A quick glance across the UK retail banking, life & pensions and investment management sectors reveals an interesting finding: retail banks, building societies and other mutuals are the ‘black sheep’ of the outsourcing family. Whereas some financial services sectors are veterans in their outsourcing journey, including those coming full circle and bringing operations back in-house, the retail banking sector is taking its first steps. There are, of course, pockets of experience, such as credit card outsourcing, ATM replenishment and overflow contact centres but the core current account, savings account and mortgage operations of UK retail banking providers remain largely in-house.
New entrants have been the lifeblood of the retail banking outsourcing industry for some time and, by their very nature, they have tended to be smaller, more niche providers. Consider the wave of new mortgage lenders leveraging the capabilities of outsourcers, such as Deutsche Bank’s mortgage subsidiary ‘db mortgages’ using Vertex and Kensington and GMAC-RFC signing agreements with HML. There are also the foreign deposit takers, such as First Bank of Nigeria’s FirstSave and Iceland’s Landesbanki subsidiary IceSave, which outsourced their operations to Newcastle Strategic Solutions Ltd (NSSL).
The outsourcing trend was undeterred by the credit crunch. In 2009, Aldermore announced it had signed a contract with NSSL to develop and administrate its multi-channel savings offering and Tesco Bank announced a similar deal with Vertex for mortgages a year later.
There appear to be three key reasons why new entrants cannot resist outsourcing, whereas it continues to be eschewed by established banks and building societies.
Sunk Cost and Capability
Technology is one of the largest fixed costs faced by banks. New platforms cost tens – even hundreds – of millions of pounds to build, let alone maintain, develop and replace. Removing a major product line and giving it to an outsourcing provider is also not cheap or easy. Only several rows into an NPV spreadsheet, it can become very difficult to make the business case stack up, regardless of the potential downstream cost savings. Of course, many costs are sunk – the platform cost £100m whether it continues to support mortgages, current or savings accounts or not, and normally just increases the dreaded central overhead or recharge to other product lines. That is without considering the large number of technical, development and support jobs, let alone the operational staff, who are dependent upon it.
New entrants tend to have few if any of these problems. Indeed, outsourcing offers the opportunity to acquire capability without sinking a huge amount of capital. Metro Bank has communicated the benefits of its relationship with Temenos, which is based on ‘pay-per-transaction’, rather than infrastructure costs. Furthermore, outsourced relationships can be more attractive to potential buyers, rather than being faced with a costly and time-consuming IT integration programme, just at the time they want to be leveraging increased scale from the acquisition.
Speed to Market
In the largest banks, it is generally accepted that major new product or channel innovations take a lot of time. Unperturbed by stories from new entrants getting from scratch to market in six months or deliver major innovations in months, it is simply accepted as the flipside of the many benefits associated with greater scale.
However, a hybrid model does exist, whereby strategically-important innovations and developments are delivered through third parties, enabling quicker market entry and, potentially, first mover advantage. For new entrants, speed to market is absolutely critical, as they continue to burn capital until they turn a profit. For the incumbents, who are normally already delivering profits, the capital burn does not seem anywhere as critical and the urgency to get to market is therefore often correspondingly smaller.
Oversight and Governance
The increasing scrutiny of the regulator on outsourcing relationships and specifically the requirements under SYSC (8), represent a significant challenge and cost for those outsourcing operations. To do this properly requires fundamental changes to operating models, governance forums and even job roles and descriptions. But these challenges are much smaller for new entrants. Building an outsourced operation ‘from scratch’ can be simpler and there may be less resistance to change from existing staff, albeit it still represents a major and onerous undertaking. Indeed, with the right outsourcing partner and model, it can be much easier to prove to the regulator that the necessary skills, experience and competencies are in place through a third party that may otherwise take a long time to recruit, train and establish in-house.
In Summary
Outsourcing certainly is not the solution for every new product, channel or innovation. Indeed, it might not be the right solution for some banks, building societies and mutuals at all depending on their strategy, change capability and cost base. Mutuals, for example, may value local staff employed locally as a core part of their proposition, which cannot necessarily be retained in an outsourced relationship. But even allowing for the obvious differences in circumstance, the difference in the use of outsourcers by new entrants compared to incumbents is striking. Rather than ignoring new entrants as a different breed with a different set of circumstances, it would be wise to consider whether incumbent institutions should reconsider the value these options might offer. Now that could be something to change the playing field and the fortunes of shareholders and members respectively.
