With $65 million in its checkbook, LeapSource opened its doors in September, 1999. The pure play business process outsourcing (BPO) provider closed those doors in March, 2001.
What happened? And what does it mean for BPO outsourcing?
LeapSource’s demise “will have little impact on the overall business process outsourcing marketplace,” says Marc Pramuk, senior industry analyst for IDC, a global market intelligence and advisory firm in Framingham, Massachusetts.
This one company’s failure to generate a positive cash flow has nothing to do with the market’s acceptance of BPO outsourcing, insists Pramuk. “There is still a large and under served market for BPO services,” he observes. In fact, as the economic outlook remains uncertain, companies will feel even more pressure to outsource transactional processes so they concentrate on the core processes that produce their profitability. “The appeal for BPO will increase rather than abate” in the current downward spiraling economy, he predicts.
He attributes LeapSource’s failure to a basic rule from Business 101: surviving businesses have to generate more revenues than expenses. Like many dotcoms whose underwriters became undertakers, LeapSource could not generate enough cash flow to keep going. “It is critical for service providers to align their cost structure with the timing of their growth and client acquisition to prevent a dramatic liquidation of capital and ultimately their demise,” he explains.
Pramuk, one of the nation’s leading BPO analysts, attributes LeapSource’s failure to a “breakdown of execution.” He says that merely understanding the BPO marketplace — which LeapSource did well — never guaranteed that the provider could successfully execute a viable business plan. “They underestimated how hard it would be to implement their plan,” he continues.
A Rosy Beginning
Realizing there was a significant market for back office finance and accounting BPO, GTCR Golden Rauner LLC, a Chicago, Illinois private equity investment firm, raised the capital to fund a BPO start-up. The firm had funded outsourcing ventures in the past. The $65 million it raised was the largest BPO venture funding at the time.
Golden Rauner selected Christine Kirk, Julie McCollum and Kim Hartmann, three executives in the BPO practice at Arthur Andersen in Tempe, Arizona, to head the new BPO firm. They leapt at the chance. Kirk has a proven history of building BPO businesses. In 1995 she founded the BPO outsourcing division at Andersen. Her division began with two members and operated out of an out-of-the-way back office at the Big Five accounting firm’s Phoenix office. When she left, her division numbered more than 700 people. In total, eight other executives in Andersen’s BPO division joined Kirk at LeapSource.
Growing Through Acquisition
“LeapSource planned to fuel rapid growth through acquisition,” continues Pramuk. LeapSource purchased CorpCare Financial Sourcing in December 1999 and ICG Consulting in February 2000. The company used its venture dollars to complete LeapSource’s suite of service offerings. But even more important, the executives thought they were purchasing a stable base of customers.
However, this did not happen. These acquisitions did not result in enough new business fast enough, Pramuk points out. But they did take a lot of change out of the corporate checkbook.
Pramuk suggests new BPO companies form partnerships and strategic alliances to acquire the resources they need. “LeapSource didn’t have to buy any companies. It could have achieved the same results with a strategic alliance,” he says.
Building A Shared Services Center
At the same time LeapSource was building a $6 million state-of-the-art shared services center, which opened in October 2000. The firm planned to service at least five clients from this center at the outset but built the facility to accommodate the expected rapid growth. Pramuk says the center could easily service another 10 clients. Originally about 200 employees worked in this service center; the company planned to expand to 500 in the following three years.
“You can’t build just enough for your existing clients. We couldn’t build half a building,” says Kirk, LeapSource former CEO.
Some BPO vendors say $6 million was a high figure. David Schnitt, CEO of Ledgent, a Torrance, California BPO start-up, says his company built its own shared services center “so it could take advantage of the latest technology.” He says Ledgent only spent $400,00 on its physical infrastruture.
LeapSource needed customers to keep the technology and its employees busy. Pramuk says LeapSource borrowed a line from Kevin Costner’s film “The Field of Dreams”: Costner said, “If you build it, they will come.” Unfortunately, only four customers ended up on LeapSource’s client roster, too few to support the technology overhead. “They underestimated the outsourcing sales cycle and the complexity of the buying process,” Pramuk notes.
“It wasn’t that easy to sell in a start-up environment,” says Kirk.
LeapSource literature talked about targeting the high end of the market. But the company’s initial clients were middle market companies, which typically carry a higher sales cost, according to the analyst.
Kirk says the firm decided to go after the middle market “because it was a huge market no one was serving.” They discovered that it still took a substantial amount of time to sign these companies. And they didn’t have the volume that larger clients produced.
The Importance of Scale
The result: They didn’t get scale fast enough. “Success in outsourcing requires utilizing all resources to the maximum,” says Pramuk. Two-thirds of the shared services center sat idle for six months, putting another drain on its funding. In the end, LeapSource couldn’t grow its revenue fast enough to pay for this investment, which Pramuk says became a “white elephant.”
In addition, LeapSource had a number of highly paid CPAs on its staff who were responsible for change management, a key component of finance and accounting outsourcing. With so few clients, these people were also underutilized, adding more expense, continues Pramuk.
Then the economy turned and investors got spooked. LeapSource just got unlucky. “LeapSource made its investment when the economy was roaring and then had to pay for it when the economy was crumbling,” says Pramuk.
Kirk says the company could find no one to supply a second round of funding. “We thought we had more time,” she says. Schnitt of Ledgent says he’s lucky his venture capital partners “are patient investors. They understand it’s a long process to get a new BPO off the ground.”
Pramuk says outsourcing is a difficult model for vendors to make money in the early years because outsourcing suppliers must make large capital investments in infrastructure. “Most of what LeapSource did was right. They saw the unmet need in the market. They just built too much capacity too fast on unrealistically high expectations,” he concludes.
P.S. At least LeapSource lasted almost two years. Pets.com lost $66 million in 10 months.
Lessons from the Outsourcing Primer:
Here are some of the mistakes LeapSource made:
- They made acquisitions to buy customers that didn’t materialize.
- They underestimated the time needed to get a BPO firm to profitability.
- They didn’t realize how long the sales cycle was.
- They changed their market focus from large clients to the mid market, diluting their sales and marketing efforts at a time when they needed to build a strong brand reputation.
- They built an expensive shared services center without adequate planning for when the revenues would come in to cover its cost.
- They had high personnel costs for people that remained underutilized — just like their shared services center.
- They didn’t form strategic alliances to get the expertise and technology they needed quicker and cheaper.
- They were unlucky. The market changed dramatically during their lifetime.
- The result: LeapSource ran out of time and money.