Global sourcing: a strategic imperative

By outsourcing trade processing requirements to a global bank, smaller players can maintain and grow their existing trade customer base, meet the expectations of their customers, and continue to enjoy a revenue stream from these activities, writes Mike Quinn, global trade services, JPMorgan Chase.

In a highly competitive and increasingly global marketplace, all companies are scrutinising every aspect of their business model. Senior management must maintain a constant focus on their markets, on the needs and satisfaction of their customers, and on the financial performance of their enterprise. However, the key determinant of financial success – the ability to truly differentiate one’s performance – is determined by the company’s ability to focus on its core competencies. The many other activities performed within a firm, though equally important in delivering value to customers, are not the value-added factors that determine client loyalty and long-term profitability. In virtually every industry, companies seek outsourcing alternatives to handle the non-value-added activities that distract the organisation from its primary mission. Increasingly, these outsourcing alternatives are based offshore. And while many companies have embraced domestic outsourcing, they have yet to reap the benefits afforded by a more global approach.

What is outsourcing?

Though a topic that has recently raised significant sensitivities, concerns and even controversy, outsourcing has been around for centuries. Outsourcing is the practice of using an outside vendor to perform an activity or ‘process’ that would normally be done in-house. Almost every company in existence ‘outsources’ some activity, although they may not view it as an outsourcing event. Probably the most common example would be janitorial services. Offices are periodically cleaned by staff of either the building management company or a third-party vendor. Cleaning of the facility is a necessary activity to maintain a healthy and controlled work environment, but it is not a differentiator for the firm or one of its core competencies and is consequently subcontracted to another company. Subcontracted vendors specialise in the outsourced activity, are experts at what they do, have scale since they are cleaning more than one office and, as a result, usually have a lower cost structure and can offer the service to customers at a lower price than customers would pay to do the work themselves.

Most popular today among banks participating in global trade is either outsourcing or providing insourcing capabilities, depending on their place in the business cycle. A number of banks have found that by outsourcing their trade processing requirements to a global bank, they can maintain and grow their existing trade customer base, meet the expectations of their customers, and continue to enjoy a revenue stream from these activities, as well as reduce the need for investment in new technologies to support the trade business. Banks such as Wachovia, Bank of New York, ABN Amro and JPMorgan Chase ‘rent out’ their staff and global branch networks to the outsourcing bank, and provide a broad array of services to ensure the customers’ needs are being met. This provides the outsourcing bank with an ‘end-to-end’ revenue opportunity: they are now positioned to ‘service’ both importer and exporter. Often through these arrangements, outsourcing banks can expand their capabilities by participating in or selling cross-border risk transactions through their partner bank.

Typically, when people think of outsourcing, they immediately think that lower cost is the main driver. However, in industries such as financial services, which require greater investment in intellectual capital and are supported by highly complex processes and activities, the motivation for outsourcing lies in improving the firm’s focus on core activities. When the management team is freed from involvement in routine administrative and transactional servicing requirements, their energy and creativity can be leveraged to improve their strategies and develop wider and deeper business relationships with customers. What this provides the firm that chooses to outsource is the ability to significantly grow their business in a shorter period of time without the attendant distractions of gearing up their internal capacity. New products can be launched faster and on a smaller scale than previously, as the resources necessary to support these offerings are more readily available and can be deployed across multiple clients by the provider. By the same token, short-term market contractions can be weathered, since the firm’s resources are not underutilised.

One of the most compelling examples of this is in the hedge fund industry. What was ten years ago a nascent industry with few practitioners and small portfolios has blossomed into the fastest growing investment option. From 1996 to 2006, assets under management grew from $97bn to $1trn, with more than 8,000 funds available. As the industry developed, so did providers of outsourced services. First, the prime broker provided the necessary support to settle the trades of the hedge funds, securities lending and custody.

Other providers, such as Goldman Sachs, soon offered ancillary services including access to research, institutional trading, portfolio accounting and access to risk-management systems. Still other companies, such as GlobeOps and JPMorgan Hedge Fund Services, now provide full middle and back-office support services, fund accounting and administration, and more complete risk-management offerings. Through judicious use of an outsource provider, fund managers are now able to launch their business more quickly, without the distraction of learning and establishing all of the necessary operating processes. They, too, look at outsourcing as not only a domestic ‘play’ but also one where global resources can be leveraged. Database maintenance, corporate actions booking, status monitoring and follow-up, customer servicing and documentation tracking are straightforward examples of ‘mobile’ processes. More sophisticated processes are equally portable. Risk analysis and modeling, NAV calculation, GAAP reporting and position pricing analysis can be successfully completed in any location.

Advantages to the provider

Another important reason to consider outsourcing is the opportunity to take advantage of superior processes that would not otherwise be commonly available. Because the outsource provider is solely focused on a narrow set of processes and activities, they tend to develop ‘best practices’ for their execution over a period of time. These best practices, which yield higher quality and greater cost efficiencies, are not easily replicable outside of a process centre managed by specialists. Many banks providing outsourced services do so through separate legal vehicles, to capitalise on that focus and to avoid dilution of their offerings due to other priorities in their parent institution.

A superior technology platform may exist in an outsourced environment because of the specialisation and investment that the provider can make, since economies of scale are easier to achieve in the outsourcer’s environment. Similarly, the supporting infrastructure necessary to drive the technology is better leveraged over a wider base of users’ firms. In addition, it is easier to ‘scale’ capacity in an outsourced environment than in an individual firm. Because the outsource provider has a highly-skilled staff well versed in the key processes provided to their customer base, they have the flexibility to reallocate resources among the clients they support. These economies of scale, superior focused processes and more highly leveraged investment spending result in lower costs to the supplier; and therefore lower operating costs to the outsourcing party.

Expanding the outsourcing proposition

The concept of outsourcing has been practiced for a number of years. However, the trend toward outsourcing has increased dramatically as management comes under increasing pressure to improve returns to their investors and increase their market share. In careful self-examination of their business and its underlying value proposition, companies are coming to the realisation that they do not need to do everything themselves. An area for immediate attention is the internal support services that are necessary for a company to operate. Processes such as human resources administration, recruitment and benefit administration do not constitute a core competency of a manufacturing or a services company, and can often be better served by firms that specialise in these disciplines.

Mellon Financial Services dramatically changed its corporate profile by focusing on key areas where it had expertise and could develop a profitable business model around that offering, reducing its reliance on commoditised banking products. Firms whose main business is not accounting are not differentiated by finance and accounting functions of payable and receivable processing, general ledger and legal reporting, expense-report processing or travel management. A firm’s technology requirements for maintaining and developing software and managing hardware infrastructure are often better served by technology specialists in third-party businesses. We have recently seen large global banks entering into global partnerships with several providers of specialised services to manage these functions globally on behalf of the bank. A recent example is ABN Amro’s decision to outsource the management and development of its technology platform. Rather than contract with one party, it selected three ‘specialists’ to manage various aspects of its infrastructure.

In the mid 1980s, apparel companies recognised their core competency was designing and marketing garments rather than producing them. As a result, cutting and assembly was subcontracted to other providers with the required skills and economies of scale. Similarly, companies are now looking at their entire value chain and identifying the activities and processes which, though important to customers, are not provided by them in a unique or proprietary manner. Functions such as market research, customer service, fulfillment, collections and telemarketing have proved ripe for outsourcing. Even the sales function can be ‘outsourced’ to different channels, including agents located globally and even ‘rent a sales force’ companies.

Outsourcing as a globalisation enabler

Virtually every industry is undergoing globalisation – that is, customers are global, products are global, and financial flows are global. With the real-time communication linkages and ever increasing availability of information, most mid-sized to large companies are comfortable operating in international markets. Companies of all sizes have begun to source, manufacture and/or distribute products in global markets. With that increased globalisation comes increased risk, as their ability to manage their supply chain becomes more challenging than under their domestic paradigm. The increased complexity of operating in multiple jurisdictions, each with their own documentation and compliance requirements, as well as potential duties and taxes, is further compounded by post-9/11 security concerns and reporting. Both current multinationals and emerging international players look to outsource to trade management and logistics providers, such as JPMorgan Chase Vastera, to manage their global supply chain requirements.

The same phenomenon is true in the outsourcing field. Outsourcing providers of choice are often located offshore. Increasingly, companies are facing the challenges of outsourcing processes to another country. The most visible of these initiatives has been the movement of systems development and programming from the OECD countries to places like India. Other activities are increasingly moving offshore, with customer service centres and telemarketing leading the way. These moves are made primarily to capture the benefits of labour cost arbitrage and, in some cases, to improve quality. Highly skilled university graduates can be employed at lower salaries, providing a clear quality enhancement and cost savings over entry level employees in the US or Western Europe. Also, since these jobs are viewed as more ‘professional’ and much higher paying than other jobs available locally, the outsource provider has access to a highly motivated work force. Investment banks have for years maintained ‘captive’ outsourcing centres in low cost, high-skill areas like India that produce financial analysis and modelling. Today, they are increasingly moving to third-party outsource providers that have developed expertise and superior processes through focus on a smaller number of specific activities. However, these initiatives are typically centred on a single process, with very discrete activities supporting it.

Global sourcing

In global sourcing, a more sophisticated approach is taken to create seamless interactions across multiple providers based in multiple countries. Buyers of outsourcing services now review their sourcing as a portfolio of options encompassing local, near-shore and offshore. By taking this approach, firms can capitalise on the most skilled resources at the most effective price while mitigating the risks. They can ‘follow the sun’, having activities performed within the time zone and languages of their clients and suppliers. No single activity resides in a single location, but can be performed as expertly in multiple locations, providing near-perfect redundancy and flexibility to respond to changes in demand as well as local events. While requiring stronger coordination and more active management than traditional single source offshore outsourcing arrangements (as, in all probability, multiple suppliers will be used), global sourcing provides a better return on investment and a more resilient infrastructure.

Firms engaging effectively in outsourcing on a local or a global basis need to develop a strategy for outsourcing which is consistent with the business strategy and becomes an integral part of their operating plan. It is often beneficial to engage an outside consultant – that has no vested interest in the outcome but does have practical experience in outsourcing – to facilitate the development of the strategy. A holistic view of the firm’s value proposition, key differentiators and critical interdependencies must be defined and understood by the senior management team. By focusing on the greater value to be gained by quality and control improvement through process redesign, increasing the scalability of the firm’s capacity and therefore market flexibility, and leveraging the resulting increase in focus on their core competencies, firms can capitalise on the benefits of outsourcing without incurring additional risks. Only with a clear understanding of the desired end state and a detailed grasp of the fundamental drivers of their business should firms embark upon any level of outsourcing, whether local or global.

As US and European firms continue to evolve and compete in increasingly global markets, senior managers must scrutinise every aspect of their business plan and challenge their assumptions. In that process, global sourcing needs to be evaluated as a potential tool to improve the firm’s focus on its core competencies and therefore increase its overall profitability.

Sources:

BusinessWeek Online, 26 January 2006

Hedge fund statistics are drawn from JPMorgan hedge fund services and a report from Hennessee Group