Offshoring's Allure

By Jack Milligan

Shifting back-office functions overseas can be rewarding, but operational and political risks must be kept in mind.

Are U.S. financial institutions part of the global outsourcing movement?

You bet. In India, for example, Citigroup Inc. runs call centers and global processing centers, while software development is an emphasis for Bank of America Corp. and Wachovia Corp. Meanwhile, J.P. Morgan Chase & Co.'s equity research department recently relocated 50 junior analyst jobs to Mumbai.

While these aren't huge bets, they could mark the beginning of a gradual shift of back-office jobs from U.S. regional banks to overseas locales, a practice known as "offshore outsourcing," or more simply, "offshoring." Indeed, A.T. Kearney estimates that a wide swath of the country's financial services industry — including banks — will send more than 500,000 jobs offshore over the next five years. This represents about 8% of their current workforce and would save over $30 billion a year in operating costs, according to the Chicago-based consulting firm, which is owned by Electronic Data Systems Corp.

"The era of doing everything by yourself and doing it in one country may be coming to an end for competitive reasons," says S.A. Ibrahim, president and CEO of Novato, Calif.-based Greenpoint Mortgage Funding LLC, which outsources a wide variety of back-office and call center support services to India.

Yet institutions need to look carefully before they leap. Outsourcing in general is fraught with operational and security risks. Contending with different cultural, legal and regulatory environments elevates those concerns to a whole new level. And in today's slow-growth job market, it can be politically touchy to move jobs overseas.

It's not surprising that offshoring so far has been mainly the province of a few huge global institutions, such as Citigroup, American Express Co., HSBC Bank PLC, Standard Chartered PLC and General Electric Capital Corp. These players have operated overseas for decades and know their way around. U.S. regional banks, by contrast, have mostly confined their overseas initiatives to a few areas, such as software development.

That may soon change. The simple fact is that banks are under enormous pressure to operate more efficiently in a business where revenue growth is sluggish at best. How can executives resist the lure of offshoring when a technical worker in India makes about 20% of his American counterpart? Institutions that don't begin thinking seriously about this issue could eventually find themselves at a competitive disadvantage.

But thinking about offshoring also means thinking about ways to handle the risk. Pilot projects, for example, offer a means to get comfortable with offshore vendors without placing too big of a bet. As with traditional outsourcing arrangements, clients need to emphasize strict monitoring of service agreements and develop robust contingency plans to deal with potential disruptions of service.

Once a major offshoring commitment is approved, the next key decision involves organizational structure. The fastest way to get into the offshore game is to work with third-party outsourcers. But multinationals, such as Citigroup and GE Capital, have found it advantageous to establish their own subsidiaries offshore to handle the work, in effect trading speed for control.

Though offshoring ultimately hinges on the needs of each institution, the trend clearly cannot be ignored. "Companies in our industry are thinking about it," says Steve Bartlett, president and chief executive of the Financial Services Roundtable, a trade group based in Washington, D.C. "They owe it to their customers and shareholders to explore the options."

Coming Flood?

From one perspective, offshoring is nothing new. U.S. companies have been shifting manufacturing and textile jobs overseas for decades, particularly to Mexico and China. During the '90s, this trend broadened to include more technical back-office service functions, with airlines and computer companies leading the way. Now, financial services firms are increasingly joining the charge.

Deloitte & Touche LLP predicts that the "trickle" of financial companies currently outsourcing overseas "will soon be transformed into a flood." Deloitte analysts say that over time, offshoring has the potential to dramatically alter the basic structure of the global financial services industry by separating the front end of the business — product design and sales — from the back end, which includes servicing, processing and administration.

And increasingly that back end will be located in places such as India. "There's an overseas work force out there that can give a real competitive advantage to the U.S. companies that act first," says Paul Wirth, the New York-based managing partner of Deloitte's national banking practice.

There's no question that offshoring has the potential to lower an institution's expenses. Calvin S. Yee, a director at New York-based Gunn Partners, cites an offshoring project for one large American bank that he declines to name because of a client confidentiality requirement. This institution operates its own back-office facility in India, which contributed to a 13% reduction in total administrative services overhead between 1992 and 2002, according to Yee.

The huge differential in wages between the U.S. and India accounts for almost all of the savings. "We call it labor arbitrage," Yee says. "You're doing the same thing somewhere else, only cheaper. It's a labor play — nothing more, nothing less."

All of the banks contacted for this story declined to make their executives available to discuss offshoring. But some other financial services companies were more forthcoming, such as GreenPoint Mortgage. "In the mortgage business, cost control is extremely important," Ibrahim says. "This was an imperative for us; we had no choice."

Ibrahim's company is the mortgage origination subsidiary of Greenpoint Financial Corp., the New York-based thrift. Over the last few years, it has outsourced a variety of back-office functions to Progeon Ltd., a subsidiary of Bangalore-based Infosys Technologies Ltd., a well-known Indian technology company. These activities include credit analysis; call center support; tax and escrow analysis; and document reviews, both before and after closing.

Ibrahim declines to quantify the savings Greenpoint achieves by offshoring these jobs to India. But he does point out some other advantages: when its back-office work is being handled on the other side of the globe, a U.S.-based company gains a 24/7 operational capability that it lacked before. "For us, offshoring is both a cost play and a revenue play," Ibrahim says.

Spokespersons for American Express and GE Capital also tout the multiple benefits of offshore outsourcing. American Express, for example, sees value in a "distributed network" that spreads work around the globe. In addition to India, American Express maintains service centers in Phoenix, Ariz., Sydney, Australia and Brighton in the U.K. "This gives us a material advantage in cost, quality and speed," the spokesperson says. "You can't just look at cost. Quality and speed also come into play."

Modern global telecommunications make this kind of "distributed network" possible. Physical proximity is no longer essential for many kinds of back-office support work, since people can communicate instantaneously via telephones and computers, regardless of whether five miles or five thousand miles lie between them. "Whether you have someone in Singapore or Idaho doesn't really matter," says Deloitte's Wirth.

Speed or Control?

Even as U.S. banks contemplate the potential benefits of offshore outsourcing, they cannot afford to ignore the drawbacks. As the national economy struggles with sluggish job growth, political leaders are sensitive to the issue of jobs migrating overseas.

In trade talks last summer, U.S. Trade Representative Robert Zoellick gave the Indian government assurances that the Bush Administration would not try to derail the growing offshoring trend. But legislatures in a handful of states, including New Jersey and Michigan, are considering prohibiting their state governments from outsourcing overseas. Some regional banks may simply decide to wait until the economy picks up before sending scarce American jobs to locales such as India and the Philippines.

Then there are the operational risks. Institutions that locate important back-office functions thousands of miles away in a different culture and legal/regulatory environment always face the threat of some significant interruption in service, which can be caused by war, labor unrest, currency devaluation and corruption. And it remains to be seen whether overseas workers can broadly assume responsibilities for dealing directly with customers.

One approach for mitigating that risk is a pilot project, where the goal is not only to achieve some cost savings, but also to gain experience managing an outsourcing relationship across distance and cultures. From a technical standpoint, call centers and various document management tasks such as application processing and accounting opening can be easily transferred offshore. And as the institution grows more comfortable with the arrangement, these activities can be scaled up to the point where the associated cost savings are more significant.

For institutions that want to make a more substantial commitment, choosing an organizational structure for the venture is a key issue. Large multinationals, such as Citigroup and GE Capital, have tended to favor a captive arrangement, where they establish a fully owned offshore subsidiary to handle the work. Among the regional banks, BofA has chosen this strategy, with plans to open an Indian business processes subsidiary this spring. A.T. Kearney's Bierce says concerns about control, confidentiality and security have led these companies to, in effect, own rather than lease the necessary capability.

However, the fastest and easiest way to get into the offshore game — and hence likely more attractive to smaller U.S. banks — is to work with third-party outsourcers. Cost savings usually materialize more quickly when the work is outsourced, although the bank will surrender some degree of control to its vendor.

Greenpoint considered establishing its own subsidiary in India, as some of the multinationals have done, but decided it didn't want to hassle with the real estate and local legal/regulatory environment. Instead, it hired Progeon as a traditional third-party processor and assigned five of its own India-based employees to work side-by-side with the 400 people Progeon has dedicated to the project. "In many ways, Progeon is a part of our company and that's the way we treat it," Ibrahim says.

Andrew M. Dresner, a vice president at First Manhattan Consulting Group, stresses the importance of monitoring service levels very closely, and also negotiating financial penalties for poor performance. It's also crucial to work out a contingency plan in case the vendor's operations are seriously disrupted. "It's not that dissimilar from any other outsourcing arrangement," he says.

Passage to India

When it comes to offshore locations, U.S.-based banks face a lot of choices. Countries that can provide back-office support at rates compellingly lower than those in the U.S. include India, China, Brazil, Mexico, Hungary, the Philippines, Canada, Ireland and Russia.

Yet by and large, financial services companies have tended to flock to India, which isn't surprising considering the numerous advantages. When A.T. Kearney recently ranked the top overseas outsourcing locations, based on cost of labor, labor skills and political environment, India came out on top.

It's not that Indian labor is cheapest; that distinction belongs to China and Russia. Nor does India have the most secure political environment; Canada, Ireland and Australia fare better in that category (albeit with higher labor costs).

What India does possess in abundance is trained laborers, millions of whom speak English as a second language. Indian software engineers are particularly sought out in global markets. Of the 100 or so software companies in the world earning the top rating (Level 5) from Carnegie Mellon University's Software Engineering Institute, 40% are located in India.

Indian labor is also competitive in jobs that require less education, such as call center support. In some instances, accent "neutralization" training, combined with intensive viewing of American or British television, can turn out employees that sound "native" to customers in the U.S. or U.K.

Andrea Bierce, a vice president with A.T. Kearney in Chicago, tells of listening in on one service call in which the representative — a native Indian who spoke with an excellent English accent — helped a caller from London. The rep knew enough about local conditions to ask her English customer whether she had shopped at a big department store sale in London that weekend.

Not surprisingly, India has become a magnet for the few financial services companies that have ventured into offshoring. Citigroup, for examples, operates four call centers and two global processing sites in Mumbai (formerly Bombay), which support businesses in 25 countries.

American Express has been conducting a variety of back-office processing tasks from a center in Delhi since 1994, and it added a call center in 2002 to field inquiries from around the world. This year, the travel and credit card giant plans to outsource selected account servicing and some risk management functions to third-party vendors in India, according to a spokesperson.

GE Capital opened its first Indian service center — GE Capital International Services, or GECIS — in 1997. Today, GECIS supports 13 General Electric businesses around the world by providing a variety of financial, accounting and back-office activities, along with software development, customer-service functions, actuarial analysis, risk modeling, data mining and statutory financial reporting. The parent company also operates an advanced research and development facility in India, staffed with approximately 400 employees, many of whom have PhDs.

Non-U.S. players include Netherlands-based ABN AMRO N.V., HSBC Bank PLC of the U.K. and Standard Chartered PLC, also based in the U.K.

To date, much of the offshoring undertaken by banks has involved software design or call center support. But A.T. Kearney predicts that the next wave of jobs going overseas will include analysis and research, regulatory reporting, human resources and accounting. This was underscored recently when Morgan Chase's equity research department relocated 50 junior analyst jobs to Mumbai, in part because it will only have to pay between $35,000 and $50,000 for a skilled employee with an MBA, compared with about $150,000 in the U.S., according to a spokesman.

The New York-based bank also has exported some of its most important software development work to the J.P. Morgan European Technology Centre in Glasgow, Scotland. According to Scottish government sources, projects assigned to the technology facility include a system for keeping track of the bank's various derivatives transactions, as well as asset and treasury management systems.

Despite these examples, however, offshoring still encounters resistance from U.S. regional banks. K. Srinvasan, for example, says he's spent the last year talking with executives at U.S. regional banks as New York-based national sales director for Polaris Software Labs, an India-based IT outsourcing firm that is expanding into the BPO market. He recalls a conversion with the chief technology officer at one southeastern bank in which the executive stated: "My bank's making money and I see no reason for sending things to India."

"I think it has a lot to do with culture," Srinvasan says.

Indeed, given their druthers, most U.S. financial institutions would probably prefer to keep their back-office operations under closer scrutiny and control back home. But as global telecommunications open up white-collar labor pools overseas, the advantages of offshore outsourcing simply cannot be ignored. "It really is a global economy now," Bartlett says. "This is just one more manifestation of it."

Mr. Milligan is a freelance writer based in Charlottesville, Va.

Copyright © 2004 by Banking Strategies, published by BAI.

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