FAO has been on a rapid tear the last three years, after more than a decade of modest adoption. Whereas the Human Resources Outsourcing (HRO) market entered rapid growth earlier, chief financial officers (CFOs) proved to be far more measured and conservative when making decisions to transition their finance and accounting (F&A) processes over to a third party.
Part of the reason for this is that HR leaders often wield less corporate influence than finance leaders and in many cases, the outsourcing decision was made for them. In economic downturns, many organizations, particularly those in financial distress, looked at their HR functions, considered the strategic benefits of using a third-party HRO provider, and made the decision to move down the HRO path.
CFOs, on the other hard, exerted more influence and control over their functions, helped by the sensitive compliance/control issues involved and less political motivation internally to start moving F&A processes over to a third party.
Moreover, CFOs tend to have a more conservative mind-set when it comes to their own processes and take longer to be convinced of making radical changes to their business model. Even moving from reconciling data in Lotus 123 to Microsoft Excel was a drawn-out process for many finance departments in the early '90's
What resulted since the early wave of Sarbanes-Oxley-driven outsourcing assessments is a more outsourcing-focused culture across organizations' leadership. This culture largely is a result of the onset of rapid globalization and a series of successful FAO endeavors by such blue-chip firms as BP, Unilever, P&G, and Wachovia. The heavy people-emphasis, exploding offshore talent-base, and absence of a need to replace F&A systems have created long-term sustainability for the FAO industry. Exhibit 1 illustrates how FAO has really begun to mature as an industry and is now at a very similar growth stage to the HRO market.
Exhibit 1 - Evolution of FAO market in the Outsourcing spectrum
The 2002 Growth Spurt
The first significant FAO growth spurt occurred in 2002 where we saw 19 FAO deals signed as opposed to a mere nine in 2001 (see Exhibit 2). Everest commented on this 2002 growth spurt before (see "Why Finance And Accounting Outsourcing Will Experience Double Digit Growth"). There are multiple reasons why it happened; some are unique to 2002, some which may be recurring.
Exhibit 2 - FAO market has grown by over 45% since the beginning of 2005
One of the drivers behind the growth in 2002 was that both buyers and suppliers seriously began to recognize the concept and value of labor arbitrage for finance and accounting outsourcing. That is, it suddenly became apparent to multiple market participants that they could take work offshore to countries with a university-educated English-speaking workforce who understood US GAAP accounting. Market participants realized that in finance and accounting this was not only doable but was actually somewhat low risk in that the systems were not changed and, for the most part, the processes were not changed other than the necessary workflow changes to perform the work remotely.
Quickly, it became apparent that a general ledger accountant could sit either in Peoria or Bangalore and it didn't really matter; after all, when was the last time that you sat down and had a face-to-face visit with your general ledger accountant? This offshoring 'epiphany' was a one-time event that pushed FAO forward that will not be repeated. However, this was not the only factor that created in 2002 the largest-ever annual growth rate in FAO.
The other major factor in 2002 was the sheer fact that a number of companies experienced financial distress. The North American economy was still hurting from the 2000 dot-com crash when it 9/11 struck. With companies looking for margin enhancement, 2002 saw unprecedented growth in FAO.
Fortunately, or unfortunately, the fact that FAO did well in 2002 due to a faltering economy is a scenario likely to repeat itself. There is an old adage that says "in good times outsourcing is a good business; in bad times outsourcing is a great business."
The 2004/2005 Growth Spurts
In 2004 we saw a huge increase in FAO due to the fact that the market suddenly had the realization (another epiphany!) that FAO not only didn't hurt the ability to meet Sarbanes-Oxley compliance, but in fact FAO actually helped with FAO compliance (see "Increasing Regulatory Requirements Create a Stronger Case for F&A Outsourcing"). In 2005 we still had some remaining Sarbanes-Oxley-compliance-driven growth, but a new disruptive force also entered the marketplace.
In 2005 Genpact, newly untethered from its GE parent, hit the market with full force. In 2005, Genpact had instant credibility due to its heritage; that is, the GE reputation for Six Sigma quality and management excellence provided Genpact the opportunity to bid on many FAO contracts that other start-ups could not have dreamt.
Not only did Genpact have the sudden ability to bid alongside the largest FAO players in the world (IBM, Accenture, Cap Gemini, and ACS), the Indian-headquartered provider also had a significant cost advantage. In 2005 other brand-name providers either bragged about plans to establish offshore FAO centers or actually had some up-and-running offshore centers.
However Genpact was well beyond mere plans and well beyond a toe-in-the-water offshore approach; Genpact had primarily all of its cost structure offshore, that is, delivery centers and corporate headquarters in India. Moreover, the protection of being a privately-backed supplier with strong financial backing from GE and General Atlantic Partners enabled the company to price aggressively to build critical mass and scale quickly, which further developed credibility in the eyes of CXOs in F500 organizations. All these reasons allowed Genpact to rapidly become a Tier-One global FAO supplier.
However, success has its price; Genpact won so many deals in 2005 that they spent much of 2006 absorbing and integrating the deals already won. In addition, other suppliers (e.g., Accenture, CapGemini, HP, IBM, Progeon, and WNS) responded by expanding their offshore staffing and bidding more aggressively.
The Next Market Disruptor
Accenture and IBM have been the traditional FAO market-share leaders, but 2005 was the break-out year for Genpact, which is now in the major leagues (Exhibit 3).
Exhibit 3 - FAO Market Share
However, with Genpact preparing a public offering in 2007 and the company currently digesting more than 20 rapidly acquired new customers in the last two years, the firm will surely slow down in 2007 as it catches its breath.
Moreover, we are currently operating in an "Indian offshore bubble" economy, where many Indian providers are currently enjoying valuations 30 times their revenues. This situation surely cannot last and we fully anticipate there will be a market correction next year in these valuations as adoptions cannot possibly occur at a rate fast enough to sustain such high valuations. Hence, do not put all your money on the Indian FAO providers having it all their own way next year, especially as several of the Western giants need to fill excess capacity and are desperate to refill the deal void created by Genpact's market surges of 2005 and 2006.
So, who will be next? There is going to be a lot of growth in FAO and there are a number of capable suppliers who covet that growth and want their fair market share. The next supplier to pull out all of the stops and shake up the market could be CapGemini, HP, Progeon, or WNS.
What Will Cause the Next FAO Growth Spurt?
We don't have a perfect view of the future. We can ascertain how many companies are evaluating FAO, the supplier capability/capacity, and the success and failures of the buyers so far; but it is not so easy to predict when these evaluations will turn into actual contract signings. One thing is clear: in today's globalized economy, all global firms need to evaluate their sourcing strategies to ensure they are taking advantage of low-cost offshore talent and evaluating which global sourcing models work best for them.
The next FAO growth spurt could be demand driven such as the economic and regulatory driven market we saw in 2002 or it could be supply driven such as we saw in 2005. If we see a catalyst for demand and supply driven growth in the same year, the growth will be explosive. Why? Because the next big year will be met by a much more mature market than we have had in the past. FAO is far from a mature market, but relative to 2002 the supplier base, the technology, the offerings, the transition and work-flow processes,have all matured. And the potential buyers are better informed.
What Implications Does This Have For Buyers?
Potential buyers should start kicking the tires now. The market is strong and growing, but it is not in hyper-growth at the moment. A buyer approaching the market on a 'normal' growth year will get more attention and better service than a year when everyone decides to buy all at once.
What Implications Does This Have For Suppliers?
If we look back at information technology outsourcing, we see that the top-tier market-share players were all established fairly early. Once these Tier-One suppliers were established, it became very difficult for other potential suppliers to aspire to join that first tier. Membership in the Tier-One club for FAO is not yet cast in stone. 2007/2008 is the timeframe for the Tier-Two market-share players to make a decision that they will remain Tier Two or take aggressive steps to take share.
Lessons from the Outsourcing Journal:
- FAO is now a truly sustainable industry with a long-term future and value proposition.
- The next economic downturn (perhaps 2007) will drive a wave of new FAO deals as assessments quicken.
- India's current FAO capability is closely resembling that of ITO in the '80s and '90s as we see tens of thousands of qualified accountants emerge from Indian colleges.
- The next wave of FAO engagements is coming-likely in the latter half of 2007.