Almost daily, it seems, some bank somewhere is announcing with great fanfare and optimism that it has hired an outside company to handle at least some operations.

But when the reality of the commitment sinks in, some conclude that the arrangement - the fashionable term is "outsourcing" - did not live up to the hype.

Though few says they were mistaken to farm out operations, even fewer express complete satisfaction with their vendor arrangements, according to the American Banker's 1992 technology survey.

The survey, conducted by Ernst & Young, garnered responses from chief information officers at 68 major banks, which together account for a 28% of all commercial banks' noninterest expenses.

One key concern about outsourcing is cost savings. One-fourth of the survey respondents said they were dissatisfied what their processors delivered.

Other concerns include lack of flexibility in long-term contracts with service providers, inadequate technical support, and a perceived inability to introduce enhancements of products and services.

In the survey, 36% were somewhat satisfied and only 5% very satisfied with the cost savings that outsourcing generated. Twelve percent were somewhat dissatisfied and 14% very dissatisfied.

Savings in Early Years

The dissatisfaction seems to increase with the age of a contract. This may be because outsourcing decisions are often motivated by a desire to improve short-term earnings.

The contracts, by nature, are long-term commitments, on the order of 5 to 10 years. But they are typically structured so that the savings for banks accrue almost entirely during the first few years.

Service vendors, on the other hand, usually don't begin turning profits until several years into the contracts.

Though most bankers understand the profit equation, by year five or six of a 10-year contract the reality is often difficult to accept.

"Banks that were forced [into making the long-term commitment] by immediate financial needs or that haven't properly considered their long-term strategic needs have a high risk of becoming dissatisfied in the latter years," said Greg Schmergel, the Ernst & Young consultant who coordinated this year's survey.

Danger of Falling Behind

Another source of dissatisfaction is a vendor's inability or unwillingness to keep up with technological advances.

"It's very difficult to predict major technological changes 10 years down the road," he said. "If the contract doesn't allow for major changes, bankers may be stuck."

Of course, that needn't be the case. Properly structured, outsourcing agreements can effectively accommodate change and provide lasting benefits for banks and providers, said John Rodelli, a senior vice president at Continental Bank in Chicago.

"You have to approach this as a partnership where both sides have to make money on it for it to work," said Mr. Rodelli, whose bank recently entered into an outsourcing agreement with a unit of International Business Machines Corp.

Mutual Benefits

When negotiating an outsourcing contract, bankers must be willing to look at the deal from both sides of the table, and be able to accept it as a workable arrangement for both sides.

But Mr. Rodelli also concedes that timing is important. Had Continental committed to a long-term outsourcing arrangement in 1981, he said, it would have been a scary proposition, since the bank went through significant changes during the 1980s - drastically reducing staff and existing several lines of business.

There is a widespread feeling that even the best-performing, most attentive outsourcing provider cannot and should not make the major strategic moves that need to be decided and dictated by senior bank managers.

The "lock-in" issue was the most sensitive of four that the survey probed (see chart on page 1). The number that expressed some degree of satisfaction with the long-term tie-in - 25 - equaled the number that were somewhat or very dissatisfied. The rest were neither satisfied nor dissatisfied.

By contrast, those satisfied with their vendor's technical support outnumbered the dissatisfied by 40% to 12%.

On product and system enhancements, 26% were somewhat satisfied and 3% very satisfied; but 9% were somewhat dissatisfied and 13% very dissatisfied.

The dissatisfaction may be due in part to the fact that the functions outsourced by banks often are key profit centers like credit card, mortgage, and student loan processing.

If a bank is intent on capitalizing on a certain service or type of technology, it will almost always come to regret a decision to farm out that service or technical operation to an outside party.

"Outsourcing is a very valid strategy option that should always be considered," said George Rusznak, chief of the banking industry consulting practice for Cambridge, Mass.-based CSC Index.

"But the criteria must be very clear and they must include provisions for exploiting it and making absolutely certain that if you keep [a function in house], it is strategically essential to your business, and that you do it better than anybody else can."

A True Partnership

This is not to say that when bankers decide to outsource a function, they can just walk away. Rather, both parties must treat the business as a partnership.

"I would bet that the banks that are dissatisfied are the ones that have not taken on the full partnership approach" to outsourcing, said Les Muma, president of Fiserv Inc., a Milwaukee-based vendor.

Although a significant number of bankers have voiced dissatisfaction with outsourcing agreements, and only a small number are extremely satisfied it is important to note that most banks fall somewhere in the middle.

That finding, said Ernst & Young's Mr. Schmergel, supports his theory that most outsourcing contracts are negotiated to the point that vendors will provide acceptable service and cost savings at a price banks are willing to pay.

"It is not something banks can expect to get superlative performance on from vendors," Mr. Schmergel said. "There will always be some problems, but extraordinary performance is rare."

Ms. Murphy, a freelance writer, is based in Takoma Park, Md.

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.