Shared Services: To Sell and How to Sell
Divesting internal shared services presents an ideal opportunity to an organisation to unlock capital tied up in the operations of a company – capital which may then be better deployed towards meeting the strategic objectives of the organisation. This is fairly radical way of looking at an operational model which was once considered untouchable.
Shared services once were the perfect solution to delivering efficiencies. They combined the benefits of consolidation, the control of keeping operations in house, and if they could be located in low-cost destinations they would be able to deliver additional savings. However, setting up a shared services function called for large upfront investments, and the usual justification of shared services over strategic outsourcing was risk and lack of service provider capability.
In recent years however, those justifications have been challenged. While the high cost of capital and difficult economic conditions have made shaping new business cases for investment in shared services all the more daunting; service providers have invested significantly in building capability and domain expertise. They have demonstrated good risk management practices, and brought innovative solutions to the market; helping their clients realise additional value from operations.
Combining the factors, there is a subtle shift in the thinking and approach towards shared services. There is some evidence pointing to the fact that large corporations have looked at their back office functions and wondered if it’s appropriate for them to maintain all that infrastructure and overheads, when there are other options. Unsurprisingly the answer is often no; and options such as a divestment are attractive possibilities.
Understanding the divestment of a shared service
Simply, divesting a shared service is transferring internal operational functions to another party for a commercial consideration and establishing a separate agreement for an ongoing provision of services. Divesting an internal shared service function is in some ways no different from the usual M&A activity where businesses routinely change ownership in line with corporate strategy. A shared service is part of the operational capability for an organisation and any decision to divest must begin with a view on how the organisation sees itself in the short-to-medium term. A clear operational strategy will enable an organisation to shape a view on its requirements and challenges, and against that backdrop, decide whether or not the shared service continues to be the viable option. If not, then the divestment option may be the one to pursue.
Delivering the divestment
Divesting the shared service is not a task that any sensible management team should take lightly. Given the long-term and strategic implications of this decision, it is best to appoint a dedicated team to facilitate the transaction and the transition. The team should be accountable and empowered to make appropriate decisions, engage with the market and execute the transaction. Specifically, the team should deliver the following outcomes:
1. The overall proposition
Crystallising the idea of divesting the shared service into a proposition that can be understood and evaluated by the market is the cornerstone of the initiative. Clarity on what is being divested is vital for potential buyers to make an informed decision. The complexity in this case comes from knowing where to draw the line among the sellable components: people, systems, facilities, IT architecture, support function etc. This is an art rather than science and completely contextual to each situation – in line with the overall operational strategy and requirements of the organisation. Carefully considering the implications of including or excluding each component in the proposition and making wise judgement calls with clear and documented rationale must be the first deliverable. This process will also allow for an initial exchange with key stakeholders and get their opinions and preferences at an early stage of the process.
2. A market test
Once there is internal clarity and consensus, it would be sensible to test the proposition against the market. The idea may be to test market acceptance of the proposition; the acquisition appetite of potential buyers (including different types of buyers); and establish indicative price points. The test may be executed anonymously via an independent advisory firm, which may assess the scope, potential fit and then liaise with potential buyers to understand their appetite and willingness to acquire. An effective market test also provides a good temperature check from the market about the timing of the divestiture, which may influence the eventual price or even market participation.
3. Identifying the buyer and the partner, and the valuation
Concurrent with the market test (or shortly after), a list of potential buyers needs to be developed. Many types of service providers – global systems integrators, regional service providers, specialist or niche ITO and BPO providers, niche players or even private equity houses may be interested. In addition to the potential buyer, a sensible valuation needs to be agreed as a baseline. A tender process combining the requirements of a divestment along with on-going service provisions will help in identifying the right partner that will not only be able to execute the acquisition but also deliver the service in line with requirements and expectations. At this stage, from a commercial standpoint, it is important to balance the need for as a high a price-point for the divestment, with the price of ongoing service provision.
The actual valuation can be reached using a variety of models – revenue projections, discounted cash flows or profitability multiples (or a combination to triangulate), but any model will only reflect the underlying assumptions on profitability and potential from the shared service and its fit with the overall delivery footprint of a potential buyer.
4. Executing the transaction
While the steps above provide a lot of food for thought in terms of possibilities available, the actual change is felt when plans are put into action and the transaction is executed. Time will be spent in frenetic activity but and aspects must always be kept in mind to address the emotional or cultural aspects, and the technical aspects of the transaction.
- Rigour and discipline: divesting the shared service will be complicated with many moving parts and conflicting stakeholder situations. A disciplined approach is needed to make sure that all aspects are managed carefully – from scoping, to market engagement, to stakeholder and employee engagement. All through the process, the team must keep challenging its own hypothesis and assumptions to ensure the best possible outcome for the organisation.
- Creating a profit centre from a cost centre: from a technical perspective, as mentioned earlier, it is important to provide clarity on what is being divested. For example, it may be consolidating the service entities in one legal entity. Once this is done, the ownership of this entity may be transferred as part of transaction. This makes the transaction neat and clear and can be underpinned by a sale contract.
The divestment process will result in two main agreements:
- The sale agreement: covering the terms of the sale, including the price, assets, employee transfer etc.
- The service-back agreement: from an ongoing service delivery perspective, this is perhaps the more important document. This should be treated like a standalone outsourcing contract and must address all the relevant operational, governance and risk issues to ongoing service.
As with any strategic initiative, there are some risks to manage which can derail either the process or dilute the anticipated value from the divestment. The main ones are:
- Price vs. service continuity. There is a conundrum between the upfront consideration and the ongoing price of service. Naturally, the organisation would want the highest price possible for the shared service. However, the down side of this is that the buyer is subsequently likely to charge a higher price for ongoing service. Given the fact that post-divestment, there will be a high dependency on the service provider, this may place the selling organisation in a difficult place. Finding the right balance for the upfront price and the price of ongoing service will be important to ensure service continuity, and this can be tested through benchmarking – preferably by an independent advisor.
- Service provision. Post-divestment, the organisation will need to treat its relationship with the buyer as a normal outsourcing relationship. However, given the legacy connection between the divested shared service, this may be easier said than done. Taking the legacy organisation on a controlled journey from in-house service to an outsourced service is important.
- The people. For those directly affected by the divestment process, there might a lot of stress and uncertainty. While the new organisation may provide alternate or even better prospects, the change itself may be difficult and care must be taken to retain the right people.
While it is premature to say that no new business cases are being written for new shared services or that all existing ones are being divested, the divestment of shared service and establishing a service back arrangement make a lot of sense. However, such a decision and its execution need careful analysis of the operational requirements of the organisation, which then needs to be balanced against the risks of outsourcing. Selecting the buyer/service provider requires significant time, attention and management focus to ensure the right price and solution. If managed well such a divestment may unlock a lot of value at the time of the divestment as well as through ongoing service.
About the Author
Piyush Sodhi is a Senior Manager in the Aecus BPO team with extensive experience in banking and financial services. Aecus is an award-winning consultancy specialising in helping clients to get the best results from ITO and BPO, in the financial services sector and other industries. Aecus helps clients with outsourcing strategies, implementation, optimisation and innovation.