Financial services factory

Factory

Financial services factory

Suresh Gupta Partner, Capco

Abstract According to a recent survey of CEOs by IBM (2006)1, financial

occurred in the manufacturing sector, wherein best-in-class

services (FS) firms are increasingly looking at innovating their

companies like General Electric have developed sophisticated

business model and operational capabilities to achieve differ-

sourcing models to optimize the value chain of their opera-

entiation, efficiency, and resilience in a commoditized market-

tions. By componentizing their business processes, the FS

place. Recent research conducted jointly by a team drawn

firms have begun to look at each component independently of

from Capco and the London Business School highlights how

the other components while selecting the best sourcing option

the world’s top financial services firms are deploying new

(i.e., insourced or outsourced, onshore and/or offshored, etc.)

sourcing strategies and models to move up the process inno-

Should the trend continue tomorrow’s banks would look and

vation curve. This closely resembles events that have already

behave no differently to a factory.

1

“Expanding the innovation horizon,” The global CEO study 2006, IBM Global Business Services

43

Financial services factory

In recent times, the financial services industry has witnessed

■ As the level of sophistication has grown, FS firms have

a shift towards a more demanding operating environment,

begun to outsource and offshore not just horizontal

brought about by increased competition and a commoditized

processes but also vertical business processes.

marketplace. This has forced leaders to innovate to achieve

■ While cost savings continue to be the dominant motive for

differentiation, efficiency, and resilience in their markets.

componentization and utilization of global sourcing, quali-

Unfortunately, most FS firms are saddled with rigid, inflexible

ty improvements and flexibility are rapidly catching up as

legacy technologies and processes. This problem is compounded further by the often insular management styles and

important drivers. ■ Experience confers sophistication; the more experienced

risk averseness of executives who have risen to the top by the

among our respondents outsourced/offshored more chal-

very practices which today look out-of-synch with the newly

lenging processes, experienced fewer hidden costs, man-

globalized markets.

aged multiple models effectively, and collaborated intensively with their suppliers.

Nevertheless, there are encouraging signs from the FS sector.

■ The most significant management challenges in global

Based on responses from the world’s top FS firms who partic-

sourcing of services are often at the operational level.

ipated in the recently released London Business School/Capco

Good project management capabilities are cited as the sin-

study2, we find that increasingly they are developing manufac-

gle most important ingredient for an effective global

turing-like capabilities by componentizing their processes and deploying low-cost, high quality, and flexible operating models.

sourcing capability. ■ Experienced companies demonstrated advanced knowl-

The research further highlights how the leading FS firms are

edge on the decision-making process of sourcing options,

exploiting the new sourcing strategies and models in moving

which include the weighting of coordination and control

up the process innovation curve. Our research, comprising of

issues as well as the competence of the company at imple-

responses from sixty-two senior (CXO level) respondents from

menting sourcing arrangements.

the largest banking, financial services, and insurance companies, highlight the following findings: ■ Borrowing a leaf from the manufacturing sector, FS firms

Componentization — an important step in enabling outsourcing

have begun to actively componentize their business

The concept of componentization has been prevalent in the

processes to help deploy alternative sourcing models.

manufacturing sector for decades. It became popular as the

Using the concept of modularity, companies are decon-

manufacturing firms focused on achieving optimal rates of

structing their end-to-end business processes into a series

production efficiency. For the leading firms this not only

of discrete components; each component is then treated

meant investments in new plant and equipment, but also off-

independently when assessing the best organizational

shore relocation of production facilities to benefit from lower

model (i.e., insourcing, outsourcing, co-sourcing,

labor costs. For many companies today these investments

nearshoring, offshoring, etc.) to support it.

and offshore relocations are outsourced to third party con-

■ Having proved the concept of componentization, firms no

tract manufacturers who play increasingly important roles in

longer think about ‘whether to outsource’ and ‘whether to

driving innovation and efficiency in these sectors. In some

offshore’ decisions in isolation, but consider multiple

industries, such as pharmaceuticals, contract manufacturing

mixed options simultaneously.

represents over 50% of all manufactured goods3.

■ The use of multiple-vendor, multiple-geography sourcing

44

framework is providing further impetus for innovation and

As noted by Irving et al. (2003)4, the financial services sector

reduction of complexity.

is also no stranger to the practice of contractual outsourcing:

2 Gupta, S., P. Puranam, and K. Srikanth, 2006, “Sourcing in the banking and financial services industries: exploding myths and describing emerging best practices,” Capco Institute Research in collaboration with London School of Business, June

3 van Arnum, P., 2000, “Bulls or bears? Outlook in contract manufacturing,” Chemical Market Reporter, Feb 14, FR3-FR6 4 Irving, B., S. Shojai, and S. Gupta, 2003, “Discovering the endgame in the offshore debate,” Journal of Financial Transformation, 8, 103-112

Financial services factory

the industry has a long history of utilizing “correspondent

complex business processes by deconstructing these into less

services” including corporate trust, custody, securities clear-

complex individual activities which could then be performed

ing, etc. However, for a long time such outsourcing agree-

by workers possessing specialized skills. Moreover, it helps in

ments has been limited to onshore ‘utility’ business models.

increasing productivity and quality of the process. New capa-

Use of componentization of complex business processes and

bilities can be added by using outsourced/offshored ‘pack-

offshoring of individual components to multiple destinations

ages’ while leveraging a highly efficient cost base.

and providers around the globe by financial institutions is relatively recent and an emerging trend.

Our research indicates that when used in conjunction with offshoring, componentization can deliver massive benefits.

The findings of Gupta et al. (2006) supports this hypothesis:

This model assumes three important capabilities: disaggre-

almost 25% of the firms in the sample use ‘multi-location/

gating (and digitizing) a process into self-contained compo-

multi-vendor’ business models for managing individual com-

nents and using broadband to ship them offshore; processing

ponents of their operational value chains. For example, one of

each component using best mix of offshore resources and

the FS institutions uses two vendors and two captive centers

shipping them back to the original location; and reassembling

(one onshore and another one offshore) for managing its

the ‘processed’ components into a coherent whole. This divi-

mortgage underwriting process. Taken together, the process

sion of effort cannot take place in a vacuum, however; the dif-

is dispersed around three different countries; each location

ferent components must work together, and the whole must

performs specific activities in the end-to-end process before

accomplish more than any subset of its parts. Therefore, one

the end-results are ‘assembled’ back in the onshore location

needs a structured way of coordinating tasks and decisions at

for fulfilling the original customer request.

each component to ensure consistent and useful performance of the end-to-end process.

Thus a world in which globally dispersed third-party contract ‘manufacturers’ would make it possible for the financial serv-

Here it helps to look at how the manufacturers use compo-

ices firms of tomorrow to become virtual organizations that

nentization. Carmakers routinely arrange to manufacture the

focus predominantly on servicing their clients does not

components of an automobile at different sites and bring

appear that far.

them together for final assembly. They can do so because they have completely and precisely specified the design of

The approach to componentization

their parts6. At the same time, however, this componentiza-

Componentization is the process of breaking up processes or

tion allows carmakers to mix and match individual parts to

activities into logical, self-contained groups that result in

come up with many different styles and models to suit cus-

independent reusable components that are available for use

tomer preferences. Another example is how consumers often

across a firm. In this sense, componentization is analogous to

buy bed frames, mattresses, pillows, linens, and covers made

the concept of ‘modularity’ practiced in the design and man-

by different manufacturers and distributed through different

ufacturing of physical goods. Modularity is also a means of

retailers. The parts fit together because different manufac-

reducing complexity. As noted by Baldwin and Clark (2000)5,

turers make the goods in standard sizes. Thus, in practice,

“if an artifact can be divided into separate parts, and the

componentization can promote innovation: the manufacturers

parts worked on by different people, the ‘one person’ limita-

can independently experiment with new products and con-

tion on complexity disappears.”

cepts (i.e., futon mattresses and fabric blends) as long as their products conform to the standard dimensions.7 (Some

Thus, FS firms using componentization are able to simplify

sectors of the FS sector have already experienced the eco-

5 Baldwin, C. Y., and K. B. Clark, 2000, Design Rules: Volume 1 – The power of modularity, The MIT Press, Cambridge, Massachusetts 6 Nevins, J. L. and D.V. Whitney, 1989, Concurrent design of products and processes: a strategy for the next generation in manufacturing, McGraw Hill, New York

7 Christensen, C. M. and R. S. Rosenbloom, 1995, “Explaining the attacker’s advantage: technological paradigms, organizational dynamics, and the value network,” Research Policy, 24, 233-257. Baldwin, C. Y., and K. B. Clark, 1997 “Managing in an age of modularity,” Harvard Business Review, 75:5, 84-93

45

Financial services factory

nomic benefits of componentization. For example, FTS, a provider of credit card processing services enjoys a signifi-

OTC confirmation process

cant market capitalization, in some cases way above the credit card issuers themselves. Similarly, Fair Isaac has gotten into the heart of credit decisioning in virtually every credit card

Sell OTC contract

Confirm

Execute receipts and deliveries

Process exceptions

Process fails and exceptions

Close

decision that happens in the world. Both FTS and Fair Isaac developed these businesses as credit card issuers componentized their business processes [IBM (2006)].) Componentizing the financial services processes would entail standardizing (and documenting) each component activity in

Figure 1 – The OTC derivative process

such a way that if two different vendors were working on the same component they would produce consistent results in

A global investment bank used this model when offshoring

processing the activity. Except in the case of routine com-

pieces of their OTC derivatives process. Figure 1 is a highly

moditized processes, such as processing invoices, such a uni-

simplified depiction of the overall process. As a way of reduc-

versal standardization would be almost impossible. However,

ing operational costs, the investment bank wanted to off-

the information technology systems provide the necessary

shore as much of the process as possible to their offshore

glue for enabling this standardization in practice when deal-

center in India. As a start, they decided to componentize and

ing with technology-enabled business processes. As long as

offshore the OTC confirmation process. The offshore center

the different locations and vendors use the same IT systems,

in India took over the responsibility of initiating (phone calls,

one can be reasonably comfortable that the outputs from

faxes, e-mails, etc., to the counterparties) while the more

multiple providers can be ‘assembled’ into a coherent whole.

experienced resources based in London processed excep-

Unfortunately technology-enabled nirvana is still a distant

tions. Using this model the investment bank was able to min-

dream in many FS processes. Can componentization and off-

imize their investment in knowledge transfer and training of

shoring work for those processes. The answer is ‘yes’ except

the India-based staff while reaping as much as 40 percent

that the coordination challenge in dealing with such process-

savings in operating costs.

es tends to be magnified. Once a firm has proven the concept, they can begin reaping

46 - The

The coordination challenge in componentizing FS processes

significant cost savings by using dramatically lower cost off-

lies in (a) specifying clearly the hand-offs between various

shore labor. However, our research suggests that labor arbi-

locations and (b) the knowledge transfer and training neces-

trage alone is not sufficient to sustain offshoring; firms must

sary for ensuring that geographically dispersed resources

also look at skills, capabilities, and experience of the available

apply a common set of decision rules when processing indi-

resources as well as managing the structural and operational

vidual components.

risks associated with far-flung locations.

Componentization may, in fact, be helpful for processes that

Assuming risks are appropriately managed, it makes concep-

cannot be automated completely: relatively ‘simple’ compo-

tual sense to parcel out individual components using whatev-

nents can be handed off to low-cost, less skilled resources

er model works best for a given component (captive, out-

while the more ‘complex’ components would be processed

sourced, and/or shared ownership) and particular location

directly by experienced, skilled resources.

(onshore, nearshore and/or offshore.) Indeed, this multi-loca-

journal of financial transformation

Financial services factory

tion, multi-model approach to provisioning FS processes is

ple, by compressing the time it takes to approve a mortgage

the hallmark of componentization. Similar to how a modern

or a credit card application retail banks can gain significant

manufacturing firm operates, a bank may have research per-

competitive advantage. In one instance, by applying these

formed in India, derivatives processed in Russia, reference

concepts, an investment bank enjoyed over 50% decrease in

data processed in Singapore, applications development

the cost of fails and 32% improvement in productivity in its

sourced from centers in Europe and Asia, and customer serv-

mortgage-backed securities back-office operations9.

ice handled in Ireland, India, and South Africa. Each location chosen for its unique skill sets and capabilities!

The Capco–London Business School research findings support componentization trend

Using componentization facilitates application of best practice manufacturing tools and techniques

Capco and the London Business School undertook a research

By componentization FS firms can take advantage of tools

shoring in the financial services industry. Our research specif-

and techniques that have been instrumental in revolutioniz-

ically revolved around answering the following questions:

study to identify best practice trends in outsourcing and off-

ing the manufacturing sector. For example, by applying the concepts of Lean Manufacturing in areas such as check pro-

■ How do experienced firms differ in their sourcing strate-

cessing, credit application and approval, and call centers,

gies from inexperienced players? What can the newcom-

banks could see one-off improvements in their efficiency ratio of 2 to 5 percentage points according to Goland et al. (1998)8. The concept of Lean Manufacturing looks at optimizing all aspects (inputs, process, outputs, and performance feedback) of a typical manufacturing process (Figure 2).

ers learn from them? ■ What makes a process suitable for outsourcing or for off-

shoring? Are the criteria different? ■ What do they see as the primary constraints and manage-

ment challenges?

The idea is to eliminate waste of any kind at every stage of

The dataset included 62 responses from a wide cross-section

the manufacturing process, including materials, labor, work-

of firms in the industry, including large global firms with wide

in-process, defects, etc. It is not hard to visualize how a bank’s

experience in outsourcing and offshoring. Two-thirds of the

process, say loans underwriting, could be modeled following

respondents were in the top fifteen in their sector and in their

this structure. Hence, by applying the Lean Manufacturing

region (Figure 3). The respondents included executives from

principles, banks can gain long lasting advantages in terms of

seven of the top fifteen commercial banks, seven of the top

both processes (quality and lead times, for instance) and output (cost, customer satisfaction, and market share). For examRespondents by business type Investment bank Inputs (Materials, labor, etc.)

Process (e.g., drilling, welding, etc.)

Outputs (e.g., nuts and bolts, etc.)

41%

Retail banking

27%

Insurance Asset Management

25% 7%

Other 0% Respondents by location Performance feedback (e.g., defects, units per hour, etc.)

Figure 2 – Typical manufacturing process

8 Goland, A. R., J. Hall, and D. A. Clifford, 1998 “First national Toyota,” McKinsey Quarterly 9 Gupta. S., 1989, “Process control for the securities industry,” UMI Dissertation Services

U.K.

56%

U.S. Europe

27% 16%

Figure 3 – Survey respondents

47

Financial services factory

ten investment banks, eight of the top ten diversified financials firms, and five of the top thirty insurance firms. The

Achieve strategic agenda

largest response group was from the U.K., followed by the

Performed technology upgrade

U.S., and Europe. The services sourced by these firms includ-

Achieve process transformation

ed IT application development, IT maintenance and service,

Access to quality workforce

horizontal processes (cross business unit), vertical processes (business unit specific), and voice-based processes.

Achieve flexibility Achieve quality improvement

Based on the responses from FS firms who participated, we

Achieve cost savings

found that a number of them are developing manufacturinglike capabilities: they are increasingly modeling their labor intensive processes — such as check sorting, credit evalua-

0%

10%

20%

30%

40%

50%

60%

70%

80%

Outsourcing Offshoring

tion, and call centers — as ‘factories.’ They are optimizing these processes by componentizing and providing the most

Figure 4 – Criteria for sourcing success

effective and efficient sourcing model for each component. The componentization of the operational, IT, and business

offshoring against the superior skills, quality, and lower costs

processes of the FS firms and utilization of alternative sourc-

available offshore and from third-parties.

ing models is enabling the leading firms to derive benefits that go beyond the expected cost savings, including higher

Consistent with the theme of componentization, almost 25%

quality, access to scarce skills, and greater flexibility.

of the respondents in our research utilize in-house and outsourced, ‘multiple-vendors, multiple-locations’ models for

Both ‘core’ and ‘non-core’ processes are being componentized

sourcing their IT and business process needs.

Our research reveals that the trend towards componentization is extending to both ‘core’ and ‘non-core’ processes. We

The emergence of a global sourcing model as the byproduct of componentization

found that over half (58%) of our respondents are using

Financial services firms finally appear to be adopting what

some combination of outsourcing and offshoring for vertical

can truly be described as a ‘global services sourcing model’

processes (i.e., mortgage underwriting); many of these

on the strength of a process of componentization of the serv-

processes have traditionally been viewed as ‘core.’ A partial

ices value chain. The ability to componentize the operating

explanation for this shift may stem from the fact that vendors

model has opened up a range of sourcing options (Figure 5).

are increasingly offering more sophisticated solutions and

Now it is possible for a North American or European firm to

acquiring domain knowledge and experience to penetrate the

establish competency centers in different locations around

vertical BPO segment. Also, countries such as India and the

the globe based on the most optimal combinations of cost,

Philippines have moved up the maturity curve and are able to

quality, or skills offered by a particular locale. Many of these

offer specialized skills among the white-collar workforce.

‘competency’ centers may be ‘captive’ while some others may

Finally, global FS firms have become more sophisticated in

be outsourced to third-parties.

their decision making and in understanding and managing

48 - The

the operational and structural risks of outsourcing and off-

In our study, the majority of the respondents use several dif-

shoring. They seem better prepared to trade-off the incre-

ferent sourcing options. 67% have outsourced to offshore

mental coordination effort and expense of outsourcing and

vendors. A significant 52% have outsourced vertical business

journal of financial transformation

Financial services factory

processes to an offshore location and 39% to an offshore

On-site

Near-shore

Offshore

Complete ownership

Status-quo (neither outsourced nor offshored)

In-house, near-shore (captive center in nearby location)

Captive offshore

Shared ownership

JV onshore

JV near-shore

JV offshore

No ownership

On-site vendor

Offsite near-shore vendor

Offshore vendor

Near-shore

Offshore

• Process is world class • Direct customer contact • Process not mature • Brand impact

• No one else offshored • Lack of scale • Frequent changes • Complex/tight linkage

• Familiar with offshore location • Long-term viability • Risk of competitor access • Difficult to get back to SQ • Domain experience

• Difficult to get back to SQ • Complex/tight linkage • Business transformation • Less defined/ unstable

• Difficult to get back to SQ • Complex/tight linkage • Business transformation • Less defined/ unstable

• Familiarity with offshore location • Difficult to get back to SQ • Complex/tight Linkage • Business transformation

• Frequent changes • Complex/tight linkage • Business transformation

• Frequent changes • Complex/tight linkage • Process not mature

• Familiarity with offshore location • Long-term viability • Lack of scale

captive. 49% of the European participants have established onsite/near-shore shared services and 67% of European respondents manage captive centers offshore.

The anatomy of a componentized operating model The more sophisticated of our respondents are seeking to create a robust and dynamic operating model enabling them to respond to market forces with unusual agility and nimbleness. The ‘product-focus’ characteristic of the financial serv-

Figure 5 – Sourcing options

ices sector of the old days is giving way to a new ‘processfocus’ and, as a result, componentized operating model. On-site

The results from our research indicate an increased willingness to ‘flex’ the sourcing model over time as a firm gains experience and confidence in managing componentized

Complete ownership

processes. There is also clear evidence of firms becoming more proficient over time at managing this network of distributed service delivery centers spread across geographic and ownership boundaries. Our research also shows that there is a robust and fairly wide-

Shared ownership

ly shared logic around the match between process characteristics and sourcing options — given certain process attributes, some choices are perceived as being superior to others. These are summarized in Figure 6.

No ownership

The future Financial services firms are moving to a componentized,

Figure 6 – Top reasons for choosing a particular sourcing model

agile, and dynamic operating model by increasingly leveraging best practices found in the manufacturing sector. Global sourcing must form the key underpinning of this model.

management team. As the operating model changes so too

Offshoring as a way of exploiting labor arbitrage has become

will the processes sourced and the nature and location of

a dated concept. Global sourcing will be characterized by its

sourcing decisions.

spread of sourcing partners, locations, and its ability to remain dynamic and flexible. A corollary is that once a sourc-

True agility in the componentized world would require insti-

ing decision has been made, organizations must recognize

tuting dynamic sourcing models, where a firm could change

that these are not set in stone. This is an ongoing process

the supply sources of an individual component without

which should be supported by a proactive central change

undergoing a painful and prolonged transition — establishing

49

Financial services factory

multi-vendor, multi-location sourcing models with built-in redundancies is a necessary first step in that direction. Such models coupled with robust governance structures and processes would provide the sufficient next step in realizing a flexible and agile operating model. In the current environment, trailblazers in the financial services sector are proving that offsetting rising costs, tightening profit margins, and increased competition through comprehensive componentization and dynamic sourcing programs will be a strong defense. Companies can only ignore these signs at their peril.

50 - The

journal of financial transformation