Pricing the F&A Outsourcing Contract

Business Finance: What makes pricing the FAO [finance and accounting outsourcing] contract so challenging?

Lisa Ross: When a CFO is looking at pricing an outsourcing contract, they clearly want to feel that they're going to be getting the value they anticipate. And the problem with what to involve in pricing is that word "value," because one CFO's definition may differ from another's, and from the outsourcing supplier's. There are intangible elements like value and expectations that need to go into the contract pricing, and there are also tangible elements like time saved and money saved. Clearly the tangible elements are easier to price than the intangibles -- and therein lies the challenge of pricing.

BF: What are some of the components of a typical F&A outsourcing contract?

LR: They generally have service level metrics that are constructed to measure the performance of the outsourced finance function. They may include credit sets that the outsourcer can get for performance above expectations. There may be contract benchmarks that the CFO can use to measure results against those of peer companies; if the provider is not performing in accordance with the benchmarks, the CFO can make adjustments either in terms of the service levels they're getting or in pricing.

Sometimes the CFO might want the supplier to have more skin in the game and may request some kind of gain-sharing mechanism, wherein the outsourcer receives something special if they perform x, whatever that might be.

BF: Isn't there some controversy, though, around gain-sharing arrangements?

LR: There is, and it's all around the whole value-and-expectations discussion. Expectations change over time, and some companies are not so diligent -- they don't meet every quarter or every month to discuss how everything's going. And then a year or three years down the road the service provider believes they're performing per the contract, but the CFO may not agree. So it has to be extremely clear what needs to be accomplished. There are so many factors, expected and unexpected, that could affect the achievement of the gain-sharing target.

BF: What are the most common pricing models?

LR: The majority of FAO contracts are priced using FTE-based models because they involve transaction-processing components. If you outsource A/P or A/R, which are the most commonly outsourced functions, it's a routine transaction; there's little customization, the outcome is pretty clear, and it's just based on the number of people needed in that size of company to manage that function.

As you move up the finance value chain and outsource more strategic types of functions, the pricing becomes more complex. It might be priced by transaction; sometimes there's a fixed price if the service is pretty straightforward and doesn't fluctuate in terms of volume. But what we're mostly seeing these days are hybrid models combining FTE-based and transaction-based pricing. And that's why the pricing discussion becomes so complex and confusing around questions like what's being outsourced, how should we measure it, and how much should we pay for it when there are so many different ways that it could be done?

The method that's chosen could be just the preference of the CFO -- what they feel most comfortable with. It helps for them to be as educated as possible as to the different ways that contracts can be structured and how much they cost.

BF: And presumably consultants can play a useful role in the process?

LR: In general I would say a consultant can be extremely useful, not only with the pricing discussion but with the whole supplier selection process and so on. That said, in some cases consultants try to strip away innovation and value that's difficult to price and try to bring the pricing down to the nuts and bolts of what's being done. So the supplier feels, "Well, here's the lowest price because that's your goal; however, it's not always the lowest price that gets you the best product in the end. We may be able to do financial analysis for you the cheapest way possible --but is that really what you want?" Sometimes you get what you pay for.

At the same time we see some suppliers, especially some of the less developed offshore providers, trying to lowball pricing just to win the contract. But their ability to turn a profit is significantly reduced, so you wonder if some of those contracts will succeed in the end.

BF: Has the increasing number of providers in the marketplace shifted negotiating power to the buyers' side?

LR: It's a very competitive landscape on a global basis -- more so because people are seeing demand, so everybody wants a piece of it. It's a relatively immature market compared to other BPO [business process outsourcing] areas, and providers in those areas are saying, "We offer IT services, we offer HR services; let's try to converge this finance and accounting offering." We also see some of the niche providers that offer only A/R services trying to broaden their portfolio and get into a fuller scope of services.

So the negotiating advantage has shifted somewhat because of increased competition in many areas. However, we're not at a point where the lowest-priced supplier always prevails. It's not commoditized at all. And that has to do with the finance function. CFOs, although they're looking to cut costs, don't want to lowball pricing and potentially get sub-par services, so they're willing to up the ante in the hopes that the outsourcing move will achieve their desired objectives.