Most current outsourcing initiatives are focused on cost reduction through transferring whole portions of a bank's operations, hardware, and systems development to a third-party vendor.

Outsourcing expertise is often occupied with finding cheaper ways to handle what banks consider commodity functions.

Little attention has been paid to adding more value to these services. With many financial institutions moving from legacy systems to those based on client/server technology, an opportunity exists for banks to get more value-added services from their outsourcing providers.

With rapid changes in technology driving down data processing costs, vendor partnerships can be created to provide value that banks cannot generate internally.

The four major challenges of value-based outsourcing are:

*Identifying areas of technology ripe for outsourcing.

*Qualifying outsourcing partners.

*Developing long-term relationships with partners.

*Creating joint ventures among partners, while managing their combined efforts.

The skills required of a bank's internal technology staff to design, structure, and manage value-based outsourcing partnerships are very different from those needed for pure cost-focused outsourcing deals of the past.

The reward for attaining these new skills is getting a head start in obtaining tomorrow's technical capabilities.

The Cost Approach

What should be outsourced?

Traditional wisdom has been to outsource commodity functions and processes, while retaining internally the differentiating aspects of technology.

Sometimes this has translated into outsourcing the "utility," the mainframe data processing "glass house," and core operations functions.

In 1995, for example, 49% of the $3 billion that U.S. banks spent on external information technology services went toward such commodity outsourcing of data processing and related services, according to ADS/Tower Group's 1996 Survey of Information Technology Services in Banking.

The remaining expenditures for information technology service were mostly absorbed by contract programming and project management services - basically, ad hoc, project-specific "temporary help."

In this approach, the bottom-line rationale is that if an outsourcer can deliver the same service as the in-house shop but at lower cost, then the service should be outsourced. For this arrangement to be successful for the bank and the vendor, a contract commitment of at least three to five years is normally required so the up-front costs of the outsourcing conversion can be fully recovered and net savings realized.

The implication is that the transaction volumes and functionality the bank requires and the technology that can provide such service will remain relatively static.

In the last 10 years, of course, this underlying assumption has often proved wrong. However, it is this cost-based paradigm for outsourcing that most bankers and outsourcers think of when the term is used.

Adding Value

An alternative approach is to identify how significantly more value can be added by selectively incorporating outsourcing as one component in a comprehensive technology transition strategy.

In this approach, value in information technology is defined as continuing increases in the efficiency and effectiveness of services delivered to banks' customers through substantial improvements in systems development and maintenance, data processing, storage, and communication.

Such increased effectiveness and efficiency affect not only technology operations, but also technology development tools. However, the skills required to develop systems using the new tools are rapidly changing; most banks lack those skills.

Banks traditionally have taken the approach of not using any new technology until it has been proven elsewhere.

This approach is still valid. The cycle of time to prove a technology application, however, has shortened considerably.

For example, branch automation applications, which only three years ago could be evaluated and operated independently from other bank systems, now must be capable of integration with other retail applications, such as those for call centers.

Network management, client/server development, integrated development of retail and wholesale platform automation and branch automation, document imaging, and electronic check processing are other examples of areas where underlying technology processes are changing rapidly.

Yet the skill sets required to understand whether a technology is proven and then to manage the transition to absorb it into the bank are available only at a premium.

As an example: To fully leverage benefits from client/server technology, the design, implementation, and management of a cost effective data communications network infrastructure is a prerequisite. However, the range of skill sets required to establish such an infrastructure are simply not available at most banks internally or at one vendor.

The conceptual design of the network requires technology expertise at companies like Arthur D. Little or Bell Labs. The follow-up physical design of the network requires input from communications engineering consulting firms independent of the major network providers. The actual implementation might be outsourced to either a major network provider (such as AT&T, M&I, or Sprint) or firms such as EDS and Comdisco, which have begun acquiring the necessary staff skills.

Post-implementation management of the network systems might be subcontracted to one of the major network providers who have the ultimate expertise in network operations.

Thus, the entire process of design, implementation, and management of the network can be selectively outsourced for discrete value-added from multiple partners, with the bank's technology managers essentially playing the role of a general contractor.

The cost of such a network, from start to completion, can be anywhere between $5 million and $20 million for a large regional bank, depending on current, but more importantly, future business requirements.

While the level of functionality to be delivered to each branch, sales, and transaction location is the basic cost driver, transforming it into a value-added program requires redesign of the underlying business processes that the technology serves.

For instance, the question of whether each branch needs a local area network server or whether clusters of branches can share one server can be answered not by the technical designers, but through the process of redesigning the basic business processes that the technology enables.

The form of such redesign will have a major impact on the costs and the value-added of the network.

In the above example, the technology process being outsourced adds value to the bank by enabling a cost-effective transition away from disparate legacy network solutions to an integrated, flexible network for client/server architecture.

In such examples, outsourcing to capture value contrasts sharply to cost-conscious, commodity outsourcing.

Making It Work

For the value-added outsourcing process to be effective, the bank's internal technology organization must put in place specific frameworks, processes, and structures.

Thus, for value-added outsourcing to be effective, an overarching systems architecture blueprint needs to be in place.

The blueprint should be driven by the bank's business strategies and processes, and should form the basis for developing an overall technology transition strategy, with value-based outsourcing as one component.

The bank's information technology organization needs to develop skills to support successful, value-added outsourcing. Such skills include: continual, structured learning of technology trends and prioritization of practical transition opportunities; development of project management methodologies that allow integration of multiple vendor deliverables; and honing of sophisticated contract negotiation and contract management capabilities.

Information technology management needs to be structured to become general contractors, positioned to manage the transition toward a client/server networked architecture and away from legacy architecture and systems.

Specifically, new management approaches and responsibilities must be developed to enable information technology management to develop and sustain vendor relations, scope outsourcing programs, work with vendors in developing their proposals, evaluate and structure joint ventures between vendors, and manage the specification and subsequent adherence to service standards.

In essence, a depth of management experience in large-scale, complex partner management, purchasing, and negotiation is required.

Also, in-depth knowledge of each of the bank's line of business processes and current trends in technology to meet such needs is critical.

Structuring and staffing the information technology function to provide this form of leadership is very different from either past management of a bank's legacy systems or supervision of commodity outsourcers.

To summarize, banks can choose to use value-based outsourcing as an integral component of managing the technology transition from legacy systems to a client/server networked architecture.

To ensure the bank's success in value-based outsourcing, basic redesign of the underlying conceptual framework of its internal technology, and its processes, skills, and organizational structure are required.

The payoff is a greater opportunity for success in an accelerated transition to the new world of banking technology.

Mr. Allen is chairman and Mr. Kalawar managing director of Aston Limited Partners, New York, a consulting firm specializing in banking.

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