As a recently released report by CFO Research Services, Outsourcing the Back Office: The Path Toward Sustainable Benefits, based on a survey of 288 senior finance executives found, being competitive on every front today means companies must increasingly focus on their core competencies - those items that help the company grow not only in profitability, but in market share in their industry.

Other tasks which are important but play a more supporting role are increasingly moved to a specialized outsourcer. Properly executed this strategy lets management keep focused on the issues that are key to increasing shareholder value.

During the first quarter of 2006, more than 83 information technology and business process outsourcing deals worth in excess of $22.7 billion dollars were signed. This represents a 173% year-on-year increase, according to the TPI Index, a quarterly report on the state of the global outsourcing industry.

It is a statistic that supports the sentiment from Catherine Smith, Executive Vice President and CFO of Kennametal, Inc., a $2.3 billion maker of metal cutting tools and mining and highway construction equipment headquartered in Latrobe, Pennsylvania. “utsourcing has almost become a ticket to the game,” Smith says. “We have to be competitive on every front, and outsourcing is one way to get there.”

Kennametal’s introduction to the world of outsourcing however holds important lessons for companies that are about to embark on outsourcing projects of their own. “It was pretty miserable at first,” Smith says of her company’s effort to outsource its domestic accounts payable process. In fact the company’s experience was so bad that Kennametal’s suppliers threatened to shut down some of its plants. “They weren’t going to ship to us because they weren’t getting paid,” she says. The issue it turns out was not the vendor Kennametal chose, or the software, but the way the changeover was managed with its suppliers. An aspect of outsourcing that is often not given the importance it deserves.

“Before engaging an outsourcing vendor, management should remember there are few things more important to the success of the project than setting up a governance team,” says Mark LaNeve, the CFO of Capgemini’s North American outsourcing business. “You have to build the right type of governance model going in, and it should establish proper management relationships at all levels,” he says. It is important, according to LaNeve, that each side understand the perspective, the culture, and the growth strategy of the other.

Setting up the governance structure and understanding each other’s strategic growth plans is critical for the client and its prospective outsourcing vendor especially because outsourcing is not just about cutting costs any more. Capgemini’s experience with TXU, the Texas utility, is a case in point. At the end of the first year of operations, Capgemini Energy, the company set up to manage the outsourcing services, had reduced operating costs by $150 million, a 30% benefit to the company’s bottom line.

“This happened because both sides were constantly in conversation to ensure Capgemini understood TXU’s perspective, strategy and growth model,” LaNeve explains, “and TXU in turn understood Capgemini’s strategy for supporting them, and its outsourcing business.”

Kennametal was able to turn what could have been a failed introduction to outsourcing into an industry success story. Their outsourcing vendor now handles more than 96% of its domestic accounts payable activity electronically without any manual intervention, which is on the high end of what most companies have been able to accomplish. How did this happen? “We stuck with them, they stuck with us and we got most of our suppliers on board,” Smith says. Good faith and hard work resulted in implementing the proper governance model and that saved the project which is now yielding tangible results. It used to cost Kennametal $4.30 to process one invoice, it now costs $2.25. “We’ve got a goal now of getting it down to 81 cents per invoice,” Smith says.

Continuous improvements in Kennametal’s invoice processing costs demonstrates another key to outsourcing success: thinking of the relationship between client and outsourcer as one that will develop over time to both parties’ benefit, and not just aimed at a quick one-time reduction in operating costs. A good cultural fit between both parties is essential.

“Select vendors with whom your company can feel comfortable for the long term,” LaNeve advises. “One of the areas where we have found outsourcing contracts can really help American companies is by leveraging an outsourcer’s capabilities to meet the requirements of the Sarbanes-Oxley legislation,” LaNeve says.

“Instead of taking on the cost and complexity of building controls and systems in-house to implement compliance, you can contract an outsourcer who has already taken the time to understand the mandates and has the systems and controls in place,” he says.

But this implies the outsourcing vendor chosen is itself a growing, innovating company that is constantly learning and absorbing technology, legislation and the evolving world of international accounting standards.

For all these reasons, choosing an outsourcer requires a lot of due diligence, but this message does not appear to have become standard operating practice in the marketplace. As the CFO Study results demonstrated, only 33% of survey respondents said their companies use a structured, well-documented process for selecting and managing vendors, and less than 20% use a formal governance process to oversee their outsourcing relationship.

“If clients choose not to pay careful attention to and investigate their outsourcer as part of the negotiation of the proposal, they have already stacked the odds against the outsourcing project succeeding,” LaNeve says.

As for Kennametal, it learned this lesson the hard way, but after the corrective action to straighten out its accounts payable outsourcing arrangement, it is rapidly accelerating its offshore efforts. It has already begun to outsource its domestic accounts receivable collections efforts. Going even further it is setting up a new company in India to handle its infrastructure management which technically means Kennametal will be outsourcing to its own offshore entity.

Why so aggressive? “Anything less could put the company at a competitive disadvantage,” Smith says

Executive Review Items:

* Has your company’s Board authorized a top-down review of core versus non-core competencies within your organization?
* The chief financial officer increasingly leads outsourcing feasibility studies, and is a key part of the team that sets up the governance structure to execute the outsourcing plan? Has management taken steps to equip your CFO for this task?
* Does your company’s strategic plan contain an analysis of your top competitors’ outsourcing initiatives?
* Learn more about the CFO Study and the ways to achieve better, faster more sustainable results through outsourcing.

Source: CapGemini

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