FAO Research believes that one of the most contentious parts of Finance and Accounting Outsourcing (FAO) contract discussions today centers around contract pricing. Compared with commoditized IT outsourcing contracts and other types of mature business-process outsourcing service engagements, FAO contracts are less standard and more ‘case-by-case’ in terms of pricing. The market is yet to develop fully and to prove that specific functions should be priced specific ways.
Pricing of FAO contracts can prove especially challenging, as they encompass many intangible elements, like company culture and executive preferences that affect pricing. Moreover, standard terms and definitions as related to FAO are nonexistent. Subsequently, interpretations and expectations between service providers and customers/their advisors are misaligned, resulting in frustration and nonperformance of agreed-upon metrics. How to tie all of these elements into the wording of a contract tied to pricing is time consuming and involves a great deal of frustration.
The pricing mechanism that will continue to be used for routinely outsourced finance functions that are expensive to resource and manage will be on Full-time Equivalent (FTE) basis. When automation kicks in more fully, customers will move to transaction-based pricing or a combination thereof. Depending on what exactly is outsourced, fixed pricing will be employed more often for certain functions such as general accounting. Other types of outsourced functions will involve variable pricing to allow for cost flexibility and seasonal fluctuations. We also expect hybrids of these models to be incorporated in FAO contracts this year.
There is a significant difference between pricing models in FAO contracts for large companies versus mid-market entities. We see FTE-based pricing as the most common pricing model for large multinationals, at least initially, since the outsourced processes are usually customer specific and resource intense. For the mid-market, however, we see a trend in pricing toward a transaction basis, as outsourced functions rely on tools having little-to-no staff transfer, using the service provider’s processes and IT systems for volume-intense services.
An increasing number of FAO contracts in 2008 will incorporate incentive schemes. Many customers appear to have it ‘stuck in their heads’ that without such performance-based incentives, their suppliers will fail to deliver. Many consultants and providers take the position that credits, charges, earnbacks, etc. are sufficient enough to ensure contract success and allow for the most appropriate mechanisms to ‘penalize’ and ‘reward.’ Customers, on the other hand, driven by their perceptions of what constitutes effective pricing and/or by consultants assisting them with negotiations, want continued process improvements, real business impact and innovation tied to their finance functions. As a result, they are demanding that pricing be tied to performance of specific functions, in project situations or for the contract as a whole.
Discussions about termination fees will play an increasingly adversarial role in the finance sourcing lifecycle this year. Customers seem to be ‘on edge,’ mainly due to our challenging global economic climate and their resulting risk adversity. Also, the confidential nature of finance functions and the criticality of operational performance, especially in light of regulatory requirements and harsher stockholder demands, have caused customers to put greater emphasis on remedies if the supplier fails to perform and/or if they need to exit. Mistakes and missed service levels are bound to happen — no one provider is perfect in every way. Since there have been many outsourcing contract failures to date — not so much in FAO but for other types of services — customers want to protect themselves, just in case. What ends up happening, however, is that everyone feels that their backs are against the wall as negative ‘what if’ scenarios are discussed. As a result, the abilities of both parties to build a high level of trust and openness of communication initially are hampered in this regard.
As a whole, FAO Research sees the FAO customer as being much more sophisticated in 2008 during FAO contract pricing discussions than in previous years when the market was less mature. They will approach the due diligence phase with clear-cut expectations as to how they want pricing to be structured, which is not always a good thing. The positive impact is that an educated customer (with or without an external adviser) usually leads to a shorter buying cycle resulting from a less steep education curve about outsourcing, in general, and what to expect. The negative point, which we believe will outweigh the positive, is that buyers may misunderstand that what they want in theory cannot be realized and/or tied to pricing. They may form misguided expectations as to what providers can and cannot achieve — some of which are driven by over-zealous advisers, some by inflexible providers in terms of how they want to price services, and some by the customers themselves who may not fully understand the impact of their expectations upon service delivery, especially when they want to “do more with less.”
The success or failure of the entire pricing discussion lies solely on the provider’s and customer’s abilities to build a high level of trust in one another, pre-contract. Not only will both the parties be in a better position to speak the same language and predict future needs, but also ensure a smoother transition and initial operational engagement, as expectations will be understood and acted upon. Especially in light of cost uncertainty, global economic and competitive pressures and the immaturity of the FAO market, customers, their advisers and the FAO service providers must make a more concerted attempt this year at aligning long-term needs to pricing and having ‘standard’ expectations laid out and options discussed. If trust is the underlying element of the relationship, we see no reason that antagonistic conversations should take place at the time of pricing negotiations.
Lisa is the CEO and founder of FAO Research, an independent research firm focused exclusively on the FAO and procurement outsourcing markets. As a leading analyst in the outsourcing industry for more than 12 years, she works closely with customers, advisors and suppliers of outsourcing services.