GAME FOR FAO

Outsourcing F&A processes isn't child's play, but if you're game like D3P of America, FAO can help your start-up quickly get a handle on managing processes such as AR.

by Russ Banham

Take a hike down Tokyo’s main drag and venture into most any restaurant. There you will typically find a Pachinko machine—Japan’s answer to Vegas-style slot machines. It is illegal to gamble in the country and Pachinko, which looks like a slot machine but doesn’t have a payout, provides a way to get the same thrill without risking a trip to the pokey.

Pachinko is made by the Field Corporation, which pumped $250 million a few years ago into D3Publisher of Japan, a distributor and publisher of software for budget-genre entertainment for game console platforms. Known as one of the top 10 software publishers in Japan, D3P a few years ago wanted to extend its wings globally and expand into publishing interactive entertainment software for the higher-priced game console market (think Game Boy, PlayStation, Nintendo, and Xbox). An infusion of cash from Field Corporation got the project going.

In November 2004, the company opened an office in Los Angeles for its new subsidiary, D3Publisher of America. The developer and publisher of interactive entertainment solutions shipped its first product—a Cabbage Patch Kids game for personal computers—in early 2005. Faster than you can say “Pong,” orders started flying in over the transom.

“Being an unknown publisher with an unknown product is very hard, but being an unknown publisher with a known product makes things a bit easier,” explains Kim Motika, vice president of worldwide sales and operations of D3Publisher of America, Inc.

A quick glance at D3P of America’s array of published titles today would thrill most teenagers and 30-something Gen X’ers with Game Boys hidden in their sock drawers. Earth Defense Force 2017 is one of the company’s newer published titles. “Planet Earth is under attack from alien invaders,” the game warns. “Grab your gun, join your squad, and repel the attacking forces in this action-packed, arcade-style shooter. You are Earth’s last line of defense!”

For a startup company, getting products such as Earth Defense Force 2017 on the shelves of retailers without blowing a wad on infrastructure costs is a challenge, Motika said. “Our goal is to be a top 10 publisher in the U.S. in the next five years,” she says. “To do that, we needed to have a product lineup that would enrich retailers like Best Buy, Target, Toys “R” Us and Wal-Mart, encouraging them to do business directly with us. But, when you’re a startup, you don’t have the distribution infrastructure to handle as many major accounts directly as we wanted to have.”

Enter outsourcing—in this case the engagement of a third-party warehousing facility, Ditan Distribution. This was the first step in D3P’s outsourcing journey that would lead to a robust FAO engagement. Ditan received orders from D3P’s customers and then picked, packed, and shipped products to retailers. The software company was then notified of the fulfilled orders so it could begin the invoicing process.

“We were able to access their distribution network, which saved us both time and money,” Motika said. “They delivered what we needed right out of the chute.”

Although distribution was addressed, other pain points began to emerge as a result of the company’s rapid growth. By mid-2005, D3P of America had developed solid, direct relationships with several major retail customers selling video games and console equipment. This led to demands that stressed its infrastructure.

“We started to feel the effects in our accounts receivable department,” Motika explained. “We had one person in accounting whose job was to set up an account, decide if they were creditworthy or not by doing credit checks, determine how much of a credit line to extend the account, and then, once the order was shipped, to track the invoices and payables.”

Two months after shipping its first product, it was clear that a single person could not manage receivables for the order volume experienced by the company. “We were on target to do $7 million in revenues our first six months,” Motika says. “It was impossible for one person to handle $7 million in collectibles, much less the growth we were anticipating.”

Enter outsourcing again—this time in the form of a three-year receivables management outsourcing engagement with Vengroff, Williams & Associates (VWA) of Garden Grove, CA. Last May, the F&A service provider was contracted by D3P of America to manage its collections services, dispute resolution, and application of cash receipts with the goal of reducing outstanding invoices and increasing response to disputed claims.

Being a startup has many drawbacks, but in this case it had one huge advantage—the ability for the provider to start from scratch. Most engagements call for the provider to work around the buyer’s established processes, regardless of whether they are effective or not. This makes it difficult to easily and fully leverage the provider’s own processes and system, but designing a client’s process from the ground up means a near perfect alignment of both sides.

That was the case for D3P. VWA essentially built a customized AR outsourcing model that was sensitive to the client’s startup status, its small AR personnel staff, and its limited technological resources.

“I told Kim that rather than go out and hire a $120,000-a-year credit manager and staff an entire department, we could come in and manage all the receivables, including the deduction management process and credit mitigation, writing up procedural documentation that would pass their internal audit,” recalled Greg Stewart, vice president of the direct-to-retail division at VWA.

“We wouldn’t be as successful as we are today were it not for having them as a partner,” says Motika. “We just completed our current fiscal year with $41 million in revenues and plan to double that this year. Last year we racked up 50,000 transactions and we expect to handle 100,000 transactions this year. There is no way for a startup to put together a team of people and purchase the right equipment quickly to handle this kind of volume. They’re an integral part of our team.”

Ironically, Motika, who also oversees financial operations at the fledgling company, said her career path actually crossed with that of Stewart even before the two were wed in the FAO chapel. Prior to joining VWA about 18 months ago, Stewart was the director of credit at Microsoft Corp., managing the company’s Xbox product. Motika, meanwhile, worked at D3P of Japan.

“It’s a small industry,” Motika noted. “I’d run into Greg all the time and knew he managed the entire Xbox collections relationship, and you can imagine how big that business is.”

“In this industry, we all know each other, it seems,” Stewart said. “When I was at Microsoft, Kim and I would run into each other at trade shows in the entertainment space. She had my phone number.”

VWA provided receivables outsourcing services for Microsoft, which explains Stewart’s migration to the BPO provider. “The company’s vision was very much aligned with where I saw myself headed in my professional career, and I joined up with them in January 2006,” he recalled.

As D3P of America went through the traditional RFP process in seeking an outsourcer for its receivables process, Motika’s confidence in Stewart helped nailed the deal. “I figured if they could do a good job for Microsoft, they could do it for us,” she said. “I called Greg and spoke about our challenges.”

Stewart noted that it was immediately clear to him that D3P faced potential problems with its single-person AR department. And because the in-house staffer was also new to the retail business, the situation was potentially catastrophic, with cash flow and profit margins at risk.

While outsourcing seemed an ideal solution, the company wanted to make sure there would be no disruptions to D3P’s relationships with retailers, especially after it had worked so feverishly to build those relationships. So the key to the outsourcing engagement centered around a seamless workflow.

“Greg talked about how VWA could be our de facto credit and collections unit as if they were a part of our company,” Motika said. “Our customers today have absolutely no idea VWA is in the background. They think VWA’s people are our employees. When VWA emails them, it comes across as our address. When they answer the phone, they say ‘D3P.’ When they send correspondence, it has our company’s name at top.”

VWA was established in 1963 with a focus on third-party collections—the late stage of the transaction process. Fifteen years ago, the service provider began tackling the market segment in need of services for the front end, and it gradually developed credit analysis functions and tools. Today, it services the entire receivables management process for more than 3,000 customers worldwide, including General Electric, Ford Motor Company, Federal Express, and other Fortune 1000 companies.

“Our approach enables our clients to easily insource or outsource all or part of the quote-to-cash function, with solutions that are customized to each client’s requirements,” said Robert Sherman, VWA senior vice president of sales and marketing.

Among VWA’s broad menu of services are full, order-to-cash processing, third-party collections, deduction management, dispute management, and tax resolution. The company boasts $20 billion under management.

A year into their three-year engagement, D3P of America said it is bullish on the experience. VWA was 100-percent live within 30 days of taking over the company’s receivables, making collection calls, negotiating settlements of open inventory issues, and assisting the credit management function. The service provider has also customized its state-of-the-art deduction management system, called DMS, to D3P’s particular needs.

The process calls for VWA to download account information from D3P on a daily basis, including all recent invoices and credits and debits applied to accounts. This enables both client and provider to have the exact, up-to-date status information.

“They know which invoices are outstanding and which credits have been applied, as well as when and how. They manage our receivables by contacting our customers and working with them as far as payments. We have a weekly conference call to discuss the aging of receivables, who’s paying and who isn’t and how to correct this,” Motika said.

VWA provides D3P of America a weekly cash-flow projection, and each month it gets an overview of collections explaining why a particular invoice is in dispute and the strategy for solving the problem.

“They work closely with us on credit applications to make sure the credit is applied to the proper invoices so they are cleared up and the aging is clean,” Motika added.

As in any outsourcing relationship, D3P of America is able to focus on core competencies and not build internal teams to handle receivables management and warehousing and distribution. Also an important consideration, to the engagement is VWA’s scalability.

D3P’s business is highly seasonal, with 40 percent of sales coming around the Christmas season and another 30 percent emanating during March and April around Easter.

“Summers are quite slow,” Motika said. “The benefit of VWA’s scalability is that they can scale the number of people on our account based on our seasonal volume. If we had a team of four accountants here doing this, what would we do with them in the summertime? It would be a tremendous waste of their time and our money. VWA offers us the ability to add or delete people from our team based on our volume, which is a huge savings for us.”

She added that the company provides VWA with monthly forecasts of revenues so it knows when its volume is increasing or decreasing. “We’re helping them reach critical peak efficiencies needed to compete in an evolving industry,” Stewart said.

One year into the engagement, Stewart said VWA has met or exceeded the key performance indicators stipulated in the contract. “We do a quarterly scorecard with all our outsourcing partners, and in the four quarters we’ve been withD3P of America, we’ve been in the 90 to 100-percent range on all the KPIs,” he said. “We’re also taking on additional scope. For example, we recently assisted them in entering the Canadian direct-to-retail space.”

Nevertheless, Motika said for now she sees the outsourcing arrangement to be a temporary one. “Our ultimate goal is to have our own staff handle receivables management,” she says. “The question is timing. If you think about revenue growth, when does it make more sense to have a process
in-house as opposed to outsourcing it? My experience over the years tells me that when you hit the $125 million to $150 million mark in gross revenues, it begins to make sense to bring things in-house.”

But she also pointed out that other considerations may change her outlook. For instance, one daunting issue to all finance organization is around manpower and training. Another is deep domain expertise, especially around the retail sector. To insource the process, she reflected, the company would need to ensure they have capable people on board.

“Retailers in general play a game on how much they want to pay and when they want to pay it based on a formula that takes into account their inventory on hand and gross profit per square foot,” Motika explained. “They never want to be upside down in this equation. VWA understands this implicitly and has great experience with retailers getting the maximum payment. We would need to ensure that an internal staff understood these needs and implications, as well.”

If D3P of America reaches Motika’s revenue threshold, any move to insourcing would be gradual, she added. “There has to be a transitional period; you can’t do this ‘flick of the switch,’” she said.

Should the company decide to end its outsourcing engagement, D3P of America would also need to build its own receivables system because of intellectual property issues using VWA’s system (see accompanying sidebar). Nevertheless, the data always belongs to the client, “If they ever decided to end the outsourcing arrangement, we’d help them with the data conversion to upload their data into whatever tool they wanted,” he said. “We’d certainly ease the transition.”

AT CONTARCT'S END: RESPECTING IP RIGHTS

Startup companies looking to kick into gear quickly without incurring the time and expense of building an internal finance and accounting team may find
traction by outsourcing to a world-class provider that can build parts of an F&A system from scratch. There is one hitch, however: continue to use the system created by the service provider after a relationship has ended and you could be infringing on the provider’s intellectual property rights.

“What’s going to happen in BPO is what has already happened in ITO,”said attorney Kenneth Adler, chair of the outsourcing group at Thelen Reid Brown Raysman and Steiner. “The rules are different, but the outcome is similar.”

Adler, who specializes in intellectual property litigation as it relates to outsourcing, said a company that develops software on behalf of another has clear IP rights, including copyright and patent protection. The same rights likely apply to business process outsourcing.

“If a company built a BPO system for a client and hosts that system on an ASP basis, the question arises as to the rights of the client to use that software after the term of agreement expires,” he explained.

In the case of the three-year AR engagement signed by service provider Vengroff, Williams & Associates with software publisher D3P of America, VWA owns exclusive rights to all its software. While the system provided to D3P “would invite IP considerations (in the event the parties end their partnership), the data belongs to the company,” pointed out Greg Stewart, VWA’s vice president of the direct to retail division. “D3P would need to upload this data into another tool.”

Stewart himself has been through this transition himself as the former director of credit at Microsoft, which previously had an outsourcing arrangement with VWA. “We migrated from VWA’s receivables tool to Microsoft’s own product,” Stewart said. “As long as you have the software, importing the data is very simple.”

Adler said the key to avoiding litigation in the aftermath of a BPO engagement is to spell out both parties’ expectations clearly in the contract.

“Is the client paying me full freight for lifetime rights to the software, with the idea that they may take it to market themselves at some point, or are they just paying me partially, with the idea that this will be used for the length of the engagement and then jettisoned?” he asked. “The question is about expectations, which should be addressed upfront in the contract.”

Adler noted that some customers may want the system to become standard in the marketplace so the vendor maintains it over time. Other customers may want the system to be specific just to its own needs.

“What rights does a customer have to use the software during the term and after the term; do they get to own a copy of the software and use it afterwards?” he questioned. “Both service providers and customers need to pay more attention to the IP issues and give more thought to their strategies in this context. The pricing then follows.”

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