Making the right strategic cost choices:

sourcing, resourcing or outsourcing operations

A relentless pressure to reduce costs will drive many global investment management companies to increase the outsourcing of their operations. While cost reduction remains a central goal, new trends and opportunities are emerging that extend the concept of outsourcing. Cost reduction, recognised as a bottom-line issue, can with new
options appearing also contribute to top-line revenue. However, resources required to handle the data management issues that come with outsourcing must also be considered carefully. This article examines the trends and the pros and cons of
outsourcing opportunities under a new business paradigm.

by Rodney Nelsestuen, Senior Research Director at TowerGroup, USA

As the investment management industry battles back from recession in the midst of continuing uncertainty, a new wave of issues is augmenting the time-honoured challenges of competing effectively and efficiently in the marketplace. Increasing regulatory costs are emerging at the same time that clients are demanding more from their investment companies. Trust is no longer taken for granted and companies are obliged to spend more high-quality (and costly) time with clients to maintain relationships.

In addition, investment management companies are revisiting their products and services in an effort to rationalise their business while scaling it appropriately to capital and risk constraints. While it is clear that costs must be reduced, these factors also require higher performance of the business as a whole, an area that outsourcing can contribute to, but not without changing traditional thinking and approaches, as well as balancing advantages and disadvantages.

OUTSOURCING REQUIRES HOLISTIC VIEW

Through 2015, the outsourcing of both operational services and technology will increase at a rate more than twice that of overall spending on information techno­logy. Reasons to outsource have grown in number. While cost reduction remains a fundamental goal, many companies are seeking service providers who can also deliver the latest technologies, state-of-the-art business processes, and who are committed to continuous upgrades of both.

Today, another reason for outsourcing is to tap into innovation. Innovations in both pricing and the delivery of bundled IT and service options will significantly alter the nature of outsourcing. These include risk-taking where the service provider contractually agrees to reducing errors, financial losses, or to make and sustain other operational improvements as part of the compensation model.

Over the next five years, business process outsourcing (BPO) and information technology outsourcing (ITO) will increasingly be bundled together. In addition, the resurgence of managed services and the entry of cloud services will increase the offloading of operational costs, but in different ways. Service providers will continuously improve the technology supporting outsourced processes. This will allow companies to see technology as a strategic differentiator but under either a variable cost, on-demand cloud model, or in the case of more utility-based services, a low-bid fixed-price model.

Worth noting here is that ‘low cost’ will be transformed around these improvements. These improvements are not free, and to the untrained eye may seem more expensive than managing the technology in house. However, outsourcing avoids the costs of ownership, which involves a significant amount of administration and overhead that extends beyond service usage.

Outsourcing today requires a complete understanding of the goals and objectives the company is pursuing. Without a holistic view of what is to be accomplished, outsourcing becomes only a low-cost bidder game. Figure 1 provides one method of evaluating outsourcing objectives.

The quantification of the value proposition in outsourcing is but one element of the business case. Understanding and placing a value on several key objectives will reveal a more holistic and thorough understanding of the ‘what’ and ‘why’ of a firm’s decision to outsource operations.

Figure 1. Visual scorecard for outsourcing decisions. Source: TowerGroup, 2011. 

MANAGING GROWING COMPLEXITY

The combination of large-block services with on-demand services will create new risks. Specifically, more connections from more providers make the integration of disparate services difficult, and lack of integration increases operational risk.

To manage that complexity, yesterday’s dashboard is insufficient to support tomorrow’s business operations. With the addition of discrete cloud services under a hybrid model, companies will need an integrated view of many more components of their operations. As the public cloud becomes mainstream, the challenge of integrating all services will grow exponentially. Certainly, outsourcing providers will continue to offer large-block services for the foreseeable future. But as they begin to parse these larger services into smaller, on-demand cloud-based options, companies will find themselves connecting to more – not fewer – service providers.

To manage growing outsourcing complexity, companies are seeking to partner with fewer large-contract providers while still being open to accessing discrete on-demand services from the best source. Companies should seek out providers that are capable of deploying flexible, real-time business intelligence to manage the growing complexity with a holistic view of front-to-back operations.

Innovation includes the ability to conduct applied research, offer centre-of-excellence (COE) leadership, leverage new infrastructure to improve delivery, and redesign services and processes that have an impact on client experience. These are all increasingly competitive factors among service providers and are also key value points sought by investment management companies.

With more aspects of financial services moving to real time, anytime, anywhere service standards, business transformation has become the battleground for operational excellence. Since changing the business internally is costly, time consuming, and a high-risk endeavour, the option to outsource more functions seems a logical choice, as outsourcing forces change and adaptation by the enterprise. As more services are outsourced, the integration of the service provider with the enterprise acquires a new significance. While integration has its positive side, it also has its drawbacks in the form of increased interdependencies.

As companies demand better service, they are also seeking providers with greater business acumen and domain knowledge. Investment managers rely on providers to have first-hand, industry-leading knowledge of sophisticated outsourced processes. They expect providers to have the resources to back up this knowledge, and they will look for the outsourcer to demonstrate the ability to collaborate with both other providers and the company itself in creating a seamless service delivery model.

CONVERGENCE OF OUTSOURCING SEGMENTS

Traditionally there have been four well-known segments to outsourcing: application development and maintenance (ADM); infrastructure outsourcing (ITO) including collocation services; business process outsourcing (BPO); and managed services (including application service providers, or ASPs).

With the foreseen rise of outsourcing as a proportion of IT spending, the distribution of the types of outsourcing will change as technology and operations become more integrated and software is embedded with infrastructure, bundled with managed services, and provided through both on-demand cloud services and more offerings of platform-based business process outsourcing. On top of change in traditional models, the cloud is rapidly becoming a key source of discrete services, with the result that these approaches are undergoing significant change as illustrated in Figure 2.

The distinctions between the types of outsourcing spending will become less important as services converge. The lines of demarcation between the five modes of outsourcing as detailed in Figure 2 will be blurred if not erased by inclusion of software and hardware in BPO services, the extension of ITO beyond processing, the expansion of cloud computing to include more software as a service (SaaS) offerings, and the redistribution of some ADM spending to platform as a service (PaaS), and the growth of managed services (which can include IT, ADM, and BPO).

Figure 2. The changing, expanding outsourcing ecosystem. Source: TowerGroup, 2011. 

KNOWLEDGE PROCESS OUTSOURCING INTEGRAL

As the outsourcing industry grows, intellectual capital or knowledge process outsourcing will become an integral part of most all services. As the financial crisis deteriorated, many investment management companies reduced their manning levels. As of 2011, more cuts are in store. This creates a shortage of people who can apply strategic thinking to operations given the ‘lights-on’ spending limits most companies have maintained.

The improvement in outsourcers’ skill levels creates an opportunity for investment management companies to examine afresh the entirety of their operational needs throughout the enterprise. They can then determine which needs to fill in house and which to fill with outsourced services based on a strategic view of business operations, and in light of the enhanced skills that many pro­viders have accumulated. All this, coupled with better collaborative capabilities, will create better operational synergies and knowledge management.

GOVERNANCE MODELS NEED UPDATING

As more functions are outsourced and as the business value of those functions increases, the traditional governance models for outsourcing are no longer adequate to meet business needs. To manage under this new paradigm, collaboration has entered the governance lexicon as illustrated in Figure 3.

Collaboration helps overcome complexity. As delivery options increase to include on-demand services, the importance of governance will also increase. Rather than managing the process, investment companies will need to manage the expectations. Governing for outcomes allows the provider to contribute expertise more directly and in the manner that the provider finds most efficacious.

Figure 3. Governance of outsourcing in the 21st century: collaborate with the supplier of fail. Source: TowerGroup, 2011. 

COST-CUTTING AS MAJOR OPERATIONAL GOAL

Cost reduction has emerged as a major operational objective throughout the global investment management industry. Driving more companies not only to outsource standard and generic functions but also consider accessing more discrete and specialised services, this will make outsourcing more varied in its options, and more complex. Investment management companies must rethink traditional approaches to evaluating, selecting, and managing their service provider relationships.

However, multiple systems create multiple sources of data. This complicates the ability for a company to both obtain the right data and then to harvest the insight which data can provide through analytics. Moreover, with increasing regulatory demands for more data and at a more granular level, the intermediate collection of data is often slow, complex, and fraught with error – an issue that regulators have little tolerance for in today’s regulatory climate. Thus, as complexity increases, firms must rethink traditional approaches to evaluating, selecting, and managing service providers, seeking those with superior technology and industry expertise, and an abiding knowledge of your business.

Rodney Nelsestuen is a Senior Research
Director with TowerGroup, a Corporate Executive Board Company, in the
Financial Services practices. He conducts research on business and IT strategies, emerging trends, growth strategies, and issues germane to all verticals across the financial services industry. With more than two decades in financial services, he spent over eight years as CEO of a commercial lending institution and six years as an enterprise-level CIO. In addition, he has served in diverse finance, marketing, credit, operations, and technology roles at both the operational and executive levels. He holds an MBA, a Graduate Certificate in Information Systems Management, has completed the Graduate School of Banking, and an MFA in writing. He joined Tower­Group in 2006.