There has been speculation that the number of new data processing outsourcing contracts for banks and thrifts is on the decline.

In fact, similar projections of a slowdown were made a little over a year ago. There were articles in the banking press at the time noting that banks and thrifts seemed to be signing fewer major contracts for outsiders to process their data.

And indeed, the aggregate value of new outsourcing deals signed in the first half of 1991 was slightly below the level of the last half of 1990.

Yearend Surge

But during second-half of 1991, an additional 18 contracts were signed, representing banks with some $74 billion in assets.

For the full year, outsourcing -- as measured in assets of new banks using outsourcing -- grew 35%

Several large outsourcing contracts signed in the second halves of recent years involved First Fidelity Bank, Continental Bank, and CalFed Inc.

Yet recent articles have again been suggesting that outsourcing is on the decline.

Keep in mind that the three large transactions each occurred in a second half. First Fidelity, with $28 billion in assets, signed in second-half 1990, $25 billion-asset Continental Bank and $20 billion CalFed in second-half 1991.

This annual cycle may be repeating itself.

A Sound Strategy Still

Meanwhile, the strategic positioning of banks that have outsourced has improved.

The fundamental forces driving the phenomenon toward outsourcing have not changed.

First Manhattan Consulting Group surveyed institutions with more than $10 billion in assets that have outsourced data processing over the past two years.

The companies report that their original objectives are generally being met.

Moreover, several institutions said that vendors had absorbed unexpected costs that would have fallen to the companies had they done the work in-house.

Moving Faster, Working Better

All institutions reported that they were further along in implementing their technology upgrades than they would have been under an in-house plan.

This has enabled them to better meet customer service demands and has led to acceleration of cost efficiencies in front offices as well as and back-office operations

The companies also said that outsourcing had helped in absorbing new acquisitions.

For example, First Fidelity Bank has almost doubled the number of bank conversions since contract signing.

And being able to rapidly integrate acquisitions boosts competitiveness.

Bankers also note how critical it is to think through the option of outsourcing.

Before signing a contract, it is important to negotiate terms -- performance standards, volume adjustments, inflation adjustments, charges for new services, provisions to introduce new technologies, and change-of-ownership clauses, among others.

Good Reasons to Sign On

Banks turn to outsourcing for good reasons, the most important of which are:

* The need to focus on cost control, particularly given the slowdown or shrinkage in revenue growth.

Our firm's analysis shows that many traditional sources of franchise-related revenues have been shrinking on an inflation-adjusted basis for the past eight years.

* The need to focus investment spending on new sources of revenues, rather than on upgrading outdated infrastructure.

* The opportunity to reduce redundancy in industry spending for non-value-added services and infrastructure.

For example, we estimate that two $10 billion-asset banks operating side by side both spend $21 million more per year than they would need to if they were operated on common core systems and a fully leveraged infrastructure. This equates t a 20% increase in stock price.

* The need to replace aging core systems.

* The need to introduce new technologies, such as image processing and expert systems.

* The need to create value quickly in acquisitions.

In summary, we foresee that banks will continue to use outsourcing broadly and selectively for basically the same reasons that the early users did.

Unless the fundamental reasons that have prompted institutions to move to outsourcing and other strategic alliances change, it is premature to predict a decline in activity.

Outsourcing continues to be an option that should be considered in every institution's strategic positioning.

Mr. Wills is managing vice president at First Manhattan Consulting Group, New York.

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