Contracting out the finance function

Technical

Briefing

DEVELOPING AND PROMOTING STRATEGY

AUGUST 2001

Contracting Out the Finance Function Part 1 – General FAQs on contracting out.

■ ■ ■ ■

■

What is meant by ‘contracting out’?

Why do it?

Which activities can be outsourced?

What about the finance function - isn’t this a core activity?

What is the new paradigm for the finance function?

Part 2 – ■ ■ ■ ■

A case study What is meant by internal outsourcing?

What advantages does this offer?

Are there any risks of establishing a shared service centre?

Part 3 – Tips on establishing successful shared service centres

Part 4 – Further reading

For further information please contact: Technical Services: Tel: +44 (0)20 7917 9237 Fax: +44 (0)20 7580 8956 techservices@cimaglobal.com

report prepared in 1998 by KPMG, for the Institute of Chartered Accountants in Australia, alerted accountants to the many changes taking place in the business world. As the report predicted, continuous and ever increasing pace of change has led to a very different business environment in the 21st century, from that of even ten years previously:

A

‘Partly through the use of available technology and partly through new ideas and concepts being implemented, transaction processing is being radically changed to reduce costs and to free up finance staff for more value added activity’. any of the changing conditions facing management accountants have inevitably been driven by IT, in turn allowing globalisation of business practices between and within multinational companies.

M

nprecedented developments in computer hardware and software capabilities, and international communications have meant that the ‘traditional’ functions of finance staff - transaction processing and ‘number crunching’ - can be performed almost instantly.

U

he primary implication of this for finance staff is that their expertise will be called upon to add value and to contribute to strategy and business management decisions to a far greater extent than ever before. Rather than just crunching the numbers, finance professionals will be an integral part of business decision-making.

T

he outsourcing of many aspects of business activity is one of the strategies that have been suggested as a source of adding value and streamlining activities to maintain competitive advantage.

T

The Chartered Institute of Management Accountants 63 Portland Place London W1B 1AB Tel: +44 (0)20 7637 2311 Fax: +44 (0)20 7631 5309 www.cimaglobal.com

Which activities can be outsourced?

Part 1 - General FAQs

In theory, any of the operations that a business performs which are not either in direct or strategic support of its specific business activity, or which do not constitute an inextricable part of that business, could justifiably and (potentially profitably) be outsourced. Such operations are often termed ‘non-core’ activities.

What is meant by ‘contracting out’?

The term ‘contracting out’ (or ‘outsourcing’) refers to the process of procuring a good or service from a third party, (rather than generating such an offering internally), in accordance with terms which are legally enforceable, or contractual.

General activities performed by many businesses, but commonly viewed as ‘non-core’ include: ■

Outsourcing is a considered decision to move internal functions to an external supplier.

■ ■

Why do it?

■

■ ■

Cost reduction

■

In a fiercely competitive business environment, businesses strive to deliver greater value at reduced cost.

Direct costs (of labour and raw materials) may be an obvious initial focus of cost reduction.

■

What about the finance function – isn’t this a core activity?

Direct costs are relatively transparent and arguably, therefore, relatively easy to manage but where these have stabilised at an acceptable level, pressure to reduce indirect (or overhead) costs – those costs less directly related to units of output – increases.

The best indication of a core activity is whether it adds direct value to an enterprise’s products and services. For businesses that sell financial services (such as the administration of payroll services), it could be argued that the finance function is a core activity.

The cost of the finance function is one such cost. (In May 1999 the median costs of the finance function ran at 1.5 per cent as a percentage of sales).

For other businesses, the objective of the finance function is typically to provide the financial services (transaction processing, budgeting, credit management, debt recovery, bill payment, etc.) necessary to support the core activity.

Outsourcing aspects of the finance function may, therefore, secure such savings.

■

facilities management; some elements of personnel management such as recruitment and training; cleaning services; printing services; catering services; property maintenance/management; legal services.

The provision of many of the financial operations and services necessary to support the core business remains nothing more than that – a support service. Accordingly, for the large majority of organisations, whatever their nature and legal constitution, their financial services operations are largely ‘non-core’ and consequentially, there remain, at least on paper, potential benefits of some degree of outsourcing. However, outsourcing is no panacea because organisations need more from the finance function than mere routine accounting services.

To create a value-driven structure for the finance function, the boundaries between the finance function and other functions must be lowered and finance professionals must become experts in their organisation’s core business.

Focus on core competencies to add value In assigning responsibility for the provision of noncore services to a third party, businesses are afforded more opportunity to focus on the core competencies integral to the creation/addition of value.

Furthermore, by careful selection of an experienced supplier, it is possible that the non-core services supplied will be provided not only at a reduced cost, but also at a higher quality than could be provided ‘in-house’.

Where such suppliers have a large customer base and have a large operation, the outsourcing company could benefit from the reduced costs associated with their supplier’s economies of scale.

The question of outsourcing is less clear cut in relation to the finance function than it might be for other support services, because the activities and outputs of the finance function serve multiple purposes for multiple users.

Where a core activity (e.g. the production of sandwiches for sale in a café) has a high profit margin, the internal provision of financial services to support this operation erodes this profit unnecessarily if a similar service can be purchased for fewer resources from an external source.

Where other ‘support’ operations (e.g. printing, catering, facilities management, and other services) may be clearly separate from the core activity of the business, (some of) the services provided by the finance function align with the core activity much more closely, so that they are often assumed to be an integral process.

2

For example, for a company involved in the exploration, extraction and wholesale of natural gases, the production and printing of marketing expertise and literature needed to advertise this activity is not absolutely necessary for the business to continue – these are non-core activities.

The same is not necessarily true of all aspects of the financial services activity.

Part 2 – A case study In considering the outsourcing option for one multinational operation, the financial controller found it helpful to analyse the accounting and finance department and classify its operations according to six main activities:

The processing of sales invoices and purchase orders which provide the information for the production of month-end financial and operational reports – may be mechanical, repetitive, even computerised, and as such, may be viewed as ‘non-core’. Such activities constitute a large proportion of the work of the traditional finance function.

■ ■ ■ ■ ■ ■

In its purest form, the essence of any business rests with the decision makers, and the choices made from available options. It is this decision-making function which holds the key to the long-term survival of any business.

computer hardware facilities; software development and support; inputting and processing transactions; preparing output and providing information; business interpretation and analysis; and judgement, policy and service specification.

It was agreed that the company would benefit from buying in the expertise available from a third party in relation to the first two of the classifications. The company did not have particular in-house knowledge of computer hardware or software implementation or support. Savings were to be made by assigning responsibility for these activities to a specialist third party with existing knowledge and experience, rather than by developing them in-house.

Hence the strategic financial and management decisions regarding the long-term viability and profitability of the business, for which the management reports and information are provided and for which finance staff (most commonly the finance director) are responsible, are core.

In relation to both inputting and processing transactions, and the preparation of output and provision of information, these were regarded as simple, repetitive and highvolume activities which would benefit from the economies of scale offered by an external supplier, providing a similar service for multiple clients. Savings in terms of a reduced headcount could be reaped by the company, with many staff simply transferring to the new service supplier, although inevitably some staff redundancies were unavoidable.

What is the new paradigm for the finance function?

Outsourcing the finance function will require different skills on the part of the remaining staff who have to manage the service provider. There will be a shift in emphasis from providing those services to managing the relationship with the organisation that does. However, outsourcing frees up time for the finance function to concentrate on value-adding activities. It should be seen as an opportunity.

For the final two classifications of financial services’ operations – business interpretation and analysis, and judgement, policy and service specification – it was felt that these activities rely on thorough knowledge of the core of the business and relate to the longer-term strategic success of the company. Accordingly it was agreed that responsibility for these aspects of financial service operations remain in-house.

In the new business environment where competition is global and fierce, companies are focusing on sustaining competitive advantage by enhancing their comparative advantage(s) over competitors. Organisations, and their chief executive officers, now expect finance directors and financial controllers to become more involved in matters of production, distribution and sales and to play a fuller role at a strategic management level, in particular, helping to decide which markets to serve with which products.

What does ‘internal outsourcing’ mean?

The term ‘internal outsourcing’ describes a situation whereby a (usually large, multinational) organisation, with financial processing centres in all or several of the countries in which it operates, chooses to consolidate these activities at one site, or shared service centre (SSC).

Companies also need better information than ever before in order to remain competitive. Information needs to be predictive as well as historic and contain non-financial indicators as well as financial ones. The Balanced Scorecard approach ties reporting back to a company’s strategy and gives an overall view of the organisation’s performance. For best practice guidance on using the Balanced Scorecard, please refer to CIMA’s Technical Briefing entitled The Balanced Scorecard.

‘Internal outsourcing’ is sometimes viewed, and entered into, as a first step towards ‘full’ outsourcing. It allows an organisation to investigate the potential benefits of consolidation of activities, while retaining full internal control and thus minimising the control risks often associated with the assignment of control to an external party at the centre of the outsourcing option.

3

Shared services involves the centralisation of functions and processes and, very importantly, changing what was typically a ‘back office’ culture into an entrepreneurial and professional business. Many multinational companies have established SSCs due to the insupportable cost of administrative offices using different systems and that management information on costs is incompatible with other divisions.

Benefits of shared service centres Financial benefits ■

What advantages does this offer?

Where similar financial operations (invoice processing, raising of purchase orders, stock reconciliation, etc.) are performed in relatively small numbers at multiple locations, the implications for overhead costs (rent, insurance, facilities management, staff salaries, etc.), and conversely the opportunities for potential savings, are obvious. Higher overhead costs increase the unit cost of transaction processing.

■ ■ ■ ■

By consolidating all financial transaction processing centres to one ‘shared service centre’, a company could expect to enjoy substantial benefits by reducing overhead costs and thus reducing unit transaction costs: ■

Headcount reductions; It is conceivable that by consolidating, for example, five regional operations, each supported by ten finance staff, to one shared service centre using a common financial processing system, the more routine/number crunching functions would benefit from economies of scale, so that the same volume of processing and overall activity might be performed by say 30, rather than (5 x 10) 50 employees.

Reductions in premises (and associated e.g. insurance, security, legal etc.) costs; Systems consolidation; Economies of scale; Potential tax savings can be achieved through a structure where sales are made by a central unit, which then pays the local sales organisations a commission. It is then possible to move more profits to a low tax regime.

Potentially favourable labour rates.

In a shared service centre: ■

processes are visible and measurable;

■

processes can be standardised to organisational ‘best in breed’;

■

there exists the opportunity of measurement and therefore improvement of processes through internal benchmarking. Alternatively, management will be able to see what it actually costs to provide the services and based on this may decide to outsource certain functions;

■

a standard/single platform can be adopted;

■

there tends to be a high customer service - focused culture;

■

process ownership moves from the business to the shared service centre and all transaction processing can be centralised at a single location and processes standardised across operating countries;

■

Non-financial benefits

the shared service centre takes responsibility for managing the costs and quality of services delivered to internal customers.

4

■

Quality of service provision; The benefits of operating a shared service centre for the delivery of financial services are not only financial. Almost all organisations operating a shared service centre for the provision of financial services report marked improvements in the quality of service delivered.

This is because the establishment of a shared service centre involves not just a change of organisational geographical location but often change in the philosophy of internal service provision.

The quality improvements arise from the change in the relationship between finance and other staff. In establishing a dedicated shared financial service centre, the relationship adopts a more professional supplier/customer nature.

■

Consistent management of business data.

It is important that the individuals working in the shared service centre see themselves as working within the client organisation, rather than for an external supplier.

At the same time, it is essential that the shared service centre is seen as a service provider to the core business. If the same service can be obtained more cheaply elsewhere, it will be and this puts pressure on the shared service centre to perform.

The tension created by this paradox of being both inside and outside the ‘parent’ organisation has to be managed carefully by the shared service centre manager.

Are there any risks of establishing a Shared Service Centre and, if so, what are they?

Table: Summary of risks involved with establishing shared service centres

Setting up a shared service centre can be an enormous task, requiring substantial initial investment, although most European shared service centres have a relatively short (three to six year) pay-back period and generate a positive return over the life of the project.

■ ■ ■

Where companies are seeking to take advantage of international differentials in labour rates/taxation etc., by establishing a shared service centre in continental Europe, there may be other potential barriers to overcome. These include: ■

■

■

■

■

■

■

■

■ ■

Legislation: although in principle single market legislation supports the shared service centre in concept, some local laws are not yet aligned and must be accommodated.

Taxation: tax administration requirements vary between European countries. Advice may be needed to ensure compliance with local requirements. Transfer pricing legislation must also be adhered to.

Financial reporting requirements: decisions about the location and format of accounting documentation must take into account local reporting requirements.

Currency: decisions regarding managing/exploiting currency fluctuations should be considered.

Language/culture: the need for linguistic and cultural sensitivity should not be underestimated. Many organisations have cited cultural resistance to be the major obstacle to the effective establishment of a shared service centre. These may be hard to gauge and the benefits of substantial investigation into the way your own organisational culture matches that of the location of the shared service centre should not be underestimated; Technology: selection of appropriate scanning, printing, e-commerce and other systems; Human resources: consider how to deal with employee redundancy/ relocation issues. It is also expensive to make staff redundant in Europe.

When a shared service centre matures and the work becomes increasingly routine and less demanding, staff turnover can become a significant issue. Many people accepting posts in shared service centres see it as a stepping stone to other career opportunities.

Therefore, robust human resource management policies are required to as far as is possible ensure that employees’ work environment is empowered and stimulating.

■

Staff morale can recede leading to staff turnover.

How much will it cost to make staff redundant if necessary?

Lack of systems integration across an organisation – what resources will be required to migrate diverse systems?

Linguistically challenged nature of accounting profession.

Payback on establishing a SSC – European projects have shown an average payback period of five years, double the period for similar projects in the US. Has the organisation got the resources to spread the major set up costs?

Is outsourcing to a third party, which specialises in providing such services a better option?

Before embarking on such a project, decisions must be made on likely timescales, benefits, potential problems and how these will be managed and critical success factors.

To achieve the potential savings, any internal resistance needs to be broken down with a good business case which has full board room backing.

Part 3 – Tips on establishing successful shared service centres Key elements for the successful establishment of a shared service centre:

Many, if not all of these potential problems can be overcome by enlisting the assistance of experienced practitioners to help project manage the ‘internal outsourcing’ project.

5

■

A clear vision of how the shared service centre fits into the overall business model.

■

Senior management commitment. Senior management need a clear vision and strategy and to support the process.

■

Integration with other change initiatives.

■

Clear scope and delineation of responsibilities.

■

Buy-in of operating units impacted by the change.

■

Ensuring that the organisation that remains after service transfer is robust.

■

Support from those who have implementation experience to help navigate through the challenges faced.

■

A strong customer-focused culture.

■

A commitment to continuous improvement.

Companies that have contracted out the finance function or part of it

Other CIMA Technical Briefings ■ ■

■ ■ ■

■ ■ ■ ■ ■ ■ ■ ■ ■ ■

British Airports Authority BBC Boots Healthcare International (featured as a casestudy presentation at CIMA’s ‘Transforming the Finance Function’ Hot Topic Forum, 17 November 2000 and available on CIMA’s website) BP Conoco Elizabeth Arden PeopleSoft Safeways Sainsbury’s (payroll only) Scottish Airports Limited Sears SmithKline Beecham Sun Oil

■ ■ ■ ■ ■ ■ ■ ■

The Balanced Scorecard Leadership Skills Emotional Intelligence ABM Internet Tax (available from CIMA’s website only) Customer Relationship Management (available from CIMA’s website only) Intellectual Capital Management Pricing Strategies The Climate Change Levy (available from CIMA’s website only) ERP

Technical Advisory Service Further references can be obtained from CIMA Technical Advisory Service – Tel: 020 7917 9259.

Email: TAS@cimaglobal.com

Part 4 – Further reading

CIMA Mastercourses Seminar on Twenty-First Century Management Accounting, Tel: 0207 917 9244 for further information or book on-line on our website: www.cimaglobal.com

Innes, J. and Bellis-Jones, R. (eds) (1998), Handbook of Management Accounting, Gee Publishing/CIMA. Law, I. (1999), Harnessing outsourcing for business advantages, FT/Prentice Hall.

May M. (1999), Transforming the Finance Function to add Company-wide Value, Pearson Education Limited.

Sheridan, T. (1997), Organising the finance function, FT/Prentice Hall.

Wood, D., Barrar, P. and O’Sullivan, K. (1997), Outsourcing finance activities: a practical approach for small and medium-sized enterprises. A report to the Board for Chartered Accountants in Business, ICAEW.

6