Banking Inside Out

Some of America’s top consulting firms have a blueprint for the bank of 2010: Nike Corp.

Some time back, Nike decided its core competency was designing shoes, not making them, and now it outsources everything but the design. Look at Nike! consultants say, the cobbler who makes no shoes. Look at Sara Lee! She gets all the credit for those sugary treats without setting foot in the kitchen. One day, the experts predict, we may look at Citibank and find behind its colossal name recognition the fingerprints of hundreds of other companies: the product development genius of Bank X; the marketing wit of Group Y; the customer-service skill of Company Z; and dozens of other world-class companies all working under the Citibank banner. A handful of Ivy-league outsourcing relationship managers will be eating Chilean sea bass in the gourmet cafeteria and overseeing virtual banking via Microsoft. And they’ll be the best at everything they do. But who will they be?

And is this really where we’re headed?

Maybe. Mind you, the Nike model may be an exaggeration.

“What we’re talking about here is the difference between a ballerina and a sumo wrestler,” says George Freibert, president of Professional Bank Services, a financial institution management and corporate governance consulting firm in Louisville, Ky. “Nike is the ballerina. A NationsBank BankAmerica can’t move that nimbly.”

One thing bankers and outsourcers can say with certainty is that the old model of outsourcing is dead. To view outsourcing as a make-or-buy, cost-cutting measure is like calling a computer a machine for making spreadsheets. The key word for outsourcing today is not savings but strategy.

Now that bankers have won the right to compete in all areas with other financial services companies, they’re a little like the dog that chased the car and caught it. Few banks have a prayer of competing effectively on their own in all the areas in which they operate. Hence, the theory goes, they need to identify the core businesses in which they can create a competitive advantage and outsource the rest to people who shine in those areas.

In the new model touted by accounting/consulting firms and countless other service providers, that means outsourcing business processes (BPO) such as information systems, human relations and training, accounting and finance, and customer management. But for some bankers, the new corporate model affords the institution too little control and brings outside vendors too close to the bank’s core competency and strategy. And when we’re talking about core functions and strategy, we’re clearly talking about a board issue.

Getting to the core

Finding a bank’s core competency is “a much more difficult process than the books tell you,” says Joe Marzetti, director of corporate supplier management for $70 billion BankBoston. There are, of course, financial institutions with an obvious coreu00e2u20ac”MBNA with affinity cards, for example. But most institutions, bankers and consultants agree, have a difficult time nailing down precisely what their competitive advantage is over other providers. The term “moving target” comes up a lot.

Five years ago, when G2R, a research firm in Mountain View, Calif., asked executives about their core competencies, respondents would write the word “everything,” recalls Kepler Knott, vice president, process markets. “[Today,] there’s a great deal less being considered core.”

Knott’s definition of a core competency: “If you would create competition for yourself if you outsourced it, it’s core.” Knott describes three concentric rings. The first is that which is core. The second is critical to the operation, but noncore. The third is neither critical nor core. Anything in the third ring, Kepler and others suggest, should be dumped. The middle ring, he says, is the “landing zone” for outsourcing. And that circle is expanding.

One item that’s moved from the first ring to the second is finance and general accounting, according to John Barnsley, world leader, global business process outsourcing for PricewaterhouseCoopers (PWC). “These areas were always [believed to be] sacrosanct,” he says. “They were felt to be core. But the process end of finance and accounting are not actually core at all.”

While many businesses now agree with that, Craig McDonald, founder of World Research Advisory notes, “There’s confidentiality control and proprietary information to consider in finance. It all depends how strongly you weigh that over the compelling profit motive.”

Dennis McGuire, president of Technology Partners, Inc., which brokers information technology (IT) outsourcing deals between companies and suppliers, chuckles over the predictability of debate between IT and business executives. He says he can pretty much bet that if he draws a square with four quadrants and puts a different IT function in each, the IT people will point to one corner and say, “That’s really important. That definitely needs to stay in-house.” The business side will point to the same quadrant and say, “That’s very important, that definitely needs to be outsourced.” To the IT people, that corner is the core. To the business side, it is critical to what they do, but it is not the source of competitive advantage; therefore it should be handled by the best outside party.

Mary Lynn Kiley is director of employee services with BankBoston, identified as a leader in BPO. In the 14 years she’s worked with the company, outsourcing has become more focused; she now oversees employees whose jobs are to manage the bank’s outsourcing relationships. “It feels very good,” she says, “to work for a company that knows what business it’s in.”

Examining the options

Let’s say the board sits down and, after much discussion and several projection analyses, decides its core business is facilitating transactions, managing risk, and mortgage servicing. How should it direct the bank’s management to go about intelligently outsourcing other processes?

For many banks, the first step is reengineering. Rather than looking at the cost of a department by itemizing desks and hourly wages, a bank hires an accounting firm to track the cost of a process from start to finish. Who gets involved and how much time is required of them? What materials are consumed in the process? What is the result? It’s often a good idea to hire an outsider to do this, says McDonald, because “you can get into some unbelievably messy and brutal political wars about cost allocation.”

Once the components are broken down and assigned a value, the bank has the option of improving on the process by, say, cutting out a couple of intermediary steps or extra forms. Or it might decide to use an outsourcer.

“If a company outsources,” Knott says, “it doesn’t mean that they reengineered their business processes. But if they reengineer, they will outsource.”

There’s something else that might emerge. As First Union Corp. discovered, reengineering showed where the bank had excess capacity in its distribution center to create another company. It eventually wound up outsourcing its services to others.

There’s very little a bank does that can’t be outsourced these days. Although, as Jay Singer, senior manager of KPMG Peat Marwick’s Advisory Service Practice, points outs, even if you could outsource everything, you may not want to. All banks that outsource get from their suppliers, he says, “the same flavor of plain vanilla,” thus weakening their competitive advantage. And there are multitudes of outsourcing suppliers, making the choice more confusing. Furthermore, negotiating a 10-year contract with a third party who will essentially be a partner in your business is trickier than negotiating a business sale. After all, you have to live together.

Wave of the future?

Banks were among the first serious users of outsourcing, and many depended heavily on these outside consultants to help them with technical competencies that were foreign to old-style banking. Banks have long outsourced functions that benefit from an objective eye, such as audit, credit review, and compliance review. Banks are also used to hiring outsiders for things like check and credit card processing and credit scoring.

“Banking is a highly regulated industry, and regulation brings standard processes,” says Peter Bendor-Samuel, president of Everest Software Corp. and publisher of Infoserver, a Web-based publication for strategic outsourcing information. Standard processes are the easiest ones to outsource. As Stephen Racioppo, managing partner of Andersen Consulting’s New Business Models practice notes, “The harder a thing is to do, the more complex and the more unique, the harder it is to buy.”

As the evangelists of the BPO movement would say, bank functions are more standard than complex. But in either case, they argue, wouldn’t a firm that performs those functions for a lot of businesses be more suited for the job? Among those PWC believes may be better outsourced are finance and accounting; tax compliance; human resources; real estate management; applications process; supply chain procurement; and customer service management.

According to a recent survey performed for PWC by Yankelovich Partners, Inc. of 300 senior executives around the globe (75 from financial services companies), more than 30% of financial services companies outsource payroll, benefits management, and real estate management. More than 20% outsource tax compliance, applications process, and human resources. Fewer than 20% outsource general accounting and finance, internal auditing, procurement, and claims administration. And fewer than 10% outsource customer service management.

KPMG Peat Marwick has its own numbers. According to Jay Singer, nearly 40% of financial institutions outsource applications processing, 25% outsource mortgage processing, and 32% outsource check processing. Only 14% outsource automated bill payments.

Clearly these numbers don’t sound like an outsourcing boom. But something has driven the major consultancies to establish BPO practices in recent years. So, while today this is a supplier-driven phenomenon, some say tomorrow this model could be reality.

Learning to let go

PWC’s Barnsley says there’s a time lag between laying the groundwork of a revolution and seeing the changes. “A lot of the work that’s been done in outsourcing is 15 or 20 years old,” he says. “It’s moving up the value chain.”

It depends on whom you talk to. Some of the bigger banksu00e2u20ac”Citibank is said to be a pioneeru00e2u20ac”seem to have gotten religion and echo the strains of the BPO giants. At BankBoston, says Joe Marzetti, the bank is looking more and more like the Citibank model at the top.

“There are certain things about finance and accounting we would want to control,” he says. “But there’s an awful lot of operational accountingu00e2u20ac”payroll, accounts payableu00e2u20ac”that are possible to outsource.”

Among the things BankBoston outsources are training, benefits administration, tuition reimbursement, and matching-gift programs. It also has outsourced some of its programming and has requests for proposals to outsource its property management.

Two concerns have kept BankBoston from outsourcing its call center, however. First, most call center providers require customers to dial a toll-free number. But from the bank’s standpoint, it is less expensive to have customers dial a local number. But even if that should change, Marzetti says BankBoston worries about having nonbank personnel be the first line of communication with its customers.

First Union shares those concerns. After all, in the eyes of the customers, the person on the other end of the phone line represents the bank itself. Taken to an extreme, a totally outsourced bank could become a “virtual” companyu00e2u20ac”not a model many real businesses have signed onto yet. Besides, where would this leave the bank in terms of carving out its corporate identity, a important goal in today’s competitive market?

“I’d be hard-pressed to find an example of a Fortune 500 or Fortune 100 corporation that is a virtual corporation,” says George Watt, a senior vice president and managing director for First Union’s Strategic Supply Service Group. “[However,] I’d agree that all of us in our industry have lots of opportunities to take a more strategic approach to non-mission-critical functions.”

Watt cited several banks that he says take a “very aggressive” tack on outsourcing, including First Union’s new acquisition, CoreStates. He says the Philadelphia institution was “way out of the industry model… [and] well beyond our level of comfort.”

Watt’s view is that the bank should “keep that which adds value to shareholders and that which adds value to customers, and outsource everything else.” First Union “evaluates every service and develops the best source for that service at the smartest cost.”

Looking within

Ironically, such soul-searching can lead down a path directly away from outsourcing. At First Union, for instance, it means a lot more is handled in-house. Benefits management, recruiting, and on-demand printing are all outsourced, according to Watt. The company’s training center is a corporate concern, although most of its employees are outsourced. Corporate travel services are examined every year as an outsourcing candidate, but they’ve remained in-house. In other words, First Union is long way from farming out all the business. A long way from the virtual corporation.

They’re not alone. While consultants can tout the merits of the new, outsourced corporation as a model, there are lots of sticking points that keep bankers from diving in.

One of these is that customers might be inspired to go directly to the outsourcing supplier for products and services. A key example of this is in the bank brokerage business, where customers may come to believeu00e2u20ac”rightly or notu00e2u20ac”that there’s no reason to use their bank as a go between. Why not walk to the nearest Schwab office and skip the middleman? But James B. Moore, president of Mentis Corp., an international research firm tracking communications technologies for financial services industries, says relationships with outsourcers are designed to create solutions for customers, not divert them from the bank.

“Consumers,” he says, “don’t want to buy checking account disbursement services.”

Bankers also are concerned about the fate of employees whose jobs will be outsourced and the effect outsourcing will have on the morale of those left behind. The theory is that outsourcing should be a huge boon to employees who get hired by the outsourcer, according to BPO proponents such as PWC. For a data processor, or a customer service representative, or a property manager, being hired by an outsourcer that specializes in that area offers vast opportunities beyond working in a peripheral capacity for a bank, according to PWC’s Barnsley. Furthermore, a bank always has the option of looking for an outsourcer that will hire its workers.

Not surprisingly, the PWC/Yankelovich study reported that almost 60% of financial services firms were afraid of losing control of a process and of unclear metrics for meeting objectives. More than 40% worried about their own lack of experience with outsourcing.

Both of these worries could be aided by yet another outsider: the outsourcing broker. Brokers of outsourcing deals help banks evaluate which functions should be considered core competencies and which would be better served by an outside supplier. They manage the process of identifying appropriate suppliers and soliciting bids.

The finer details

Though suppliers, consultants, and brokers may talk a good game, it’s all that nebulous “performance improvement” that keeps some banks skeptical. Everyone has heard of princely suppliers who turned out to be frogs and contracts that looked like a big savings but wound up only paying off for the supplier. Worst of all, these contracts can sometimes last a decade.

So before any outsourcing deal is signed, Bendor-Samuel of Everest Software recommends the company make its demands in the form of performance metrics. For example, a bank could require that the call center supplier’s employees pick up the phone within 30 seconds; that they transfer the call only 20% of the time; and that any questions be answered within 30 minutes. It should be up to the provider to figure out how to accomplish those objectives within their budget.

With good performance metrics, Bendor-Samuel says, banks only have to focus on the end result, not micromanage the supplier. A bank shouldn’t need to worry about whether its marketing distribution supplier is capable of providing targeted television or Internet advertising, for example. It should only have to set a goal for market share. Let the supplier worry about how to reach the goal.

“The document is the key agreement,” agrees McDonald of World Research Advisory. “What if you wind up saying to the supplier, ‘I want more copies,’ or ‘I want them two days earlier.’ If these aren’t built into the service plan, you have to go back and renegotiate the deal and the price. It’s becoming much more common to build in win-win performance metrics.”

McDonald adds that an attorney is generally necessary to negotiate the contract but that banks should be wary if their counsel has had little experience with outsourcing. “Someone with experience in outsourcing will understand all the ways they can get screwed,” he offers.

McGuire adds another cautionary note. “Nobody lies about anything as much as they lie about outsourcing,” he says. “Executives lie about how good a deal they got. Suppliers exaggerate. There’s a lot of pain in [the transition]. The outsourcers often have a lot of discipline in the area where they work, and the [bank’s] middle managers aren’t used to that much discipline.

“What’s the biggest risk? That you will get what you asked for.”

The board’s role

There probably aren’t too many changes a bank will make that are more dependent upon leadership at the top than outsourcing. Outsourcing means clearly defining the bank’s core and setting a course for a new kind of institution. Essentially, that strategic direction must come from the board.

“Outsourcing might even change the fundamental culture or personality within the company,” notes Andersen Consulting’s Racioppo. And no matter how well outsourcing is done, “it’s pretty traumatic,” says McGuire, adding, “The first year is the worst.”

Suppliers are conscious of the board’s role in outsourcing, says McGuire, who sizes up which directors sit on the boards of companies that already outsource and identifies who their suppliers are in order to gauge their readiness for an outsourcing pitch.

But in the fervor to be the best at everything and move toward the bank of the next millennium, there’s one thing neither boards nor executives can afford to forget: “Just Do It” may work fine for an athletic shoe manufacturer, but it can’t serve as the motto for a financial services provider.

As George Freibert says: You can outsource a lot of things in banking, but “you can’t outsource the responsibility.”

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