‘The nature of outsourcing is changing. Clients are maturing. They are more selective about their suppliers and are getting more picky about what they want and don’t want.’ So says Ian Law, KPMG consultant and outsourcing expert.
As with all management trends, outsourcing continues to evolve. So what are the factors driving its development and how will they affect both the companies that outsource and those that provide the service in future?
Ironically, one of the main factors driving new outsourcing agreements is the drawing to a close of their predecessors. A key feature of the current outsourcing industry is that many of the first wave of outsourcing contracts are approaching their renewal dates.
A KPMG survey, ‘The Maturing of Outsourcing’, based on 123 UK organisations with experience of out-sourcing IT, found that 60% of deals would be hitting their renewal dates in the next eighteen months. Less than a third intended to renew the contract with their current supplier, while one in ten planned to bring the service back in-house. Three-quarters expressed significant dissatisfaction with an important aspect of the deal.
Inflexible and ambiguous contracts were often cited as causing the highest levels of dissatisfaction, while often expectations had been highest, but least met, in terms of the relationship between client and provider. Many companies had been looking for more of a strategic relationship than they had actually received.
This searching for a new type of relationship between outsourcing provider and client company has also been noted by Arthur Andersen partner Graham Pascoe. ‘Companies are no longer seeking to just cut costs or divest themselves of a troublesome part of the business,’ he says.
‘Instead they are seeking gain-sharing relationships on a performance-related percentage basis. Outsourcing relationships are alliances with partners who can help the company succeed by giving them a competitive edge – outsmarting rather than outsourcing.’ In other words, outsourcing is not just about delivering a minimum level of service with penalties for poor performance, but a partnership where both sides acknowledge the potential to be gained from exceeding basic performance levels.
The current round of renewals is prompting firms to question whether they should necessarily be outsourcing all the functions that they do. ‘It’s got to the stage where outsourcing is eating its way through companies,’ says Law.
KPMG is concerned that many people do not think hard enough about which activities will really reap benefits by being handed over to a third-party to run. The stock answer is often simply that non-core functions are suitable for outsourcing. But how do you define non-core functions? ‘We are focused on the decision-making process quite a lot at the moment,’ says Law.
If a company decides to outsource a function, it has to be happy to lose some control over it. The client also has to be prepared for unexpected events – the outsource provider being taken over by a competitor, for example. If a company is expecting a significant re-organisation or expansion through mergers, then outsourcing may not be appropriate, as service providers do not always allow enough flexibility.
These are all issues that companies considering outsourcing need to address.
Should they decide that the move is a good one, the range of tasks that can be taken off their hands continues to expand.
Although KPMG itself is not an outsource provider, Price Waterhouse is, and has just expanded its service offering with the launch in April of a new business procurement outsourcing practice.
PW estimates the current potential global market for procurement outsourcing to be #140bn. The firm already offers finance and accounting, internal audit, tax compliance, human resources and real-estate management. Partner David Bridger, deputy global leader for the new operation, says: ‘It’s early days, but companies have been expressing interest.’
Under the new service, PW will take over the long-term contracting of non-core procurement activity. ‘We will apply best-practice techniques to areas that have been historically non-core,’ says Bridger. ‘It’s not so much about reducing process inefficiency as reducing procurement inefficiency.’
Two-pronged savings strategy
Companies can look for savings in two ways – first, through improved supplier performance; and second, through reduced costs of the internal procurement process itself.
It isn’t just large firms which are spotting the opportunity to expand their services through providing some form of outsourced service.
Cliff Cooper, managing partner in chartered accountancy firm Cooper Lancaster Brewers, says: ‘A lot of pensions work is now being outsourced, for example, management accounting and the trustee administration. We are doing that kind of work for several large pension schemes.’ CLB sees this as an expanding area resulting largely from tighter regulations for pension schemes.
So popular has the term outsourcing become that even factoring companies see their service as a branch of outsourcing. ‘Perhaps one in forty enquiries we get is for the service ledger administration service only, with no funding element,’ says Guy Stead, sales director for Maddox Factoring, part of the Bibby Group. He adds that the outsourcing of sales-ledger administration could become increasingly appealing to companies worried about their ability to cope with invoices in ecus.
New types of client organisation are also being won over to outsourcing.
Catering facilities, for example, have long been outsourced in the private sector. One company alone, Sutcliffe Catering, numbers 86 of the FTSE-100 companies as customers. But now higher education organisations are taking up the service too.
Jane Dean, newly appointed director of colleges and universities at Sutcliffe, says: ‘The higher-education sector is looking closer at the performance of all its operations as it strives to maximise cost efficiencies. For many universities, the student refectory has produced a severe drain on resources, with subsidies amounting to tens of thousands of pounds annually.’
‘Now many are turning this debit into a credit by turning to contract caterers.’ Bournemouth university has eliminated its #80,000 catering subsidy since handing over the operation to Sutcliffe, which invested #400,000 in a new 400-seater food court.
If the slower-footed public sector is getting into outsourcing, then so are the fast-footed start-ups. The fact that just about every function can now be outsourced means small, dynamic companies can grow rapidly without administrative blockages.
Start-up companies, particularly in the ‘hi-tech’ or biotechnology sectors, are making extensive use of outsourcing, says Arthur Andersen’s Pascoe.
They keep their innovation or research activities in-house and outsource accounting, manufacturing and distribution functions. ‘We have seen this particularly with our clients in Silicon Valley,’ says Pascoe.
A UK example, though not a hi-tech one, is Virgin Cola. ‘They started with only six people in the organisation,’ Pascoe says. ‘They sub-contracted all their bottling and everything apart from the marketing angle.’
New auditing issues evolving
As outsourcing has matured and become a major feature of modern business life, it has created new issues for the auditing profession. In April, the Auditing Practices Board proposed new guidance on the subject. Its draft Statement of Auditing Standards, ‘Audit Evidence Considerations When an Entity Uses a Service Organisation’, reflects the concerns of firms auditing clients who outsource significant activities. How should they obtain sufficient appropriate audit evidence?
‘It’s an important issue and one that is growing all the time,’ says Ian Plaistowe, APB chairman. ‘Companies have the task of maintaining control over their assets and maintaining proper internal controls.
‘Where they outsource part of these functions they need to be able to satisfy themselves as to what is being done on their behalf. A number of companies look on outsourcing as a way of reducing their costs and they may not always pay enough attention to their responsibilities.’
The emerging consensus seems to be that the auditors review the way the directors monitor the outsourced activities. If they cannot get all the evidence they need from the client, then they may need to consider visiting the outsourcer, or relying on work done by the outsourcer’s auditor.
‘This is a big issue,’ notes Mary-Louise Wedderburn, ACCA’s senior technical officer. ‘The impact depends on what the client is outsourcing. If it simply outsources something like cleaning, that’s fairly marginal. But when it outsources the accounting function or investment management activities, that has a more direct impact on the evidence the auditor needs.’
Kevin O’Donovan, a KPMG partner and chairman of the APB’s working party, warns that there is some question over the effect that outsourcing of functions such as accounting could have on directors’ ability to meet their legal responsibilities for maintaining books and records.
‘This is an emerging area,’ says O’Donovan. Directors also need to ensure that auditors will be able to gain access to sufficient audit evidence, he says. ‘We’re now suggesting directors should seek advice before they sign an outsourcing contract to make sure they can meet their responsibilities, and that their auditors can too. They should speak to their auditors and legal advisers.’
If auditors are looking into how they can gain evidence for audit purposes, IT companies have also been working on ways that companies can test the outsourced IT service they receive.
‘In the past, if you went to an outsourcer, you would have to rely on them for information on how your system was running,’ says Peter Williams, sales support manager for Datarange Communications, a value-added reseller and network systems integrator.
In an attempt to help companies become less dependent on their outsourcing supplier’s assurances, Datarange has started supplying Jyra, a tool that monitors application response times. ‘Now companies can measure system performance themselves,’ says Williams. ‘It gives them a big stick that they can hit their service providers with.’
The outsourcing world has grown up. Service providers have seen opportunities to expand their services. Clients have learned from their experiences and begun looking for ways to get the most beneficial service agreements in place. The fact that bodies like the APB are now assessing the implications is a reflection of how far the outsourcing market has come and how far it can still expect to go.
GETTING OUT OF THE CONTRACT
The fact that many contracts are coming up for renewal, and that the type of the service sought is being reviewed, means clients need to spend more time drawing up and negotiating service agreements.
Some companies that have decided to terminate existing contracts have learned the hard way that termination issues have to be considered right at the beginning of the outsourcing relationship, before the contract is signed. Experience has shown that terminating an outsourcing contract is no straightforward matter. As KPMG’s consulting and outsourcing expert Ian Law explains, it raises human resources questions.
Under the Transfer of Undertakings (Protection of Employment) Act regulations, staff should transfer from the outsourcer to the client. But what if they don’t want to go? What if the outsourcer attempts to poach them? And what if the pay and benefits they have received with the outsourcer exceed those of the client’s own employees, so that the client is faced with running a two-tier remuneration system?
Law advises the best way to minimise problems is to think about all the implications of termination right at the start of the relationship and even before the outsourcing contract is signed. He gives the example of a case where a client decided to switch outsourcers. Supplier A had to transfer all the data to supplier B. But instead of putting the payroll on disk, it handed over a paper printout and made supplier B input all the data manually. The terminated supplier was able to behave in such an unhelpful manner because the initial contract had simply required data to be transferred in ‘any medium’.
Sarah Perrin is a freelance journalist
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