Increased Interest in FAO
Market research results are consistent – finance and accounting (F&A) organizations are showing increasing interest in FAO. Multiple industry surveys have shown that the majority of mid-sized to large companies, when asked about FAO intentions, report that they intend to outsource or continue to outsource at least some parts of their F&A operations in the near future. Many indicated their desire to extend existing outsourcing to encompass additional functions. At a recent BPO conference, all of the service providers, industry analysts and outsourcing advisors agreed – today’s F&A outsourcing initiatives differ from those of the past in the breadth of the scope of services being put out to bid. No longer are the FAO initiatives restricted to single functions such as payroll or benefits administration. Instead, multiple, related F&A processes are getting outsourcing attention. This coincides with the growing maturation of service providers’ existing FAO offerings, as well as their increasing mastery of more specialized finance and accounting services and expanding global offerings.
The FAO Value Proposition
The F&A outsourcing focus remains primarily on transactional processes, such as accounts payable and receivable, payroll and General Ledger accounting. Why? Because those areas are routine, “rules based” and don’t require in-depth business knowledge. They’re relatively simple to transfer to an outside provider. Many FAO providers now have a successful track record in delivering these types of services to customers. More importantly, outsourcing transactional processes is a means to free up internal resources to devote more time and attention to important areas of business analysis. And, yes, you can also save money outsourcing these types of processes since service providers can often do them more efficiently, leveraging their expertise in process simplification, standardization and management. However, while lowering the cost of accounting and other F&A processes is important to companies; getting more timely and accurate, analyzed financial information to the business leadership as a basis for their decisions is even more so. Where outsourcing can save money and, at the same time, create greater ability for internal managers to meet short business deadlines on non-routine financial and accounting matters, the value proposition for FAO is highest.
The FAO Puzzle
While there is evidence of increased interest in FAO because of these potential gains, the truth is that many recent broader FAO initiatives have failed to result in an outsourcing contract. Where alternative and more effective means of achieving objectives are identified by an organization, a decision to back away from an outsourcing solution makes good sense. At other times, though, these decisions seem to defy logic. Why, with almost all aspects of the deal defined and some very strong indicators of benefit for the customer, would contract negotiations be suspended? This white paper explores some major challenges facing FAO negotiation success and discusses ways of overcoming the particular difficulties faced, based on TBI experience in FAO.
There are 4 Major Challenges Observed in FAO
Challenge #1: Pinning down scope can be difficult
Clear definition of the target scope of services is fundamental to success in any outsourcing action. This takes more than naming the processes and identifying the associated activities to be considered for outsourcing. It further requires in-depth analysis – defining the process flows to accomplish the activities being considered for outsourcing, articulating necessary interfaces with work done in other parts of the organization, and identifying required handoffs for review and approval and the control processes to be retained or outsourced as shared responsibilities. This is true of all outsourcing initiatives, but FAO carries additional challenges in this area.
Pinning down FAO scope is made more difficult because Finance & Accounting operations in complex organizations are typically partly decentralized to business units, reporting to executives with P&L responsibility for each business and outside of direct supervision by the CFO. Thus, the corporate view alone is likely to be inadequate; due diligence has to extend into the business units.
Activities, historically decentralized to business units, often include a mix of business-specific analysis and general accounting leading to possibilities of use of non-standard processes and dissimilar information quality. In order to provide the basis for an optimal outsourcing solution, FAO due diligence must be designed to identify:
- Operating similarities and differences across F&A units in the current work structure;
- F&A processes that can and should be standardized even if currently done dissimilarly by different units;
- Where to draw the line between routine financial analysis that can be outsourced and Strategic business analysis that will need to be retained.
The common inclination of senior corporate sponsors of outsourcing investigations to minimize the involvement of “outside” personnel in the outsourcing assessment can be particularly counterproductive in FAO assessments. Difficulties in pinning down scope will magnify the lack of opportunity to conduct detailed due diligence in both the business units and the corporate office prior to contracting. Frankly, poorly defined baseline scope spells “risk” to the service provider. Service provider response will either be higher pricing to cover perceived risk of the unknown, or negotiation of an out-of-scope pricing approach (vendors call it use of “the change management process”), treating services needed that weren’t clearly defined in advance as “new” and subject to additional pricing. Both approaches can lessen the perceived attractiveness of the deal on the part of the customer.
Challenge #2: FAO costs often higher than expected
A common breakdown in FAO pursuits is caused by disagreements about the outsourcing financial base case analysis. Take two senior financial analysts, one from the service provider and one from the customer organization, and ask them to work together cooperatively to analyze ROI for the proposed FAO, and you may get unpleasant results. Unproductive head butting can occur – most often around the subject of transition and transformation costs; costs not “baked into” the baseline service pricing.
Some F&A managers have difficulty understanding how outsourcing could have real benefits when projected initial costs of operation under outsourcing may be higher than the current run rate. It is simple. F&A processes are some of the most ingrained in organizations and changing them must be done very carefully. There are often institutionalized inefficiencies in F&A (e.g., think spreadsheet reliance for system interfaces; awkward handoffs of outputs from one unit to the next; over-reliance on paper, etc.), that vendors must address in order to assure smooth operation and cost control. Transformation of F&A processes to industry best practices, eliminating the inefficiencies, requires up-front investment of time and money. Transformation projects involving paper reduction through scanning and automating or integrated financial system design and implementation, for example, can be expensive – regardless of who does them. Pricing will need to reflect this and could be higher than expected by the customer, particularly if they’ve never formally investigated the cost of similar process and tool improvement projects themselves.
We have also seen unrealistic cost savings expectations on the part of customers around work of very confined scope. An already lean operation in an area of small scope, moved outside of the organization, might make sense in the context of a larger outsourcing action, but its individual cost is unlikely to be substantially lower than when done internally. Most of the operational costs in F&A are driven by employee compensation. Unless a service provider can find a way to decrease needed FTEs, their salary and benefits costs will be similar to the organization’s baseline costs. Small scope simply offers less opportunity for the vendor to increase profitability through transformation.
Finally, “soft” cost savings may be difficult to estimate and this may hinder the accurate analysis of the financials. For example, how do you quantify the added value of redeployment of internal resources to timely and accurate business analysis. That benefit clearly needs to be recognized in the business case. Difficulty in putting numbers to it, though, often results in underestimation of the true cost benefit and ROI for an FAO action.
Challenge #3: Apprehensions about regulatory compliance
Perceived risk related to compliance with regulatory requirements, such as HIPPA, Sarbanes-Oxley, ERISA, SEC filings, etc., is high in FAO, and another reason why organizations may choose to not outsource. There is growing thought that, in the long-run, regulatory requirements such as SOX will accelerate the outsourcing of finance and accounting processes. The thinking here is service providers will provide and leverage their expertise and efficiency in on-going compliance and change management to benefit clients, for whom these activities would otherwise be more costly if done internally. This may be true, but at the moment, there are substantial challenges to building this level of customer confidence in FAO provider capabilities.
Some FAO providers have proven ill-prepared to make needed commitments to their customers in meeting regulatory requirements. They don’t understand that they need to be more proactive about supporting customer organizations in risk recognition/avoidance/mitigation activities. During discussions about SAS 70 compliance in a service provider facility at which a client’s work will be done, for example, the early response from the vendors has been “that’ll cost you”. They’ve been adding in costs in this manner to cover their risks, instead of building those costs into their solutions from the start; recognizing that helping their clients manage regulatory risk is a basic part of FAO scope. Fortunately, this is changing…there is more recognition now within the service provider community of the need to assume this responsibility as a routine part of outsourcing governance.
There’s no room for lack of clarity in FAO actions in terms of service provider obligations to assist customers in meeting regulatory requirements, and there is little room for error in providing some FAO services. 100% service levels (e.g., in meeting on-time SEC filing requirements) are extremely rare in other types of outsourcing actions, but common requirements in FAO. The three things that are most important in contracting to cover regulatory risks are: 1) explicit articulation of service provider and customer roles and responsibilities with regard to meeting regulatory requirements and 2) negotiation of a shared-risk arrangement – assurance that the vendor will “share the pain” and 3) that there will be a collaborative approach to dealing with the management of risk.
A final point about the regulatory requirements challenge in FAO is that it can lead to negotiation tactics that are too driven by fear of the unknown. Too often, the focus shifts to adversarial negotiation’s, i.e., “crossing the t’s and dotting the i’s” in an effort to protect the customer from the unknowable. What is more important is flexibility in behavior and contract language and the ability to work together in a collaborative manner as the business environment changes. FAO contract negotiation teams need to recognize that business change is inevitable, including changes in regulatory requirements and that, despite all precautions, mistakes can occur. Negotiation should be a time during which both parties work to establish the necessary foundation for joint customer-service provider action to adjust services and contractual terms as the future requires. Anticipating all possible changes in advance is impossible; trying to write binding contractual terms to stave off any upsets that might be caused by regulatory change is fruitless. These mindsets bog down FAO contract negotiations and can also cause them to fail.
Challenge #4: Low organizational readiness for FAO
Last, but by no means least, today’s FAO customers still often exhibit low levels of outsourcing maturity and cultural readiness to accept outsourcing as a viable alternative to the internal control of finance and accounting processes. With little experience in outsourcing to date, it can be very difficult for potential FAO customers to accept that an external service provider could become part of their organizational “team”, providing the high level of commitment to the business that they believe is required.
A common question, for example, is “How can we be sure that service provider personnel will care enough to respond when needed to deal with emergencies that arise outside of regular business hours?” Conducting reference checks with current service provider customers to learn how responsive service provider personnel have been in emergency situations often provides strong corroborating evidence that the service provider is prepared to provide this level of support. Still, the “control” perspective from which F&A management naturally views the business world can make it difficult for them to accept reassurance on this point. Without the personal experience in successful outsourcing, trusting an outside party with a critical business process may simply be too scary for some F&A management.
Another indicator we find of low outsourcing maturity and cultural readiness for FAO is what we call “the secret project” – attempts to conduct outsourcing assessments or procurement actions without communicating this to or involving the affected organization and business leadership. There are more of these types of projects than we at TBI would like to see. We’re not saying that it’s impossible to conduct this work without publicly announcing that it is underway, but rather that the “secret projects” we see clearly reflect fear of the strength of anti-outsourcing cultures on the part of senior management, and unwillingness to directly challenge these.
In circumstances of low outsourcing maturity, starting small may be the best approach. No amount of due diligence or contractual assurance is likely to completely overcome inexperience-based fears. Unless the organization has strong cultural leaders who champion and have faith in an outsourcing solution, as well as the patience to see it through and to work with other stakeholders to win their support and their understanding of the solution, any large FAO initiative is likely doomed. With little management understanding of the outsourcing process and “no proof” of its value proposition, the total challenge to successful FAO contracting can be overwhelming. Fears of regulatory risks, uncertainty about scope, and pricing issues are all made more difficult to overcome. Sometimes creating successful but, small and discrete experiences in outsourcing an F&A process, to a competent service provider, will positively impact an organization’s outsourcing maturity and cultural readiness for large scale FAO.
The key to success here must be cultural change, one-step at a time.
Successful Approaches to Overcome Key Challenges in FAO
In our outsourcing consulting practice, TBI works with companies to help them analyze potential value of FAO and, where an outsourcing strategy appears to have substantial benefit, to identify and overcome the challenges to its success – crafting and negotiating effective outsourcing arrangements. The table below illustrates approaches used in FAO assessment and outsourcing initiatives to successfully address the challenges discussed above.
The outsourcing of Finance and Accounting functions is a growing phenomenon to which CFO’s and Controllers are increasingly paying attention. The vendors who market in this area are going through the normal maturity cycle, regarding service delivery pricing, service deliver pricing, regulatory compliance and creating value add. This is the first phase of a cycle that is mirroring previous outsourcing trends in IT and HR.
As in these other areas offshore providers have entered the fray over the past two years; offering the potential for significant cost reductions. Sarbanes-Oxley has added significant complexity to the role of the modern CFO; creating more urgency to the concept of outsourcing as a means to simplify corporate finance functions. The drive to maintain competitiveness globally continues to put pressure on all back office functions to be cost competitive and world class in productivity
All of this has created a booklet in assessing the value of outsourcing Finance & Accounting departments and in many cases, implementing outsourcing strategies. F&A is a complex area that touches every nook and cranny of all midsize and large corporations.
Such assessments must be thorough, objective and done within the context of the strategic plan of the corporation.