For years, the financial industry has relied on outsourcing to shore up areas where institutions sought advanced technology, greater economies of scale and lower costs. But when JPMorgan Chase and UBS yanked their long-term contracts with IBM and Perot Systems, respectively, in favor doing things in-house, a chilly wind blew through the halls of outsourcing providers nationwide. Can more such moves be expected, or are these deals the exception to what rules?
When JPMorgan Chase & Co. announced in mid-September that it would cancel a $5 billion outsourcing contract with IBM Corp. that was to have lasted until 2010, affecting 4,000 workers, it raised more than a few eyebrows in financial services and technology outsourcing circles. After all, the newly merged mega-bank, which combines the assets of Bank One Corp. and JPMorgan Chase to create one of the largest financial services companies in the world, was not the only example of an institution pulling out of a large outsourcing contract. Around the same time investment bank UBS AG also announced it would end its 11-year outsourcing contract, worth $1.8 billion, with Perot Systems Corp., based in Plano, TX.
Yet what may look like a reversal of fortune for providers of outsourcing services-big business in financial services, particularly among small and mid-tier banks, and increasingly among larger banks in recent years-appears to be something of an anomaly. Instead, these two "in-sourcing" deals, industry experts say, shine light on a more subtle change in the outsourcing market, which entails a shift in service agreements away from the mega-deals that have defined the business over the last five years. The shift also reflects other realities: Over the course of a long-term contract, the outsourcing needs of the financial company involved are likely to change.
Now, experts say, smaller and more tightly focused deals with multiple vendors will be the norm. Additionally, large firms want greater control of their technology assets and will be a lot more particular about what they choose to outsource going forward. "When we look at [the JPMorgan Chase and UBS] deals, they were both very large and had lots of infrastructure involved, and that is not easy to manage," says Virginia Garcia, a senior analyst for financial services strategies for TowerGroup, based in Needham, MA. "Outsourcing will be more targeted going forward, with more and more deals targeted to specific types of outsourcing and specific applications or functions or business processes."
A glimpse at spending in the outsourcing market presents an intriguing, often contradictory picture. Outsourced IT spending is set to increase from about $478 billion in 2003 to $555 billion in 2008, according to research company Gartner Inc., based in Stamford, CT.
While mega-deals worth $1 billion or more are currently on the rise year over year, their total value and numbers have declined over the last five years, according to Gartner. In 1999 there were 18 deals valued at $74 billion. By contrast, in 2003, there were 16 deals valued at just over $34 billion. This does represent an increase from 2001, however, when the number of deals slipped to 13 worth $24 billion.
"There is a lot of activity going on that is tending to reshape the nature of the contracts," says Bruce Caldwell, a principal analyst for IT infrastructure and outsourcing services for Gartner. "You might have seen comprehensive deals awarded to a single outsourcer in the past. But the trend has been to move toward more multi-sourcing instead of a comprehensive deal with one outsourcer."
With outsourcing expected to gain more traction in the financial services industry rather than lose ground, industry experts are quick to point out that JPMorgan Chase's cancellation of the IBM contract had more to do with internal management decisions about how best to control technology assets than anything else. It also reflected the changing needs of the new JPMorgan Chase.
"This deal was a casualty of the merger, that is very clear from the instant the merger was announced," Garcia says.
She adds that Austin Adams, Bank One's CIO, and Jamie Dimon, the company's CEO, had long supported in-sourcing technology for Bank One, and they felt information technology was a core competency.
Adams agrees with that assessment, saying IBM would continue to be a strong partner for the newly merged bank for IT infrastructure services for several lines of business. "Technology is so critical to our future that we want to more directly control and influence it," he says, adding Bank One invested $1 billion in data centers and technology infrastructure upgrades over the last few years.
"One of my strongest professional beliefs is that the firm gains a competitive advantage when technology is developed and maintained in a cooperative and synergistic way throughout the organization," Adams says.
Similarly, the decision to change the outsourcing contract between UBS and Perot Systems had more to do with internal management decisions at UBS and the investment bank's changing needs. "They have a significant initiative on the table where they are trying to manage their technology across the investment bank, with the retail brokerage unit formerly called PaineWebber and the Swiss bank under a combined entity," says Jill Mullen, vp and head of the financial services industry group for Perot. "The decision we made going forward with them is in support of their strategic initiatives."
Mullen adds that the change in UBS' business strategy is a hallmark of most outsourcing contracts. "Outsourcing is not a one-time decision," she says, adding that banks and other companies must "look at the benefits, given where they are at a particular point in time, and continually reevaluate the contract and choose a partner who will work with them to accommodate the business decisions they face."
For banks, like companies in other industries, the most commonly outsourced functions are IT services, followed by customer service functions and then software development, according to a 2004 survey by Oblicore Inc., a Columbia, MD-based provider of software that helps companies monitor and manage their service level agreements. Such technology is frequently referred to as a "dashboard."
Oblicore says the single largest reason that outsourcing agreements don't work are difficulties managing the contracts, which can be Byzantine documents, thick with legalese that make it hard to determine performance metrics. "About 75 percent of contracts do not live up to the expectations of the outsourcers," says Hal Steger, svp of worldwide marketing. "Outsourcing contracts can be very complicated and it is very difficult for people to manually figure out if their contracts are being met."
Other vendors, like Hewlett-Packard Co., based in Palo Alto, CA, realizing that large financial institutions are less interested in going to a single provider for all of their outsourcing needs, have taken a more fluid approach. "It is important to focus on understanding and delivering on the full expectations of the customer," says Joe Hogan, vp of worldwide strategic outsourcing for Hewlett-Packard managed services. "We think we work better in a multi-vendor environment, with a large number of partners and providers who assist with delivering services to customers."
Working with a multiple number of outsourcing partners and carefully managing contracts are critical concerns for Wachovia Corp., based in Charlotte, NC. The bank outsources its on-line bill payment transactions to CheckFree Corp., some of its on-line banking code development through an offshore arrangement with Accenture, and the front-end of its online banking to Corillian Corp. It also outsources pieces of its retail lockbox activity to Remitco, a division of First Data Corp., and some aspects of its front office brokerage activity to Thomson Financial Corp. "Outsourcing is not new to Wachovia," says Joel McPhee, head of the global services office for the bank.
Unlike JPMorgan Chase, he says Wachovia did not need to bring in-house any of its outsourced activity when First Union and Wachovia merged in 2001. One of the key differences, McPhee said, is that neither bank had outsourced any of its core banking functions. Though Wachovia was smaller than First Union, the merged entity decided to go with Wachovia's data center in Winston Salem, NC, because the bank had recently invested in state-of-the-art equipment.
"We have outsourced in pockets at times," McPhee says. "But there are services or processes that I think we would deem core and critical that we would not outsource or offshore."
To better manage the outsourcing agreements the bank does have, Wachovia is in the process of trying to develop software, typically called a "dashboard," to manage the contracts, and to measure compliance and performance metrics. "It is important to have a governance process to monitor the relationship and measure the service level and how you are consuming the resources from the supplier," McPhee says. "If it is going to impact a company's bottom line, you have to be able to measure and monitor this activity to gain the efficiency you signed up for."
Similarly, KeyCorp, based in Cleveland, has a carefully focused and managed outsourcing strategy with ABN Amro for trade finance processing. The two banks have worked together since 2001 facilitating import and export letters of credit and collections as well as open account processing and purchase order management. The service contract with ABN Amro has allowed KeyCorp to become more competitive in area that was previously experiencing some difficulties, says David Verhotz, svp and national sales manager for KeyCorp's global trade services.
"When you are looking for capital resources internally for systems and product development, you are competing for resources," Verhotz says. "As you do this, you determine where you should allocate the resources that get the biggest bang for the dollar. The problem with the trade finance business is that in some cases it is not growing at double-digit rates in order to get those capital resources, so many banks find themselves at a crossroads."
By partnering with ABN Amro, one of the largest banks globally for trade finance, KeyCorp has also tapped the larger bank's technology expertise in this area. "You will lose clients if you can't provide sophisticated, state-of-the-art products and the competition will take the business away and you will drop down the food chain," Verhotz says, noting that KeyCorp's outsourcing agreement with ABN Amro allows the bank to private label its trade finance service in a seamless process.
An important component of the service contract is the use of a software dashboard, created by ABN Amro, which lets KeyCorp carefully monitor such metrics as processing volume by customer, transaction turnaround time as well as management of customer inquiries.
Verhotz says that as result of the partnership, the unit has seen almost no customer attrition, which he said certainly would not have been the case if the unit had gone it alone. "The biggest thing we got out of it on the sales side was being on the same competitive playing field as JPMorgan Chase and Citibank."
Yet another component to the outsourcing story for financial services players is the increasing importance of offshore outsourcing to places like India and the Philippines. Though large banks frequently don't talk about their offshoring activity, given that the topic is caught up in a political firestorm with the loss of U.S. jobs overseas, most banks are outsourcing operations in some form.
According to Deloitte Consulting, based in New York, about 80 percent of the world's largest financial services companies have moved some of their operations offshore. The consulting firm estimates that by 2010, the top 100 firms globally will have moved about $400 billion of their cost base offshore, saving each firm about $1.5 billion annually.
Though smaller financial services firms are significantly less active in offshoring than their larger counterparts, they are also getting involved, often with highly specific and focused contracts. E-Loan Inc., for example, based in Pleasanton, CA, offshores key parts of its loan application process though vendor Wipro Technologies, one of the world's largest software and IT outsource vendors.
E-Loan is a home equity, mortgage and auto loan lender that originated more than $6 billion in loans and had $153 million in revenue in 2003. By leveraging Wipro's workers in India for back-office processing of its U.S.-originated loans, Chris Larsen, E-Loan's chief executive officer, said customers can shave two days off the company's loan processing time, which normally takes 10 to 12 days. He said offshoring this work also saves the company 60 percent of the cost of doing the same work in the U.S.
Larsen says offshoring functions that are fairly standardized and which have no competitive advantage kept in-house is key. "It comes down to who is the most efficient at the known tasks. When you are early in the growth stage of a task, it is not all about cost, but about who can be smarter and who can invent new ways of doing something, and those tasks are probably less suitable to offshoring."
