Business process outsourcing (BPO) is the practice of contracting an external service provider to fulfill a business function or process. BPO is sometimes referred to as information technology-enabled services (ITES) because outsourced processes in the modern business world are often reliant on IT in one way or another.

Generally, companies outsource non-core tasks—functions that, while essential to business, are not part of its core value proposition—that are similar across companies and industries. These include back-office operations (internal business functions) like accounting, IT services, procurement, quality assurance and human resources management, and front-office (client-facing) roles like sales, marketing or customer support. Deloitte’s 2021 Global Shared Services and Outsourcing Survey Report found that IT, finance and payroll are the most commonly outsourced roles.

Traditionally, companies have outsourced functions mainly to cut costs, save time and improve performance. While these benefits remain the primary drivers of BPO, the trend toward digital transformation has more firms looking beyond cost-saving strategies with an increased focus on access to technology and provider expertise.

BPO was first used in the manufacturing industry, where firms gained efficiencies by outsourcing tasks for supply chain management. Today, BPO services are used in healthcare, asset management, energy, pharmaceuticals, e-commerce and many other industries as companies leverage new and innovative ways to improve customer experience and gain competitive advantages.

With the proliferation of new technologies like robotic process automation, artificial intelligence, and machine learning, and the widespread acknowledgement of their value in improving agility, standardization and scalability, a new paradigm is emerging in the BPO industry. Increasingly, companies are seeking providers who can bridge their technology gap and drive transformation through integrated analytics, AI, ML, automation and other new technologies.

As a result, outsourcing is transitioning from simply a cost play to a value play, with vendor compensation often structured around outcomes and the technology solutions offered rather than just the time and materials spent.

A McKinsey analysis of BPO deals closed between 2016 and 2020 found that a quarter included at least one digital component—analytics, automation or cloud capabilities, for example—and that the number of such deals doubled during that period as the overall outsourcing industry saw single digit growth.

Identifying which functions are appropriate for business process outsourcing requires strong business process management and a complete understanding of organizational processes. Typically, the outsourcing of a function or process will involve the following steps:

• Deciding to adopt BPO. Organizations base their decisions to adopt BPO on many factors, including their company size and industry, market size and economic forces, and their overall needs and goals. For instance, startups or small businesses may decide to outsource any number of front or back-office functions because they feel they lack the in-house expertise, or simply because they do not have the staff to perform them. Larger organizations may decide to outsource because a third-party vendor can complete the task more efficiently or effectively.
  
  
• Identifying tasks to outsource. Next, organizations identify which business functions might be best suited for outsourcing, and what impact outsourcing will have on technology requirements and current processes. In making this decision, companies evaluate how this new business model will affect all aspects of their company—from processes and workflows to finances and taxes to company culture.
  
  
• Choosing a BPO provider. In this stage, organizations determine which vendors offer the best outsourcing services at reasonable rates and turnaround times. Depending on an organization’s needs and their assessment of service providers, an entire business operation might be contracted to one vendor, or the operation might be divided among multiple vendors. Comparing vendor offers against requirements and expectations helps organizations make this decision.
  
  
• Deciding contract type. An organization must decide whether to offer a vendor a fixed-price contract or a time-and-materials contract. If the service provider agrees to a fixed-price contract, they are paid a fixed amount regardless of the amount of time and resources expended on the outsourced role. For a time-and-materials contract, the provider is paid based on the amount of time and resources utilized during the work.
  
  Alternatively, the contract may be based on performance outcomes. Whatever the contract type, service-level agreements (SLAs) should be established to simplify the evaluation of the quality of service provided.
  
  
• Transferring outsourced roles. Develop and implement a plan for moving the workload to the vendor. Communication, both internally and with the vendor, is crucial to a smooth transition.
  
  
• Evaluating vendor performance. The organization should regularly assess the vendor’s performance against the objectives and goals outlined in the contract, usually on a quarterly or annual basis. This will help the organization decide whether to renew, amend or terminate the contract.

Business process outsourcing offers valuable benefits for organizations and allows for greater focus on highly skilled and specialized roles essential to core objectives. These benefits include:

• Reduced cost. By outsourcing functions to third-party vendors, organizations can reduce in-house labor costs related to staffing and training and take advantage of fee-for-service plans that are more cost efficient than the fixed costs of retaining full-time employees. Through offshore outsourcing, organizations can leverage lower-cost labor markets and tax advantages.
  
  
• Increased focus on core business competencies. By outsourcing non-core competencies, organizations free up resources that can be directed toward business differentiators that drive value and give the company competitive advantage.
  
  
• Improved efficiency and standardization. BPO providers are often specialists in non-core business operations, like payment processing, call centers or accounting. Thus, they can handle these operations with greater efficiency and expertise than if the services were handled in-house.
  
  
• Access to innovations. As specialists in the services they provide, BPO vendors often invest in the latest technology solutions available in their field of service to maintain an advantage over competition and offer the greatest value for their clients. This allows companies to access cutting-edge technology, like advanced analytics or automation solutions that handle more complex processes, while minimizing costs.
  
  
• Efficient global presence. Outsourcing providers can deliver around the clock service to customers in multiple languages, eliminating the need for an organization to staff a local office. In addition, for organizations looking to expand their business, a partnership with a BPO vendor in the region can grant a better understanding of local markets and help streamline the expansion process.

Business process outsourcing can be classified according to the location of the hired outsourcing company and the type of service rendered.

BPO, based on location:

• Offshore outsourcing. This is when an organization contracts a provider in a foreign country. A German firm hiring a vendor in the Philippines, for example.
  
  
• Nearshore outsourcing. Here, the contracted vendor operates in a neighboring country, like a US firm outsourcing to Mexico.
  
  
• Onshore outsourcing. Also referred to as domestic or local outsourcing, this is when both the organization and the service provider operate in the same country.

BPO, based on the type of service:

• Knowledge process outsourcing (KPO). This is the outsourcing of core, information-related business activities to a third party, or different group within the same organization, with a high level of knowledge and expertise in a particular area. Examples of KPO services include research and development (R&D), data and technical analysis, and consulting services.
  
  
• Legal process outsourcing (LPO). LPO is a subset of KPO involving the outsourcing of higher-level legal work like the drafting and revision of legal agreements and patent applications, legal research, and client advising.
  
  
• Research process outsourcing (RPO). Another subset of KPO, this is the outsourcing of research and analysis functions. Organizations that commonly engage in RPO include biotech and investment companies

Choosing a service provider to meet an organization’s outsourcing needs requires thorough planning. The goal is to choose an affordable vendor with the right mix of expertise and experience. The following are general steps to follow when evaluating and choosing a BPO provider:

• Define the requirements. All relevant stakeholders should be involved from the outset in choosing a vendor. Each department should outline requirements and expectations as they relate to the functions to be outsourced. The key objectives and foreseeable risks of outsourcing these functions should also be enumerated.
  
  
• Publish a request for proposal (RFP). A request for proposal is a document that describes a job and invites bids from qualified vendors. The expectations for the role and the contract terms are often stated in an RFP.
  
  
• Select a vendor. Evaluate the proposals. Assess the strengths and weaknesses of the shortlisted vendors and compare against stated requirements and objectives, weighing any value-adds offered by vendors.
  
  
• Negotiate the contract. Once a vendor has been selected you can begin to finalize the contract. Because the contract terms have already been detailed in the RFP, most of the terms should already be agreed upon. Make sure that the service parameters and delivery timelines are clearly understood by all stakeholders.
  
  
• Transfer the workload and regularly evaluate performance. Follow the preestablished plan for the transition of services to the vender. Communicate regularly with relevant in-house teams as well as with the external service provider to maintain efficient business operations and foster a collaborative relationship. Monitor and evaluate vendor performance against the key performance indicators (KPIs) outlined in the SLA, and use these evaluations to determine whether a contract should be renewed.

Though it offers many benefits, BPO exposes an organization to some risks as well. Outsourcing your organization’s business processes to an external service provider raises questions about work quality, data security, and work culture compatibility, especially when the provider is located in a different part of the world. BPO can introduce the following risks:

• Security issues. Business process outsourcing often requires the sharing of sensitive information with vendors, which increases security risk. For one, most communication and information sharing is done over the internet, a viable entry point for bad actors.
  
  In addition, despite best efforts to align security standards, it can be more difficult to ensure that a third-party vender is adhering to data privacy protocols and following proper security measures than it is with an in-house team. Different countries have different security requirements and data privacy policies, which can pose a threat to data security for organizations that use offshore outsourcing.
  
  
• Unforeseen costs. Organizations do not always accurately estimate the cost of an outsourced service. Some unforeseen and indirect costs—for example, due to currency fluctuations (for offshore and nearshore outsourcing), hardware or software upgrades and delayed delivery—might be incurred.
  
  
• Overreliance on external service providers. Working with one BPO vendor for a long period of time can lead to an overreliance on the vendor. The vendor becomes more or less a part of the organization and replacing them is not always easy. A vendor might take advantage of this knowledge to exploit the organization.
  
  Regulatory compliance issues. Despite being third parties, BPO companies still have to comply with the client organization’s regulatory requirements. An organization risks sanctions from relevant authorities when there is regulatory non-compliance. Different workplace cultures and norms might increase the chances of falling out of compliance, especially in offshore outsourcing.
  
  
• Communication barriers. Language barriers can restrict business activities in offshore outsourcing, leading to poor communication and delays in service delivery.
  
  
• Increased potential for disruption. Another risk of offshore outsourcing specifically, issues like political instability and natural disasters in a provider’s country of operation can interrupt an organization’s business activities.