Consider the Source

Top 5: Tips for Successfully Transitioning ADM Operations Offshore

By: Jim Hussey, Director, TPI

A well-planned, effective transition of Applications Development & Management (ADM) operations to an offshore managed service delivery model establishes a positive working relationship between outsourcing clients and their service provider(s). A bumpy transition only casts doubt and concern, introduces unnecessary risk and increases the likelihood of challenges that could have been avoided.

To help clients and service providers achieve more predictable success during the formative period of transition, TPI recommends establishing a transition framework  that utilizes clear quality gates (or “tolls”) with defined entry and exit criteria strategically aligned with the major transition activities of knowledge acquisition, knowledge transfer, stabilization and steady state.

These are the TPI Top 5 actions you can take to ensure a successful transition offshore:

1. Develop a detailed transition plan during the agreement phase of the engagement.
2. For continuity, ensure that transition team members form the nucleus of the service delivery organization.
3. Assess true behavioral risk within the ADM organization, anticipating reaction at every level of the IT and business organization, and closely monitor throughout the transition.
4. Focus on application and process knowledge development versus the service provider’s individual resources.
5. Have a realistic understanding of your current ADM execution model and anticipate internal challenges to instituting the new service delivery model.

Transitioning a current environment to a new service delivery model that leverages one or more service providers is a technical challenge combined with an organizational change agenda that touches an organization at a very deep and personal level.

Effective planning before transition initiation is critical. Formation of a detailed plan, honest assessment of plan achievement and the ability to take corrective action are keys to transition success.

TPI’s seasoned advisors can help guide your organization through the intricacies of successfully transitioning your ADM operations offshore. Contact Jim Hussey, Director, TPI, to learn more.

Investing in Future Talent

By: Hary Bottka, Project Director, CHRO Services

I recently had an opportunity to blog for Pinstripe, in which I discuss why forward thinking organizations are using the economy to invest in their future talent pool.  I was taken aback by some statistics that I heard at a recent Roadshow by Taleo which supports my point:  42% of employed workers are disengaged from their jobs.  The reality is these statistics underscore the need for the RPO industry to prepare for the future.

Stay tuned for more insights on the latest RPO and HRO market issues as our HRO Group will be making more appearances on Pinstripe. 

Effective Negotiations for Software Licensing Agreements

By: Hack Heyward, Director, TPI, Inc.

 

 

 

When a buyer is in a position to apply some leverage in negotiations with software vendors, there are three critical provisions that can be used, but may require a significant push:

 

1. Maintenance fees as a percentage of the discounted license fee, not the list license fee.
2. Language that locks the software vendor into providing a defined set of services throughout the term.  Many software vendors offer several types of support, but will redefine the terms over time requiring buyers to purchase a more expensive level of support.
3. A fixed percentage of the license fees over a period - usually no more than five years.

On the other hand, here are two provisions, related to your software license, that would be great to have, but are very difficult to obtain because vendors don’t have much flexibility:

1. Paying for and receiving maintenance only when it is most convenient.  Ideally one would like to begin paying maintenance only when licenses go into production and value has been gained, instead of immediately upon licensing.
2. Negotiating the price of maintenance down between 17% and 20%.  Wall Street has adopted this percentage as a predictor of gross margins.  Even though the ongoing maintenance revenue coming into a public company like Oracle depends greatly on other factors like the original discount and whether licensees simply drop maintenance, Wall Street can calculate this percentage and ask about it.  If a public software company began allowing this percentage to erode, Wall Street would hammer it. 

In summary, I suggest that buyers negotiate where the vendor has the ability to be flexible.  Remembering these two steps will save companies a lot more money:

1. Get the greatest possible discount at the beginning and make sure that the annual maintenance percentage is tied to it.  Find out what discount the government and similar sized companies receive.
2. Don’t overbuy. Purchase fewer licenses than project people may need. This won’t be easy because technical people naturally want to have enough licenses and budget managers don’t want to ask for more funds.  Push back, because the penalty for not buying enough licenses is  buying more, while the penalty for buying too many is annual maintenance on extra “shelfware”. Most software vendors won’t sell maintenance on just 75 if 100 are licensed. 
     

Tips for Managing Risk in Your Outsourcing Services Engagement

By: Cynthia Batty, Global Competency Lead, Service Management, TPI

Buyers of sourcing services must seriously consider risk when they contemplate outsourcing — and the results are often included in the outsourcing contract. Outside of disaster recovery and business continuity, though, most clients never follow up with an action plan after the engagement begins, nor do they consider additional risks associated with outsourcing. Between the pressure of transition and startup and the daily demands to deliver services and satisfy business stakeholders, risk is often left for “later.” Resist this tendency by ensuring that operational, reputational, financial and relationship risks are actively managed.

Consider these TPI Top 5 tips for making ongoing risk management a part of your governance process:
 

1. Identify risk responsibilities in the contract. Risk responsibility was documented and is likely scattered throughout your service provider contract in many different exhibits. Evaluate all your contract documents for every area where risk management and responsibility is identified, and make a risk responsibility matrix that shows what you and your service provider are contractually responsible for. Share the matrix with your entire management team and your service provider, and incorporate it into your governance process.

2. Identify and document additional risks in the engagement. Many potential risks in the engagement will not be addressed in the contract, including those your organization may cause. To determine potential risks, hold a series of workshops with your outsourcing management team, the service provider, business stakeholders, and any other organizational entities necessary. Contact us for a checklist of categories to examine closely for risk factors. 

3. Rate the risks; develop and implement risk mitigation strategies. Rate each identified risk on a scale with two axes: probability and impact. Holding a group discussion can quickly identify risks that require mitigation strategies. Those that have high probability and high impact are obvious candidates for deeper consideration. Pay special attention to risks in the low probability/high impact category; strategize what you will do in every case where you think mitigation will be required, and identify (and act on) any mitigation requirements that might affect or change how you act in daily operations.

4. Manage your identified risks. Maintain a risk tracking log, noting when you encounter a situation where you need to activate your mitigation plan. Periodically meet with your key team members (and the service provider, when applicable) and review mitigation plan deployments to learn what worked and what could be improved. Periodically review your risk tracking log to determine if the risk profile (probability vs. impact) has changed, and update plans accordingly.

5. Publish your risk tracking tool. The risk tracking log can be as simple as an Excel spreadsheet, a more sophisticated Access or Lotus Notes database, or a commercial-off-the-shelf application. Whatever tool you use, ensure that everyone involved in the outsourced services management knows where to access the tracker. This is your roadmap for the organization to respond to risk events that will inevitably surface. 

TPI’s Service Management & Governance experts can help you achieve your organizational goals through objective advice, knowledge of your industry and experience with arrangements from simple to complex. Contact Cynthia Batty, Director, TPI, to learn more.

 

Accounting Considerations in Sourcing Environments: Compliance and Controls

By: John Klee, Senior Advisor, TPI

One of the most critical points in an outsourcing environment is often one of the least addressed.  U.S. public companies receiving outsourced services have statutory requirements to substantiate that proper controls are in place to assure the integrity of data, systems, etc.  Additionally, there are requirements for a firm’s external auditors to report on the reliability of a company’s management assertions regarding these internal controls.  Both clients and service providers need to understand these requirements and it is best to address them during negotiations rather than after services begin.

Why is this issue being discussed in this entry?  As noted, it is always better to address issues upfront in negotiations than after the contract has been signed.  Part of a client strategy should be to have the best compliance and controls built into the contract requirements.  This exhibits foresight and evidence to auditors conducting reviews and positions both clients and providers with built-in controls, which is far easier accomplished beforehand than attempting to build in these requirements once delivery has begun. 

The three main regulatory or organization issuances that define and standardize these requirements - The Sarbanes-Oxley Act of 2002, SAS70 (AICPA Statement on Auditing Standards – Issued 1992), and COSO (1992 Committee of Sponsoring Organizations Internal Control - Integrated Framework). The crux of these regulations and standards are to certify and assert that public disclosures are truthful and reliable and  management is satisfied that they have taken the appropriate steps to ensure that the processes and controls in developing this data are consistent so that stakeholders can rely on it.  Additionally, they can provide transparency into financial statements, offer companies a framework and guidance in the design, implementation and test of control mechanisms, and offer a common ground in which clients and service providers can work from.

Compliance and control is important since it offers assurances to investors and more often than not, it is the law. 

Points and Reminders:
• Clients and service providers need their accounting experts to sign off on any accounting treatments.
• Every contract can be different; slight nuances to contract language can alter accounting treatments.
• Recognizing and addressing these issues upfront, in the client’s sourcing strategy, improves their RFP and negotiation position. 
• Everyone benefits from a clearly defined strategy.

And one last parting thought, “It’s an Accounting Issue.  No, it’s a Contract Issue.” 

Accounting Considerations in Sourcing Environments: Agreement Language

By: John Klee, Senior Advisor, TPI

* TPI is not an accounting firm and does not give accounting advice or guidance. Clients and service providers need to engage their own accounting groups for formal opinions; however, TPI is familiar with the RFP formation and industry practices that should be incorporated into the client decision process.

 

There are several issues that must be considered around agreement language that can impact how the revenue is reported.

• Gross versus Net Revenue reporting: Service provider costs, related party transactions and alliance agreements.
• Pricing structure and embedded leases

GROSS VERSUS NET REVENUE REPORTING – Most service provider revenue is reported as gross sales.  That is if revenue is 100 and costs of sales are 97, the revenue is reported gross or 100.  However, some revenue has to be reported as net; that is, it is netted or charged against the actual expense in the service provider’s financial statements.  This lowers reported revenues and alters any reporting metrics that use these numbers.  You can see the impact on reporting below.

 

• Simple Net Revenue reporting
  • Pass-through costs – The service provider is passing a cost directly through to the client without adding any value or assuming risk.
  •  Resale – Perhaps the most common of pass-through costs, is the service provider re-selling a product (hardware, software, etc) with the client having the financial risk.
  • Shipping & Handling (EXCEPTION) – Is reported as gross revenue.  While the service provider adds no value to this, they are the ones who purchase and are responsible for these costs.
• Related Party Transactions
  • Parent / Subsidiary:  A parent company strikes an agreement with a subsidiary or significantly controlled company where one provides services to the other.  (For those with accounting backgrounds, you may recall eliminating entries that remove the revenue between related companies.)  Any revenue reported via sales between the two entities needs to be removed and reported net of any profit.  
  •  Alliance Agreements:  Clients may enter into relationships, often co-terminus, with service providers such that each assumes both role of client and service provider, aligning themselves for a common goal. These agreements normally have the service provider committing to sell or present to their other clients the original client’s products.  The challenge is that the contract language may create a relationship between the two parties that alters how they can recognize all or parts of revenue earned between the two agreements.  The contract language that most often creates this scenario is in the termination section.  This is a complex issue and both parties’ accounting experts (often outside auditors as well) will need to read the contacts to determine the appropriate accounting treatment for the revenue streams between the parties.   

PRICING STRUCTURE AND EMBEDDED LEASES – What is the service provider doing to win the deal?  What is the nature of the services being contracted for?  These questions need to be answered to determine service provider revenue recognition and client expense timing.  Embedded leases offer challenges for both parties. Clients may need to carve out part of their service costs, often with the service provider’s help.  Service providers must do the same with their revenue streams. The “lease” part of the transaction will be recognized in a different cadence (normally straight-line) than the actual billing or invoice streams.

• Service provider and client issues:
  • Financial Engineering. Did the service provider shift fees to make the start up less financially stressful to the client?  Perhaps the deal starts towards the end of a fiscal year and the client does not want the hit to their cash around year end.
  • Services supported by dedicated assets.  Does the client physically control the asset or access to the asset?  Do they consume nearly all of the output? 

Both of these scenarios could force the service provider to recognize a lease on their books and straight-line some of the revenue recognition.  The cash AND expense timing are irrelevant.  Either situation above may also cause the client to carve out part of the service price and recognize it separately.   

As always, client and service provider accounting experts should be engaged, but we can offer direction to the teams on issues that need to be addressed.

Thought for the day, “Expense and revenue recognition don’t always mirror cash flows.  The matching principle, recognizing revenues and their related expenses in the same period, is not as straightforward as it used to be. Cash may be king, but generally accepted accounting principles are checkmate.”

More to come…

 

Continuous improvement and innovation in services agreements – making it really work

By Cynthia Batty, Global Competency Lead, Service Management, TPI

It sounds like a great idea: continuous improvement and innovation are commonly included in outsourcing contracts, generally in two ways. First, TPI’s method for continuous annual improvement of service level performance has become the industry standard. We highly recommend this approach which has enjoyed nearly two decades of successful deployment.

The other way that continuous improvement and innovation are included is typically a clause in the Master Service Agreement that requires the service provider bring forward three to five ideas each year to improve services and technology or save money. Because these ideas may cause a reduction of the fee to the Service Provider, these clauses are normally supported by Gainshare clauses.  This means if there is significant reduction of the fees, then a structured program will allow the Service Provider to also reap some of the financial benefit for a period of time after the idea is implemented.

The challenge with continuous improvement and innovation in contracts is that the achievement of the objectives involves both the service provider and the client – it’s not a one-way street. Unfortunately, in the rush of daily service delivery, often neither party returns to the contract to recall that these promises were made, or to create a process through which they could be delivered. Most of the midlife engagements we see have such clauses in the agreements, which have never been executed – or even thought about by either party!

Continuous improvement and innovation are creative conditions; ideas do not simply materialize out of thin air in the course of service delivery. Every client situation is unique, and potential innovations must be proposed in the context of the situation. We recommend that clients create a specific focus on innovation in their governance process.  This requires that an innovation structure is created and time is set aside for both teams to think about potential ideas, review industry conditions, take input from the service provider’s experience in other engagements and best-practice think tanks, and come up with proposals that the leadership teams can evaluate.

Merely having an idea is not enough for the innovation process; there are technical feasibility studies to be done, contract review to ensure that the idea is really a new one and not contemplated already in the agreement, and the financial business case to support investment or validate gainsharing. The Innovation team will reach out to the Client’s Service Management & Governance team members for support – the Contract Manager, Finance Manager, and Service Delivery Managers, and often business stakeholders. Retained functions such as Architecture and Security teams may also be involved on both sides of the relationship. This innovation process creates buy-in across the two organizations which will have to represent the value of the idea to their respective leadership teams, making the likelihood of the idea’s implementation much greater.

Continuous improvement and innovation are a way of thinking that can only thrive in a well-governed relationship. Governance excellence is essential – and we find that clients who focus on structure and process in their relationships not only are able to realize the benefits of continuous improvement and innovation, but that other benefits also come along: friction between the two teams is dramatically reduced, problems get solved in an orderly way, and the management chain knows exactly what is going on in the services relationship. TPI has created a tool to help clients look at the continuous improvement of their own governance and management capability – our SM&G Maturity Assessment. This tool can be used to baseline a client organization’s shared and sourced services management capability, and repeated periodically over time to measure continuous improvement in this essential capability. A well-managed relationship is a happy, productive, and innovative relationship.

Accounting Considerations in Sourcing Environments: Start-up & Transition and Asset Ownership

By: John Klee, Senior Advisor, TPI

* TPI is not an accounting firm and does not give accounting advice or guidance. Clients and service providers need to engage their own accounting groups for formal opinions; however, TPI is familiar with the RFP formation and industry practices that should be incorporated into the client decision process.

There are several issues that need to be considered around start-up & transition and asset ownership including:

• Asset ownership:  Asset valuations, Lease Types
• Start-up, Transition, Transformation and One-Time Charges: Expensed vs Capitalization
• Restructuring costs

ASSETS - Some deals may include the purchase or transition of assets from a client to the service provider.  While this is less common than in prior years, it still happens.  What are the issues that need addressed?

• Ownership – who actually owns the asset?
  • Ownership is often based on control.  Remember the old saying, “Possession is nine-tenths of the law”?  If you have exclusive rights to possess and control the property or consume all or most of its output, then you likely “own” the asset from an accounting interpretation.  Whether you have title or not will determine if you have the asset on your books as PP&E (Property, Plant & Equipment) or a lease.
• Valuation – how do both parties value the transaction?
  • It is always easier for the entity transferring the asset (normally client); they use book value as the basis and assign the actual “price” based on the contract details. The receiving entity will look for FMV (Fair Market Value) often using outside companies that provide this service.
• Leases – Operating versus Capital and Embedded leases.
  • Leases can be determined to be operating or capital.  Without getting into the detail, the benefit is that operating leases do not show up on a company’s balance sheet.  However, the entities that issue accounting guidance in the US and International markets are working together in redefining their leasing guidance and eliminating the operating lease.      

UPFRONT COSTS – There are a variety of costs incurred before actual services begin or in the initial stages of delivery.  Most of these costs are expensed by the client.  Service providers need to follow various revenue recognition guidelines in order to recognize the revenue when actually earned (and not at risk) versus when billed or cash is collected.

• Client costs – when to recognize
  • As stated, most transition and transformation costs are expensed by clients.  This includes setting up any Governance Offices related to the new contract.  This does not mean that any actual capital expenditures (PP&E) made for the Governance Office are not capitalized.
  • Costs that may be capitalized are those related to the development or modification of internal use software.  This can be done as a project, as part of a service contract’s scope of work or within the transition/transformation work.  The general rule is that the actual costs of development/modification of the SW created or modified for internal use can be capitalized. 
• Restructuring Costs:  A Special Case.  If clients are exiting a line of business or laying off people in an executive-level charted plan, they may be able to accelerate the recognition of some of these costs.  However, the rules are tightening on this and client accounting staffs will need to review current pronouncements. 

As always, client and service provider accounting experts need to be engaged, but we can offer direction to the teams on issues that must be addressed. 

Thought for the day, “Accounting rules are leaning towards full-disclosure, which is giving owners and investors as much information as possible.  Off-Balance Sheet financing, major accounting scandals and other issues have driven regulatory and accounting guidance to tighten rules and attempt to increase transparency in financial statements.  This is good for everyone, but the person making all the journal entries.”

More to come…

 

ExcellerateHRO departing multi-process HRO; not as simple as it sounds...

By Jeff Croyle, Partner, TPI

By now, you’ve probably heard that EHRO and Cardinal Health are terminating their HRO deal and that EHRO is getting out of the “utility-based, multi-process HR” business.  It is important to understand that EDS/HP is not exiting the HRO space; instead they will continue to pursue customized HRO solutions. And EHRO will still be in the benefits administration business.  Following are my thoughts on the announcement.

EHRO started as a joint venture between EDS and Towers Perrin in 2005; 3 months ago Towers Perrin sold their 15% stake and EDS is now the sole owner of EHRO.  (EDS itself was purchased last year and now is a wholly owned subsidiary of HP.)  Separate from EHRO, EDS has a few HRO and payroll clients yet there was never an effort to integrate EDS and EHRO clients onto the same platform, leverage investments or share best practices.  Many of EDS’ HR clients were “lift and shift” operations whereas EHRO tried to build their client base leveraging the platform built to support Cardinal Health.  It is safe to say that neither approach was very successful for either EDS or EHRO.  EDS has decided that going forward they will only support customized solutions, leveraging EDS’ core strength in technology buildouts (and doing it under the EDS brand instead of EHRO).  This approach is contrary to the direction taken by most other HRO providers that are interested in leveraging their investments by building a “one-to-many” platform. 

Taken by itself I don’t see the EHRO announcement as having much impact.  EHRO has never had the scale or track record to have an impact on the HRO market and we don’t see there being much of a demand from buyers interested in totally customized solutions with large upfront investments.  But coupling this news with Fidelity’s recent announcement that they are also getting out of the HRO market, it’s clear that firms are still struggling to make money in the multi-process HRO space.  Luckily for buyers, the India-heritage BPO firms are more than willing to step in and fill the competition void with EHRO and Fidelity’s departure from this space.”

“It’s an Accounting Issue” - Accounting Considerations in Sourcing Environments

By: John Klee, Senior Advisor, TPI

How many times have we, as advisors, heard that from both service providers and clients?  What does that mean?  Do they know what it means or is it just some vague, black hole that they are afraid to enter?  Well, someone has to step through that door and while TPI does not give accounting advice it is often the TPI advisor who is looked at for answers when a question arises.  Clients and service providers need to be strongly encouraged to engage their own accounting resources, but we need to do more.

Speaking from a U.S. GAAP perspective, there have always been accounting specific rules that impact outsourcing contracts.  And since the passage of The Sarbanes-Oxley Act of 2002 (SOX, SOXA, SarBox, etc), the focus and need for accurate reporting and controls has risen.  TPI is familiar with RFP formation and industry practices that should be incorporated into the client decision process.

Why are the underlying accounting considerations important?  Sourcing strategy, RFP structure, SPsSolution, contract drafting and negotiations all will be impacted by the accounting considerations.  Clients may not accomplish their goals if they ignore the accounting treatments of transactions.  Service providers will be faced with several revenue recognition challenges as they maneuver to win the deals; clients should be aware of what motivates a Service provider during negotiations.

When is the best time to address these issues?  NOW!  Waiting to address and decide on these issues exposes the process to delays and temporary or permanent derailments.

Accounting considerations are integral to streamlining the process

• The client can improve the efficiency of the process by:
  • Setting forth a strategy and RFP design consistent with their internal accounting direction 
  • Engaging the internal accounting team sooner rather than later  
• Which should then:
  • Avoid potential delays in the schedule and or rework, and  
  • Save both time and money on behalf of both the client or the service provider 

The earlier you begin the discussions the better position the client has:

• In setting forth their sourcing strategy;
• Incorporating requirements into the original RFP;
• Getting service provider compliance;
• Service provider negotiations are generally more productive and efficient prior to contract signing than after;
• Restructuring financials to comply with accounting considerations is easier before “savings value” has been communicated than after.

What accounting issues can impact the Sourcing strategy and/or RFP structure? 

• Asset ownership:  asset valuations, embedded leases in service contracts, lease capitalization
• Start-up, transition and one time charges:  expensed vs. capitalization
• Potential alliance agreements:  Related party transactions, gross vs. net revenue recognition
• Regulatory compliance:  Sarbanes-Oxley Act, SAS70, etc
• Pricing structure:  service provider revenue recognition
  • After collecting cash, recognizing the revenue streams related to those collections is often a Service providers management’s greatest concern 

I will specifically address some of these accounting issues in future blogs.

Until next time, I leave you with this thought, “It’s an Accounting Issue.  How do you know?”