FAO Research Observation

The utilization of outsourcing as an operational alternative took on a whole new meaning in the Finance domain last week when, for the first time to the knowledge of FAO Research, a company announced its intent to outsource Finance functions as part of its bankruptcy reorganization plans. We have seen numerous examples of companies outsourcing information technology (IT) and other business processes as further moves to get out of debt, some of which have been successful, and others that have failed miserably. FAO Research expects that as the finance & accounting outsourcing (FAO) market continues to grow, companies will continue to evaluate third-party administration of finance functions as a further means of not only facilitating economic prosperity as in the case of bankruptcy but also exploring a host of other business and strategic benefits.

(FAO Research expects that as the finance & accounting outsourcing (FAO) market continues to grow, companies will continue to evaluate third-party administration of finance functions as a further means of not only facilitating economic prosperity as in the case of bankruptcy but also exploring a host of other business and strategic benefits.)

A Pure Example of Outsourcing Finance Amidst Bankruptcy

As publicized on April 2, 2007, Delphi Corporation plans to hand over many of its finance & accounting (F&A) processes to service provider Genpact International LLC if approved by the U.S. Bankruptcy Court. Approval of this proposed 7+ year FAO contract would allow Delphi, a supplier of mobile electronics and transportation systems, to reduce its accounting staff by 650 positions in the United States and Europe and save $150 million over the same timeframe. Delphi would make job cuts over a 24-month period and would consult with workers councils in Europe, as required. This deal would enable Genpact to handle the processing of bills and receipts, travel and expense reporting and contract administration. Estimated at $220 million, the Delphi arrangement would be among the highest-valued FAO contracts to date. (See the 7% segment below.)

Dollar Values of the Biggest FAO Contracts, 2004-2005

Why Delphi Wants to Outsource Finance

This step to outsource F&A is the latest taken by Delphi since October 2005 when it began Chapter 11 reorganization. It already has spent $3 billion to offer buyouts and early retirements to more than 20,000 hourly workers, according to published reports. In further attempts to escape bankruptcy, Delphi plans to close most of its U.S. manufacturing plants (21 of 29) to reduce the costs associated with facilities and workers. Delphi has reported that this shift to outsourcing will allow it to “improve productivity over time by reducing the number and type of unique, non-common systems” and build a “streamlined shared-service (finance) organization.” FAO Research believes that recent other Delphi filings infer additional areas of consideration to be addressed by outsourcing.

(FAO Research has found that the proposed Delphi contract, albeit the first of its kind in the Finance domain, is one of a handful of instances in which companies deprived of cash flow have outsourced as part of a bankruptcy restructuring program.)

FAO Research Analysis – What Does This All Mean?

FAO Research has found that the proposed Delphi contract, albeit the first of its kind in the Finance domain, is one of a handful of instances in which companies deprived of cash flow have outsourced as part of a bankruptcy restructuring program. For example, ANC Corporation – parent to National Car Rental and Alamo Rent-a Car – filed for bankruptcy protection in 2002, became a new company (Vanguard Car Rental) the following year and entered into a major IT outsourcing arrangement with Perot Systems Corporation to help it emerge out of bankruptcy. Also, Delta Air Lines filed for bankruptcy protection in 2005 and then outsourced IT processes to IBM and business processes to Affiliated Computer Services (ACS) as part of its plan to recuperate from bankruptcy. In its current form, the Delphi FAO contract surprisingly includes a non-traditional service provider – Genpact which has achieved significant success since inception as an independent company in 2005 and has a wealth of India-based resources operating in the Finance domain.

Even so, FAO Research believes that the Delphi example will not open the floodgates for companies on the verge of economic failure to outsource finance functions solely for the purpose of debt reduction. Outsourcing must not be viewed as a means to an end, as exemplified by Delta which already announced earlier this month its intent to bring back in house some of its outsourced IT processes and to reduce the scope of its human resources outsourcing contract as of January this year, both for undisclosed reasons. Rather, Delphi’s proposal to outsource during bankruptcy illustrates that outsourcing should be viewed as yet another option that companies can exercise during difficult economic times, in addition to mergers, acquisitions, divestitures, corporate takeovers, consolidations, downsizing, bankruptcy, management changes and other reorganization tactics that typically are part of comprehensive restructuring plans.

FAO Research concurs that the outsourcing of finance seems to be a logical fit for companies, whether in bankruptcy or not, that have exhausted other cost cutting and operational improvement measures, including Lean, Six Sigma and ERP systems/automation. The types of finance functions we have seen primarily move to third-party providers include low risk, high volume, labor intense, repeatable functions that are non core yet crucial to day-to-day operations. Since they are systems based and have achieved relative success in being administered and governed externally – and in many cases offshore, despite being in the highly-confidential finance arena – external administration of these functions has helped companies achieve significant financial and operational benefits from the economies of scale proven by a growing landscape of service providers. Aside from reductions in manpower and related costs, the most successful and established FAO contracts have moved beyond transaction processing to encompass analytics, financial analysis and other types of high-end processes that further leverage the technology, skills and experience of suppliers around the globe.

FAO Research advises that companies should not jump into FAO as a “quick fix”, and suppliers should not boast FAO purely as making an immediate financial impact, especially with bankruptcy situations. We have found that more often than not, finance buyers expect too quick of a positive financial effect and become disappointed when their transition and/or financial promises take longer to deliver, especially by companies in financial distress which are riddled with so many obstacles as may have been the case with Delta. We also have discovered that mismatched expectations are as much of a fault of the supplier as they are of the client seeking pure cost-cutting solutions in most bankruptcy situations, since in some cases, suppliers have made lofty promises just to win the deal and are not setting themselves up for success. The worst type of communication between a vendor and its customer would center around “disentanglement,” but for reasons such as the aforementioned, finance outsourcing contracts have mechanisms to disassociate and terminate if need be (hence the need in many cases for external legal counsel well versed in outsourcing contract structures such as that of Delphi and others).

FAO Research data indicates healthy growth in the FAO market, with nearly 30% more FAO contracts signed in 2005 versus 2004 and similar growth predicted from last year. (Our 2006 contract analysis is currently in process.) All FAO contracts have been sole sourced. They have spanned a range of agreements, including new contract wins, contract renewals, services scope extensions including growth from non-FAO contracts, geographic scope expansion, multi-tower outsourcing contracts and joint venture agreements.

To put the proposed Delphi contract into perspective, FAO Research data and market experience indicate that FAO service provider businesses stand on firm foundations, being supported by “healthy” companies, not bankruptcies, to drive growth in contract creation and expansion. As a general rule, financially-sound companies exploit FAO’s ability to lower costs, unify platforms and share services to improve overall profit and performance. In light of the Delphi situation, however, companies around the world – both big and small – will be evaluating the “performance” of their Finance departments just a little bit differently from now on.

(Aside from reductions in manpower and related costs, the most successful and established FAO contracts have moved beyond transaction processing to encompass analytics, financial analysis and other types of high-end processes that further leverage the technology, skills and experience of suppliers around the globe. FAO Research advises that companies should not jump into FAO as a “quick fix”, and suppliers should not boast FAO purely as making an immediate financial impact, especially with bankruptcy situations. As a general rule, financially-sound companies exploit FAO’s ability to lower costs, unify platforms and share services to improve overall profit and performance.)

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This FAO Research report is a complimentary copy of FAO Research’s “HOT TOPICS” thought pieces highlighting timely news and events and providing our analytic perspective on FAO market impact. Our Hot Topic reports will be published six times this year as part of our 2007 Annual Subscription Package. Analysts contributing to this report include Lisa Maio Ross and H. Paris Burstyn. First Published April 11, 2007.