Large companies started delegating financial functions to external providers a long time ago. In recent years, more and more small and medium-sized enterprises have also been outsourcing their financial processes. This is a decision with strategic implications that can only be made properly on the basis of a well thought-out business case.

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. [1]

[1] Outsourcing involves contracting out business processes to an external partner who delivers the outsourced services in accordance with agreed service levels and costs. The term ‘outsourcing’ merely refers to the fact that services are delivered by a partner outside the organisation, regardless of whether the process takes place within the same country or from one country to another.

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). [2] But for some time now, many international industrial companies have been going a step further by creating so-called global business services (GBS) [3], 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.

[2] An SSC is a separately resourced central unit providing and managing all types of processes within or outside an organisation. The goal is to deliver defined services to agreed levels of quality at agreed costs. It involves removing repetitive, shared services to free up human resources in the business for value-adding work. Shared services centres exploit scale effects and potential for configuring processes more efficiently.

[3] This refers to the organisational bundling of governance mechanisms relating to shared services. Global business services are increasingly relevant given the various forms of central delivery (headquarters, centres of excellence, internal shared service centres and outsourcing). The idea is to manage the quality of services and minimise the operational risks.

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 [4], one that is likely to lead to as many accounting functions as possible being outsourced.

[4] The business case sets out the economic rationale and impact in the run-up to an outsourcing project. It contains an outline of the processes involved and the organisation that will work with these processes following outsourcing. It also compares the costs of the outsourced portion of the business with the status quo, and forecasts the point within a timeframe of five years at which the outsourced process will be profitable.

Nearshoring for SMEs

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 [5] 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.

[5] Offshoring is the process of relocating tasks to another country where costs are lower. It can involve farming out functions to an internal unit or to an external partner (outsourcing).

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 [6]  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.

[6] Nearshoring is the process of farming out processes to nearby countries with lower costs. In Europe this means eastern European countries such as Poland, Romania and Bulgaria; in North America it means South American countries such as Puerto Rico, Costa Rica and Mexico.

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

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.

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.

Concentrating on core competencies

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.

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.