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Analysis: IT insourcing – the new black?

Insourcing IT functions can yield competitive advantage and develop the capabilities of core functions.

Harry John by Harry John  on 10-Dec-2014 
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Key Takeaways
  • IT insourcing can lead to a significant reduction in costs.

  • The savings, however, must be considered alongside offsetting spikes in staff costs, as insourcing generates greater demand for internal capabilities.
  • Including knowledge transfer clauses in supplier contracts can help to mitigate the risks associated with bringing IT operations in-house.

In November 2014, it was rumoured that Citigroup was planning to develop a captive, India-based back-office IT operation, in place of current outsourcing arrangements with the likes of majors, Wipro and Tata Consultancy Services (TCS).

 

The news followed reports in early 2014 that claimed Swedish Nordea Bank would be tying up its long-standing deal with IBM in favour of an IT ‘insourcing’ project.

The new black?

Insourcing – the process of bringing previously outsourced operations back in-house – is not necessarily new. According to Alex Golbin, managing director – head of IT sourcing and supplier management at BNY Mellon, a level of selective insourcing has and will continue to exist for categories in which a strategic focus can yield competitive advantage.

 

Nor is the trend peculiar to the financial services sector, but the supposed drivers of the move to bring elements of IT back in-house chime with wider concepts which currently frame industry discourse.

 

Procurement’s potential is increasingly obvious to the wider business because of regulatory and competitive headwinds, and the function increasingly being challenged to see in what ways it can add value beyond what is considered its traditional remit. For Golbin, IT insourcing is a win-win.

 

He says: "IT insourcing makes sense when there is commitment to develop captive capabilities at scale, especially for core functions. Benefits to the organisation [as a result of IT insourcing] include better unit costs and an improved ability to invest time and resources into developing strategic capabilities."

Hard numbers

As IT outsourcing relationships unfold, poor communication and change management issues strain these arrangements most, with 50% and 38% of the time respectively, according to an IT Outsourcing Europe report. Both of these factors can lead to project scope creep and poorer than expected partner performance, and will contribute to a dissipation of predicted cost-benefits over time.

 

 

 

In a 2014 quarter two earnings conference call – “the first quarter where we [have seen] the result[s] of [the] much talked about insourcing from IBM” – president and group CEO at Nordea Bank, Christian Clausen attributed a 2014 quarter two reduction in IT costs of 10.2% to the results achieved from insourcing, as part of a wider cost-reduction initiative that has seen back-office processes offshored to a captive service centre in Poland.

 

In the same period, however, Nordea’s full-time equivalent increased by 1%, which equates to around 260 additional hires in three months (in a near 30,000-strong organisation), directly as a result of the insourcing project, which equates to a 20% hike in quarter-on-quarter staff costs.

 

Including knowledge transfer clauses in supplier contracts can ease the burden of additional recruitment efforts by allowing the transfer of relevant staff from the outsourcer. In cases where work has been outsourced for a significant period of time, though, knowledge transfer may be enabled, but developing the entire portfolio of internal expertise such as service delivery management will always be cost and resource-hungry.

Headwinds

Cost containment has become increasingly important for banks in the post-crisis environment. At the same time as new players are proving themselves competitive by leveraging more agile IT systems, established players continue to be held back by ageing legacy platforms, which eat away at budgets and prove a source of risk.

 

In November 2014 UK regulators the Financial Conduct Authority and the Prudential Regulation Authority fined Royal Bank of Scotland, NatWest and Irish Ulster Bank a combined total of £56m ($88m) for RBS Group’s 2012 IT failing which affected more than six million UK customers.

 

IT is at the heart of a bank, and issues such as these damage reputation and put in question an organisation’s ability to deliver the appropriate level of customer service. The need to more effectively manage IT is compounded by diminishing customer stickiness, and when third-party arrangements gone awry stop the organisation from fulfilling its commercial goals, procurement will have to answer to its stakeholders.

Decisions, decisions

In Deloitte’s From Bangalore to Boston report, which assess drivers for insourcing IT, the entire cohort highlighted improving customer service as the most important driver for bringing outsourced operations back in-house, with 77% citing improved IT controls as chief among the benefits.

 

With wider doubts concerning the ability of financial institutions to effectively manage their supply chains, it is likely that a growing number of financial institutions will begin to wrestle with the question of whether to retender or insource IT operations, at the end of contract.

 

In the wake of system outages, vendor data breaches and group fragmentation (in the shape of ring-fencing in the UK and similar structural reforms in the US and elsewhere), the sustainability of existing supplier arrangements naturally come into question.

 

Regulators blamed RBS’ IT outsourcing arrangements initially in 2012, and in 2014 the Irish Central Bank in charge of Ulster warned in a press release that outsourcing the management of these systems is no defence for failings, which the fines are designed to reflect.

 

Insourcing is not necessarily a guarantor of better control, but the figures presented in the report suggest at least a perception that organisations are better placed to effectively manage IT when it is performed in-house – but just how should it be performed in practice?

 

Nordea Bank’s decision to deliver IT services from an offshore captive – which is the same route Citigroup is rumoured to be taking – in a low-cost location should afford a high degree of cost-effectiveness by leveraging lower employment costs among an established base of local human resources.  

 

Close attention should be paid to demographics in prospective offshore locations, and how they align with the profile of the organisation, to determine the suitability of the local talent pool as compared to internal capabilities.

 

Alongside benchmarked demographics and salaries, the prevalence of, and opportunities present within, local academic centres will provide a good indication of the availability of technical expertise depending on the business need, both currently and in the future.

 

Offshoring, however, can limit control over day-to-day processes and regulatory compliance, and in many cases incurs additional management to ensure co-ordination with the rest of the organisation, often on a continuous basis. Near/onshore service centres offer a remedy to these issues, but typically suffer from reduced cost-effectiveness, depending on location.

 

Procurement must understand the business need, and when internal and external drivers make sense and correlate with that need, IT insourcing represents a viable alternative to mechanistic retendering.


Harry John Harry John is category research manager at Procurement Leaders, specialising in financial services procurement. He draws upon a background in academic research and analysis, and experience in cross-industry indirect category research. Follow Harry on Twitter @aharryjohn
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