Outsourcing Budgets Growing Rapidly

turning to outsourcing to expand their product lines, cut costs, and rid themselves of tedious processing. Banks now spend $4.5 billion on information technology outsourcing, nearly 25% of their information technology budgets, according to the Tower Group, a research firm based in Newton, Mass. Outsourcing's budget allocation should grow by 11% a year, increasing to $6.8 billion by 2001, said Robert Hunt, a senior analyst at Tower. More banks are sending their mortgage, credit card, and trust processing to outsourcing companies as the volume increases, Mr. Hunt said. It's more economical to have an outside firm process large numbers of accounts, he added. And as banks explore new delivery channels, such as home banking, they sometimes find that their technology staff is not trained to write the necessary software to support the channels. Therefore they look to outsourcers for these skills, Mr. Hunt said. Also, acquiring banks are turning to outsourcing to help merge them with their counterparts. And, as the century date change approaches, some companies are sending their year-2000 programing upgrades to outsourcers so the internal staff can do other enhancements and new products, he said. With the rapid change in technology, many banks don't want to make big technological expenditures, said Kevin Mellyn, vice president for Mercer Management Consulting Inc., New York. "It's hard to justify spending on proprietary development if there are others you can share that risk with," he said. Many banks are turning to outsourcers for specific applications, such as home banking, said Mary Knox, research manager of Mentis Corp., Durham, N.C. Outsourcing also allows financial businesses to test new technology and see what satisfies their customers. "As banks redefine their core competencies, they are realizing it's not processing transactions as much as it is maintaining customer relationships," Ms. Knox said. "The margins banks are enjoying are going to collapse," said Carl Faulkner, managing director of M One Inc., a consulting firm in Phoenix. "As it tightens more and more, they'll look at more fee-based revenue. By outsourcing, their cost to get into new lines of business is much smaller with much less risk." Outsourcing also has its downsides, however. Banks don't have as much control over the processing and they can't customize it as much. Also, it can be difficult to integrate an outsourcer's product with the rest of the institution's offerings, Ms. Knox said. And banks must always turn over a little of their profits to the companies processing their data, said Ladd Willis, executive vice president of First Manhattan Consulting Group, New York. While this makes sense if the bank is only processing a few transactions, it might be more costly to outsource after the product line grows. Banks and nonbanks that are just starting a new product line are working with outsourcers, several processing firms said. A Wisconsin appliance chain decided to give credit to customers buying its products, instead of having them charge it on their credit cards or go to the bank for loans. The chain approached M&I Data Services, a subsidiary of Marshall & Ilsley Corp., Milwaukee, to process the accounts, said Patrick C. Foy, president of M&I's outsourcing business group. The stores are breaking even on the merchandise, but are making money from the interest on the credit. Until three years ago, M&I used to sign up each year one nonbank customer who wanted to process traditional banking products. Now it gets a couple of requests a month, Mr. Foy said. "Banks used to do all this, but the retailers are cutting the banks out," said Mr. Foy, who declined to name the chains. Banks and insurance companies are also getting into each other's businesses, he said. Insurance companies are offering savings accounts and finding ways to take extra premiums, while banks are offering insurance products. Both turn to outsourcers to keep track of the account activity, claims, and payments. Provident Investment Center Inc., a subsidiary of $4.5 billion-asset Provident Bank of Maryland in Baltimore, wanted to offer low-cost term life insurance, but did not want to do the processing and reporting in-house. So it engaged New York-based Essex Corp. in January 1997 to handle the operations, while Provident employees sell the product. It is now looking to start offering property and casualty insurance and plans to use an outsourcer. "Outsourcing allows us to test the marketplace to see what is of most interest to our clients," said Donald Sheeler, the center's president. Earlier this year, the center turned over its statement processing, securities clearing, and custody of its investment operations to Advanced Clearing Inc. in Omaha. Customers previously received separate statements for each of their holdings, but now the outsourcer sends them a consolidated statement and tax report. With the increase in number of mortgage products, many banks look to outsourcers to manage their new offerings. Wendover Financial Services Corp., a subsidiary of Electronic Data Systems Corp., Plano, Tex., said several banks have asked the company to process their new products-such as an adjustable rate home equity line of credit or a reverse annuity mortgage. "To do it, the bank would have to modify or buy new technology and retrain the staff," said Larry Walker, Wendover's chairman. "They ask us to outsource it and integrate it with the rest of their business." Outsourcing also allows banks to eliminate some legacy systems, said Lesley Grimes, vice president of product Planning for Alltel Information Services Inc. of Little Rock, Ark. She has seen more nonbanks approach the company to get into the subprime market, while banks are expanding their equity home loan offerings. BNY Mortgage Co., a Harrison, N.Y.-based subsidiary of Bank of New York, could not offer half of its 35 or so residential mortgage products if it did not outsource, said Patrick McEnerney, president of the three-year-old firm. "The entry cost is fairly substantial and it wouldn't be cost- effective," he said. BNY Mortgage uses more than a dozen outsourcers to service its products. For instance, Wendover handles its reverse mortgage products, while Alliance Mortgage Co. processes its specialty rehabilitation loans. When choosing an outsourcer, financial institutions must carefully review the company's offering since it will handle the firms' customers. Mr. McEnerney said he has changed outsourcers several times in an effort to find the best servicers. Foreign banks eager to enter the U.S. mortgage or auto loan business are calling on outsourcers such as Wendover, Mr. Walker said. Many banks venturing into the home banking arena are turning to outsourcers to help launch their products. Provident Bank of Maryland began piloting M&I's PC banking and bill payment software in 1996 and offered it to customers in early 1997. Now, the bank is piloting M&I's Internet banking product, which it plans to launch early next year, said John King, managing director of community banking. Provident decided to use M&I, which has been handling the bank's data processing since 1991, because the bank wanted to enter the market quickly. Also, M&I enables Provident to more quickly make enhancements to the offerings, Mr. King said. "They can throw a lot more manpower than a bank on their own could do," Mr. King said.

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