01 September 2007 Comments

 

Outsourcing decisions

Jeremy Badman, Director, Strategic IT and Operations, Oliver Wyman

News of financial institutions outsourcing IT operations or bringing them back in-house frequently occupies the minds of the financial services industry. Only last month the media spotlight fell on the London Stock Exchange and news of it ending a four-year outsourcing arrangement to bring operations and staff back in-house. The debate for CIOs and CEOs about the benefits of outsourcing IT operations or them remaining in-house will no doubt continue, but how do product maturity, growth and competitive dynamics effect agreements between outsourcers and the firms they seek to support? Oliver Wyman believes the maturity of the products being supported has a large impact on the suitability of outsourcing certain components of IT. So the question for CIOs and CEOs is – given my breadth of products and business lines, how do I determine what type of outsourcing is best for me?

Financial institutions contemplating outsourcing IT functions must give due consideration to the nature of their business and the types of products the technology is supporting. Given the high importance of technology in most banking products, it is often hard to clearly separate the technology strategy from the business strategy. For relatively mature products, such as credit cards and FX trading, outsourcing IT tends to be more successful as the business strategy is not evolving so quickly and the technology is relatively stable. Since the product is no longer evolving at a rapid pace, and the regulatory environment isn’t changing quickly, the focus for the bank is on adapting to margin compression and the need for operations to be efficient and scalable. In this case then, outsourcers can offer low-cost solutions and access to relevant experience to help scale up the technology infrastructure.

On the other hand, outsourcing the technology supporting relatively new products, those evolving quickly or with very high growth in transaction volumes, can be a more difficult affair. Many of these new products rely to a significant degree on technology. As an example, outsourcing the IT application development, testing and production support for the algorithmic trading business could be restrictive to its growth. IT needs to be tightly integrated into the business with strong business knowledge, which traditional outsourcing relationships have failed deliver consistently. Also, it is hard and costly to build sufficient flexibility into the contracts between the bank and supplier. In the worst-case scenario, outsourcing technology can leave a bank bereft of the some of the expertise needed to pursue the business opportunity.

So, the lifecycle of a product can fundamentally impact any IT outsourcing project. For some products, outsourcing IT functions can be hugely successful, providing large cost savings or improvements in service quality. For other products, outsourcing certain IT services can restrict the very business strategy it looks to support. If your business strategy positions you as a product innovator arguably outsourcing certain business-facing components of technology may be too restrictive. If you are looking to be a fast follower, then being quick off the mark and being able to adapt to changes observed in the market is what is important. In this case, outsourcing can help you to do it, and pursue it efficiently by lowering your costs and providing additional technology scale as required.

Where once outsourcing might have been a case of “mess for less”, outsourcers are now helping financial institutions reshape inefficient systems and processes. Some vendors have developed services where they not only run a ring-fenced part of the IT and operations for a firm, but over the course of a few years re-engineer the infrastructure and business processes. The arrangement is structured with an explicit plan for the bank to take the re-engineered IT and operations back in-house at the end of the contract. This type of outsourcing is perfect for relatively mature businesses that may have evolved as highly complex or inefficient. The bank gets a guaranteed saving during the re-engineering phase, and receives back a sustainable, efficient set of systems and process.

Outsourcing is clearly here to stay. For the new outsourcing projects, we expect to see a strengthening of the trend towards a more component-based approach. We will also increasingly see banks retaining in-house the IT teams supporting their more innovative products, even where they outsource those same IT services for other products.