United States General Accounting Office

GAO Report to Congressional Requesters

October 1997 FINANCIAL

MANAGEMENT

Outsourcing of Finance

and Accounting

Functions

GAO/AIMD/NSIAD-98-43

GAO United States

General Accounting Office

Washington, D.C. 20548

Accounting and Information

Management Division

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.

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Results in Brief 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.

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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 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.

Outsourcing Definitions

Vary

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

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).

3

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

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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 function4

 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.

Federal Agencies Are

Increasingly Considering

Outsourcing

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

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.

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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).

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Objectives, Scope,

and Methodology

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.

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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

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

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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

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.

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

Group, 1995).

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

Research Inc. 1997).

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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.

Most Outsourcing to Date

Has Involved Stand-Alone,

Labor-Intensive Tasks

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

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

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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

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

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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.

Factors Associated

With Successful

Outsourcing

Decisions

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

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

12Public-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).

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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

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

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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.

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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

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

13PA Consulting Group, Strategic Sourcing: International Survey 1996, (London, UK; PA Consulting

Group, 1996).

Page 14 GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting
B-274832 

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.

Market Research Needed

to Determine Capacity and

Quality of Outsourcing

Vendors

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

Page 15 GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting
B-274832 

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

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

Page 16 GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting
B-274832 

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

Page 17 GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting
B-274832 

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

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

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

Page 18 GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting
B-274832 

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.

Performance Measures Must Be

Established and Used to

Monitor Outsourcing

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

14Privatization and Competition: Comments on S. 314, the Freedom From Government Competition

Act (GAO/T-GGD-97-134, June 18, 1997).

Page 19 GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting
B-274832 

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.

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

Page 20 GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting
B-274832 

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

Page 21 GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting
Appendix I 

Definition and Scope of Finance and

Accounting Function as Used in This Report

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.

(continued)

Page 22 GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting
Appendix I 

Definition and Scope of Finance and

Accounting Function as Used in This Report

 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.

Page 23 GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting
Appendix II 

Major Contributors to This Report

Accounting and

Information

Management Division,

Washington, D.C.

Geoffrey Frank, Assistant Director

Francine DelVecchio, Communications Analyst

National Security and

International Affairs

Division

James Hatcher, Assistant Director

Chicago Field Office Neal Gottlieb, Auditor-in-Charge

Adrienne Friedman, Senior Auditor

Lenny Moore, Auditor

(918918) Page 24 GAO/AIMD/NSIAD-98-43 Outsourcing Finance and Accounting
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