How financial turmoil will shape outsourcing

The current financial shake-up is changing how firms in the sector think about outsourcing. Peter Fawcett outlines the options they need to consider.

The restructuring underway in the banking industry is of such a magnitude that in the short term, many firms are simply parking the outsourcing debate to the side, as they seek to understand who owns who, who will have what jobs and whether the various financial rescue packages are successful.

When the dust settles, the resulting merged entities will look at what outsourcing arrangements they have inherited and how they can be optimised.

For those firms undergoing mergers or acquisitions, there are some specific challenges to consider, particularly if there are existing outsourcing arrangements already in place. There are major drivers in favour of outsourcing, predominantly around reducing costs. However there are also key challenges, including how to combine different sourcing strategies and cultures. There are also penalty clause implications to consider if contracts are to be changed or terminated.

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If we look into the crystal ball, the financial services 'survivors' will likely be the ones to continue to aggressively reduce costs through a variety of sourcing routes. This could be a mix of offshoring, outsourcing and shared services.

Outsourcing in particular is seen by many financial institutions as a faster way to drive dramatic and sustainable cost reduction than other initiatives. More conventional long-term cost reduction business transformation initiatives often prove to be highly complex, take a long time to deliver and have a high risk of failure. Meanwhile, traditional short-term 'slash and burn' cost reduction initiatives can often damage a firm's longer term position by losing core skills.

A sizeable number of major financial institutions are offshoring and outsourcing as a way to achieve radical cost reduction, with some major breakthrough deals recently announced such as the $1bn Aviva deal in July.

HSBC is an example of a firm that has gone down the offshore captive route (where a company will take advantage of a lower paid workforce employed overseas within its own global group), leveraging their substantial operations in India. A number of investment banks have consolidated substantial parts of their UK back operations into trading centres such as Singapore, as part of their plans to consolidate their operations globally.

In order to understand which route will deliver the greatest savings at lowest risk, firms need to consider whether it is cheaper to stay in-house, what level of sustainable savings are achievable and what investment is needed.

Recently there has been a trend towards offshoring via an outsourcer, with a growth in the number and quality of outsourcing firms now serving the financial sector. For those firms new to offshoring, the time and expense in setting up a captive and the need for fast results is likely to deter them from doing this on their own.

If a suitable supplier is available which has already gained a good reputation with another financial institution, this can seem the easiest route. The extra hurdle of a supplier margin or potential VAT can then be offset by gaining benefits earlier and not having the upfront costs of setting up a captive.

Many global banks may continue to keep operations in-house, particularly if they already have an existing overseas operation in such regions as Eastern Europe, India or Singapore. It is a comparatively straightforward task for them to take on the back office operations from an acquisition and build this into their existing captive offshore organisation.

Recent deals are largely going down the outsource route, with some banks selling their captives to outsourcers, to realise the value generated in them over time.

However if a firm chooses to go with an outsourcer in the midst of a major merger integration or consolidation, the client must ensure they receive benefits from the supplier. Firms need to ensure they don't get locked into deals they live to regret.

Another important factor is planning for regulatory concerns including gaining all the appropriate approvals, and ensuring current and future compliance needs are met.

Change management through these difficult times is critical. The top executives must ensure cross-function changes happen across the organisation and a change plan is in place to manage the sensitive issues of people and culture.

Ensuring accountability over time is often a challenge if firms suffer from high staff turnover. Bonus structures, such as may be obtained in the current climate, can offer managers an incentive to deliver the required cost savings over the long term.

Once the turbulence subsides in the financial world, cost pressures are likely to drive surviving firms to place outsourcing and offshoring back onto their top management agenda.

At that point it will be even more important for the surviving firms to understand the dynamics of the sourcing marketplace in order to drive sustainable cost advantage. Those that get their sourcing decisions wrong could end up with inflexible and expensive arrangements they will live to regret.

Peter Fawcett is a director of consultancy Alsbridge