Sourcing – i.e. whether to in-source or outsource a business operation – is a very hot topic in the board rooms of Financial Services Groups. The reason is that Banks believe outsourcing business processes (BPO) can deliver cost savings that are not achievable by the bank itself because:
- The outsourcer is supplying the service to several banks and achieving economies of scale, or
- The outsourcer is supplying the service using low cost off shore resources.
The problem for UK banks is that BPO is still a relatively new game – only a small percentage of the total cost base is outsourced – and the experiences that UK Banks have had to date have been somewhat mixed.
This lack of success is probably, at least in part, the Banks going up a learning curve in managing these relationships. Where a function is managed in-house, Banks often re-organise it in a relatively unfettered way. Similarly, in-house managed projects are changed, stopped or delayed according to relatively quick and flexible decision making processes. This kind of behaviour has to become much more formal and contractual in an outsource situation and Banks’ management are not used to that.
Another important factor appears to be that Outsourcing companies are undertaking uneconomic contracts in the hope that by using a loss leader they can gain a foothold in the still formative UK Banking Outsourcing market. Once established, the logic goes, they will recoup the losses on subsequent contracts.
Given this rather unhappy backdrop, the editors have rather cautiously tried to distil some of the key factors that appear to make an outsourcing activity a success or not. Read on for more detail.
- An Outsource will probably work IF
- You are in a deal with several banks at the same time
- It is possible to move a substantial body of the cost offshore
- The business process and technical interfaces between the bank and the outsourcer are few, clear and simple.
- You can write a 2 tier Service Level Agreement (SLA)
- An Outsource will probably not work IF
- The plan is to re-engineer the process and outsource after re-engineering.
- The outsourcer supplier has no freedom of movement to make savings.
An Outsource will probably work IF
“You are in a deal with several Banks at the same time”
For the banks and outsourcer involved it may seem frustratingly slow to agree requirements and service levels and implement the service when multiple parties are involved but it is actually a good situation to be in. Most of the long term successful collaborations in the industry (e.g. BACS) have all involved multiple banks from the start. This is probably because the outsourcer cannot tailor his services too closely to the peculiarities of one bank. This may appear bad to an individual bank but the basic process implemented by outsourcer is likely to be lower cost, more robust and flexible to change for being “lowest common denominator”. If there is something really important that is unique then it probably should not be outsourced.
Conversely, it is a bad idea to outsource to a supplier who does not have any other banks signed up but proposes to use your bank as a springboard for signing up other banks. Typically what happens is that the outsource supplier builds a processing capability that is too closely aligned to this first bank and cannot then win other banks’ business and hence achieve the required economies of scale.
“It is possible to move a substantial body of the cost offshore”
Most UK banks do not have an operational capability “in-house” to run processing centres in China, India or other such low labour cost locations and it is very tricky to setup such a capability from scratch with no major presence in the country. With skilled labour, buildings and land costs at just 20% to 30% of even low cost UK locations the prize is worth going after. The obvious answer is an outsourcing partner who does have a demonstrable offshore capability.
“The business process and technical interfaces between the bank and the outsourcer are few, clear and simple.”
One of the keys to a successful outsourcing arrangement is the definition of the boundary around what the Outsourcer is responsible for and what stays with the bank. The boundary that is easiest to draw from a management point of view is one based on an organisation chart. Frequently this is the wrong answer. This is because the business processes and systems often cut across organisational boundaries in a way that makes the ongoing relationship extremely difficult. A better way of defining an outsource boundary is to examine the business process and system interfaces and use these to draw the line. Two examples illustrate this point
- A good boundary would be one where the outsourcer’s systems are connected to the bank by a simple file transfer interface and a bad one would be where the outsourcer’s staff have to use core banking systems in an intensive and interactive way. The latter is a particularly bad example because every little change either party would want to make to the core banking systems would be the subject of contractual wrangles. In the former case both parties have a high degree of freedom to make changes independently of each other.
- Another good outsource boundary would be where multiple sequential steps of the business process are carried out by the outsourcer without reference to other bank departments. Hence perfection of securities can be carried out relatively easily by an outsourcer whereas Returned Cheques usually require lots of interaction with branches, relationship managers, lending officers and other banks.
“You can write a 2 tier Service Level Agreement (SLA)”
Outsourcing contracts are inherently long winded and complex with miles of sub clauses relating to various “exceptional” circumstances and specifications of obligations on either party. This contractual complexity is necessary, however there ought to be a high level SLA, of the order of a page or two that specifies the fundamental business idea. For banks the idea will crudely break down into three elements
- Key unit cost
- Key volume parameter
- Key quality criteria
Some hypothetical examples might be;
If it is not possible to write and sign up to such a “headline” SLA (for legal reasons, lack of will, technical factors etc.) the chances are the underlying business idea will fail and so will the outsourcing arrangement.
An Outsource will probably not work IF
“The plan is to re-engineer the process and outsource after re-engineering”
Frequently banks are attracted to an outsourcing deal by a partner who owns a software package or platform that allows the bank to re-engineer the process and outsource the operation in one go. The industry experience is that this is very risky for the simple reason that the business process the bank will settle on at the end of a re-engineering project is not the one they expected to end up with when they started the project. This is not to say the re-engineering is unsuccessful in terms of cost and quality improvements made. It is just very normal to not understand how the target business process will work until a lot of the re-engineering has been completed, at least until after user testing and some production pilots. Given this uncertainty about how the business process will end up it is somewhat futile trying to write and implement a business process outsourcing contract until most of the re-engineering has been completed. Any contract written prior to this point will require significant re-writing (with consequent burn up of management time) and often risks drawing the boundary of the outsource agreement at the wrong points in the business process and systems (see “The business process and technical interfaces between the bank and the outsourcer are few, clear and simple.”)
“The outsourcer supplier has no freedom of movement to make savings.”
Banks appear paranoid about two things when negotiating an outsourcing arrangement;
- The outsourcer makes changes that cut their costs but also damage the customer service
- The outsourcer makes changes that cut their costs and the bank will look silly for not having negotiated a deal whereby the bank gets those cost saving benefits.
The first is a legitimate concern whereas the second is not. If the bank cannot see, in a fairly obvious way, how the outsourcer is making money then the outsourcer almost certainly isn’t. If the deal is not profitable for the outsourcer then he will end up either
- Making the kind of changes that damage customer service, or
- Renege on the contract, or
- Trying to recover profitability by charging very high prices for every change the Bank wants to make.
Too many outsourcing deals go pear shaped because there is nothing in it for the supplier. The suppliers are obviously to blame in large measure because they go into the thing with little concrete idea of how to make money. Nevertheless the bank ends up suffering the fallout.
Another risk is that in their efforts to avoid the first problem banks specify not only the results required but also too much of how the outsourcer is to run things leaving the outsourcer no room to make changes to cut costs.