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Financial Accounting Outsourcing (FAO) Annual Report - January 2007

IT Outsourcing in the Small and Medium Businesses

2006 will probably be a year of rapid growth for finance and accounting outsourcing (FAO). We believe FAO has reached the "emerging rapid growth stage" in its life cycle, thanks to a constellation of events that have come together to create the perfect conditions for growth.

According to research from the Everest Research Institute, the number of new FAO contract signings started to take off in 2002. Of the 108 FAO contracts signed to date, 70 percent were signed since 2002.

But the real growth started in 2004 when 31 deals were signed and continued through 2005. We expect this kind of growth to continue this year. We predict FAO will enjoy strong double digit growth for the next five years. We anticipate the cumulative average growth rate (CAGR) to be 24 percent over that five-year period.

Why now? Here are the reasons:

1. FAO has reached a critical mass.

   The FAO market has reached a critical mass by the dawn of 2006. The Everest Research Institute reports total contract value (TCV) for FAO deals has now reached $12 billion.

   Today enough companies have outsourced their finance and accounting functions for long enough to produce proven results. And these results have been so successful that their competitors are discovering they can not compete unless they embrace FAO, too.

   Once you get to a critical mass, the acceptance snowballs.

2. Offshoring has produced significant cost savings.

   In 2002, many skeptics said the savings offshoring produced were a fluke or a one-time occurrence. But then FAO buyers also enjoyed those same savings in 2003. By 2004 the savings were changing the dynamics of the marketplace.

   Today, there is significantly higher permission to offshore. Over 50 percent of the Forbes 2000 are offshoring some business function, according to the Institute. It reports offshoring FAO functions can reduce costs of the F&A function by 30-40 percent. These significant savings are a huge driver.

   The combination of large savings and higher acceptance offshoring is creating a compelling reason to outsource.

3. Sarbanes-Oxley concerns are no longer an issue.

   In 2002 companies were worried about sending work offshore and meeting the stringent reporting requirements of the new Sarbanes-Oxley Act. Company executives, who faced jail time if they could not certify their financial results, were not so eager to outsource these functions. Many US companies took a wait-and-see attitude toward FAO.

   By the end of 2004 the marketplace had resolved these issues. In fact, outsourcing improved control and reporting, making it easier to comply with the law. This realization removed a big barrier and the contract signings soared.

4. Suppliers have matured.

   Supplier experience has grown with the marketplace. This maturity has allowed suppliers to produce better offerings; one result is lowered risk to buyers. In addition, these suppliers are adding more value through new tools and technology.

5. New suppliers have entered the market.

   The FAO market has seen a surge of new entrants. One path has been captives that have transformed themselves into full-fledged suppliers. Genpact is a good example. The company started as a business unit of GE and quickly scaled up. Last year the subsidiary received venture capital to become a spin-off. Now GE is just one of its many finance and accounting customers.

   Another example is WNS, which started life as an Indian captive of British Airways. In 2002 it also received investor funding to become an independent company.

The investors recognized the business opportunity The Everest Research Institute reports two-thirds of the total FAO contract value signed to date has yet to be collected, showing the youth of this market. We believe additional new suppliers will enter the market this year.

Why? We believe they see a huge market potential for growth. And the barriers to entry are low. Since the buyers typically want to continue to use their own systems, the new suppliers don't have to make large capital investments in costly ERP systems. They just have to be able to handle the imaging, manage the work flow, and have a source of well-trained, low-cost labor.

Of course, new suppliers are emerging from different constituencies. BPO suppliers like Xchanging are extending their offering to FAO, and Indian offshore IT players like Progeon are moving strongly into FAO as well.

What This Means for Buyers, Suppliers

What does this mean for buyers? They will find even better options than the pioneers. And the competition for new customers has intensified as both established and new providers fight for market share.

What do these developments mean for suppliers? New entrants translate into lots of competition. Suppliers will have to be able to differentiate themselves from the pack if they are going to thrive in the long-term.

Lessons from the Outsourcing Journal:

1. 2006 will be another year of rapid growth for FAO. The Everest Research Institute predicts double digit growth through 2011.
2. A constellation of events are fueling this growth. They include:
   • The market has reached a critical mass.
   • Offshoring has produced savings in the 30-40 percent range.
   • Sarbanes-Oxley concerns have disappeared.
   • New suppliers have entered the market and the current players have matured, creating better and less risky offerings for buyers.
3. Buyers have more options and can take advantage of the competition between suppliers. Suppliers are in a riskier position and will have to differentiate themselves to win market share.

Publish Date: January 2006

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Copyright © 2006 - Everest Partners, L.P.

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