realize the full benefit of KPO to India.
KPO to India can yield enormous cost savings and increased efficiencies to the customer. It can also leverage India's vast knowledge class to perform high-end skill- and judgment-based services and functions. But the potential KPO customer must be aware that KPO presents a number of risks – particularly with regard to controlling intellectual property and protecting sensitive data – that must be considered and addressed. These risks can be managed, however, through appropriate due diligence, planning and a well-crafted KPO contract that properly identifies and addresses the risks and that provides real and practical protections and enforcement mechanisms.
1. Study conducted by Evalueserve in 2004.
2. Knowledge Process Outsourcing (KPO)– An Emerging Opportunity, Kelly Services White Paper, July 2006.
3. India produces 441,000 technical graduates, nearly 2.3 million other graduates and more than 300,000 postgraduates every year. A Survey of Business in India in The Economist, June 3, 2006.
4. A Deutsche Bank research report published in October 2005 reports that wages for skilled workers in India are rising on an average by 12-15% per year.
5. The National Association of Software and Service Companies (NASSCOM) predicts that the Indian IT sector faces a shortfall of 500,000 professionals by 2010 that threatens India's dominance of global offshore IT services. Financial Times, July 20, 2006.
6. The Patents (Amendment) Act, 2005.
7. A Survey of Business in India, The Economist, June 3, 2006.
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