February 24, 2010

As the financial industry continues to recover and reshape as a result of the economic and industry turmoil over the past 18-plus months, many banks -- especially those involved in M&A activity -- will be dealing with large-scale systems integration, conversions and upgrades. The laser focus on improving the bottom line and driving earnings back to profitability through cost reduction, as well as continued industry consolidation and reorganization, means putting IT systems in place that can expand and contract with need.

As this level of systems integration is massive, the banking industry is ripe for IT outsourcing to leverage provider expertise, utilize repeatable processes and avoid massive hiring. But as institutions determine if outsourcing is the right fit and evaluate other available options, bank executives should keep the following outsourcing trends in mind.

Prices Going Up. The aggressive supplier pricing seen in 2009 will not continue. As the world economy and the financial services sector have stabilized, pent-up demand for outsourcing services means that securing top-tier providers for prices that were available in 2009 will be increasingly difficult. In addition, as outsourcers continue to focus on ways to improve their margins, they will look to develop initiatives aimed at improving their cost of delivering services -- typically through utilizing repeatable processes and standardizing their delivery models. The bottom line: As the opportunity for a highly aggressive pricing deal is more limited, financial institutions should look for outsourcing providers that offer specific banking vertical expertise and avoid "one size fits all" service offerings.

Supplier Consolidation. Banks embarking on IT outsourcing initiatives should be aware of consolidation in the outsourcing market. Palo Alto, Calif.-based HP's acquisition of EDS in May 2008 started the trend, and outsourcing M&A activity heated up again this past fall when Dell (Round Rock, Texas) acquired Perot Systems and Xerox (Norwalk, Conn.) acquired ACS. Companies need to be mindful of potential future combinations, particularly with smaller providers that may not be able to sustain organic growth.

Outsourcing provider consolidation, however, offers the ability to leverage additional products/services from suppliers or incorporate them in your favor in negotiations -- for example, "I'll go with provider A if it can bundle aggressive hardware pricing into my desktop computing tower." The bottom line: Pay close attention to contracts and M&A-related clauses, such as clauses ensuring that key personnel and delivery teams are kept intact and protecting against post-merger integration issues. Also, evaluate individual transaction components to capitalize on the best deal -- whether bundled or unbundled.

Optimal Number of Suppliers. From an infrastructure perspective, there are natural forces that suggest that fewer suppliers are generally better than more. Operational synergies exist within certain tower combinations -- for example, desktop support, help desk and network device support -- that can be best realized through the use of a single supplier. These synergies derive from: a) the supplier's (and correspondingly, the customer's) ability to manage across, not merely within, those towers; b) lessons learned by understanding the breakpoints that fall both between as well as across a broad segment of the IT ecosystem; and c) processes that not only diagnose and fix problems that arise, but that also prevent problems from occurring in the first place (again, leveraging an understanding of the interfaces and handoffs between towers). Opportunities also exist for supplier scale economies (leading to lower supplier costs and ultimately more aggressive pricing for the customer) as well as the simplification of supplier governance in managing one to two infrastructure suppliers versus four to five that might be selected in a so-called "best of breed" approach.

On the other hand, from an applications perspective, a portfolio approach with multiple suppliers (typically at least two and often up to four or five, depending on the range and complexity of the company's applications) creates desirable ongoing pressure on the suppliers to both maintain competitive pricing as well as high levels of performance. The bottom line: When it comes to infrastructure, fewer suppliers are typically better, but when it comes to applications, don't put all of your eggs in one basket.

Outsourcing offers a number of appealing benefits to banks that need very specialized IT experience. However, decision makers should not enter the process lightly. IT outsourcing is not a quick fix. The success of an IT outsourcing relationship hinges on effective supplier management underpinned by a comprehensive governance framework that includes ongoing contract and financial scrutiny, operational performance monitoring, and value creation from technology innovation and service/cost improvements.

Pace Harmon is an outsourcing advisory firm based in Tysons Corner, Va.