The outsourcing market is growing faster in the financial services industry than in any other vertical. IDC Canada forecasts a compound annual growth rate to about 8.6 per cent to 2008, compared to an average of 3.9 per cent. Two IDC Canada analysts offered Susan Maclean their perspectives on this strong sector, which represents about 18 per cent of the entire Canadian spend on external IT. Matt Jarrett, a senior analyst with Financial Insights Canada within IDC Canada, is responsible for the Canadian financial services research vertical. He has participated in the initial stages of major outsourcing relationships at financial institutions. Leslie Rosenblood, another IDC Canada analyst, provides insight into the IT outsourcing industry.
IT Focus: Why is the financial services industry so advanced in its adoption of outsourcing?
Matt Jarrett: A high percentage of services tends to indicate a fairly mature industry selling products and services that depend heavily on technology.
Leslie Rosenblood: You tend to find they are further along the adoption curve when the value they provide is in the form of bits as opposed to atoms.
IT Focus: Are there any trends you see in the recent outsourcing contracts by Canadian financial services companies?
Jarrett: Yes, lots. Some of the more traditional services areas like consulting and integration are not growing at as fast rates. The reason for this is in essence a transfer of funds from consulting and integration services to outsourcing. So, functions like the rollout of a new desktop platform…you roll it into a massive outsourcing deal that is part of a business transformation element.
Rosenblood: This is related to an overall trend in the outsourcing market that includes financial services but is not limited to it. About five to seven years ago, the major and sometimes the sole motivation for outsourcing was cost savings. “I want you to do exactly what I’m doing now but I want you to do it for less.”
IT Focus: And they could because they had economy of scale.
Rosenblood: Yes. There were a few reasons. Economy of scale, process excellence, in some cases labour arbitrage. There are a number of factors that went into the cost savings aspect that they were able to pass on to their customers. It is very rare that you see a major outsourcing deal today where cost savings is the primary motivating factor. It’s almost always an element in the deal but it is not the primary one which is to keep on top of process and technological excellence without having to make the massive investments themselves in networks, servers, best practices.
Jarrett: Essentially, you use service acquisition as the means to get yourself out of that acquisition cycle and stay at the top of the technology curve. One of the many trends in that area is looking at things like how you license software today. Traditionally it is a bum and seat mentality. You have one user; you pay for one licence. One of the changes is that we see an increasing amount of sales of products on demand. You pay as you use it; a pay by the drink mentality. The financial institutions and enterprises across other verticals have started to demand this. So, now you see IBM’s OnDemand messaging; HP has their messaging around the adaptive enterprise. Your usage of a particular product or service is variable and, importantly, tied to critical business metrics.
One of the key things traditionally was the notion that you outsource non-core functions; things which are non-differentiating for you and don’t create as much competitive advantage. In the financial services patch, a lot of really core level things like network infrastructure have already been outsourced, so there’s been movement farther up that value chain. Anything that is customer-facing or brand-related are areas where you tend to differentiate. Those are also areas where you’ll see slower adoption of outsourcing but we’re starting to see more movement over time as firms become more comfortable with outsourcing as third party service providers become better at outsourcing those sorts of functions.
Capital markets have a big focus on the development of straight through processing (STP). Through the rest of 2005 and 2006, expect to see a greater focus on the automation of processing procedures in front office functions — that would be direct trade functions — and in third party connections. One of the main methodologies that these firms will use is outsourcing to attain that straight through processing.
IT Focus: Now that outsourcing has several years under its belt, are there lessons learned that are being applied to make outsourcing more of a win-win for all involved?
Rosenblood: When the outsourcing focus was on cost savings, the effort was to be extremely effective on price points. Companies would browbeat outsourcers to razor thin profit margins. This was great for the first 18 months but when new technology was introduced or they hired more or anytime anything deviated from the original deal, the costs and headaches incurring for new outsourcing protocol or service, there was no margin left. That’s why there’s been the shift to focus on process excellence over cost savings.
Jarrett: There are clauses you can build into your deals which help protect potentially both parties and certainly the party that is completing an outsourcing arrangement. A most favoured nation clause gives the financial institution price point or service level protection. At the time the deal is inked, this clause guarantees that there is not another financial services firm of comparable size and scope who will receive services of comparable scope and nature for a lower price than the price that has just been inked in the deal.
You can build declining price points into your deal to hedge against inflation [and] continuous, significant decline in [hardware] pricing. Because the average length of most outsourcing deals today is probably seven to 10 years, you need to have that price protection built into the deal. So you say “here’s our price in year one; our lower price in year two” — and all the way down.
Firms are getting smarter at how they are building in benchmarking clauses today. You need to be able to compare the same for same services. To have one bundled price may be fine from a cost comparison of your current cost to your new cost in the deal, but you need to have visibility into the price points associated with each of the variable services and product offerings so you can benchmark at agreed upon times within a deal. Make sure you agree ahead of time on a process for selecting a benchmark party to begin with and then a process for ensuring that the benchmark results are adhered to from a price adjustment perspective.
Demand reduction clauses say that a third party service provider will work to reduce the demand for services within that organization and reduce costs not only through declining price points but through strategies that a firm would use if they were providing that service internally. Obviously you want to minimize your use of resources so you build in benefits for the third party service provider that motivate them to provide the same sort of demand reduction.
Another clause is the ability to shift from one service level to another. There are tons of service levels; few are critical in nature. Each has a weighting level. You want to be able to shift from service level A to service level B if you experience difficulties.
— Maclean, freelance writer/editor, covers a wide range of IT applications. She is based in Guelph, Ont. and can be reached at www.sumac.net.