To be or not to be … is there a question?

by Santiago Patiño

 

It seems that recently, there are more financial institutions revisiting the issue of in-house vs. outsourced data processing. In light of the impositions of regulatory requirements associated with privacy, disaster recovery and data security, organizations running core systems in-house are wondering if it’s really worth the trouble.

In November 2005, Revered Gonzo Techie Guru Carl Faulkner predicted that outsource service providers were driving banks to in-house core processing solutions with pricing that made absolutely no sense (see “Can You ‘Splain This To Me?”). In June 2003, RGTG Faulkner questioned the vendor logic that prices go up when account volumes increase, where textbook economics suggests the opposite: in a largely fixed cost scenario, increased volumes should decrease unit costs, which are obviously not being passed along to the banks and credit unions (see “Core Outsourcers Are Thrashing Their Best Customers”).

Gonzo’s mother ship, Cornerstone Advisors, amassed a significant statistical database for its 2007 benchmarking study (The Cornerstone Report: Benchmarks and Best Practices for Mid-Size Banks).The following is an excerpt from the 2007 Cornerstone Report:

 

Assets supported by IT FTE:	Median	High Performer
In-House	$96,107,270	$127,703,100
Outsourced	$143,547,500	$231,793,200
Bank FTE supported by IT FTE:	Median	High Performer
In-House	27	32
Outsourced	30	53

 

The chart suggests that outsourced organizations report a higher ability to support assets and FTE than in-house organizations, which makes sense because they have fewer FTE in the IT department. But, at Cornerstone we note that core spending is relatively neutral between the two delivery channels. Bank technology spending, on average, is nearly identical between in-house and service bureau shops. The noted difference when comparing these costs is that banks that fail to manage vendor relations, technology projects, staffing and infrastructure spending report higher technology costs. That’s it. From a cost perspective, the method of delivery simply does not matter.

 So if cost doesn’t drive the in-house vs. outsource question, what does?

 The difficulty lies in that we may no longer weigh a decision against commonly held beliefs that aren’t as black and white as they once were. For example: 

It’s cheaper to outsource. In an in-house environment, there are many fixed costs, while an outsourced arrangement allows for variable costs that increase in proportion to the institution’s account growth. This is good news and bad news. Once the fixed costs are depreciated, it can be cheaper to be in-house. Outsourced arrangements can become very expensive when an organization experiences rapid growth unless tiered pricing is negotiated into the contract.

1. In-house allows for best of breed applications. Maybe, yet to be fair, most outsourced vendors will claim that their suite of products supports a best of breed environment. Middleware has improved the ability to interact between in-house and outsourced application systems.
2. In-house allows for more control and flexibility. How many vendors provide source code today and allow you to make modifications? The majority of institutions already outsource programming because the software cannot be modified.
3. In-house allows for more control over processing deadlines. Sometimes, yet with properly drafted service level agreements, outsourced vendors can be managed to production schedules just as well, if not better, since there may be monetary punishments for not meeting agreed upon standards.
4. Outsourcing is for small institutions. With hardware costs becoming more commoditized, many small organizations (even start up banks) are doing a fine job running core in-house. At the same time, larger organizations are outsourcing not only their core delivery, but also activities that are required to run the business, e.g. ATM and credit card processing, Internet banking, bill pay services, payroll, lockbox, etc.
5. In-house staffing can be problematic. This is still true. Depending on the talent pool available in your geographic area, it can be difficult to hire qualified employees, train them on your ways, pay them, and give them a place to work with all the required technology. It’s much simpler to let someone else worry about this so you can focus on your core business. By outsourcing, you also don’t have to concern yourself with IT vacations, sick days, etc.

If the standard beliefs about outsourcing and in-house delivery no longer apply, the issue then becomes: what factors should drive the decision to process core systems in-house or let somebody else do it for you.

 Here are five factors that should be deeply explored in your effort to define or ratify your future solution: 

1. Costs – Is this the least expensive way to post the debits and credits?
2. Risks – Do you have the appetite for the responsibilities associated with compliance, security and reputational risks?
3. Talent – Is technical talent available and maintainable?
4. IT Governance – Is the culture of project and vendor management well developed or do projects just happen when they can?
5. Growth – Is your organization in a rapid growth mode?

 

Like the man said: “There ain’t no simple answer here.” But while the justification behind some commonly held beliefs has become, with time, open to debate, there are a few realities you will need to accept before finalizing an in-house vs. outsourced decision: 

• There is no perfect delivery method.
• Don’t believe the old wives’ tales – not all of them apply today.
• Don’t fixate on one aspect – a complex decision requires a complex analysis of all factors.
• Changing delivery methods will cure some problems but expose your bank to new ones.
• Without solid vendor management and IT governance practices, delivery method doesn’t matter – you won’t be happy with either.

May this sprinkling of truth guide you as you take on the unknowns.
-SP

 Special thanks to Quintin Sykes for his valuable input on this article.