Strategic Outsourcing: Analyzing the Cost Benefits

Originally published: Nov-28-2006

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Over the last twenty years, the attitude of business toward outsourcing has undergone change reflecting the need to compete globally and focus on core competencies. Today corporate executives think in terms of two process categories: (1) those they need to own and manage directly; and (2) those that are non-core and can be contracted out, in whole or in part, to achieve improved efficiency and effectiveness.

Outsourcing and Receivable Management

Some companies view receivable management as a support function, making the strategic decision to outsource all or most of the activity. Others see it as a vital ingredient in their customer relationships, but seek opportunities to outsource some tasks.

Although reduction in operating costs should not be the sole reason to outsource, practically every outsourcing decision should result in cost savings. Yet some companies (or departments within companies) actually resist outsourcing, believing they can do it better, faster, and cheaper in-house. In a few cases, this may be true. But in most, this thought process is not based on a complete and accurate analysis of the facts.

Analyzing Direct Costs

When considering outsourcing all or part of any business process, the following associated costs need to be taken into account:

It is essential to understand these costs in the context of the activities which make up the function. Unfortunately, most organizations capture them on a cost element basis (i.e. total salary, total benefits, total postage, etc.) and not a process or activity basis. Without a good understanding of the process cost, it is difficult to compare the value of an external provider.

The process to determine activity-based costs involves five steps:

1. Identify all activities that make up the function.
2. Group similar activities (10-15 with no one representing more than 20% of the total cost).
3. Determine the activity drivers, for instance:
   • Labor driver (% of person’s time used by an activity)
   • Non-labor driver (% of office space utilized or number of machine hours required for the activity).
4. Determine the cost of the activity drivers.
5. Produce the list of costs related to each activity.

For a truly complete understanding, anticipated future costs of maintaining the process in-house should also be calculated.

While it is difficult to compare value without understanding the process cost, it is possible to get a “feel” for the cost savings of outsourcing 1st party receivable collections. ABC-Amega has developed a simple ROI tool that compares the direct costs of each in-house collector – FTE (full-time equivalent) – required to perform the function to the “per FTE” or “monthly management fee” quoted by the collections outsourcing provider. The worksheet also calculates the Cash Flow benefit of outsourcing this aspect of receivable management based on an improvement in DSO.

Analyzing Indirect Costs

Besides the direct costs involved, there are other, cost-related benefits of outsourcing to be considered. These include:

• Turning Fixed Costs into Variable Costs. For most companies, employee related costs and the associated overhead are relatively fixed, regardless of product or service demand. This can be very costly during slow sales periods. Outsourcing turns these fixed costs into variable costs, as the providers have greater economies of scale and thus can price for variable demand.
• Reducing Investments in Assets. There are current expenses that benefit future years, like investments in training, other employee development, and transformation/reengineering programs. Outsourcing effectively transfers these ongoing investments to the provider.
• Improving Cash Flow. Future growth is always depending upon adequate cash flow. Outsourcing some or all of the receivable management function can assure a company of tying receiving resources directly to sales volumes. Companies experiencing strong growth cannot afford to have cash tied up in receivables while new credit and collection staff take 3-6 months getting up to speed.

Benchmarks

Once you have determined your process costs, comparison to industry benchmarks can give you an idea how you are doing in relation to other companies, and how the outsourcing provider stacks up.

Sources for credit and collection benchmarks include:

• Credit Research Foundation – www.crfonline.org
• National Association of Credit Management – www.nacm.org
• Credit Today – www.credittoday.net
• Institute of Management and Administration – www.ioma.com

It is not unheard of to achieve 50-75% reduction in process costs by outsourcing! Obviously, given this kind of differentiation, efficient back-office operations can provide significant cost advantage.

Conclusion

The drive toward outsourcing is “irreversible”, states an Outsourcing Center BPO Special Report, and will have long-term ramifications of (1) forcing companies to use process-based (activity-based) costing models, and (2) eradicating cost centers forever.

If your company hasn’t yet gotten your outsourcing feet wet, consider a quote from PricewaterhouseCoopers: “Only the companies that are best-in-world are going to do well [in the global economy] and they are going to have to focus on what they do well and outsource the rest.”

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ABC-Amega provides effective 1st party receivable management outsourcing solutions for projects small and large, short term and long, national and international. We’ve been doing it since 1989. If you’d like to speak to one of our representatives about how our solutions can help you resolve your issues, call 1-800-732-0206 or email info@abc-amega.com.