The market will gain momentum as providers reach critical mass, and buyers who once shied away from outsourcing jump in with both feet.

by Phil Fersht

In 2005 and 2006, the industry surged after going about its business sleepily until several factors enabled it to double in size during the past two years. So what happened?

• Lifting of the Sarbox shackles: As CFOs started to realize that an outsourcing engagement can actually help drive greater efficiency, visibility, and automation into F&A business processes—coupled with the fact that most of today’s FAO suppliers are actually quite good at implementing Sarbox for their clients—we now see many firms find positive correlations between outsourcing and Sarbox compliance.

• Rapid improvement from “lift and shift” models: The earlier wave of FAO deals were driven largely through the ability of providers to take customers’ existing processes and run them at lower costs in cheaper locations. This resulted in many early adopters experiencing a reduction in quality, with little upside in receiving greater accounting rigor and better technology.

The general sales strategy of many suppliers was to customize solutions for their clients to win business so their clients would not feel too many negative ramifications of outsourcing. This has radically changed. Customers are being better educated from industry advisors to understand that as the business climate rapidly globalizes, they need to embrace sourcing models that can help them take advantage of labor arbitrage and transform tired and cumbersome business processes, taking advantage of Six Sigma and LEAN approaches being offered by some of today’s best-in-class solutions.

In addition, most providers today layer technology far more effectively to help customers achieve single charts of their accounts across disparate systems and geographies and help orchestrate their processes more effectively in an outsourced environment.

• Suppliers finding many FAO models profitable and less complex: Most of the F&A providers have enjoyed less complexity and greater profitability in FAO due to the heavy labor arbitrage focus and lower dependence on complex technology re-engineering. Moreover, these engagements are largely based on the relationships between a finance department and a single service provider, which enable SLA metrics to be developed and accounted relatively smoothly.

PREDICTIONS FOR 2007
Here’s what to expect in the coming year:

• Continuation of rapid growth as market reaches maturity: The Everest Research Institute anticipates the multi-scope FAO market to reach $2.5 billion and total number of multi-scope FAO deals to surpass 200, with growth in excess of 30 percent.

• Buyers’ market: 2007 will be a buyer’s market as competition heats up. New players have entered the market (HP and Convergys) seeking flagship deals, and providers with small market shares have made dramatic increases (Genpact, Xansa, and Infosys). The year will bring an intense battle for market share with some suppliers prepared to take on new customers at lower margins to develop scale and market presence.

• Emergence of global outsourcing vendors: With the increasing importance of financial processes at the heart of a BPO end-state, major outsourcers are realizing they need F&A competencies to compete for major global deals with multi-tower elements. Expect renewed developments in FAO delivery competency from IBM, Accenture, Capgemini, ACS, and EDS. We will also see Hewlett-Packard add some serious competitive bite after some successful, large FAO deals this year.

• New entrants to emerge: A small number of buyers with strong F&A service delivery competence will likely enter the market as suppliers because barriers to entry continue to remain low. We will also see the leading supplier acquire leading-edge captives that could pose a competitive threat if they were to become providers in their own right, or fall into the hands of a competitor.

• Intermittent capacity constraints: Although there will be an ample number of suppliers fighting for each deal, look for intermittent capacity bottlenecks from some suppliers due to too much success.

• Capability expansion: Suppliers will continue to increase their capabilities. We have seen IBM and Genpact complete the successful integration of their Equitant and Creditek acquisitions. Look for more capability build-out in 2007.

• Acquisition of captives: Capgemini recently made news with their acquisition of Unilever’s India FAO/BPO center. Look for more of these deals in 2007 as suppliers use these acquisitions to round out their geographic capabilities and gain market share.

• Increased deployment of hybrid sourcing models: Customers and suppliers will continue to develop creative models to deliver F&A sourcing solutions. This will involve F&A services where buyers can take advantage of their suppliers’ core strengths but retain ownership and control with more options value available to them in the future. Variations around the “build, operate, transfer” model will continue as fully outsourced models are not the optimum solutions for every company.

• Moving up the food chain: As we saw in 2006, buyers will continue to move FAO beyond pure transactional processes. Look for more expansion into services such as financial analysis and management reporting in 2007. As this continues to occur, the complexity and variety of pricing structures in use (e.g., fixed vs. per FTE vs. transaction/consumption-based) within agreements are likely to increase, as simple bases for transaction charges no longer become practical and applicable.

• Increased multi-tower bundling: 2007 will see continued growth in multi-tower deals (currently 14 percent of the BPO market) as buyers try to coordinate their outsourcing across all of SG&A. We will continue to see increased synergies develop across HR and F&A towers within BPO engagements and also increased deployment of procurement processes within multi-tower BPO deals. The majority of buyers will continue to pursue multi-vendor strategies but become more prepared to consider single-vendor, multi-tower options where vendors demonstrate increased cost-savings, operational synergies, and efficiencies across processes.

• Increased consolidation across BPO towers with F&A at the hub: As suppliers try to respond to the increased interest in outsourcing across all the BPO towers (HR, F&A, and procurement), expect providers to look at spreading their focus through increased organic development, acquisition, and partnership approaches. Moreover, with the deployment of technology platforms becoming so critical to a sourcing relationship, the synergies of having a single provider deploying technology services to enable BPO processes are becoming more apparent. Expect those ITO-focused suppliers (for example Cognizant, Satyam, and Infosys) to continue their interest in being heavily involved in BPO engagements.

• Global footprints: Mark 2007 as the year when we will see all significant suppliers establish a meaningful local presence in all continents. Leading Indian providers are already making significant investments in South America, and most Western providers continue to bolster their presence in Central Europe, India, China, and the Philippines.

• Technology emerging as the key differentiator: As labor arbitrage becomes more like a hygiene factor in the FAO market, technology could become the next key differentiator and agent for transformation. Nearly 70 percent of suppliers feel that technology could have a stronger impact on FAO in the coming years, and the role of technology is becoming critical to the success of a relationship.

• Increased adoption in the financial services vertical: Since 2005, we have seen six, large-scale FAO contracts signed by financial services companies including Zurich Financial Services,Wachovia, and Lloyds TSB. The banking and insurance sector is seriously evaluating the benefits of FAO, and many more firms will adopt global sourcing models in the future as they discover that many third-party providers can help them reach an ideal end-state at lower cost.

Several financial services buyers have adopted higher-value processes—for example management reporting, financial analysis, and forecasting—in smaller, single-process contracts, but many now consider under-laying these with widespread, transactional F&A processes on a much wider scale.

Culturally and emotionally, it has been harder for financial services firms to transition management of their F&A processes over to a third party as they play a core role in the day-to-day running of their businesses, but this is going to change during 2007 and beyond.

• The mid-market will start to emerge: Scarcity of accounting talent, combined with intense competition for deals and lower delivery costs from major providers, will open up the FAO market to buyers with finance departments as small as 50 staff members.

As leading FAO providers reach such a critical mass of clients to start having a leverageable platform and greater synergies across less resources, they will look at smaller deals where they can make the economics work. Moreover, the emergence of low-cost, Indian mid-market providers will enable more mid-market buyers to explore workable options.