Efstathiou uncut: all aboard with the sourcing skipper

When I returned to these Western shores 6 years' ago, I was given the the unenviable task of working with the indomitable Andy Efstathiou. 

Now, analysts who have spent 20 years working in commercial banks are not to be messed with - and I quickly learned my lesson with Andy, who (literally) has an encyclopedic knowledge and perspective of everything that has gone wrong with the world.  I recall Andy warning us years' ago that this was all going to go horribly wrong... and did anyone listen?

Andy has since become a good friend over the years, and has always been one of my first ports-of-call when I want to understand anything about sourcing and the banking sector.  He now runs the Banking Sourcing Program for BPO analyst NelsonHall, but his real claim-to-fame is that he finished seventh in the US Olympic trials for sailing in 1988 (pictured).  Not many people knew that...

Anyhow, I caught up with Andy last week to pose a few direct questions on the current state of the banking industry, how sourcing strategies will evolve after the recession, and how banks can navigate these choppy waters (sorry):

Phil Fersht (PF): Andy, firstly, let's not beat around the bush here. What's the climate like in the banking, financial services and insurance (BFSI) sector these days? Do you expect things to continue improving, or are we in a false dawn right now?

Andy Efstathiou (AE): Banks will continue to do well as long as they are on performance enhancing stimulus. However, the banks are aware that some day they will have to stand on their own two feet. In order to do that they need to be able to scale operations in both directions without eating overhead on the downside or investing capital to expand on the upside. Therefore banks have been aggressively working with outsourcers to create engagements built around transaction based pricing.

PF: What's different with regards to IT investments in BFSI after the crash? How do you see this changing? Do you see more firms moving to broader outsourced/managed service models, or a continuation of project-based spend?

AE: Global banks have been standardizing their IT environments so that processing is done in fewer regional operating centers. During the crash most investments were frozen. Q4 2008, Q1 and Q2 2009 were way down from historical averages. Q3 2009 has been very strong (up 15% seasonally adjusted) and Q4 is shaping up to be stronger still. Savings are coming from internal consolidations and from greater use of outsourcing in select processes and geographies.

PF: Do you see more BFSI firms moving into BPO models and selling off their captives these days? What do you see as the drivers / inhibitors? Which processes are going to fuel growth for BFSI-specific BPO in the medium-long term?

AE: I think essentially all captives will be sold off over the next 3 years. Most captives never made their business case because they remain subscale. The remaining captives reach a point of diminishing gains when they do achieve scale. Interestingly the captives currently sold or for sale are the ones that have achieved scale economies (e.g., Citi and AMEX). Cognizant's recent acquisition of UBS' India Service Center is the continuation of a trend for global enterprises with Indian captives to sell those captives and source the services from India based 3rd party vendors.

The captives getting sold now are those that have reached economic scale. This is due partially to the need for financial firms to raise capital and partially to the fact that once a captive is at scale further high growth rates from cost cutting in operations is limited by the lack large pools of transactions which can be on-boarded.

PF: Has the fact that several of the major banks received such a large quantity of TARP funds held them back from outsourcing IT/Business Processes? When you talk to banking CFOs/CIOs today, are they less focused on outsourcing as a result, or more?

AE: No one with TARP money wants to be quoted. However, CFOs/CIOs are focused (appropriately) on conserving capital and reducing cost. None of them will commit to an outsourcing project that requires capital from the bank (such as setting up a captive) or reduces cost over the long run (pay back periods have been reduced aggressively in the past year). To the extent outsourcing helps put capital back in their pocket and reduces overall cost (especially if volumes swing unpredictably) then they are very interested in outsourcing.

PF: With regards to protectionism, are you seeing offshore-centric initiatives being put on hold? How long will these protectionist attitudes remain, or do you see them as more bravado than reality?

AE: Offshoring has been on hold because financial institutions were not sure whether they would be here or how much they would have to shrink operations. Now they know the answers to those questions and they intend to aggressively offshore in the next 12 months. In September we asked 480 institutions what their plans for offshoring were in the next 12 months. Only 2% intend to shrink offshore operations. 37% expect to increase offshoring activities.

PF: Do you see the surge from the newer break of service providers continuing in this climate, or are you anticipating the incumbent western providers coming back strongly?

AE: The incumbent western providers will all be bought up by product companies. Most product companies still have war chests to buy even more services firms. It is more likely that new firms will spring up with private equity money to fill the demand void for product agnostic services. I also expect more U.S. activity to come from European services firms.

PF: Do you anticipate a lot more consolidation in the BFSI space?

AE: Yes. As FDIC fees increase, fewer consumers borrow, regulators close more banks, and eventually interest rates rise (bad for interest margin) more banks will be forced to merge or simply close up shop.

This means banks will process work in fewer, larger centers delivering service across North America. States hardest hit by the crisis (e.g., California, Nevada, Florida and New York) will see the highest loss of operations centers. In short, for finance, what happens in Vegas, won’t be processed in Vegas.

PF: And finally, if you are seeking a sourcing career in the BFSI sector today, what advice do you have?

AE: Avoid at all costs the credit and risk based businesses. The credit crisis has killed chances for much growth in credit over the next 5 years. What will grow in the financial sector is non-credit or operational services. Examples of these include payments, asset management, depository services, channel based delivery. In insurance these would include: annuities, retail insurance (e.g. car and home insurance). The biggest opportunity today is in payments which is consolidating old delivery mechanisms and creating new delivery mechanisms (such as mobile payments).

PF: Thanks for your time with us today, Andy. Your views here are very welcome to many who are closely observing this sector.

Andy Efstathiou (pictured) has responsibility for the development and delivery of NelsonHall's research and advisory services in banking processes and the application of business process outsourcing in the sector. Andy has 25 years' financial services experience, having worked for money center banks, including Citibank and Bank of America, in key roles managing the customer and counterparty operations with other financial institutions. You can email him directly here.

Comments

[Arul Nathaniel]

Andy, You make an interesting comment in the light of the recent Dell/ Perot and Xerox/ ACS deals - 'It is more likely that new firms will spring up with private equity money to fill the demand void for product agnostic services.' Are you seeing this happen, and if so, could you share some examples?

[Andy Efstathiou]

Amanda:
The most likely acquirers of captives will be either larger India based firms and Private Equity backed India based firms that want to scale operations. Examples of the former are Infosys and Wipro. Examples of the latter are Genpact,Xchanging.

[Andy Efstathiou]

David:
The specific survey I mentioned did not inquire about what processes would be offshored. However, in other ongoing conversations I have identified the following processes as likely to go offshore: image based components of check processing, first level default management support for mortgage processing, and analytical services (credit analysis, portfolio due diligence).

[Amanda Hare]

Andy,

You mentioned we'll see most of the banking captives being acquired. We've now seen Tata, Cognizant make captive acquisitions - which other service providers can you see investing in banking captives in the coming months?

Amanda

[David Gurney]

Thanks for sharing an excellent discussion, gentlemen. When you say 37% of financial institutions will increase offshoring activities, can you elaborate on which specific process you expect these to be?

David Gurney