IT Outsourcing and Offshoring: Hype or Opportunity?

IT Outsourcing and Offshoring: Hype or Opportunity? IT Cost Benchmarking in the European Banking Industry BCG REPORT

IT Outsourcing and Offshoring: Hype or Opportunity? IT Cost Benchmarking in the European Banking Industry RAINER MINZ HEINZ MÖLLENKAMP ASTRID BLUMSTENGEL EDELTRAUD LEIBROCK EDUARD NEUFELD CLAUDIA VAN LAAK ANNETTE WOLTER JUNE 2005 www.bcg.com

Table of Contents Note to the Reader 4 Acknowledgments 5 Preface 6 Executive Summary 7 The Myths and Realities of IT Outsourcing and Offshoring 9 Outsourcing: It Is on the Rise, but the Benefits Can Be Elusive 10 Offshoring: Most Banks Take a Cautious Approach 14 Annual IT Benchmarking Along Key Dimensions 19 Performance: Higher IT Spending Correlates with Higher Revenues, but the Root Cause of the Link Is Unclear 19 Investment Cycle: Wide Variations in Change-the-Bank Spending Reflect Banks Current Business and IT Positions 22 User Satisfaction: Transparency Problems Dampen Ratings 24 Management Practices: There Is Room for Improvement in IT Planning and Control 26 Methodology 28 Glossary 29 IT Outsourcing and Offshoring: Hype or Opportunity? 3

Note to the Reader If you would like to discuss your banking business or its IT-related aspects with The Boston Consulting Group, please contact one of the following leaders of our global Financial Services and Information Technology practices: Europe Rainer Minz BCG Cologne +49 221 55 00 50 minz.rainer@bcg.com Heinz Möllenkamp BCG Cologne +49 221 55 00 50 moellenkamp.heinz@bcg.com Hanno Ketterer BCG Amsterdam +31 35 548 6800 ketterer.hanno@bcg.com Ralf Dreischmeier BCG London +44 207 753 5353 dreischmeier.ralf@bcg.com Christophe Duthoit BCG Paris +33 1 40 17 10 10 duthoit.christophe@bcg.com Klaus Keßler BCG Athens +30 210 7260 200 BCG Düsseldorf +49 211 30 11 30 kessler.klaus@bcg.com Pedro Soria BCG Madrid +34 91 520 6100 soria.pedro@bcg.com Dieter Tschach BCG Vienna +43 1 537 5680 tschach.dieter@bcg.com Martin Tschopp BCG Zürich +41 1 388 8666 tschopp.martin@bcg.com The Americas Simon Kennedy BCG Boston +1 617 973 1200 kennedy.simon@bcg.com Boyd Pederson BCG Toronto +1 416 955 4200 pederson.boyd@bcg.com Michael Spellacy BCG New York +1 212 446 2800 spellacy.michael@bcg.com Asia-Pacific Thomas Achhorner BCG Hong Kong +852 2506 2111 achhorner.thomas@bcg.com Danny Dale BCG Melbourne +61 3 9656 2100 dale.danny@bcg.com Thomas Reichert BCG Sydney +61 2 9323 5600 reichert.thomas@bcg.com 4 BCG REPORT

Preface Information technology, in its capacity to enable superior products and processes and to enhance overall operational efficiency, can be a significant source of competitive advantage for banks. They therefore need to optimize their IT strategy and align it with their business strategy to the fullest extent that they can. In order to embark on an IT improvement journey one clearly worth making now that IT spending represents roughly 11 percent of the average bank s revenues banks can begin by asking themselves a few elementary, yet critical, questions: What is the state of our IT function today? What would our target IT function look like? What steps can we take in order to begin the journey toward our IT goals? To answer these questions, banks need to analyze their IT cost positions within a peer group, identify IT cost drivers, and understand how IT spending influences their overall cost and revenue footprint. Banks also need to develop a firmer grasp on how their IT strategy meshes with their short- and longterm business strategies. In The Boston Consulting Group s annual IT benchmarking in banking study, we have addressed these questions with 25 leading European banks in an attempt to provide insights on IT performance, investment cycles, user satisfaction, and management practices. In addition, we have chosen IT outsourcing and offshoring as the special focus of this year s survey because it has become an increasingly complex and important issue in banks efforts to achieve both their operational and their strategic goals. This report, the second in an annual series, summarizes the key findings of our survey conducted in 2004. It is based on actual data for 2002 and 2003 and on forecast data for 2004. Our findings, in addition to our experience working with leading banks on IT-related issues, have helped us identify the most promising levers that banks can use to improve their IT performance. Putting these levers into practice remains a major challenge for most banks, requiring a highly focused plan of action that is fully supported by senior management. We hope the report will be thought provoking and serve as a source of useful information for senior business and IT executives in these extremely challenging times for the global banking industry. 6 BCG REPORT

Executive Summary Relatively few European banks have benefited from IT outsourcing obtaining IT services from an external company to the extent they anticipated. Nonetheless, most intend to increase outsourcing activities in pursuit of reduced labor costs, specialized skills, process expertise, superior technical resources, and increased ability to focus on core businesses. European banks devote an average of 8 percent of their IT spending to outsourcing, compared with 21 percent for other European industries. Legal constraints have limited outsourcing activities for some European banks. U.K.-based institutions generally have the most outsourcing experience and report the highest level of outsourcing success. Banks that pursue outsourcing must make key decisions on the overall scope of their efforts, the specific IT functions to be outsourced, and the outsourcing model to be followed. Desktop services and local support are currently the IT functions most widely outsourced by European banks. Initial decisions lay the foundation for further steps, so banks should focus first on developing the right outsourcing strategy for their institution. Key elements of outsourcing strategy include determining the bank s overall potential and readiness for outsourcing, establishing business cases for specific activities, and setting priorities. IT offshoring obtaining IT services from internal or external personnel abroad has not been widely pursued by European banks. Most banks that have engaged in offshoring have not fully achieved their most important goals, such as significant reductions in labor costs. U.K.-based banks report the best and most consistent offshoring results. As they do when considering outsourcing, banks that pursue offshoring must make choices regarding the scope of their program, the IT functions to be offshored, and the model to be followed. Application development is the most commonly offshored IT activity. To be successful at offshoring, banks must first ensure that their institutions are ready, both organizationally and culturally. Cultural elements are particularly crucial when it comes to the willingness of bank employees to accept an arrangement that requires close collaboration with people from other cultures and that may lead to job cuts in the home market. Both offshoring and outsourcing carry potential risks such as new costs and additional management complexity that must be considered when assessing the potential advantages of these activities. Both offshoring and outsourcing should be approached in phases and initially should involve simple processes with well-understood interfaces. Banks that spend more on IT tend to have higher revenues, but it is unclear whether these revenues result from higher IT spending or whether banks with higher revenues simply spend more on IT. Most banks struggle to translate IT spending into higher revenues or into lower non-it operating expenses. IT spending by European banks has been relatively stable since 2002, growing by an average of 0.5 percent per year. On average, IT costs represent 11 percent of revenues, 15 percent of total operating expenses, 0.26 percent (26 basis points) of total assets, and about 22,000 per bank employee. To improve IT performance, banks need to establish a strong IT organization, manage an integrated project portfolio at the corporate level, and develop and control IT performance indicators linked to business metrics. European banks have widely varying priorities regarding IT cost cutting, restructuring programs, and the development of new IT functionality. On average, banks spend 73 percent of their IT budgets on maintaining the steady state of IT operations (run-the-bank costs) and 27 percent on innovation primarily in application development that changes the bank s IT functionality (change-the-bank costs). IT Outsourcing and Offshoring: Hype or Opportunity? 7

Extended periods of insufficient spending on change-the-bank IT initiatives are risky because investing in new IT functionalities helps lay the groundwork for a bank s improved competitiveness and ability to shape the market. The largest share of IT costs is for employees. At European banks, salaries and benefits account, on average, for about 41 percent of total IT costs (24 percent for staff personnel costs, 15 percent for external-employee costs, and an estimated 2 percent for the manpower-related part of outsourcing costs). Clearly, IT is not just about computer hardware and software but also about people and should be managed accordingly. Banks internal customers are only moderately satisfied with their IT departments. IT users see a lack of transparency in cost allocation as the largest shortcoming. They report reasonably high levels of satisfaction with the availability of mission-critical, end-user applications and with IT departments overall responsiveness and problem-solving skills. Relatively high IT spending and change-the-bank cost shares do not generally lead to higher user satisfaction in the same year. In subsequent years, however, such spending may have this effect. To improve internal IT user satisfaction, banks need to establish a process that combines regular analysis of user satisfaction with follow-up action aimed at actually solving the problems that have been identified. European banks assess the quality of their IT management practices as moderately high (with excellent ratings being rare). The area with the greatest room for improvement is IT planning and control. Banks give themselves relatively high ratings for aligning IT and business strategies and for having an efficient sourcing mechanism in place. Banks that rate their IT management practices above average tend to have more-satisfied IT users. To improve IT management practices, banks should increase their efforts to plan and manage IT projects collaboratively with future users that is, with their business units. 8 BCG REPORT