Weighing Up the True Cost of Processing
Shared services has become an accepted business strategy. Indeed, the model has reached a level of maturity that poses a seminal question for many companies: do we seek further improvements in the finance function through internal initiatives (which will incur additional cost) or outsource to a third party and concentrate on the core business? This article outlines the questions that CFOs must analyze to sensibly address the finance outsourcing conundrum.
Just Another Trend?
Trends in financial management like trends in the fashion industry tend to be in vogue for a season and then pass away to be reinvented in ten years time with a catchier name or a new look. Shared services was born out of the nineties drive to reduce costs and was normally on the back of a large-scale ERP implementation. Today’s SSC has developed significantly, facing the pressures of improving business efficiency, and further cost reduction where business performance and benchmarks are increasingly linked to share price. The next logical step to performance improvement seems to be business process outsourcing (BPO), with most providers offering at least 25 percent reductions in cost.
Outsourcing however, comes with risks; Enron and subsequent financial fiascos marked a watershed in financial management and have caused businesses to focus much more strongly on compliance, Sarbanes Oxley, IAS, Basel II to name but a few. Does this signal the end of outsourcing or indeed does it strengthen the case, with segregation of duties as a key compliance control?
Before considering finance BPO, the CFO must take stock of exactly what the finance function is there to deliver. Only once the finance strategy is defined, can companies sensibly assess the outsourcing decision.
The key and most vital decision to make is what to outsource,. Whilst Figure 1 gives a general indication of the suitability of finance processes to outsourcing, it is by no means "one size fits all." The mid-grey areas are seen as ‘probables’ for inclusion in scope by most organisations; the dark grey as ‘possibles’ and light grey ‘impossible’ or undesirable.
The True Cost of Finance
Assuming that an organization has managed the transition to a shared service environment, the CFO is likely to face a series of expectations. These include pressure to manage the service to a level demanded by the business, to extract greater value from resources and to provide senior executives with a strategic plan that delivers enhanced value over the next five years at less cost.
The debate about outsourcing is dominated by cost. However, few organizations understand the true cost of operating the finance function. The first step is to accurately calculate this. Figure Two provides a template showing how an informed outsourcing decision can be reached. The data is from a fictitious company, Ignition, and includes its current costs and transaction volumes. Ignition operates across Europe, has offices in eight European cities and sells through distributors in those markets where it does not have a presence. The total cost of finance is £5.7m.. This excludes finance systems maintenance and development. Adding this into the mix results in a total cost of finance of £6.6m.
Ignition now needs to assess the total cost of the activities in scope.
The Case for Outsourcing
Now the decision is better defined. Can Ignition manage the cost base of these activities to a level that is acceptable, or should the outsourcing agenda be pursued?
Assuming that the outsource provider can reduce costs by 35 percent, the total cost of the activities in scope would fall to just over £3m. Add back the cost of activities not in scope and the total cost is £4.1m (£3m plus £1.1m). However, this simplistic approach assumes that there will be a one for one saving when the outsource provider takes over. What will be the cost of co-operation?
Aside from quantitative analysis, some qualitative questions need to be addressed.
- How ‘mature’ is the finance function and is it in a state to be outsourced?
- How will the remaining ‘inhouse’ activities be managed, and what dependencies do they have with the outsourced activities? What incremental value can be extracted from an outsource provider and how will this be achieved?
- What is the best case cost and value achievable by maintaining finance in-house?
- What business behaviour needs to change to make this a success – outsourcing is almost like finding a child minder for your children, you lose some of the chores but none of the responsibility.
What regulatory obligations are there and how will these be managed?
Looking at Ignition from an internal perspective, consider the potential improvements and investment required to achieve a reduced cost-base at current service levels or better. Figures 5 and 6 show the situation before and after, for an internal improvement programme and a comparison with the outsourced case. This shows that a potential £1.6m can be saved from the current cost base, albeit half from the accounts payable activities. Therefore Ignition would be £0.4m better off to make the internal improvements. Allowing a net neutral position after three years, this would give a budget to achieve these improvements of £1.2m. Possibly too little to build an e-payables solution, standardize the processes across the business, implement purchasing cards, configure the financial system to provide standard reporting, etc.; but close enough for the decision to be finely balanced financially. This is far too simplistic an analysis to apply directly to your business, but it does highlight some of the decisions required to conclude the debate regarding finance BPO.
As a final thought, what about a half-way house? Is it possible to outsource through a managed operation, elements of a finance process? There are providers now who would take on the transactional element of accounts payable for a cost per transaction. This has the benefit of changing a fixed cost to a variable cost, whilst not exposing the business to the perceived risks of a full finance BPO. Managed Operations look to automate the simple parts of the process for example, data entry, filing, routing of work and leave the more complex exception management to the business to complete.
The decision to outsource or improve in-house is not this simple. Factors not included in the analysis above include ageing finance systems and sunk costs for their replacement, the maturity and preparedness of processes to be outsourced and business knowledge from the outsourcer.
The role of finance BPO must clearly underpin the broader finance agenda, which in turn must match the business strategy. This seems axiomatic but can be overlooked in the debate on outsourcing. Once the finance strategy is set, the outsourcing decision can be made.
Like the fashion industry, new ideas and products enter the market, some with real promise for improvement; but shared services forms a solid foundation for all of these initiatives – so perhaps it is, after all, our one fashion essential.
Nick Jarman has worked in shared services since joining Atos KPMG Consulting from Esso Petroleum in 1997. Having worked on a number of pan- European and UK projects, he spent two years in Australia working on pan-Asian shared services including an assessment for a major US company for global outsourcing of finance, HR and IT. Nick.Jarman@AtosKPMGConsulting.co.uk
Marianne Newton joined Atos KPMG Consulting from Jeferson Smurfit, where she was the IT Director responsible for shared services for Finance and IT. She now leads the epayables solution within AKC and has worked with clients such as Shell and Unilever to radically improve their finance processes via automation. Marieanne.Newton@AtosKPMGConsulting.co.uk