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Banks Take Control of Outsourcing Relationships

Banks are outsourcing more than ever, but they expect more than just low-cost labor. They're demanding -- and getting -- more value out of their outsourcing relationships by rethinking what's possible, restructuring deals and enforcing tighter controls.

"There are a lot of manual processes and inefficiencies contained in the mortgage origination process," adds Accenture's Moore, who estimates that the average cost per loan is more than $1,800 though, he asserts, it should be below $1,000. "Particularly in a low-growth origination market, you have to look to a lower or variable cost structure," Moore says.

Processes including treasury management, wholesale lockbox, remote capture disbursements and check processing also are being outsourced, according to experts.

Structured work lends itself well to low-cost labor markets such as India, says Thomas Young, partner and managing director, infrastructure, at TPI. Unstructured work, such as unclearly defined application enhancements, he says, not so much. "Clients will say, 'I'm not sure what I want, but if people could start working on it, that would be great,' " Young relates. "How do you structure that into a contract?"

In the current economic environment, banks also are finding unique outsourcing opportunities. One large bank reportedly convinced Cisco to provide its Halo Telepresence system to the bank via an outsourcing arrangement. Rather than lay out the capital for Halo, which normally costs about $1 million per conference room plus a monthly service fee, the bank pays a per-month utility bill. In a managed service arrangement -- an offering structure that most observers now put in the outsourcing category -- Cisco installs and maintains the equipment; when the bank decides it no longer wants it, Cisco will take it back.

Savvier Contracts, Stricter Control

As the outsourcing work itself evolves, banks are refining their outsourcing contracts and the way they manage them. "Without a great governance model, outsourcing doesn't work well, no matter where you put it," points out CGI's Cofran.

Outsourcing agreements five years ago were measured in inputs, such as cost per full-time equivalent (FTE) or number of hours. Newer arrangements are based on output: speed and efficiency of loan processing, for example, or quality of application development.

Craig Boivin, CTO at Maple Grove, Minn.-based Highland Banks ($560 million in assets), built performance standards and penalties for unmet goals into his contract with Fiserv. For instance, the vendor needs to provide 99 percent uptime over a three-month period. If its uptime is between 96 percent and 98 percent, the bank will pay 10 percent less in fees, Boivin explains. Another control built into the contract: If Fiserv wants to offshore certain tasks or move data, it must get Highland's approval.

"In the past, banks put standards in their outsourcing contracts that had no teeth to them," Boivin says. "Vendors tend to focus on customers that will have financial impact." He quickly adds that fortunately, so far, his bank hasn't had to enforce its penalties.

But the contract is not the whole story; the relationship still needs to be monitored and managed. "There's a much greater focus on governance than there's been at any time in the past 10 years," says TPI's Young. "The more custom and complex your agreement is, the more governance you need. Very few firms have it worked out properly. As a result, they're leaving a tremendous amount of value on the table."

Young estimates that if a $100 million deal is managed poorly, the bank could lose 3 percent to 10 percent of the deal's value, whereas good governance (including checking invoices, which, by the way, also can be outsourced) costs 3 percent.

Bank of America and J.P. Morgan Chase are leaders in the area of contract negotiation and governance, according to Everest Group's Bendor-Samuel. "They're the most sophisticated in thinking through this," he says. "As they figure it out, everybody else watches them."

Meanwhile, the large banks also are trimming down the list of providers with which they work. TPI's Young relates a story of visiting the head of procurement recently at a large New York bank. The man, who oversees 60,000 vendor contracts, understandably was feeling overwhelmed, Young recalls. And new software and service purchase requests pour in all the time.

To streamline vendor management efforts, Everest Group's Bendor-Samuel says, large banks are creating "hybrid" outsourcing relationships that encompass multiple tasks, rather than having each of many providers do one thing. He calls this "portfolio rationalization."

"It's not that I'm backing away from using third parties," Bendor-Samuel explains. "But I'm spending a lot of time keeping track of 100 of them. What if I could keep track of 20?" In the provider selection process, "The winners tend to be those that can do lots of things and are flexible to work with," he adds.

Warning: Outsourcing Is not for Everyone

Despite the growing possibilities, Highland Banks' Boivin offers a universal truth about outsourcing: It's not right for every bank. "If you're fairly generic in the services you're offering, outsourcing is the way to go," he says. "If you're a highly specialized bank requiring a lot of customization, outsourcing is probably not the best choice."

First Tennessee Bank ($26 billion in assets) in Memphis recently brought IT back in-house from a core banking provider. CIO Bruce Livesay explains that his bank's holding company sold off a mortgage firm that represented half of its business, and the outsourcing arrangement did not scale down well, nor did it allow the bank to grow in other areas. Instead, the bank will hire 65 IT workers for a new, bank-run data center.

Making this switch will take 18 months and cost $37 million, Livesay reveals. But he expects the investment will pay for itself in less than four years, through a combination of better use of virtualization, better resiliency, better use of storage and reduced service fees. He also says his bank is better positioned now to adapt to new rules.

Livesay adds that he's not opposed to outsourcing. "There are places to do it and places not to do it," he says. "There are certain things I wouldn't consider outsourcing [such as data management]. There are other things that I would say are less differentiating, such as internal HR systems."

Related Sidebar: A Small Uptick in Outsourcing Among Community Banks

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