‘Bundling’ Can Contain Costs; Aid Quick Product Ramp-Ups

By Jack Milligan

HR, procurement and accounting are among the functions optimized when IT and business processes are combined.

| SYNOPSIS |Outsourcing has been used by financial institutions for many years as a way of cutting cost, principally in terms of back office technology. And, that remains the chief rationale for outsourcing programs today. But as outsourcing matures, banks are testing the possibilities of bundling: the combining of information technology and business process outsourcing in the same contract. Staff functions like human resources, procurement and accounting are among those that could be shifted overseas. One hurdle to wider adoption: The Sarbanes-Oxley Act, which keeps banks from transferring accountability for regulatory compliance. The need to underwrite a BPO vendor’s compliance skills is what gives banks — particularly the largest U.S. institutions — pause.

Since February 2004, consumers who apply for a home equity loan at E-Loan Inc. have been given a unique option. Those who choose to have their applications processed by an outsourcing firm in India will have their loans close two days sooner than if the entire transaction was handled in the U.S. E-Loan, an online consumer lender headquartered in Pleasanton, Calif., benefits as well: The outsourcing arrangement gives it a powerful advantage in the marketplace in the form of a lower cost structure.

“We think there’s no way you can be a low-cost producer without taking advantage of opportunities like offshoring,” says E-Loan chairman and chief executive officer Chris Larsen.

E-Loan’s decision to incorporate outsourcing into the lending operation of one of its most important products shows how far this still controversial trend has come —and the advantage it can give a competitor. Outsourcing got its start many years ago as a way to cut costs — often by companies whose profitability was under pressure — and that continues to be its primary motivation for most companies, including leading U.S. banks. (Larsen refers to E-Loan’s arrangement as “offshoring” because the provider is located outside the country.)

As outsourcing matures, a growing number of financial services organizations are outsourcing not only important systems and technology functions, but the accompanying business processes as well. This manifestation of the outsourcing phenomenon—sometimes referred to as “bundling” because it combines information technology outsourcing (ITO) and business process outsourcing (BPO) in the same contract—is increasingly being applied to important staff functions such as human resources, procurement and accounting. Some companies are going even further and incorporating a combined ITO/BPO play into their core business models to lower costs and enter new markets faster.

“We estimate that 50% to 60% of U.S. banks engage in IT outsourcing,” says Virginia Garcia, a research analyst at Needham, Mass.-based TowerGroup. “That number is greater the smaller the institution is, although the trend has changed in the last decade or so.”

Small community banks learned long ago that they lack sufficient size to operate their back office processing activities as efficiently as their bigger competitors, and have come to rely on a variety of third-party processors. Large banks, too, have outsourced major pieces of their information technology infrastructure to a variety of major players including Armonk, N.Y.-based International Business Machines Corp. (IBM) and Plano, Tex.-based Electronic Data Systems Corp. (EDS). More recently, some of these same institutions have outsourced various customer service and administrative activities to low cost offshore locations like India and the Philippines—a strategy that was a political hot potato in the 2004 presidential election.

For a variety of reasons, large U.S. banks have been slow to embrace the bundling concept, although that might be changing in part because of the growing capabilities of third-party providers themselves. “It has evolved more slowly in the U.S. industry than I would have expected three years ago, but I expect we’ll see more of it— especially if banks hit a down profit cycle,” says John T. Weisel, managing partner for North American financial services application outsourcing at Bermuda-based consulting and outsourcing firm Accenture Ltd.

When ITO and BPO are combined in the same contract, a bank farms out one of its processes to a third-party provider to manage, and it relies on that firm’s underlying technology infrastructure, too. Administrative activities that some institutions are beginning to outsource through this bundled approach include human resources, procurement and various accounting functions. Like E-Loan, some are also beginning to experiment with bundling in various consumer lending businesses, including mortgage and auto loans.

“They’re looking to move processes out of the bank and leverage a provider’s common infrastructure and manpower,” says Rusty Wiley, the lead partner for banking at IBM Business Consulting Services. At the heart of this bundling approach is what TowerGroup’s Garcia refers to as “process transformation,” where the process itself is re-engineered in ways that would not be possible if the institution continued to manage it itself. Often, the limiting factor is its own outdated technology platform. Large banks— particularly those that are the product of multiple mergers over the past decade or so—tend to have a hodge-podge of legacy systems that make it difficult, if not impossible, to gain improvements in operational efficiency and functionality by redesigning administrative processes like human resources.

Frank Brienzi, Accenture’s managing partner for banking business process outsourcing, provides the theoretical example of a bank with 40,000 employees that outsources responsibility for both the administrative processes and underlying technology infrastructure for its human resources function to a single provider. While moving on to the provider’s technology platform would in itself result in cost savings, Brienzi says, even bigger savings would come from a significant reduction in the bank’s human resource staff. And in all likelihood, the bank would end up providing better service by, for example, enabling employees to manage their individual benefit programs online. This might be a feature the bank would not be able to offer without an expensive systems overhaul.

Weisel says that in the last 12 to 18 months, Accenture has begun to see banks and other financial services companies consider bundling arrangements for some of the basic processes that underlie consumer products like first and second mortgages, home equity lines of credit and auto loans. “The bank provides value in determining whether to underwrite risk and not in running the most efficient mortgage fulfillment operation,” he says.

Examples of major bundling deals include a master service agreement in January 2004 between Accenture’s outsourcing division and Deutsche Bank to provide the German multi-national institution with corporate purchasing and accounts payable services in the 76 countries where it does business. Accenture will provide the necessary systems and processes to manage Deutsche’s “procure-to-pay process,” while the bank will retain responsibility for supplier selection and manage the authorization process. Weisel says that Deutsche wanted to focus on its core competencies—which do not include managing a global procurement system. “They have an operating philosophy that if someone else can do it better, they’re willing to consider alternatives,” he says.

Contrary to what one might expect, the cost savings to Deutsche are not the result of improved operating efficiency from switching to Accenture’s technology platform. Instead, the saving results from tighter processes that will enable Deutsche to manage to a 90% compliance level with its procurement policies and eliminate “rogue buying.” “That’s where the real juice in the deal is,” Weisel says.

Toronto-based Canadian Imperial Bank of Commerce (CIBC) outsourced its human resources operations and underlying technology to EDS six years ago. While growing from a regional bank to one of North America’s largest financial institutions with businesses in Europe, Asia and the West Indies, CIBC managed to accumulate 30 separate HR systems. The operation was both highly inefficient and unable to accommodate improvements in functionality without a significant financial investment—money that CIBC was reluctant to spend.

Instead, the bank contracted with EDS to administer its various HR processes while simultaneously improving the system’s functionality. Employees can now manage their own benefit programs through an online portal, and business managers have easy online access to benefit and compensation data for planning and budgeting purposes. Over a two-and-a-half year period, some 200 members of CIBC’s HR staff were transitioned to EDS, and the 30 HR systems with approximately 100 different interfaces, 330 processes and 1,000 different HR procedures were transferred as well.

Chris Lord, EDS’ senior vice president for the Canadian financial services market, says that employee retention rather than cost savings was CIBC’s primary motivation. “Their ability to focus on HR strategy, policy and employee retention is significantly enhanced,” he says. “Now they’re dealing with strategy rather than tactics.” By outsourcing the administration of its HR system to EDS—while also relying on EDS’ technology infrastructure—the bank was able to improve the system’s capabilities for approximately the same amount of money it was spending to run its disparate collection of legacy systems.

Other organizations are beginning to incorporate ITO and BPO bundling into their core business strategies. Anne Politis, an executive vice president at Rocky Hill, Conn.-based Integrated Loan Services (ILS), a technology outsourcing firm that focuses on the mortgage industry, provides several examples where her company helps lenders with discreet pieces of their mortgage operations. In one instance, a mortgage lender has outsourced the processing of all mortgage loans that comes through its Internet channel to ILS while retaining responsibility for the credit decision. In another, ILS works with a credit union that wants to maintain a steady staffing level, which can be a challenge in the highly volatile mortgage origination markets. When mortgage origination volumes peak, the credit union outsources the overflow to ILS for processing rather than hiring more people that will have to be let go later when volume falls.

Perhaps the most intriguing example of a start-up is the industrial bank that made a strategic business decision to jump into mortgage lending and turned to ILS to provide all the necessary processing services on its own technology platform. Essentially, all the bank provides are the originators who make the credit decision— which enabled it to enter the market faster and more cheaply than if it had built its own platform and processed the loans itself. “They didn’t want to bring in all the necessary resources to get the mortgage unit up and running,” says Politis. “They wanted a minimum number of people to make the risk decisions and outsourced the rest.”

E-Loan, too, was motivated by a strong desire to cuts costs when it outsourced the processing of some of its home equity lines of credit. E-Loan has disclosed the arrangement to its home equity clients, who can opt out and have their loans processed domestically if they choose. This is highly unusual since companies generally try to hide outsourcing arrangements from their customers—even when the provider has direct customer contact.

“We don’t think you can go into offshoring without giving an option to the customer,” says Larsen. “It’s an important enough issue that the customer needs to be able to make the decision.”

Larsen says that only about 16% of E-Loan’s customers choose to have their loans processed in the States, and claims the rest are “absolutely comfortable with offshoring.” He adds that customers like the fact that their loans close two days sooner when processed in India, and seem to appreciate E-Loan’s disclosure on the matter. “I think that diffuses the controversy behind the issue,” he says.

In addition to the compliance issue, bundling also involves more complicated decision-making than traditional IT outsourcing because it necessarily involves both technology and business unit executives who must agree on a common tactical approach. And line executives generally have less experience — and confidence — in outsourcing.

“Traditionally, banks have been able to make decisions when it was just systems and technology,” says Brienzi at Accenture. “When it also involves processes, the decisioning becomes more complex. You’re bringing in people from the business side and there’s a necessary educational process.”

However, as their comfort level with outsourcing has grown, Lowes believes that large banks are beginning to realize that working with third-party providers on the process side can result in gains in operational efficiency without harming service levels.

For his part, IBM’s Wiley says that several of the largest U.S. banks are in the midst of evaluating their entire organizations to see what staff and business line processes, along with their underlying technology, can be outsourced.

And as banks start to seriously consider bundled outsourcing arrangements, there are several factors they need to keep in mind. With plenty of experience in this regard, both IBM and Accenture provide some important advice from the outsourcing trenches, beginning with the importance of senior management support for the undertaking. Sustained sponsorship from the senior-most executives in the bank—including the CEO—is crucial because the decision itself involves so many different people, many with the clear agenda of protecting their own turf.

Otherwise, says Wiley, “Business heads and IT people will never stay in the room long enough to agree on an approach.” Weisel also says it’s important to create a formal “governance group” that brings together all the major constituents with a stake in the decision, including business units, operations and technology. And don’t expect things to go smoothly. “It can be a very contentious decision-making process,” he says.

It can be a lengthy process as well—sometimes too long in Weisel’s view. He suggests setting a deadline for when the governance group must make its recommendation to senior management, which he believes can be accomplished within six to nine months. “A lot of bank managements make the decision-making process more complicated than it needs to be,” Weisel says. “It goes on too long.”

And banks must steel themselves to make the difficult decision to relinquish control of a function to an outside firm, which has always been a factor in outsourcing but becomes heightened when they start giving up control over internal processes that are important to employees and customers. “There has to be open acceptance to what we call the hollowing out of the financial services organization,” says Wiley. “This will continue and organizations need to accept it.”

One company that has made that difficult cultural shift is E-Loan, and Larsen believes that his company’s experience with managing a bundled outsourcing relationship will help make it more successful in the future. “I think every company will have to have that skill,” he says. “We think it is a strategic advantage, just knowing how to do it.”

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

Copyright © 2005 by Banking Strategies, published by BAI.

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