Podcast transcript: What PE is outsourcing to create value

20 min approx | 21 April 2022

Winna Brown

According to Deloitte’s 2021 Global Shared Services Outsourcing Survey, there appear to be 4 outsourcing trends:

  1. Prioritization of cost reduction;
  2. cloud and robotic processed automation (RPA) have really become “table stakes”;
  3. a need for clients to invest in building supplier management capabilities;
  4. and finally, an increased need for service providers to be agile.

The path to successful value creation of private equity today goes beyond the typical lever such as G&A cost-cutting sales force effectiveness and strategic sourcing. It’s about an approach that leverages digital tools including automation, strategic outsourcing, and advanced analytics. Going forward, private equity companies of all sizes may need to look at outsourcing as a way to access cutting edge technologies and capabilities that can lead to revenue growing opportunities in addition to reducing costs.

Today, I’m delighted to be joined by Greg Schooley, EY-Parthenon US Value Creation Leader. We’re going to discuss what tasks private equity is outsourcing across business functions such as finance, IT, HR and customer service, and they’re doing so, in a way to create value for stakeholders.

So Greg, you recently led a panel at the EY Strategic Growth Forum. Can you tell us a little bit about what the focus of the panel was and why so many heavy hitters from private equity were part of the discussion?

Gregory Schooley

Well, hi Winna. It’s my pleasure to be here. I’d love to dig into this. It was a great discussion that we had out there in the desert in Palm Springs. EY’s Strategic Growth Forum is a tremendous event where we bring investors like together with a huge group of exciting entrepreneurial companies that are looking to network, learn lessons on how to drive value in their business and also understand how they should be growing their business with their capital, as well as potentially, capital provided from other investors. The focus of the panel was how value creation in private equity is evolving. So we spent a fair bit of time, discussing the tried-and-true lessons of value creation that private equity investors have been using for the last 20-30 years, such as strategic sourcing, sales force effectiveness, cost reductions, especially in SG&A, but the majority of the time in this discussion was spent focusing on the new areas, or the high priority areas for private equity in value creation going forward. And those areas were, first of all, the war for talent. We are living through the COVID Great Resignation currently and everybody highlighted the need to attract the best talent, to motivate the best talent and keep the best talent. Secondly, huge priority on ESG, not only as something that requires attention from a defensive point of view, but also how it can create value in terms of business performance for private equity-owned companies. And the last area that we spent a lot of time focusing on was outsourcing and automation. How can mid-sized companies take advantage of this opportunity to streamline their business in the way that Fortune 100 companies have done in the past. The audience of the discussion were a bunch of entrepreneurs and owners of the attendees of the strategic growth forum. So, it was a tremendous event.

Brown

Sounds like a fascinating and really important discussion, I wish I had been there. And now we’ve spoken on the podcast previously a lot around talent and the war on talent and we’ve spoken about ESG. But one of the areas we haven’t really dived into was strategic outsourcing. So, I’d love to spend some time with you, really kind of diving in a bit deeper on that value creation lever and maybe talk us through how the narrative around outsourcing has really evolved over the last 20 years, because people have been outsourcing forever, but I feel like there is a step change in the way it’s being approached and the opportunities that are being presented.

Schooley

Yeah, I totally agree with you. The world of outsourcing has evolved dramatically in the last 20-30 years. I think of those articles that we read in the Wall Street Journal and other publications that highlighted the mega outsourcing deals from the 90s and early 2000s where big corporates like Procter & Gamble, IBM or others would outsource entire functions to low-cost outsourcing providers. And then reading articles a few years later, about how many of those deals did not work out that well, for either party. The outsource provider realized after a period of time that they locked in very, very complex operations. They locked in commercial terms that turned out to be overly optimistic, so their profitability was much lower than forecasted. They locked in commitments that they couldn’t get out of. And then the clients, the companies that we were the recipients of the services often were unhappy with the quality of the service that was being provided and they, too, felt locked in. So, what has happened in the past 20 years is that you’ve seen the industry shift from these mega, you know, your mess for less deals, to much more point solution, outsourcing arrangements where third-party firms are providing help in specific areas that are easier to carve out of an operation, and also, for the outsourced provider, easier to scale in terms of labor, in terms of technology, in terms of know-how. And so, this has really changed the game from the mega outsourcing deals to more point solution driven deals. What this also means is that you don’t only have to be a Fortune 100 company to take advantage of these services. Since these services are now more focused on very discreet processes and activities within a given function, small-cap companies and mid-cap companies can take advantage of outsourcing as well.

Brown

So given what you’ve outlined and call it the “the shift” from these larger outsourcing deals to more pointed opportunities, how do you think PE should look at this opportunity and how would they assess the cost benefit of making the investment in outsourcing given PE doesn’t hold companies for an extended period typically. So, does it still make sense for them?

Schooley

Yes, good question, and I’ll answer that question first by repeating something that John Toriello, from General Atlantic, said during our discussion that day in Palm Springs. What John said was “the key role of a CFO is to determine which activities actually generate value for the company vs. which activities simply need to get done. And any activity that simply needs to get done, should be considered a candidate for outsourcing or automation.” So, this notion that the company needs to do A to Z, everything within finance, HR, IT, etc., you know, is really being turned on its head beyond just what our competitive advantages are. I mean, we obviously need to invest in our competitive advantages to grow the business, but now a more active oversight of all of these processes and tools such that if you feel like you’re just spending money and occupying people’s time to stay even with everybody else, you should get out of that and let somebody that specializes in that process, in that technology, provide you that kind of support. Winna, you asked about, how should they consider the cost-benefit analysis?

Brown

Mmm.

Schooley

Very good question. I mean, the typical holding period for a private equity investor is, you know, on the short side, 3-4 years, longer side 6-7 years, but it’s not an eternity. That’s, again, part of the reason why focusing on more point solutions makes outsourcing much more attractive for private equity-owned companies, because you can outsource things more quickly. So, to be very, very tangible, you know, typical savings that we see, and EY does a lot of outsourcing advisory work for our clients, anywhere from 5%-10% on the low end and all the way up to 30%+, relative to what a company might be spending on its own. So, the return is very significant. Now, it’s not like flipping a switch. You need to do a thorough assessment of all of your activities within a given function, need to determine which of those activities you want to keep in-house because of the strategic value those activities provide the company, and then, which activities are, as John said in his statement, just activities that need to get done. They’re not really providing any value add to the company itself. Then you need to go through a whole RFP process, negotiate with vendors and eventually transition. So, it does take several months, but the payback is significant. So, what we would recommend to our private equity clients is that in the first 1-2 years of ownership, once they’ve acquired a business, they should go through an exercise like that so that they have a meaningful amount of time with the outsourcing support flowing through their economics, so they can see the value impact in their P&L well ahead of the time to exit.

Brown

OK. And given the very compelling cost savings that you outline that can be achieved, if a company or private equity firm wanted to explore outsourcing for one of its portfolio companies, what are the options? I mean, is it entire functions that need to be outsourced or can you actually get more granular and simply say, actually I want to keep finance in house, but this particular area or task or specific area within finance I want to outsource, like certain tasks as opposed to the whole function; can you do that?

Schooley

Exactly. And that’s really, really what I think the key change is relative to 20-25 years ago when you would see a big company outsource 80%-90% of the personnel in a given function. You know, now if you just bought a company and you’re looking at SG&A and opportunities for outsourcing within SG&A, you’re probably going to start with finance and IT because those are typically the biggest areas of spend, but like you’re saying, when you’re not going to outsource all of finance, because finance has an enormously strategic value to bring to the company. I mean, obviously, it helps you understand your economics, how to manage the business, where you’re making money, losing money, and so forth; so the activities within finance, to give you an example, that we typically see most likely to be outsourced, are the more mundane activities, like customer credit review or accounts receivable, collections, accounts payable management, travel expense, customer billing. Within IT, another big, big area of spend for most companies, especially mid-cap companies, you know, we see things like IT help desk being outsourced or data center operations or user access, setup and maintenance, network support and I could continue; but these are very specific areas where you can find vendors that provide these services to hundreds of companies, that have very proven platforms where they can provide high-quality support and very scalable support for a given private equity-owned business.

Brown

OK, that actually sounds really, really quite interesting and compelling, but I guess to your earlier point, it’s really also important to make sure that you do your homework about the vendor that you want to work with, make sure it’s a good fit culturally, because they have to interact, presumably, quite often with your in-house teams, given, you know, you may only be outsourcing specific areas. You want to make sure that you’ve got the right relationship there.

Schooley

Absolutely. The outsource vendor, and I even resist the term vendor because it’s really a business partner with whom you’re going to be working every business day as long as the contract’s in place. Now again, some of these are more point solution type offerings where it’s easier to go from party 1 to party 2 in case things don’t work out, but you don’t want to enter into an agreement that is intended to be a 5- to 10-year agreement and have things go south quickly. So, I totally agree with you, Winna, that you want to do a lot of due diligence, you want to make sure you’re working with a service provider that has a trusted and proven platform. Very often the software that is driving the service is the competitive advantage of the outsource provider, that they’ve spent often tens of millions or more in developing a software platform to support the service. So, you want to make sure you feel comfortable with that platform, that platform provides you the quality and data and other attributes that you’re looking for, that you need for your business and that they’re going to be responsive for you, because in 100% of outsourcing situations, there will be speed bumps in the road, so you need to be able to be confident that your partner is ready to work through those speed bumps when they do arise.

Brown

Yeah, that’s really good advice. And Greg, what are some of the top trends or areas that you’re seeing that are starting to take hold in outsourcing that maybe PE should kind of keep an eye on. So, I’m thinking not the traditional areas that we just touched on in IT and finance, but maybe some areas that, thanks to the advances in technology, are actually a little bit more cutting edge and areas that people maybe would not have traditionally thought about for outsourcing, but maybe private equity should keep an eye out for.

Schooley

Yeah, good question. I mean, like, I said earlier, typically folks are really trying to streamline the G&A stack and to take cost out there. They’re also trying to variablize their cost structure when much of G&A is fixed, an outsourced provider can make it variable for you, which helps when you have a very aggressive growth business. But to your point, Winna, other areas outside of kind of the boring back-office stuff that we’re seeing more and more of, which do start touching on strategic value would be customer support. I mean, we’ve all dealt with offshore call centers before, so we know that as a consumer, but now some of these call centers are becoming very advanced and are actually being used for proactive selling, as opposed to just reactive customer support. So, we see advancements there. We also see advancements in development, people are outsourcing more to third parties around the world to develop new products, especially in software, but even other areas, whether it be med devices or other products that companies are realizing they can tap into rare and valuable talents around the world with third-party outsource providers and do it in a very cost-effective, scalable way. Now, the one thing that I will highlight that the listeners should think about is that, as this outsourcing trend grows and evolves, the risk of cyberattack has also grown. So, as you outsource more sensitive data to third parties, you need to be very, very cautious around what cybersecurity protocols and systems the third party has in place, because remember you, especially with customer data and new product information out there, these are the jewels of the company and you certainly cannot risk having a criminal crack into your systems and somehow steal or block progress in these areas. So, cyber becomes a very critical component of how you manage your business.

Brown

Yes, and that’s a good reminder to everyone out there. Cyber-attacks certainly are on the rise and certainly an area that we’re absolutely seeing has to priority focus area for all private equity portfolio companies.

Schooley

Absolutely. And that goes without saying, whether a company outsources a lot or outsources a little, everybody needs to double down on cybersecurity.

Brown

Absolutely. So, Greg, really appreciate you taking the time to walk us through how outsourcing is really becoming a strategic driver for private equity and an opportunity to create value in their portfolio companies by really kind of focusing, if you will, their energy, as you said, on activities that are value-adding and outsourcing those that are really just a, they need to be done and could be done by anybody and doesn’t have to be done in house. I also really liked the look at the up-and-coming areas that perhaps not everyone has considered with respect to outsourcing. So, looking forward to seeing more of our clients actually going down that path.

Schooley

Well, it’s been my pleasure, Winna, always catching up with you. The last words of wisdom I’d leave for the audience is that, you know, we shouldn’t just think about outsourcing being labor cost, arbitrage, taking advantage of offshore talent, it remains partially that way, but it’s truly become much more about access to differentiated talent and intellectual property, better scaling of a business and an activity, access advanced technology and process know-how; so, it’s much more than just cost savings now.

Brown

Great insight and great words of advice for everyone to look at outsourcing through new eyes. Thank you, Greg. Really appreciate you joining us today.

Schooley

My pleasure. Talk soon Winna.