Guy Warren, managing director of the financial services division of LogicaCMG, talks about business process outsourcing and the growing importance of offshoring. Interview by Michael Imeson.
When pitching for business process outsourcing (BPO) contracts, Guy Warren’s mind is focused on one thing: how to solve what he calls “the 42.5% problem”, or “how to create value for both parties”. This is the cost-saving that LogicaCMG, a major provider of outsourcing services to the financial sector, has to achieve on the prospective client’s business processes before a contract makes commercial sense for either of them, says Mr Warren, MD of LogicaCMG’s financial services division.
“In other words, we have to be able to do it for 42.5% less than the bank can do it,” he says.
That percentage is made up of three elements. First, a 15% saving has to be made to arrive at a BPO contract price that is 15% lower than the bank’s costs of performing the process itself, otherwise there is little financial incentive to move out of house. Second, a further 10% saving has to be made to create the provider’s profit margin. Third, in the EU a further saving is needed to enable the provider to absorb the cost of having to charge value-added tax (VAT) on its services – which financial services companies cannot reclaim and which in the UK stands at 17.5%. Although there are ways of addressing the VAT issue, they in turn cost money.
Search for savings
So how is this 42.5% saving to be found? There are several ways, according to Mr Warren. “One is to embark on a major transformation, using more automation and taking advantage of technological advancements,” he says. “Another is to recruit a second or third customer to share the services being provided.”
Yet another approach is to carry out most of the processes in cheaper countries, while retaining a small proportion of the work in the customer’s domestic market. “By conducting most of the processes in developing countries, where salaries are considerably lower than in the West, we are able to achieve the necessary savings to make the deal work for both parties,” he says.
This “wage arbitrage” between countries has meant that more business processes are being taken offshore – that is, carried out in a processing centre that is not in the financial institution’s home country. “Keeping some of the people onshore is important to meet cultural sensitivities and time-zone requirements, and to maintain the knowledge base,” says Mr Warren.
The company, which was formed in December 2002 through the merger of Logica and CMG, provides a range of management and IT consultancy services besides BPO to customers in many industries, with financial services accounting for 16% of its £1.7bn revenues last year. It has 21,000 staff in 34 countries and is headquartered in London.
Human resources (HR), payroll, customer relationship management, managed learning, credit management and the installation and support of SAP business application software are among the back-office processes that financial services organisations outsource to LogicaCMG and its competitors, many of which are carried out offshore.
Growth areas
Payments processing is a particularly strong growth area in Europe. “Regulators won’t let banks charge for moving money between countries in the eurozone,” says Mr Warren. “They have to take out a lot of the cost, so European banks in particular are setting up payments factories. If you are going to create one, do you create it in Holland, the UK or Germany? No, the obvious place is a cheaper country such as India.”
HR functions are increasingly being outsourced as internal HR departments struggle to keep up with developments, such as increasing amounts of employee legislation, especially in the EU. HR departments are focusing more on strategic decisions and contracting out key administrative tasks such as training or payroll.
Middle-office processes that are outsourced include cheque clearing (such as the iPSL joint venture between Unisys and three major banks that clears 74% of UK cheques), life and pensions administration by companies such as Capita, and valuation statements for financial advisers. The latter is a new service developed by LogicaCMG, which allows advisers to show their customers the value of all their investments from different financial services firms. Front-office processes increasingly being outsourced include customer relationship management systems, websites and ATMs.
India in favour
India is favoured by many BPO providers, not only because of its lower wage costs, but also because it is English-speaking and has a high level of education. “It has around one million new graduates a year,” says Mr Warren. “It also has a decent infrastructure, though there are power cuts most days in Bangalore so you need a UPS [uninterrupted power supply].”
Overheads as a percentage of salary for an employee in India are significantly higher than for a better-paid person in Europe or North America. Telecommunications and travel add significantly to the total cost of providing the service from India. The £3500 cost of a UK manager’s business class flight from London to India is greater than the annual salary of an administrative worker, so knowledge transfer can be a significant part of the total service cost.
Another consideration is that the wage differential between salaries in the West and India is being steadily eroded. In Bangalore and Mumbai, for example, there is 15%-20% annual salary inflation for some skilled staff and an annual attrition rate of up to 30%, as more Western firms arrive and pay to get the best people.
India has a favourable tax regime for export-only companies, such as BPO operations, which is why Bangalore is “superheated”, says Mr Warren. But at some point in the future he thinks the regime will become less favourable. “The outsourcer will then look at a new low tax regime,” he says.
Next stop China
“China is the next country to watch for BPO offshoring. There are millions of people learning English in its schools and universities.” LogicaMG is considering the possibility of setting up an outsourcing centre there, probably starting with IT outsourcing and moving later into BPO outsourcing.
Whenever a bank announces that it is transferring processes overseas there is usually a hue and cry in the media. “Financial services companies have got better at explaining to their existing workforces that they will become stronger companies through outsourcing,” says Mr Warren. “Although jobs at home might be lost initially, in the long term jobs are protected by the company becoming more cost-effective.”
It is not just a desire to cut processing costs that is driving BPO. It is also the increasing tendency for many financial organisations to concentrate on their core business and let others who are experts in their field carry out the non-core, but nevertheless essential, processes.
“A hundred years ago most organisations that used electricity had a main board director who was responsible for power generation in the factory and sourcing electricity from local providers,” says Mr Warren. “Today, where does electricity sourcing sit in an organisation? Somewhere in administration. It’s a clerical job, with someone in charge of ensuring the bills get paid.” Other sourcing functions are going the same way as power, with many businesses contracting out functions to expert, but low-cost providers.
Strategic decisions
“Financial organisations were originally fully self-servicing but in the past 10-15 years that has changed. People are taking strategic decisions about what they want their businesses to be. For example, UK financial services provider Bradford & Bingley has concentrated more on distributing other people’s products than manufacturing its own,” he says.
Other organisations are doing the opposite: concentrating on manufacturing, and outsourcing the distribution. This, along with the trend to outsource processes, means that organisations are moving from the traditional, vertically integrated model to a flatter one “focused on the core business and outsourcing much of the rest, increasingly offshore”, according to Mr Warren.
There are a number of factors that a financial institution has to consider when choosing a BPO partner. One is to select only the highest quality provider, something that regulators will be watching. Another is to ensure that the provider offers flexible terms to account for adjustments that may have to be made due to a change in business strategy, regulatory change, new products and services, new technology or a merger.
But, as Mr Warren says, price is the central factor. And if a provider cannot address “the 42.5% problem”, then the customer will find another company that can.
