PwC: Less Haste, More Advice - Damien McMahon and Robert van der Eijk
In the face of growing economic uncertainty and increasing market volatility, outsourcing deals demand a higher level of scrutiny and due diligence. PwC’s Robert van der Eijk and Damien McMahon talk to FDE and highlight the key considerations.
The financial crisis has had companies confined to a state of short-term paralysis while others resorted to quick wins by reducing headcount, slashing marketing budgets and scrutinising employee travel expenses. Even those companies with existing outsourcing relationships have been considering the option of downscaling or looking for an exit from their service provider. That said, the recessionary dust appears to have settled across several industries and many companies seem to be in a position to regroup.
‘In the first half of this year many were waiting on the sidelines, as they were not in crisis yet,’ says Damien McMahon, partner of the finance and treasury solutions group at the Belgium office of PricewaterhouseCoopers (PwC). ‘Some left it too late and now they are stampeding into activity. They may have missed some strategic options.’
‘With the urgent need to cut costs, there is a danger that outsourcing deals are rushed through,’ adds Robert van der Eijk, partner, PwC. ‘The challenge is to ensure that long-term programmes are sustainable and "stick". PwC research tells us that 75% of change management programmes fail in the long term.’
PwC’s experts advise that companies adopt a strategic ‘lifecycle’ approach to outsourcing, with the focus on the long-term health of the business and the value to be derived from sustainable partnerships. To avoid costly mistakes, the use of external advisors who have this type of approach ingrained onto their DNA, could be a wise move.
‘There is a need for more planning, more rigour and also more flexibility in outsourcing. Our framework (see figure 1) makes sure that all the relevant areas are checked and that our clients make the optimal decision,’ says McMahon.
Service provider due diligence
With an average five-year outsourcing contract, it is vital that a service provider is in good shape financially and will still be around for contract renewals. In the current climate, no service provider should be considered immune from scrutiny and the cash position of the provider in this current climate is an increasingly important consideration. A buyer of outsourcing services should also understand how the provider will be able to make a reasonable profit while still delivering the ervices to the required quality and timescales.
‘It is very important that buyers conduct the appropriate due diligence on their suppliers. If a vendor is offering very low cost services then it could be that they are struggling themselves,’ says van der Eijk.
One strategy to mitigate the risk of over reliance on one vendor and to foster a competitive yet collaborative spirit is to adopt a multi-vendor approach.
‘The credit quality of suppliers has become very important, so clients are looking to spread the risk across multiple service providers. That is a natural reaction in the current circumstances. Clients want cost reduction, but if service providers slash costs too far, then their risk increases. They realise that it is not always best to go with the lowest cost provider,’ says McMahon.
‘Multisourcing models deliver tangible benefits and facilitate innovation and performance improvement,’ comments van der Eijk. ‘Clients are increasingly asking whether they should have a multi-vendor approach and whether niche vendors offer a better service in terms of price and quality. More importantly, many are asking whether they have gone too far with their outsourcing policies.’
With a multisourcing arrangement, an advisor can manage and govern the roles, relationships and performance of each of the contributing service providers. The most effective governance strategy, however, is often not necessarily the one that has the most detailed and rigid service level agreements. Having undertaken due diligence to weed out potential problem providers, the multisourcing relationship should focus on trust and collaboration between service providers and client, and amongst the service providers themselves.
In today’s business climate, cross border outsourcing contracts require greater scrutiny in contract pricing as the volatility of foreign exchange rates raise the threat of an economic hit to both provider and buyer. The currency impact can be minimised when contracts include a clause to allow for periodic adjustments in response to currency fluctuations. By not having such a clause, unintended financial treatments can often lead to tension in the sourcing relationship.
‘There has certainly been a change in the services that we are asked to provide,’ says McMahon. ‘People see what we have been saying about financial risk management, which is now the only priority for CFOs. They are looking at currency risk management more, for instance, now that they have seen that dollar and sterling rates can change dramatically.’
Make or buy?
While outsourcing transactions containing a counterparty or currency risk component frequently attract the attention of the CFO, it’s when the finance and accounting (F&A) function itself is on the agenda for outsourcing that the CFO gets involved.
On the one hand, an internally owned and operated shared service organisation (SSO) housing back office processes in a low-cost location may provide benefits such as labour arbitrage, economies of scale, process standardisation, improved internal controls and transparency. On the other hand, this type of ‘captive’ operation may be costly to operate and suffer from employee attrition as business process outsourcing (BPO) delivery centres and other captives may be looking to attract the same scarce talent in a given location. As a result, some captives have been snapped up by BPO service providers in what are known as ‘asset monetisation’ deals. Aviva and Philips are recent examples of companies that have bitten the bullet and sold their captives to third party outsourcing companies. Selling one’s captive might be too much of a loss of control for a CFO and there may also be resentment in the fact that someone is swooping in to take over all the good work that has already been done.
‘The objectives must go beyond cost savings,’ notes van der Eijk. ‘Leading companies want better reporting, more transparency and the flexibility to respond to changes in the market. They must also look at trends in the outsourcing space. Prices are going up in India whereas outsourcing to the CEE region gives a company more control, and sometimes, lower risk. It is also worth considering whether a company might get better value from a captive shared service centre.’
‘The key thing at the start is to get the right business case,’ says McMahon. ‘It may be difficult to assess the value early on, and companies may need to do more digging around. Use different scenarios. People once only thought about growth, but now they must look at the possibility of contraction. They should also look at different countries and different kinds of risk.’
There are certainly many issues to balance in order to make the right outsourcing decisions, especially in the F&A space. With so much to consider it is a welcome relief that most of the groundwork has been done by consultants who map out the outsourcing lifecycle from the strategic business case through to deal re-negotiation to help ensure long-term success for their clients.