In the spotlight: new business models
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Large organisations look to concentrate on their core competencies by seeking ways of farming out processes that aren’t directly involved in value creation. There are two options for doing this. They can either bundle service processes previously carried out by local business units at a central, internal service centre, or delegate processes to an external company. The latter is known as outsourcing.
Whichever of these solutions is chosen – internal bundling or outsourcing – the idea is to have local services performed as efficiently and with as much automation as possible in a shared service centre (SSC). But for some time now, many international industrial companies have been going a step further by creating so-called global business services (GBS), governance models designed to manage the various functions centrally and eliminate a situation where there are group and local financial functions running in parallel. Whether the services managed by and centralised in these GBS centres are ultimately performed inside or outside the organisation itself varies from company to company.
In the last five years, an increasing number of small and medium-sized enterprises (SMEs) have also been opting to outsource internal services. This has become possible because there are now specialist providers that concentrate on delivering services to a large number of smaller organisations. For many SMEs, the savings made possible by farming out individual functions seem disproportionately low at first glance compared with the project costs of outsourcing.
Let’s take an example of an SME accounts department employing five people. The management wants to outsource the accounts receivable process to an external SSC. Under the most optimistic scenario, this might save half a full-time equivalent at most. That’s too little to recoup the costs of outsourcing. For this reason, these specialist providers don’t just highlight the potential staff savings. Since they’re specialists in the relevant information technology, they can also propose workflow solutions running all the way from scanning vendor invoices to payment approval. The result is a very different business case, one that is likely to lead to as many accounting functions as possible being outsourced.
Given that Indian staff can also learn German, it may be possible to overcome language barriers. But setting up and maintaining a fully functioning supplier relationship poses a much greater cultural obstacle.
Multinational companies often take advantage of global wage arbitrage to outsource service processes to faraway, low-wage countries such as India. But this kind of offshoring doesn’t make sense for most SMEs. Usually they don’t have the resources or business maturity to monitor and manage outsourcing services over such a great distance. Given that Indian staff can also learn German, it may be possible to overcome language barriers. But setting up and maintaining a fully functioning supplier relationship poses a much greater cultural obstacle.
A more feasible option for SMEs can be nearshoring, in other words outsourcing to eastern European countries such as Poland or Romania. A popular nearshoring destination at present is eastern Germany. The region is seen as structurally weak and struggling to achieve significant success, and with unemployment and emigration so high there’s no shortage of people prepared to do the repetitive operational tasks required in an SSC.
Specialist providers focusing on SMEs have to operate smartly and make good use of their resources to keep their prices attractive. The big challenge is that at SMEs a single person often covers a large part of a process, making it difficult to achieve substantial savings by outsourcing individual process steps.
Pressure on costs and margins is the main driver of the trend to outsourcing. There are companies where management always discuss shared services as soon as they find themselves under cost pressure, but shelve the idea again once the pressure has let off. That’s not a very strategic approach. If short-term cost savings are necessary, there are other options that will get directly to the goal – for example reducing working capital.
When choosing an outsourcing destination it’s important to remember that offshoring will help accelerate development in that country. Prices will soon increase in any location where offshoring becomes established. The greater the difference in prices between the destination and the country of origin, the more prices will increase in the wake of offshoring. And as prices increase, so too will wages. The more quickly wages increase, the greater the staff turnover at the SSC will be, as SSCs will start poaching staff from each other.
When outsourcing it’s important to ensure compliance with the relevant legal requirements. Particularly relevant is the Swiss Federal Act on Data Protection (DSG/FADP), which governs the handling and outsourcing of personal data. Outsourcing is permitted provided that the outsourcing provider processes the data only in the manner permitted for the client itself, and provided that there are no statutory or contractual duties of confidentiality that would prohibit outsourcing. The client organisation must also ensure that the outside provider guarantees data security (Art. 10a DSG/FADP).
If the data is handled abroad, depending on the destination additional measures must be taken to protect the personality rights of the individuals and organisations whose data has been outsourced. Outsourcing to countries with a reasonable level of data protection from a Swiss point of view is basically possible without any special protective measures. The Federal Data Protection and Information Commissioner (FDPIC) publishes a list of countries offering a reasonable level of data protection by Swiss standards.
The contract between the company outsourcing its services and the SSC has to take account of these future developments. Firstly, the services delivered by the SSC must be clearly defined. The agreement should also stipulate the indicators by which the performance of the SSC is to be measured, in other words the mechanisms for checking whether the services are delivered properly. On the remuneration side it’s crucial to agree not only what the SSC will charge for its services, but also the financial consequences if it fails to meet the agreed levels of service.
Contracts between outsourcing customers and SSCs generally run for several years. Both sides need to form an idea of the extent to which future cost savings will be possible. The service provider has to be able to calculate the level of staff it’s going to need, and whether the prices it’s charging will enable it to earn a sufficient margin. The more familiar the SSC’s staff are with the process and the greater the degree of automation, the fewer resources will be required and the more profitable the arrangement will be for the service provider. At the same time the client company has to make sure that the service provider remains flexible and is always prepared to adapt as requirements change in line with customer needs and market behaviours.
Alongside long-term cost and margin considerations, the desire to focus on core competencies is an important factor when deciding for or against shared services. If possible, the idea is to outsource anything that’s value preserving, but not value creating. Added to this is the consideration that any function has individual administrative processes that can feasibly be farmed out to an SSC.
The question of whether it’s advisable to outsource functions involving customer contact isn’t easy to answer. Call centre tasks, for example, can be taken care of externally as long as the service provider does a good and professional job of representing the client company. Let’s take an example from the insurance industry. Especially in the event of a claim, customers expect friendly, prompt and professional service, and they want to know quickly how their problem is going to be solved. Claims settlement is an area where loyal customers can be gained.
The more familiar the SSC’s staff are with the process and the greater the degree of automation, the fewer resources will be required and the more profitable the arrangement will be for the service provider.
Not all processes can be outsourced. Strategic processes, for example formulating corporate strategy, are not something that can be farmed out. There are also processes such as issuing payment instructions that should not be outsourced for control reasons. In cases where a process for handling trade receivables is outsourced, the external service provider generally makes a payment proposal that then has to be signed off by the person responsible at the client company. External providers also should not be given access to bank accounts.
Large organisations try if possible to delegate service processes and functions in their entirety. But of course there are many versions in between, especially for SMEs. For example while some companies only outsource incoming orders to a call centre, others prefer to delegate the process for incoming payments and reminders, while others still outsource the whole process for handling trade receivables right up to the approval of payments. Nevertheless, even at SMEs there may well be a good business case for outsourcing entire financial functions.
A third factor in the decision to opt for shared services is operational readiness (in other words service reliability). A Swiss company, say, has a sales organisation in Portugal employing ten people, including a bookkeeper. But what if something happens to the accountant? Who’s going to prepare the next set of financial statements? This isn’t a risk with an SSC.
On the other hand operational readiness may also be a reason for not outsourcing a particular process. Anything that’s well understood and documented properly can be outsourced without any problem. This mainly applies to large companies, where processes have generally reached a high level of maturity. But processes at smaller companies have often evolved around particular people and are not very highly standardised. Here care is required, because process heterogeneity is often reflected in the price of the external service.
Again and again in connection with shared services the question arises as to when processes to be outsourced should be optimised. There are three options to choose from:
It used to be that in most cases the answer was to optimise first, then outsource. But as PwC’s 2014 report Shared Services – the Edge Over shows, this has changed. A global survey of 100 companies representing a total of 377 service centres revealed that 49% opt for variant two: first outsource, then optimise. The companies polled agree that the third option, optimising processes at the same time as outsourcing them, has no hope of success.
This highlights a consideration that’s particularly important for SMEs: outsourcing and offshoring are projects involving major cultural change, and staff often see them as a threat. So it’s understandable that employees don’t find the prospect of optimising processes for them to be taken away or outsourced very motivating.
There are various reasons why the trend towards shared services remains unbroken, with no end in sight: time and margin pressure, the desire and necessity of concentrating on core competencies while farming out as much of the rest as possible, and the need to maximise operational readiness.
Now that an increasing number of highly specialised service providers are offering shared services for many different small companies rather than just large organisations, outsourcing has become an interesting proposition for SMEs as well as big players. Since SMEs can rarely afford internal centralised shared services, nearshoring is generally more feasible than farshoring.
It’s important to bear in mind that processes at SMEs are often not as mature or standardised, meaning they’re only suitable candidates for outsourcing if the business case has been thought through properly.
SMEs in particular have to be aware that the processes set in motion by outsourcing have major implications in terms of culture change. If management fails to explain the intentions behind outsourcing clearly, they run the risk of losing staff with the best labour market profile who can find a new job most easily.
There are signs of imminent consolidation among providers of shared services to SMEs; they too have to go for volume, and providers who don’t have the critical mass won’t be able to compete.