Shared service or outsourcing? Make the right choice

Which model is best for cutting costs and boosting services? By Richard Plasek, management consultant, finance transformation and operational research, CapGemini Consulting.

Richard Plasek

Organisations are constantly searching for ways to minimise operating costs and maximise service quality. Shared services and business process outsourcing (BPO) models for back office finance operation have been proven to help deliver these objectives. However, companies are often unsure about how far they should go in their shared services strategy and when to turn to BPO.

Back to the beginning

Shared services operating models date back to the early 1990s, when companies recognised that consolidating transactional activities can reduce costs. Many established internal processing centres, where one team performed transactional activities such as accounts payable for multiple divisions or countries. To ensure service quality as well as consolidation, these operations were established as businesses in their own right with accountability for customer satisfaction.

The scope of shared services has since expanded and now includes full end-to-end processes such as order to cash or financial reporting. Other functions have followed - for example, IT or HR - where processes such as compensation and benefits are standardised across many business units and provided by one internal supplier.

By the late 1990s, use of BPO was spreading and companies had started to outsource their non-core finance and accounting activities, such as accounts payable or receivables, to third-party providers. Outsourcing contracts included full end-to-end processes delivered from a network of global delivery centres to maximise labour arbitrage (use of cheaper labour rates in Eastern Europe or India) and skill quality. Typical functions using BPO for non-core activities included finance, HR, IT and procurement. 

BPO as part of the shared services operating model

Modern shared service organisations use several operating models to deliver quality services at minimum costs. For example, accounts payable functions are typically delivered from one common location combining labour cost and technology to maximise efficiency. Tax advice services are part of the centre of excellence model and payroll is usually outsourced, with the provider offering expensive specialist legislation and tax knowledge across a wider pool. With any of these, companies must learn how to manage third-party provider relationships, often the first step on their BPO journey.

The typical benefits for shared services – efficiency and lower costs – mean that this model is often adopted by BPO providers. Major companies have reaped the benefits of establishing internal shared services and then partnered with BPO providers to access cheaper locations. The typical shared service processes - accounts payables/receivables, travel and entertainment, general ledger, fixed assets and inter-company reporting and tax - are now leading the trend in BPO.

Can companies leapfrog to BPO and what are the benefits?

A typical BPO journey, as explained above, is to establish internal shared service operations first. This strategy enables companies to get to know processes, fix any critical areas and reap early benefits through consolidation and standardisation. This process, however, can take several years and requires heavy investment in facilities and skills. In some areas, such as Eastern Europe, the shared services model might not be suitable because the cost saving from labour arbitrage is relatively low.

An alternative strategy is to leapfrog direct to BPO. Companies choosing this strategy for finance back office operations could accelerate savings and enable the business to focus resources on growth. The internal shared services model needs investment. With BPO, organisations could instead use this cash to become true business partners, concentrating on added-value activities such as marketing, finance or investment appraisal.

The expected benefits for companies taking the direct BPO route include:

• accelerated financial savings – a BPO supplier can impose more discipline, control, transparency and speed up process improvement activities such as purchase order compliance or electronic invoicing
• flexible cost structure – variation in volumes can be linked to BPO charge rate. Capital expenditure is limited to initial transition costs
• higher quality services from day one – turning back office activities into someone’s front office will have a positive effect on the quality of service delivered to the business
• freeing up resources – financial, human, IT, facilities and other resources can be freed up and redeployed
• risk sharing – a BPO provider will share risks as it invests in the long-term partnership
• overcoming the lack of expertise in shared services and transition knowledge.

How can companies decide what strategies to take?

Leading companies look at several factors before making a decision. Internal shared services are more suitable if:

• process consolidation benefits form the largest part of the business case
• internal resources and skills are available to manage large transformation programmes, and
• stakeholders are risk averse and see BPO as a high-risk strategy.

Going direct to BPO is more preferable if:

• the company’s strategy requires resources and skills to be focused elsewhere
• the business case is dependent on fast process re-engineering and improvement, and
• the business demands a rapid improvement in service quality.

Upfront investment is reduced for the customer, and while the BPO investment sees a return through margin charged, they can also be encouraged to deliver and share savings that offset this margin.

IT systems and communication are no longer an issue due to technological advances in telecommunications, the internet and workflow. To ensure success, companies going direct to BPO must:

• ensure stakeholders’ buy-in and support for the BPO business case. Communicate to keep up the momentum and manage expectations throughout the transformation
• establish cultural fit and compatibility with the BPO provider. This will enable the two organisations to deliver synergies
• ensure service level agreements are structured to meet business needs, and align penalties and rewards
• establish a service-orientated culture within the business. BPO is a partnership with clear responsibilities split between the two parties
• establish a transparent baseline and implement robust performance management. Ensure responsibilities are clear and understood
• minimise business disruption during transformation
• allow time for the negotiation period and learning about how the commercials work from both parties’ perspectives.

Shared services and BPO models are not mutually exclusive but whether you choose to start out with shared services or leap straight to BPO, doing your homework first is vital for success.

CIMA will run a Mastercourse on 'Shared services' on 7 November 2006.

July 2006