Transformational deals take wing (Corporate Dealmaker)

Transformational deals take wing

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If Trinity Industries Inc. were one of the railcars it manufactures, you could say it was in danger of jumping the tracks back in 2002. The $2.9 billion company was struggling through one of the worst slumps in its history. Demand for railcars had fallen by about 50% to a near 14-year low, and steel prices were rising -- sales were off $19.6 million in 2002 on revenue of $1.5 billion. At the same time, the hundreds of acquisitions that had established Trinity as a player in not only rail but also inland barge, construction and industrial products had left it with a patchwork of finance and accounting, or F&A, systems that offered little visibility into companywide finances and made it difficult to spot inefficiencies or opportunities for growth.

"We grew through acquisitions and inherited a lot of disparate finance and accounting systems," says Jake Farkas, director of business-process outsourcing at Trinity. "We had 22 business units distributed across a lot of geography, and some were using processes that were outdated and that were hindered by a lack of standardization."

Over at chemicals giant E.I. DuPont de Nemours & Co., another set of issues was coming to a boil. In the course of its 203-year history, delivery of human resources services had developed as a predominantly local function, with a variety of systems cutting across multiple geographies, cultures and languages. There was no central clearing-house to collect and analyze information from its 160,000 employees and retirees in 70 countries and no standardization for the delivery and tracking of HR services. DuPont had little ability to mine HR data that could help it better manage its global work force. Not only was the decentralized operation inefficient and unwieldy, it certainly didn't fit with CEO Charles O. Holliday Jr.'s vision for more communication and collaboration among the company's global business units, which in 2002 he realigned into five growth platforms.

Different companies, operating on different scales and facing different problems. But the remedy for both Dallas-based Trinity and Wilmington, Del.-based DuPont turned out to be the same: transformational outsourcing, which is what those in the field have dubbed business-process outsourcing deals that entail a fundamental rethinking of the process in question and its role in supporting corporate strategy. In transformational deals, BPO is tied to strategic outcomes such as adoption of best practices, better utilization of employees and improved internal capabilities. When executed properly -- no easy task, since these deals can cost billions of dollars and take years to implement -- the end result can be a more competitive company that is better positioned for growth.

Overall, BPO activity has waxed and waned in recent years. But the desire of companies to get a return on their deals beyond just cost reduction seems to have risen steadily. Outsourcing of services such as HR, F&A and procurement was up 58% in the first half of 2006 to $11 billion versus the same period in '05, according to the outsourcing advisory firm Technology Partners International (see chart). At the same time, more companies are beginning to recognize the opportunity for internal transformation that these deals present. According to TPI, the proportion of companies that said they were outsourcing to improve quality was up from 11% in 2004 to 21% in the first quarter of 2006. In addition to Trinity and DuPont, Unilever, Wachovia Bank NA and Procter & Gamble Co. are a few of the other corporations that have recently executed transformational outsourcing deals with an eye toward better aligning a process with corporate strategy.

In many ways, transformational outsourcing is a close cousin to other types of deals, combining elements of post-merger integration, divestiture and joint venture. Often necessitated by M&A, as in the case of Trinity, transformational deals are also transactions in their own right. Because of their size and scope, such deals are inevitably making their way onto the agendas of senior-level executives, who don't just sign off on them but often must play an active role in ensuring that business case objectives are met. Sometimes in-house dealmakers get them done: Trinity's Farkas had no experience managing outsourcing when he was brought over from the company's M&A team, where he was director of business development, to lead the F&A transaction. And sometimes not: Conway, a career DuPont man, was an engineer and IT executive before getting into outsourcing, first in an IT outsourcing transaction in 1997 and now in the HR deal.

A bigger part of dealflow
Business-process outsourcing is cyclical, but the desire to improve services is not
BPO contracts with values > $25 million
Quarter	Contract value (bill.)
1Q 2004	$8.1
2Q 2004	10.4
3Q 2004	4.2
4Q 2004	6.0
1Q 2005	3.4
2Q 2005	5.7
3Q 2005	4.3
4Q 2005	8.7
1Q 2006	7.4
2Q 2006	3.6

BPO deals by industry January through June 2006
Industry	Percentage
Financial services	38%
Manufacturing	31
HC & pharma	8
Telecom	8
Business services	4
Media	4
Energy	3
Retail	3
Travel	1
Source: Technology Partners International

No matter who's leading the effort, it's a lot of work. Making a transformational outsourcing deal pay off takes a huge amount of internal change. As is often the case in a large post-merger integration, some of the company's best and brightest employees may be pulled away from their regular jobs for weeks or even months to help plan, execute and implement the deal. Governance is a major issue, particularly when processes involving accounting and sensitive employee data are being outsourced and overhauled. Existing protocols and governance structures must be adjusted -- and new ones must sometimes be created from scratch -- to ensure that there is sufficient oversight and regulatory compliance in the new environment. All this while training managers and employees on new IT systems and keeping them abreast of changes that will be coming down the pike during what is often a lengthy implementation and transition phase.

"The amount of work that needs to be done is almost always underestimated," says Conway. "Even with all the planning and recognition of that, you probably still don't do enough. We find even now, as we're getting closer and closer to our rollout schedule around the world, some people still haven't gotten word."

Selecting the right consultants to help direct the planning and implementation phases in a transformational deal -- and, of course, the right vendor to handle the outsourcing itself -- are critical decisions (see box). DuPont spent 16 months just preparing for and conducting the RFP process. The company worked with a number of consultants including the Hackett Group to benchmark HR best practices, and with EquaTerra Inc., the outsourcing, internal transformation and shared services advisory firm, to explore the relevant governance issues. It ultimately went with Convergys Corp., a consultant and leading provider of HR outsourcing services, as its service provider. For its finance and accounting outsourcing, or FAO, Trinity selected Outsource Partners International Inc. as its service provider and worked closely with OPI and the management and technology consulting firm BearingPoint Inc. to plan and implement the new F&A system.

The idea to transform Trinity's F&A system had been percolating in the mind of CFO Jim Ivy since he joined the company in 1998. At the time, Trinity, which had made more than 400 acquisitions in its 73-year history, had 22 business units with more than 250 F&A employees and zero integration. Each business unit was managing payroll, accounts payable and receivable, financial reporting and other F&A processes using different operating systems. The result was a lengthy and resource-intensive financial closing period that monopolized the time of skilled business unit controllers.

Ivy, a former Ernst & Young partner who has since retired from Trinity, believed that by outsourcing transactional work, standardizing F&A across its global business units and using a new system (Trinity went with an Oracle Corp. product), the company could slash the time needed to close the books, better utilize the skills of controllers and allow executives to make more informed strategic decisions by more readily tracking performance companywide. Farkas was recruited from the M&A team to lead the effort, which came with a $78 million price tag and took a year to implement.

"We didn't just want to put in new systems and automate old processes," says Farkas. "We wanted this to be a true business transformation. We wanted to be able to put in place what I would call best-in-class processes."

DuPont began planning for its $1.1 billion transformational human resources outsourcing, or HRO, in June 2004 and expects the new system to be fully operational in late 2007. The external component involves outsourcing data management and reporting, payroll, benefits and compensation administration, expat relocation, nonexecutive recruiting and some training and development activities, as well as a long list of other services, all to Convergys. The company expects to save 20% in HR costs in year one and 30% over five years. But, says Conway, "[y]ou don't do these deals to save money."

Instead, it's the internal transformational benefits that are driving the HRO. Delivery of HR services will be enhanced by employee and manager self-service systems that will provide access 24/7 to HR information via online portals and call centers. But the broader strategic benefit will come from DuPont's ability to consolidate and analyze HR and work force data. Working closely with Convergys -- which also provides HR services to Whirlpool Corp. and Fifth Third Bancorp -- DuPont will be able to do such things as compare compensation and varying levels of HR services across its worldwide operations, measure employee satisfaction, identify key employee skills and understand how changes in compensation or employee deployment might affect business objectives. If all goes as planned, that data will allow DuPont to make more informed decisions on how best to manage its global work force.

This is not new territory for DuPont or Conway. In 1997, Conway helped manage a $4 billion IT outsourcing deal -- thought to be the largest of its kind -- with Computer Sciences Corp. and Accenture. In that deal, CSC purchased DuPont's IT architecture and, according to published reports, took on 3,000 DuPont employees. CSC and Accenture were also charged with developing software. The contract was renewed in 2005 -- but that milestone, while significant, doesn't quite capture the complexity of the relationship. According to Conway, there probably hasn't been a week where some piece of the contract wasn't being clarified in some way.

"One thing we've learned is that these deals do not stay static," says Conway. "The contract is a living document, and negotiations, modifications and changes occur all the time. Even at this early stage [in the HRO], we're already into a few of those."

Before DuPont could determine what form its new HR delivery system would take, it had to understand the existing HR organization, a daunting task for a company as large as DuPont. "A lot of this stuff is not written down," says Conway. "It is institutional knowledge that has grown up over so many years, and so it takes a lot of work to document it. We did all that during the RFP process. The future state is what we've been working on since we signed the transaction."

DuPont signed in November 2005 with Convergys, which began guiding the company through a blueprinting process to define the future state. Multiregional functional teams mapped out 150-plus HR processes such as payroll, benefits administration, recruiting, hiring, training and performance management. The 100 blueprints that were created provide a clear picture of how those services need to be built and delivered in the new environment.

"The underpinning to make this work is the IT enablement ... and we've had IT involved from the very beginning," says Conway. "It's what automates and allows you to take out cost in transactions and what delivers value to employees and managers. We started at a very high level, but you've got to take it down where the rubber meets the road. That's a whole other round of work, which has been going on for several months."

One of the greatest challenges for DuPont has been to prepare managers and employees for the new system. That effort began early and continues today with senior vice president of HR Jim C. Borel holding town hall meetings around the globe to sell employees on the idea of HR simplification and standardization. During the RFP process, an executive steering committee made up of senior vice presidents met at least monthly. And CEO Holliday, along with the company's COO, CFO and senior-level vice presidents of all the businesses, receive regular updates on progress and educational material to help them communicate a consistent message to employees.

"What we've learned is that you've got to stay at the message and deliver it several ways," says Convergys vice president of operations Debbie Ashley. "And even though it might be the same message, you've got to say it over and over, and it's got to come from the top."

Trinity also got senior executives involved early on, forming a program management committee that met weekly throughout the 10-month planning and implementation stages of its FAO. Led by Farkas, the program committee included CFO Ivy, the vice presidents of HR and IT, and representatives from service providers BearingPoint and OPI.

"When you have a senior-level team participating on a weekly basis, you get things done," says Farkas. "It's not like we would float ideas around. We would address issues and make decisions in that meeting."

The rapid-fire decision making created momentum behind the project and in the end allowed Trinity to go live with the new F&A system a day early and under budget. That's not to say there wasn't some pushback throughout the process from business unit presidents and controllers who weren't too keen on changing their existing F&A systems. To help address this, says Farkas, the program management team began convening monthly, sometimes mandatory, meetings of each group. It was the first time the business unit presidents or the controllers had ever been in the same room with their counterparts. The objective was twofold: Get key stakeholders aligned behind the project, and give them a forum to voice concerns.

"There is an old adage," says Karen Farwell, a change mangement consultant with BearingPoint. "People will buy into that which they have a hand in creating. We needed to get representatives, if not leadership, from every organization that we were touching somehow involved."

When there was resistance, the project management team worked to "build consensus through robust change management and communication," adds Farkas.

The employee meetings were illuminating. For instance, business unit controllers were to play a critical role in the transformation. Traditionally, their jobs had been highly transactional, requiring them to spend lots of time on back-office work. Now that they would no longer be consumed with those functions, some were concerned about transitioning into more strategic roles where they would be expected to identify trends and spot new growth opportunities.

To help ease their concerns and secure their buy-in, Ivy promised the controllers the tools they would need to succeed in the new environment if they helped implement the program. When the F&A system went live, the company launched the Controllers Development Program to provide monthly leadership, management and finance training. (The program was envisioned to last six months, but the controllers have kept it going on their own, an added benefit to Trinity, says Farkas.)

At peak periods during the transformation, there were as many as 150 people engaged in the effort, about two-thirds from Trinity, says Farkas. In the end, the business case targets were hit. The number of days it took to apply cash receipts to receivables records dropped from nearly eight days to two -- "one of the best in the business," he says. Approving accounts payable invoices was slashed from 22 days to four, and closing the general ledgers dropped from seven days to five. There's greater visibility into financials, data is being mined to uncover inefficiencies and there's greater communication between business unit presidents and controllers.

DuPont's commitment of time and talent to its HRO project is commensurately large. The company has three senior executives and about 30 functional experts from HR, IT, procurement, sourcing, legal and finance dedicated full-time to the project, with a further 100 or so working part-time. About 30 people are assigned to a newly created governance structure that will be responsible for regulatory compliance and overseeing the adoption of the self-service HR delivery systems. When the HR system is fully functional, a total of 40 permanent employees will be dedicated to governance, "the most critical part of making a transaction work long term," according to Conway. "We actually started defining our governance process and structure before deal signing -- several months before we began thinking about how we would lead and manage it."

Conway says it takes about 4% to 6% of the total value of the transaction to manage the effort each year, and maybe an even higher percentage during implementation. That means with a total HRO value of $1.1 billion, DuPont may spend up to $6.6 million annually on a permanent governance organization that will include corporate- and business unit-level employees.

DuPont has worked closely with EquaTerra to develop the new governance organization. The two identified the issues in play, defined the decision rights between DuPont and Convergys and identified the employees who will be responsible for managing service delivery, financial management and contract administration. A common mistake that companies make in outsourcing deals is to assume they can outsource accountability to their service provider, says Mike Beals, the outsourcing management practice leader at EquaTerra.

"There are some elements of governance that a service provider has to participate in," says Beals. "But when a service provider says, 'I'll take care of it for you,' by definition that cannot happen, because you have different fiduciary responsibilities that prohibit that from taking place. For example, they cannot tell you how to independently verify invoices. They cannot tell you what to do with their monthly service report. You have to determine your own policies."

But it's not just governance in the traditional sense of regulatory compliance and oversight. DuPont's governance organization will also ensure that the employee and manager self-service delivery systems are actually adopted throughout the far-flung company. "Where does lost value come in? What happens is you end up with HR generalists in the field that never get scaled down," says Beals. "Part of the business case is that they be replaced by the self-service mechanism. At the end of the day, someone's going to look to the governance folks and say, 'How much savings have we realized? How much value have we realized?' This isn't just about managing the service provider. You're going to be held accountable for the ultimate results of the thing."

No matter how much researching, planning and communicating takes place, deals as big and broad as DuPont's HRO and Trinity's FAO rarely go off without a hitch. In Trinity's case, for instance, the amount of work necessary to interface the IT systems was seriously underestimated.

"We did our due diligence and tried to figure out how many systems we'd need to interface," says BearingPoint's Farwell. "We'd say, 'How do you process this?' They'd say, 'We do this, this and this.' Then we'd get out there and realize there were 18 other things that they did that they didn't mention because they're rote."

In addition, the budget for retraining employees on the new F&A system was far too small. Trinity had already devoted millions to the FAO, and the added cost could have undermined the deal. To help lessen the blow, BearingPoint turned its Dallas office into a training center, renting computers, tables and chairs, and saving Trinity money in the process.

Issues such as these are bound to arise, not only in the implementation phase but also throughout the life of the contract, which makes it critical that there be a strong, collaborative relationship between the company and its consultants and service providers.

"What I've seen is that there's a lot of focus on the mechanics of the deal and the cultural component is sometimes overlooked," says Convergys' Ashley. "In the DuPont case, we are going to be in business a minimum of 14 years. There will be surprises. If the collaboration and trust are not there, the level of complexity and difficulty increases."

Transformational outsourcing deals are big, unruly and expensive. And just like in a high-dollar acquisition, negotiating the contract is sometimes easier than realizing the projected synergies. But when done right, these megaoutsourcing deals can be, well, transformational. And in a highly competitive market, that can be well worth the investment.

A better bidding process

Building a strong relationship with your outsourcing service provider is one of the best ways to ensure that you fully realize the strategic benefits of the transaction. But what many companies don't realize is that laying the foundation for that relationship should begin before the RFP is even drafted. Why? Because relationships that are based on contracts typically fail, but contracts that reflect relationships have a much higher probability of success, particularly in deals as intricate and complex as transformational outsourcing transactions.

Consider the transformational telecom outsourcing, or TTO, that I handled recently for a global entertainment company. In this case, outsourcing allowed the company to solve issues around network bandwidth allocation and converged data, voice and video applications, all necessary to take advantage of the advanced work flow and product delivery methods critical to next-generation entertainment companies. Equally important, though, the outsourcing helped the service provider invent a new way to provide its services that virtually guarantees operational and fiscal efficiency. We accomplished this through an innovative combination of utility pricing, economic drivers and service levels.

Although a strong contract is important, the relationship between a company and its outsourcing service provider is the most important deal asset. One of the best ways to establish that bond is to create a negotiating environment based on what I call a process of inclusion during the vendor selection phase. When managed effectively, an inclusive process can offer a window into how the parties will act in the relationship before final negotiations take place, and it sets the stage for success that will last many years after the contract is signed.

The traditional procurement process is one of exclusion in which the company creates a set of requirements, puts them into an aggressively worded request for proposal and then eliminates vendors who fail to comply. Yes, other factors come into play. But the reality is that by the time the customer and the vendor get to the business of working out the complexities of the transaction, there is a high probability that the relationship is based on fear and not respect. This prisoner's dilemma-like scenario tests a vendor's ability to survive the process, a skill that has absolutely no application once the customer signs a contract, as it cannot exit without either paying a large termination-for-convenience fee to the vendor or concocting a breach to attempt to terminate for cause.

A process of inclusion, on the other hand, provides a framework for negotiations based on the company aggressively seeking not to eliminate vendors unless they simply cannot win. This means that the company has a stake in helping the vendor solve the problems that are keeping it from winning. The result is an atmosphere where each vendor and the company are working as a team to overcome an obstacle--just as they will after the deal is signed.

The thinking behind this is fairly simple, but the difference in the negotiating environment is profound. And although the execution of the process of inclusion requires more practice than one might think at first, there are a handful of concepts that can help companies develop the right mindset.

The first rule is that the customer will do what it can to keep each of the bidders in the process as long as that bidder is viable. This means that as the customer you have to inform bidders in what ways they are not meeting your expectations and give the bidders a chance to remedy the problem.

In the telecommunications outsourcing deal mentioned above, the winning bidder was at one point significantly more expensive than the other providers. Wanting to help them stay in the process, we gave them an opportunity to explain why they were so expensive. Keep in mind that there are certain conditions that can cause this outside of greed, such as an inefficient service delivery model. In this case, the vendor talked about research and development costs that it incurred in intelligent traffic allocation algorithms. We used this knowledge to test the value of those algorithms by designing a new pricing structure based on the advantages gained from this technology, resulting in a net savings over the other providers and providing an economic incentive for the customers' constituent users to buy bandwidth efficiently. A process of exclusion would not have gotten these results.

The second rule is the flip side of the first rule. The company must promise each bidder that it will be eliminated the instant that the company knows the bidder cannot be selected. Integrity is paramount, and each bidder should be comfortable spending the time, effort and money to do its best. That will not happen if the process is compromised by including a bidder that is simply a stalking horse.

Anyone who has ever been in sales will appreciate the difference between having the opportunity to overcome an objection and wasting time pursuing business that cannot be won because of a condition that exists.

The third rule is that the company must state its strategic requirements as best it can at the beginning of the process. It is unfair and senseless to spring surprises on bidders at the last minute. This requires that the company knows how the end product of the negotiation should look and where its own weaknesses are. If proven expertise is not available in-house, then the company should retain an adviser to help and possibly lead it through this.

I had a client company that outsourced its human resources function because it was divesting the business unit that had handled HR, and the buyer was withholding related transition services for negotiating leverage in the corporate deal. When we went out to bid in this deal, one of the first concerns I raised with the bidders was the lack of people available from our side for the transfer of HR knowledge. Knowing how these deals work, I did not want to surprise the vendor when we got to contract negotiations with this news, since it affects their business case. Additionally, dealing with these types of issues in the RFP stage normally results in very little if any negative impact to the deal, whereas introducing them at the end can make the deal fail and will certainly tarnish the relationship.

There's more to running an inclusive bidding process than this. But following just these few basic rules is a good start. - Ed Hansen

Ed Hansen is a partner at Morgan, Lewis & Bockius LLP and a member of the Global Outsourcing Group.

Treat your bidders right