Every discussion about the future of outsourcing can be predicated on two incontrovertible truths. First, that the financial services sector will continue to be the biggest user of outsourced services for some time yet. Second, that outsourcing will continue to grow, in scope as well as in volume.
A recent document published by TPI, the outsourcing adviser, notes that “financial services institutions are in the vanguard when it comes to developing and implementing creative and innovative sourcing strategies”. The financial services industry accounted for 28% of the number and 23% of the value of contracts signed in the first half of 2006, second only to the manufacturing sector (for transactions valued at over $50m).
Therefore, apart from the fact that financial sector outsourcing is wide in scope and growing, what else is there to say about its future direction?
Evolving market
Roger Sparks, head of the European financial services practice at TPI, which works exclusively for customers, not providers, says the nature of the financial services outsourcing market is shifting. “We are seeing fewer of the big, £500m [$955m]-plus, one-size-fits-all deals of three years ago or so,” he says.
“Contract lengths are shortening to five or seven years, down from seven to 10. And banks are sourcing from several providers, not one. Individual deal sizes are therefore lower, but there are more deals so the size of the market is growing.”
The other obvious trend is that offshoring is on the up. “Three or four years ago, 25% of outsourcing had an offshore component,” says Mr Sparks. “Now it is more than 50%. Our view of the market is definitely representative, as we do more sourcing advisory work worldwide than anyone else.”
Chris Gentle, global financial services director at Deloitte, says that “outsourcing and offshoring in financial services IT are becoming one and the same thing”. “Until about 2003/04, about 20% was offshore and 80% onshore,” he adds. “In the last year or so, the offshore amount has increased and this trend will continue. The years 2003 and 2004 were pivotal.”
Another way of looking at it, says Mr Gentle, is that in 2003 about a quarter of financial institutions offshored something. Now about two-thirds offshore some element of their processes or IT.
The reason is the continued low cost and growing sophistication of the main offshore locations. This trend is assisted by the fact that some banks have set up “captive” organisations offshore to which they channel their high-volume, low-value work rather than to third-party vendors – places such as India, China, Malaysia, Mexico, Indonesia and Costa Rica.
“Hybrid models have developed and will become more prevalent in IT and business process outsourcing. For example, an offshore captive will do some of a bank’s work, and the rest will be done by an offshore third party.” Mr Gentle believes that “knowledge processing” outsourcing will become more prevalent, by which he means high-value work, such as equity research.
Another trend is that IT outsourcing may level off, though not decline. “IT is maturing, after being the pioneer 10 years ago,” says Mr Gentle. “We will see more business process outsourcing and offshoring. We will also see some more call centre offshoring, but only if customers are certain that quality can be guaranteed.
“There will be more shared services in human resources and finance. Finance departments in particular will go through transformation programmes to make their technology more effective, improve their processes and reduce paper. Smaller banks will have to resort to outsourcing more in order to gain economies of scale and compete with the larger banks.”
Central and eastern Europe
Although Europe and the US are the main outsourcers, there are parts of Europe where outsourcing is still in its infancy and likely to stay that way for some time. This is in the former Soviet bloc, where banking is still at the emerging stage, where the mindset is to do it yourself, where labour costs are low enough to keep most operations in-house, and where domestic suppliers of services cannot usually meet the service quality levels demanded by banks.
Heinz Wiedner, chief operating officer at Raiffeisen International, which runs the central and east European (CEE) operations of Austrian bank RZB, explains the context. Raiffeisen is present in 16 CEE countries, including Poland, Hungary, Ukraine and Russia.
“Raiffeisen International does some outsourcing, but on a small scale, on a country-by-country basis, not across the organisation. For example, cash transport to branches, ATM support and maintenance, software development are outsourced in certain countries. But cash transport in Ukraine and Russia, for example, we must do ourselves.
“In most CEE countries, there isn’t a competitive market for many of the processes or services that can be outsourced in western Europe. Very few providers can guarantee the quality and the cost.
“If they can’t guarantee these, then you don’t outsource. For us, there aren’t even the basics of third-party service provision. Emerging markets still work in a different way.
“So our strategy is to centralise and standardise across our network using shared services – so we have a payment processing centre, and a card processing centre. In five to 10 years we may eventually outsource these functions if we feel a third party has the know-how, the quality and can provide it at 20% lower cost than we can. But today there is nobody who can handle a payment centre for us.”
Mr Wiedner believes things will change. He monitors the market constantly to see if there are suitable companies to take on certain services. “In the long-term, we don’t want to do certain things ourselves, such as IT, or software development. These are not our core businesses,” he says.
“I am optimistic that in five to 10 years there will be third parties that can take over our processing centres. We could even sell the centres to them. Two companies are already interested in buying them from us, but I don’t think they could run them at a higher quality and lower cost than ourselves.”
Offshoring to places such as India makes no sense for Mr Wiedner because labour costs in CEE, especially Romania, are low. The other problem with India is communications. “It takes weeks for an Indian to get a visa to come to Europe.”
Banks play both sides
Banks themselves are major service providers to other financial institutions, in areas such as payments handling, global custody, securities services, and fund and asset administration. These service areas will continue to grow.
HSBC Securities Services, for example, supports fund managers – alternative and institutional – that want to outsource their non-core services. Paul Stillabower, head of business development, says fund managers and pension funds have long outsourced their custody services and funds administration. But in the past four to five years they have progressively outsourced middle office services, too.
HSBC Securities Services’ three big clients are Gartmore Asset Manage-ment, HSBC Investments’ middle office and Royal London Asset Management. Mr Stillabower sees more business on the horizon for him and other providers like him.
Drivers of this growth include hedge funds, which are moving into more institutional investment, dealing more with retail funds and subject to more regulatory scrutiny. “At the same time, traditional fund managers are looking more at the alternative space as a way of increasing returns, attracting investment customers or rewarding and retaining key staff.
“That can place a strain on them, especially in areas such as derivatives processing. Their infrastructure to support derivatives trading, such as OTC [over-the-counter] matching and settlement, is still quite manual. So that is leading fund managers to look more at outsourcing their middle office, as well as their fund administration and custody, which has been outsourced for several years.”
Win-win prospects
It seems that outsourcing will continue to be a win-win situation for the biggest banks. They have got both sides of the business wrapped up.
On the one hand, they are customers, contracting out non-core functions to vendors that can perform them better, and cheaper, than they can; yet in other areas they are vendors, providing administration, custody and other services to asset managers, smaller banks and other financial institutions. Long may they prosper.
