Restructuring the Expense Base

... creating an environment where costs are better aligned with revenue and profit

Many companies are struggling with how to go about restructuring their business models to reduce costs and create an environment where costs are better aligned with revenue and profit. That is, reducing the fixed cost base and turning some of the cost reduction into a variable cost so that if headcount or transactions are reduced due to a business contraction, costs are also reduced automatically. Conversely, if the business grows, expenses grow consistent with the upturn in volume in a predictable way.

This challenge requires some level of “out of the box” thinking. It requires companies to face options that may be culturally difficult for them to implement. Meeting this challenge may require a company to consider outsourcing certain, non-strategic technology support functions or to consider restructuring or outsourcing certain business processes. This kind of thinking doesn’t come naturally to most companies, especially when addressing business processes. There is the natural tendency to assume that no outside firm can understand your own business model well enough to deliver quality service at aggressive cost structures and ensure high client or end user satisfaction levels.

Technology Infrastructure

When technology support functions are outsourced a company can leverage buying power and the process excellence of the outsourcer. This usually produces some savings, often considerable savings. It should also result in an agreement, with measurable service levels, for the technology elements supported and unitized pricing that more closely matches the state of your business.

In the area of technology infrastructure outsourcing there are several areas of opportunity that can be applied successfully to almost any company, regardless of size. Desktop (PC) support, server management, network management, security management, storage management and application maintenance are some of the areas of opportunity worth exploring. We have addressed two of these potential areas below.

Desktop Support – Most non-manufacturing companies have at least a one-to-one ratio of PCs and telephones to the employee base. Supporting this base requires periodic capital investments, software licenses, maintenance contracts, support staff (with offices, training, support tools and other hidden costs) and many other costs that aren’t evident. The Gartner Group and META have programs to help financial executives identify the total cost of ownership (TCO) of these desktop assets. If the management team needs to cut expenses, they can’t always predict what impact the expense reduction will have on business productivity because service levels aren’t defined or measured, they have just evolved over time.

Companies that support and manage their desktop requirements with internal staff find their cost base does not always respond directly to the economic environment. For example, a 15% reduction in staff may not result in any cost reduction for desktop support for a year or more without imposing severe service level reductions on the remaining user community. As growth occurs companies often experience little increase in cost for a period of time (typically for the additional cost of new PCs and telephones) and then a substantial increase in costs as the other cost elements are expanded to support the larger user base (for support staff, software licenses, support tools and the like). Figure 1 illustrates the dynamics of an internally managed IT desktop infrastructure as the business expands or contracts.

Figure 1

An outsourcing arrangement for desktop support can be structured to incorporate the capital cost of acquiring the hardware, the software licenses and a series of defined support functions for a fixed monthly cost per desktop (or laptop) under contract. These contracts invariably contain defined, measurable service levels covering items like response times for the outsourcers Help Desk, time to repair a malfunctioning desktop and percentage of problems repaired remotely (through the outsourcers Help Desk). Because so many of the service elements are carefully defined and measured management is in a position to determine the impact on their cost base and their business productivity when varying service levels.

The result of contracting for desktop support in this way is a monthly cost base that is more responsive to business conditions, an infrastructure that is more scalable in the event of rapid growth or contraction and a measurable service level benchmark that is also closely aligned with the cost structure. Figure 2 illustrates the dynamics associated with an outsourced desktop infrastructure during business contractions and expansions.

Figure 2

Server Management – As companies grow their investment in business applications their computing platforms (servers) generally grow as well. The business applications that support financial consolidations, inventory management, client business services, regulatory compliance, human resource applications and other critical business functions are housed in raised floor data centers and supported by technology experts with an enormous appetite for training, support tools and consultants. Once again the costs of supporting this ever changing, business critical environment are not always easy to get at and often don’t respond very well to changing economic conditions. In some cases, a lack of capital investment to upgrade critical platforms to contemporary technologies results in evolved platforms that are:

• less reliable than their contemporary counterparts

• unable to deliver maximum business functionality

• more costly to maintain

A fair amount of the expense associated with supporting this kind of environment is tied up in capital infrastructure (space, power, air conditioning and the cost of the latest computing technology). If the business mission requires seven days per week, twenty four hours per day technical support, the support expense can grow very rapidly. The company’s ability to maintain a staff of competent professionals can be severely strained.

More often than not, service levels are not adequately defined nor are they consistently measured when handled by internal staff. More importantly change management processes used by internal staffs are rarely as mature as those used by outsourcers. Immature change management processes, the processes used when modifying a technical configuration or an application configuration, generally result in an unexpected loss of application availability to the user community and potentially an adverse economic impact on the business enterprise.

Servers don’t need to be physically co-resident with the user community or with the technical support staff. The availability of low cost telecommunications facilities makes it economically feasible to locate the production servers off-site at an outsourcer’s facility. Furthermore, servers and associated storage capacity can be obtained in ways that limit the periodic capital investment usually associated with maintaining these platforms. Support of a group of business production servers closely parallels the environment described above for supporting desktops. The outsourcer will develop a monthly cost per server that incorporates the capital acquisition of the server, software licenses required to support the specific business requirements and a service level agreement that defines the outsourcer’s responsibilities in great detail. The company’s technology staff can be reduced and focused on supporting the business applications residing on the servers.

The dynamics associated with outsourced server infrastructures are similar to those associated with outsourced desktop infrastructures. The company pays for the number of servers required to support the business. If the business environment changes resulting in a reduction of transaction volumes that leads to a reduction of servers required to support specific business applications, costs for supporting and maintaining the installed base of servers is reduced appropriately. Conversely, if rapid growth requires greater computing capacity, expense increases will more closely match the related business increase. The benefits of outsourcing the servers that support your critical business applications parallel those referenced in the previous section.

Business Processes

Business functions / processes are somewhat more difficult to assess and impact effectively. Re-engineering processes usually requires some sort of transformation change agent. Many companies utilize outsourcing as a mechanism for driving difficult process changes. Although Business Process Outsourcing (BPO) is more complex than Technology Infrastructure Outsourcing (TIO), BPO offers greater opportunity to reduce costs and align costs with the business environment than does TIO.

How many companies today handle their own employee payroll functions? ADP is one of America’s largest business process outsourcers, and most companies don’t consider that they have already outsourced at least one aspect of their business.

Opportunities often exist in HR / benefits management, billing and collections processes, customer service, to name a few typically promising areas. To identify the areas of opportunity, companies find greater success in utilizing external change agents.

External change agents are people with expertise in:

• identifying promising areas of opportunity within the business

• identifying outsourcers with functional skills, industry knowledge, leverageable assets and quality track-records

• developing business cases with the supporting financial and business related considerations clearly defined for senior management

• articulating the strategic values associated with outsourcing a specific area of opportunity

• developing the tactical plans required to implement an outsource opportunity, once it has been approved

The external change agent is also critical to ensure that internal vested interests don’t derail an opportunity before it can be fully explored. Most business process change investigations meet a fair amount of resistance that must be overcome. The external change agent must have the ability to engage internal management and professionals in the process, listen to valid concerns and issues, diffuse potential difficulties, and communicate effectively to all parties to ensure a successful transition.

Under a Business Process Outsourcing (BPO) arrangement a set of processes are identified that constitute a definable set of results. In the case of payroll, the BPO arrangement is designed to provide for accurate and timely distribution of payroll checks as well as the calculations appropriate for taxes, benefits deductions, savings plan contributions, etc. The BPO service provider must link into human resource and financial databases maintained by their clients, or generate data feeds to and receive data feeds from their clients. How the checks get prepared for distribution is not material to the client contractual relationship. Only the Service Level Agreements (SLAs) are important. The SLA defines, for example, when the checks must be available for distribution, standards for accuracy and reporting requirements. Figure 3 illustrates the Payroll BPO model.

In the Payroll model, the BPO service provider charges the client a flat price per employee. That price is a function of the service characteristics and SLAs associated with the service. As the company grows its employee base, payroll costs increase in direct proportion to the employee increase. Similarly, costs decrease proportionately for companies experiencing employee contraction. This type of model keeps fixed costs to a minimum and variable costs closely tied to the economic conditions as they relate to employees.

Figure 3

There are several varieties of BPO models that can produce similar expense base restructuring. These models either focus on the generic functional processes (e.g. payroll, HR management, invoicing, telecommunications bill and contract management) or they are more industry focused (e.g. insurance policy administration, stock transaction clearing and settlements, credit card processing, laboratory testing, supply chain management). The common denominators across both the generic and industry specific models are the unitized pricing (per transaction, per employee, ...) and the Service Level Agreement to define the standards of performance.

Summary

Restructuring the expense base from a high percentage of fixed costs with low variable cost content to a lower fixed cost base with higher variable cost content often implies moving some service functions outside of the enterprise to firms with process excellence and scale. These same companies can act as transformation change agents to spur improvements in internal processes and provide service level benchmarks that allow management to make financial decisions with predictable service impacts.

During difficult economic times those companies able to appropriately align their expense base can more effectively focus on business-growing initiatives in order to prosper rather than focusing most of their organizations energy reacting to drastic cost cutting initiatives in order to survive. The right combination of foresight, internal sponsors, external change agents and partners can mean the difference between growing (in the face of an adverse business climate) and struggling to survive.