Outsourcing the Finance Function

In the UK, over the last two decades, nearly all of the FTSE 100 companies - and a fair sprinkling of the FTSE 350 - have chosen to outsource some or all of their back office and administrative functions.

The trend is spreading across Europe and around the world, as CFOs and strategy directors - under constant shareholder pressure to achieve cost and efficiency savings and use innovative techniques to boost growth - come to see outsourcing as a serious answer to many financial and strategic dilemmas.

The outsourcing of operational services such as finance is forecast to increase considerably in the next few years.

The real change in the outsourcing of finance functions in recent years is in its scale. The number of companies considering outsourcing their entire finance function has grown rapidly, while major outsourcing operations have created large shared service centres around the world to take over the finance and other functions of these companies.

BP INITIATIVE

A key moment in the growth of outsourcing came in 1999, when BP Exploration outsourced its entire finance department. This sent a signal to the rest of industry that if BP was prepared to take such drastic action, they might do so, too.

Colin Goodall, then CFO at BP's upstream operation, faced a problem critical to the future of his business.

TIDE OF CHANGE

BP had built its activities in the North Sea in a market where the price of oil was $25 per barrel. The sudden drop in the oil price to around $10 per barrel in the mid to late 1980s undercut the viability of BP's production. The cost structure of the business had to change, and change radically.

A recent acquisition had left BP with inefficient infrastructure that stretched from the head office in Glasgow to Southern England, the Shetlands and Norway. Accounting and finance people were scattered in several locations, none of which were integrated.

In 1991, BP linked with the consultant Accenture (Andersen Consulting as it was then), to create a joint venture based in Aberdeen. The finance team at BP moved over to form the nucleus of the new company.

Within the first nine months, the staff were well on the way to making the transition from being an internal BP support function to becoming a client-focused service delivery team. The new delivery centre is now a central part of the North Sea oil industry.

OFFSHORING TREND

Graham Pascoe, a partner in PricewaterhouseCoopers in London, says that offshoring is also currently in vogue.

Whole commercial, production and administrative centres are being moved to India, China and Eastern Europe, where companies can employ articulate, well-qualified people at a fraction of what they would cost in Western Europe.

Pascoe says that CEOs and CFOs are looking for cost savings in key areas and consistent quality from suppliers. He says that around 70% of large companies have already outsourced their pensions administration to outside suppliers, and around 60% outsource their payroll and HR functions.

COMPANY TRANSFORMATION

Cap Gemini, one of the leading players in the outsourcing arena, has built a massive centre at Kraków in Poland and another in Guangzhou in China. These shared services take work from around the world.

Tom Riley, Cap Gemini's vice-president for Asia- Pacific, says that one of Cap Gemini's clients, the major retailer Dairy Farm Holdings, although based in Hong Kong, uses Cap Gemini's centres around the world.

In 1998, the company decided to outsource its entire finance activity. "There were 200 people in its finance function. After we completed the deal, there was only one," says Riley.

Riley explains that Dairy Farm joined with Cap Gemini to create OneResource Group (ORG). ORG now provides accounting, finance and procurement services to companies in the region.

During the first 18 months of operation, ORG radically reshaped the finance function for Dairy Farm. In the first 18 months of the operation, it helped to support growth in 125 outlets and the opening of several new businesses.

All of Dairy Farm's business units were converted to a single financial system. The exercise saved 30% in costs and led to a 50% overall reduction in finance and accounting staff.

DALLAS DEAL

Dallas-based energy company TXU is another example of a company where sluggish performance was transformed by a high-profile outsourcing deal.

The company was afflicted by large overheads and losses from a poorly performing European subsidiary. A new CEO, John Wilder, took charge in February 2004, and in mid-May announced an outsourcing deal that transformed the company.

It was perhaps the most significant outsourcing of business processes in the history of the utility industry.

It would shed many non-core functions and processes to a new joint venture established with Cap Gemini. The functions outsourced included finance and accounting, human resources, IT, supply chain, customer care and revenue management.

Cap Gemini Energy now handles a whole range of TXU's finance functions. Altogether, TXU expects to save 30% of the projected $4.3bn it would have paid for those business services over the ten-year deal - approximately $1.5bn, including roughly $150m in operational savings this year.

The joint venture is also expected to generate about $3.5bn in revenues through to 2014 and enhance TXU's competitive position in the utility business.

OUTSOURCING MOTIVES

Recent research shows that CFOs initiate outsourcing for a diverse range of reasons. By far the most common reason is to focus on the core business, second comes improving shareholder value and third enhancing service levels.

The remainder of the top ten reasons are: to reduce transaction and implementation costs, introduce innovation, migrate to new technology, shorten implementation time, gain process knowledge, re-engineer business processes, supplement IT staff and resources and convert fixed assets to variable costs.

A new study by LogicaCMG and Warwick Business School looked at the experience of more than 1,200 organisations from across Europe, the USA and Asia-Pacific.

Authors Professor Leslie Willcocks of Warwick Business School and Sara Cullen of Cullen Group say that the use of outsourcing will increase substantially in the next three years.

Willcocks and Cullen use percentage of operational costs as their measure of outsourcing growth. In 2005, the average was 12%. By 2008, they estimate it will be 20%. Mainstream business process outsourcing will also grow from $140bn in 2005 to $220bn in 2010.

CEO COMMITMENT

Their report argues that CEOs will become much more involved in the definition, negotiation and management of outsourcing projects. CEOs will begin to care more about outsourcing because it will represent a major cost, and it can also affect an organisation's market valuation.

The report also observes that outsourcing can disable an organisation if not managed properly - if outsourcing is undertaken to drive down costs, it should not be at the expense of other strategic or operational benefits.

The study further suggests that, as commitment from CEOs increases, outsourcing companies are more likely to dictate contract terms and service level agreements.

Companies will invest much more in active contract management and design. The authors expect to see a slow, but rising, tide of improvement in clients' ability to manage ITO, BPO and offshore outsourcing arrangements in the next few years. CEOs and senior management involvement is imperative to make this happen.