Crossing the chasm: minimizing the risk of off-shoring steps up to the next level

Citation

Gentle, C. (2006), "Crossing the chasm: minimizing the risk of off-shoring steps up to the next level", Journal of Risk Finance, Vol. 7 No. 2. https://doi.org/10.1108/jrf.2006.29407baf.001

Crossing the chasm: minimizing the risk of off-shoring steps up to the next level

Crossing the chasm: minimizing the risk of off-shoring steps up to the next level

The trend in off-shoring business functions to lower-cost locations appears to be building momentum into a second phase. With this shift comes a host of operational risk factors requiring enhanced governance systems and new operational capabilities.

After the US election, the topic has fallen from the front pages and leader columns. Behind the scenes, however, financial institutions are continuing to transfer people and processes to countries such as India, but also nearer to home such as Ireland or Costa Rica. Such a shift involves significant parts of the business. Poor execution could jeopardize the whole operation, but tarnish reputations too. The state of play in off-shoring in 2006 will be shaped by the following six points:

1. 1.

   Crossing the chasm. Relentless margin pressure and intense competition have made off-shoring a competitive necessity for most financial services companies. Yet the actual practices for operating off-shore are still maturing. We have identified a huge divide in how different firms approach and manage their off-shore operations – and the results they achieve. The ability to cross this chasm will shape not only the future of off-shoring within financial firms, but ultimately the entire financial services industry.

2. 2.

   Stratification of strategies. Low-cost IT outsourcing used to be the predominant off-shore activity. But today, companies are off-shoring a wide range of functions and applying a wide range of approaches. The general trend is toward multiple functions and full service, with a shift toward captive operations and captive/outsourced hybrids. An increasing number of companies are also taking advantage of highly qualified off-shore talent to improve service quality – not just reduce costs. Companies that apply these best practices generally enjoy a substantial advantage in cost savings and service quality.

3. 3.

   Double your money. According to our work, the industry as a whole could double the cost savings from its off-shore operations. Using the sample of the annual Deloitte Off-shoring Benchmark, the participants could reduce their annual cost base by up to $16 billion – trebling current savings of around $5 billion. The additional benefits would come from two key sources:

   • •

     scaling headcount from around 3.5 percent of total headcount offshore, with average cost savings of 38 percent, to the current best practice of around 7 percent of total headcount and 60 percent cost savings; and

   • •

     the efficiency gains created by expanding the scope of operations to “full service,” which means relocating all types of functions – from IT and back offices to middle and front-office activities – off-shore.

4. 4.

   Beware of “off-shore fatigue.” Many companies report a sharp decline in off-shore results after the third year. We believe this phenomenon stems from taking off-shore benefits for granted, and not replacing top managers with equivalent talent when their tour of duty ends. Companies must stay vigilant, periodically rotating key managers and staff to maintain a constant mix of experience, skills, and enthusiasm.

5. 5.

   Focus on the “Four Cs.” Managing an off-shore operation is a major undertaking. But as with most business activities, success ultimately boils down to doing a few things exceptionally well. There are four key elements to off-shore success:

   • •

     managing and minimizing complexity;

   • •

     ensuring compliance with regulations – particularly those related to privacy and security;

   • •

     creating a culture that helps on-shore and off-shore workers perform their best; and

   • •

     balancing near-term cost savings against the need for long-term strategic investment.

     Get those four things right and success will follow.

6. 6.

   Scale or fail. Off-shore operations that aggressively expand their scope and scale typically deliver much higher returns – and are able to sustain those benefits over time. On the other hand, financial institutions that make a half-hearted attempt at off-shoring tend to fare the worst. The ability to generate and sustain cost savings around off-shore operations will be of increasing future importance. Failure can leave off-shore operations marooned. The message is clear: do not dabble; stay home if you are not committed.

Operational efficiency is the key driver

A new industrial revolution is sweeping stealthily through the financial services industry. As markets mature and margins decline, competition is heating up – putting firms under constant pressure to cut costs. Desperate to retain investor confidence, many financial institutions are restructuring their operations to improve operational efficiency. Two key tactics are being deployed: reengineering on-shore business processes, and moving parts of the business to lower-cost locations off-shore.

Today, off-shoring is a common practice throughout the industry. Yet the benefits and impact vary widely, and most financial institutions are still learning how to do it well. The scale of off-shoring continues to grow, from 26 percent to 70 percent of all financial institutions between 2003 and 2005 – outpaced only by the scope, range, and variety of off-shoring practices and results. That is a sure sign of an industry still searching for the best way to do things.

At the same time, many smaller firms have consciously decided not to pursue off-shoring in order to concentrate on attempting to improve on-shore efficiency – largely because they lack the scale to capitalize fully on the benefits. Such decisions are likely to produce a set of new competitive dynamics within the industry. Are these firms right to pursue such a strategy? And how much ground will they lose to the major players as a consequence?

Taking off-shoring to the next level

Off-shoring is now a common operating practice for the global financial services industry. However, the contribution off-shoring makes to the competitive advantage of a financial institution varies hugely. This points to the fact that off-shoring is experiencing some growing pains – which may sound odd when over 40 percent of off-shore firms are making cost savings of greater than 40 percent. Huge opportunities exist for the application of best practices across off-shore operations in financial services. In short, it is critical that financial institutions that choose to move off-shore increase the scale and scope of these activities rapidly; otherwise, failure is very possible. Again, the message is clear: do not dabble off-shore.

The development of off-shoring in financial services is reaching a critical phase. Arguably, off-shoring is enjoying its first full decade, since the pioneers first established operations in India in the mid-1990s. The key to success for the industry is how quickly it can reduce risk while scaling operations over the next five years. A new breed of executives has been created in many major financial groups with titles such as head of global off-shoring or sourcing. This is a sure sign that off-shoring is coming of age. But significant challenges wait. Not only for this new and senior cadre of executives in the industry leaders, but for all financial institutions. We have identified five groups of financial institutions with clear stratification in strategies occurring across the industry:

1. 1.

   Off-shore giants. With established off-shore operations, these firms need to focus on scope and scale, streamlining their systems and processes (where they have not already done so) and aggressively expanding off-shore functions and headcount. They also need to integrate their on-shore and off-shore operations, including a global standard for ethical behavior. Most importantly, they need to guard against off-shore fatigue that can undermine their ongoing efforts and eat away at the benefits.

2. 2.

   Experienced off-shorers. The challenge for these financial institutions is to scale wherever possible. Often these firms have been off-shore for some time and now have to inject new momentum into their off-shore operations. Particularly, smaller players need to increase off-shore headcount to between 10 and 20 percent of total staff numbers.

3. 3.

   New off-shorers and planners. These firms have the opportunity to adopt rapidly best practices from the industry leaders. Also, it will be important to build momentum rapidly to avoid fatigue creeping into the process. To ensure this comes about, introducing a tour-of-duty culture will be critical.

4. 4.

   On-shore giants. There are a small number of major financial institutions remaining on-shore. In the race to improve operational efficiency, their focus will be on streamlining on-shore operations. Ahead, it will be critical to ensure that industry off-shore leaders are not establishing too great a gap in cost efficiency over the on-shore giants. It may be wise to add financial institutions with strong off-shoring capabilities into acquisition-target reviews.

5. 5.

   Smaller on-shorers. These firms face the toughest challenges in the future. Lacking scope and scale, smaller players need to look continually at a variety of strategic options. Perhaps highest on this list should be the consideration of using shared-service back offices to gain economies of scale. These smaller firms may be able to sidestep the trend – at least temporarily – but eventually will be forced to address the growing cost gap.

Off-shoring has become a competitive necessity in the financial services industry, and the overwhelming majority of firms have no choice but to pursue with gusto. The diversity of off-shoring models in use today clearly point to still-maturing practices. The need to ensure that operational risk is managed is paramount, since any major problems are likely to result in a severely tarnished reputation for off-shoring.

It is clear that off-shoring is here to stay, but needs tight management. Financial services companies must acknowledge that fact and adjust their strategies accordingly. In the end, those firms that can take their off-shore performance to the next level through the application of best (operational and risk) practices will be the ones most likely to cross the chasm to success.

Chris Gentle