Six Outsourcing Truths…

Reprinted with permission from GonzoBanker

"A satisfied customer — we should have him stuffed!" -Basil Fawlty, Fawlty Towers

Most anybody in the industry knows that financial institutions outsource more than they did five years ago, and they will have outsourced more in another five.

There are very valid reasons for this trend. The biggest we see is that banks and credit unions are finding it increasingly difficult to attract and retain key areas of talent: disaster recovery management, data center penetration/breach, data communications, to name just a few. A vendor’s ability to hire talent for tens or hundreds of clients that you have trouble hiring yourself can be a huge advantage to you.

Another reason is that many necessary and important, but not particularly strategic areas – infrastructure design, payroll processing, etc. – really do lend themselves to being outsourced if the terms are right.

Let’s stipulate that you will outsource more and manage more vendors. That said, it is critically important that you approach this with management/board expectations set right in terms of how the relationship will work. What follows are some truths about outsourcing that need to be factored into your relationship and vendor management strategy.

1. It isn’t a “partnership.” Sorry, it’s not. I’m in a partnership. In fact, I have two great partners, and here’s the thing: We share the upside when we do well. And, we share the downside if we don’t. There are days our relationship runs strictly on trust, not master agreements and terms/conditions. You and your vendors don’t have the same agreement. You pay minimums no matter what happens to your business. You take the downside if volumes drop. Real differences are settled by contract language. If everybody wants to talk about the “spirit” of partnership, fine. But the basis of the relationship is that they are selling a service and you are buying it, and you need to treat the arrangement that way.

2.  It almost certainly won’t be cheaper than insourcing. We have run financial models on hundreds, if not thousands, of financial proposals for both in-house and service bureau delivery of the same system from the same vendor, and here’s the thing: When you factor in all costs, volume growth for the term of the agreement and project-related charges, outsourcing can sometimes be the same cost, but will likely be higher.

Even if base pricing looks equal, growth is always more expensive in pay-by-the-drink arrangements (where you pay for every additional account/transaction day) than it is in a licensing deal (where you don’t). The second reason is that you’re not getting all that expertise and risk mitigation you no longer have to hire for free. Why would you? We often hear the argument that “you will save a lot of staff costs if you outsource to us.” Sure you will, but that cost is more than recovered in monthly fees you wouldn’t pay if you were in house.

Don’t get me wrong here. I’m not saying you should be in house because it’s cheaper. The reasons to outsource are still valid. They just aren’t less expensive.

3. You don’t benefit from vendor economy of scale, at least during the term of your deal. Have you ever seen an outsourcing agreement that says, “If, during your contract term, we find out that economy of scale has reduced our per-unit processing costs, we’ll pass some of that on to you by way of a lower base price?” Neither have we. You can get lower pricing, but only at contract renewal and when you negotiate well. If vendors can get per-unit cost down, they keep it. Don’t confuse tiered pricing with economy of scale. Tiered pricing is what you get for giving a vendor more incremental volume, and you should pay less for it in the first place.

4.  You get the releases that the entire user base gets. Period. One of the big pushbacks we hear from our in-house clients is, “We’ll lose control if we outsource.” To a large extent, we don’t see that to be the case. Outsourced clients can keep 100 percent control over and can customize data management, acquisitions/conversions, workflow tools, and many other things that are very important. What you don’t control and can’t customize is the two annual system releases. You may get some kind of vote on what goes into a release, but it is increasingly rare that there will be anything in a release solely because one client wants it. Beyond that, vendors just don’t want to customize code that much. Unless you are willing to pay a whole bunch of money—which you won’t be when you see the quote, which is so high because they really don’t want to do it. Remember that thing about outsourcing being more expensive?

5. Service-level agreements with teeth are rare. If there are any service-level agreements in a standard vendor contract, they usually address three things: system availability, response time and production report availability. Those are good to have, of course, but they don’t address the reasons you want to outsource. Our in-house clients don’t have issues with up-time and response time. They get the same great (and cheap) hardware and mature (but not always cheap) software that outsourcers use.

As outsourcing grows, this is going to become a more important conversation. Financial institutions don’t need better SLAs for up-time. They need better SLAs for things like:

• How quickly will processing errors get corrected?
• How fast will bona fide system code issues get addressed?
• How fast will one-off requests get priced and scheduled?
• How quickly will a new third-party interface be available, and will the price be reasonable? Will those interfaces be maintained for the entire term of our contract?
• At what point do financial penalties go into effect if these are not met?

Vendors have some valid points here. SLAs need to be very clearly defined, they need to be clearly measurable, and they need reasonable time targets to hit. These are all totally fair points that have to be factored into an agreement. Here’s mine: There aren’t enough performance SLAs in most contracts right now. If outsourcing continues at its current pace, more of them need to start being incorporated into contracts.

6.  Outsourcing is permanent. You won’t insource back. You know it and vendors know it. In-house shops stay in-house. In-house shops change delivery to outsourced. Outsourced stay outsourced. I can’t remember the last time I saw an outsourced client change systems to in-house delivery. It just doesn’t happen. The investment in people and infrastructure, often from scratch, is just too big an effort.

Bottom line? Vendors push outsourced solutions hard because outsourced is a better model for them. You’re going to buy the argument and outsource more. But, let’s be realistic about what outsourcing brings to the table and what it doesn’t. Managing to these expectations is increasingly important, especially if you start to outsource more strategic functions (like off-hours customer support, to name one).

Eyes wide open.

Terence Roche is a principal in Cornerstone Advisors, a CUES Supplier member and strategic provider based in Scottsdale, Ariz.