Emerald Group Publishing Limited
Copyright © 2004, Emerald Group Publishing Limited
Offshoring: from pull to push
Chris GentleDirector at Deloitte (email@example.com).
Few would argue that offshoring – the relocation of business functions and processes to a lower-cost location on a long-term basis – is an emerging trend in the financial services industry. For many companies, the potential of offshoring to reduce operating costs significantly has made it an increasingly appealing strategic option.
But lately offshoring has begun to undergo an important metamorphosis, transitioning from "something to consider" to "something that must be done". And the financial services business are doing it. Why? Enormous industry pressures, such as depressed equity markets and increased competition in mature product markets, are demanding that firms find new ways to improve profit margins. These pressures, coupled with the attention-grabbing success of offshoring banking pioneers, strongly suggest that offshoring will soon become a prerequisite among all types of financial services firms.
But the case for offshoring does not stop there. In addition to the obvious benefit of cost savings, relocating to less expensive locations also offers organizational advantages: upgrade delivery quality; build organizational resilience; react to competitive pressures and provide business-continuity. All of these are top priorities for financial services firms in 2004.
These factors, taken together, have enabled offshoring to capture the attention of the financial markets. Consequently, firms that choose to proceed without developing coherent offshoring strategies do so at their peril. Soon, the lack of such a strategy could send a financial institution's share price spinning, as financial markets perceive that such organizations will be left at a significant competitive disadvantage.
We estimate that $356 billion of cost for the global financial services industry will be relocated offshore through either outsourced or captive models within the next five years. The average cost saving on current projects is 39 percent. As offshoring gains momentum, firms are moving a broader range of functions to lower-cost locations. Currently, the majority of offshore moves involve establishing small IT shops – in India, for example – for the development of software. Within two years, this figure will become inverted, with a new majority of offshore moves encompassing all types of business processes – IT (applications development, coding and programming), operations (finance & accounting, processing and administration and operations) and contact functions (for instance, trading support).
Those institutions currently offshore, including many of the leading investment banks, will lead the shift – they anticipate that the proportion of cost savings will rise as they scale their operations. We expect that in the next two years, the average number of functions is likely to increase from less than two to more than four. This move is likely to be accompanied by growth in the average size of offshore locations from less than 500 to closer to 1,000.
Aside from scaling quickly, the key issues for financial institutions still planning their offshoring strategies involve how to select the best locations and how to choose the most appropriate ownership models.
The offshoring challenge
We estimate that potentially in excess of 50 percent of the functions of financial services firms could be moved to lower cost locations, with cost savings of up to half the original cost base. There are two principal drivers creating momentum:
Taking global investment banking as an example, many of the leaders have spent 2003 establishing offshore capabilities. In doing so they are starting to transform their business model away from a pure operational focus on the key financial centers of Wall Street, City of London and Tokyo/Singapore/Hong Kong. In 2004 the challenge will be to scale these operations.
In spite of the market bounce in 2003 the pressure to improve operating efficacy, effectiveness and flexibility will continue apace. Together these trends place even greater pressure on firms with no offshore capability to compete in 2004.
Offshoring however is not a panacea for good operational management. Our research shows companies get a lot more benefit when they plan well and execute quickly. The negative results from poor planning are magnified when dealing with a different culture and a location thousands of miles away.
The transformational significance of moving offshore shouldn't be underestimated. If the shift of administration and operations to lower cost locations is to yield significant cost reductions a whole new set of management capabilities are required. Does the business have people to manage this transition or experience in the destination location? What technology investments are required? How will our regulator view the shift in location? To ensure a degree of success two watchwords need to be applied to the relocation of any activities: culture and complexity.
All offshore decisions must consider the impact on the morale of existing employees. Damaging the team ethos within the domestic business can dissipate the benefits gained from moving offshore. Moving positions offshore is a hugely emotive issue; building in PR issues is equally important.
Many financial services firms are already complex businesses, especially in the back office. Moving sizeable chunks of the business offshore raises the possibility of increasing complexity around business processes. It is critical that processes are re-engineered not only to enhance simplicity, but also to ensure transparency around the cost savings gained.
It is imperative that financial services firms consider the offshore option – it is a move that is likely to be transformational not only for a firm but also for the industry as a whole.