Metrics, Sub-metrics and Adjusted Metrics: Some Basic Accounting Concepts in Outsourcing. In the assessment of the “base case,” accounting analyses highlight many different metrics. Classic accounting principles in IT-enabled services and technology infrastructure have evolved. Traditional lexicon of outsourcing metrics is based on classic accounting principles used in software development and technology infrastructure development. These have evolved into a multiple set of metrics, sub-metrics and risk-adjusted metrics.
- “TCO” (total cost of “ownership” / “outsourcing”) seeks to identify all present and future costs of an activity. TCO adopts classic cost-accounting principles of fully allocated costing, or activity-based costing).
- “EVA” (economic value added) seeks to measure the projected increase on the economic value of the enterprise customer.
- “CBA” (cost-benefit analysis) compares the costs and the benefits and balances them to determine whether one outweighs the other.
- “NPV” (net present value) is a tool used to measure, in today’s terms, the values of future streams of revenues (or benefits) and expenses. It serves as a neutralizer where there will be future disparities in the rates of growth or decline in benefits and expense items.
- ROI (“return on investment”) means the enterprise customer’s return on investment, or net cash flow divided by initial investment. As of mid-2005, there was no generally accepted accounting principles (“GAAP”) for defining “ROI”.
- ROE (” return on equity”).
- Speed of realization of ROI or ROE.;
- “Cost savings” and other financial impacts of an outsourcing.
- ROIE (“return on infrastructure employed”) provides a retrospective comparison of net corporate earnings with the annual IT (or, in the case of BPM, other infrastructure) operating expenses, notably, the networks, systems and applications that support the enterprise. ROIE is expressed as a ratio of “EBITDA” (earnings before interest, taxes, depreciation and amortization) divided by annual expenses of the relevant business process.
- ROIE takes a look at the outcomes of an investment or outsourcing contract already made and compares it to the assumptions, economic cycles and business growth that followed the investment, after the fact. By comparing yearly technology expenses (or yearly business process outsourcing expenses) with net earnings, the CFO can identify the net effect of a collective set of projects to determine whether they are aligned to business metrics and objectives. ROIE allows the measurement to determine whether cost growth is rising faster than revenue growth.
- Some consultants tweak the accounting functions. Understanding the consultant’s methodology is critical to evaluating the likelihood of the consultant’s providing fact-based advice that will be useful for the enterprise customer to conduct future strategies like demand management, supply chain management, human resource development and provisioning of support services to a changing global enterprise.
- Risk Adjusted Metrics. One consultant reportedly adds a long list of “risk-adjusted” metrics to its ROI computation. What is the risk that the project (or the contract) will not achieve its ROI? Adopting a business-performance metric framework, the enterprise customer would evaluate aggregate and individual business performance metrics that would be affected by the project (BPM) or the outsourcing (BPO). Such KPI include the effectiveness of the project or BPO on marketing and sales, product development, relationships with suppliers, human resources and human capital development, IT and finance department operations. These higher level metrics are then quantified into service level metrics for inclusion in service level agreements.
- Externality-Impact Metrics, or Total Economic Impact. Another consultant reportedly evaluates, on a prospective basis, “TEI” (total economic impact) so as to include future operational benefits after the implementation of a new technology or process; TEI seeks to identify what new economic benefits and consequences, such as new projects, lower costs from aggregation of a new infrastructure or contractual relationship platform for lower per-unit costs of support, thereby enabling the deployment of future technology on a scalable basis, “better” processes and other externalities that can be expected to flow from implementation.
- Customer-Specific Unique Fact-Based Metrics. A third consultant underscores “case-based” analysis and research.
- The essential business terms and expected benefits of an outsourcing transaction — pricing, performance, payment and perceived benefits — all depend on effective accounting and the integrity of the balance sheet and earnings statements.
- Achieving financial goals depends on the methodologies for evaluating the proposed outsourcing or insourcing.
Should We Adopt “Charge-back” Accounting?
In cost accounting as in process control, success depends on transparency of cost and function. By identifying and allocating the costs of the different elements of service, management can decide whether in-house clients are abusing in-house staff and other resources.
For example, a marketing department might want to design a number of new data bases and new data capture mechanisms for measuring the effectiveness of a proposed marketing campaign. By adopting “work orders” and accounting for changes made, the information technology department can show the true amount of services delivered. Not only is this information useful for allocating expenses (and thereby limiting costs to those departments with sufficient budgets), but also for identifying bottlenecks in the process of production. If the marketing department lacked sufficient budgetary resources to engage the IT department in extensive changes on the marketing data base, and if the marketing department demanded that the changes be done at the same time as the financial statements must be prepared, the marketing department can be identified as a bottleneck in cost and priority.