As the EMEA market for FAO surpasses even the American appetite, the
mid-market in particular is coming to the fore.
 
By Aris Maroulis
 
The Business Process Outsourcing (BPO) and Information Technology Outsourcing (ITO) markets continue to grow around the world, and the EMEA region has already surpassed the Americas in market size. In Europe, Finance and Accounting Outsourcing (FAO) is also growing, especially in Continental Europe, after its initial adoption in the UK.
 
Whereas FAO has traditionally been undertaken by large corporations, market analysts and Archstone Consulting predict that several economic, FAO market, and technology drivers have emerged that allow for mid-market companies (€1.5-6 billion in revenues, or roughly $2 billion at press time) to benefit from FAO. Mid-market companies in Europe face an additional set of challenges, but we predict that FAO adoption will increase in mid-market Europe.
 
The key questions are:
1. Why has there been low FAO adoption by mid-market European companies until recently?
2. What market developments have fueled an expected increase in FAO adoption by mid-market European companies?
a. Economic, Financial and Competitive Drivers.
b. Service Provider Industry Drivers.
c. Technology Drivers.
3. What challenges do mid-market European companies face in FAO, and what are some possible mitigation strategies?
4. What benefits can mid-market European companies expect to derive from FAO?
5. Is there a minimum company size to consider FAO?
 
Growth, FAO and Europe
By all indications, the global outsourcing industry continues to grow at a steady pace across all geographies and segments (Business Processing Outsourcing, or BPO, defined in this article as Finance-Human Resources-Procurement-Facilities Outsourcing, and Information Technology Outsourcing, or ITO). TPI reports that the Total Contract Value (TCV) of the global outsourcing industry in 2008 was nearly €72 billion (US$93 billion, a 5.6 percent increase over 2007) with an aggregate Annual Contract Value (ACV) of €14.1 Billion (US$18 billion, a 9.5 percent increase over 2007).
 
Some readers will be surprised to read that, since 2007, EMEA has surpassed the Americas in both number of contracts awarded and in TCV. According to TPI, since 2006, EMEA’s share of global TCV has increased from 38 percent to 55 percent. While European growth has largely been fueled by ITO, Finance & Accounting Outsourcing (FAO) has emerged as a significant driver of growth. Importantly, whereas the UK has traditionally seen the highest FAO adoption in Europe, Continental Europe has recently emerged as a high growth FAO buyer region, with some market analysts estimating that Continental Europe accounts for almost 50 percent of the European FAO market.
 
This growth, however, is not isolated among larger European corporations. In fact, most market analysts predict that 2009 will see a significant growth in FAO adoption by European mid-market companies, defined as those with €1.5-6.0 billion (US$2 billion) in revenues. While our estimates indicate that the European mid-market FAO annual growth rate is slightly lower than the global average of 40 percent, as reported by the Everest Research Institute, European mid-market companies are now facing several market developments that point towards an expected increase in mid-market FAO adoption. Let’s look at some questions this raises.
 
Q: Why has there been low FAO adoption by mid-market European companies until recently?
First, a more challenging business case is involved. The FAO value proposition was until recently primarily around cost reduction. Larger companies had the necessary scale to improve their outsourcing business case through offshoring. Mid-market companies often do not have the scale to support a near-shore (typically Eastern Europe) and offshore (typically India) service delivery model. At the same time, their language requirements and their low maturity often do not lend themselves to a 100 percent offshore solution (particularly for Continental European companies). Additionally, mid-market companies have a lower ability to absorb one-time costs, which, combined with a lower offshore component, often led to longer payback periods.
 
In addition, lower FAO adoption in the mid-market created a lack of peer pressure to act. Many European mid-market companies focused more on growth than on cost efficiency. Viewed initially as only a cost-cutting initiative for larger players, outsourcing was seldom on the executive agenda for mid-market firms due to perceived lack of scale, low maturity, and different priorities. Until recently, FAO adoption was relatively low, especially in Continental Europe, even among larger companies. This low adoption combined with the small number of outsourcing examples from comparable companies resulted in limited peer pressure for mid-market companies.
 
Finally, fewer FAO service provider options existed. Large FAO providers in Europe (e.g., Accenture, Xansa) had traditionally focused on large corporates. Until recently, the service provider options for mid-market European companies were largely limited to country-specific or industry-specific FAO providers.
 
Q: What market developments lead us to predict that FAO adoption by mid-market European companies will significantly increase?
Economic, financial, and competitive drivers are behind this. The current economic environment has forced mid-market companies to consider cost-reduction levers that were previously not high on the priority list. Additionally, as larger European companies and the European businesses of larger U.S. corporations continue to use outsourcing and FAO to gain a cost advantage, mid-market companies find themselves at a greater relative cost disadvantage. Moreover, many mid-market companies seeking to lower their finance function costs lack the scale and resources to create internal shared services, thereby making FAO a more likely cost-reduction lever, at least for transactional processes. Finally, cultural resistance is decreasing as outsourcing and FAO become more prevalent in the economy.
 
In addition, several drivers in the service provider market point to increased FAO adoption by mid-market companies in Europe.
 
FAO solutions are maturing, and many providers’ value propositions are expanding beyond labor arbitrage to include quality and productivity improvement, access to a talented labor pool and commercial and operational flexibility. This bodes well for mid-market companies who cannot rely solely on labor arbitrage as an FAO driver.
 
Additionally, we have seen the emergence of offshore FAO locations that can accommodate multiple European languages, which is especially relevant for European buyers due to multiple language requirements. For example, Archstone Consulting recently advised on a major multi-tower deal in which 100 percent of the European FAO scope (with six different languages) is to transition to a single delivery center in the Philippines. The emergence of such centers allows for delivery models with a high offshore component (which maximizes labor arbitrage) while also allowing for economies of scale that would not be available by the more typical near-shore (Eastern Europe) and offshore (mostly India) delivery model.
 
A further driver is that many development costs for tooling have already been paid for by earlier large FAO deals. A similar driver is found in delivery centers that have already attracted major clients, allowing for mid-market clients to round out existing capacity.
Finally, FAO supplier options have increased (more than 25 FAO providers) and Tier-Two and -Three providers have expanded their capabilities. While Accenture and Xansa continue to dominate the larger FAO market in Europe, no clear leader has emerged in the mid-market FAO market, with many FAO providers now increasingly focusing more on mid-market company challenges.
 
We also are seeing an increasing number of mid-market companies implementing single ERP systems, which, while not a precondition for outsourcing, facilitates such an event. In addition, mid-market companies are less likely to require high process customization, which makes platform solutions (for example, Software as a Service plus BPO) even more attractive. At the same time, we are seeing more and more outsourcing service providers offer such SaaS platforms.
 
Q: What challenges do European, and especially mid-market, companies face in FAO, and what are some potential mitigation strategies?
A natural challenge for outsourcing in Europe is the complex language requirements in the region. In an outsourcing environment, high language requirements not only have high cost implications since some languages carry a cost premium, but may also make certain offshore locations less viable. For example, in an FAO environment, it is virtually impossible to find most European languages (other than English) in India. A potential mitigation strategy is to consider making English the language of record where possible and to consider English fluency as a critical factor in retained resource decisions.
 
Another challenge faced by mid-market companies is process fragmentation and lack of scale. Many mid-market companies have neither the maturity to focus on back-office process excellence nor the scale to pursue internal improvements such as shared services. To help mitigate these challenges, mid-market companies may consider increasing their process standardization that may also make platform solutions more appropriate. Another mitigation strategy is to consider a concurrent transformation via FAO and retained organization centralization to address FTE fragmentation in multiple countries. Finally, such companies can also consider emerging FAO locations that offer both labor arbitrage through offshoring and the opportunity to consolidate European scope to a single location due to growing language capability (e.g., the Philippines).
 
Mid-market companies also face significant challenges in recruiting and retaining finance talent. Since mid-market companies typically do not have an abundance of finance talent, greater emphasis is required on identifying and retaining critical talent for the post-FAO environment. Skills training and retention bonuses should be focused on critical resources. This may require a more careful workforce management and succession planning throughout the finance function than was the case prior to outsourcing.
 
Importantly, mid-market companies are less able to absorb the upfront cost of outsourcing (e.g., transition cost and severance). Companies should work collaboratively with providers to find structures that limit the P&L impact of FAO. For example, providers can re-badge key resources (thereby reducing the severance cost, as appropriate within the Acquired Rights Directive) or may spread transition costs as accounting rules permit.
 
Achieving the targeted cost reduction from outsourcing presents particular challenges for mid-market companies. Given their limited scale, cost reduction for mid-market companies cannot come solely from offshore labor arbitrage, but must be completed with process improvement benefits. This implies that mid-market companies are better served by FAO providers that offer both labor arbitrage and process improvement in their solution. Additionally, mid-market companies must work proactively and collaboratively with their FAO provider to seek process improvements, and not just “throw it over the fence.” Moreover, mid-market companies are challenged by having few functional resources with BPO, program management and supplier management experience.
 
Consequently, mid-market companies should consider external consulting and legal support in strategy development, service provider selection and contracting. Mid-market companies can also hire-in required talent or shift internal resources across functions (IT functions typically have resources with greater program and service provider management skills that can be adapted to FAO environments).
 
A further challenge is the lack of existing adequate process documentation, which may be faced by many companies but is even more pronounced in mid-market companies. Consequently, mid-market companies should understand the documentation requirements early in the RFP and supplier negotiation process, so that the effort can be priced accordingly into the business case.
 
Finally, mid-market companies face the challenge of being a “small fish in a large pond” within larger outsourcing service providers, which leads to challenges of communication and prioritization. Mid-market companies need to define clear governance structures and communication processes in the contract. Additionally, mid-market can also consider Tier-Two providers with comparable quality that may offer greater executive visibility and focus.
 
Q: What benefits can mid-market European companies expect from FAO?
First, cost reduction. We have seen U.S. clients achieve 25 percent to 40 percent average run-rate savings from FAO (initially dependent on the size of the offshore component), with average payback periods of one to three years. Run-rate savings from FAO clients in Europe tend to be slightly lower in the 20 percent to 35 percent range due to a higher near-shore component. High upfront social costs are an additional challenge in Europe, resulting in payback ranges of two to five years. We believe that most mid-market European companies can achieve 20 percent to 30 percent in run-rate savings with payback of three to five years, depending on the mix of near- and offshore solutions.
 
Another benefit is commercial and operational flexibility. In addition to cost savings, FAO can also provide commercial and operational flexibility. For example, FAO can provide a platform to integrate M&A activity faster and with less cost. Additionally, FAO can provide financial flexibility by converting part of the cost structure to variable cost, facilitating a greater absorption of business growth and contraction, which is particularly challenging for mid-market companies. Finally, FAO allows mid-market companies to gain access to process tools from outsourcing providers, which would otherwise not be available due to low process maturity and lack of scale.
 
Resource repositioning is another benefit. Mid-market companies are even more challenged to staff value-creation initiatives. Mid-market companies are, therefore, even more interested in freeing up internal resources from transactional activities and repositioning them to support higher value finance processes such as financial planning and analysis, budgeting and forecasting, etc.
 
Access to and retention of talent is important. The recruiting and retention of finance talent is always a challenge, and especially so for mid-market companies. Mid-market companies benefit from access to an FAO provider’s talent pool, while also allowing them to concentrate limited recruiting and talent development resources on high potential resources in less transactional finance areas.
 
Finally, companies can achieve process maturity, harmonization and standardization, and increased control and compliance. Mid-market companies often experience low process maturity and low process standardization. This is especially prevalent in Europe as a result of strong local heritage and country organizations. FAO provides mid-market companies the external impetus and the opportunity to harmonize or standardize processes across countries with the support of outside assistance. The combination of this process harmonization and the additional controls inherent in an FAO relationship significantly increases the overall business controls.
 
Q: Is there a minimum company size to consider FAO?
While there is no minimum company size to consider some form of outsourcing, a general rule of thumb we use at Archstone Consulting is that multi-process FAO produces multiple and balanced benefits for companies over €1.5 billion (US$2 billion) in revenues.
 
In our experience, a minimum outsourced FAO scope for Tier-One and most Tier-Two FAO providers (those providers with the greatest scale and process offerings) is approximately 50 FTEs. This allows for some near-shore or offshore component, which is necessary for the business case. Using various industry benchmarks such as finance function cost as a percent of revenue, finance budget per FTE, and transactional finance FTEs as a percent of total finance FTEs, we arrive at that minimum size of €1.5 billion (US$2 billion) in revenues.
 
Let us consider a hypothetical example based on benchmarks for mid-market companies from the Corporate Executive Board and The Hackett Group. Assuming that transactional finance FTEs account for 40 percent of total finance FTEs and that it is possible to outsource approximately 75 percent of transactional FTEs (using FAO for more rules-based processes), we conclude that the outsourced finance scope is approximately 33 percent of total finance FTEs. Using a benchmark of €125,000 (US$162,000) for the total finance cost per finance FTE and that total finance function cost as a percent of total revenue for mid-size firms is approximately 1.25 percent; we arrive at a company size of approximately €1.5 billion (US$2 billion) in revenues. In our experience, that translates to companies with a total finance function size of at least 150 FTEs.
 
In our experience, outsourcing leads to improvements in quality, efficiency and access to a talented labor pool. However, our experience also shows that companies with over €1.5 billion (US$2 billion) in revenues and over 150 FTEs in their finance function have the minimum scale to expect to see major financial benefits. Of course, benchmarks vary across industries, geographies and companies with different process maturity and efficiency, but we have seen that our premise holds true in many cases.
 
In closing, we believe that changes in the economic environment, the FAO provider market and the technology landscape, have created a congruence of factors that allows mid-market companies (and especially those in Europe) to benefit from FAO as an additional cost reduction and process improvement lever, which was previously only available to larger companies.
 
Aris Maroulis is a Director with Archstone Consulting, based in their Netherlands office. He can be reached at amaroulis@archstoneconsulting.com. Archstone Consulting is an advisory management consulting firm specializing in the consumer products, retail, life sciences, and general manufacturing industries.