The Right Fit

Bank outsourcing strategies abound, the trick is finding the one that works best.

In light of recent outsourcing developments, banks are re-evaluating their relationships with IT vendors with a view toward getting more value.

In April, Bank One's chairman and CEO, Jamie Dimon, announced that his company's three-year-old IT services contract with IBM and AT&T, called the Technology One Alliance, hadn't worked. Addressing an industry group, Dimon said that Bank One had moved the management of its servers and databases back in house in order to "control our own destiny."

Several months earlier, Washington Mutual(WAMU) had announced that it too was bringing some of its IT operations back in house.

Yet just a month before Dimon's statement, American Express announced a megadeal with IBM, followed by Deutsche Bank's release that EDS would provide IT services to its North American cash management operations. J.P. Morgan Chase, too, said it was considering a deal with either IBM or EDS.

Those deals are fundamentally different from the ones that Bank One and WAMU negotiated several years ago. The older deals were based on an "alliance" or "partnership" model. The newer deals have adopted a more traditional vendor-customer relationship. Bank One, for example, dissolved the Technology One Alliance about a year ago, but maintains separate relationships with IBM and AT&T, said Bank One spokesman Tom Kelly.

The end of the Technology One Alliance coincided with the arrival of Dimon, noted Randy Peyser, banking industry general manager at IBM Global Services. "When Jamie Dimon came in, he looked at it and decided that structure wasn't appropriate to what he wanted to do. But that left the underlying services in place."

"Whenever you get new management, they have their own way of doing things," he added. "You've seen that at a number of places, including Washington Mutual."

No matter who's in charge, though, customers and vendors need to work together. "The customer can't just throw services over the transom and say, 'You run it.' It's an ongoing commitment," said Peyser.

But big IT services deals are just one type of outsourcing. Other deals involve outsourcing of either a vertical activity like item processing, or a horizontal activity like HR or accounting.

Outsourcing deals can be categorized in two ways, according to GartnerGroup analyst Susan Cournoyer. The first is the extent to which an outsourced service is either shared or is limited to a single enterprise. The second is the extent to which the primary benefit is either efficiency or value.

A deal can thus be assigned to one of four categories (see figure, page 30): Management (including IT services megadeals); Creation (including joint ventures by large banks to provide services like check imaging to smaller banks); Access (including IT service bureaus like Alltel, Fiserv, Jack Henry and Metavante); and Optimization (including deals in which a bank outsources some horizontal function like HR or accounting).

MANAGEMENT: American Express

At first glance, the seven-year, $4 billion deal between American Express and IBM looks like a traditional IT services contract. IBM will manage mainframe and mid-range processing at American Express' two principal data centers in Minneapolis and Phoenix, where some 2,000 employees will be transferred to IBM.

But where this deal breaks new ground is in the way it's priced. In traditional deals, services are offered on a prix fixe basis, with the contract specifying service levels that the provider must achieve or else be penalized. In the American Express deal, services are offered a la carte, giving American Express the freedom to choose the types and amounts of services it wants.

The distinction is important, for it incorporates the notion of elasticity of demand for IT services. "Think of it like an electric utility," said Glen Salow, CIO at New York-based American Express. "No matter how much or how little you use, it will be there and that's what you'll pay for."

In addition to lowering its utility bill, American Express enjoys lower unit costs, giving it more IT power for less money. "They IBM produce electricity more reliably than you could produce it yourself," Salow said. "As new and improved ways are developed to generate electricity, you as a consumer will benefit."

Even before the IBM deal, American Express was benefiting from economy of scale. Few organizations rival it in raw computing capacity. Its mainframes alone provide tens of thousands of MIPS, or millions of instructions per second (a typical large company might employ a few hundred MIPS). The technology plant as a whole processes a billion transactions a day worldwide.

Yet for all its size, the IT infrastructure wasn't capable of supporting the kind of inorganic growth the company envisioned for itself, particularly in its U.S. credit card business, which has been energized by the introduction of the Blue card and by a court decision permitting banks to issue American Express cards.

The projected spike in technology consumption led the company to look for an outsourcing partner. "If someone was running a data center three or four times as large as ours, they could do it at a much better level of economics," said Salow.

For its part, IBM is looking to expand its outsourcing business, which already constitutes a big chunk of its revenues (IBM Global Services posted $10 billion in outsourcing revenues the first quarter of 2002).

Equally important is its expertise in managing data centers. IBM has begun delivering the latest data center technologies to its customers directly from its R&D labs. "We will match up people from IBM Research with a bank to do something with new technology," said IBM's Peyser.

Acting as roving centers of excellence, teams of IBM employees move from account to account, honing their skills at each stop. The knowledge they gain enables IBM to price deals more aggressively. At American Express, for example, many of the 2,000 employees being transferred to IBM will eventually be shifted to other accounts as labor-saving technologies are introduced. "Over time, IBM will engage some of the technologies that enables them to do more things with fewer employees," said Salow.

CREATION: J.P. Morgan Chase

J.P. Morgan Chase spent several years and hundreds of millions of dollars building i-Vault, a state-of-the-art facility for storing and accessing billions of images of checks, statements, signature cards and other types of document. When it was completed, Chase hit upon the idea of offering it to smaller banks on a service provider basis.

There was one hitch, however. Since most banks that would be interested in using i-Vault lacked an image capture capability, how would the images get created in the first place? The answer: take a medium that's readily available to most financial institutions-microfilm-and digitize it. That led Chase to team up with ACS, a leading provider of microfilm services, to offer banks the benefits of document imaging without the expense of building an in-house system.