of financial institutions to turn to outsourcing for more than just managing computing power. Increasingly, outsourcing relationships are defined not merely by technological capabilities designed to save money, but also by strategic business goals, including cutting costs and increasing revenue. This trend - including the emergence of a new term of technical jargon, "cosourcing" - has shifted the tenor of outsourcing relationships from those that emphasized a buyer and a vendor to those that embrace an array of consulting, reengineering, and technology services. In turn, technology providers are being asked to shoulder a greater share of risk in return for a reward that is in some cases linked to the financial institutions' success. "In the past five to ten years, as the outsourcing market has become increasingly competitive, the price/performance mixture has moved steadily in the customer's favor," said Peter Bendor-Samuel, president of the Dallas-based consulting firm Everest Group. "Customers are getting more value out of the transactions." "There is a big push on the part of suppliers to become more relevant, and cosourcing is an attempt to move up the value chain by connecting what they do with business results," said Mr. Bendor-Samuel, who is also managing editor of Infoserver.com, a Web-based publication about outsourcing. More-established market participants - including the outsourcing pioneers Electronic Data Systems Corp., International Business Machines Corp.'s services division, and Alltel Corp.'s information services unit - are particularly eager to differentiate themselves from their competition by emphasizing long-term strategic relationships. "People like ACS (Affiliated Computer Services Inc.), Fiserv, and M&I (Data Services) have taken the margin out of it for the big guys," said Mr. Bendor-Samuel. "Now big suppliers are looking to find a way out of the commodity trap by looking for ways to increase their profitability and coupling business process and consulting capabilities with infrastructure." Whereas traditional outsourcing contracts often had their origins with technology officials at a financial institution, these newer relationships bring a variety of business officials besides the chief information officer into the contract's approval and implementation. "In the early days, vendors were primarily selected on the basis of price and by a technology manager," said Jeffrey M. Lynn, global consulting executive for the banking, financial, and securities industry for IBM. "Today partnerships are selected on a more strategic basis, with more links to business managers, and more than just the top technology officials," Mr. Lynn said. He sees cosourcing as an extension of the original concept of outsourcing - namely, deciding between the areas that are a company's core competency and those less strategic areas that they can afford to turn over to outside providers and gain the benefit of their additional expertise. "The next logical level in strategic partner relationships is to tie measures of mutual success together," Mr. Lynn said. That would transform a relationship in which savings by one party might lead to a loss by the other into a situation where "we are going to win together, or lose together." Together with the consulting company A.T. Kearney Inc., which it acquired in 1996, EDS has attempted to stake its claim in the field. Although the Dallas-based company's service mark on the word CoSourcing hasn't stopped rivals from seeking to impart their own definition to the term, EDS has gone further than most in tying measurable achievements by its partners to its own bottom line. It sees cosourcing as one of four quadrants on a matrix whose axes are the ability to influence outcomes (high or low), and the scope of change (broad or narrow). To William J. Jeffery, vice president of the Chicago- based A.T. Kearney, cosourcing requires both a broad mandate and a high ability to influence the outcome at the client partner. Outsourcing, by contrast, has more traditionally been narrow in scope, with a limited ability to effect outcome like revenues. While broader in mission, reengineering likewise has not been expected to directly contribute to the bottom line. "Because clients are looking for EDS to be more than just a service provider, these are true partnerships with a shared vision, common objectives, and joint implementation teams," Mr. Jeffery said. Spanning a wide variety of industries, including a widely noted contract that joined EDS' fortune to that of Rolls Royce's aerospace Group, EDS' cosourcing relationships in financial services include agreements with Mellon Bank Corp., Sage Group of South Africa, and Commonwealth Bank of Australia. Common to each of these situations was the desire by the client institution to take advantage of EDS' experience in developing systems for other financial institutions - frequently in other lines of business and in other parts of the world. Mellon Bank hired EDS to help create a new software engineering group that could boost the bank's software code-writing efficiency. The bank created a new organization by integrating Mellon's development teams in business lines including banking, investment management, mutual funds, and institutional trust services. "In the case of Mellon, they had the belief that the system engineering product management processes were broken," said John A. Meyer, corporate vice president and head of EDS' financial services division. One year into a 40-month contract with EDS, the bank "should be getting greater productivity out of their existing staff to develop more systems they could sell to their existing client base," said Mr. Meyer. A 20-person project office, staffed equally by Mellon and EDS personnel, has responsibility for planning and implementing new products. EDS' compensation is partly determined by how well the bank ranks in the Software Engineering Institute's capability maturity model, an assessment standard developed and measured by Carnegie Mellon University. "Part of our payout is to get them from a CMM Level 1 to Level 2, or a 400% improvement in productivity," said Mr. Meyer. "Our risk and reward is tied to teaching them the processes they need" in order to improve the specific business objective - better software development - originally identified by Mellon. Leveraging knowledge from EDS experience in other markets was a prime consideration in the case of Sage Life Ltd., a $2.2 billion-asset member the Sage Group of Johannesburg, a diversified financial services company including insurance and mutual funds. Having hired Andersen Consulting to conduct a business reengineering study in the early 1990s, officials at Sage began to see that its legacy mainframe computers were holding it back against larger competitors in the South African marketplace. "We realized we needed to move into newer technology to get new products to market better," said Janssen Davies, managing director of Sage. Attending a seminar for top executive officers from around the world at Stanford University in 1995, Mr. Davies participated in a case study examining EDS' business philosophy of close client cooperation and long- term business engagements. Before he returned to South Africa, however, he paid a visit to EDS' headquarters in Dallas to discuss his company's business needs. Thus began a negotiation process that culminated in the signing of a 10-year contract in June 1997. The cosourcing agreement combines aspects of both consulting - in which clients are generally billed for the time and materials of the consultants - and more traditional outsourcing arrangements that set fixed fees for particular levels of transactions. What is unusual about the arrangement is that EDS' entire fee - a potential $88 million, EDS officials estimate - is tied to the number of new life insurance contracts sold by Sage. The technology company receives less than 5% of gross recurring premiums, said Mr. Davies, and even that percentage is slated to decrease at the same time that revenue is expected to rise. EDS's management of Sage Life's entire information technology infrastructure is tied to specific measurable service levels monitored on a monthly, weekly, and daily basis. Failing to meet them can result in a penalty to EDS. More importantly for Sage, however, the contract's incentive structure is envisioned as a way of relying on the outsourcer's judgment about top quality investments without having to worry that the EDS would lead it astray with poor choices. "Because they pay for it, we don't care what technology they choose because they will surely run the shop as cost-effectively as they can," said Mr. Davis. "There is a strong belief that both parties are competent and capable and that EDS would not invest in information technology unless they can get revenue out of it," he added. In the event that new products are set to be introduced that do not result in an increase in policies signed, the contract calls for EDS and Sage to predetermine whether the investment will be made jointly or by one of the companies. Another built-in protection feature is that EDS is contractually committed to help Sage rise to the top quartile of the world's most- efficient insurance companies within four years. "If EDS can't deliver, I can go to EDS, and say, 'now I am going to make you eat your cooking,"' said Mr. Davies - forcing them, in effect, to make restitution with more aggressive technology investments. "This is all leveraged off the premise that technology can help you to increase your profitability by increasing market share." EDS officials say they are more than prepared to take risks - as long as they have access to the top levels of management and the ability to affect the company's strategy, which they said they feel at Mellon and Sage. Of Sage, EDS account manager James Nowicki said: "They were thinking outside the box, and EDS recognized the opportunity and was willing to take some risk to work toward a structure that benefits both parties." Notwithstanding overall satisfaction with the arrangement thus far, EDS officials said an unexpectedly high level of single-premium life insurance policies (as opposed to recurring-premium policies) has led them to press for modification of the contract that would give a share of those revenues as well. "We want to be measured the same way that our customers are measured," Mr. Meyer said. "I see a lot of our competition putting their foot in the door and getting their billable hours going as long as they can." But designing appropriate ways to measure business success can also be maddeningly complicated. That has led some technology outsourcers to shy away from connecting fees directly to business results, even if they strive for more collaborative relationships emblematic of the general trend toward cosourcing. For example, Alltel Information Services officials said that on the one occasion that remuneration was tied to an operating cost improvement, the agreement proved far too rich for Alltel. Speaking of an 1987 deal with a $3.5 billion-asset bank which he declined to identify, Alltel senior vice president Dodd Miles said: "We got 50% of the benefits, but we didn't supply 50% of the effort. It wasn't as win-win as it should have been." Rather than trying to enforce a contract that Alltel officials had told the bank it would regret, the company shifted to more conventional pricing methods. "If we had kept them to it, they probably wouldn't be doing a lot of business with us," Mr. Miles said. But Alltel officials nonetheless recognize great changes in the way outsourcing is practiced now versus a decade ago. "We were a company with a unique business model," said Randy J. Watson, senior vice president of Alltel's large bank segment, describing the approach originally taken by predecessor Systematics. "We would come and take over the information technology department lock, stock and barrel and run it out of Little Rock," the location of the company's Arkansas headquarters. "We no longer get as many opportunities to take over everything, making it more difficult for us to have complete control over the technology platform from front to back," said Mr. Watson. The heightened strategic importance of technology has led an increasing number of bank departments to demand a role in outsourcing decisions. And the proliferation of new electronic delivery channels, including the Internet, has led to more and more vendors that need to work together on the same projects. The need to coordinate the disparate contributions of many vendors creates a new need for a coordination process that Mr. Watson dubbed "cosourcing before there was a name for it." "Niche providers are doing more and more and vendors are overlapping," said Mr. Watson. "That is why we want to be the one who is in the lead." Another approach to more closely linking risk with reward is the joint venture structure utilized by Fiserv Inc. and Canadian Imperial Bank of Commerce (CIBC) when they formed Intria Items Inc. in December 1996. The technology company pioneered this approach in 1994 in a $480 million partnership with Chase Manhattan Corp. The partnership was dropped and item processing was brought in-house when the bank merged with Chemical two years later. "Banks see some benefit in seeing Fiserv participate in the success of the joint venture as a motivation for Fiserv," said Leslie M. Muma, president and chief operating officer of the Brookfield, Wis.-based company. "Although we run the service day-to-day and provide the expertise, the bank retains control over the unit that is cosourced." Irrespective of the form the cosourcing takes, its rise is nearly certain to make some aspects of life riskier for technology companies. And it may not assuage uncertainty for financial institutions, either. "It is risky for the outsourcer to put up money and lose their investment," said Mr. Bendor-Samuel. "It is risky for the customer to put their business in the hands of someone else. You have materially given a lot of power to an outside provider." But for some practitioners, cosourcing provides an up-to-date technology partner ready and willing to guide them through the shoals of an increasingly competitive financial world.

"This is all leveraged off the premise that technology can help you to increase your profitability by increasing market share," said Sage Life's Mr. Davies.

Limited Time Offer

Save $400 off your subscription. Special offer ends April 30, 2017.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.