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Outsourcing is Now More Popular with Banks than In-House, and Bill Gates Knows Why

First, I want to be clear about the word "outsourcing" because many writers today use the word to mean "offshore contracting." In this bank technology context, outsourcing has nothing to do with geography. I'm talking about the banking industry in the U.S. where outsourcing was known, 45 years ago, as "service bureau" or "third party processing" or even "correspondent banking." The outsourcing word was adopted as a modern word in 1989 as a result of the IBM/Kodak deal.

First, I want to be clear about the word "outsourcing" because many writers today use the word to mean "offshore contracting." In this bank technology context, outsourcing has nothing to do with geography. I'm talking about the banking industry in the U.S. where outsourcing was known, 45 years ago, as "service bureau" or "third party processing" or even "correspondent banking." The outsourcing word was adopted as a modern word in 1989 as a result of the IBM/Kodak deal.Now, what does Bill Gates have to do with this subject? Simply that Bill stated at a conference, "Technology is still too complicated and we haven't done enough to simplify it for the ordinary citizen." Maybe Steve Jobs has, but that's another blog. In my opinion, Bill's quote applies perfectly as to why banks have been favoring outsource mode in recent years. "Enough already, let the experts deal with it."

In addition, while technology increased in complexity, it also got broader for both good and bad reasons. Regulatory add-ons increased the burden of IT people and many of them couldn't keep up. And it's pretty clear that when CEOs go home at 5:00 p.m., they too may get a call at 3:00 a.m. The good part, of course, is that bank technology does a lot more work now than it did just five years ago (44 percent more solutions in the past five years). But there's a price to pay for everything, and the outsource experts know how to handle and leverage the burdens, thus making the cost scalable and very reasonable.

Here are the current stats to prove the recent increase in outsourcing:

70 percent of new core sales to financial institutions in 2007 were for outsourcing. 30 percent were for in-house systems.

Three years ago, it was almost a flip-flop-77 percent for in-house and 23 percent for outsource.

If the current rate continues, there could be a shift in the base of FIs using core systems. But currently there is still a slight preference for in-house systems as it relates to the total installed base of 16,881 FIs.

53 percent of all FIs use in-house. 47 percent of all FIs use outsourcing.

There are some significant details behind this mix. Very large banks prefer in-house; very small banks prefer in-house, but for entirely different reasons. Large banks are constantly making changes to their systems to achieve uniqueness, whether real or perceived. Large banks are also psychologically strapped to the idea that they can do IT better than even the largest IT vendor. That mentality is fed, at least in the top three banks, by the fact that each one spends more on internal IT than the largest IT vendor's total revenue. Small banks, on the other hand, use their systems like a PC-buy it, use it 'til it breaks, never look inside. Small banks also love their 1-800 number because it doesn't have a SSN. Who can blame them?

One thing is certain. The top seven vendors of core systems now offer solutions both ways, and it wasn't always like that. It took one of them 40 years to break away from the Henry Ford attitude- tYou can have any color (method) you want as long as it's black (outsource).

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