After three years as a top technology issue, outsourcing appears to be fading as the pace of new deals levels off and banks haggle for more favorable terms.

Although data processing companies continue to land new business, bankers, consultants, and vendors say that the contracts now take longer to nail down and that the megadeals of recent years may be over.

"There was definitely a spike of interest from 1989 into 1992," said a chief technologist with a leading money-center bank who asked not to be named. "But in the second quarter of this year, it started to abate."

The rising prominence of outsourcing in recent years owed as much to successful marketing, and banks' financial woes, as it did to new insight into how to manage a technology operation.

Perot Was a Pioneer

Outsourcing as now known, has actually been sold since the 1960s, when Ross Perot's Electronic Data Systems Corp. profited hugely from the concept.

Back then, the service had the less sexy moniker of "facilities management" or "service bureau processing" and the principal customers were either small banks or larger banks that contracted for specialty processing services.

This changed somewhat in the late 1980s when leading vendors, including IBM, launched intensive marketing campaigns to take over most of the computer operations of major corporations. Technologists coined the term "outsourcing" to describe these megadeals.

Big Banks Won Over

Many large banks, lured by the promise of a quick fix for runaway computer budgets, opted to outsource the guts of their data processing operations. Among them were Continental Bank Corp., Chicago; Equimark Corp., Pittsburgh; First Fidelity Bancorp., Lawrenceville, N.J.; and Hibernia Corp., New Orleans.

The banks touted multimillion-dollar savings from these deals. Armchair experts predicted that outsourcers would quickly displace bank data processing units across the country.

But, in practice, it hasn't worked out like that. Instead, outsourcers are emerging as niche players that complement, rather than displace, most large banks' data processing units.

The reason is that bankers are taking a closer look at the benefits of outsourcing. Among those taking a hard line is Michael Zucchini, chief information officer of Fleet Financial Group Inc.

In a speech before the American Bankers Association's National Operations and Automation Conference in Denver this May, Mr. Zucchini argued that banks outsource for only four reasons: two good and two bad. The good reasons are to gain economies of scale or to acquire speciality expertise for such things as student loan and credit card processing.

Questionable Motives

The bad reasons are to slash costs quickly or to surrender control of a data processing operation that is difficult to manage. Mr. Zucchini argued that many of the recent megadeals were entered into for just those reasons.

The problem with the quick-fix approach is that it costs more in the long run, Mr. Zucchini argued. To illustrate the point, he described a hypothetical outsourcing deal in which a vendor took over three of a bank's data centers and consolidated them into a single operation.

Before the outsourcing deal, the bank was paying $60 million annually to run the three data centers, Mr. Zucchini said. But the outsourcer offered to consolidate and run the data centers for $45 million annually over 10 years, funneling a quick $15 million to a bank's bottom line. Many financially troubled banks would love such a quick earnings boost.

Windfall for the Outsourcer

But the problem is that the real cost of operating the data center would be $30 million annually, after a one-time consolidation charge of $10 million.

If the outsourcer finished the consolidation in less than two years, it would reap a windfall after the third year of the contract. Mr. Zucchini argued, reasonably, that the bank would have been better off doing the consolidation itself.

Mr. Zucchini argued that large banks abdicate their management responsibility when they decide that an outsourcer is inherently better at running a bank's data processing operations than the bank.

"It means that information technology must not have had proper management, from the CEO to the CIO," he said.

Anecdotal evidence suggests that the banking industry is beginning to follow Mr. Zucchini's reasoning.

Shift to Smaller Banks

In the first six months of this year, roughly the same number of outsourcing contracts were signed as in the same periods in 1991 and 1990, according to research by M. Arthur Gillis, president of Computer Based Soutions Inc., New Orleans. But the asset size of the banks involved in the deals dropped significantly, indicating a shift to smaller institutions.

Officials from one major outsourcing vendor, who requested anonymity, said they now expected most of their business to come from small to midsize banks, rather than large banks.

Better Deals Sought

The officials added that outsourcing contracts now take longer to negotiate because banks are trying to craft more favorable terms.

And this spring, Chase Manhattan Corp. spurned a retail operations outsourcing offer from IBM after deciding to cut costs in-house.

"Banks are making more creative decisions these days," said an outsourcing vendor who requested anonymity.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

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