The Outsourcing Versus In-House Debate Settled Once and For All

by Jimmy Sawyers

One of the most common questions asked today is: "Should we outsource?" This question does not have a simple answer and is unique to each organization. "Pat" answers such as "You should outsource anything that is not a core competency of the organization" should be discounted as unreliable advice as it is most likely coming from an outsourcing vendor or someone who has a vested interest in outsourcing. A more intelligent approach is required and significant due diligence must be performed before the correct answer is determined.

Much of the outsourcing hype these days can be related to outsourced programming. Nearly all Fortune 500 companies outsource programming, much of it to Indian companies that comprise about 60-80 percent of outsourcing business worldwide. Citibank, Nortel Networks, Charles Schwab Corp. and others save money by hiring programmers in countries where wages are low and intellectual talent is high. For example, an experienced programmer in the U.S. who might command a salary of $80,000 a year could be replaced by a Russian programmer for about $24,000 a year, significant savings for large companies. Pakistan, Israel, Egypt, Ireland and the Philippines are also becoming major players in the outsourced market. At call centers in Mumbai (formerly Bombay), 99 percent of the staff are college graduates.

So how does the outsourcing question apply to financial institutions, specifically the majority of community-based financial institutions representing those institutions with $3 billion or less in total assets? This market is rarely addressed in BusinessWeek, Fortune or Forbes, yet many financial institution managers, consultants, vendors, etc. correlate outsourcing at Citibank with the average community-based financial institution. A few facts to put the outsourcing issue into perspective:

• The overwhelming majority of financial institutions already "outsource" programming because most financial institutions buy core processing software that is "object code only" meaning the financial institution cannot modify the programs.





• The term "outsourcing" in community-based financial institutions normally means the CPU or main computer is not physically located at the financial institution. For example, a Jackson, Mississippi financial institution may be processed from a data center in Los Angeles, California.
  
  
• From a cost standpoint, outsourcing core processing for a community-based financial institution is arguably a more expensive option than in-house. When outsourced, the financial institution typically pays the outsourcer on a per unit basis which means every new account added increases the financial institution's expense and could effectively penalize the financial institution for growth. In an in-house environment, many of the costs are fixed so the financial institution's unit costs of growth are less. Of course, labor costs associated with the in-house solution must be considered.





• In the community-based financial institution environment of today, outsourcing does not "outsource" all of the financial institution's technology. Most systems today require a wide area network (WAN) as the technology infrastructure to distribute information. While the host system may be physically outsourced, almost all of the network components still exist at the financial institution.





• Hardware costs are not always significantly less with an outsourced system. Computer hardware has basically become a commodity with rapid advances that have led to more processing power at less cost. Accordingly, many organizations that could not afford the "big iron" or large mainframes that were required 25 years ago, can install an in-house system for relatively low cost. As Moore's Law indicates, chip processing power doubles every 18 months while the cost decreases significantly. Today, demand for PCs, chips and software has fallen. The life of PCs has been extended resulting in fewer and less frequent upgrades. All of which has led to more bang for the buck when it comes to technology purchases.

In sum, much of the average community-based financial institution's technology is outsourced, just not in terms of physical location of hardware. Functions such as ATM processing and credit card processing are almost always outsourced completely, for very good reasons involving economies of scale and infrastructure. Core processing is a different dynamic that must be evaluated based on the financial institution's requirements, growth projections and the competitive offerings of core processing vendors. Proper due diligence to determine which environment is best for the financial institution, both from a strategic view and a cost/benefit standpoint, is a prudent exercise that will result in financial institution management making an informed decision backed with adequate documentation.

Installments will include:

1. System Selection: Strategies for Success
2. The Anatomy of a System Selection
3. 20 Questions for Vendor References
4. 20 Rules of Vendor Negotiations
5. The Outsourcing versus In-House Debate Settled Once and For All

First published on BankersOnline.com 8/26/02