Small and midsize companies finally benefit from finance process outsourcing.
Kris Frieswick, CFO Magazine
September 01, 2000
Re’Nu Office Systems may seem an unlikely candidate for financial business process (BP) outsourcing. After all, the Santa Fe Springs, California-based firm generated only $10 million in sales last year and employed a finance staff of five — hardly the profile of a traditional outsourcing client, one that usually signs a large, multiyear, multimillion-dollar contract.
Still, the company, which refurbishes and manufactures office panel systems (the walls that make up office cubicles) needed finance support. Before Re’Nu was acquired in February 1999 by $125 million office-workstation and equipment-marketing firm Business Resource Group, president Leigh Cook says, “We just couldn’t provide our new parent with all the types of information that it wanted as fast as it wanted with the staff we had. [Hiring] a controller probably could have whipped our finance department into shape, but the time the hiring would have taken would have been huge, and it would have been unfair to throw that at any one person.”
In response, Re’Nu outsourced its finance department in November 1998 to LOR Management Services LLC, a former CPA firm based in Los Angeles. LOR now handles all of Re’Nu’s finance functions, including monthly reports to its parent. The company also acts as Re’Nu’s application service provider (ASP) for its finance software package, Great Plains. And although Re’Nu encountered some initial bumps with connectivity to the remotely hosted programs (due to problems with an unrelated installation of a high-speed line), Cook says he is very pleased with his new outsourcing arrangement. It currently costs a fixed fee of $15,000 a month and has allowed Re’Nu to reduce its finance staff from five to two, one of whom is a newly hired controller who oversees the outsourcing contract.
Until recently, however, a company like Re’Nu probably wouldn’t have been able to secure a business process outsourcing contract at all. Such contracts are usually large and long term (10+ years), with the company’s existing staff and relevant equipment assets absorbed by the outsourcer, and with the client billed on a cost-plus basis. In addition, the primary financial BP outsourcers have been the Big Five accounting firms, which, until recently, wouldn’t even look at a client unless it had sales of more than $1 billion.
But a convergence of several factors has made it easier for clients like Re’Nu to find financial business process outsourcing (BPO) on a small scale. The Internet and the availability of bandwidth, for example, have allowed a new genre of outsourcers to arrive on the scene. Called “growthsourcers” by some, these financial outsourcing boutiques are springing up all over the country and delivering their services via the Web, which allows them to target a smaller market by centralizing their operations into shared services centers that serve multiple clients.
For their part, companies have grown increasingly comfortable with handing off processing functions of all types. And a hot job market argues in favor of that trend. Although no size estimates are available for this new market area, today, start-ups, dot-coms, and small and midsize firms are just as capable of outsourcing their financial functions as the big corporations are. In fact, says Frank Casale, executive director of the Outsourcing Institute, an outsourcing research, consulting, and marketing firm, “in the last three years, we’ve been overwhelmed with requests for information and help from small companies that want to use outsourcing across the board.”
One of the drivers of this growthsourcing trend is the combined BPO/ASP capability that companies such as LOR are offering. Some observers point to this one-two combination as particularly beneficial for companies that cringe at investing in large, powerful accounting programs as well as at the demands of staffing up and running a finance department. And nowhere is this paired offering more attractive than in the dot-com start-up world.
Randy Schwed, controller of Epoch Partners, a prerevenue dot-com financial-services start-up based in San Francisco, points to this as a key factor in his decision to outsource his financial processes. “We’re developing a lot of proprietary applications that are core to our business model,” Schwed says. “We’d rather have [IT personnel] doing that than working on financial systems, which are boring and don’t make the company any money.”
He feels the same way about creating a new finance staff. Epoch is an online investment bank created by Charles Schwab and financed by Schwab competitors Ameritrade Holding Corp., TD Waterhouse Group Inc., and venture capital firms Kleiner Perkins Caufield & Byers, Benchmark Capital, and Trident Capital. The company’s Web site will allow online access to initial public offerings for the brokerages’ combined client base of roughly 6 million.
Once launched (scheduled for June 9), Schwed expects a growth curve that looks like a hockey stick. Considering the tight job market in San Francisco, he believes he won’t be able to staff up fast enough to keep pace with the company’s growth. Then there is the issue of just where he would put the new finance staffers, given that it’s still easier to get venture capital than office space in the hot Bay Area realty market. “We wanted to get up and running quickly, we needed to be able to scale quickly, and we didn’t have the resources to build everything in house,” says Schwed.
Epoch now outsources the finance department to LeapSource, a Tempe, Arizona-based financial BP outsourcer that was founded by former Arthur Andersen partner Christine Kirk. Epoch signed on the firm in April to handle an assortment of functions, including A/P and A/R, T&E reimbursements, fixed assets, document imaging and record keeping, bank and balance sheet reconciliation, transactional accounting, and financial statements. Epoch’s financial applications are hosted through a separately negotiated deal with Corio Inc., an ASP based in San Carlos, California, which is a strategic partner of LeapSource. Both LeapSource and Epoch will have access to all financial data via a Web-enabled interface.
The contract will be billed on a fixed monthly cost (Epoch would not reveal the fee amount), a factor that was crucial to Schwed. “Because we’re a start-up, I wanted to keep our costs predictable for the next six months or so,” he adds. “At some point, we’ll renegotiate so we have a metric-based fee that’s appropriate for our business.”
Not surprisingly, even financial software firms are getting into the BPO/ASP game. Longtime financial software maker FlexiInternational Software Inc., based in Shelton, Connecticut, is now providing both ASP (using its financial software) and financial BPO services to small and midsize businesses through its Financial Management Services Inc. division, according to Stefan R. Bothe, chairman and CEO of FlexiInternational. “A company’s ability to turn on a dime and take advantage of opportunities can mean the difference between success and failure,” says Bothe. “To be competitive, businesses need instantaneous, reliable access to financial information. In accounting and financial documentation, forward-looking small and midsize companies now see that BPO is the wave of the future.”
Whither the Big Five?
With all the new players in this smaller market, one may wonder where the Big Five fit in, especially since they started finance BPO. The difficulty in marketing to smaller businesses — the need for fixed monthly cost contracts, shorter contract terms, and lower fees — has, until now, kept the Big Five from aggressively entering this market, says Peter Bendor-Samuels, CEO of the Outsourcing Center, a consulting and information Web-site firm in Dallas.
“The restriction is the cost of sales,” said Bendor-Samuels. “The big guys have been asking, ‘How do I get to the small guys without bankrupting myself?’ A small dot-com may be a $4,000-a-month deal. If I’m a Big Five firm, I can’t even justify buying a ticket to come see you.”
This is changing as well, albeit slowly. “If you look at the Fortune 1,000, there’s only 1,000 of them,” says Bendor-Samuels. “But there are thousands of mid-caps.” Arthur Andersen recently unveiled a new midmarket financial BPO offering, although the company still defines “mid” as less than $1 billion in sales, according to Tom White, Andersen’ s global managing partner for BPO finance operations in Chicago. They are also going after fast-growth start-ups with high revenue predictions, says White.
However, there are several things that observers predict will keep the Big Five from succeeding in the small and midsize space. One is their fee structure, which is still usually based on cost-plus contracts, whereas most small/mid/start-ups are looking for fixed or transaction-based pricing. “From an outsourcer’s perspective, the lure of a transaction-based fee situation is interesting,” says White. “However, there’s not enough experience to price those contracts on a transaction basis. The business is too young. There’s no history yet.”
Another impediment to Big Five domination of this space is outsourcing contract length: smaller companies want shorter contracts of two to three years, and the Big Five are uncomfortable with anything less than five. “From a contract length, if there is an investment up front, the outsourcer is going to want to realize its investment,” says White. “The client company is going to want a long enough contract to feel that the outsourcer will be around. Neither one wants a contract that is too long, so the current thinking right now is that five years is a reasonable time frame.”
Another potential roadblock is the Big Five’s shyness about admitting that outsourcing leads to downsized finance staffs — a marketing point embraced by the smaller outsourcers. The larger financial BP outsourcers have gone to great lengths to convince clients and their employees that outsourcing contracts don’t necessarily mean mass layoffs, and, they claim, often create new career “opportunities.” “We don’t like to call it downsizing,” says White. “But our dot-com and midmarket business is run through a shared services center, which means there will be fewer people on site, because the technology is doing most of the work.”
Companies like Arthur Andersen may eventually miss this market if they fail to push the downsizing angle. Just ask Phil MacCutcheon, CFO of $215 million (in 1999 revenue) Sunburst Hospitality Corp., a hotel property developer and operator. MacCutcheon boasts that, thanks to outsourcing, he has trimmed his finance staff by 10 people. Today, his combined IT and finance staff number just 24. Outsourcing finance also helped MacCutcheon to slice the company’s overhead from $14 million in 1998 to $10.4 million in 1999. MacCutcheon has outsourced tax to PricewaterhouseCoopers, internal audit to a local accounting firm, payroll to ADP, and a variety of nonfinance functions to a host of other outsourcers. Isn’t it tough managing all the vendors?
“It’s a lot better than managing separate departments,” says MacCutcheon. “I don’t have the day-to-day personnel issues. I get to deal with high-level people. It’s a lot easier to deal with a vendor than a bunch of employees. But the real advantage is that it’s all at a fixed price.”
Caveat for Clients
Of course, there are caveats to using growthsourcers; nearly all of them are untried businesses to which companies are entrusting all their financial data. This is a huge marketing advantage for the Big Five outsourcers, and it was what attracted Manny Krakaris, chief financial officer of Command Audio Corp., in Redwood City, California, to choose Arthur Andersen as its financial BPO provider and finance software ASP in January.
Command Audio is one of Andersen’s first forays into the start-up marketplace, and one of its smallest clients. Command Audio, which has a total of four finance staffers, now outsources all A/P and accounting functions to Andersen, and may outsource Securities and Exchange Commission reporting and eventually A/R — as soon as it has some receivables.
“I wouldn’t have felt as comfortable with a smaller firm,” says Krakaris. “I was trying to achieve a couple of things. First, I needed to know if they could do what I want. Then, there’s the aesthetic aspect: How will this be perceived by various constituencies, Wall Street, and investors? That’s where there’s value in one of the Big Five. People take comfort in knowing that their accounting expertise is unparalleled. I didn’t want anyone to question our internal controls.”
Start-ups and dot-coms, however, are often willing to trade some of that establishment credibility for speed. Many outsourcing clients scream through the due-diligence process with their financial BPO provider, a task that used to take months. These days, some clients, like Epoch Partners, complete the deal in just a few weeks.
“There’s certainly a risk there,” says Epoch’s Schwed. “You need to build in an escape in the contract so if the organization that you’re working with doesn’t do well, you can go elsewhere or bring it in-house. But the greater risk is in not being able to execute our business plan quickly enough.”
Despite the need for speed, experts and CFOs alike advise extreme caution when setting up engagements with new, less-established outsourcing players. “The biggest drawback of these deals is trust,” says Re’Nu’s Cook. “You’ve got someone handling all your financial business. You’re putting them in charge of collections, which affects cash flow, and it touches your customer base. You’ve got salespeople, and you’re allowing someone they don’t know to interface with their customers. They’re dealing with your vendors, making sure they get paid. What if they don’t get paid on time, and they put us on credit hold, and we can’t make our deadlines? That’s why we hired a controller.”