Sourcingmag.com contributor Karen Watterson spoke to TPI advisors Charles "Chaz" Foster and Tom Hynd about what a financial services firm looking to do business process outsourcing (with a measure of IT outsourcing thrown in) will experience during its assessment by TPI; how TPI evaluates the effectiveness and quality of internal services; how TPI advises clients to mitigate against unexpected expenses; what's in that final report that TPI delivers to its client; how long most outsourcing gigs last these days; what's driving financial services firms to outsource onshore and offshore; what kinds of carrots and sticks TPI is advising clients to build into outsourcing agreements — and why shared rewards just don't make sense.
Let's say a financial services firm is looking to do a business process outsourcing engagement, including some information technology, and they've called you in to do an assessment. Where do you start?
Chaz Foster:I think the first two things that we always try to understand…[are] what are the goals and objectives? We need to document those and have everybody agree to those. We need to make sure they're aligned with the overall business strategy of the firm. [If they're not], you get further down the pipe and people change their minds.
The second thing that we really try to accomplish is [determine] what are the current and future business requirements? Most of the activities that we are working on are internal services that are delivered to the business unit. So we try to look at those business units as clients and understand and document not only what their requirements are today, but what their future business requirements are — so that you can start thinking about this service delivery model and how you will deliver those services…
Once you've got that service delivery model…framed out and everybody agrees to that, then start thinking about sourcing, whether it be internal or external, offshoring, nearshore or farshore — how that would play into the delivery of those services within that overall service delivery framework.
Tom Hynd:You start with the framework, as Chad says, and then you carve out a specific body of area that you want to do a rigorous evaluation of. And then we do a very detailed deep dive into that area to understand the true cost structures of those areas and compare that to the marketplace. We look at market comparative cost data, as well as do an analysis on the risk factors associated with that, the maturity of the service delivery markets in that area.
Chaz:[We establish] the strategic importance of those functions to the client itself. A lot of that is going to help [determine] whether those functions could be outsourced, whether they would be better as a shared services or centralized model, or if they would be better off in an offshore model but still in a captive mode where the client might want to control those functions going forward because they were of strategic importance.
How do you get those first steps of determining goals and objectives?
Tom:When we start the strategy and assessment work, we very much want face to face interviews. And it depends on the particular area how high in the organization those interviews take place. In the example of a fair sized regional bank, the interviews included all the CEOs and business heads. If it's more IT focused, we will interview, certainly, all the IT managers and then selected business managers that are consumers of those services.
Is the CFO generally always involved?
Tom:Usually, but not always.
Chaz:You have the personal interviews, and then as you start to document the goals and objectives and future business requirements, you can move into a workshop approach, where you have more people around the table at the same time. And you start rationalizing and actually scoring. Because sometimes when you do those interviews, not everybody has the same vision as to what the goals and objectives are or what the future business requirements will be. You can start working through with them and getting the group to all be pulling in the same direction.
Tom:What we have found when we do the strategy and assessment work — yes, clients are looking for what I'll call the results, the finances, some risk analysis, and so on at the end. What we really find is that clients are trying to learn through the process what's going on in the industry, what the views are, what sourcing is or isn't, what the nature of the supplier marketplace out there is.
So it's very much a journey the clients use to learn about the market — and then to lead to making a management decision. We find that at least 30% of the time, when we do strategy and assessment work, it doesn't necessarily lead to moving on to some big sourcing transaction. People are looking for detail, education, knowledge and understanding of their environment, the sourcing marketplace, the risks to making a management decision. And frequently the management decision is not to change for a variety of reasons.
How does TPI evaluate the effectiveness and quality of IT services being delivered in-house?
Tom:We do it in a variety of ways. First, with interviews with the businesses that are receiving services from the IT. That's always a great source of starting the process. Second, when we dig into IT, we're looking at how they operate in terms of what services they provide, what the service levels associated with that are. Are they reported? What's the cost of the services being provided? How does that compare to the marketplace at large? As you're doing the detailed volume service level financial analysis of particular areas, you get to understand pretty in depth how clients are operating, and you can make some judgments on the areas where they're weak, areas where they're not, and then you obviously discuss those with the clients.
As part of this initial assessment process on your part, do you do site visits to look at the physical equipment?
Tom:No, we deal with lists. In this business there is no value in wandering through the data center counting boxes. We organize the process. We have the templates. We describe explicitly what information we need. So we command it from that direction.
Chaz:On the BPO side, depending on how high level or low level the assessment is, we may look at some of the operations and how they are performing today. But if it were a distributed operation with three or five or 10 sites where they do [that function], we wouldn't do site visits on all 10 of them.
Do most of your clients operate on a chargeback basis for IT?
Tom:Honestly, what we see is a large variation of the level and quality of chargeback or expense allocation among clients. And the more that there's some sort of opaque allocation mechanism in place, the less satisfied the consuming businesses are with the services being provided.
When we're done, we've had clients tell us that it's so detailed that one of the values that we bring is, they actually have a much better understanding of their own cost structures and how those cost structures compare to the marketplace. Frequently, they don't know. They might have a sense, but they don't know.
About how much of your time is spent out gathering information and how much is spent analyzing what you've heard or seen?
Tom:It tends to overlap in reality. But a sizeable portion, probably 50% to 60% of the time, is actually gathering and consolidating the information — and even the analysis portion of it is what I'll call pure internal. With most of the clients you don't just do your analysis and provide a report. Part of doing the analysis is going through the assumptions made, then the client reacts to it and validates it; so it's an iterative process even on the analysis side.
How do you mitigate against unexpected expenses that haven't been tallied?
Tom:One of the challenges that we always have is working with clients to identify all expenses, including rogue IT organizations usually within the businesses. So we make a major effort to try to identify those areas, get the client to actually work with those businesses to aid in identifying those so that you have a cost comparison.
If we end up doing an analysis, it becomes pretty clear, pretty quickly that you may not have all the expenses associated with a particular area. We did one last year for a big client. We identified to the client where it obvious that we did not have all the expenses associated with that particular area [of desktop computing]. The employer knew that there was a lot of expense and people-related expenses in the businesses. And if you wanted to move forward with any sort of transaction, you had to draw the businesses in and draw those people in; otherwise, it wasn't worthwhile.
If there's hidden expenses out there, we'll just tell clients, don't move forward. Frequently, costs aren't the only driver for outsourcing. [But] they are usually one of them.
We tell people, that if you can't get through at least above six, seven, eight percent savings, don't bother doing it because the impact to the organization is so big, the size of the project, that it's not worthwhile.
Chaz:When we say six, seven percent, that's more an [IT outsourcing] type of rate. On BPO, it's going to be higher than that. Although of course, the overall dollars are usually smaller in BPO than they are in large ITO transactions.
At the end of the assessment, TPI comes up with an analysis. What does this include?
Tom:We actually provide a relatively thin report. It may only be actually 20, 30, 40 pages. But [we] use PowerPoint as the vehicle to actually communicate and review it. But then we provide a CD of all the data we've assembled. All the financial models, all the analysis, all the interview notes, any of the more detailed work that was performed.
Then what happens? You go away or…?
Tom:It depends. Usually we are there through the management discussions, debates and so on, and then a big chunk of the time, we "go away" — the client decides for whatever reasons not to go forward with the transaction. Other times they may go through an internal debate and then decide to move forward with all or some of what has been assessed. Frequently it's some portion of what we looked at that may move forward with a transaction. Now a transaction is actually a continuation of more detail.
You know, you normally go through a very structured RFP process, and there are various management decision points about continuing to move forward in the process or stopping the process depending on whether the financials look good or don't look good. But usually there's some number of weeks, a month, or sometimes two months, where you've got internal management debates, discussions, analysis of, "What do we do?"
In that report you deliver, do you generally include a prioritized list?
Tom:Usually it's not that it's prioritized, but we certainly go through and produce and identify the areas that have the biggest opportunity, if there are opportunities there. We may prioritize internal initiatives that can have their effect on the decision. And frequently the debate revolves around, "Where do I want the execution risks for these initiatives? Do I want to keep the execution risks internally or do I want to put the execution risks on the supplier?" which is how you normally structure an agreement. For example, if you've got to vacate a data center, you want to relocate that. Do you want to do it yourself or do you want to put the risk of doing that on a supplier?
What kind of time horizon do most of your clients think in?
Chaz:When they are looking at these agreements, you're generally looking five to seven years at this point in time.
Tom:Once in a while, suppliers will still talk clients into extending out to 10 years. If it's a defined area — limited — you might even get down to three but not for anything of significance. The norm is five to seven years, at this stage.
How do you work around the fact that not all service providers are created equal and that a lot of the results depend on the quality of people working for that service provider?
Tom:The process we work through with clients very much allows the client to judge the service provider in a wide range of areas — way beyond cost – cost is just one element. We come up with a scorecard of all the elements to think about when judging the supplier and then actually put weights associated with those, depending on the objectives the client is trying to achieve. And we use that as a basis to work with a client to judge suppliers.
And that includes internal suppliers, right?
Tom:Yes it does. So it's the quality of the corporation, it's the quality of the team being proposed to actually run the service and deliver the services. Its reputation by other clients of that particular service provider, the financial responses, the actual solution they are proposing for whatever the problem is, and on and on and on. It's a relatively robust list. That list lets our client in a structured way work through how to judge [whom] to do business with.
You also assess business impact risk. Can you share with readers some of the risks that companies don't normally think about in a sourcing scenario, particularly financial services firms?
Tom:Well, the major one is securityÉ It's logical security, physical security, it's the data privacy issues that are there, it's business continuity risk, disaster recovery risks that we look at. Folded in there is the viability-of-company risk. Frequently, we spend a lot of time on termination risks. What happens if? What is the range of termination capabilities, costs and support within the contract? Usually what we do in the case of a particular transaction is have a whole workshop around risks. We'll lay out the risks and talk people through, "How big are these risks?" "What are the risks?" "How can you mitigate the risks?"
What's driving financial services firms to consider sourcing? What are the pain points they hope to address?
Chaz:If you look at the competitive changes that are going on in the marketplace, the new global insurance, the conversion, and the M&A activity that is happening, you're seeing continual consolidation. You're also seeing what we are calling a delamination or a new differentiation within the marketplace, where certain firms are continuing to be monolithic service providers — where they provide all products to all companies — [organizations] like Citibank and JPMorgan Chase. But other firms are deciding that they're only going to play in a subsection of the marketplace, and they're going to do that very well. They've really become back office processing engines within the financial services industry.
You've got the regulatory burdens that many of these firms face. They put together three- and five-year plans where they are going to make investments in systems and operations and do different things, and then regulators come in and say, "Well, you need to makeÉ spend x amount of moneyÉ you need to accomplish x and you need to accomplish y." All of the sudden that impacts their budget because they have to hit those regulatory totals before they can start working on their three- and five-year plan. [When] you move towards an outsourced arrangement, all of the sudden, rather than sitting on you, that regulatory risk goes to the service provider who's doing that for multiple clients.
You've got significant continued operating spending pressure. As we've seen, those firms that manage their overhead ratio more successfully are rewarded in the marketplace with shareholder value creation.
And, I think the final bit is, you're seeing a lot of firms [try outsourcing], because of the volatility of the marketplace, changing interest rates, changing volumes. For example, in the mortgage origination industry, they're trying to move more toward a cost variability model, where their costs are going to go up and down as their revenues do, depending upon the cycle of the marketplace.
Do most financial services firms buy insurance to mitigate the risk [of outsourcing]? Or is that too expensive?
Tom:No, actuallyÉ that's a better question than you think. It so happens that I am speaking at a seminar next week where insurance companies are just now starting to think about offering explicit insurance to corporations covering outsourcing, particularly offshore outsourcing.
Most corporations consider their current coverage to cover these areas. They've never delved into the murky world of corporate insurance. There's constant… what I'll call tension between corporations on the buy side of insurance and on the sell side to what's actually included in their contracts. So most of what I've seen is the insurance people saying, "No matter what we do, make sure things are covered in the contract, the actual agreement — but that existing policies remain enforced." They tend to resist insurance industry efforts to add on explicit additional policies covering areas. It will be interesting to see how this latest development will work out.
I'll bet that's one of the pain points that people don't even want to think about.
Tom:Yes. But most insurance executives that I've dealt with say, "It's covered under our existing policy," and they'll argue with the insurance providers that it is.
What are the biggest factors in a financial services firm's budget for managing IT services?
Tom:Hands down, it's people… And there's fundamentally two ways you can economize the scale here. That is what you're seeing happening in the banking industry in the U.S., which is this consolidation into a relatively small number of big national banks and a second tier of large retail players. Then you have the small community banks.
In this industry, the community banks get their economies of scale by in effect outsourcing to service providers all the work that they need to have done. So the economy of scale comes from the service provider side; the more people they support, [the more] they can drive down the unit cost.
The regional players in the banking industry are the ones that are caught in the middle — not being able to get the economies of scale of the large [banks] and that are debating what to do. Normally, they have their own in-house operations, so how do they get the economies of scale throughout their operations there? It's focused on people.
You can consolidate data centers, you can automate data centers, you can use tools to operate in the technology environment with your people — and that's what the people are changing there. Operating functions are the same way. Frequently, item processing is an example of that — that in order to operate, you have to have so many centers geographically to converse with people that operate in those centers. So those are the drivers in that environment.
What kinds of things in financial services organizations are driving the decision to remain nearshore or go offshore?
Chaz:Some of it can be time zones. Some of it can be the need to have, some of the work within one or two time zones because the timing of completion can be very important. Some of it — by moving further offshore — you get to start working on a 24-hour cycle, which is better. Looking at the operation and the time sensitivity of the operation and the data processing itself can be very important.
Also from a risk and management standpoint, many people feel that because something might be closer, they're going to be able to manage that with greater oversight. So they might look at things that are higher risk or more strategic in nature from a nearshore perspective — although we are seeing fairly high end processes offshored to places like India, Malaysia and China at this point in time.
What kinds of carrots and sticks are you advising clients to build into their agreements?
Tom:We have a huge number of levers that are put into these agreements. If, for example, the service level methodology is very robust, what happens if the supplier doesn't meet the service levels? Are there financial penalties? How do you account for those over time? How does a supplier earn back credits against those? If they missed service levels and they fixed the problem, do they have an ability to earn back that financial penalty? And so these agreements are really built in.
The other big leverage points are various termination clauses, the right to terminate for cause. Frequently, we try to negotiate a right to terminate independent of cause.
There are right-to-use-third-parties for portions of the work. You have rights for partial termination of agreements, open ended, so if you've got multiple things that are being performed within an agreement, a right to pull out one piece of that and give it to somebody else. So some sort of varieties within an agreement that provide leverage to ensure continuity of services and support being provided.
People talk about shared rewards and bonuses and so on. We frequently see our clients enamored by it…in certain areas with certain suppliers. The difficulty is actually figuring outÉ how do you measure that? So if you are actually agreeing with a supplier, that if you do certain things, we'll give you some sort of bonus, it tends to be difficult to figure out within a modern corporation. What do you actually measure within that, that is going to sustain as a measuring point, an algorithm over the term of the contract that would make it fair?
So most of the ideas fog down at that level of the mechanics of figuring out, what actually do we measure?
I think it comes into a concept of how you share savings. Most people have clauses in [their contracts] about sharing savings, but it's very difficult to get too mechanical, because in a corporation, usually the accounting — particularly the management reporting — is so complex. What are you actually going to measure savings against? A corporation isn't static, even for a year, let alone multiple years.
Any advice for mid-sized companies regarding IT and other business process operations? What should they be looking at, or doing, or considering?
Chaz:I think that a mistake a lot of these firms make is not taking an enterprise view. And that's looking across the enterprise and what are their goals and objectives, where do they want to go, what is their business strategy? And then looking at operations and IT from an assessment standpoint at the same time. Without doing that, it is very difficult to prioritize based on the size of the opportunities that are out there. There's this sequencing, interplays between IT and operations that happen all the time — and you need to think about how you sequence activities so that you don't do one thing first that really should have been the third activity. It's going to impact so [many] of the other things that you do.
So if you take this enterprise view, align it with your goals, objectives and business requirements, then you can start to look at all the opportunities that exist and start to think about sequencing those recommendations and then put a plan in place to attack them on an item by item standpoint.
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