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Table of Contents

Starting a New Nearshore Supplier

Nine Ways to Cut Costs While Keeping the Lights On

2009 Outsourcing Excellence Awards Data Reveal New Trends in Service Provider Qualities

Is Your Supplier Financially Stable? Here are Five Ways to Tell

Teaming with the Right Provider Enables Application Developer to be First to Market

U.S. Manufacturer Outsources to Chinese Supplier by Combining Product Lines to Achieve Volume

With OTC, the Sum is Greater than the Parts

Best Practices Approach to SOA Testing

Improving Quality in Business Process Outsourcing

Strategic levers to optimize your hr processes

Managing Quality In Customer-Driven Organizations

Electronic Health Records and Health Information Exchange: The Rx for an Ailing Healthcare System

Hire, better, faster.

In December 2008 Ramalinga Raju, Chairman of the Board of Directors at Satyam, admitted inflating profits for years. The future of the Indian supplier is still uncertain.

Whenever an outsourcing supplier gets in financial trouble for whatever reason, it can create a crisis for its buyers. The Satyam situation is a stark reminder that outsourcing buyers need to remain ever vigilant at every stage of their outsourcing relationship.

Of course, it's difficult to detect corporate fraud when it is propagated by a senior leadership team, particularly if they are colluding with external parties. You can't expect their statements are false. Few outsourcing buyers have the skill set to be a forensic accountant. By then, it's too late anyway.

But here at Everest we do believe buyers can beef up their due diligence to become alert to possible warning signs that warrant further review. Based on a review of best practices across Everest in light of the Satyam situation, here are some things we think you should consider. You're looking for anything that raises eyebrows.

Things to check

Here are some basic elements of a rigorous due-diligence plan.

1. Assess the supplier's general financial performance. Study the audited quarterly financial statements to ferret out sales trends. Are sales going up or down? And at what rate? Also, does the supplier have an undue exposure to any specific industry sector? If so, is this sector in trouble or hanging in? You can also ask for internal audit reports if there are any.

   Also check out the supplier's financial ratios. You can find these in equity analyst reports. If you are concerned, call the equity analyst and ask your own questions.
   
   

2. Look at the quality of its financial statements. The first thing to check is the depth and rigor of the supplier's published financials. How deep did the auditors probe? Remember Enron? If you want to play detective, interview members of the supplier's audit committee. Talk to directors on the board, the executive responsible for managing the relationship with the auditing firm, and the partner at the firm doing the audit.

   The audit firm can provide lots of telling clues. Find out how long this auditing firm has been looking at the supplier's numbers. Are there any other relationships between the auditing firm and the supplier? Is there a conflict that might produce a less than rigorous audit? Are there any external reasons that would cause the auditor to not see things as they really are? One way to do this is to look at specific issues and find out how the supplier and the auditor resolved them.

   Although it is not currently common practice, some experts at Everest believe it is a best practice to rotate audit firms every three to five years. This removes the opportunity for the two parties to get too friendly. A fresh set of eyes can see new things.
   
   

3. Check out the supplier's compliance and ethics. Does the supplier have a formal, published ethics policy? If so, read it carefully. Then discern how effective these policies have been. Also check to see if there have been any whistle-blower allegations. How did the supplier handle them?
   
   
4. Determine who owns the company. Carefully review the ownership structure. In Satyam's case, the owners tried to buy a company called Maytas to restore the fictitious assets with real ones. But this wasn't really an arm's-length transaction due to family ties between the two groups. So, look at any acquisitions over the last few years. Is there anything curious about them? Was there common ownership between the two parties? Also check out the relationship between the company's largest shareholders and its executives.
   
   
5. Observe the power of the CEO. This is an unconventional hypothesis. But studying the public firms that have had problems in the past, we note that most had strong founder chief executive officers. Two examples are Adelphi and Demeer Group in the UK; both had powerful CEOs who wielded an unduly large influence that made them untouchable within the corporation. This is also true of class-conscious societies like India. Once these leaders gain a certain level of stature, no one in the organization dares question them. You can sleep easier at night working with suppliers that rotate executive leadership so no one can create personal fiefdoms.

If the business you are outsourcing is "mission critical," Everest suggests that you plan for more robust due diligence using the techniques outlined in this article and make routine checks at least annually.

Lessons from the Outsourcing Journal:

• The Satyam situation was a wake-up call. Buyers need to continually monitor the performance and credibility of their suppliers. There are five things to do:
  1. Assess the supplier's general financial performance
  2. Look at the quality of the financial statements
  3. Check out the supplier's compliance and ethics
  4. Determine who owns the company
  5. Observe the power of the CEO
  6. Plan for more due diligence if your outsourcer is handling mission critical work.

Publish Date: April 2009

Copyright © 2009 - Everest Partners, L.P.

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