Financial Management: Outsourcing of Finance and Accounting Functions

Published by the Government Accountability Office on 1997-10-17.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                       United States General Accounting Office

GAO                    Report to Congressional Requesters

October 1997
                       Outsourcing of Finance
                       and Accounting

      United States
GAO   General Accounting Office
      Washington, D.C. 20548

      Accounting and Information
      Management Division


      October 17, 1997

      The Honorable Strom Thurmond
      Chairman, Committee on Armed Services
      United States Senate

      The Honorable Fred Thompson
      The Honorable John Glenn
      Ranking Minority Member
      Committee on Governmental Affairs
      United States Senate

      According to Office of Management and Budget (OMB) estimates, the
      federal government spent over $7 billion in fiscal year 1997 performing,
      maintaining, and improving finance and accounting operations. Auditors,
      however, have consistently reported that these operations continue to be
      plagued by deficiencies that undermine the government’s effectiveness
      and drain resources that could be used elsewhere. Outsourcing—
      contracting for performance of a function previously performed
      in-house—is one approach considered by private sector organizations, as
      well as state and local governments, to help reduce costs and improve the
      quality of financial management operations.

      This report responds to one aspect of your request for information on the
      use of outsourcing to achieve cost savings, management efficiencies, and
      operating flexibility in finance and accounting operations. Specifically, the
      objective of this report is to present information on (1) the extent to which
      selected private sector and nonfederal public organizations used
      outsourcing as a strategy to improve financial operations and reduce
      costs, (2) existing outsourcing vendor capacity to perform finance and
      accounting operations, and (3) factors associated with successful
      outsourcing. As agreed with your offices, we will report separately on the
      remaining three areas included in your request.

      This report is based on our analysis of information obtained from 15 large
      private sector and nonfederal public organizations that either outsourced
      or considered outsourcing a finance and accounting function. In addition,
      we analyzed information obtained from finance and accounting
      outsourcing consultants and vendors and related outsourcing literature.

      Page 1                   GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting

                       Our analysis of the experiences of 15 private sector organizations coupled
Results in Brief       with discussions with industry experts and outsourcing vendor officials
                       and an extensive review of available literature revealed that nonfederal
                       organizations use a variety of strategies to improve their financial
                       operations and reduce costs. While all the private sector organizations we
                       reviewed considered outsourcing as a financial improvement option, to
                       date, they have relied principally on other strategies, such as consolidating
                       systems and operating locations or reengineering business processes, to
                       achieve their financial improvement objectives.

                       To the extent that these private organizations have outsourced any portion
                       of their finance and accounting operations, such outsourcing was
                       generally limited to routine, mechanical tasks, such as check writing or
                       payroll processing. Only 3 of the 15 organizations we contacted had
                       outsourced an entire process within a finance and accounting function.
                       The existing limited capacity of outsourcing vendors to perform larger,
                       more complex finance and accounting operations may have constrained
                       wider use of outsourcing by these organizations. Experts in the
                       outsourcing field have estimated that it may be 3 to 5 years before this
                       type of capacity is widely available.

                       The experiences of the organizations in our review as well as our analysis
                       of pertinent literature may provide some lessons learned for future federal
                       agency outsourcing decisions. Specifically, the following factors were
                       considered as part of the outsourcing decision process and were often
                       associated with successful outsourcing:

                   •   establishing an outsourcing policy that specifies what process and criteria
                       to follow in making the outsourcing decision that will achieve the
                       organization’s overall goals,
                   •   performing a strategic analysis to determine the organization’s core
                   •   benchmarking the organization’s processes against those of world-class
                       organizations to determine comparable costs and identify any deficiencies
                       in its operations,
                   •   performing market research to determine whether a competitive market
                       exists for the outsourcing services the organization needs, and
                   •   considering carefully the ramifications of potential job loss or other
                       possible adverse personnel impacts that could occur as a result of

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                          In addition, after an organization decided to outsource, two key factors
                          were identified with successful outsourcing arrangements. First,
                          successful outsourcing organizations ensured that they maintained
                          sufficient expertise and control to effectively oversee the outsourcing
                          vendor to prevent fraud, waste, or mismanagement. Without effective
                          oversight controls, organizations cannot effectively ensure that vendors
                          carry out their fiduciary responsibilities. Second, successful outsourcing
                          was more likely when an organization established a results-oriented
                          contract with an outsourcing vendor that included appropriate
                          performance measures.

                          A few organizations have outsourced parts of their operations for many
Background                years. Recently, however, interest in more widespread use of outsourcing
                          has increased dramatically. This trend is documented in a recent research
                          report which states that outsourcing has become “a growing business
                          phenomenon and possibly even a cultural phenomenon.”1

                          Early outsourcing focused on relatively low-skilled support functions such
                          as janitorial, food service, guard, or data entry services. However, a recent
                          international outsourcing study found that outsourcing in some areas,
                          such as information technology—including information systems
                          development—is growing rapidly.2 Some organizations have also begun to
                          outsource functions dependent on information technology, such as
                          customer service, research and development, logistics management, and
                          finance and accounting.

Outsourcing Definitions   While outsourcing is growing, the concept is not clearly or uniformly
Vary                      defined. Definitions of outsourcing can be viewed as ranging from the
                          prolonged use of consultants to perform a simple task to transferring the
                          responsibility for performing an entire internal function to a third party. In
                          our recently issued glossary of terms associated with government
                          privatization initiatives,3 we state that “under outsourcing a government
                          entity remains fully responsible for the provision of affected services . . .
                          while another entity operates the function or performs the service.” We

                          Alex. Brown & Sons Incorporated, Outsourcing: Growth Opportunity of the ’90s (Baltimore, MD; Alex.
                          Brown & Sons Incorporated, 1996).
                            PA Consulting Group, Strategic Sourcing: International Survey 1996, (London, UK; PA Consulting
                          Group, 1996).
                           Glossary: Terms Related to Privatization Activities and Processes (GAO/GGD-97-121, July 1997).

                          Page 3                           GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting

                           also state that this approach “includes contracting out, granting of
                           franchises to private firms, and the use of volunteers to deliver public
                           services.” Consistent with this definition, we have defined outsourcing for
                           this report as applied to nonfederal organizations as contracting out the
                           continuous performance of a process, activity, or task that was previously
                           performed within the organization.

                           One form of outsourcing used in the federal arena is cross-servicing, an
                           arrangement where one agency provides support services to another
                           agency on a reimbursable basis. Cross-servicing can range from providing
                           computer and software timesharing services to full-service administrative
                           processing. An analogous arrangement in the private sector is the use of
                           shared service centers, which are locations or organizations within a large
                           organization that provide common services to operating locations or
                           business units. In accordance with the definition of outsourcing used in
                           this report, these intra-organization arrangements are discussed as
                           alternative strategies that nonfederal organizations have used to improve
                           their financial operations.

                           In addition, when considering outsourcing, an organization may focus on
                           an entire function or portions of a function. To illustrate, an organization’s
                           finance and accounting function4 is comprised of processes, activities, and
                           tasks. The payroll process includes various activities, such as calculating
                           employees’ gross compensation for the pay period, determining and
                           deducting amounts from gross compensation to calculate net pay, and
                           printing and distributing payroll checks. Each activity, in turn, includes
                           one or more tasks. The activity of calculating employee compensation, for
                           example, includes such tasks as collecting time cards, tabulating time
                           worked or leave taken per employee, and multiplying hours worked or
                           leave taken per employee by the appropriate pay rate. An organization
                           would have the option to outsource an entire process, one or more of the
                           activities, or merely one or more of the tasks.

Federal Agencies Are       OMB  Circular A-76, first issued in 1966, encourages agencies to obtain
Increasingly Considering   reliable, internal cost and performance information before acquiring goods
Outsourcing                and services from the private sector through outsourcing. The circular
                           established the policy and procedures federal agencies must follow in

                            Considerable ambiguity exists as to what constitutes an organization’s finance and accounting
                           function. Appendix I, which is based on our synthesis of available sources, lists and describes the
                           processes we considered to be part of the finance and accounting function for the purposes of this

                           Page 4                            GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting

determining whether existing federal government commercial activities
should be outsourced. OMB officials told us that they consider outsourcing
to be a viable tool for improving financial management in the federal
government and stated that they would like to see federal agencies
outsource as much of their accounting and finance functions as possible to
other government agencies or the private sector.5

At present, a number of federal agencies have their payroll processed by
the Department of Agriculture’s National Finance Center through a
cross-servicing arrangement. Several other agencies, including the
Department of Justice and the Agency for International Development, have
outsourced portions of their financial operations.6

Recently, there has been considerable interest in outsourcing DOD’s
support activities. In August 1995, the Deputy Secretary of Defense
directed the military services to make outsourcing of support activities a
priority. A May 1995 report by the Commission on Roles and Missions of
the Armed Forces identified financial management as a prime candidate
for outsourcing in DOD. Further, an August 1996 Defense Science Board
(DSB)7 Task Force report on outsourcing found that functions such as
accounting, payroll, travel reimbursement, invoicing, debt management,
and other support functions are routinely performed in the private sector
by a range of outside vendors and recommended that those functions be
outsourced. A November 1996 DSB report estimated that such finance and
accounting outsourcing could result in substantial savings for DOD.
However, subsequently, while agreeing that the potential for savings
exists, we questioned the size of DSB’s savings estimates.8 In addition, a
number of studies to determine the feasibility of outsourcing certain DOD
finance and accounting activities, such as travel processing, payroll, and
contract disbursements, have been requested by the Congress and are now
under way.

 In a 1989 decision, the Comptroller General stated, with regard to federal agencies, that the services
of contractors could not be procured to exercise discretion, make value judgments, or set policy on
behalf of the government. (B-237356, December 29, 1989.)
 The Government Management Reform Act (GMRA) of 1994 established a franchise fund pilot
program. Under this pilot program, designated agencies will provide common administrative support
services such as personnel, payroll, or accounting services through self-supporting organizations in a
businesslike manner.
 The Defense Science Board is a Federal Advisory Committee established to provide independent
advice to the Secretary of Defense.
 Defense Outsourcing: Challenges Facing DOD as It Attempts to Save Billions in Infrastructure Costs
(GAO/T-NSIAD-97-110, March 12, 1997).

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                     The objectives of our review are to develop information on (1) the extent
Objectives, Scope,   to which selected private sector and nonfederal public organizations used
and Methodology      outsourcing as a strategy to improve financial operations and reduce
                     costs, (2) existing outsourcing vendor capacity to perform finance and
                     accounting operations, and (3) factors associated with successful

                     To accomplish our reporting objectives, we obtained information on
                     finance and accounting outsourcing from an outside consultant with
                     unique information on the business process outsourcing market. We also
                     conducted an extensive literature and Internet search on the subject of
                     outsourcing, and we interviewed individuals from a number of
                     organizations representing varying perspectives on outsourcing finance
                     and accounting operations.

                     Our interviews included 12 judgmentally selected private sector
                     corporations, 1 large international quasi-government organization, 1 state
                     government organization, and 1 city government organization. These
                     organizations represent a broad cross-section of U.S. industries ranging
                     from commodities to the transportation and manufacturing industries. We
                     selected the organizations based on either (1) literature citations
                     indicating that they had outsourced one or more accounting functions or
                     (2) size, industry, and level of accessibility. All but one of these
                     organizations had annual revenues in excess of $1 billion and about
                     two-thirds had annual revenues exceeding $15 billion. Our interviews of
                     cognizant key officials in these organizations focused on first determining
                     if they used finance and accounting outsourcing to improve their financial
                     management organization. If they used this type of outsourcing, we asked
                     them to describe the factors they considered important to a successful
                     outsourcing arrangement. We also asked executives at each organization
                     about outsourcing trends they were aware of in their respective industries.

                     We contracted with G-2 Research, Inc., to provide us with detailed
                     information related to the finance and accounting outsourcing market. G-2
                     Research is the market research firm that identified business process
                     outsourcing (BPO), which includes finance and accounting outsourcing, as
                     an emerging market approximately 5 years ago. At the time of our
                     fieldwork, G-2 specialized in tracking and compiling data on the BPO
                     market. G-2 informed us that it uses annual interviews of nearly 3,000
                     corporate executives as well as its regular contacts with major
                     outsourcing vendors, to track the outsourcing market and identify trends
                     and major market participants.

                     Page 6                   GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting

                        Through an extensive literature and Internet search, we identified
                        outsourcing vendors, customers, trade organizations, consultants, and
                        knowledgeable academicians and obtained information on the finance and
                        accounting outsourcing industry capabilities and trends. We subsequently
                        talked with 13 major outsourcing vendors and 12 consultants who are
                        active in the outsourcing industry.

                        Many of our discussions with private sector organizations addressed
                        information of a sensitive business or proprietary nature. To protect this
                        type of information, our report does not identify either the outsourcing
                        service providers or end-users that we talked to.

                        Finally, we synthesized and analyzed the numerous documents acquired
                        from our search or provided by the various organizations we interviewed
                        to determine procedures and factors that are generally accepted as vital to
                        successful outsourcing.

                        We provided a draft of this report to our consultants at G-2 Research, Inc.
                        and the President of the Private Sector Council. We incorporated the
                        technical clarifications they provided as appropriate in the report. We also
                        provided relevant sections of the report to those organizations included in
                        our review that are referred to in specific examples throughout the report
                        and incorporated their comments as appropriate. Our work was
                        conducted in accordance with generally accepted government auditing
                        standards from July 1996 through September 1997.

                        Organizations have a number of options for improving their financial
Outsourcing Is One of   management operations. In addition to outsourcing they can, among other
Several Approaches      things, reengineer their business processes, consolidate the performance
Considered for          of functions in shared service centers, or implement new enterprisewide
                        accounting and information systems. Over the past several years,
Improving Financial     organizations have to varying degrees and in varying combinations used all
Management              of these financial management improvement approaches.

                        The use of outsourcing to help improve finance and accounting activities
                        is growing and there are clear indicators that more large private sector
                        organizations are actively considering it as an option to improve efficiency
                        and drive down administrative costs. A 1996 American Management
                        Association (AMA) member survey found that finance and accounting
                        outsourcing, while used less frequently than other types of outsourcing,
                        has grown rapidly since 1994. Eighteen percent of the 619 responding

                        Page 7                   GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting

firms were outsourcing all or part of one or more finance and accounting
functions other than payroll. Payroll was outsourced in whole or in part by
38 percent of the responding firms. In addition, the survey found that
larger firms—those with 10,000 or more employees—were more likely to
outsource one or more financial processes.9

This buttresses the results of a 1995 survey, conducted for an outsourcing
firm, of 400 senior managers of medium and large firms on business
change strategies.10 That survey found that 25 percent of the respondents
considered payroll and accounting processes best suited for outsourcing.
A research organization has predicted that business process outsourcing
(including finance and accounting outsourcing) will grow by over
20 percent a year until the year 2000.11

Representatives of all of the 15 organizations we spoke to said they had
considered outsourcing as a management strategy for improving their
financial management operations, and 12 organizations had outsourced
portions of their finance and accounting functions. However, only 3 of the
12 organizations outsourced one or more entire processes such as
accounts payable, pension payments, general ledger accounting, fixed
asset accounting, or excise and property tax administration.

Thirteen of the 15 organizations indicated that they had also used other
options to improve their financial operations, such as reengineering all or
parts of their accounting and finance functions, establishing a shared
service center, or upgrading their financial systems. For example, officials
from one company stated that their approach to improving financial
management consisted of: (1) consolidating the accounting function into
as few locations as possible and having each location move to a single
system to accomplish the function, (2) simplifying existing processes,
(3) developing systems that capture data at the point the transaction
originated, regardless of the location within the organization, and
(4) outsourcing all or parts of processes that could be done more
efficiently or effectively by a third party. Through these steps, the
company was able to reduce the number of accounting staff by
approximately two-thirds in a 15-year period. However, according to

 American Management Association, Outsourcing: The AMA Survey, 1997, (New York, NY; American
Management Association, 1997). For the purposes of this survey, payroll outsourcing was considered a
human resource process rather than a finance and accounting process.
 The Wirthlin Group, Executives on Re-Sourcing: Quantitative Survey (McLean, VA; The Wirthlin
Group, 1995).
   G-2 Research, Inc., Business Process Outsourcing: Market Overview, (Mountain View, CA; G-2
Research Inc. 1997).

Page 8                           GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting

                            organization officials, most of the efficiencies achieved were due to
                            actions other than outsourcing, and they estimated that outsourcing
                            accounted for less than 10 percent of the total savings. Officials from
                            another organization told us that they were able to reduce the number of
                            personnel involved in processing accounting transactions by an estimated
                            90 percent over a 12-year period through the use of shared service centers,
                            consolidating systems, and reengineering their accounting processes.

                            Even companies that outsourced entire processes had reengineered these
                            processes or obtained new accounting systems prior to or at the same time
                            as outsourcing. For example, one company reengineered its accounting
                            processes concurrently with outsourcing a number of accounting
                            processes. According to a company official, the reengineered processes
                            along with the outsourcing arrangements contributed greatly to large
                            productivity improvements.

Most Outsourcing to Date    Most organizations that have used outsourcing for portions of their
Has Involved Stand-Alone,   finance and accounting operations—particularly larger companies—have
Labor-Intensive Tasks       contracted for services that typically involve discrete, repetitive,
                            labor-intensive tasks. According to the AMA 1996 outsourcing survey, over
                            70 percent of the organizations that used outsourcing for clerical,
                            bookkeeping, or data processing portions of their finance or accounting
                            functions only outsourced parts of these processes.

                            A good example of this task-oriented type of outsourcing is in the
                            accounts payable process, where a company might handle all the activities
                            and tasks associated with managing accounts payable in-house, but
                            contract with an outsourcing vendor to carry out the check printing and
                            mailing tasks. Another example is payroll processing, where a company
                            might handle the human resource and payroll tasks of entering data and
                            computing employee gross pay amounts in-house, but contract with a
                            vendor for net pay computation and paycheck printing and distribution
                            tasks. Such arrangements might also require the vendor to do other tasks,
                            such as accumulating employee pay information and preparing and
                            distributing W-2 statements at the end of the year.

Mixed Success of            Recent research has shown that, in general, although outsourcing
Outsourcing Arrangements    organizations did not fully achieve the benefits they envisioned, most
                            achieved at least partial benefits. For example, the 1996 AMA member
                            survey found that less than 25 percent of the responding member firms

                            Page 9                   GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting

                       that outsourced finance and accounting activities and established cost
                       reduction, time reduction, or quality improvement goals believed they had
                       fully achieved their goals. However, most respondents indicated that they
                       had partially met their goals for these areas.

                       Some of the 12 outsourcing organizations we contacted, while not willing
                       to share specific results with us, indicated that they had realized their
                       anticipated benefits, while others indicated that they had not. The
                       outsourcing vendor of one of the organizations, with its client’s consent,
                       told us that it reduced the number of staff processing accounts payable by
                       almost one-third, cut the amount of time to process accounts payable
                       transactions by over two-thirds, and was able to implement a computer
                       matching process for about 30 percent of the firm’s purchase transactions.
                       In contrast, one company that outsourced pension payments believed that
                       its costs actually increased. In addition, to the extent that cost reduction is
                       an outsourcing goal, reductions in the number of an organization’s finance
                       and accounting personnel does not in itself translate into reducing the
                       organization’s overall costs because such reductions may be offset by
                       increased outsourcing vendor contract costs.

                       The generally limited use of outsourcing for repetitive, labor-intensive
Current Vendor         tasks may be attributed, in part, to the lack of a mature vendor
Capacity May Not       marketplace with sufficient capacity to provide the larger scale, more
Meet the Outsourcing   complex finance and accounting services often required by large
                       organizations. However, there are indications that the outsourcing market
Needs of Large         may be on the verge of dramatic growth. Some experts in the field have
Organizations          estimated that in 3 to 5 years, organizations with large, complex finance
                       and accounting operations will be able to outsource their entire
                       accounting or finance function. To date, existing capacity concerns appear
                       to have been a significant factor in organizations with large, complex
                       finance and accounting operations moving relatively slowly toward

                       Three organizations that outsourced portions of their accounting function,
                       for example, found only one vendor that was capable of providing the
                       breadth of service they required. According to one consulting firm, while
                       large organizations have been able to find vendors to outsource portions
                       of their finance and accounting functions, they have not been able to find
                       vendors that could take over the entire function. The firm’s study of
                       payroll practices at over 50 firms confirmed that payroll outsourcing may
                       not be a viable option for larger operations because outsourcing vendors

                       Page 10                   GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting

                             presently cannot offer them payroll services at cost-effective rates. One
                             organization found that it could not outsource its payroll process because
                             it was too complex for payroll vendors.

                             One state government decided to consider outsourcing its payroll
                             processing to a third party and requested pricing and service information
                             from major payroll outsourcing vendors. None of the vendors could
                             perform the proposed outsourcing at what the state deemed to be a
                             competitive price. The proposed fees were above what it cost the state to
                             do payroll internally, and the vendors refused to consider a long-term
                             contract with the state.

                             We have previously reported that the lack of a competitive marketplace
                             affects the cost savings that can be achieved through outsourcing.12
                             Consequently, if available outsourcing vendors cannot provide desired
                             services at a competitive rate, an organization procuring outsourcing
                             services may not achieve its outsourcing objectives.

                             Our work with outsourcing users, vendors, and consultants identified the
Factors Associated           following five key factors often associated with successful decisions to
With Successful              outsource finance and accounting operations.
Outsourcing Should Be        A corporate outsourcing policy can ensure that all factors associated with
Done in Context of Overall   an outsourcing decision are identified and addressed. Concerns over
Outsourcing Policy           whether and the extent to which outsourcing may affect an organization’s
                             goals and operations must be carefully considered. Such a policy should
                             be explicit on the extent to which outsourcing will be used to reduce
                             costs, improve efficiency, or increase organizational flexibility. The overall
                             view gleaned from the 15 organizations and outsourcing experts
                             interviewed is that the outsourcing decision and implementation should
                             involve the same type of rigorous analysis, careful planning, and
                             management involvement as any other major business decision.

                             Many experts believe that a corporate policy that describes and requires a
                             structured outsourcing process is necessary for successful outsourcing.
                             For example, on the basis of extensive research, one organization

                              Public-Private Mix: Effectiveness and Performance of GSA’s In-House and Contracted Services
                             (GAO/GGD-95-204, September 29, 1995) and Defense Depot Maintenance: Commission on Roles and
                             Mission’s Privatization Assumptions Are Questionable (GAO/NSIAD-96-161, July 15, 1996).

                             Page 11                        GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting

                           developed an outsourcing policy to guide and provide a structured process
                           for deciding whether to outsource. In part, the policy requires (1) clear
                           objectives for outsourcing, (2) a recognition of all available service
                           delivery options (e.g., internal staff versus third party), (3) a rigorous
                           cost/benefit analysis, (4) buy-in by all affected parties, and
                           (5) communication with employees throughout the outsourcing
                           decision-making process.

                           Under another organization’s outsourcing policy, the designated
                           outsourcing team was to identify those functions that were candidates for
                           outsourcing and apply specified criteria for deciding what functions to
                           outsource. Outsourcing proposals were to include a detailed risk analysis
                           that addressed the proposed outsourcing’s potential impact on such key
                           areas as cost, savings, service quality, system conversion, retraining of
                           personnel, and the potential for disruption of services. Management
                           believed that the outsourcing arrangements developed under this policy
                           were successful in that the company met its outsourcing goals.

                           In contrast, two organizations we talked to had negative outsourcing
                           experiences, which they attributed, in part, to not having an outsourcing
                           policy in place that clearly prescribed a methodology for analyzing costs
                           and for considering all relevant risks associated with such an outsourcing
                           decision. Not until one of these organizations had obtained bids from
                           vendors and was near awarding a contract were concerns raised about the
                           validity of cost estimates and the increased legal and computer security
                           risks. The organization’s president decided to cancel the planned
                           outsourcing until the organization had an outsourcing policy and cost
                           estimation methodology in place. Another organization made the decision
                           to outsource in a rapid fashion without going through a structured process
                           that would be specified in a corporate outsourcing policy. The resulting
                           outsourcing arrangement was not well received by the organization’s
                           employees and resulted in confusion over the purpose and extent of the

Assessment of Core         Decisions on outsourcing are becoming part of the organizational strategic
Competencies Critical      planning process with the goal of increasing competitiveness in the world
When Determining What to   market. In considering whether to outsource, organizations have assessed
                           functions strategically in terms of their relationship to core competencies.
Outsource                  Core competencies, as defined by G-2 Research, Inc., a firm specializing in
                           business process outsourcing market research, are the essential, defining
                           functions of an organization—those things that if given to an external

                           Page 12                  GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting

party, would create a competitor or result in the dissolution of the
company. A hospital’s core competencies, for example, would be those
directly associated with caring for patients. Core competencies have also
been defined as those few functions within a company where the company
can dominate, that are important to the customers, and that are embedded
in the organization’s systems. Involvement of an organization’s senior
management in the process was often identified as essential to ensuring
that an organization’s competencies are assessed strategically on an
organizationwide basis rather than by function.

Other functions are considered non-core and can be considered either
critical or noncritical. Non-core critical functions are important to an
organization but are not directly linked to what the organization perceives
as its primary mission. If not performed at world-class levels, however,
these functions can place an organization at a competitive disadvantage or
even endanger its existence. For most organizations, such functions would
include finance, accounting, and human resources administration.
Noncritical functions are those that supply no competitive advantage and
that even if performed poorly, may not seriously harm an organization.
Examples generally include cafeteria services, groundskeeping, and

Outsourcing arrangements for many organizations usually start with
noncritical functions. As the organization becomes more accustomed to
relying on others to perform simple, noncritical functions, the organization
tends to consider outsourcing a more diverse and critical set of activities.
Reasons that an organization might want to outsource one or more of its
critical but non-core functions (such as finance and accounting) include
the potential for (1) significant cost savings, (2) access to needed skills
and expertise, (3) access to the latest technology or world-class
capabilities, (4) accelerated implementation of planned improvements,
and (5) freeing management resources for other purposes.

For example, after identifying its core competencies, one organization
decided that outsourcing should be used as an option to improve business
performance through reducing costs in non-core areas, leveraging the
expertise of best-in-class service providers, and providing a better career
path for employees in non-core areas. As part of its determinations, senior
management decided that any function that was not a core competency
could be subject to outsourcing. Factors considered included whether or
not a function (1) involves decision-making, (2) adds significant value to
the company’s bottom line, or (3) interfaces directly with its customers.

Page 13                  GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting

                               Company officials informed us that they believed there was no long-term
                               risk to the company’s competitive position in outsourcing these types of

                               Another organization we spoke to also identified its core and non-core
                               activities within the accounting and financial management function. In this
                               case, management decided not to outsource any finance and accounting
                               activity that

                           •   was important to maintaining control of the business,
                           •   was important to maintaining the company’s competitive position,
                           •   involved company confidential information,
                           •   involved a critical expertise that the company could not afford to lose, or
                           •   was used to develop staff for managerial advancement.

                               Based on these criteria, the organization concluded that managerial
                               analysis and decision support work were core activities, but that other
                               activities, such as the clerical aspects of the accounts payable and payroll
                               processes, were non-core and therefore candidates for outsourcing.
                               Officials of this organization also pointed out the need to maintain control
                               of the outsourced activities or tasks and said it was important to keep
                               some level of knowledge and expertise in-house.

Identifying Deficiencies       Benchmarking generally involves identifying organizations that have
Through Benchmarking           developed world-class processes and then, using applicable performance
Is a Key Factor for            measures (such as cost per transaction, average processing time, or error
                               rate), comparing an organization’s performance to that of the world-class
Outsourcing Decisions          organization. Benchmarking lets an organization know how well it is doing
                               and puts it in a better position to assess which improvement initiative, if
                               any, best fits its situation. A key result of an effective benchmarking
                               process will be a full understanding of the extent and nature of any
                               existing deficiencies in an organization’s finance and accounting
                               operations. As discussed later in this report, this understanding of
                               deficiencies in an organization’s finance and accounting function is critical
                               to successfully establishing and monitoring an outsourcing contract.

                               A recent international outsourcing study found that the most important
                               single factor contributing to successful outsourcing was that the activity
                               was well defined.13 Many of the companies we talked to have used

                                  PA Consulting Group, Strategic Sourcing: International Survey 1996, (London, UK; PA Consulting
                               Group, 1996).

                               Page 14                          GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting

                            benchmarking to help them determine if any finance or accounting
                            processes or activities they perform were in need of improvement and the
                            extent of improvement needed. Once processes have been benchmarked,
                            an organization is able to determine areas that need improvement and
                            decide on a means of improvement. While some organizations have chosen
                            outsourcing as a first-line means of process improvement, many others
                            have relied more heavily on reengineering processes, installing
                            enterprisewide systems, or establishing shared service centers as their
                            primary approach to improving financial management.

                            If through benchmarking an organization finds a particular internal
                            process to be world-class, it might decide that little could be gained by
                            outsourcing. In situations like this, some organizations may offer their
                            services externally and turn the function into a profit center. If all or part
                            of an organization’s finance and accounting function were determined to
                            be world class, and if the organization determines that the function is not
                            one of its core competencies, it may decide to outsource the function to
                            free management resources.

                            Consistent, objective, and measurable baseline data on operations
                            compared with baseline data from a world-class organization is essential
                            to a reliable benchmarking assessment. One outsourcing industry
                            consultant said, for example, that an organization must develop reliable,
                            quantitative data on costs as well as other objective measures of the area
                            being considered for outsourcing. Failure to obtain reliable data can
                            increase the risk that data will be manipulated to achieve a desired result.
                            For example, the organizational component being considered for
                            outsourcing may have an incentive to exclude relevant costs so that the
                            costs of its operations appear to be lower than they actually are.
                            Outsourcing vendors performing this analysis, on the other hand, may be
                            inclined to include as many costs as possible.

Market Research Needed      As discussed previously, vendor capacity for large, complex accounting
to Determine Capacity and   and finance functions is a consideration in the outsourcing decision
Quality of Outsourcing      process. Although vendor capacity is expected to grow rapidly over the
                            next several years, the existence of a competitive marketplace for
Vendors                     outsourcing services is a factor that will affect the efficiencies and cost
                            savings that can be achieved.

                            A number of vendors, outsourcing users, and outsourcing experts we
                            talked to recommended that large organizations with complex processes

                            Page 15                   GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting

                           pilot test a segment of a process before attempting to outsource an entire
                           process. The segment chosen for the pilot should be one that is most
                           amenable to outsourcing. Then, after a successful pilot, the organization
                           could gradually expand the scope of the outsourcing arrangement. A pilot
                           test approach to finance and accounting outsourcing would give the
                           organization time to streamline its outsourcing process while allowing the
                           vendor marketplace to build up the capacity to perform services for large

                           Organizations must also research the quality of vendor services. An official
                           of one organization that had outsourced an accounting process stated that
                           its vendor had a turnover rate much higher than the organization’s internal
                           staff that previously performed the process. He said that the high vendor
                           turnover presented a problem as his employees were constantly dealing
                           with new vendor employees who did not know the organization’s business.
                           One large company decided to bring its outsourced payroll process back
                           in-house and do its own payroll processing because of the poor service it
                           received from its vendor.

                           Organizations must also consider if process improvement is an
                           institutional goal and whether or not the services offered by vendors
                           represent an improvement over the effectiveness and efficiency of existing
                           processes. One organization credited its outsourcing vendor with bringing
                           “cutting edge” technology to some of the organization’s accounting and
                           finance processes. Another organization for which process improvements
                           were important decided not to outsource its accounts payable after
                           determining that none of the potential accounts payable vendors would be
                           able to improve upon its current business operations.

Personnel Issues Must Be   Organizations cited outsourcing’s potential impact on personnel as a
Addressed                  particularly sensitive issue in considering whether and what finance and
                           accounting operations to outsource. Outsourcing is likely to result in a
                           reduction in the number of an organization’s employees. Addressing
                           sensitive issues associated with potential job loss and other possible
                           adverse personnel impacts will be critical to dealing with potential
                           resistance to outsourcing and to building momentum for change.

                           According to one organization, the issue of job loss resulting from
                           outsourcing is the most difficult hurdle to overcome in reaching a decision
                           to outsource all or part of an organization’s finance and accounting
                           operations. In some instances, we were told, organizations determined

                           Page 16                  GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting

that internal opposition to outsourcing was so widespread and vocal that
planned outsourcing was halted until employee concerns were addressed.
For example, we were told that addressing the concerns expressed by
labor unions was considered to be of paramount importance to one
organization in reaching a decision to outsource all or part of a function.
In addition, a member of the organization’s management stated that it is
difficult to convince an organization’s senior managers to reduce their
“power” (based on the number of people reporting to them) by firing or
laying off personnel in conjunction with outsourcing all or part of a

When to tell employees outsourcing is being considered, how to involve
employees in the outsourcing process, and whether to require the vendor
to offer employment opportunities to the displaced employees were
repeatedly identified as essential elements to any outsourcing decision.
One organization, citing its corporate philosophy supporting its employees
as its most valuable asset, told us that it has strived to avoid employee
layoffs even when selected jobs were phased out through process
improvement or outsourcing. Instead, it has relied primarily on attrition
and job transfers to reduce numbers of employees and has offered, at
certain times, retirement incentive packages to employees whose jobs
have been phased out. The organization’s top management advised
employees when it was seriously considering outsourcing and sought
appropriate employee input in the outsourcing decision.

One organization’s officials told us that they have delayed outsourcing
specific activities because the affected employees may not have the
necessary skills to transfer to other areas in the accounting department.
Organization officials stated that, rather than displacing existing staff, they
will continue to pursue internal operating efficiencies and will wait for the
employees to leave through reassignment or normal attrition before
outsourcing those positions.

Officials from another organization that adopted this approach also stated
that they believed this strategy contributed to successful outsourcing. The
organization believed that because it kept employees informed, it was able
to prevent rumors and speculative gossip from becoming a barrier to
outsourcing its general ledger accounting processes. The organization also
arranged for the outsourcing vendor to offer employment to virtually all of
the displaced employees. The vast majority of the employees transferred
to the vendor and, for the most part, continued to perform the same duties
they had before outsourcing. The outsourcing organization expressed its

Page 17                   GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting

                         belief that the employees were treated fairly and equitably and now have
                         more career opportunities because the vendor has multiple career paths.

                         In contrast, we were told that some of another organization’s employees
                         may have first learned about the potential outsourcing from its
                         outsourcing vendor. This created a great deal of resentment and ill-feelings
                         and was a major barrier to the outsourcing arrangement, particularly
                         because none of the outsourced employees were to be retained by the
                         outsourcing vendor.

                         Another risk posed by outsourcing is the loss of important corporate
                         knowledge. One organization that outsourced accounting activities
                         required the vendor to hire key employees—those who had
                         decision-making responsibilities related to the outsourced area. However,
                         the outsourcing vendor found, while training its new staff, that it needed
                         the unique accounting process knowledge held by lower-level staff. The
                         outsourcing vendor then hired the former lower-level employees to train
                         its new employees and discovered that many of these lower-level jobs
                         required a much longer time to learn than planned.

Effective Controls and   We identified two key factors that, once organizations decided to
Performance-Based        outsource, were associated with an increased likelihood of the
Contracts Essential to   outsourcing arrangements’ ultimate success. These key factors are
                         (1) maintaining sufficient expertise and controls to effectively oversee
Successful Outsourcing   outsourced operations and (2) establishing a well-defined, results-based
                         contract with the outsourcing vendor. An organization needs to address
                         these critical factors not only to help ensure that it is meeting its cost
                         reduction and/or process improvement goals, but also to avoid an
                         increased risk of unexpected cost increases, poor quality services, or even
                         fraud. In addition, effective oversight controls are critical to ensuring that
                         outsourcing vendors effectively discharge their fiduciary responsibilities
                         for the funds and other resources entrusted to them.

Effective Oversight of   Ensuring that an organization maintains sufficient expertise and has an
Outsourcing Vendor Is    effective set of controls in place to oversee the vendor’s operations were
Essential                identified as essential to successful outsourcing. In recent testimony, we
                         stressed the need for effective contract monitoring and oversight to
                         evaluate contractor compliance and performance in outsourcing

                         Page 18                   GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting

                               arrangements, but found that such monitoring was not always done

                               The PA Consulting Group’s report on its 1996 survey also raised concerns
                               about the adequacy of contract oversight. The study found that contract
                               monitoring was very important in ensuring that organizations reach their
                               outsourcing goals and that service quality and customer satisfaction were
                               the areas most commonly monitored by organizations. However, the study
                               also found that the level of skill and sophistication necessary for
                               effectively monitoring outsourcing arrangements may exceed the
                               capability of many organizations.

                               One organization’s experience illustrates the importance of maintaining
                               sufficient in-house expertise to maintain effective oversight controls over
                               an outsourcing vendor’s performance. The human resources department
                               had outsourced the pension payment process believing that they could
                               “wipe their hands clean of it.” However, the organization has subsequently
                               had to consider bringing the process back in house, in part because it has
                               become increasingly concerned about whether it can retain sufficient
                               expertise in-house to effectively oversee the outsourcing vendor to ensure
                               that the organization’s retirees are properly paid.

                               Among common contract monitoring techniques organizations have used
                               to maintain control over the outsourcing vendor’s operations were
                               retaining the right to audit the vendor’s operations and periodic reports of
                               cost and service performance and meetings to discuss performance. For
                               example, one organization stipulated in all of its agreements with vendors
                               that its internal audit department must be able to audit the vendor’s
                               records, procedures, policies, and controls related to the outsourced
                               function. Another organization that outsourced a number of accounting
                               processes received monthly performance reports that tracked vendor
                               performance against contractual expectations. In addition, the
                               organization had ongoing meetings with the vendor to discuss
                               performance concerns and any potential process improvement changes
                               and conducted periodic evaluations to determine if outsourcing goals were
                               met and to establish future expectations.

Performance Measures Must Be   A well-defined results-based contract—based on clearly defined,
Established and Used to        results-oriented performance measures rather than on the processes to be
Monitor Outsourcing            followed—is recognized as one of the primary ways of helping to ensure

                                Privatization and Competition: Comments on S. 314, the Freedom From Government Competition
                               Act (GAO/T-GGD-97-134, June 18, 1997).

                               Page 19                        GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting

that an organization will achieve the desired level of benefits. While a
results-based contract will not guarantee good contractor performance, it
will help in measuring the performance and the extent to which expected
benefits have been achieved.

Service providers, consultants, and end-users agreed that outsourcing
contracts should be results- rather than process-based. According to one
service provider, process-based requests for proposals and contract
documents often preclude providers from developing the most appropriate
outsourcing solution. Officials of one organization that had outsourced
major portions of its accounting and finance functions told us that they
developed a results-oriented request for proposal that was very descriptive
of both current functions and what was expected from the vendor in terms
of improved performance. The contract detailed performance
expectations for the outsourced processes, including the timing of reports
and the presentation, availability, and quality of accounting and finance
information and established a related set of performance measures
intended to help determine the extent to which the goals of the
outsourcing arrangement were achieved.

Outsourcing contracts that are process rather than results driven may also
tend to reinforce any existing finance and accounting deficiencies and
limit the vendor in implementing efficiencies and changing processes to
improve operations and reduce costs. For example, more staff would be
required to process accounts payable if the contract required the vendor to
manually match the purchase order, receiving report, and invoice than if
the contract specified the vendor was responsible for making timely and
correct payments for 99.5 percent of the dollar value of the invoices
processed. In the latter case, the vendor would be able to take advantage
of such techniques as electronic data interchange and evaluated receipts,
thus enabling payments to be based upon efficient and accurate
computerized matches of key elements on the purchase order and
receiving report.

We are sending copies of this letter to the Ranking Minority Member of the
Senate Committee on Armed Services and the Chairmen and Ranking
Minority Members of the Senate and House Committees on
Appropriations, the House Committee on National Security, the House
Committee on Government Reform and Oversight, and the Subcommittee
on Government, Management, Information and Technology of the House
Committee on Government Reform and Oversight. We are also sending

Page 20                  GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting

copies to the Director, Office of Management and Budget, and the
Secretary of Defense. Copies will be made available to others on request.

If you or your offices have any questions concerning this report, please
contact either Lisa G. Jacobson or David R. Warren at (202) 512-9095, or
(202) 512-8412, respectively. Major contributors to this report are listed in
appendix II.

Lisa G. Jacobson
Director, Defense Audits
Accounting and Information Management Division

David R. Warren
Director, Defense Management Issues
National Security and International Affairs Division

Page 21                   GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting
Appendix I

Definition and Scope of Finance and
Accounting Function as Used in This Report

              Transaction Processing
              Accounts Payable
              Processing and paying vendor invoices for business expenditures incurred. Activity
              begins when an invoice is coded and approved for payment. Excludes purchasing and
              receiving activities.
                Invoice Processing
                Match invoice, purchase order and receiving report; resolve discrepancies; approve
                and code invoices for payment; maintain appropriate files.
                Payment Processing
                Prepare checks, electronic payments, and wire transfers; initiate and process
                recurring payments; respond to vendor inquiries.
              Benefits Plan Accounting
              Activities to account, track, and report on benefit plans.
              Revenue accounting and the documentation and issuance of bills for products sold and
              services rendered.
              Cash Application
              Recording and tracking payments received from customers.
              Credit and Collection
              The extension of credit to customers and collecting of slow pay and past due receivables
              from customers.
              Fixed Asset Accounting
              Recording and controlling the physical records and financial activities related to fixed
              assets of the corporation.
              General Accounting
              Overseeing, coordinating, and controlling the accounting records and closing activities
              of the corporation. Includes maintaining the general ledger, preparing the trial balance
              and other finance reports, and related activities.
              Inventory Accounting
              The accounting for and valuation of raw, intermediate, and finished materials, spare
              parts, supplies, or products received, transferred, retired, or sold.
              The payment of wages, salaries, and pensions in accordance with organizational
              policies. Activity begins at the point of entry into the payroll system. Does not include
              benefits administration.
                Time and Attendance Processing
                The input of employee time cards into the payroll system.
              Travel and Entertainment Accounting
              Overseeing and processing expense reports and cash advances.
                Cash Advances
                Approve and disburse cash advances; resolve cash advance problems.
                Expense Reports
                Verify that expense reports meet guidelines; approve expense reports; prepare
                payments; resolve travel expense problems; distribute travel and entertainment

              Page 22                        GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting
Appendix I
Definition and Scope of Finance and
Accounting Function as Used in This Report

  Travel and Entertainment (T&E) Card Administration
  Oversee issuance of T&E cards, monitor use of T&E cards.
Control and Risk Management
Financial Budgeting and Forecasting
Establishing long-term and short-term financial plans, budgets, and forecasts. The focus
is on developing detailed financial budgets and controlling actual expenses by
comparing them to an historical budget.
External/Consolidated Reporting
Reporting consolidated financial information as dictated by generally accepted
accounting principles, Securities and Exchange Commission regulations, and statutory,
subsidiary, and international reporting requirements.
Decision Support
Banking and Cash Management
The activities involved in the handling of cash flows and bank relations for noninvestment
Cost Accounting
Calculating product or service fixed, variable, and semi-variable costs. Developing
allocation schemes and analyzing cost variances.
Financial Analysis and Management Reporting
Analyzing financial and operational information to assess, interpret, and predict business
performance to support management decisions. Evaluating capital investment decisions.
Gathering, evaluating, and presenting financial, operating, and contractual information
about proposed business transactions for internal management.
Tax Planning
Examining tax issues for the corporation to optimize tax effectiveness of management
Treasury and Trust Management
The activities associated with securing funds to meet the corporation’s cash flow needs
and investing any excess funds.

Source: GAO analysis of Institute of Management Accountants’ finance and accounting functions.

Page 23                         GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting
Appendix II

Major Contributors to This Report

                        Geoffrey Frank, Assistant Director
Accounting and          Francine DelVecchio, Communications Analyst
Management Division,
Washington, D.C.
                        James Hatcher, Assistant Director
National Security and
International Affairs
                        Neal Gottlieb, Auditor-in-Charge
Chicago Field Office    Adrienne Friedman, Senior Auditor
                        Lenny Moore, Auditor

(918918)                Page 24                 GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting
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