Outsourcing feature: Austerity rules

With an emergency budget recently and cost cuts around the developed world these are austere times indeed, but most financial institutions have already made their cuts with outsourcing increasingly taking up the slack for decimated internal IT departments. Justin Quillinan questions if this focus on short-term cuts is wise in the long-term, potentially threatening quality and innovation, and examines other outsourcing trends, such as the rise of cloud computing and its impact on traditional managed service models

In the aftermath of the recession outsourcing projects in the financial services sector are increasing, but often with a stronger emphasis on cutting costs and doing deals quickly to avoid spending money on the selection process.

“In my opinion, external consultants are being cut out and CIOs are less in charge of outsourcing projects than they were before 2008, with CEOs and CFOs driving deals more openly,” says David Skinner, a partner in the global sourcing group at business law firm, Morrison Foerster. “Cost is the major issue and business transformation and strategic sourcing rarely appear as key drivers now.”

This may be inevitable at a time when firms in all sectors are seeking cost cuts across the board, often leaning on IT to play a big part having already, in many cases, renegotiated existing outsourcing contracts to reduce expense. “There was a rush of re-negotiations last year and in 08, as financial institutions with existing contracts often went back to their suppliers and demanded that they share their pain by agreeing immediate cost reductions, re-profiling existing transactions and allowing lower volumes,” says Skinner.

The problem here is that this is a short-term approach and while it works during difficult austere times, it isn’t a long-term option and can adversely impact innovation if you dispense with your own internal IT department or squeeze suppliers too much – indeed even overseeing the quality of managed services becomes difficult if you don’t have internal expertise. Some smaller banks and insurers who have cut internal expertise have also found that driving a ‘bargain’ with suppliers is now difficult as well. As Martyn Hart, chairman of the National Outsourcing Association (NOA), says, “outsourcing has traditionally been seen as a cost saving mechanism for business, so during the last torrid few years it is not surprising that interest in it grew. However, continued focus on expense above everything else, means that many are now pushing through higher volume low cost contracts, over shorter time frames. This short-termism can be dangerous and these kinds of contracts frequently fail.” Attracting the lowest common denominator isn’t necessarily the best policy for either party.

Another key trend is the rise of cloud computing, which could revolutionise traditional outsourcing models in the coming years, enabling smaller business process outsourcing (BPO) providers to bid for larger contracts with appropriate partners or, conversely, it could lead to mammoth multinationals using higher volumes in the cloud to offer cheaper rates, concentrating the outsourcing market. If a few conglomerates come to dominate, as is eminently possible, financial institutions could eventually find it harder to drive a tough bargain due to a lack of competition.

“In the race to cut costs immediately, important factors such as innovation and continued development have been pushed aside as businesses look for a ‘quick-win’,” agrees Daniel Naoum, co-founder of Valueshore, which provides outsourcing services in Spain. “The problem is that this only gives a brief respite for firms, and offers little benefit to a global outsourcing market trying to prove its worth as budgets become available post-recession.”

Smaller outsourcers are being pinched hardest and struggling to win new custom. “Clients are more wary of small suppliers and the big five (IBM, CSC, Accenture, HP/EDS and TCS) have taken some advantage of this,” reckons Morrison Foerster’s Skinner. This is not an altogether welcome trend either, for it means that as demand for outsourcing recovers, the balance of power shifts back towards the major providers, with costs rising again.

Limited liability under threat?
The judgement earlier this year in the long-running court case between BSkyB and Electronic Data systems (EDS), now part of HP, may also increase costs. The case rumbled on for almost a decade, starting in 2001 when EDS agreed to supply BSkyB with a customer management system, costing £48 million. The system failed to work, and BSkyB sued for consequential losses of £700 million, resulting partly from the knock on effects across other IT systems that would have been integrated with the customer management package. This was far in excess of the £30 million maximum liability specified in the original contract, but BSkyB argued, successfully in the end, that EDS’ sales people had been guilty of misrepresenting the system’s capabilities. In the event, HP/EDS paid a sum in the region of £220 millionto BSkyB earlier this year. The case has wider ramifications by showing that outsourcing providers are not protected by the limited liability clauses in most contracts in the event that false promises were made, especially when the consequences ripple right across the customer’s business. This risk could cause costs to be priced upwards.

According to Skinner there could be good consequences too though. “It has made suppliers ensure that sales people are more controlled in what they offer to customers and that internal legal departments review documents more closely,” he says.

In outsourcing costs are not always what they seem anyway, and in the financial sector especially companies should probe deeper to identify overall Return on Investment (RoI) figures, and avoid merely seeking short-term gains. “Companies often fail to measure the true RoI of outsourcing,” says Alessandro Moretti, executive director of IT risk and security at UBS. “Calculations of cost savings, for example, can miss the opportunity cost of outsourcing, in the management, training and transition time involved.”

Benefits should also be factored in, such as availability of skills, and for this reason enterprises should not turn their back on offshoring to particular regions just because the headline cost savings are diminishing. Much has been made of the rising wage costs in India, although given current rates of wage inflation it could still take two decades before they catch up with most of Europe. “In any case the benefits of offshoring are more than cost savings,” argues Moretti. “Firms can still gain much from being able to resource the skills they need ‘on demand’. It’s not easy to turn on (or off) 1,000 skilled people on short notice. Near-shoring doesn’t always carry the same advantages.”

Certainly the signs are that the financial sector is still turning to India, whose big providers such as Wipro, Satyam and HCL continue to win business, despite last year’s scandals involving false accounting. Meanwhile, TCS has expanded sufficiently to join the elite, making it a ‘big five’ operator, doing away with the traditional big four, according to Skinner’s ranking.

Near shoring
Near shoring offers some advantages, notably reduced travel time in managing the contract, and skills specific to a region. Valueshore decided to bet on growth in near shoring for financial IT outsourcing, selecting Spain for its growing expertise in the banking sector. “IT outsourcing in Spain is on the rise primarily because the country’s workers are highly skilled in IT and European business,” argues co-founder Naoum. The high unemployment rate and parlous state of some Spanish banks, particularly the regional Caja institutions, which could lead to many posts being lost and yet more skills coming on to the outsourcing market, is also no doubt a contributing factor.

Near shoring may appeal for specific purposes as well. When it comes to compliance, for example, an increasingly complex area, where regulations differ between different countries and regions, some additional local expertise may be beneficial. “Organisations are more aware than ever of the dangers and threats posed to storing sensitive data inappropriately, especially with the Data Protection Act in Europe, and the penalties that can be encountered should these stipulations not be met,” says Mark Bates, CEO of RDT, which supplies an outsourced insurance admin system called Landscape.NET. Outsourcing can minimise the burden, he argues, and often the market is regulated enough to be more compliant than some firm’s own in-house risk processes.

Cloud computing
Trusting outsourcers to ensure compliance, especially if it’s keeping track of data, and to generally run a smooth operation becomes even more of an issue in the field of cloud computing, a growing trend. The cloud is emerging as a serious option for financial institutions, even if the concept is mostly only being piloted at the moment, because of its promise to cut costs and increase speed of deployment. According to Jon Clark, development director at Aom International, which supplies a hosted capacity planning package called Work Ware, larger outsourcing providers in particular are pushing the concept. “Cloud computing can make it easier for nimble BPO firms to gain traction quickly too, and allow offshore firms to bolt on new service lines,” he adds. “For example, virtual contact centres can be set up in a matter of days using cloud-based technology and innovative staffing models.”

However, the complexity and scale involved in handling large cloud projects, which take advantage of economies of scale savings, is also another factor that could ultimately squeeze smaller outsourcing providers, suggests Clark.

Despite the claimed advantages the financial sector has been ambivalent about cloud computing so far, hence the approach of using pilots only, which contrasts with its usual position of being among the leading adopters of new technologies, especially where there is scope for gaining competitive advantage as a result. The reason is all to do with the uncertainty about the risks of losing control over critical data at a time of high anxiety over compliance. “Financial institutions are naturally concerned about the security issues of cloud computing too,” says UBS’ Moretti. “It’s a little bit like a hedge fund – with no disclosure about where data is processed. This is different to traditional outsourcing deals where a rigorous process of risk assessment and disclosure is undertaken.” Until the same safeguards are built into cloud outsourcing, traditional models may well exist for a good few years yet.

A key benefit of cloud computing – namely, its ability to deliver flexible deployment – is also a potential downfall. “While the cloud makes computing resources (applications and data) more portable and effectively easier to connect to any outsourcing provider, the use of cloud computing in outsourcing is not something that has been tested and reviewed properly yet,” suggests Moretti. “Not many financial institutions will gamble their customer data, unless it’s a private cloud or part of a specific contract where all of the terms are negotiable.”

Cloud computing strategy is therefore another factor that must now be taken into account when looking at the current trends in outsourcing during these austere times. Whatever route you decide to go down though – traditional or cloud – it is always worth remembering the fundamentals that never change. Have strong service level agreements and avoid the false economy of cutting corners or rushing contracts when deciding how and where to outsource, and with which provider.

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