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Business Process Outsourcing: Transform the way you do business |
Shifting Sources of Value in Financial Services Outsourcing By John Shuck, Industry Principal, Financial Services
But where will players in the banking and insurance industry find the principal sources of value going forward? A quantitative review of how outsourcing has changed in the last several years suggests some answers. We examined 446 transactions of banks and insurers worldwide in the period 1999-2004. Last year the total contract value (TCV) of recorded deals in the financial services industry grew to over $19 billion. Banking recorded 64 percent with deals totaling $12.2. billion. Insurance made up the remaining 36 percent at $7 billion. Most of the outsourcing to date has been done by larger institutions. Everest research found banks and insurers with at least 25,000 employees and more than $5 billion in annual revenue accounted for 67 percent of the outsourcing transactions. But it's the smaller transactions--those under $250 million in TCV--that are growing. In 2003 and 2004 there were 17 and 19 transactions, respectively, over $250 million. In the under $250 million category, there were 103 in 2003 and 128 in 2004. Smaller transactions are growing for two reasons. First, although IT transactions still comprise about three quarters of the value of all outsourcing done, BPO is increasing its share of the total. Since BPO transactions, on average, have a little more than half of the average TCV of IT-related transactions ($91 million versus $171 million), this serves to increase the share of small transactions. Second, from our client work we believe that buyers of outsourced services are actively trying to limit risk and create flexibility. The data show that in IT-related transactions, the average annual contract value has declined slightly while the average contract term has declined substantially over the last several years from over 6.5 years to less than 5.5 years. In BPO deals, although the average contract term has not declined materially in the last several years, the average annual contract value has declined markedly, from $23 million in 2002 to $13 million in 2004. So, more buyers are finding value in smaller deals. Banking Value in IT and Shared Services OutsourcingIf we look at the outsourcing landscape for the banking industry, it appears that banks are ahead of their cousins in the insurance industry in the speed with which they have adopted outsourcing. Three quarters of the IT-related TCV from 1999 to 2004 was in the banking industry, while banks represented only 57 percent of the BPO TCV over the same period. Since most of the volume (and value) created by outsourcing to date has been in the IT area, this suggests that banks have been more aggressive in trying to realize these savings. We believe that this is so for several reasons: first, managing operating cost is a relatively larger profit lever for banks than it is for insurers. Second, the banking industry is in a long phase of consolidation which puts tremendous performance pressures on all participants. About one-quarter of the TCV outsourced by banks is in BPO. Of this amount, about 70 percent is in outsourcing of core industry processes, like check processing, mortgage processing, and credit card processing. This form of outsourcing has been around for some time in the banking industry, and a relatively mature supplier industry has grown up around it. Based on the data, banks have not done much so far in outsourcing corporate center functions such as human resources (HR), finance and accounting, and procurement. In particular, our experience shows that procurement outsourcing can drive very substantial benefits for all but the most sophisticated institutions. We think that these will be very active areas for banks going forward. Additionally, for those banks that have not outsourced application development and maintenance, there will be substantial opportunities to improve cost and quality by working with outsourcers. Insurance Value Along All DimensionsAs we have seen earlier, most of the value to date from outsourcing has been drawn from IT-related transactions. However, insurers have done only one quarter of the financial services transactions in IT. In addition to the data, Everest's client experience suggests that many insurers still have substantial opportunity here in IT. Moreover, despite the fact that insurers seem relatively more active in BPO than banks (insurers had 43 percent of BPO transactions compared to only 24 percent of ITO transactions); we know from talking with suppliers that the insurance core process outsourcing market is still emerging. Key suppliers are just starting to bring important offerings to market here. Although the core process area already accounts for three quarters of insurance BPO, going forward insurers will have much greater opportunity and choice in outsourcing core process functions, such as policy administration and claims. And, like banks, insurers will also be able to create substantial value and service improvements in outsourcing HR, finance and accounting, and procurement. As with banks, we believe that insurers will find surprisingly substantial value in the procurement area. Not a North American PhenomenonThis is not a North American phenomenon. European banks and insurance companies have outsourced aggressively. Everest analysis found that North America only accounted for 36 percent of the $90.5 billion in TCV for the five-year period. Europe, the Middle East and Africa (EMEA) accounted for 35 percent. Asia/Pacific did 13 percent of the volume with multi-regional transactions equaling 16 percent. Why Now?According to the Federal Deposit Insurance Corporation (FDIC), the federal entity that regulates banks, non-interest expense as a percent of net operating revenue is rising. In December 2004, non-interest expense reached 59 percent of net operating revenue, approaching the industry's recent high point of 61 percent in December 1999. IT consolidation and inefficient processes contributed to this rise in non-interest expense. So did merger-related costs. We believe regional banks will continue to merge. This puts pressure on banks to demonstrate merger synergies. At the same time, we predict operating expenses at banks may grow by six percent this year. We believe North American banks can reduce this non-interest expense by an additional 3.5 to 6 percent by outsourcing additional IT functions as well as their call centers and procurement activities. The insurance industry is in the same boat. The property/casualty industry is consolidating. Premium prices are softening. Low interest rates are cutting into investment yields. Loss adjustment expenses are increasing and long-tail loss reserves look increasingly questionable. Life insurers face the same challenges. In addition to the challenge of low interest rates, term life has become commoditized while group life suffers from slow job growth. Distribution costs remain high. And now there's more competition as banks enter the field. Everyone in the financial services industry has to spend additional dollars on compliance costs thanks to the Sarbanes-Oxley Act and new accounting standards. As cost pressures mount, financial services companies continue to look for innovative partners to help them reduce both cost and risk. We believe banks and insurance companies are moving away from traditional sourcing relationships and instead entering into partnerships that create value. That's why they are turning to outsourcers. How the study was done: The Everest Group examined 446 banking and insurance transactions between 1999-2004. The data came from Computer Wire, which collates information on public announcements only. All the deals had a TCV of at least $20 million. Publish Date: May 2005
Copyright © 2005 - Everest Partners, L.P.
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Cost pressures, strong market scrutiny, and the need to improve stock market performance will continue to drive banks and insurers to outsource.
