Offshoring, especially for business process outsourcing (BPO), is about to hit a wall. After all, despite being a relatively new phenomenon made possible by advances in communications, it remains subject to one timeless principle of economics: supply and demand.
The HR pros call it attrition. On any particular project outsourced to a service provider in India, you can expect at least a 15% turnover rate for personnel assigned to the project within a year. For some projects, BPO chief among them, it is not unheard of for a whole staff to turn over by year's end, according to Paul Schmidt, a partner in the global services delivery practice at TPI, one of the larger sourcing advisory organizations.
With technology so closely tied to business strategy, to talk about BPO today is to understand the consequences of not being able to deliver expected services in a timely manner because of high turnover.
Schmidt puts it much better than I can: "There is a tremendous opportunity for value leakage," he says. In other words, if you don't pay enough attention upfront to the realities of attrition at your service provider, you will end up with higher costs, lower-quality deliverables, or, worse, a project that goes bust.
The high attrition rate, particularly in India, finds its roots in the phenomenal growth of outsourcing and offshoring. A recently completed TPI study, "India: An Attractive BPO Destination Marred by Alarming Attrition" by Dinesh Goel and Prabhash Thakur, pegs the growth of BPO attrition during the past three years at approximately 50% per year.
What's fueling this attrition is that despite all you may have heard about how many computer science majors graduate from Indian universities annually, there is a finite talent pool -- and those graduates know it.
The study reports that "the rate of attrition seems to be increasing," and it questions whether the offshore BPO industry can sustain growth and satisfy clients over the long term given this trend. The study cites inconsistent delivery of service levels, loss of client-specific knowledge and additional investment in retraining service provider staff as consequences of these high attrition rates.
Obviously, you can't just ignore the problem and assume that it's up to the service providers to fix it. There are steps you should take, as an offshoring client, to help mitigate the fallout of attrition.
Schmidt recommends a carrot-and-stick approach.
A company must insist on a service-level agreement that quantifies the level of attrition it is willing to tolerate. There must also be clauses within the SLA stating that when turnover reaches a certain threshold, it is the service provider's responsibility to retrain and re-educate workers.
On the carrot side, Schmidt says the client should provide ample training and career movement. It should also consider including engaging and challenging work in the mix. And allowing individuals to rotate through opportunities to work in the U.S. is certainly a big motivator for keeping them on a particular project -- not to mention reward and recognition programs with financial incentives.
That said, Schmidt doesn't see service provider fees going up long term, mainly because of the competitive climate that persists in India.
Soon enough, supply and demand will increase the cost of offshoring. Over time, this will level the playing field and will motivate companies to reconsider whether they should keep projects in-house or send them overseas.
1/23/2007
Outsourcing Product Engineering to Offshore Service Providers
By Steve Banker
ARC is in the process of doing a study on outsourcing of Product Engineering to Offshore Service Providers. In other words, the majority of engineers are based in low cost countries, and there are cost arbitrage advantages that can result from outsourcing of product engineering.
At this point we have had initial discussions with most of the significant suppliers who compete based on the Global Service Delivery model. Perhaps the two most interesting conversations involved Satyam Computer Services, who sent a large team into visit ARC last week, and Quality Engineering & Software Technologies (QuEST).
Satyam, with revenues of over a billion dollars, is a provider of diverse IT and Business Process Outsourcing services, including engineering services. In what they call "extended engineering services", they did over $80 million in business in the last calendar year. In contrast, QuEST is a much smaller company. They had 2006 revenues of about $40 million. They were also much more focused on product engineering services (about 90 percent of their revenues come from engineering services).
Satyam emphasized that they could be a strategic partner that they could speed the customer's time to market. While they are willing to do simpler and more mundane forms of product engineering, they make it clear that they are also capable of providing much more complex services.
In contrast, QuEST was more willing talk about their desire and ability to do non-core engineering. Further, they stress the cost arbitrage advantages of offshoring. Initially, they argue, "Our engineers may only be 60 percent as productive as yours, but in 6 to 12 months, perhaps our engineers will be 80 percent as productive as yours."
Satyam's folks absolutely disagreed with the idea that Indian engineers had to be less productive than their client's. They pointed to one client that measured both Satyam's engineers and their own engineers on productivity. Satyam's engineers, based on these metrics, were indistinguishable from the client's engineers. With time, the right management, processes, and metrics, parity can be achieved.
While I accept the idea that with time, trusted outsource partners will be used more strategically, and their value will go beyond simple labor arbitrage, most companies will begin their engineering outsourcing with less complex tasks, and the initial focus will be cost savings. Based on that premise, what are the economics?
Economics
The surface economics of outsourcing product engineering are very positive. While pay differs by industry and specialization, a fully loaded (salary and benefits) American mechanical engineer with 10 years of experience will cost a company about $10,000 per month. In comparison, offshore providers charge as little as $2,400 per month for relatively simple activities like converting Computer Aided Diagram (CAD) diagrams for use in technical publications to as much as $7,500 for complex Computer Aided Engineering (CAE) modeling and analysis, where engineers are in short supply. $3,000 is a good estimate for the average rate for a seasoned mechanical engineer.
However, in a new engagement with an offshore supplier, there would typically people sent to the company's site, particularly early in the engagement to scope the requirements. The higher the ratio of engineers on site with the customer (the customer pays for travel), or near site (supporting the customer from an office in their home region) as compared to offshore, the more it will cost. However, as a rough industry guide, Western companies should expect to pay a blended rate of about $25 per hour ($4,150) per month.
However, Indian engineers will not be as productive as American engineers. The offshore productivity ratio is the true key to the economics of offshoring Product Engineering Services. Let's assume that offshore suppliers are being overly optimistic on their employee's productivity, and that the true productivity range is from 25 percent to 70 percent. Let's further assume your blended fee for an Indian engineer is $25 per hour versus $60 for an American. If the offshore engineer is 25 productive as the American, the Western firm would have better off keeping all the work internal. They will find themselves 40 percent less cost effective than if they had done the work themselves. If the Indian engineers are 70 percent as productive as the US based engineers, the Western firm is a clear winner. They will find have spent 68 percent less on labor to accomplish a given amount of work. The break even productivity rate is 42 percent. That is the point at which there is no cost advantage, or disadvantage, from offshoring.
This analysis does not consider the extra costs of supervision and travel that would be incurred by a Western firm, which can be substantial.
Factors Affecting Productivity
It is clear that a primary consideration affecting the cost efficiency of an outsourced arrangement is the productivity of the engineers at the out-sourced firm. What are the factors that affect this?
First of all, good metrics are critical. But beyond that, the more seamlessly the two companies’ PLM systems are integrated, the easier it is for offshore engineers to be productive.
The offshore, nearshore, on site ratio also matters. Offshore engineers are the least expensive. On site engineers, foreign engineers from low cost countries that spend several months at a customer's development center working on a project, cost more. Near shore engineers, engineers in a development center in the same region, cost the most, and in fact will cost more than a Western companies own engineers. While some suppliers tout the advantages of 24 hour follow the sun development, these advantages can be more mythical than real, particularly with more complex engineering or projects that are difficult to scope. The vast difference in time zones between North America and India - 6:30 am in Boston is 5:00 pm in Bangalore, India - make having telephone conversations onerous. This makes ongoing supervision and control very difficult. Thus, the higher the ratio of offshore to onshore (or nearshore to offshore), the higher the productivity, but the higher the cost will be.
The ratio of on site, or near site, to offshore should differ depending upon the complexity of work undertaken and a particular supplier's business model. If CAD migration is done, or drawing conversions, all that may be needed is a relatively quick trip to the customer's site to understand the requirements and how they will be measured. With time, as the customer and the outsourcer get to know each other, not even that is required. Specs can just be faxed or emailed over. In contrast, higher value activity, like conceptual design, analysis, and design validation will usually require a higher onsite presence to guaranty productivity.
The tool, industry, and customer experience of the outsourcers' engineers also affects productivity. CAD/CAM/CAE tools are complex. It takes time to learn how to use them well. According to QuEST, many Indian students graduate with no experience having used any of these tools. To deal with this problem, QuEST works with six engineering schools. Experienced QuEST engineers teach courses on how to use CAD tools. The college students can take this course as a paid elective. Of their 900 engineers, about 200 have come out of these CADAM programs. This allows them to get people they know are dedicated to mechanical engineering, and it gives them better insight into which of the graduates have the right skills.
The folks at Satyam vehemently disagree with this premise. They believe that if you recruit more prestigious Indian schools, the typical graduate has better CAD skills than the typical American graduate. One Satyam manager used to work at GM and was responsible for hiring engineers. She argued it has been far easier to find Indians with tool skills than Americans.
From a productivity perspective, even after you have learned to use one tool well, for example Dassault Catia v5, if a customer needs the firm to use different tool, say UniGraphics' NX, the time required to come up to speed on the new tool is significant.
Industry experience affects productivity, including the productivity on a particular tool. If an engineer has aeronautic industry experience, they understand how an airplane is assembled, how they are stamped, and because of this knowledge, they can use the tool in a more productive fashion. Similarly, knowledge of a customer's processes and operations can make the offshore provider more efficient. Unlike in manufacturing, where Lean and Six Sigma are considered operational best practices, there is little agreement on what constitutes operational excellence in product development. The product development processes vary greatly company to company. To the extent that a Western company develops a long term relationship with an offshore company, and the offshore supplier dedicates staff to that customer, productivity can improve.
Satyam has a required course that new engineers assigned to important clients most pass through. The course trains the young engineer on their client's processes and works to pass on some industry domain expertise. Further, they attempt to train their engineers on the industry domain knowledge by actively rotating engineers onsite to see first hand the manufacturing processes.
Productivity can also be adversely affected by the different culture's communication styles. Indians can be very agreeable. In an effort to please they may tell you that work is complete, when it is not done yet. Having Indian managers, who are trained in "soft skills", to manage their own Indian engineers can be one way to avoid this problem.
Finally, it is clear that the cost of Indian engineers is rising and that retention of good engineers is an issue. However, at Satyam the attrition rate is in the single digits, lower than the double digit rates in the IT area. To the extent that Indian companies can keep their engineers engaged on interesting projects, they can help to retain their best engineers. For this reason, a certain amount of rotation of engineers into and out of key accounts may be necessary. Satyam also points out that while wages are rising, young engineers are available. At one of their client's, the average age of the internal engineering force is in the high 50s. In some multinational manufacturers, a whole generation of engineers is on the verge of retirement, and there do not appear to be enough young domestic engineers to fill the vacancies.
One thing is clear; it takes time for offshore engineers to become more productive. This is one reason that companies that are looking to offshore peak engineering demands, rather than engaging in a long term relationship, will never have the productivity and cost efficiencies from their engineering services vendors of companies that view these relationships more strategically. Companies will find it very difficult to engage with large firms, like Satyam, if they are not interested in longer term relationships. But even smaller firms, like QuEST, are unwilling to engage in short term tactical engagements.
ARC is in the process of doing a study on outsourcing of Product Engineering to Offshore Service Providers. In other words, the majority of engineers are based in low cost countries, and there are cost arbitrage advantages that can result from outsourcing of product engineering.
At this point we have had initial discussions with most of the significant suppliers who compete based on the Global Service Delivery model. Perhaps the two most interesting conversations involved Satyam Computer Services, who sent a large team into visit ARC last week, and Quality Engineering & Software Technologies (QuEST).
Satyam, with revenues of over a billion dollars, is a provider of diverse IT and Business Process Outsourcing services, including engineering services. In what they call "extended engineering services", they did over $80 million in business in the last calendar year. In contrast, QuEST is a much smaller company. They had 2006 revenues of about $40 million. They were also much more focused on product engineering services (about 90 percent of their revenues come from engineering services).
Satyam emphasized that they could be a strategic partner that they could speed the customer's time to market. While they are willing to do simpler and more mundane forms of product engineering, they make it clear that they are also capable of providing much more complex services.
In contrast, QuEST was more willing talk about their desire and ability to do non-core engineering. Further, they stress the cost arbitrage advantages of offshoring. Initially, they argue, "Our engineers may only be 60 percent as productive as yours, but in 6 to 12 months, perhaps our engineers will be 80 percent as productive as yours."
Satyam's folks absolutely disagreed with the idea that Indian engineers had to be less productive than their client's. They pointed to one client that measured both Satyam's engineers and their own engineers on productivity. Satyam's engineers, based on these metrics, were indistinguishable from the client's engineers. With time, the right management, processes, and metrics, parity can be achieved.
While I accept the idea that with time, trusted outsource partners will be used more strategically, and their value will go beyond simple labor arbitrage, most companies will begin their engineering outsourcing with less complex tasks, and the initial focus will be cost savings. Based on that premise, what are the economics?
Economics
The surface economics of outsourcing product engineering are very positive. While pay differs by industry and specialization, a fully loaded (salary and benefits) American mechanical engineer with 10 years of experience will cost a company about $10,000 per month. In comparison, offshore providers charge as little as $2,400 per month for relatively simple activities like converting Computer Aided Diagram (CAD) diagrams for use in technical publications to as much as $7,500 for complex Computer Aided Engineering (CAE) modeling and analysis, where engineers are in short supply. $3,000 is a good estimate for the average rate for a seasoned mechanical engineer.
However, in a new engagement with an offshore supplier, there would typically people sent to the company's site, particularly early in the engagement to scope the requirements. The higher the ratio of engineers on site with the customer (the customer pays for travel), or near site (supporting the customer from an office in their home region) as compared to offshore, the more it will cost. However, as a rough industry guide, Western companies should expect to pay a blended rate of about $25 per hour ($4,150) per month.
However, Indian engineers will not be as productive as American engineers. The offshore productivity ratio is the true key to the economics of offshoring Product Engineering Services. Let's assume that offshore suppliers are being overly optimistic on their employee's productivity, and that the true productivity range is from 25 percent to 70 percent. Let's further assume your blended fee for an Indian engineer is $25 per hour versus $60 for an American. If the offshore engineer is 25 productive as the American, the Western firm would have better off keeping all the work internal. They will find themselves 40 percent less cost effective than if they had done the work themselves. If the Indian engineers are 70 percent as productive as the US based engineers, the Western firm is a clear winner. They will find have spent 68 percent less on labor to accomplish a given amount of work. The break even productivity rate is 42 percent. That is the point at which there is no cost advantage, or disadvantage, from offshoring.
This analysis does not consider the extra costs of supervision and travel that would be incurred by a Western firm, which can be substantial.
Factors Affecting Productivity
It is clear that a primary consideration affecting the cost efficiency of an outsourced arrangement is the productivity of the engineers at the out-sourced firm. What are the factors that affect this?
First of all, good metrics are critical. But beyond that, the more seamlessly the two companies’ PLM systems are integrated, the easier it is for offshore engineers to be productive.
The offshore, nearshore, on site ratio also matters. Offshore engineers are the least expensive. On site engineers, foreign engineers from low cost countries that spend several months at a customer's development center working on a project, cost more. Near shore engineers, engineers in a development center in the same region, cost the most, and in fact will cost more than a Western companies own engineers. While some suppliers tout the advantages of 24 hour follow the sun development, these advantages can be more mythical than real, particularly with more complex engineering or projects that are difficult to scope. The vast difference in time zones between North America and India - 6:30 am in Boston is 5:00 pm in Bangalore, India - make having telephone conversations onerous. This makes ongoing supervision and control very difficult. Thus, the higher the ratio of offshore to onshore (or nearshore to offshore), the higher the productivity, but the higher the cost will be.
The ratio of on site, or near site, to offshore should differ depending upon the complexity of work undertaken and a particular supplier's business model. If CAD migration is done, or drawing conversions, all that may be needed is a relatively quick trip to the customer's site to understand the requirements and how they will be measured. With time, as the customer and the outsourcer get to know each other, not even that is required. Specs can just be faxed or emailed over. In contrast, higher value activity, like conceptual design, analysis, and design validation will usually require a higher onsite presence to guaranty productivity.
The tool, industry, and customer experience of the outsourcers' engineers also affects productivity. CAD/CAM/CAE tools are complex. It takes time to learn how to use them well. According to QuEST, many Indian students graduate with no experience having used any of these tools. To deal with this problem, QuEST works with six engineering schools. Experienced QuEST engineers teach courses on how to use CAD tools. The college students can take this course as a paid elective. Of their 900 engineers, about 200 have come out of these CADAM programs. This allows them to get people they know are dedicated to mechanical engineering, and it gives them better insight into which of the graduates have the right skills.
The folks at Satyam vehemently disagree with this premise. They believe that if you recruit more prestigious Indian schools, the typical graduate has better CAD skills than the typical American graduate. One Satyam manager used to work at GM and was responsible for hiring engineers. She argued it has been far easier to find Indians with tool skills than Americans.
From a productivity perspective, even after you have learned to use one tool well, for example Dassault Catia v5, if a customer needs the firm to use different tool, say UniGraphics' NX, the time required to come up to speed on the new tool is significant.
Industry experience affects productivity, including the productivity on a particular tool. If an engineer has aeronautic industry experience, they understand how an airplane is assembled, how they are stamped, and because of this knowledge, they can use the tool in a more productive fashion. Similarly, knowledge of a customer's processes and operations can make the offshore provider more efficient. Unlike in manufacturing, where Lean and Six Sigma are considered operational best practices, there is little agreement on what constitutes operational excellence in product development. The product development processes vary greatly company to company. To the extent that a Western company develops a long term relationship with an offshore company, and the offshore supplier dedicates staff to that customer, productivity can improve.
Satyam has a required course that new engineers assigned to important clients most pass through. The course trains the young engineer on their client's processes and works to pass on some industry domain expertise. Further, they attempt to train their engineers on the industry domain knowledge by actively rotating engineers onsite to see first hand the manufacturing processes.
Productivity can also be adversely affected by the different culture's communication styles. Indians can be very agreeable. In an effort to please they may tell you that work is complete, when it is not done yet. Having Indian managers, who are trained in "soft skills", to manage their own Indian engineers can be one way to avoid this problem.
Finally, it is clear that the cost of Indian engineers is rising and that retention of good engineers is an issue. However, at Satyam the attrition rate is in the single digits, lower than the double digit rates in the IT area. To the extent that Indian companies can keep their engineers engaged on interesting projects, they can help to retain their best engineers. For this reason, a certain amount of rotation of engineers into and out of key accounts may be necessary. Satyam also points out that while wages are rising, young engineers are available. At one of their client's, the average age of the internal engineering force is in the high 50s. In some multinational manufacturers, a whole generation of engineers is on the verge of retirement, and there do not appear to be enough young domestic engineers to fill the vacancies.
One thing is clear; it takes time for offshore engineers to become more productive. This is one reason that companies that are looking to offshore peak engineering demands, rather than engaging in a long term relationship, will never have the productivity and cost efficiencies from their engineering services vendors of companies that view these relationships more strategically. Companies will find it very difficult to engage with large firms, like Satyam, if they are not interested in longer term relationships. But even smaller firms, like QuEST, are unwilling to engage in short term tactical engagements.
1/21/2007
Outsourcing: What International Banks Should Know
As press reports continually remind us, outsourcing is an important focus of every large business. Banks are no different.
A 2005 study by Deloitte Touche Tohmatsu found that the majority of global financial services companies (including banks) surveyed have at least one outsourcing contract.[FOOTNOTE 1] Operations outsourced by such companies include customer call centers, information technology-related services, data processing, investment management and back office clearing operations. Some banks also are establishing subsidiaries to provide these services (called "captive outsourcing") instead of using third-party service providers such as Accenture, OfficeTiger, Infosys or Metavante.
This article looks at international standards and U.S. regulatory requirements for outsourcing of business operations by a bank.
INTERNATIONAL GUIDANCE
There is no dearth of guidance on how banking organizations should handle their outsourcing relationships. At the international level, for example, the Joint Forum, which consists of international banking, securities and insurance regulators, has issued guidance describing the factors that financial services companies and their regulators need to take into consideration in outsourcing arrangements.[FOOTNOTE 2] The Bank for International Settlement's Basle Committee, a group of international bank regulators that sets standards on international banking issues, has included a discussion of outsourcing issues in its publications.[FOOTNOTE 3]
U.S. GUIDANCE
In the United States, there are laws, regulations and regulatory guidance on outsourcing. Under the federal Bank Service Company Act, a bank, including the U.S. office of an international bank, must provide notice to its primary federal regulator when it outsources certain business operations, such as data processing, within 30 days of entering into such an arrangement.[FOOTNOTE 4] A federal banking regulator also must be provided access to the bank's service provider as part of its examination of the bank.
In New York, state-chartered banking organizations and state-licensed offices of international banks must provide prior notice to the New York State Banking Department (NYSBD) of any "data processing" outsourcing arrangement, although the NYSBD generally applies its requirement to any outsourcing of business operations.[FOOTNOTE 5] The NYSBD requires that the contract provide it with access to the service provider's records, books and staff as necessary to examine the bank.
The Federal Financial Institutions Examination Council, a committee of federal and state bank regulators, has issued detailed guidance on outsourcing through its Information Technology booklets, in particular, "Outsourcing Technology Services" (June 2004) and "Supervision of Technology Service Providers" (March 2003). Individual bank regulators also have issued outsourcing guidance.[FOOTNOTE 6]
In addition, some U.S. laws and regulations carry their own service provider provisions, such as the "Interagency Guidelines on Information Security Standards," adopted by the federal banking regulators. The guidelines, with which the banks are expected to comply, require U.S. banks, including U.S. offices of international banks, to implement written information security programs addressing (i) security and confidentiality of customer information, (ii) anticipated threats or hazards to the security or integrity of such information, (iii) unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer, and (iv) proper disposal of customer and consumer information.[FOOTNOTE 7]
Moreover, the guidelines specifically require banks to oversee service provider arrangements and to include a provision in their contracts that the service provider "implement appropriate measures designed to meet the objectives of these Guidelines." Banks also need to monitor the service providers' compliance with this contract provision, such as by reviewing audit reports.
GENERAL PRINCIPLES
What are the more important general principles to be gleaned from all this guidance?
Ultimate responsibility for outsourcing relationships lies with the board of directors and senior management.
The board of directors and senior management of a bank are responsible both for establishing and approving a comprehensive policy to govern the outsourcing process, and for the consequences of any outsourcing arrangement. No outsourcing arrangement should impede a bank's ability to service customers and comply with relevant laws and regulations.
Effective due diligence on potential service providers is critical.
A due diligence checklist for any potential outsourcing arrangement should include the following:
* Obtaining certified copies of the service provider's organizational documents;
* Considering the qualifications and background of the service provider's senior management;
* Researching the reputation of the service provider in the industry;
* Checking the service provider's references and seeking additional references from others;
* Evaluating the financial condition of the service provider by reviewing its audited financial statements and asking for a certificate or other proof of insurance;
* Assessing the service provider's technological and systems capabilities to determine whether it will be able to do the job effectively;
* Reviewing the service provider's internal controls environment and audit function; if there have been lapses in controls, finding out how these lapses were addressed; and
* Examining the service provider's legal and regulatory compliance record, particularly in its home country and in the United States.
A risk management program must take into account all relevant risks.
There are various potential risks involved in any outsourcing arrangement, particularly one involving a provider in another country:
Country/political risk: How politically stable is the government of the country in which the service provider is located? Is there concern that the government could interfere with the service provider's ability to do the job?
Reputational risk: Could problems with the service provider reflect poorly on the bank and its ability to effectively service customers, or, worse, is the service provider violating regulations or agreed-upon procedures such that the bank regulators will seek an enforcement action against the bank?
Operational risk: Is the service provider going to be able to perform the contracted-for services without undue problems or delays? Does the service provider have a business continuity plan in the event of a disaster that disrupts operations?
Compliance risk: Is the service provider able to comply with all relevant laws and regulations and specified company practices?
Strategic risk: Is the outsourced activity in line with the bank's corporate goals? Is there effective oversight of the service provider to ensure compliance with overall corporate goals?
Information security risk: Does the service provider have adequate systems in place to protect data, such as limiting access to records to only those persons needing to review them, providing adequate physical security at the building and having electronic authentication policies such as frequent change of passwords?
The contract with the service provider should be as specific as possible regarding the expectations of the parties.
All the oral "understandings" reached during negotiations are useless unless they are put in writing. A contract must address all of the parties' expectations and describe specific rights and responsibilities, particularly where the contract is calling for a change in the usual procedures followed by the service provider.
For example, a service provider may subcontract out some of its work under a particular service contract, but subcontracting may raise additional risks for the bank. The contract should provide for disclosure to, and approval by, the bank of all subcontracting relationships.
The contract's provisions should include a discussion of the following items:
* Pricing structure, including additional costs for special services;
* Measurable service levels and performance standards;
* Security and confidentiality of information;
* Preservation of intellectual property rights;
* Audit and oversight rights;
* Regular reporting requirements;
* Business continuity plans;
* Acknowledgement of the regulatory right of access to the service provider's systems, records and personnel as part of an examination of the bank;
* Dispute resolution, assignment and indemnification provisions; and
* Termination provisions (the bank should be able to terminate the contract without penalty if the relevant regulator orders the bank to terminate such relationship).
The service provider must understand and acknowledge the importance of regulatory compliance.
In 2002, the U.S. Treasury Department's Office of the Comptroller of the Currency, which charters and regulates national banks, took regulatory action against both a national bank and its service provider for various reasons, including failure to safeguard customer loan files, some of which had been left in a trash dumpster. The contract must be very specific about the service provider's responsibility to comply with changes in all applicable laws or regulations, even if a particular change is applicable only to one jurisdiction.
The bank must have an effective monitoring and oversight mechanism of the outsourcing relationship.
The bank needs to monitor the service provider's performance under contract on a regular basis through review of periodic required reports, audited financials and SAS-70 reviews of the adequacy of the service provider's policies and procedures controls. There also should be periodic on-site meetings at the service provider's office, and regular telephone or e-mail contact.
Offshoring has special risks to keep in mind.
As noted above, a bank's decision to outsource operations to another country requires heightened scrutiny of the risks involved, such as country/political risk and compliance risk. The bank should carefully consider whether the service provider will be able to deliver on a consistent basis the contracted-for services.
For example, there may be restrictions under particular laws or regulations that could impede full performance, such as the strict European Union data transfer laws that permit transfer of personal data to non-EU countries only under certain conditions. A bank's counsel should carefully review any potential data transfer issues, particularly if information might be transferred from an EU location or concern EU residents, whether or not the information was initially stored or intended to be stored in an EU location.
ACROSS MULTIPLE JURISDICTIONS
International banks may find themselves in a bind when they seek to have only one contract with a service provider encompass multiple jurisdictions. It can take months for a bank to agree with a potential service provider with respect to one jurisdiction, let alone more than one.
Additional problems arise after a contract is in effect and the bank seeks to add a new jurisdiction. The service provider may be reluctant to re-open issues that it thought had been decided. The bank must be able to require what is needed from a service provider with respect to a particular jurisdiction despite potential protests. The service provider likely will be familiar with the principal requirements imposed by various countries.
In negotiating any global master outsourcing agreement, an international bank should plan for an expansion of the contract into other jurisdictions and have the service provider agree to a new schedule if it is necessary to accommodate an expansion of services into the new region. Then, when the time comes to discuss the new schedule for a U.S. office of an international bank, the bank should be able to explain the proposed revisions and whether they are derived from law or regulations such as the Interagency Guidelines, from best practices guidance expected to be followed by banks such as review of audit and SAS-70 reports, or from established company policy such as employee background checks.
CONCLUSION
Outsourcing can save a bank millions of dollars, but cost savings alone cannot dictate a service provider contract. The bank must establish an overall policy on outsourcing, conduct effective due diligence of potential service providers, set out expectations in a well-drafted contract and be able to effectively monitor the service provider. In addition, regulatory compliance is a key element of any outsourcing arrangement.
A 2005 study by Deloitte Touche Tohmatsu found that the majority of global financial services companies (including banks) surveyed have at least one outsourcing contract.[FOOTNOTE 1] Operations outsourced by such companies include customer call centers, information technology-related services, data processing, investment management and back office clearing operations. Some banks also are establishing subsidiaries to provide these services (called "captive outsourcing") instead of using third-party service providers such as Accenture, OfficeTiger, Infosys or Metavante.
This article looks at international standards and U.S. regulatory requirements for outsourcing of business operations by a bank.
INTERNATIONAL GUIDANCE
There is no dearth of guidance on how banking organizations should handle their outsourcing relationships. At the international level, for example, the Joint Forum, which consists of international banking, securities and insurance regulators, has issued guidance describing the factors that financial services companies and their regulators need to take into consideration in outsourcing arrangements.[FOOTNOTE 2] The Bank for International Settlement's Basle Committee, a group of international bank regulators that sets standards on international banking issues, has included a discussion of outsourcing issues in its publications.[FOOTNOTE 3]
U.S. GUIDANCE
In the United States, there are laws, regulations and regulatory guidance on outsourcing. Under the federal Bank Service Company Act, a bank, including the U.S. office of an international bank, must provide notice to its primary federal regulator when it outsources certain business operations, such as data processing, within 30 days of entering into such an arrangement.[FOOTNOTE 4] A federal banking regulator also must be provided access to the bank's service provider as part of its examination of the bank.
In New York, state-chartered banking organizations and state-licensed offices of international banks must provide prior notice to the New York State Banking Department (NYSBD) of any "data processing" outsourcing arrangement, although the NYSBD generally applies its requirement to any outsourcing of business operations.[FOOTNOTE 5] The NYSBD requires that the contract provide it with access to the service provider's records, books and staff as necessary to examine the bank.
The Federal Financial Institutions Examination Council, a committee of federal and state bank regulators, has issued detailed guidance on outsourcing through its Information Technology booklets, in particular, "Outsourcing Technology Services" (June 2004) and "Supervision of Technology Service Providers" (March 2003). Individual bank regulators also have issued outsourcing guidance.[FOOTNOTE 6]
In addition, some U.S. laws and regulations carry their own service provider provisions, such as the "Interagency Guidelines on Information Security Standards," adopted by the federal banking regulators. The guidelines, with which the banks are expected to comply, require U.S. banks, including U.S. offices of international banks, to implement written information security programs addressing (i) security and confidentiality of customer information, (ii) anticipated threats or hazards to the security or integrity of such information, (iii) unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer, and (iv) proper disposal of customer and consumer information.[FOOTNOTE 7]
Moreover, the guidelines specifically require banks to oversee service provider arrangements and to include a provision in their contracts that the service provider "implement appropriate measures designed to meet the objectives of these Guidelines." Banks also need to monitor the service providers' compliance with this contract provision, such as by reviewing audit reports.
GENERAL PRINCIPLES
What are the more important general principles to be gleaned from all this guidance?
Ultimate responsibility for outsourcing relationships lies with the board of directors and senior management.
The board of directors and senior management of a bank are responsible both for establishing and approving a comprehensive policy to govern the outsourcing process, and for the consequences of any outsourcing arrangement. No outsourcing arrangement should impede a bank's ability to service customers and comply with relevant laws and regulations.
Effective due diligence on potential service providers is critical.
A due diligence checklist for any potential outsourcing arrangement should include the following:
* Obtaining certified copies of the service provider's organizational documents;
* Considering the qualifications and background of the service provider's senior management;
* Researching the reputation of the service provider in the industry;
* Checking the service provider's references and seeking additional references from others;
* Evaluating the financial condition of the service provider by reviewing its audited financial statements and asking for a certificate or other proof of insurance;
* Assessing the service provider's technological and systems capabilities to determine whether it will be able to do the job effectively;
* Reviewing the service provider's internal controls environment and audit function; if there have been lapses in controls, finding out how these lapses were addressed; and
* Examining the service provider's legal and regulatory compliance record, particularly in its home country and in the United States.
A risk management program must take into account all relevant risks.
There are various potential risks involved in any outsourcing arrangement, particularly one involving a provider in another country:
Country/political risk: How politically stable is the government of the country in which the service provider is located? Is there concern that the government could interfere with the service provider's ability to do the job?
Reputational risk: Could problems with the service provider reflect poorly on the bank and its ability to effectively service customers, or, worse, is the service provider violating regulations or agreed-upon procedures such that the bank regulators will seek an enforcement action against the bank?
Operational risk: Is the service provider going to be able to perform the contracted-for services without undue problems or delays? Does the service provider have a business continuity plan in the event of a disaster that disrupts operations?
Compliance risk: Is the service provider able to comply with all relevant laws and regulations and specified company practices?
Strategic risk: Is the outsourced activity in line with the bank's corporate goals? Is there effective oversight of the service provider to ensure compliance with overall corporate goals?
Information security risk: Does the service provider have adequate systems in place to protect data, such as limiting access to records to only those persons needing to review them, providing adequate physical security at the building and having electronic authentication policies such as frequent change of passwords?
The contract with the service provider should be as specific as possible regarding the expectations of the parties.
All the oral "understandings" reached during negotiations are useless unless they are put in writing. A contract must address all of the parties' expectations and describe specific rights and responsibilities, particularly where the contract is calling for a change in the usual procedures followed by the service provider.
For example, a service provider may subcontract out some of its work under a particular service contract, but subcontracting may raise additional risks for the bank. The contract should provide for disclosure to, and approval by, the bank of all subcontracting relationships.
The contract's provisions should include a discussion of the following items:
* Pricing structure, including additional costs for special services;
* Measurable service levels and performance standards;
* Security and confidentiality of information;
* Preservation of intellectual property rights;
* Audit and oversight rights;
* Regular reporting requirements;
* Business continuity plans;
* Acknowledgement of the regulatory right of access to the service provider's systems, records and personnel as part of an examination of the bank;
* Dispute resolution, assignment and indemnification provisions; and
* Termination provisions (the bank should be able to terminate the contract without penalty if the relevant regulator orders the bank to terminate such relationship).
The service provider must understand and acknowledge the importance of regulatory compliance.
In 2002, the U.S. Treasury Department's Office of the Comptroller of the Currency, which charters and regulates national banks, took regulatory action against both a national bank and its service provider for various reasons, including failure to safeguard customer loan files, some of which had been left in a trash dumpster. The contract must be very specific about the service provider's responsibility to comply with changes in all applicable laws or regulations, even if a particular change is applicable only to one jurisdiction.
The bank must have an effective monitoring and oversight mechanism of the outsourcing relationship.
The bank needs to monitor the service provider's performance under contract on a regular basis through review of periodic required reports, audited financials and SAS-70 reviews of the adequacy of the service provider's policies and procedures controls. There also should be periodic on-site meetings at the service provider's office, and regular telephone or e-mail contact.
Offshoring has special risks to keep in mind.
As noted above, a bank's decision to outsource operations to another country requires heightened scrutiny of the risks involved, such as country/political risk and compliance risk. The bank should carefully consider whether the service provider will be able to deliver on a consistent basis the contracted-for services.
For example, there may be restrictions under particular laws or regulations that could impede full performance, such as the strict European Union data transfer laws that permit transfer of personal data to non-EU countries only under certain conditions. A bank's counsel should carefully review any potential data transfer issues, particularly if information might be transferred from an EU location or concern EU residents, whether or not the information was initially stored or intended to be stored in an EU location.
ACROSS MULTIPLE JURISDICTIONS
International banks may find themselves in a bind when they seek to have only one contract with a service provider encompass multiple jurisdictions. It can take months for a bank to agree with a potential service provider with respect to one jurisdiction, let alone more than one.
Additional problems arise after a contract is in effect and the bank seeks to add a new jurisdiction. The service provider may be reluctant to re-open issues that it thought had been decided. The bank must be able to require what is needed from a service provider with respect to a particular jurisdiction despite potential protests. The service provider likely will be familiar with the principal requirements imposed by various countries.
In negotiating any global master outsourcing agreement, an international bank should plan for an expansion of the contract into other jurisdictions and have the service provider agree to a new schedule if it is necessary to accommodate an expansion of services into the new region. Then, when the time comes to discuss the new schedule for a U.S. office of an international bank, the bank should be able to explain the proposed revisions and whether they are derived from law or regulations such as the Interagency Guidelines, from best practices guidance expected to be followed by banks such as review of audit and SAS-70 reports, or from established company policy such as employee background checks.
CONCLUSION
Outsourcing can save a bank millions of dollars, but cost savings alone cannot dictate a service provider contract. The bank must establish an overall policy on outsourcing, conduct effective due diligence of potential service providers, set out expectations in a well-drafted contract and be able to effectively monitor the service provider. In addition, regulatory compliance is a key element of any outsourcing arrangement.
Asia Pacific Outsourcing Market Bucks Global Trend
Outsourcing deals inked in the Asia Pacific in 2006 topped US$25 million, a 43 percent increase on the previous year, according to advisory firm TPI Inc. Asia Pacific managing director of the outsourcing consultancy, Arno Franz, said 2006 was a stand-out year for the region accounting for 13 percent of the global market.
"It is the first time market share has exceeded 10 per cent since 2002; but the relative immaturity of the Asia Pacific market makes it prone to spikes in activity so it remains to be seen if this is the start of an ongoing growth trend," Franz said.
The compound annual growth rate for service providers in the region is 10.5 per cent, according to TPI, which is more than double the global rate of 4.5 percent.
Despite the 'lumpy' nature of the Asia Pacific market in terms of yearly contract awards, Franz said the sustained growth in annualized revenues since 2002 suggests there is some strength in the region's outsourcing market.
The big six service providers, namely Accenture Ltd., Affiliated Computer Services Inc., CSC Corp., EDS Inc., Hewlett-Packard Co., and IBM Corp., are losing market share.
This group won 40 percent of the region's contracts last year, compared with a 60 percent share in 2002.
Franz said the increased competition shows clients are more receptive to doing business with the non-Big Six providers.
"Alongside the global giants of outsourcing, there is clearly room for smaller, specialized service providers who can address specific client needs," he said.
"At the moment success for service providers in Australia, India and Japan , seems to be the determining factor for success in the Asia Pacific."
Indian outsourcers are increasingly becoming the big winners in the region.
For example, Tata Consultancy Services Ltd. (TCS) announced today it has become the first Indian IT company to net $1 billion in revenues in one financial quarter (Q3 ending December 31, 2006) and post a 40 percent revenue increase year on year.
TCS recently signed a multi-year application development and support contract worth $90 million with Qantas.
Another provider Infosys Technologies Ltd., said earlier this month it expects full year revenue to be US$3.09 billion, up by 43.6 percent from revenue in the previous fiscal year.
In Australia, more than A$7 billion (US$5.46 billion) worth of outsourcing contracts are up for grabs in 2007.
According to research firm IDC, which has released the results of its 2006 Australian outsourcing end-user survey, a number of large contracts are expected to go with selective sourcing as organizations continue to unbundle mammoth IT contracts and look to best-of-breed providers.
IDC research manager for outsourcing and BPO (Business Process Outsourcing), Aprajita Sharma, said tier one providers face tough competition from Indian offshore outsourcers.
"It is the first time market share has exceeded 10 per cent since 2002; but the relative immaturity of the Asia Pacific market makes it prone to spikes in activity so it remains to be seen if this is the start of an ongoing growth trend," Franz said.
The compound annual growth rate for service providers in the region is 10.5 per cent, according to TPI, which is more than double the global rate of 4.5 percent.
Despite the 'lumpy' nature of the Asia Pacific market in terms of yearly contract awards, Franz said the sustained growth in annualized revenues since 2002 suggests there is some strength in the region's outsourcing market.
The big six service providers, namely Accenture Ltd., Affiliated Computer Services Inc., CSC Corp., EDS Inc., Hewlett-Packard Co., and IBM Corp., are losing market share.
This group won 40 percent of the region's contracts last year, compared with a 60 percent share in 2002.
Franz said the increased competition shows clients are more receptive to doing business with the non-Big Six providers.
"Alongside the global giants of outsourcing, there is clearly room for smaller, specialized service providers who can address specific client needs," he said.
"At the moment success for service providers in Australia, India and Japan , seems to be the determining factor for success in the Asia Pacific."
Indian outsourcers are increasingly becoming the big winners in the region.
For example, Tata Consultancy Services Ltd. (TCS) announced today it has become the first Indian IT company to net $1 billion in revenues in one financial quarter (Q3 ending December 31, 2006) and post a 40 percent revenue increase year on year.
TCS recently signed a multi-year application development and support contract worth $90 million with Qantas.
Another provider Infosys Technologies Ltd., said earlier this month it expects full year revenue to be US$3.09 billion, up by 43.6 percent from revenue in the previous fiscal year.
In Australia, more than A$7 billion (US$5.46 billion) worth of outsourcing contracts are up for grabs in 2007.
According to research firm IDC, which has released the results of its 2006 Australian outsourcing end-user survey, a number of large contracts are expected to go with selective sourcing as organizations continue to unbundle mammoth IT contracts and look to best-of-breed providers.
IDC research manager for outsourcing and BPO (Business Process Outsourcing), Aprajita Sharma, said tier one providers face tough competition from Indian offshore outsourcers.
1/19/2007
Why Outsourcing Takes Your Business to a Higher Level
Outsourcing is a term used in business and it is gaining popularity on the net as millions of web site owners discover they do not have all the tools and skills necessary to handle each and every portion of their businesses.
Unlike having to find, interview, and hire an employee - and thus incur the tax liability of a new employee - often savvy business owners turn to outside companies. Outsourcing services take on the tasks underlying a business leaving the owner more free time to pursue the front-end of his or her business.
Wikipedia states:
"Outsourcing" involves transferring or sharing management control and/or decision-making of a business function to an outside supplier, which involves a degree of two-way information exchange, coordination and trust between the outsourcer and its client."
Outsourcing, therefore, becomes an integrated part of your business. The importance is to determine what should be outsourced, why it should be outsourced, and who will provide your outsourcing services.
Business segments typically outsourced include:
* Information technology
* Human resources
* Facilities
* Real estate management
* Accounting
* Direct Online Marketing and SEO
In addition, many companies also outsource their customer support and rely on call center functions.
Using the Know How of Others
The business owner must be able to step back and make an honest evaluation of his or her talents. We are not all created equal. We all have different strengths. One surefire strength for business success that a business owner must cultivate is the ability to delegate responsibilty through the use of outsourcing. That's how a well-run, profit-pulling online business accomplishes its goals.
Today's businesses - large and small - gain immense benefits by finding other companies outside their own arena who possess the technological know how to analyze, plan, and implement target objectives.
In the case of the smaller web site owner looking to gain greater footing with the hot market of search engine results, finding an outsourcing service to handle marketing (and a small portion of advertising) is one such effective strategic move.
Traditional approaches to search engine marketing have, for decades, focused primarily around a web site's meta tags, firming up web page content, and then submitting the site on a regular basis to the search engines. From a purely advertising basis, other companies will insist that just driving "targeted traffic" to a site is "enough."
While both of these methods are viable, a good outsourcing company often adds these two methods at low cost or no cost - just bonuses while the real work of marketing is underway.
Choosing the Right Outsourcing Company
As an online business owner it is easy to become frozen in place trying to keep up on all the possible, working, methods for marketing online. Even if one could find the time to read everything and devise a plan, putting that plan into action becomes cumbersome. Doing even the "smallest" of tasks can literally take hours of your week away from you. Hours better spent on web site enhancements and new products, mailing list contacts, and just being there for your web site visitors. Unless the web site owner is willing to give up some control, the grind of working the foundation of marketing too often must supercede the human approach to being there for your customers.
While we all love to do our initial digging online, pick up a phone and call or send email inquiries or submit forms for call back when choosing an outsourcing service. Make sure your questions are addressed intelligently and at a level of understanding that you feel most comfortable with. Avoid listening to prescripted sales pitches where all they want to do is monopolize the phone and beat you down to the point where you really don't know what they can or cannot do. Take control of the conversation, then turn that conversation into an effective two-way street of open communication. Any company not willing to do that - or vague in their explanations of how - should be moved to the bottom of your list as you locate the best outsourcing company to work with you and your website.
Finding a company that understands and weeds out fad flash-in-the-pan methods, and builds your marketing business on solid, proven methods of web site promotion should be your goal. Find that company and establish a two-way street of information and trust in order to work effectively together.
How to Incorporate Outsourcing Into Your Business
"Prior to the contract development of any outsourcing agreement, the outsourcing company develops a request for proposal (RFP) document which highlights the major requirements and scope of the project which is to be outsourced."
Through a bid-like process, or the acceptance of agreed upon stated services at given costs, the recipient company has an actual proposal of services in hand. They know what they are getting, what timeframe to expect, and projected results from this outsourced service.
By outsourcing, the owner understands what the benefits to the service(s) are, but the strategizing, planning, and implementating can be safely placed into more knowledgeable and efficient hands to get the job done.
In Summary
Outsourcing is not just for the "big guy." Overall outsourcing is viewed by many organizations as a strong business tactic that ultimately is a superior economical approach to developing products and services.
Simply put, don't try to do everything yourself. You may have many fine strong points, but running your online internet business single-handly should not be one of them. Learn when and delegating responsibility can actually make your business grow by leaps and bounds. Then find an outsourcing service you can work with - one with a complete understanding of your web site - one that is willing to go extra miles to make your business a success.
Unlike having to find, interview, and hire an employee - and thus incur the tax liability of a new employee - often savvy business owners turn to outside companies. Outsourcing services take on the tasks underlying a business leaving the owner more free time to pursue the front-end of his or her business.
Wikipedia states:
"Outsourcing" involves transferring or sharing management control and/or decision-making of a business function to an outside supplier, which involves a degree of two-way information exchange, coordination and trust between the outsourcer and its client."
Outsourcing, therefore, becomes an integrated part of your business. The importance is to determine what should be outsourced, why it should be outsourced, and who will provide your outsourcing services.
Business segments typically outsourced include:
* Information technology
* Human resources
* Facilities
* Real estate management
* Accounting
* Direct Online Marketing and SEO
In addition, many companies also outsource their customer support and rely on call center functions.
Using the Know How of Others
The business owner must be able to step back and make an honest evaluation of his or her talents. We are not all created equal. We all have different strengths. One surefire strength for business success that a business owner must cultivate is the ability to delegate responsibilty through the use of outsourcing. That's how a well-run, profit-pulling online business accomplishes its goals.
Today's businesses - large and small - gain immense benefits by finding other companies outside their own arena who possess the technological know how to analyze, plan, and implement target objectives.
In the case of the smaller web site owner looking to gain greater footing with the hot market of search engine results, finding an outsourcing service to handle marketing (and a small portion of advertising) is one such effective strategic move.
Traditional approaches to search engine marketing have, for decades, focused primarily around a web site's meta tags, firming up web page content, and then submitting the site on a regular basis to the search engines. From a purely advertising basis, other companies will insist that just driving "targeted traffic" to a site is "enough."
While both of these methods are viable, a good outsourcing company often adds these two methods at low cost or no cost - just bonuses while the real work of marketing is underway.
Choosing the Right Outsourcing Company
As an online business owner it is easy to become frozen in place trying to keep up on all the possible, working, methods for marketing online. Even if one could find the time to read everything and devise a plan, putting that plan into action becomes cumbersome. Doing even the "smallest" of tasks can literally take hours of your week away from you. Hours better spent on web site enhancements and new products, mailing list contacts, and just being there for your web site visitors. Unless the web site owner is willing to give up some control, the grind of working the foundation of marketing too often must supercede the human approach to being there for your customers.
While we all love to do our initial digging online, pick up a phone and call or send email inquiries or submit forms for call back when choosing an outsourcing service. Make sure your questions are addressed intelligently and at a level of understanding that you feel most comfortable with. Avoid listening to prescripted sales pitches where all they want to do is monopolize the phone and beat you down to the point where you really don't know what they can or cannot do. Take control of the conversation, then turn that conversation into an effective two-way street of open communication. Any company not willing to do that - or vague in their explanations of how - should be moved to the bottom of your list as you locate the best outsourcing company to work with you and your website.
Finding a company that understands and weeds out fad flash-in-the-pan methods, and builds your marketing business on solid, proven methods of web site promotion should be your goal. Find that company and establish a two-way street of information and trust in order to work effectively together.
How to Incorporate Outsourcing Into Your Business
"Prior to the contract development of any outsourcing agreement, the outsourcing company develops a request for proposal (RFP) document which highlights the major requirements and scope of the project which is to be outsourced."
Through a bid-like process, or the acceptance of agreed upon stated services at given costs, the recipient company has an actual proposal of services in hand. They know what they are getting, what timeframe to expect, and projected results from this outsourced service.
By outsourcing, the owner understands what the benefits to the service(s) are, but the strategizing, planning, and implementating can be safely placed into more knowledgeable and efficient hands to get the job done.
In Summary
Outsourcing is not just for the "big guy." Overall outsourcing is viewed by many organizations as a strong business tactic that ultimately is a superior economical approach to developing products and services.
Simply put, don't try to do everything yourself. You may have many fine strong points, but running your online internet business single-handly should not be one of them. Learn when and delegating responsibility can actually make your business grow by leaps and bounds. Then find an outsourcing service you can work with - one with a complete understanding of your web site - one that is willing to go extra miles to make your business a success.
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