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These days most companies want their executives to focus on strategic issues rather than the back-office work. Many, however, still choose to outsource specific functions piecemeal.
Now a few big companies have become early adopters of the “end-to-end human resource outsourcing.” They’ve uncovered the usual synergies, to be sure, but the direct cost savings and the dramatic headcount reductions have proved even more rewarding.
The outsourcing, so often presented as a cure-all for companies that sign on for it, may not be so healthy for companies that offer it. In July, one company in the US announced that it was withdrawing from the consideration for a massive outsourcing contract. It said that the risk and accounting issues associated with the long-term contracts were its main concerns, and that its simultaneous plan to lay-off 2,000 workers was not a factor.
In the US, the traditional IT outsourcing has long been a business marked by the headline-grabbing deals ranging from 5 to 10 years in length and hundreds of millions, if not billions, of dollars in value. That hasn’t completely changed. Customers are now more interested in jobbing out discrete pieces for shorter time frames.
Increasingly, they don’t want to parcel it out at all, but prefer someone else to come in-house and run it as a “managed service.” Outsourcing is now an established and well-understood way to cut costs. One big industry change, however, is that the services such as the “e-business on demand,” in which customers buy only the computing functionality they need, have more momentum than the traditional deals. And on the plus side for the outsourcers is the virtual disappearance of the per-user, per-month pricing system that was once the chief selling point. Today the outsourcers may be doing less for clients, but they do get paid. And with the outsourcers eager to satisfy clients’ desire for more flexibility, companies clearly have more leverage than before.
Factors to consider before deciding whether or not to outsource a project: It begins by addressing four categories — cost, benefit, flexibility and risk—and then wades into each one for a closer look.
1. Cost: For the first category, you’ll need to create two boxes, one listing all relevant expenses for the project if it were to be handled in-house, and one estimating the costs if you were to outsource it. Place all the projected costs relating to project—hardware, software, personnel, consulting, and anything else you can think of— prorated where appropriate. It is recommended breaking out these separate cost categories and doing estimates for year one, year two, year three and so on depending on the estimated length of the contract. Then calculate the total cost per year and, finally, the total cost for the whole project.
2. Benefit: The second category itemizes the primary (or direct) benefits that you can expect from the outsourcing arrangement; things like direct cost savings, faster cycle times, higher system availability, etc,.
Assign a monetary value to each of these benefits. Items such as the cost savings and the reduced need for labour should be easy to quantify; things like faster cycle times will be more difficult, and some intelligent guesswork will come into play here, but the difficulty in quantifying certain benefits does not render the exercise meaningless.
3. Flexibility: Write down all of the downstream (or indirect) benefits you expect from the outsourcing. These are not direct benefits like cost savings, but rather options that are now available to you since you entered the outsourcing deal. For example, if you tap a reliable internet service provider to host your web site, you may gain the ability to run a TV ad, or engage in some other marketing effort that may drive substantial traffic to the sight, and know your system won’t crash if it gets flooded with the traffic.
As another example, outsourcing may give you the option to re-deploy internal employees to other projects. This is all about the options you get as a result of outsourcing. Put a rupee value on the options you would have if you decided to outsource. You need to spend a lot of time on this category because most people don’t think of this at first.
4. Risk: This category involves placing a monetary value on the certainty of your other estimates. Here you identify the key risk factors, quantify their impact on the cost/benefit estimates, and then generate the risk-adjusted costs and benefits. The key risk factors include what would happen if the outsourcer were to go out of the business - hardly a far-fetched idea given the predictions of an impending shake - or the effects of employee resistance to adopting new business processes. We can create a distribution curve that says, if you were to do 100 projects like this, what would the range of outcomes be — high, low and mean? The idea is to try to determine how realistic your preceding estimates are.
Reporting relationships of internal auditors: The latest rush of the high-profile accounting scandals is adding fuel to the debate of over-reporting relationships in the finance department. No longer satisfied with the financial audits controlled exclusively by senior corporate executives and accounting firms, the regulators and the institutional investors are now insisting that the publicly-traded companies reorder some of those reporting relationships.
Some finance chiefs see internal audits as something of a sniff test for overly sophisticated accounting schemes. If a company is engaging in activities beyond the understanding of the internal audit department, that’s a warning sign. If there’s that kind of a disconnect, it really weakens the control function. The international reform advocates say the internal auditors must have direct links to audit committees. That way, they can report concerns without the fear of reprisal from their bosses. Of course, some companies have always allowed the head of internal audit a private audience with the audit committee. The internal auditors should meet separately with the audit committee at least every quarter.
At most large public companies, however, the issue isn’t whether there is an internal auditor, but who the auditor’s boss should be. It’s one thing for regulators and investors to say the internal audit department should get its general marching orders from the board audit committee, but the internal auditors usually report to the head of finance. The most popular solution, according to the US Institute of Internal Auditors,is to provide auditing executives with two masters: the audit committee for policy-making and a senior corporate executive - usually the CEO - for more routine work. The internal audit teams are now working much more closely with their independent audit firms. Most chief audit executives get their policy direction from the audit committees. But they tend to be managed and evaluated by the finance heads. Such a setup, however, can cause an internal auditor to become too beholden to finance or operations.
The ultimate responsibility for financial statements may lie with the corporate managers, but the audit firms have failed in their role as the financial watchdogs. And with their profession about to undergo a major overhaul, they have been a very quiet voice in the reform debate. There’s a void of leadership in the audit industry. The firms are all in defensive mode. For corporate executives, that defensive mode already means tougher, more-expensive audits and less wiggle room when it comes to the interpretation of accounting rules. It may go a long way towards fostering a more independent and adversarial role for the auditors of public companies. It’s a very different environment from nine months ago. Instead of focusing on whittling down fees, the senior executives are challenging to make sure auditors are doing an adequate job.
In the past two decades, the accounting firms have ventured far beyond their humble roots. While they have always provided some degree of non-audit services to clients, the opportunities for new business have exploded in the past 20 years. With the spread of information technology, the biggest auditors became the designers and the implementers of the IT systems. They expanded their tax, legal, and investment advisory services, and branched out into all manners of management consulting work. A survey in the US found that 72 per cent of the $5.7 billion in fees paid by 1,200 public companies to their auditors in 2000 was for non-audit services.
In the broader offering of professional services by the audit firms, the actual audit has arguably become a loss leader to land more lucrative consulting contracts. Some firms used to refer to audits as a commodity. No one believes that now. Even if there’s a wall between the consultants who might design and implement a system and those who audit the statements, appearances matter. The new laws lists eight distinct services that firms will no longer be allowed to provide to their audit clients. It also requires that the corporate audit committees pre-approve all services provided by auditors to the company.
Investors have already been attempting to reduce the ties between the public companies and their auditors. Many companies are paying extra attention to their relationships with the auditors these days. In some cases, the auditor has a base of knowledge that gives it an advantage over other providers. It puts them in a position to make better assumptions or to poke holes in our assumptions. The new restrictions, however, will likely force companies to find another firm to perform other professional work. It’s been convenient to do one-stop shopping. Now it’s just going to be a little less convenient.
A notable exception to the new service restrictions is tax work - the assumption being that issues of tax are so intertwined with the accounting and financial reporting that separating the two could jeopardize the quality of audits. Other non-audit services, however, are also essential to the audit work. To perform good audits, more skills are needed than just forensic accounting. Specifically, general accounting skills, tax planning, risk management, and security analysis are all vital competencies for the auditors to possess. All these elements are embedded in financial statements. If we legislate against providing these services, we could end up with poorer audits.
The new restrictions on the provision of non-audit services don’t resolve all conflicts of interest. The fact that clients foot the bill for their audits and can readily take their business elsewhere creates a basic conflict to begin with. But the new ground rules will at least reduce the appearance of conflicts of interest. If we’re going to rebuild trust in financial reporting, these things are needed.
Corporate executives are now realizing that the credibility of their financial disclosures can be more important than the financials themselves. That should result in less pressure on auditors from the executives trying to make their numbers. It also may improve the compensation auditors receive to conduct their work.
The International Accounting Standards, long considered the best accounting standards in the world, may be the most important piece of that puzzle. The growing number of financial accounting experts believe that the IAS itself may be part of the problem. As financial transactions have become more complicated, so too has the accounting for them. Over the last 10 years, the IAS has evolved into complex detailed rules that encourage financial engineering rather than the transparency. The highly politicized nature of the standards-setting process, wherein businesses lobby politicians to exert pressure on the board, is a large part of the problem. The IAS has enabled companies to comply with the accounting standards and yet violate the basic principles of transparency and risk disclosure.
