Financial Management: Outsourcing of Finance and Accounting Functions
(Letter Report, 10/17/97, GAO/AIMD/NSIAD-98-43).

Pursuant to a congressional request, GAO provided information on the use
of outsourcing to achieve cost savings, management efficiencies, and
operating flexibility in finance and accounting operations, focusing on:
(1) the extent to which selected private-sector and nonfederal public
organizations used outsourcing as a strategy to improve financial
operations and reduce costs; (2) existing outsourcing vendor capacity to
perform finance and accounting operations; and (3) factors associated
with successful outsourcing.

GAO noted that: (1) GAO's analysis of the experiences of 15
private-sector organizations coupled with discussions with industry
experts and outsourcing vendor officials and a literature review
revealed that nonfederal organizations use a variety of strategies to
improve their financial operations and reduce costs; (2) while all the
private-sector organizations GAO reviewed considered outsourcing as a
financial improvement option, they have relied principally on other
strategies, such as consolidating systems and operating locations or
reengineering business processes, to achieve their financial improvement
objectives; (3) to the extent that these private organizations have
outsourced any portion of their finance and accounting operations, such
outsourcing was generally limited to routine, mechanical tasks, such as
check writing or payroll processing; (4) only 3 of the 15 organizations
GAO contacted had outsourced an entire process within a finance and
accounting function; (5) the existing limited capacity of outsourcing
vendors to perform larger, more complex finance and accounting
operations may have constrained wider use of outsourcing by these
organizations; (6) experts in the outsourcing field have estimated that
it may be 3 to 5 years before this type of capacity is widely available;
(7) the experiences of the organizations in GAO's review and GAO's
analysis of pertinent literature may provide some lessons for future
federal agency outsourcing decisions; (8) factors considered as part of
the outsourcing decision process and often associated with successful
outsourcing were: (a) establishing an outsourcing policy that specifies
what process and criteria to follow in making the outsourcing decision
that will achieve the organization's overall goals; (b) performing a
strategic analysis to determine the organization's core competencies;
(c) benchmarking the organization's processes against those of
world-class organizations to determine comparable costs and identify any
deficiencies in its operations; (d) performing market research to
determine whether a competitive market exists for the outsourcing
services the organization needs; and (e) considering carefully the
ramifications of potential job loss or other possible adverse personnel
impacts that could occur as a result of outsourcing; and (9) after an
organization decided to outsource, two key factors identified with
successful outsourcing arrangements were: (a) maintaining sufficient
expertise and control to effectively oversee the outsourcing vendor; and
(b) establishing a results-oriented contract that included appropriate
performance measures.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  AIMD/NSIAD-98-43
     TITLE:  Financial Management: Outsourcing of Finance and Accounting 
             Functions
      DATE:  10/17/97
   SUBJECT:  Privatization
             Financial management
             Cost effectiveness analysis
             Accounting procedures
             Service contracts
             Internal controls
             Contract monitoring
             Federal procurement
             Federal agency accounting systems
             Human resources utilization

             
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Cover
================================================================ COVER


Report to Congressional Requesters

October 1997

FINANCIAL MANAGEMENT - OUTSOURCING
OF FINANCE AND ACCOUNTING
FUNCTIONS

GAO/AIMD/NSIAD-98-43

Outsourcing Finance and Accounting

(918918)


Abbreviations
=============================================================== ABBREV

  AMA - American Management Association
  BPO - business process outsourcing
  DOD - Department of Defense
  DSB - Defense Science Board
  GMRA - Government Management and Reform Act
  OMB - Office of Management and Budget

Letter
=============================================================== LETTER


B-274832

October 17, 1997

The Honorable Strom Thurmond
Chairman, Committee on Armed Services
United States Senate

The Honorable Fred Thompson
Chairman
The Honorable John Glenn
Ranking Minority Member
Committee on Governmental Affairs
United States Senate

According to Office of Management and Budget (OMB) estimates, the
federal government spent over $7 billion in fiscal year 1997
performing, maintaining, and improving finance and accounting
operations.  Auditors, however, have consistently reported that these
operations continue to be plagued by deficiencies that undermine the
government's effectiveness and drain resources that could be used
elsewhere.  Outsourcing--
contracting for performance of a function previously performed
in-house--is one approach considered by private sector organizations,
as well as state and local governments, to help reduce costs and
improve the quality of financial management operations. 

This report responds to one aspect of your request for information on
the use of outsourcing to achieve cost savings, management
efficiencies, and operating flexibility in finance and accounting
operations.  Specifically, the objective of this report is to present
information on (1) the extent to which selected private sector and
nonfederal public organizations used outsourcing as a strategy to
improve financial operations and reduce costs, (2) existing
outsourcing vendor capacity to perform finance and accounting
operations, and (3) factors associated with successful outsourcing. 
As agreed with your offices, we will report separately on the
remaining three areas included in your request. 

This report is based on our analysis of information obtained from 15
large private sector and nonfederal public organizations that either
outsourced or considered outsourcing a finance and accounting
function.  In addition, we analyzed information obtained from finance
and accounting outsourcing consultants and vendors and related
outsourcing literature. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :1

Our analysis of the experiences of 15 private sector organizations
coupled with discussions with industry experts and outsourcing vendor
officials and an extensive review of available literature revealed
that nonfederal organizations use a variety of strategies to improve
their financial operations and reduce costs.  While all the private
sector organizations we reviewed considered outsourcing as a
financial improvement option, to date, they have relied principally
on other strategies, such as consolidating systems and operating
locations or reengineering business processes, to achieve their
financial improvement objectives. 

To the extent that these private organizations have outsourced any
portion of their finance and accounting operations, such outsourcing
was generally limited to routine, mechanical tasks, such as check
writing or payroll processing.  Only 3 of the 15 organizations we
contacted had outsourced an entire process within a finance and
accounting function.  The existing limited capacity of outsourcing
vendors to perform larger, more complex finance and accounting
operations may have constrained wider use of outsourcing by these
organizations.  Experts in the outsourcing field have estimated that
it may be 3 to 5 years before this type of capacity is widely
available. 

The experiences of the organizations in our review as well as our
analysis of pertinent literature may provide some lessons learned for
future federal agency outsourcing decisions.  Specifically, the
following factors were considered as part of the outsourcing decision
process and were often associated with successful outsourcing: 

  -- establishing an outsourcing policy that specifies what process
     and criteria to follow in making the outsourcing decision that
     will achieve the organization's overall goals,

  -- performing a strategic analysis to determine the organization's
     core competencies,

  -- benchmarking the organization's processes against those of
     world-class organizations to determine comparable costs and
     identify any deficiencies in its operations,

  -- performing market research to determine whether a competitive
     market exists for the outsourcing services the organization
     needs, and

  -- considering carefully the ramifications of potential job loss or
     other possible adverse personnel impacts that could occur as a
     result of outsourcing. 

In addition, after an organization decided to outsource, two key
factors were identified with successful outsourcing arrangements. 
First, successful outsourcing organizations ensured that they
maintained sufficient expertise and control to effectively oversee
the outsourcing vendor to prevent fraud, waste, or mismanagement. 
Without effective oversight controls, organizations cannot
effectively ensure that vendors carry out their fiduciary
responsibilities.  Second, successful outsourcing was more likely
when an organization established a results-oriented contract with an
outsourcing vendor that included appropriate performance measures. 


   BACKGROUND
------------------------------------------------------------ Letter :2

A few organizations have outsourced parts of their operations for
many years.  Recently, however, interest in more widespread use of
outsourcing has increased dramatically.  This trend is documented in
a recent research report which states that outsourcing has become "a
growing business phenomenon and possibly even a cultural
phenomenon."\1

Early outsourcing focused on relatively low-skilled support functions
such as janitorial, food service, guard, or data entry services. 
However, a recent international outsourcing study found that
outsourcing in some areas, such as information technology--including
information systems development--is growing rapidly.\2 Some
organizations have also begun to outsource functions dependent on
information technology, such as customer service, research and
development, logistics management, and finance and accounting. 


--------------------
\1 Alex.  Brown & Sons Incorporated, Outsourcing:  Growth Opportunity
of the '90s (Baltimore, MD; Alex.  Brown & Sons Incorporated, 1996). 

\2 PA Consulting Group, Strategic Sourcing:  International Survey
1996, (London, UK; PA Consulting Group, 1996). 


      OUTSOURCING DEFINITIONS VARY
---------------------------------------------------------- Letter :2.1

While outsourcing is growing, the concept is not clearly or uniformly
defined.  Definitions of outsourcing can be viewed as ranging from
the prolonged use of consultants to perform a simple task to
transferring the responsibility for performing an entire internal
function to a third party.  In our recently issued glossary of terms
associated with government privatization initiatives,\3 we state that
"under outsourcing a government entity remains fully responsible for
the provision of affected services .  .  .  while another entity
operates the function or performs the service." We also state that
this approach "includes contracting out, granting of franchises to
private firms, and the use of volunteers to deliver public services."
Consistent with this definition, we have defined outsourcing for this
report as applied to nonfederal organizations as contracting out the
continuous performance of a process, activity, or task that was
previously performed within the organization. 

One form of outsourcing used in the federal arena is cross-servicing,
an arrangement where one agency provides support services to another
agency on a reimbursable basis.  Cross-servicing can range from
providing computer and software timesharing services to full-service
administrative processing.  An analogous arrangement in the private
sector is the use of shared service centers, which are locations or
organizations within a large organization that provide common
services to operating locations or business units.  In accordance
with the definition of outsourcing used in this report, these
intra-organization arrangements are discussed as alternative
strategies that nonfederal organizations have used to improve their
financial operations. 

In addition, when considering outsourcing, an organization may focus
on an entire function or portions of a function.  To illustrate, an
organization's finance and accounting function\4 is comprised of
processes, activities, and tasks.  The payroll process includes
various activities, such as calculating employees' gross compensation
for the pay period, determining and deducting amounts from gross
compensation to calculate net pay, and printing and distributing
payroll checks.  Each activity, in turn, includes one or more tasks. 
The activity of calculating employee compensation, for example,
includes such tasks as collecting time cards, tabulating time worked
or leave taken per employee, and multiplying hours worked or leave
taken per employee by the appropriate pay rate.  An organization
would have the option to outsource an entire process, one or more of
the activities, or merely one or more of the tasks. 


--------------------
\3 Glossary:  Terms Related to Privatization Activities and Processes
(GAO/GGD-97-121, July 1997). 

\4 Considerable ambiguity exists as to what constitutes an
organization's finance and accounting function.  Appendix I, which is
based on our synthesis of available sources, lists and describes the
processes we considered to be part of the finance and accounting
function for the purposes of this report. 


      FEDERAL AGENCIES ARE
      INCREASINGLY CONSIDERING
      OUTSOURCING
---------------------------------------------------------- Letter :2.2

OMB Circular A-76, first issued in 1966, encourages agencies to
obtain reliable, internal cost and performance information before
acquiring goods and services from the private sector through
outsourcing.  The circular established the policy and procedures
federal agencies must follow in

determining whether existing federal government commercial activities
should be outsourced.  OMB officials told us that they consider
outsourcing to be a viable tool for improving financial management in
the federal government and stated that they would like to see federal
agencies outsource as much of their accounting and finance functions
as possible to other government agencies or the private sector.\5

At present, a number of federal agencies have their payroll processed
by the Department of Agriculture's National Finance Center through a
cross-servicing arrangement.  Several other agencies, including the
Department of Justice and the Agency for International Development,
have outsourced portions of their financial operations.\6

Recently, there has been considerable interest in outsourcing DOD's
support activities.  In August 1995, the Deputy Secretary of Defense
directed the military services to make outsourcing of support
activities a priority.  A May 1995 report by the Commission on Roles
and Missions of the Armed Forces identified financial management as a
prime candidate for outsourcing in DOD.  Further, an August 1996
Defense Science Board (DSB)\7 Task Force report on outsourcing found
that functions such as accounting, payroll, travel reimbursement,
invoicing, debt management, and other support functions are routinely
performed in the private sector by a range of outside vendors and
recommended that those functions be outsourced.  A November 1996 DSB
report estimated that such finance and accounting outsourcing could
result in substantial savings for DOD.  However, subsequently, while
agreeing that the potential for savings exists, we questioned the
size of DSB's savings estimates.\8 In addition, a number of studies
to determine the feasibility of outsourcing certain DOD finance and
accounting activities, such as travel processing, payroll, and
contract disbursements, have been requested by the Congress and are
now under way. 


--------------------
\5 In a 1989 decision, the Comptroller General stated, with regard to
federal agencies, that the services of contractors could not be
procured to exercise discretion, make value judgments, or set policy
on behalf of the government.  (B-237356, December 29, 1989.)

\6 The Government Management Reform Act (GMRA) of 1994 established a
franchise fund pilot program.  Under this pilot program, designated
agencies will provide common administrative support services such as
personnel, payroll, or accounting services through self-supporting
organizations in a businesslike manner. 

\7 The Defense Science Board is a Federal Advisory Committee
established to provide independent advice to the Secretary of
Defense. 

\8 Defense Outsourcing:  Challenges Facing DOD as It Attempts to Save
Billions in Infrastructure Costs (GAO/T-NSIAD-97-110, March 12,
1997). 


   OBJECTIVES, SCOPE, AND
   METHODOLOGY
------------------------------------------------------------ Letter :3

The objectives of our review are to develop information on (1) the
extent to which selected private sector and nonfederal public
organizations used outsourcing as a strategy to improve financial
operations and reduce costs, (2) existing outsourcing vendor capacity
to perform finance and accounting operations, and (3) factors
associated with successful outsourcing. 

To accomplish our reporting objectives, we obtained information on
finance and accounting outsourcing from an outside consultant with
unique information on the business process outsourcing market.  We
also conducted an extensive literature and Internet search on the
subject of outsourcing, and we interviewed individuals from a number
of organizations representing varying perspectives on outsourcing
finance and accounting operations. 

Our interviews included 12 judgmentally selected private sector
corporations, 1 large international quasi-government organization, 1
state government organization, and 1 city government organization. 
These organizations represent a broad cross-section of U.S. 
industries ranging from commodities to the transportation and
manufacturing industries.  We selected the organizations based on
either (1) literature citations indicating that they had outsourced
one or more accounting functions or (2) size, industry, and level of
accessibility.  All but one of these organizations had annual
revenues in excess of $1 billion and about two-thirds had annual
revenues exceeding $15 billion.  Our interviews of cognizant key
officials in these organizations focused on first determining if they
used finance and accounting outsourcing to improve their financial
management organization.  If they used this type of outsourcing, we
asked them to describe the factors they considered important to a
successful outsourcing arrangement.  We also asked executives at each
organization about outsourcing trends they were aware of in their
respective industries. 

We contracted with G-2 Research, Inc., to provide us with detailed
information related to the finance and accounting outsourcing market. 
G-2 Research is the market research firm that identified business
process outsourcing (BPO), which includes finance and accounting
outsourcing, as an emerging market approximately 5 years ago.  At the
time of our fieldwork, G-2 specialized in tracking and compiling data
on the BPO market.  G-2 informed us that it uses annual interviews of
nearly 3,000 corporate executives as well as its regular contacts
with major outsourcing vendors, to track the outsourcing market and
identify trends and major market participants. 

Through an extensive literature and Internet search, we identified
outsourcing vendors, customers, trade organizations, consultants, and
knowledgeable academicians and obtained information on the finance
and accounting outsourcing industry capabilities and trends.  We
subsequently talked with 13 major outsourcing vendors and 12
consultants who are active in the outsourcing industry. 

Many of our discussions with private sector organizations addressed
information of a sensitive business or proprietary nature.  To
protect this type of information, our report does not identify either
the outsourcing service providers or end-users that we talked to. 

Finally, we synthesized and analyzed the numerous documents acquired
from our search or provided by the various organizations we
interviewed to determine procedures and factors that are generally
accepted as vital to successful outsourcing. 

We provided a draft of this report to our consultants at G-2
Research, Inc.  and the President of the Private Sector Council.  We
incorporated the technical clarifications they provided as
appropriate in the report.  We also provided relevant sections of the
report to those organizations included in our review that are
referred to in specific examples throughout the report and
incorporated their comments as appropriate.  Our work was conducted
in accordance with generally accepted government auditing standards
from July 1996 through September 1997. 


   OUTSOURCING IS ONE OF SEVERAL
   APPROACHES CONSIDERED FOR
   IMPROVING FINANCIAL MANAGEMENT
------------------------------------------------------------ Letter :4

Organizations have a number of options for improving their financial
management operations.  In addition to outsourcing they can, among
other things, reengineer their business processes, consolidate the
performance of functions in shared service centers, or implement new
enterprisewide accounting and information systems.  Over the past
several years, organizations have to varying degrees and in varying
combinations used all of these financial management improvement
approaches. 

The use of outsourcing to help improve finance and accounting
activities is growing and there are clear indicators that more large
private sector organizations are actively considering it as an option
to improve efficiency and drive down administrative costs.  A 1996
American Management Association (AMA) member survey found that
finance and accounting outsourcing, while used less frequently than
other types of outsourcing, has grown rapidly since 1994.  Eighteen
percent of the 619 responding firms were outsourcing all or part of
one or more finance and accounting functions other than payroll. 
Payroll was outsourced in whole or in part by 38 percent of the
responding firms.  In addition, the survey found that larger
firms--those with 10,000 or more employees--were more likely to
outsource one or more financial processes.\9

This buttresses the results of a 1995 survey, conducted for an
outsourcing firm, of 400 senior managers of medium and large firms on
business change strategies.\10 That survey found that 25 percent of
the respondents considered payroll and accounting processes best
suited for outsourcing.  A research organization has predicted that
business process outsourcing (including finance and accounting
outsourcing) will grow by over 20 percent a year until the year
2000.\11

Representatives of all of the 15 organizations we spoke to said they
had considered outsourcing as a management strategy for improving
their financial management operations, and 12 organizations had
outsourced portions of their finance and accounting functions. 
However, only 3 of the 12 organizations outsourced one or more entire
processes such as accounts payable, pension payments, general ledger
accounting, fixed asset accounting, or excise and property tax
administration. 

Thirteen of the 15 organizations indicated that they had also used
other options to improve their financial operations, such as
reengineering all or parts of their accounting and finance functions,
establishing a shared service center, or upgrading their financial
systems.  For example, officials from one company stated that their
approach to improving financial management consisted of:  (1)
consolidating the accounting function into as few locations as
possible and having each location move to a single system to
accomplish the function, (2) simplifying existing processes, (3)
developing systems that capture data at the point the transaction
originated, regardless of the location within the organization, and
(4) outsourcing all or parts of processes that could be done more
efficiently or effectively by a third party.  Through these steps,
the company was able to reduce the number of accounting staff by
approximately two-thirds in a 15-year period.  However, according to
organization officials, most of the efficiencies achieved were due to
actions other than outsourcing, and they estimated that outsourcing
accounted for less than 10 percent of the total savings.  Officials
from another organization told us that they were able to reduce the
number of personnel involved in processing accounting transactions by
an estimated 90 percent over a 12-year period through the use of
shared service centers, consolidating systems, and reengineering
their accounting processes. 

Even companies that outsourced entire processes had reengineered
these processes or obtained new accounting systems prior to or at the
same time as outsourcing.  For example, one company reengineered its
accounting processes concurrently with outsourcing a number of
accounting processes.  According to a company official, the
reengineered processes along with the outsourcing arrangements
contributed greatly to large productivity improvements. 


--------------------
\9 American Management Association, Outsourcing:  The AMA Survey,
1997, (New York, NY; American Management Association, 1997).  For the
purposes of this survey, payroll outsourcing was considered a human
resource process rather than a finance and accounting process. 

\10 The Wirthlin Group, Executives on Re-Sourcing:  Quantitative
Survey (McLean, VA; The Wirthlin Group, 1995). 

\11 G-2 Research, Inc., Business Process Outsourcing:  Market
Overview, (Mountain View, CA; G-2 Research Inc.  1997). 


      MOST OUTSOURCING TO DATE HAS
      INVOLVED STAND-ALONE,
      LABOR-INTENSIVE TASKS
---------------------------------------------------------- Letter :4.1

Most organizations that have used outsourcing for portions of their
finance and accounting operations--particularly larger
companies--have contracted for services that typically involve
discrete, repetitive, labor-intensive tasks.  According to the AMA
1996 outsourcing survey, over 70 percent of the organizations that
used outsourcing for clerical, bookkeeping, or data processing
portions of their finance or accounting functions only outsourced
parts of these processes. 

A good example of this task-oriented type of outsourcing is in the
accounts payable process, where a company might handle all the
activities and tasks associated with managing accounts payable
in-house, but contract with an outsourcing vendor to carry out the
check printing and mailing tasks.  Another example is payroll
processing, where a company might handle the human resource and
payroll tasks of entering data and computing employee gross pay
amounts in-house, but contract with a vendor for net pay computation
and paycheck printing and distribution tasks.  Such arrangements
might also require the vendor to do other tasks, such as accumulating
employee pay information and preparing and distributing W-2
statements at the end of the year. 


      MIXED SUCCESS OF OUTSOURCING
      ARRANGEMENTS
---------------------------------------------------------- Letter :4.2

Recent research has shown that, in general, although outsourcing
organizations did not fully achieve the benefits they envisioned,
most achieved at least partial benefits.  For example, the 1996 AMA
member survey found that less than 25 percent of the responding
member firms that outsourced finance and accounting activities and
established cost reduction, time reduction, or quality improvement
goals believed they had fully achieved their goals.  However, most
respondents indicated that they had partially met their goals for
these areas. 

Some of the 12 outsourcing organizations we contacted, while not
willing to share specific results with us, indicated that they had
realized their anticipated benefits, while others indicated that they
had not.  The outsourcing vendor of one of the organizations, with
its client's consent, told us that it reduced the number of staff
processing accounts payable by almost one-third, cut the amount of
time to process accounts payable transactions by over two-thirds, and
was able to implement a computer matching process for about 30
percent of the firm's purchase transactions.  In contrast, one
company that outsourced pension payments believed that its costs
actually increased.  In addition, to the extent that cost reduction
is an outsourcing goal, reductions in the number of an organization's
finance and accounting personnel does not in itself translate into
reducing the organization's overall costs because such reductions may
be offset by increased outsourcing vendor contract costs. 


   CURRENT VENDOR CAPACITY MAY NOT
   MEET THE OUTSOURCING NEEDS OF
   LARGE ORGANIZATIONS
------------------------------------------------------------ Letter :5

The generally limited use of outsourcing for repetitive,
labor-intensive tasks may be attributed, in part, to the lack of a
mature vendor marketplace with sufficient capacity to provide the
larger scale, more complex finance and accounting services often
required by large organizations.  However, there are indications that
the outsourcing market may be on the verge of dramatic growth.  Some
experts in the field have estimated that in 3 to 5 years,
organizations with large, complex finance and accounting operations
will be able to outsource their entire accounting or finance
function.  To date, existing capacity concerns appear to have been a
significant factor in organizations with large, complex finance and
accounting operations moving relatively slowly toward outsourcing. 

Three organizations that outsourced portions of their accounting
function, for example, found only one vendor that was capable of
providing the breadth of service they required.  According to one
consulting firm, while large organizations have been able to find
vendors to outsource portions of their finance and accounting
functions, they have not been able to find vendors that could take
over the entire function.  The firm's study of payroll practices at
over 50 firms confirmed that payroll outsourcing may not be a viable
option for larger operations because outsourcing vendors presently
cannot offer them payroll services at cost-effective rates.  One
organization found that it could not outsource its payroll process
because it was too complex for payroll vendors. 

One state government decided to consider outsourcing its payroll
processing to a third party and requested pricing and service
information from major payroll outsourcing vendors.  None of the
vendors could perform the proposed outsourcing at what the state
deemed to be a competitive price.  The proposed fees were above what
it cost the state to do payroll internally, and the vendors refused
to consider a long-term contract with the state. 

We have previously reported that the lack of a competitive
marketplace affects the cost savings that can be achieved through
outsourcing.\12 Consequently, if available outsourcing vendors cannot
provide desired services at a competitive rate, an organization
procuring outsourcing services may not achieve its outsourcing
objectives. 


--------------------
\12 Public-Private Mix:  Effectiveness and Performance of GSA's
In-House and Contracted Services (GAO/GGD-95-204, September 29, 1995)
and Defense Depot Maintenance:  Commission on Roles and Mission's
Privatization Assumptions Are Questionable (GAO/NSIAD-96-161, July
15, 1996). 


   FACTORS ASSOCIATED WITH
   SUCCESSFUL OUTSOURCING
   DECISIONS
------------------------------------------------------------ Letter :6

Our work with outsourcing users, vendors, and consultants identified
the following five key factors often associated with successful
decisions to outsource finance and accounting operations. 


      OUTSOURCING SHOULD BE DONE
      IN CONTEXT OF OVERALL
      OUTSOURCING POLICY
---------------------------------------------------------- Letter :6.1

A corporate outsourcing policy can ensure that all factors associated
with an outsourcing decision are identified and addressed.  Concerns
over whether and the extent to which outsourcing may affect an
organization's goals and operations must be carefully considered. 
Such a policy should be explicit on the extent to which outsourcing
will be used to reduce costs, improve efficiency, or increase
organizational flexibility.  The overall view gleaned from the 15
organizations and outsourcing experts interviewed is that the
outsourcing decision and implementation should involve the same type
of rigorous analysis, careful planning, and management involvement as
any other major business decision. 

Many experts believe that a corporate policy that describes and
requires a structured outsourcing process is necessary for successful
outsourcing.  For example, on the basis of extensive research, one
organization developed an outsourcing policy to guide and provide a
structured process for deciding whether to outsource.  In part, the
policy requires (1) clear objectives for outsourcing, (2) a
recognition of all available service delivery options (e.g., internal
staff versus third party), (3) a rigorous cost/benefit analysis, (4)
buy-in by all affected parties, and (5) communication with employees
throughout the outsourcing decision-making process. 

Under another organization's outsourcing policy, the designated
outsourcing team was to identify those functions that were candidates
for outsourcing and apply specified criteria for deciding what
functions to outsource.  Outsourcing proposals were to include a
detailed risk analysis that addressed the proposed outsourcing's
potential impact on such key areas as cost, savings, service quality,
system conversion, retraining of personnel, and the potential for
disruption of services.  Management believed that the outsourcing
arrangements developed under this policy were successful in that the
company met its outsourcing goals. 

In contrast, two organizations we talked to had negative outsourcing
experiences, which they attributed, in part, to not having an
outsourcing policy in place that clearly prescribed a methodology for
analyzing costs and for considering all relevant risks associated
with such an outsourcing decision.  Not until one of these
organizations had obtained bids from vendors and was near awarding a
contract were concerns raised about the validity of cost estimates
and the increased legal and computer security risks.  The
organization's president decided to cancel the planned outsourcing
until the organization had an outsourcing policy and cost estimation
methodology in place.  Another organization made the decision to
outsource in a rapid fashion without going through a structured
process that would be specified in a corporate outsourcing policy. 
The resulting outsourcing arrangement was not well received by the
organization's employees and resulted in confusion over the purpose
and extent of the arrangement. 


      ASSESSMENT OF CORE
      COMPETENCIES CRITICAL WHEN
      DETERMINING WHAT TO
      OUTSOURCE
---------------------------------------------------------- Letter :6.2

Decisions on outsourcing are becoming part of the organizational
strategic planning process with the goal of increasing
competitiveness in the world market.  In considering whether to
outsource, organizations have assessed functions strategically in
terms of their relationship to core competencies.  Core competencies,
as defined by G-2 Research, Inc., a firm specializing in business
process outsourcing market research, are the essential, defining
functions of an organization--those things that if given to an
external party, would create a competitor or result in the
dissolution of the company.  A hospital's core competencies, for
example, would be those directly associated with caring for patients. 
Core competencies have also been defined as those few functions
within a company where the company can dominate, that are important
to the customers, and that are embedded in the organization's
systems.  Involvement of an organization's senior management in the
process was often identified as essential to ensuring that an
organization's competencies are assessed strategically on an
organizationwide basis rather than by function. 

Other functions are considered non-core and can be considered either
critical or noncritical.  Non-core critical functions are important
to an organization but are not directly linked to what the
organization perceives as its primary mission.  If not performed at
world-class levels, however, these functions can place an
organization at a competitive disadvantage or even endanger its
existence.  For most organizations, such functions would include
finance, accounting, and human resources administration.  Noncritical
functions are those that supply no competitive advantage and that
even if performed poorly, may not seriously harm an organization. 
Examples generally include cafeteria services, groundskeeping, and
laundry. 

Outsourcing arrangements for many organizations usually start with
noncritical functions.  As the organization becomes more accustomed
to relying on others to perform simple, noncritical functions, the
organization tends to consider outsourcing a more diverse and
critical set of activities.  Reasons that an organization might want
to outsource one or more of its critical but non-core functions (such
as finance and accounting) include the potential for (1) significant
cost savings, (2) access to needed skills and expertise, (3) access
to the latest technology or world-class capabilities, (4) accelerated
implementation of planned improvements, and (5) freeing management
resources for other purposes. 

For example, after identifying its core competencies, one
organization decided that outsourcing should be used as an option to
improve business performance through reducing costs in non-core
areas, leveraging the expertise of best-in-class service providers,
and providing a better career path for employees in non-core areas. 
As part of its determinations, senior management decided that any
function that was not a core competency could be subject to
outsourcing.  Factors considered included whether or not a function
(1) involves decision-making, (2) adds significant value to the
company's bottom line, or (3) interfaces directly with its customers. 
Company officials informed us that they believed there was no
long-term risk to the company's competitive position in outsourcing
these types of processes. 

Another organization we spoke to also identified its core and
non-core activities within the accounting and financial management
function.  In this case, management decided not to outsource any
finance and accounting activity that

  -- was important to maintaining control of the business,

  -- was important to maintaining the company's competitive position,

  -- involved company confidential information,

  -- involved a critical expertise that the company could not afford
     to lose, or

  -- was used to develop staff for managerial advancement. 

Based on these criteria, the organization concluded that managerial
analysis and decision support work were core activities, but that
other activities, such as the clerical aspects of the accounts
payable and payroll processes, were non-core and therefore candidates
for outsourcing.  Officials of this organization also pointed out the
need to maintain control of the outsourced activities or tasks and
said it was important to keep some level of knowledge and expertise
in-house. 


      IDENTIFYING DEFICIENCIES
      THROUGH BENCHMARKING
      IS A KEY FACTOR FOR
      OUTSOURCING DECISIONS
---------------------------------------------------------- Letter :6.3

Benchmarking generally involves identifying organizations that have
developed world-class processes and then, using applicable
performance measures (such as cost per transaction, average
processing time, or error rate), comparing an organization's
performance to that of the world-class organization.  Benchmarking
lets an organization know how well it is doing and puts it in a
better position to assess which improvement initiative, if any, best
fits its situation.  A key result of an effective benchmarking
process will be a full understanding of the extent and nature of any
existing deficiencies in an organization's finance and accounting
operations.  As discussed later in this report, this understanding of
deficiencies in an organization's finance and accounting function is
critical to successfully establishing and monitoring an outsourcing
contract. 

A recent international outsourcing study found that the most
important single factor contributing to successful outsourcing was
that the activity was well defined.\13 Many of the companies we
talked to have used benchmarking to help them determine if any
finance or accounting processes or activities they perform were in
need of improvement and the extent of improvement needed.  Once
processes have been benchmarked, an organization is able to determine
areas that need improvement and decide on a means of improvement. 
While some organizations have chosen outsourcing as a first-line
means of process improvement, many others have relied more heavily on
reengineering processes, installing enterprisewide systems, or
establishing shared service centers as their primary approach to
improving financial management. 

If through benchmarking an organization finds a particular internal
process to be world-class, it might decide that little could be
gained by outsourcing.  In situations like this, some organizations
may offer their services externally and turn the function into a
profit center.  If all or part of an organization's finance and
accounting function were determined to be world class, and if the
organization determines that the function is not one of its core
competencies, it may decide to outsource the function to free
management resources. 

Consistent, objective, and measurable baseline data on operations
compared with baseline data from a world-class organization is
essential to a reliable benchmarking assessment.  One outsourcing
industry consultant said, for example, that an organization must
develop reliable, quantitative data on costs as well as other
objective measures of the area being considered for outsourcing. 
Failure to obtain reliable data can increase the risk that data will
be manipulated to achieve a desired result.  For example, the
organizational component being considered for outsourcing may have an
incentive to exclude relevant costs so that the costs of its
operations appear to be lower than they actually are.  Outsourcing
vendors performing this analysis, on the other hand, may be inclined
to include as many costs as possible. 


--------------------
\13 PA Consulting Group, Strategic Sourcing:  International Survey
1996, (London, UK; PA Consulting Group, 1996). 


      MARKET RESEARCH NEEDED TO
      DETERMINE CAPACITY AND
      QUALITY OF OUTSOURCING
      VENDORS
---------------------------------------------------------- Letter :6.4

As discussed previously, vendor capacity for large, complex
accounting and finance functions is a consideration in the
outsourcing decision process.  Although vendor capacity is expected
to grow rapidly over the next several years, the existence of a
competitive marketplace for outsourcing services is a factor that
will affect the efficiencies and cost savings that can be achieved. 

A number of vendors, outsourcing users, and outsourcing experts we
talked to recommended that large organizations with complex processes
pilot test a segment of a process before attempting to outsource an
entire process.  The segment chosen for the pilot should be one that
is most amenable to outsourcing.  Then, after a successful pilot, the
organization could gradually expand the scope of the outsourcing
arrangement.  A pilot test approach to finance and accounting
outsourcing would give the organization time to streamline its
outsourcing process while allowing the vendor marketplace to build up
the capacity to perform services for large organizations. 

Organizations must also research the quality of vendor services.  An
official of one organization that had outsourced an accounting
process stated that its vendor had a turnover rate much higher than
the organization's internal staff that previously performed the
process.  He said that the high vendor turnover presented a problem
as his employees were constantly dealing with new vendor employees
who did not know the organization's business.  One large company
decided to bring its outsourced payroll process back in-house and do
its own payroll processing because of the poor service it received
from its vendor. 

Organizations must also consider if process improvement is an
institutional goal and whether or not the services offered by vendors
represent an improvement over the effectiveness and efficiency of
existing processes.  One organization credited its outsourcing vendor
with bringing "cutting edge" technology to some of the organization's
accounting and finance processes.  Another organization for which
process improvements were important decided not to outsource its
accounts payable after determining that none of the potential
accounts payable vendors would be able to improve upon its current
business operations. 


      PERSONNEL ISSUES MUST BE
      ADDRESSED
---------------------------------------------------------- Letter :6.5

Organizations cited outsourcing's potential impact on personnel as a
particularly sensitive issue in considering whether and what finance
and accounting operations to outsource.  Outsourcing is likely to
result in a reduction in the number of an organization's employees. 
Addressing sensitive issues associated with potential job loss and
other possible adverse personnel impacts will be critical to dealing
with potential resistance to outsourcing and to building momentum for
change. 

According to one organization, the issue of job loss resulting from
outsourcing is the most difficult hurdle to overcome in reaching a
decision to outsource all or part of an organization's finance and
accounting operations.  In some instances, we were told,
organizations determined that internal opposition to outsourcing was
so widespread and vocal that planned outsourcing was halted until
employee concerns were addressed.  For example, we were told that
addressing the concerns expressed by labor unions was considered to
be of paramount importance to one organization in reaching a decision
to outsource all or part of a function.  In addition, a member of the
organization's management stated that it is difficult to convince an
organization's senior managers to reduce their "power" (based on the
number of people reporting to them) by firing or laying off personnel
in conjunction with outsourcing all or part of a function. 

When to tell employees outsourcing is being considered, how to
involve employees in the outsourcing process, and whether to require
the vendor to offer employment opportunities to the displaced
employees were repeatedly identified as essential elements to any
outsourcing decision.  One organization, citing its corporate
philosophy supporting its employees as its most valuable asset, told
us that it has strived to avoid employee layoffs even when selected
jobs were phased out through process improvement or outsourcing. 
Instead, it has relied primarily on attrition and job transfers to
reduce numbers of employees and has offered, at certain times,
retirement incentive packages to employees whose jobs have been
phased out.  The organization's top management advised employees when
it was seriously considering outsourcing and sought appropriate
employee input in the outsourcing decision. 

One organization's officials told us that they have delayed
outsourcing specific activities because the affected employees may
not have the necessary skills to transfer to other areas in the
accounting department.  Organization officials stated that, rather
than displacing existing staff, they will continue to pursue internal
operating efficiencies and will wait for the employees to leave
through reassignment or normal attrition before outsourcing those
positions. 

Officials from another organization that adopted this approach also
stated that they believed this strategy contributed to successful
outsourcing.  The organization believed that because it kept
employees informed, it was able to prevent rumors and speculative
gossip from becoming a barrier to outsourcing its general ledger
accounting processes.  The organization also arranged for the
outsourcing vendor to offer employment to virtually all of the
displaced employees.  The vast majority of the employees transferred
to the vendor and, for the most part, continued to perform the same
duties they had before outsourcing.  The outsourcing organization
expressed its belief that the employees were treated fairly and
equitably and now have more career opportunities because the vendor
has multiple career paths. 

In contrast, we were told that some of another organization's
employees may have first learned about the potential outsourcing from
its outsourcing vendor.  This created a great deal of resentment and
ill-feelings and was a major barrier to the outsourcing arrangement,
particularly because none of the outsourced employees were to be
retained by the outsourcing vendor. 

Another risk posed by outsourcing is the loss of important corporate
knowledge.  One organization that outsourced accounting activities
required the vendor to hire key employees--those who had
decision-making responsibilities related to the outsourced area. 
However, the outsourcing vendor found, while training its new staff,
that it needed the unique accounting process knowledge held by
lower-level staff.  The outsourcing vendor then hired the former
lower-level employees to train its new employees and discovered that
many of these lower-level jobs required a much longer time to learn
than planned. 


      EFFECTIVE CONTROLS AND
      PERFORMANCE-BASED CONTRACTS
      ESSENTIAL TO SUCCESSFUL
      OUTSOURCING
---------------------------------------------------------- Letter :6.6

We identified two key factors that, once organizations decided to
outsource, were associated with an increased likelihood of the
outsourcing arrangements' ultimate success.  These key factors are
(1) maintaining sufficient expertise and controls to effectively
oversee outsourced operations and (2) establishing a well-defined,
results-based contract with the outsourcing vendor.  An organization
needs to address these critical factors not only to help ensure that
it is meeting its cost reduction and/or process improvement goals,
but also to avoid an increased risk of unexpected cost increases,
poor quality services, or even fraud.  In addition, effective
oversight controls are critical to ensuring that outsourcing vendors
effectively discharge their fiduciary responsibilities for the funds
and other resources entrusted to them. 


         EFFECTIVE OVERSIGHT OF
         OUTSOURCING VENDOR IS
         ESSENTIAL
-------------------------------------------------------- Letter :6.6.1

Ensuring that an organization maintains sufficient expertise and has
an effective set of controls in place to oversee the vendor's
operations were identified as essential to successful outsourcing. 
In recent testimony, we stressed the need for effective contract
monitoring and oversight to evaluate contractor compliance and
performance in outsourcing arrangements, but found that such
monitoring was not always done effectively.\14

The PA Consulting Group's report on its 1996 survey also raised
concerns about the adequacy of contract oversight.  The study found
that contract monitoring was very important in ensuring that
organizations reach their outsourcing goals and that service quality
and customer satisfaction were the areas most commonly monitored by
organizations.  However, the study also found that the level of skill
and sophistication necessary for effectively monitoring outsourcing
arrangements may exceed the capability of many organizations. 

One organization's experience illustrates the importance of
maintaining sufficient in-house expertise to maintain effective
oversight controls over an outsourcing vendor's performance.  The
human resources department had outsourced the pension payment process
believing that they could "wipe their hands clean of it." However,
the organization has subsequently had to consider bringing the
process back in house, in part because it has become increasingly
concerned about whether it can retain sufficient expertise in-house
to effectively oversee the outsourcing vendor to ensure that the
organization's retirees are properly paid. 

Among common contract monitoring techniques organizations have used
to maintain control over the outsourcing vendor's operations were
retaining the right to audit the vendor's operations and periodic
reports of cost and service performance and meetings to discuss
performance.  For example, one organization stipulated in all of its
agreements with vendors that its internal audit department must be
able to audit the vendor's records, procedures, policies, and
controls related to the outsourced function.  Another organization
that outsourced a number of accounting processes received monthly
performance reports that tracked vendor performance against
contractual expectations.  In addition, the organization had ongoing
meetings with the vendor to discuss performance concerns and any
potential process improvement changes and conducted periodic
evaluations to determine if outsourcing goals were met and to
establish future expectations. 


--------------------
\14 Privatization and Competition:  Comments on S.  314, the Freedom
From Government Competition Act (GAO/T-GGD-97-134, June 18, 1997). 


         PERFORMANCE MEASURES MUST
         BE ESTABLISHED AND USED
         TO MONITOR OUTSOURCING
-------------------------------------------------------- Letter :6.6.2

A well-defined results-based contract--based on clearly defined,
results-oriented performance measures rather than on the processes to
be followed--is recognized as one of the primary ways of helping to
ensure that an organization will achieve the desired level of
benefits.  While a results-based contract will not guarantee good
contractor performance, it will help in measuring the performance and
the extent to which expected benefits have been achieved. 

Service providers, consultants, and end-users agreed that outsourcing
contracts should be results- rather than process-based.  According to
one service provider, process-based requests for proposals and
contract documents often preclude providers from developing the most
appropriate outsourcing solution.  Officials of one organization that
had outsourced major portions of its accounting and finance functions
told us that they developed a results-oriented request for proposal
that was very descriptive of both current functions and what was
expected from the vendor in terms of improved performance.  The
contract detailed performance expectations for the outsourced
processes, including the timing of reports and the presentation,
availability, and quality of accounting and finance information and
established a related set of performance measures intended to help
determine the extent to which the goals of the outsourcing
arrangement were achieved. 

Outsourcing contracts that are process rather than results driven may
also tend to reinforce any existing finance and accounting
deficiencies and limit the vendor in implementing efficiencies and
changing processes to improve operations and reduce costs.  For
example, more staff would be required to process accounts payable if
the contract required the vendor to manually match the purchase
order, receiving report, and invoice than if the contract specified
the vendor was responsible for making timely and correct payments for
99.5 percent of the dollar value of the invoices processed.  In the
latter case, the vendor would be able to take advantage of such
techniques as electronic data interchange and evaluated receipts,
thus enabling payments to be based upon efficient and accurate
computerized matches of key elements on the purchase order and
receiving report. 


---------------------------------------------------------- Letter :6.7

We are sending copies of this letter to the Ranking Minority Member
of the Senate Committee on Armed Services and the Chairmen and
Ranking Minority Members of the Senate and House Committees on
Appropriations, the House Committee on National Security, the House
Committee on Government Reform and Oversight, and the Subcommittee on
Government, Management, Information and Technology of the House
Committee on Government Reform and Oversight.  We are also sending
copies to the Director, Office of Management and Budget, and the
Secretary of Defense.  Copies will be made available to others on
request. 

If you or your offices have any questions concerning this report,
please contact either Lisa G.  Jacobson or David R.  Warren at (202)
512-9095, or (202) 512-8412, respectively.  Major contributors to
this report are listed in appendix II. 

Lisa G.  Jacobson
Director, Defense Audits
Accounting and Information Management Division

David R.  Warren
Director, Defense Management Issues
National Security and International Affairs Division


DEFINITION AND SCOPE OF FINANCE
AND ACCOUNTING FUNCTION AS USED IN
THIS REPORT
=========================================================== Appendix I

----------------------------------------------------------------------
======================================================================
Transaction Processing

Accounts Payable
Processing and paying vendor invoices for business expenditures
incurred. Activity begins when an invoice is coded and approved for
payment. Excludes purchasing and receiving activities.

Invoice Processing
Match invoice, purchase order and receiving report; resolve
discrepancies; approve and code invoices for payment; maintain
appropriate files.

Payment Processing
Prepare checks, electronic payments, and wire transfers; initiate and
process recurring payments; respond to vendor inquiries.

Benefits Plan Accounting
Activities to account, track, and report on benefit plans.

Billing
Revenue accounting and the documentation and issuance of bills for
products sold and services rendered.

Cash Application
Recording and tracking payments received from customers.

Credit and Collection
The extension of credit to customers and collecting of slow pay and
past due receivables from customers.

Fixed Asset Accounting
Recording and controlling the physical records and financial
activities related to fixed assets of the corporation.

General Accounting
Overseeing, coordinating, and controlling the accounting records and
closing activities of the corporation. Includes maintaining the
general ledger, preparing the trial balance and other finance reports,
and related activities.

Inventory Accounting
The accounting for and valuation of raw, intermediate, and finished
materials, spare parts, supplies, or products received, transferred,
retired, or sold.

Payroll
The payment of wages, salaries, and pensions in accordance with
organizational policies. Activity begins at the point of entry into
the payroll system. Does not include benefits administration.

Time and Attendance Processing
The input of employee time cards into the payroll system.

Travel and Entertainment Accounting
Overseeing and processing expense reports and cash advances.

Cash Advances
Approve and disburse cash advances; resolve cash advance problems.

Expense Reports
Verify that expense reports meet guidelines; approve expense reports;
prepare payments; resolve travel expense problems; distribute travel
and entertainment expenses.

======================================================================
Travel and Entertainment (T&E) Card Administration
Oversee issuance of T&E cards, monitor use of T&E cards.

Control and Risk Management

Financial Budgeting and Forecasting
Establishing long-term and short-term financial plans, budgets, and
forecasts. The focus is on developing detailed financial budgets and
controlling actual expenses by comparing them to an historical budget.

External/Consolidated Reporting
Reporting consolidated financial information as dictated by generally
accepted accounting principles, Securities and Exchange Commission
regulations, and statutory, subsidiary, and international reporting
requirements.

======================================================================
Decision Support

Banking and Cash Management
The activities involved in the handling of cash flows and bank
relations for noninvestment accounts.

Cost Accounting
Calculating product or service fixed, variable, and semi-variable
costs. Developing allocation schemes and analyzing cost variances.

Financial Analysis and Management Reporting
Analyzing financial and operational information to assess, interpret,
and predict business performance to support management decisions.
Evaluating capital investment decisions. Gathering, evaluating, and
presenting financial, operating, and contractual information about
proposed business transactions for internal management.

Tax Planning
Examining tax issues for the corporation to optimize tax effectiveness
of management decisions.

Treasury and Trust Management
The activities associated with securing funds to meet the
corporation's cash flow needs and investing any excess funds.
----------------------------------------------------------------------
Source:  GAO analysis of Institute of Management Accountants' finance
and accounting functions. 


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix II


   ACCOUNTING AND INFORMATION
   MANAGEMENT DIVISION,
   WASHINGTON, D.C. 
-------------------------------------------------------- Appendix II:1

Geoffrey Frank, Assistant Director
Francine DelVecchio, Communications Analyst


   NATIONAL SECURITY AND
   INTERNATIONAL AFFAIRS DIVISION
-------------------------------------------------------- Appendix II:2

James Hatcher, Assistant Director


   CHICAGO FIELD OFFICE
-------------------------------------------------------- Appendix II:3

Neal Gottlieb, Auditor-in-Charge
Adrienne Friedman, Senior Auditor
Lenny Moore, Auditor


*** End of document. ***