Dating from 2000, the outsourcing deal was one of the first in the UK and had long been rumoured to be wracked with problems. Its final cancellation has done nothing to benefit the argument of outsourcing technology solutions. It also puts egg all over the corporate face of JP Morgan, especially since Joe Rondinelli, vice president head of UK and Offshore fund service business development, told FT Mandate last year: “There were lessons to be learned but now it’s going well with the infrastructure to support Schroders finished and we’re now transitioning the portfolios.”
Sceptics might argue that the failure of this contract shows that outsourcing does not work, especially since the day before Schroders’ announcement, Scottish Widows Investment Partnership (SWIP) said it would also be reviewing its five-year outsourcing contract with State Street.
It should also be made clear that outsourcing and lift-out contracts incorporate expertise in back and middle office procedure, as well as being a technology solution.
Others view the announcements as nothing more than a storm in a teacup and that outsourcing is here to stay. Cosmo Wisniewski, executive director at Citisoft, an investment management consulting firm says in connection with SWIP: “It’s a sensible precaution for any company who had outsourced to take the opportunity at the renegotiation point to say it is reviewing the contract. It’s a tactic and one we’d recommend.”
And that is part of the problem with adjudging whether technology means improving the bottom line - politics and other business considerations frequently affect its performance or reputation.
Both these industry announcements came within days of Oxford Metrica, a research company, revealing that outsourcing back and middle office activities added over 10 per cent to shareholder value of European asset managers.
The study, commissioned by Bank of New York, analysed the movements in the share prices of 21 European fund management companies. Of course, what the research actually shows is the value of perception, rather than a financial analysis highlighting any corporate improvement.
Investor expectations
Essentially, the share price increased because of investor expectations of improved manager performance and confidence that the management is progressive enough to recognise its core business and stick with it – generating performance. Share price movement was unaffected by the type of outsourcing model or deal size and also that direct cost reduction was not a main driver of value.
As far as Dr Rory Knight, chairman, Oxford Metrica, was concerned this research showed: “The considerations crucial for asset managers wanting to outsource are strategy and value; not a simple cost reduction, as much of the market may believe.”
But as with everything in the sector, there is always the contrary academic point of view. A new report from Deloitte Consulting argues that many groups are bringing operations back in-house and are exploring alternatives to outsourcing.
Higher costs than expected and complexity were the two primary reasons for the negative responses. Deloitte’s figures show that 25 per cent have brought functions back in-house either because they believed they could do it better or because they had not realised savings through outsourcing, while almost half identified hidden costs as the most common problem when managing outsourcing projects.
It must be said, however, that up until the Schroders’ announcement few complete back or middle-office outsourcing contracts have been cancelled and Deloitte’s figures point to elements of outsourcing being brought back in-house and some of the larger more general banking contracts, such as JP Morgan’s cancellation of a $5bn contract with IBM late last year.
“Not everyone has had a great experience with outsourcing, partly because it isn’t a mature industry,” accepts Thomas Aubrey, European director of investment management at Thomson Financial. But, he argues, the use of technology goes beyond simple returns.
“The question being asked more frequently is: ‘Am I a technology shop and can I get returns on that’ or ‘I am an investment company and what is my core competency?’ and to me the firms want to concentrate on improving its returns and fulfiling its regulatory requirements,” adds Mr Aubrey.
Outsourcing done properly was also to include the business process and where this has claimed to have been done successfully, some asset management houses have claimed profitability within a year. Most obviously beneficial is moving to per-transaction payments rather than fixed costs based on having to maintain ever-more-costly back and middle office systems.
Asset managers are faced with an ever-increasing list of regulatory requirements most easily met by enhancing technology, an endless list of alternative investment products, each often requiring a proprietary system and ever-rising labour costs. Once handed over, the well-thought out service level agreement with the outsourcer, should encompass this ever-increasing technology build.
Even this year, UK-based Kimsey Consulting, estimated that $21.7bn will be spent on trading-related and back-office technologies in Europe.
“We’ve outsourced everything to HSBC, we’re working with them in tackling emerging market practices, new products and reducing risk but it’s their business now and they want to advance it,” explained Chris Sims, head of development at Gartmore Investment Management.
But according to Mr Wisniewski, “I don't think there’s been any one of them that have correctly anticipated the costs of outsourcing.” But the first tier providers of outsourcing like State Street and JP Morgan have to continue to invest in new technologies to keep existing customers happy and attract new ones, he added.
At the beginning of the trend the most common question to the request to outsource was from the financial directors demanding a return on investment (ROI) calculation to see if it was viable. The problem then came in ascertaining what elements should be included.
“ROI still features in the business case especially in huge technology spend on a project but it’s not a prevalent as in the past,” said Daron Pearce, head of client management for asset managers at Bank of New York. “The argument that outsourcing is viable option is no longer debated, it’s clearly a choice and has taken pressure off the ROI argument,” he added.
Pearce: ROI not as prevalent
Being able to show full risk management systems to pension funds or being to quickly launch a new fund in another European market may be regarded as more ‘valuable’ than the cost of the service. Now outsourcing to a client means keeping the technical infrastructure up-to-date, flexible scalability of operations and interoperability.
Fully integrated
“Some managers might have a fully integrated system but it’s dated and difficult to produce new interfaces for new products. Some have fully up-to-date systems and others are between the two,” outlined Mr Pearce. At one end, the company has to choose whether to spend a huge amount on fully updating its systems, allowing it to compete efficiently and flexibly or outsourcing. At the other, the investment house might consider its system ripe for outsourcing and passing on valuable technology.
What has also affected decision-making is the growth of alternative investment products often demanding their own systems and promising to be a constant drain on an investment house’s resources. The growth in hedge funds has seen few of them do anything but outsource technology to third parties.
“Now I’d suspect that outsourcing might not get the cost returns you might expect because the earlier ones were subsidised by the outsourcers,” accepts Mr Pearce. He also believes those houses who enter outsourcing much later will see returns too because they will benefit from lower unit costs based on economies of scale the large outsourcing firms will then be able to offer.
So while some of the investment houses obviously have unhappy stories, the fact that technology and business process outsourcing has become so popular shows that there remain long-term cost advantages to outsourcing, but only if the underlying business itself is understood. Additional costs to investment houses seem to be found when outsourcing activities can introduce unexpected complexity, adding cost and requiring more senior management attention.
As for the companies performing lift-outs and selling outsourcing services are they seeing good returns? “Or are they loss leading?” asks Mr Wisniewski. “Clearly it has been for them, especially lift-outs. But over 10 years it won’t be and they now need to put proper investment into what should be a viable business,” he adds.
He also thinks they must all be under financial pressure, as the second tier of players like IBT, Royal Bank of Canada and Northern Trust have entered the picture with more focused views of outsourcing. Behind them have come the specialist technology companies like Accenture and IBM who are using another outsourcing model boosted savings on labour costs by offshoring.
“The question will arise of whether this is the business I ought to be in and some won't continue in it,” concludes Mr Wisniewski.
