Outsourcing Update 2020- Insiders Speak Out

The Big4 have dusted off their 1990s-era outsourcing model with renewed promises to solve the challenges generated by legislative and regulatory pressures, all while incorporating emerging technologies. 

In our previous white paper, "What the Big Four Don't Want You to Know About the Latest Outsourcing Trend," we shared our belief that these engagements rarely make sense as a long-term solution due to:

1. OPPOSING MOTIVATIONS 
2. DIFFERENT BUSINESS MODELS
3. LOSS OF INSTITUTIONAL LEGACY KNOWLEDGE

 Seeing as none of the large, complex companies that moved to full outsourcing in the late 80s and early 90s have remained in that format, we're back to assess the success of this latest outsourcing push. 

As we anticipated, there have been a few outlier situations where companies have found themselves in unique situations where outsourcing made sense. For example, we know of a spinoff at a major auto supply company in the Midwest where staffing and building a tax department didn't make a lot of sense. Management realized those individuals would either be fired or divided in a sale. Finance decided to outsource their tax function to an accounting firm, and within 18 months, there was an announced acquisition by another company. Under these circumstances, outsourcing was a tremendous success. 

COVID-19 UPDATE

As is well known, there have been some large-scale outsourcing engagements over the last few years. At the moment, these are at a minimum struggling, if not outright failing. The coronavirus pandemic has only added to the acceleration of their deterioration.

Considering the low rates third-party firms are charging for outsourcing projects, we believe they took them on as loss leaders or opportunities to get their foot in the door. However, particularly in respect to the technology platforms they were pushing, the firms can no longer afford to have a loss leader of this scale. We believe this financial pressure will be exacerbated in the current climate, as companies cut back on costs. Additionally, as the accounting firms cut back on staff, they will find themselves unable to maintain their current pricing models.

Even without the pressures caused by the pandemic, these engagements rarely succeed. To shed light on the inherent reasons, we've spoken with two anonymous tax professionals, both of whom went from being part of corporate in-house tax departments to being integrated into two different Big4 firms' outsourcing arrangements. While we've chosen to keep their identities private, their first-hand observations reinforce the inherent shortfalls of outsourcing in the best circumstances.

1. OPPOSING MOTIVATIONS

Public accounting firm employees are driven by utilization, realization, and billable hourly rates. In-house tax and financial leaders are tasked with increasing shareholder value and reducing risk. With one side pushing to create costs and the other looking for ways to minimize them, these two opposing ambitions are inherently incompatible.

"What I've seen is the accounting firm's motivation is at odds with the client's. In short, they want to sell more services, so they're looking for out-of-scope service opportunities. That's really what's driving them, and the consulting firm is going to interpret the scope of work that they're engaged to do as narrowly as possible. It's a different mentality as far as getting the information on the return correct or defending the return. Rather than a concern for accuracy with respect to those details, the accounting firm is thinking, "What's the billing opportunity?'"

"Budget is always an issue. Everyone is used to coming to you. Everyone is used to calling you and getting your advice on things, and that's been free. But now, you work for the consulting firm, so you've got to charge for that time, and the numbers can add up fast. As a consultant, you're flying blind. The firm doesn't tell you what the budget is. They say, "Just do it." Then halfway through the month, someone sends you an email that says, "don't do any more work. Now, critical work that needs to be done can't be done because you've reached your budget limit."

"The Big4 firms internally haven't figured out how to allocate the work between their different outsourcing or insourcing groups and their general tax and consulting practices so that there's enough flexibility to use those other resources as needed."

2. DIFFERENT BUSINESS MODELS

The outsourcing model typically involves hiring the employees of the now-defunct tax department - in effect, trading them to a team for whom they never chose to play – and selling them back to your company at a much higher rate.

"I think there's a fundamental difference in business models. A large part of in-house success comes from understanding the business, understanding the people and what they want and how they want it. All of that takes upfront investment. You've got to spend a lot of time - late nights, weekends - in order to get to that point. But if you're in a public accounting firm, you've got to bill every 10th of an hour to the client. It's very difficult to be making that kind of investment." 

"The way the Big4 develop their people is different. They're not looking for a generalist that can handle all the company's tax issues. Any questions that come up, they want to send it off to their specialist and let them get involved. I think – particularly at the senior levels – they don't value the generalist who was leading groups before. Additionally, they want you to push work down to junior people. You're worried those junior associates don't know how to do it and/or don't have the capacity to do it as well. Not only the planning or bandwidth but seeing the transaction through to make sure it's executed correctly, as well as reporting it and defending it."

3. INFORMATION LOSS

In most full-outsourcing arrangements, a company hands their tax preparations over to the major accounting firm, thereby losing control of the data involved in those returns. When audits come up, they then struggle to reconstruct the information because they weren't involved in the process at the time.

"Public accountants don't understand the full implementation of the full tax life cycle. And a lot of times, the information that goes in the returns is not well-described and may not be an accurate reflection of the transaction because the people doing the work just don't know enough about how the transaction should have been reported. They report it based on what they see in the general ledger and they make assumptions. It's a real breakdown."

 "The company loses control over the information that's going into the returns, as well as the quality of the returns. They get an IDR or questions from the IRS on something, and they don't have anyone that's familiar with what's being asked or who was involved in the transaction reporting."

CAN IT WORK?

Our belief is that most of these outsourcing engagements, much like those in the 1990s, will not be renewed, and those companies will most likely rebuild their tax departments at the end of the term. Unless they happen to transform into a unique outlier situation, nothing is indicating a trend of success that would encourage others to buy into this model. 

Full-scale outsourcing's main value proposition is in situational scenarios with short-term needs. For example, spinoff companies looking to fill the gap before being re-acquired, or company mergers involving multiple service providers. In these cases, there can be a benefit to outsourcing temporarily and then later bringing the tax function back in-house.

Another option during such transitions would be partnering with a recruiting firm to secure a combination of permanent hires and freelance contractors. Through the burgeoning talent economy, tax functions can easily engage a fully vetted, experienced expert to assist with anything from planning support to acting as an interim Head of Tax.

Companies such as TaxForce screen seasoned tax professionals and match them with projects requiring their knowledge and experience. Furthermore, unlike many consultants who may have never worked in-house and therefore fail to understand the value of knowledge transfer, these on-demand tax contractors become synergistic, proactive partners.

Short-term outsourcing of a tax function can make sense in certain outlier circumstances, but financial leaders are no longer limited to traditional solutions. Now, along with the familiar options offered by the public accounting firms and in light of the economic pressures brought by COVID-19, companies are encouraged to consider co-sourcing and the talent economy as viable, cost-effective alternatives to full outsourcing. 

Seeking a macro-overview or targeted insight into managing your own outsourcing effort? Contact Stephanie Conley at 843-216-6664 to arrange a mutually convenient phone appointment with TaxTalent president, Tony Santiago.