Outsourcing and facilities management have become essential tools for all businesses. For venture capitalists and private equity firm managers, business process outsourcing (“BPO”) can provide a valuable platform for value creation. However, you should “know before you go.”
Your securities lawyers are not outsourcing lawyers. You should consider hiring specialist outsourcing lawyers to get a proper mix of skills for building your portfolio companies as platforms for growth.
Special Due Diligence for Investing in BPO Companies.
Due diligence requires special subject matter experts not only in the particular vertical industry or product niche. It also requires the help of someone experienced in negotiation of such contracts to (i) map the processes shown in the actual contracts, (ii) identify risk attributes such as unlimited liability for certain acts or omissions, (iii) provide “exception reporting” to identify where such risk attributes are abnormal or pose extraordinary risk of loss or liability and (iv) explore the relationship of the entire service delivery operations to the contract obligations, and (v) identify special legal compliance risks that exist today and those that might arise in the next five years.
Unique Levels of Managerial Maturity of the Target Customer in Relationship Management.
Aside from force majeure failures (such as by new politically driven legal environments or Acts of God), perhaps the biggest risk for the emerging BPO service provider is the possible failure by the enterprise customer to dedicate the necessary internal retained resources to communicate with and manage the service provider. Without an ongoing close and service-focused relationship between customer and provider, the relationship may sour rapidly, with subsequent contract termination or renegotiation on less favorable terms. Consequently, you should understand the maturity of the target market’s ability to manage, relate to, and even collaborate with the BPO service provider over a term of at least three to five years. This requires an understanding of the particular industry and its general practices as they relate to BPO.
Unique Ongoing Warranties of Performance.
As the world has grown to a service economy, the concept of “after sales support” and warranty service that were familiar to software development companies in the 1980’s and 1990’s has given way to the concept of continuous warranties. These are called “service level agreements.” A service provider’s unjustified breach of SLA ‘s can escalate into exponential loss of revenue and even liability for significant damages. IBM has challenged the world to deliver service “ON DEMAND,” which suggests 100% of the time with no tolerance for errors. You need to understand the risk profile associated with the particular SLA methodology typically adapted to the service provider’s business processes and the customer’s expectations.
Unique Attributes of Customer’s Reasons for Hiring BPO Services.
BPO services are novel to enterprise customers that have traditionally been handling the processes in-house. Those customers who run the internal shop well, or who think they can get all the benefits of outsourcing by setting up shared services organizations, may conclude there is no reason for outsourcing. This leaves those that have failed to manage these processes well, with the risk that the BPO service provider will be left having to deal with a “train wreck.” This risk needs to be managed through effective maintenance of contact with senior executive sponsors, the service provider’s having adequate time and resources to conduct due diligence of customer’s internal processes sufficient to understand what needs transformation, and ROI analysis that is meaningful to justify adequate pricing.
Unique Attributes of Pricing.
In many service industries, repeat customers come back because prices are renegotiated annually or adjusted to reflect markets or indices. In outsourcing, enterprise customers strenuously seek to achieve the same results, but only if the outcome is in their favor, using the technique of “benchmarking.” In this process, your BPO service provider’s performance and prices are compared to those maintained in a large data base managed by a specialist consulting firm. Pricing may therefore be subject to adverse impact due to benchmarking, mark-to-market concepts and other contractual provisions. You should understand how the pricing structure can be affected, and how his structure will dictate the target market and limit its size and potentially profitability.
Unique Cultural Issues in International Business and BPO.
Offshore BPO service providers need a local native “onshore” marketing and sales team. While foreign sales managers may be useful, native local sales managers are essential to presenting a local face, bridging culture gaps and setting the tone for a top-quality service by the local standards. If your portfolio company does not have local “native” sales management or is churning them due to cultural conflicts or lack of mutual commitment, your portfolio investment may lose worth as the marketplace will soon learn about such internal employment practices. We have seen cases where the local native sales personnel were hired but not given the time, resources or authority to complete certain sales functions, and the same environment applied to the replacement onshore native personnel. This may result in lost synergy, bad reputation for the enterprise and legal liability for discrimination on the basis of national origin. In short, the investor and the board should be vigilant for such potential reputational damage and legal liability.