Skip main navigation

Insights & Publications

Article

When to divest support services

Some companies can reduce the cost of support services, improve their quality, and raise cash to invest elsewhere. Here’s how to tell if your company is one of them.

July 2009 | byPetter Østbø, Tor Jakob Ramsøy, and Anders Rasmussen

Is a hidden gem eluding your portfolio evaluation process? Most companies periodically scan their operations to ensure that they are the best owners and in the process identify businesses that can be divested to raise capital for other opportunities. But these companies typically overlook support services, viewing them instead as cost centers—which focus on cost reductions or outsourcing—rather than as business units ripe for divesting.

The distinction is an important one. In many cases, it makes sense to outsource individual service activities, including commoditized corporate functions (such as finance and accounting, HR, and purchasing), IT functions (the help desk, infrastructure operations, applications management), and industry-specific functions (booking and fare management for airlines, payments processing for banks). Yet when a company aggregates support services into a single unit, it may constitute an attractive business that can be sold outright, with a value greater than that of a five- to eight-year contract for continued support services. The selling company reduces its operating costs, raises capital, and removes assets from its balance sheet. The purchasing company acquires assets, know-how, and perhaps an attractive geographic footprint, as well as a new support services client. Nonetheless, even executives who understand the idea in theory worry that the practical obstacles to divesting—tight credit and a weak market for assets—outweigh the benefits or that the seller will have to pay more for these services after the divestiture.

For companies that meet certain prerequisites, however, the opportunity can be significant, and there are plenty of eager buyers for shared-services units that offer real value. In our research into more than 30 recent transactions, the divesting companies generated, on average, an immediate cash injection of 250 percent of book value. There were also immediate cost savings of up to 40 percent, followed by annual additional reductions of over 2 percent, and even, in most cases, improvements in quality.1 These numbers match up well with the latest transaction multiples for similar types of assets—and divestments of shared-services units also embody hidden opportunities for value, so the benefits probably exceed those of open-market transactions.

Who should divest?

Not all companies should consider divesting a captive support services center. Before a sale attracted buyers, many companies would first need to develop their own capabilities internally or to improve the organization of their shared-services units. That is especially true for companies whose support services are still dispersed among various business units or only loosely controlled by a central unit, as well as those whose business processes aren’t standardized or whose fragmented IT systems are based largely on legacy applications and must therefore be cleaned up. Furthermore, companies facing a large, imminent restructuring (such as the divestiture or acquisition of a major business) may also find it better to keep their services internal so that they retain control over quality, avoid adding complexity to the difficulties of the transition phase, and reduce the risk of losing key people.

Obviously, if a unit has unique capabilities or a company has unusual service requirements, selling the unit outright would put the company at a disadvantage when it negotiated subsequent service agreements with the new owner, which would have the leverage to demand whatever terms it wanted. In our experience, however, sellers usually have enough qualified alternate providers to make the subsequent negotiations competitive.

We have also found that the companies best positioned to divest have service centers mature enough to permit a change of control: such a unit is a separate entity, with an existing sales and service culture; has a product catalog with clear service-level agreements (SLAs) regulating the type of service the buyer receives, as well as its quantity and quality; and provides at least 30 percent of the selling company’s needs. Finally, the unit’s growth shouldn’t be strategically important to the success of that company, which must also be willing and able to manage the resulting service contracts.

Even among companies that meet these prerequisites, divesting a support services unit is attractive only if the benefits exceed the value that could be created through a simple outsourcing contract. For sellers, this means finding a buyer that can provide quality services at a cost lower than the current one, offer a service contract sufficiently flexible to adjust for changes in technology and usage patterns, and pay a premium high enough to justify the permanent transfer of control and ownership of all assets. Buyers actually have shown a willingness to pay such a premium for support services units that offer value creation opportunities similar to those of any other acquisition (exhibit). Attractive units must have the ability to function as businesses on their own, a desirable geographic footprint (from an operational or a customer-facing perspective), industry-specific capabilities that would strengthen a service provider’s offering, significant growth potential, or unique intellectual property.

Exhibit

What buyers want

Buyers have been willing to pay a premium for support-services units that offer value creation opportunities similar to those of any other acquisition.

Examples of successful sales abound. Take, for example, WNS, the support services unit of British Airways. WNS was a wholly owned subsidiary of BA until April 2002, when the airline sold 70 percent of its shares to the private-equity firm Warburg Pincus. Under Warburg Pincus, WNS was able to expand its offering of finance and accounting, HR, and benefits-management services to numbers of new clients. Another example of such a sale involves the private-equity firms Cinven and BC Partners, which acquired Amadeus Global Travel Distribution, the ticketing arm of Scandinavian Airlines System (SAS), Lufthansa, Iberia, and Air France, in 2005. Since then, Cinven has successfully worked with the company’s management to enlarge the business and reduce operational costs. In 2007, Cinven recapitalized Amadeus, earning 1.6 times its original investment. And when the European service provider Capgemini acquired Unilever’s Indian support center, Indigo, it quickly became a platform for establishing the company’s offshore business process outsourcing services.

Not all companies meet the prerequisites, and those that don’t should wait. One Fortune 200 basic-materials company first evaluated the idea of selling its support services center four years ago but decided that the unit didn’t serve enough of the company—or offer enough services to the internal clients it did serve—to attract the right potential buyers. Further, the company was divesting a major division and decided it couldn’t risk losing direct control over its support services until the restructuring was complete. Recently, after addressing those issues, the company divested its support services center.

Who is the best owner?

In our experience, many companies will be interested in acquiring a mature support services center. The trick is to negotiate only with potential buyers for which it would have real value. The seller must understand that value for a wide range of companies—including service providers and financial buyers, such as private-equity firms—and develop a short list of no more than five candidates that would be invited to negotiate. A team that includes the CIO or the head of support services, the CFO—and, for larger deals, the CEO—usually conducts this kind of effort.

At the outset, the team should determine whether its own company is the unit’s best owner by developing a realistic three- to five-year business plan based on the assumption that the unit would be free to serve any customer and that resources would be available to support its growth. The plan should account for the unit’s growth opportunities and for cost and quality improvements that would take its performance to best-practice levels. If the plan would help the center generate more value than it is currently expected to create, the team must decide whether the company has sufficient resources to make the necessary investments and add the needed capabilities, taking into account its hopes for other business units. If the plan would require a disproportionate focus on the support services center or would be challenging to execute—given, for example, the natural constraints to serving competitors—then there is probably a better owner, and the company should consider divesting the unit.

Negotiating the deal

When the time comes for the company to divest, its executives must manage two competing challenges: getting the best possible cash payment for the sale of the business and the best possible terms for a five- to eight-year service contract. The key to success is negotiating the service contract and the sales price at the same time—typically, by inviting a short list of credible buyers (those with the size, reputation, and ability to provide contractual quality and service guarantees) to an auction that sets the price both of the unit and of the service contract’s most important products and SLAs. The top one to three bidders should subsequently be invited to participate in detailed open-book negotiations.

An excessive number of candidates can be a problem. A large multinational that began the process with more than 25 bidders found it impossible to evaluate them, because it couldn’t properly negotiate both the sale and the service contract for so many bidders at the same time. After a six-month auction failed to produce appropriate results, the multinational decided to enter into detailed negotiations with only two parties. It reached an attractive agreement within two months.

Negotiation mechanics for the sale—due diligence, valuations, and so forth—are the same as those for any other divestiture, with a notable exception: the seller must be confident that a buyer will stand by its long-term contractual obligations and its guarantees if issues arise with the quality of service. This type of transaction also differs from a standard one in that the value transferred depends on more than the amount of the up-front payment for the sale; other important considerations include the size of the initial and ongoing cost reductions, the length of the service contract, and the investment needed to transfer hardware, software, and employees.

The challenges of negotiating the service contract resemble those of any straightforward outsourcing contract. Sellers often include specific requirements, such as limiting the use of offshore employees and mandating a presence at certain locations. (One US financial institution, for example, required the buyer to keep nearly 100 employees in the seller’s US offices and to allocate a certain number of employees in the buyer’s offshore offices to work solely on the seller’s account.) Once the transaction closes, the seller must keep key people from its former captive to ensure that it has the contract-management skills it will need and understands the systems and processes it has sold.

About the authors

Petter Østbø is an associate principal in McKinsey’s Oslo office, where Tor Jakob Ramsøy is a director; Anders Rasmussen is a principal in the Copenhagen office.

About this content

The material on this page draws on the research and experience of McKinsey consultants and other sources. To learn more about our expertise, please visit the Corporate Finance Practice.