How to stay on top of the world

Technological change is a key factor in the increasing adoption of business process outsourcing.

The growth in use of the Internet over the last few years has been staggering, particularly in the US, but now Europe is catching up. The impact of electronic commerce is still not fully appreciated by most companies. But it will be.

It was recently reported that 300,000 web pages are being added to the Internet every week. By 2007, it is estimated that e-business will form 5% of Euroland’s GDP, and that 80% of EU households will be connected to the Internet. This is going to have a major effect on the way that companies do business, and on their competitive environment.

These technological opportunities will prompt businesses to undertake their non-core business processes in a totally different way.

Every activity of quoted companies is questioned by shareholders, in particular those activities which soak up lots of money, provide questionable value and detract from the bottom line.

If there is a way to have those processes dealt with, in a timely fashion at a definable cost, which reduces the ultimate cost to the company, then companies will go for it. And that is precisely what business process outsourcing provides.

So how is business process outsourcing helping companies provide better value to their shareholders? The starting point is that the cost base of services to companies is too high at present.

During the 1980s and early 1990s, most companies – particularly those with a manufacturing base – focused on improving line functions. That involved automating processes, taking labour costs out of production, reducing defects and essentially producing a better product, faster and more efficiently. For most companies, that exercise has gone just about as far as it can go.

As a consequence, the back-office costs for support, maintenance, shipping and sales service have become a larger proportion of companies’ costs.

So now manufacturing companies are looking for efficiencies in those back office functions.

Increasingly, in service organisations, where the majority of costs are back office based, there is a great focus on getting those costs under control and reducing them. This is essential if companies are to remain competitive.

Consider these examples. The best life insurance companies spend about 2% of their annual gross earned premiums on maintenance expenses; some spend up to 16%.

Why is there a move to telephone banking, to on-line banking via PCs?

It is because customers want faster access and faster response, and keeping bank branches open and staffed is very expensive. Margins are coming down and banks are making every effort to reduce their back-office costs in dramatic fashion.

A few years ago the US and Japan had five or six major players in any industry, while Europe had 15 or 16, for reasons of history and geographic and linguistic divisions. European harmonisation is now reducing the number of major players in each industry.

Pharmaceutical, oil, telecoms and automotive companies are currently getting together, and the pace of mergers and acquisitions is speeding up. Worldwide, organisations are recognising the potential of mergers for removing duplicate operations, reducing costs, improving the bottom line, and ultimately increasing shareholder value.

But this is just the beginning. Our research at PricewaterhouseCoopers indicates that when you strip most business processes down to their basics, about 70% of those processes are generic. The processes are operated differently in different countries mostly because of history, tradition and culture.

It is very easy to strip out the ‘we do it in Germany this way because …’ or the ‘we do it in the UK this way because …’ It is possible to reduce processes to common elements which enable those processes to be carried out in the same way, very efficiently, for different companies and in different countries, and even to concentrate them in one country.

In fact, a key factor in business process outsourcing is that you can arrive at a common, generic process to deal with many different local processes, and then decide on the single location where this will be handled.

Technology and telecommunications have made this possible.

Within Europe, one of the factors which will accelerate this process is the introduction of the euro, which will also affect companies based outside the designated ‘euroland’.

Many multinational companies are already asking themselves why they account for their business activities in deutschmarks, French francs, Belgium francs, Italian lira. The answer is that they do not want, or need, to account for any of these currencies on a local basis.

What they ideally want is one central location which takes in information from all territories, combines that information and provides full accounting reports and valuable management information on a timely basis. As well as finance and accounting, this can be done for other business processes such as HR management and procurement.

Some organisations have already moved along this path. For example, BMW recently announced that procurement for BMW and Rover would be centralised in one European location to reduce costs.

There will be some resistance by the individuals involved in these processes because improved efficiency often entails job losses. But this is not always the case. Efficient shared service centres can take on additional clients and so expand their work while achieving economies of scale.

At the same time, those who were back-office workers develop a new client-facing role and often find their career opportunities much improved.

We need to recognise the effects of globalisation. As the world’s markets open up and, through technology, become more accessible to everyone, will the introduction of the euro help to make European companies more competitive?

I believe that it will, because companies will be able to source products on a predictable cost basis without having to take into account currency fluctuations. But, similarly, this will increase pressure to eliminate duplicated back-office costs.

With or without the euro, we see vastly different costs in terms of production for the countries involved; the euro simply makes those costs more transparent.

The table indicates that we should all be operating out of Portugal, and certainly not from Germany.

Of course it’s not as simple as that. Cost is not the absolute factor.

Productivity is also a key factor. But this table does raise the question as to why companies should be doing all their finance and accounting, their HR administration and their procurement in all of these countries, as opposed doing it centrally in one location.

When PricewaterhouseCoopers set up a shared services centre in Europe, in cooperation with BP and Mobil, we decided that Rotterdam was the right place. This was not decided purely on the basis of cost, because there were other factors to be taken into consideration.

For example, we needed multilingual staff in that centre to provide the financial and accounting systems in many countries in Europe. Rotterdam was the right place – although it was not the lowest cost place – because it provided us with the necessary pool of multilingual talent essential to a successful operation. It is factors of this kind which now give a country comparative and competitive advantage.

For various and different reasons we have established similar centres in Poland, in the US, South America, Australia and London. All are achieving considerable cost savings for clients.

All clients’ needs are different. But an important common factor is that we do not take existing processes and embed them into a new system. Instead, we redefine the optimum process in each case and then apply it to the clients and countries concerned. That is what business process outsourcing is all about.

Perhaps an easy way to understand the implications, and benefits, of business process outsourcing is to put yourself in the position of someone who is setting up a new business.

You would not set up an internal audit department, a finance and accounts department, a human resources department, or a buying department for non-specific materials. With minimal analysis you would realise that you do not need to divert or dilute your valuable management resources to these processes. Existing companies have accumulated these as baggage over the years, from a time when they had no alternatives, and it is baggage which they now need to offload.

The efficient company, whether new or existing, needs to replace the baggage with efficient processes provided by a partner which has world-class expertise in carrying out these processes.

Is business process outsourcing a current fashion that will fade away?

The answer is no, because it is about taking cost out of back-office, non-earning services, and making them more efficient and providing the company with long-term competitive advantage.

And there are the wider economic implications. For example, a company’s choice of central service centre may be decided in the early years on such factors as local tax regimes, but those considerations will quickly change.

Business process outsourcing itself may have a major effect on governments, and their decisions on local taxation policies and the international harmonisation of taxes.

For individual companies the most important implication of business process outsourcing is that it helps them to focus on the things they do well, and what gives them competitive advantage, while generating efficiencies in their back-office operations.

It enables companies to compete more effectively.

John Barnsley is global leader of business process outsourcing at PricewaterhouseCoopers.

This article is derived from a presentation made at the launch of the first PwC European Economic Outlook in Brussels in January