"Service" is an overused word. It can apply to the level of attention customers get at gas stations and restaurants, as well as the response that a depositor obtains from a bank employee on the other end of a telephone.

But in the context of a bank's information technology, service refers to more than the simple purchase of hardware and software. Services to support information technology must also be purchased, and this is one of the most complex, difficult-to-understand areas in bank operations.

The basic types of bank technology services include application development, integration, and maintenance; training and data entry services; ongoing arrangements like outsourcing, service bureau contracts, and disaster recovery.

Spending on these services is growing twice as fast as spending on all other information technology expenses in banking, according to a recent Tower Group study of technology services purchased by banks.

Total U.S. bank spending on technology services was $3 billion in 1995, and it's growing at more than 11% per year. The largest area of spending was on large-scale outsourcing and service bureau contracts ($969 million), but the fastest-growing component was systems integration, which is growing at 18% annually.

Three types of information technology services - application development, systems integration, and maintenance - added up to more than $1 billion a year, or one-third of total spending for technology services.

Buying factors were a key issue in the study. Banks have few substantive yardsticks by which to evaluate services because they are harder to define and measure than hardware and software products. There are also about 800 potential vendors, and, for some types of services, the entry barriers can be very low. We believe the dissatisfaction rate among banks is higher with technology service vendors than with software or hardware products.

Thus, the two key criteria for buying every type of service were, first, technical skills and, second, track record. Beyond that, familiarity with applications and knowledge of the banking industry were important. Surprisingly, service cost ranked on average fourth or fifth on the list of buying criteria. Incumbency, or a prior relationship with a vendor, ranked even lower.

Most information technology services can be connected with a type of hardware platform. More than 70% of applications services are still geared toward mainframe computers, because of the need to keep aging systems running. Spending on services for client/server applications has a much higher growth rate - 29% per year. By 2000, the category will account for some $800 million per year. About 90% of outsourcing and service bureau functions are still based on mainframe computers, with most of the rest using minicomputers. Spending is increasing rapidly on services connected with certain new technologies, such as data warehousing (25% annual growth), document management (19% annual growth), and image processing (18% annual growth).

The alternative to buying a service usually is doing the job yourself, in-house. But it's common to use service providers to implement solutions, perform tasks, or handle projects that are more critical, have a one-time flavor to them, or require specialist skills. Thus, an estimated 82% of all application development service engagements have a "major" or "total" impact on the existing information technology environment, arising from needs such as new bank products, new functions, new lines of business, reengineering, or mergers.

We also analyzed application development services according to when they occur within the life cycle of the application software itself. The up- front system specification and planning stage consumes only 8% of spending, but this spending is growing 20% a year, as banks focus more on planning prior to implementation.

Services connected with implementation absorb 49% of the spending, and this is growing at a robust 15% annually, eclipsing spending on services supporting systems modification, which is only growing at 8% annually. Banks are generally not spending very much on services to simply maintain their applications; spending in this area is not growing.

The point of applications development is to create the new future of banking. We defined three broad service categories in this field:

*Systems integration, or "solution support," where the provider is responsible for delivery and may often incorporate the selection, buying, and implementation of multiple hardware or software components.

*Team project support, where the provider usually has responsibility for successful implementation, but for only one part of the solution.

*Individual development support, where the bank wants a specialist in a certain application, tool, or management skill, and the bank retains the responsibility for successful implementation.

Systems integration is growing the fastest; individual support has the slowest growth, at only 7% annual growth. As banks merge and gain more experience purchasing services, they use individual specialists less and large-scale services more. But individual support has been very popular, and it is the largest category among these three in total spending ($451 million in 1995).

Frequently mentioned as a subject of concern was the proliferation of service providers, spread over too many parts of the bank, and under insufficient management. The average top 100 bank has about 37 different service relationships of all types. A top 10 bank might have hundreds of these relationships, and most community banks only one or two, especially if outsourced. We believe that banks wish to reduce the number of service providers to control them better and to ensure better results. This is offset by the growth in total services consumption and the need for more technological specialization, so the actual number of service providers per bank may not decrease.

The solution to this issue turns out to be greater centralization of both the funding and the actual expenditures. For example, Chemical has limited the number of technology suppliers to about 30, and tries to funnel all spending on information technologies to these suppliers. About 42% of industry services spending is funded by the bank's information technology group, but about 74% is controlled by information technologies. Corporate funding and control should grow from 10% today to about 15% by 2000, reflecting efforts to get services targeted more closely at key business and cross-business objectives.

A different way to characterize information technologies services is by temporal and responsibility factors:

*Staff supplement consists of individuals hired for shorter duration for generally less critical tasks. Barriers to switching providers are low, the bank retains responsibility for successful implementation, the cost structure is highly variable, and many suppliers are small and local. Spending, which totaled $695 million in 1995, is growing at 6% a year.

*Project-based is where the provider assumes responsibility. Teams may work from six months to five years, and the work is usually critical to entire departments or a line of business. Switching costs are medium, and providers tend to be national or regional companies. Spending in 1995 was $878 million, and it's growing at 13% per year.

*Ongoing services are typically provided for the long term - five to 20 years - and involve unit-based pricing, such as for many service bureaus. It's more difficult to change suppliers, and a highly concentrated number of providers operate nationally. Spending last year for ongoing services was about $1.4 billion, and it is growing at a 12% per year.

The duration of services is another key parameter. Longer relationships are sometimes desired by both provider and bank. The provider gets a chance to know the bank's situation very well, and can afford to invest in the relationship. Likewise, the bank can come to depend on the provider, learn its strengths and weaknesses, and save the effort of selecting a new provider. Needless to say, the buyer must be satisfied for this to occur.

The average relationship duration is about 2.5 years across all types of services. Facilities management had the longest duration (4.6 years), while data entry/clerical services had the lowest (1.2 years). We believe this average duration is not increasing, but that banks are making efforts to settle on one provider - or just a few - for a specific service. Among the largest banks, longer-term relationships with major systems integrators or consultants are now quite common. Even the largest banks employ service bureaus to process products like credit cards and mortgages. BankAmerica's recent decision to renew a contract for deposit processing with Marshall & Ilsley exemplifies this trend.

Which lines of banking business buy information technology services? Roughly 55% of spending is by the retail line, paralleling the industry's overall business mix. Another 25% of spending is by wholesale lines, and close to 20% is for administrative and support functions that straddle operations. In retail banking, consumer lending and branch automation have the highest spending levels, at $1 billion combined, but they also have a low, 7% growth rate. Call center automation services are the high growth area within retail, with growth in annual spending of about 26%. Among spending for administrative functions, CIF/relationship management, item processing, and decision support that includes risk management all have annual growth rates of about 15%. Spending for electronic payment processing is growing at only 10% annually, reflecting the fact that much of the new investment in this area is being done in-house.

Within wholesale banking, the hottest area is capital markets, with $315 million spent during 1995 information technologies, with expenditures growing at an annual rate of 10%.

The nature of a service is that the company providing the service is actually what many banks are buying. Contractual arrangements may help to define what's delivered, when it's delivered, and the level of quality. But, the intangible nature of services still means that banks want to know who they are dealing with and what they've done before.

Thus, we analyzed and identified a number of generic types of service providers - systems integrators, consultants, hardware and software providers, outsourcers, and service bureaus. The field is confusing because large firms like Electronic Data Systems, the "Big Six" accounting and consulting firms, or IBM offer many different types of services.

Several clear trends did emerge, however. First, many firms with traditional strength in applications development or outsourcing have bought or built consulting practices. Their reasoning in moving up the "food chain" is to be involved in the decision-making process earlier, thereby increasing their odds of capturing the larger implementation contracts. Electronic Data Systems, for example, had virtually no consulting capability as recently as 1990, yet it now generates some $200 million annually in consulting revenue.

Many hardware and software vendors have begun to offer services to supplant stagnant or dwindling product revenues. Unisys is one well-known example. This traditional hardware vendor has switched to a services-led strategy that now generates 30% of its revenues.

On the software side, bank applications developer Hogan Systems Inc. moved from 43% professional services revenue in 1991 to 68% in 1995. Virtually all application software vendors offer planning, installation, and modification as add-ons to license sales. In a recent core system replacement by a medium-size bank, training and systems integration services were 48% of total one-time costs and were - not unexpectedly - directed completely toward the application vendor.

The number of purchased applications used by each bank is generally growing, and this is creating a demand for service firms that are knowledgeable about widely used packages, but that are not hardware or software vendors. Mergers and conversions are also factors driving the selection of service firms. One of the most important findings of the study was the fact that a demonstrated knowledge of the business issues facing the banking industry is one factor that will increase in importance over time for providers of services related to information technology.

In summary, IT services are clearly growing in importance as well as in revenue. Today, many providers compete for these dollars. Because of rapid technological change and the very nature of a service, business relationships and trust are very important. We believe all banks are putting additional focus on their consumption of information technologies and on the quality of their service providers. Those banks that do the best job could gain an advantage that could be as critical as any software or hardware purchase.

Diogo Teixeira is president of The Tower Group, a technology consulting firm in Wellesley, Mass. David Medeiros, a technology analyst at The Tower Group, contributed to this article. Based on a study sponsored by Atlantic Data Services, a professional technology services firm in Quincy, Mass. Complete report available from ADS.

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