Operational Excellence

Caveat Emptor – People outsourcing pitfalls to avoid

Looking to put in place a business change outsource structure (moving from T&M to Managed Service or Outcomes-Based Sourcing)?

 

A few tips, and traps, to avoid…

Ever increasing costs combined with a highly competitive talent market are putting pressure on large retail and investment banks to consider engaging third parties to solve the issue…and this time, to provide capabilities that have traditionally been considered too important to outsource – a key example is the business change function. The outcomes touted by these deals are enticing: a flexible pool of business change talent, supplied at a predictable and controllable cost. However, like all third-party change programmes, acts of random and unmanaged change can quickly destroy value and trust, and leave a bank unable to deliver on their strategic and regulatory change agendas.

Below, we outline not only the common pitfalls to steer clear of, but more importantly, HOW to best avoid them.

 

TIP ONE: Cost ‘engineering’. Never knowingly over engineered…

Third party vendors typically engineer their economic models to offer deferred transition costs (HR, Legal, redundancy, knowledge transfer), delivering a tempting ‘quick win’ to programme sponsors. However, the cost benefit will most certainly be recovered over the deal term, and due to the blurring of ‘transition’ and ‘run’ cost, it may end up costing a bank significantly more in the medium term.

Approach: The one-off cost of transitioning a business change function should be paid upfront by the bank, but to avoid the risk of overruns we suggest fixing the transition cost therefore passing the risk of overrun to the vendor. This forces transition planning discipline, allowing better stakeholder management with impacted staff and business areas.

 

TIP TWO: Making sustainability actually stick…

Vendors promising significant cost reductions should be treated with caution. The price paid for the outsourced service by the bank will include labour costs, service management costs (~3-5%), 20% VAT (in the UK), and at least 10%* profit margin to shareholders. Therefore, a vendor has to deliver a service 35% cheaper just for a programme to ‘break even’; leaving little headroom to invest in future skill development (e.g. a move to agile methods), limited investment in actively managing the service (reporting, governance), and no ability to absorb cost of risk / rework etc.

Aggressive vendor assumptions can result in a deal being unviable for the vendor, with management ultimately requesting withdrawal (or worse, covering up a failing service – e.g. Carillion).

Approach: Thorough due diligence on deal economics is required, with all economic and service delivery assumptions being tested with the vendor team that will run the service, as opposed to the financial ‘engineers’ and sales executives who design but don’t actually deliver the service.

* in the case of publicly listed companies or those controlled by Private Equity firms the net deal margin expectations could be as high as 20% for a 5 year deal term

 

TIP THREE: Quality dilution – one part water, three parts…

The primary lever utilised by vendors to reduce the cost of delivery is to systematically replace experienced (expensive) resources with junior (cheaper) resources, reducing the average cost for each role while the programme fee charged remains the same. Typically, the initial focus will be removal of contract / agency staff given their cost, and their roles filled with replacement resources unlikely to provide the experience or expertise required for the roles in question. Bank staff in scope for transition to the vendor have a high risk of exit shortly after transfer (oft welcomed by vendors, given the culture mismatch and structural cost differences e.g. pensions), further eroding retained functional knowledge and corporate know-how. This loss of experience leads to change delivery risk, and can rapidly erode the trust between the end business clients and the deal sponsor(s).

Approach: Designing an unambiguous role requirement framework, which has been baselined to the potential resource’s actual project delivery experience (and not vendor grade structures). This must be balanced with the recognition that the cost of delivery will not decrease significantly, or “you get what you pay for”.

Secondly, key contract/agency and permanent staff members should be identified and ring-fenced to remain as delivery resources for a minimum period (e.g. two years) to ensure continuity, knowledge retention, and reduce risk of attrition.

Lastly, vendor resources should be assigned to the bank for a minimum period of time (e.g. two years) to allow recapture of knowledge investment in the individual, and prevent the client being used as an expensive graduate training ground.

 

TIP FOUR: Keep hold of your corporate hard drive

A key scenario that must be addressed deals with the vendor no longer being able to provide the change service (due to unforeseen political or economic drivers, or due to a bank exercising a service reversal clause). In this case an orderly service transition plan must be activated (either back within the bank, or to another vendor), and knowledge transferred without business value destruction or disruption.

This scenario assumes corporate knowledge is captured and kept updated in an appropriate repository (within the bank, not the vendor environment). In our experience the effort and overhead of keeping knowledge updated is among the first costs de-prioritised or abandoned.

Approach: Knowledge capture and management must be regularly reviewed by vendor management and the business lines, with highly punitive contractual fee penalty clauses built into the contract to incentivise vendor performance.

 

In summary, careful consideration of these and other pitfalls underpin the establishment of a fruitful relationship with vendor(s) providing ‘non-commoditised’ services, and with long-term success dependent on unwavering focus on delivery quality. Upfront investment in deal design and negotiation, and ongoing investment in experienced service management will reduce the risks or programme failure and cost overrun in the long term. The great examples of success that we encounter develop into strategic partnerships between client and vendor; investment opportunities and significant scale being given to vendors, and in return, banks receiving high quality delivery and constructive challenge.

Published by: Paul Dodman