57 key lessons in bpo procurement

8/13/2019 57 Key Lessons in BPO Procurement

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Key Lessons in

BPO Procurement

Case Study Report

January 2003


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KEY LESSONS IN BUSINESS PROCESS OUTSOURCING PROCUREMENT NelsonHall

About NelsonHall

NelsonHall is a research organisation specialising in the analysis of services markets.The company tracks recent market developments and changes in vendor capabilityglobally with particular emphasis on Europe and the U.S. NelsonHall provides marketassessments and vendor assessments to both users and vendors of services. Thecompany also provides project and consultingservices.

The company tracks business services and IT services activity. In particular,NelsonHall focuses on the following services and process areas:

Business process outsourcing, including customer relationship managementservices, industry-specific processing services, procurement services, accountingservices, and HR services

IT outsourcing, including application management, enterprise applicationoutsourcing and comprehensive outsourcing services

IT services, including professional services, systems integration and full life-cycleservices

IT application demand by industry.

NelsonHall provides information to its clients in a variety of forms, tailored to yourspecific requirements. For example, information can be supplied as:

BPO & Outsourcing subscription service

Vendor assessment subscription service

Individual market assessments

Project and consulting services.

NelsonHall has extensive experience of project and consulting services. Examples ofrecent assignments include:

Market assessments in support of market entry strategies

Market assessments in support of board-level strategy reviews

Assessments of client satisfaction and vendor benchmarking

Assessments of pricing strategies.

For more details, contact:

NelsonHall:268 Bath RoadSloughSL1 4DX

Phone: +44 (0)1753 701 015Fax: +44 (0)1753 725 [email protected]

2003 by NelsonHall. i January 2003


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Abstract

The purpose of this study is to provide high-level advice and guidance for seniorexecutives who are considering business process outsourcing (BPO) as analternative sourcing arrangement for one or more of their organisations businessfunctions.

The study is based upon NelsonHalls BPO market research, including interviews withCFOs and other senior decision-makers, and identifies key lessons in each of thefollowing areas of BPO:

Selecting a sourcing approach

Selecting a BPO vendor

Negotiating a BPO contract

Making the transition to a BPO service.

The study also describes the real-life experiences of three organisations that haveadopted BPO. These case studies are:

Abbey Life Life & Pensions BPO

BBC TV Licensing Administration BPO

Deutsche Bank Money Market Trade Processing BPO.

Copyright 2003 by NelsonHall. All rights reserved. Printed in the United Kingdom. No part of the publication may be reproduced or distributed inany form, or by any means, or stored in a database or retrieval system, without the prior written permission of the publisher.

The information provided in this report shall be used only by the employees of and within the current corporate structure of NelsonHalls clients,and will not be disclosed to any other organisation or person including parent, subsidiary, or affiliated organisation without prior written consent ofNelsonHall.

NelsonHall exercises its best efforts in preparation of the information provided in this report and believe the information contained herein to beaccurate. However, NelsonHall shall have no liability for any loss or expense that may result from incompleteness or inaccuracy of the informationprovided.

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Table of Contents

1 SELECTING A SOURCING APPROACH 1ADDRESSING BUSINESS CHALLENGES 1ASSESSING SOURCING OPTIONS 3KEY LESSONS 4

2 SELECTING A BPO VENDOR 5VENDOR SELECTION CRITERIA 5

APPROACH TO VENDOR SELECTION 6KEY LESSONS 7

3 NEGOTIATING A BPO CONTRACT 8NEGOTIATING BEHAVIOURS 8PRICING APPROACH 9KEY LESSONS 9

4 MAKING THE TRANSITION TO BPO 10MOVING TO THE NEW ARRANGEMENT 10ENSURING EARLY SUCCESS 11KEY LESSONS 12

5 CASE STUDY: ABBEY LIFE 13BACKGROUND 13BUSINESS CHALLENGE 13SOLUTION 14RESULT 17

6 CASE STUDY: BBC 19BACKGROUND 19BUSINESS CHALLENGE 19SOLUTION 20RESULT 25

7 CASE STUDY: DEUTSCHE BANK 26BACKGROUND 26BUSINESS CHALLENGE 26SOLUTION 27RESULT 28

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1Selecting A Sourcing Approach

Addressing Business Challenges

In todays economic climate, many organisations are focused on reducing the cost of runningtheir business where possible, and are looking to:

Reduce process costs by improving process efficiency

Reduce overheads by taking out people and facility costs

Avoid capital expenditure.

Indeed in some sectors, the major driver for outsourcing remains severe external cost orpolitical pressure; examples include the telecommunications sector and local government.Here, organisations have often outsourced non-core, back-office processes such as finance

and accounting services and human resources as cost reduction measures.

However, in other sectors, back-office support services have been seen as too unimportant,and lacking the need for process change that is a key driving force of business processoutsourcing. Many organisations in these sectors, in addition to the cost pressures listedabove, currently also face the challenge of improving business processes that have becomedisfunctional or fallen into disrepair. Banks provide the classic example here, having struggledfor years with process silos that have come about due to the uncontrolled growth of legacysystems for different financial products, across different business units.

Accordingly, over the last few years, organisations have increasingly begun to outsourcebusiness processes as a means of both reducing cost and improving key business processes.In the banking and insurance sectors, for example, organisations increasingly have begun tooutsource apparently core processes such as cheque processing, mortgage processing andinsurance claims administration, and also customer contact management; these areas are nowseen as too important to be left to in-house legacy processes and require a combination ofprocess and service improvement and process cost reduction

Exhibit 1 lists the principal business challenges faced by organisations in different sectors.

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Exhibit 1

Principal Business Challenges by Sector

Sector Principal Business Challenges

Banking

Improvement of cross-selling to existing customers

Integration of service delivery

Delivery of improved value for money

Insurance

Development of additional distribution channels

Reduced cost base by process improvement and outsourcingsupport processes

Retail & CPG

Maintaining or increasing market share

Geographic expansion

Streamlining supply chain

Pharmaceuticals

Developing and launching new products

Building scale and distribution capability

Mergers & acquisitions

Telecoms & media

Retaining customers

Introducing new services

Reducing operational cost of service delivery & overheads

Utilities

Restructuring of businesses

Improving management and controls within regulated businesses Improve CRM capability to sell new services

Organisations are tackling these challenges both by improving in-house service delivery and byusing external business services. However, the pattern of usage of external services willtypically be driven by these basic business needs.

Current levels of satisfaction with in-house processes are universally low. However, someprocesses (typically those associated with business critical activities such as the ability to getnew products or services to market, and customer service and retention) are regarded as muchmore important than others that are typically associated with back-office support functions(such as accounting services and HR services).

Consequently, the major priority within most organisations at present is to fix business criticalprocesses rather than back-office support functions. And because, in many cases,organisations lack the key skills and technologies needed to bring about this change, they areassessing alternative sourcing arrangements for their business processes.



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Assessing Sourcing Options

Organisations reviewing the sourcing arrangements for their business processes face thefollowing options:

Retain in-house

Create an internal shared service

Create an external shared service with a competitor in the same industry

Form a joint venture with a third party to jointly operate the business

Outsource the business process entirely to a third party.

Key to understanding the relative merits of each arrangement is an understanding of the costsand benefits of each one. As a starting point, it is essential to address the following questions:

What do we want to achieve in terms of process improvements and increased process andcustomer service effectiveness?

What are our current costs and what do we want to achieve in terms of cost reduction?What degree of management involvement do we wish to have in the new arrangement?

What are our technology requirements?

Do we believe that the new arrangement might be a source of revenue?

From the outset, some sourcing arrangements will make more sense than the others. Forexample, if your organisation is intent on reducing management responsibility for a businessfunction to a minimum, you are unlikely to spend much time considering the merits of retainingthe function in-house, or of setting up a joint venture. This was the situation Abbey Life founditself in when it became closed to new business, and its parent Lloyds TSB Group decided itneeded to both reduce the cost of the operation and introduce an element of cost certainty tothe running of the Abbey Life business. Consequently, the Abbey Life life and pensions

business was fully outsourced in February 2000 under a 10-year arrangement (see section 5).

Subsequently, and by contrast, Lloyds TSB Group took a very different approach when itchanged the sourcing arrangement for its retail cheque processing business. In December2000, it entered a joint venture (iPSL) with rival Barclays, and Unisys, to provide a sharedservice for the banks U.K. cheque processing; HSBC later joined the JV in December 2001.

In another example, Deutsche Bank saw the potential to create a JV with Wall Street Systemsfor its money market operations (see section 7). It calculated that the new arrangement wouldprovide the bank with a low-cost solution for money market trade processing (and for otherproducts in future), and would also be able to take on the back office operations of otherfinancial institutions, to provide a potential source of new revenue.

However, when it comes to assessing different sourcing arrangements, it is important that you

understand your current environment in terms of costs and process performance, in order toprovide a baseline for comparison. Though the costs of in-house business processes can oftenbe hidden and difficult to calculate, this is an essential part of the evaluation stage.

As far as possible, create cost models for the anticipated term of the new arrangement (e.g. 5or 10 years) for each of the sourcing options you are considering. Create projections for:

Operating expenses

Anticipated future capital expenditure (e.g. new servers, desktop PCs, etc.)

Transition costs, including asset write-downs. This may include estimates of staffseverance payments that might have to be made under a new arrangement

Project implementation costs, including professional fees

The likely financial impact of the new sourcing arrangement on areas of the business thatwould be outside the scope of the contract.



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Apply a perceived risk approach to model the impact of certain events that might occurdownstream. For example, in the case of an in-sourced solution, model the likely impacts oflosing critical members of staff and of project delays.

Assess the technology options that would be available under different arrangements. Will thetechnology be sufficiently scalable and flexible to meet the anticipated changes in your

business? For example, in the case of transaction processing, will the technology scale toaccommodate expected increases in transaction volume (and beyond), and flex toaccommodate new transaction types?

Also, how innovative is the technology? Some technologies may enable cost reduction on yourexisting cost curve, while others may be able switch your business process onto a lower costcurve altogether.

In summary, unless you can establish a clear picture of costs and process performance underyour current arrangement, you have no baseline for comparison of alternative sourcingarrangements and, furthermore, no baseline for negotiations when you reach the stage ofselecting a vendor.

Key LessonsIt is important to understand all the drivers for change, both internal and external to yourorganisation, when considering a change of sourcing arrangement for your businessprocesses. For example, the internal trigger for change may be the ineffectiveness oflegacy systems; however, it is also important to factor in external market forces affectingyour industry, such as market pressure for lower transaction costs

Establish in-house benchmarks of both cost and process performance as a baseline forassessing alternative sourcing arrangements

Use cost modelling to gain an understanding of attainable cost levels under alternativearrangements, and as a basis for informed negotiation with potential vendors

Adopt a creative approach to evaluating new sourcing arrangements, and be open to newownership and governance models

Ensure that the technology underpinning the business service is flexible and scalable tofuture needs

When considering a new sourcing arrangement for a business process that is a costcentre, consider not only whether costs can be reduced, but whether the process can betransformed into a profit centre. However, be realistic about the chances of being able togenerate new business easily.



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2Selecting a BPO Vendor

Vendor Selection CriteriaExhibit 2 shows the most important criteria applied by CFOs in selecting a prospective BPOservice vendor.

Exhibit 2

Most Important Vendor Selection Criteria for CFOs

Criterion Key Issues

Operational Service Experience

What impact will this vendor have on my brandreputation?

Importance of day-to-day reliability

Ability to avoid project mentality

Access to Best-of-BreedApplications

Proven industry-specific technology

Standard back-office, e.g. SAP, PeopleSoft

Cost Reduction/Price PerTransaction

Ability to reduce cost by:

Improving staff management

Improving processes and applications

Use of low-cost locations

Economies of scale/third-party sales

CFOs consider operational service experience to be the most important vendor qualification.Unlike with IT outsourcing, a BPO service vendor assumes operational responsibility for abusiness function which could have a negative impact on the company brand if this ismismanaged. Hence, the potential impact of a vendor on a companys reputation is seen ashighly important.

Also in terms of operational behaviour, CFOs are concerned that a vendor should demonstrateday-to-day reliability, managing the business smoothly and efficiently.

Avoidance of project mentality is also considered key. Successful BPO arrangements arefounded on a partnership-style approach to achieving long-term business benefits, and this isnot consistent with a project approach whereby the vendor reports overruns, out of scopeitems or exceptional costs on a regular basis.



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Access to best-of-breed applications is also essential. For example, skill in applying a provenERP product such as SAP or PeopleSoft is important in the delivery of accounting services andHR services. Similarly, familiarity with, and expertise in, appropriate industry-specificapplication products is important in the delivery of industry-specific processing services such asloans processing in the banking sector.

Not surprisingly, a vendors ability to reduce the cost per transaction is an important selectioncriterion for CFOs. While this might be achieved through the use of low-cost (e.g. offshore)locations, or through the generation of third-party sales, CFOs are more interested in the firstinstance in vendors ability to reduce costs through the more traditional means of improved staffmanagement and processes. Indeed, it is probable in many instances that there will be greatercost reduction benefit achieved by using new technology and processes to switch to a new costcurve than by combining economies of scale to drive down the existing cost curve. Either way,it is important to understand the quantitative impact that will be derived from each of theseapproaches.

Other vendor selection criteria to consider include:

Ability to price competitively combined with a willingness to negotiate creatively

Sensitivity to people and cultural issuesA partnership-style approach to doing business, including a can do attitude and a clearcommitment to the long-term.

Approach to Vendor Selection

It is essential to conduct vendor selection thoroughly, and to test prospective partnersrigorously. However, it is important to take a balanced approach that enables you to identify themost suitable vendor(s) in the shortest time and at a reasonable cost to all parties involved.

The vendor selection process should include the following elements:

Market testing establishing market capability and interest in the opportunity

Communications advertising the opportunity, disseminating full and accurate details ofyour requirements, and making available accurate, appropriate and helpful information tobidders throughout the selection process

Vendor testing not just assessing submitted bids, but seeing how bid teams performagainst a real life brief.

Rather than simply issuing a request for proposal (RFP), it is first worth trying to establishmarket capability and interest in the opportunity, and you might consider holding a series ofinformal meetings with potential suppliers, and holding a briefing day for bidders.

Informal meetings and briefing days with vendors can help you to:

Create awareness of the opportunity

Assess the level of market capability and appetite for the opportunity

Refine the procurement process based on feedback from the market.

Throughout the selection process, ensure that accurate, appropriate and helpful information ismade available to the bidders, and consider the following forms of communication:

Distribution of procurement information on CD-ROM, or website postings

Regular workshops

Q&A a mechanism for handling questions from bidders regarding the procurement.



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When you have reached the shortlist stage of selection, consider testing each biddersresponse to a real-life brief. This was something the BBC did when it outsourced its TVLicensing administration business (see section 6) with the aim of testing vendors in terms of:

Their ability to respond to a real life situation, and to adhere to a specific brief

Their understanding of the businessTeamwork is the vendor able to present a coordinated end-to-end solution to theproblem? What are the individual strengths of team members, and has the team fullycommunicated the key issues amongst themselves?

Response to questioning and negotiation does the vendor take time to understand yourperspective, and demonstrate mature negotiation skills, or become defensive and covertheir position?

Furthermore, because it was likely that more than one vendor would be selected to operatedifferent elements of its TV Licensing business, the BBC brought together shortlisted vendorsto work in teams, so that it could assess their ability to cooperate and integrate with one other.

Key LessonsConduct thorough market testing, using a variety of methods, to assess vendor capabilityand interest in the opportunity

Be prepared to refine the procurement process based on feedback from the market

Define what you expect of the vendors clearly up front, and re-enforce the messagethroughout the procurement process

Keep the flow of communication with the bidders going, using multiple channels, toencourage active dialogue throughout the process

Assess how bidders respond to business issues raised during site visits and briefingsessions, to see whether the promises contained in their bids are reflected in their

behaviour

Set the bidders a business problem to solve based on your real life situation, to assess thepracticality and creativity of their response

Where it is likely that more than one supplier will be selected, bring the bidders together towork in teams to assess their ability to cooperate and integrate with one other.



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3Negotiating A BPO Contract

Negotiating BehavioursWhen you have selected your preferred partner, getting to the best contract will only happen ifboth parties are open about their business and financial aims and objectives. Contractnegotiations should be conducted on an open book basis.

It is important to adhere to your initial objectives, which will almost certainly include elements ofboth cost reduction and business process improvement. When Abbey Life negotiated the dealfor its life and pensions business with Unisys, it was motivated by the need to preserve its largecustomer base and maintain its reputation for strong service levels, but was equally motivatedto reduce overall cost. Abbey Life was not prepared to compromise on either of these high-levelobjectives.

However, Abbey Life was keen to engage in creative negotiations, and utilise the knowledgeand experience of its partner, to decide the best way of meeting these objectives.

A very important aspect of the negotiations was the realisation that Unisys would be taking onresponsibility for managing a large insurance business for the first time, despite its strength inthe provision of insurance solutions. Abbey Life believed that Unisys had the ability to managethe business effectively, but also realised that this contract was an entre for Unisys to thewider market for insurance business process outsourcing. The understanding that, in thelonger-term, Unisys would use the Abbey Life contract as a springboard for further business inthe U.K. insurance sector was a significant factor in the negotiations.

The BBC was also very conscious of how important its licensing administration business was toits preferred vendor, Capita. The BBC knew that the deal was Capitas biggest ever businessprocess outsourcing contract, and took into account both the prestige value of the contract andthe likely financial impact of the contract on Capitas cashflow, profitability and future growth.

However, the BBC was equally concerned to negotiate terms that provided strong incentivesfor Capita, and that incorporated an element of gain sharing between the BBC and the vendor.The BBCs focus on getting the vendors incentive plan right set a positive tone for thenegotiations.

While defining the details of operational service level agreements (SLAs) is very important, theprimary focus on defining the incentives means that SLAs and the details of any associatedpenalty clauses can be more easily agreed upon.

Finally, whilst a positive, forward-looking approach to negotiations is important, it is equallyimportant to incorporate contingency plans into the contract negotiations to mitigate the risk ofany downstream failure by the vendor. Contractual safeguards include:

The right to bring staff back in-house under TUPE regulations

The right to use the technology underpinning the BPO service

The right to transfer service operations to another vendor

Provisions for the return of assets



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The requirement for the vendor to vacate rented building space, if relevant.

Pricing Approach

The starting point for pricing should be the in-house cost benchmarks you established at the

start of the procurement process. As stated previously, unless you have a clear picture ofexisting costs, you have no baseline for price negotiation.

Your current cost model will provide an understanding of attainable cost levels using presentprocesses and technology and can usually be extrapolated to estimate the impact of newprocesses (removal of cost elements) and technologies. Based on this, you can expect tonegotiate a new pricing model, potentially consisting of several components; for example:

Fixed cost e.g. the up-front investment in transitioning to a new technology platform,including the cost of customisation

Variable costs the per unit element of the price, e.g. price per transaction

Ancillary costs there may be ancillary costs associated with short-term or one-off items,such as a technical support contract.

Where possible, incremental pricing should be linked to higher levels of performance by thevendor. For example, since revenue generation is the key metric of success in its licensingbusiness, the BBC negotiated an incremental pricing plan with Capita, as an incentive to reachhigher levels of licence sales. This was seen as a vital element of the new arrangement,contrasting with the cost plus pricing model that had been in place previously. In this case, thepricing model has the following elements:

A basic fee per licence sale set against a rising sales target over time

An incentive fee, composed of the basic fee plus a further amount for each additional saleup to a defined limit

A 50/50 share of all sales over the incentive fee limit

A built-in rebate system, whereby the BBC is refunded if Capita falls short of the basicsales targets.

Finally, insist upon all pricing being entirely visible and fully inclusive, to avoid hidden extrasshould things change downstream.

Key Lessons

Conduct contract negotiations with both parties entirely open about their aims andobjectives for the contract

Use the in-house cost benchmarks you established at the start of the procurement processas the basis for informed negotiation with potential vendors

Use this knowledge to insist upon both improved service quality and cost reduction dontcompromise and accept just one of these

Use an open book basis for all costing so that both parties are aware of the cost drivers

Accentuate the positive rather than the negative when negotiating. For example, focus ongetting the incentive plan right, rather than refining the details of penalty clausesassociated with SLAs

Understand exactly how important the contract is to the potential supplier during contractnegotiations

Expect to price differing service elements using both fixed price elements for one-offactivities and per unit pricing for ongoing service delivery, or at least understand thoseone-off cost elements that are to be spread over the life of the service.



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4Making the Transition to BPO

Moving to the New Arrangement

It is not uncommon for BPO deals to take two or more years from initial discussions to closureof the deal. Hence, when you have successfully negotiated the deal, it is important to keep upthe momentum for change, and not to delay the transition to the new arrangement.

Setting an aggressive timeline for the transition will help drive the process, but it is essential tohave the following in place to ensure a smooth and effective transition:

A strong governance model for the new arrangement

A comprehensive staff communication programme.

To oversee the transition, and to provide a governance structure for the new business, a joint

steering committee should be established, consisting of senior management representativesfrom your organisation and from the vendor. While it is desirable to avoid unnecessarybureaucracy in the running of the new arrangement, it is probably also necessary to set up anumber of sub-committees to oversee each of the major operational areas such as servicereviews, systems and systems development, change management, and staff communications.A senior manager should be directly responsible for each of these major operational areas.

With often large numbers of staff transferring to the new arrangement, effective staffcommunications is essential during the transition, and beyond. Set up a comprehensive, multi-channel communication programme, and consider including the following components:

A consultation process between staff and union representatives, supported by your HRteam

Drop-in rooms where staff can learn more about their new employer and how the newbusiness will work

Staff workshops and all-staff briefings

Regular video communications during team meetings

A regular staff newsletter

An email-based question and answer (Q&A) service for staff, with the option of anonymity.

Key to success is to communicate as much relevant information as possible on a frequentbasis, using multiple access channels. It is also important to encourage two-waycommunication, so that all staff questions and concerns are answered during the transition.

Elements of the programme may include a formal induction to the new business, and training

on new systems and processes.

Above all, senior management must demonstrate commitment, and be accountable for thesuccess of the communication programme.



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Ensuring Early Success

Continuing the communication programme beyond the transfer date to the new arrangement isimportant to ensure early success, as are the following factors:

The senior management team leading by example by demonstrating a committedpartnership approach to the new arrangement

Ongoing knowledge transfer to the BPO vendor, to enable them to fully understand yourculture and what motivates your business

Making sure that the service teams are motivated from the start to deliver the new servicetargets.

Early signs of success often emerge in the form of improved staff morale, and more tangiblemeasures such as reduction in staff absenteeism and attrition rates. For example, the BBCnoted that call centre staff sickness rates dropped from 15% to 6% in the first three monthsfollowing the transition to the new BPO arrangement. Similarly, Abbey Life reports a fall in staffattrition rates from 18% to 7% in the first 18 months.

It is essential to start monitoring the new service from day one. However, it is important to focuson the most important metrics for your organisation, and not to get sidetracked into measuringservice levels simply for compliance. For example, the BBC monitors Capitas performanceagainst revenue targets as the primary measure of success, and spends very little timereporting on operational service levels such as those related to call handling.

For Abbey Life, on the other hand, call handling performance was key from the start; as aclosed-book business, it was essential that every interaction with existing customers should beas smooth and incident-free as possible. Hence, for an initial period, Abbey Life conductedhour-by-hour service monitoring to ensure that the new customer call handling operation wassuccessful from the start. Less than two years into the BPO contract, Abbey Life can reportthat:

The pick-up target for in-bound customer calls of 20 seconds is being met 100% of the

time

Customer call abandonment rates have fallen from 4-5% to 2-3%

First-time call resolution rates have improved from 74% to 82%.

Abbey Life also found that, with the granularity of service level data available, it was able toreallocate staff resource where necessary much more quickly than before, and to evaluate staffperformance more closely, and improve incentive schemes.

It is also important to conduct a thorough and independent customer satisfaction survey afterthe first few months of the new arrangement, to get an early measure of how well the newservice is being received by your customers. This should be a like-for-like appraisal ofsatisfaction with the service, using the last customer satisfaction survey under the oldarrangement as the baseline.

Finally, make plans to benchmark service delivery against the outside market after two or threeyears of the new arrangement, and at intervals thereafter. This will ensure that the serviceremains competitive, and continues to match or better the cost and process improvements thatmight be available from any alternative source.



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Key Lessons

Set an aggressive timeline for transition, to maintain the momentum for change

Establish a robust governance model to oversee the transition, with senior managers

directly responsible for specific areas of the new business

Create a two-way, multi-channel staff communication programme to ensure effectiveknowledge transfer and to allay issues or fears related to the transition

Maintain the emphasis on learning and knowledge transfer well into the new arrangement

Start monitoring the new service from day one, focusing on the most important metrics foryour organisation

Conduct a customer satisfaction survey after the first few months of the new arrangement,to get an early measure of how well the new service is being received

Benchmark service delivery against the outside market after two or three years of the newarrangement to ensure that the service remains competitive.



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5Case Study: Abbey Life

BackgroundAbbey Life was originally founded in 1961, and established a link with Lloyds Bank in 1988when the company, together with five financial services subsidiaries of Lloyds Bank, werebrought together to create Lloyds Abbey Life plc.

In 1996, Lloyds Bank merged with TSB, and in the same year the newly formed Lloyds TSBGroup plc bought out the balance of the shares in Lloyds Abbey Life. Abbey Life then becamea wholly owned subsidiary of the Lloyds TSB Group plc.

The newly formed group found itself with a number of life and pensions businesses, none ofwhich (including Abbey Life) could be considered market leaders. As the groups strategy wasto have only market leading brands within its portfolio, it pursued a merger with ScottishWidows, a deal that was completed in 1999. Later that year, Abbey Life's client funds undermanagement (in excess of 15 billion) began to be looked after by Scottish Widows InvestmentPartnership (SWIP).

As part of the overall review of the Group's Insurance and Investment strategy, it was decidedto close Abbey Life to new business and, in February 2000, Abbey Life's sales capability wasbought out by Allied Dunbar. At that point, Abbey Life had over one and three quarter millionclients still being serviced.

Business Challenge

With Abbey Life now a closed-book business, the Lloyds TSB Group was keen to furtherreduce its role in the day to day running of the business, and set out to find a sourcing solutionthat would deliver the most efficient operational model for the remaining life of the business.

The challenges faced were:

The future of the business was now dependent on the efficient operation of existingbusiness. However, Abbey Lifes life insurance business had been running on 15 to 18different legacy systems, some of which were 30 years old.

With no new business flowing into the company, it was anticipated that the staff situationwould become difficult, with declining career development opportunities leading to aserious staff retention problem, and hence risk of degradation of customer service.

The group did not want to be left with a huge fixed cost on its books, and wanted to bothreduce cost and introduce an element of cost certainty to the running of the business.

Overall, it was important to reduce risk to the group.



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Solution

Abbey Life considered the following options:

Continuing with the existing approach

In-source the business to another company within the Lloyds TSB group

Form a joint venture with a third party to jointly manage the business

Outsource the business entirely to a third party.

Selecting a Sourcing Approach

For each of these options, the Abbey Life senior management team modelled 5-year and 10-year forecasts for each of the following items:

Projected operating expenses

Anticipated future capital expenditure (e.g. new servers, desktop PCs, etc.)

Transition costs, including asset write-downs. This included estimates of staff severancepayments that would have to be made if an in-sourced option were adopted

Project implementation costs, including professional fees

The likely financial impact of the new sourcing arrangement on areas of the business thatwould be outside the scope of the contract

The team applied a perceived risk approach to model the impact of certain events that mightoccur downstream. For example, in the case of an in-sourced solution, the team modelled thelikely impacts of losing critical members of staff and of project delays.

Over a 10-year term, the team calculated that the cost of operations under an in-sourcedarrangement (completely in-sourced or under a JV) would be 275m at best. The cost ofoutsourcing the business entirely to a third party was calculated to be 225m over the same

period, representing a 20% saving. The two main contributors to the 20% saving were:

Lower cost of systems in an outsourced arrangement

Process efficiencies gained from moving from multiple legacy systems to a single, moderntechnology platform.

Selecting a Supplier

While it was imperative to replace legacy systems, the clear objective by now was to outsourceall business operations, and so Abbey Life looked for a partner who could both provide a newIT solution and manage the day-to-day business.

The team applied a number of vendor selection criteria, which they prioritised as follows:

1. Must come in with a competitive price, and be willing to negotiate creatively

2. Must be able to provide career development opportunities for staff, to avoid staff retentionproblems, and consequent degradation of customer service

3. Must be able to take on the role of a regulated insurance business, with regulatory,compliance and audit responsibilities

4. Must have a proven life insurance IT solution that is EMU-compliant

5. Must be in for the long-term (i.e. able to commit to a 10-year contract with a very large up-front investment, and the likelihood of cumulative profit being deferred until several yearsinto the contract)

6. Must have a can do ethos.

A request for proposal (RFP) was sent to 11 prospective suppliers, of whom seven submittedproposals. This was subsequently reduced to a shortlist of three vendors.



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In the bid process, the team identified several danger signs in vendor behaviour, andconsciously deselected on the basis of these. Danger signs included:

Little or no knowledge of the life and pensions business, and of the type of customerservice required in this business

Over-aggressive pricing without a clear rationale. Having modelled the costs, the AbbeyLife team was suspicious of bids that undercut their own calculations and that could not besubstantiated; in particular, the team wanted to avoid getting into a low-price deal if itmeant having to pay for changes or additions to the service downstream

Reluctance to adopt a constructive, partnership approach to the negotiations.

From the shortlist of vendors, Abbey Life chose Unisys as the most suitable candidate. TheUnisys Life and Pensions Solution was a proven solution, having been implemented at anotherU.K. life and pensions company with in the region of 400,000 policies. Furthermore, Unisys hadan existing outsourcing relationship with Lloyds TSB (Unisys, Lloyds TSB and Barclays Bankhad recently formed a company called Intelligent Processing Solutions Ltd. to manage and runoutsourced cheque processing operations).

Negotiating the ContractContract negotiations were conducted on an open book basis, with both parties making theiraims and objectives very clear from the start. Abbey Life drove a hard bargain, and wasmotivated by the dual imperatives of preserving its large customer base and maintaining itsreputation for strong service levels. However, just as important was the need to reduce overallcost.

Unisys opening position was to suggest that it could deliver the same service levels at a fixedprice. However, Abbey Life insisted upon improved service levels at a reduced cost, and wasencouraged by Unisys flexibility and willingness to reach a mutual agreement.

As a vehicle for delivering the new service, Unisys created a new, wholly owned subsidiary,Unisys Insurance Services Limited (UISL).

A very important aspect of the negotiations was the realisation that Unisys would be taking onresponsibility for managing a large insurance business for the first time, despite its strength inthe provision of insurance solutions. Abbey Life believed that Unisys had the ability to managethe business effectively, but also realised that this contract was an entre for Unisys to thewider market for insurance business process outsourcing. The understanding that, in thelonger-term, Unisys would use the UISL subsidiary to generate business with other U.K.insurance companies was a significant factor in the negotiations.

Pricing of the contract was based on a mix of fixed and variable cost elements, as follows:

Fixed cost to cover the up-front investment in transitioning to the new technologyplatform, and customising to Abbey Life

Variable costs based on the number of policies processed per annum, with different price

rates applied to different policy types (life, pension, etc.)Ancillary costs Abbey Life awarded Unisys a number of ancillary assignments initially forup to the first three years of the contract only; these included responsibility for loansadministration and other accounting functions, plus IS infrastructure and developmentservices, and technical support.

Making the Transition

The first step in the transition to the new arrangement was the transfer of around 1,000 AbbeyLife staff. Both parties were sensitive to the challenge of people adjusting from a life andpensions company to a professional service provider, and three initiatives were taken to helpsmooth the transition:

Training programmesA communication programme aimed at communicating UISL's aims and intentions

Installation of a new management information system.



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Training included:

Induction to Unisys

Training on Unisys processes (e.g. performance management, service delivery processes)

Technical training on the Unisure solution.

The communication programme included:

A consultation process between staff and union representatives, supported by Lloyds TSBHR professionals

Drop-in rooms where staff could learn more about Unisys and how the new business wouldwork

Regular video communications during team meetings

A regular staff newsletter

All-staff briefings once per month

Senior management progress briefings

An email-based question and answer (Q&A) service for staff, with the option of anonymity

The Abbey Life management team consider the communication programme to have been asuccess because:

As much relevant information as possible was made accessible on a regular basis, using amulti-channel approach

Two-way communications were encouraged, including a staff Q&A service

Senior management commitment and accountability. Each of the communication strandswas sponsored by a senior manager.

The management team understood that closer and more effective monitoring of the businesswould be required under the new arrangement. A new management information system was

introduced that enabled the management team to:

Conduct hour-by-hour service monitoring

Reallocate staff resource where necessary much more quickly than before

Evaluate staff performance more closely, and improve incentive schemes.

In terms of transitioning IT systems, UISL began the major systems overhaul straight away,including upgrading and unifying the processing services, and replacing the underlying systemsinfrastructure. However, such is the scale of the operation that full migration to the new platformis not scheduled to be completed until the end of 2003.

To oversee the transition to UISL, but more importantly to provide a governance structure forthe new business, a Joint Steering Committee was established. A number of sub-committees

were set up, feeding into an overall Contract Management Team, responsible for monitoringand managing all operational issues arising, including matters relating to systems development,compliance, claims and underwriting, complaints, service reviews and change management. Asa regulated company it was important for Abbey Life to take this approach; while it was able tooutsource its activities, it could not outsource its regulatory responsibilities.

The entire process, from the initial decision to outsource through to the contract announcementtook 10 months. The timeline was as follows:

February 2000 Abbey Life decided to outsource 90% of its entire business operations

March 2000 Request for Proposal (RFP) issued

June 2000 - A shortlist of three vendors was drawn up

July 2000 Abbey Life selected Unisys as its preferred partner

November 2000 The due diligence process was completed

December 18, 2000 The contract was signed and the deal announced



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December 19, 2000 Abbey Life staff transferred to the new operating entity, UISL

Result

At the outset, Abbey Life set Unisys three strategic objectives for the business:

Improve service levels

Cut costs

Provide a stable work environment and career paths for employees.

The staff transfer went well, with Abbey Life claiming that the switch to UISL had a tangible re-energising effect on employees. In the first 18 months, staff attrition rates droppeddramatically. Staff attrition is 6% in 2002, compared to 18% in 2000 and 17% in 1997.

Fourteen categories of service level were defined, consisting of a total of 84 individual servicelevels. A service credit system was established, whereby any failure to meet a service levelwould result in the application of a service credit in Abbey Lifes favour.

However, 20 months into the contract, Abbey Life reports that UISL is meeting all service level

requirements, with significant improvements in a number of areas. Improvements in servicelevels include:

Service turnarounds (the time taken to handle a service request, such as a policysurrender or maturity, to completion). Previously, not all service requests were monitoredto completion, and the target was for 95% of requests to be completed within 10 days;however, the remaining 5% could take up to 6 weeks to complete. Now, 100% of requestsare monitored, with 95% requiring completion within six days (98% is achieved), theremaining 5% requiring completion within 20 days (100% is achieved)

The pick-up target for in-bound customer calls of 20 seconds is being met 100% of thetime

Customer call abandonment rates have fallen from 4-5% to 2-3%

First-time call resolution rates have improved from 74% to 82%

The error rate for all transactions has fallen from 5% to 1-2%

Call centre availability (opening time) targets are being met 100%.

In May 2002, Abbey Life completed its first service quality test, to assess customer satisfactionlevels. The survey, carried out by an independent research company, established thatsatisfaction levels were higher across the board than in May 1999, prior to the businessbecoming closed-book.

From a cost perspective, Abbey Life is also very satisfied to date, with cost levels already wellbelow pre-UISL levels.

The IT transformation process is on schedule (with all interim migration phases on track) for

completion by the end of 2003.

Upon completion of the systems migration, from year four of the contract onwards, Abbey Lifewill start to benchmark service delivery against the outside market, and anticipates appropriatereviews and discussions to start at that point.

Abbey Life has contractual safeguards in place to mitigate the risk of any large-scale failure byUnisys, including:

The right to bring staff back in-house under TUPE regulations

The right to use the Unisure solution

Provisions for return of assets

The requirement that Unisys would have to vacate relevant building space currently rentedfrom Abbey Life.

However, with the possible exception of some ancillary services, Abbey Life does notanticipate that the business will be brought back in-house at any point.



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On the employee front, Abbey Life is particularly pleased that not only have staff adapted to lifewithin UISL, but that job prospects have improved, with staff having moved from an operationthat was previously headed for a staff reduction, to a stable organisation that is looking to growand take on business from other insurance companies.

The question remains whether Abbey Life would have outsourced its business processes had it

not been closed to new business. However, the life and pensions sector in the U.K. is undersignificant cost pressure as a result of the Governments Stakeholder Pensions policy wherebyno provider is allowed to levy an annual management charge in excess of one per cent for theirpension product (and it is believed that this approach will become the norm across a broaderrange of products). In this environment, Abbey Life believes that it would still have looked atoutsourcing its business processes, though the decision may not have been taken until a yearor two later.



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6Case Study: BBC

BackgroundThe British Broadcasting Corporation (BBC) has been making and broadcasting radio andtelevision programmes since 1922, and has always been funded by the public licence fee.

In 1986, the Government-backed Peacock Report called for a fundamental re-think of the long-term funding of the BBC. Revenue generation through advertising was rejected and the licencefee survived (though it was pegged to the Retail Price Index). However, the effect of thePeacock Report was to propel broadcasting in the UK towards the embrace of marketdisciplines.

In 1991, the BBC established an internal market, whereby programme-makers wereencouraged to use the services of outside companies, while in-house departments becamebusiness units with P&L responsibility. Over the next decade, the BBC underwent acommercialisation process in which it steadily outsourced more and more of its businessprocesses, starting with non-core functions such as catering and procurement, and progressingto core functions such as programming and facilities, financial operations and licence feecollection.

Business Challenge

Driving this huge change programme was the need to raise money for the transition to digitalbroadcasting, which could not be funded entirely from the licence fee. Nevertheless, the licencefee remains the life blood of the BBC (currently 96% of all available funding), and hence theongoing challenges for the BBC are to:

Maximise licence sales

Minimise licence evasion

Over the last decade, the BBC has taken several initiatives to optimise its licensing business,including:

In 1991, taking over responsibility for licence collection from the Home Office

In 1998, selecting Envision (a consortium of Bull Information Systems Ltd., SubscriptionServices Ltd. (a wholly owned subsidiary of the Post Office) and WPP Ltd.) to collectlicence fees on a 7-year contract

However, in 2000 the Envision agreement was terminated following system developmentproblems and licence sales performance issues. The BBC again faced the challenge of howbest to manage its licence collection service.

By 2000, outsourcing was firmly established as part of the BBC culture, and hence taking thelicence collection service in-house was not considered an option.



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The biggest challenge the BBC faced was the procurement process itself, because:

With 96% of its funding at stake, it was imperative to select the best delivery vehicle tomeet challenging revenue targets set for the next 10 years

It did not want to repeat the mistakes made with the Envision contract

It was committed to finding a partner(s) with whom it could work for the next 10 years

The nature of the licence collection business itself is complex, involving the followingservice categories:

Operations and customer service

Field sales/enforcement/prosecution

Direct marketing

Public relations

Advertising

Media planning/buying.

Solution

The BBC put in place interim contracts to ensure continuity of service during the newprocurement phase, then set about finding the optimum delivery vehicle for the licencecollection service.

The next step was to establish an approach to the procurement process that would meet thefollowing objectives:

Provide a flexible framework to ensure that the best solution is identified in the shortesttime

Get the best response from the market

Create a confidential environment that encourages the flow of ideas

Minimise costs for both the BBC and the bidders.

The approach adopted was as follows:

Market testing establishing market capability and interest in the opportunity

Expectation setting adoption of key messages that defined what the BBC wanted fromtheir supplier(s)

Knowledge sharing making available accurate, appropriate and helpful information to thebidders throughout the procurement process

Mentoring provision of one-to-one support for shortlisted bidders

Real Life testing seeing how the bidders perform against a real life brief

Vendor selection selecting the preferred supplier(s)

Contract negotiation to deal closure.

This thorough, multi-step approach to procurement reflected the BBCs risk-averse strategy.Also, the BBC was not prescriptive about the shape of any new outsourcing arrangement. Atthe start of the procurement process, it had no preconceptions about the supplier mix thatwould be best suited to deliver the service.



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Market Testing

The BBC wanted to establish market capability and interest in the opportunity, and it adopted abroad approach to market testing, including:

Holding a series of informal meetings with potential suppliers across all the defined servicecategories

Communicating with interested bidders via the BBC website

Holding a bidder briefing day.

The informal meetings were the BBCs first opportunity to create awareness, outline the scopeand structure of the opportunity, and define high-level objectives and the overall timetable.They helped the BBC to:

Assess the level of capability and appetite for the opportunity

Refine the procurement process based on feedback from the market

Set the tone of the procurement (i.e. an open and direct approach).

The BBC also issued an OJEC notice to advertise the opportunity, and set up a website tocommunicate with interested bidders. The website was also a repository for the keyprocurement documents such as the briefing document and Q&A lists.

Shortly after issuing the OJEC notice, the BBC held a bidder briefing day to help clarify theexact nature of the procurement and the rules of engagement, and to demonstrate seniormanagements commitment to the process.

The BBC got a strong response from the market, receiving 72 initial bids.

Expectation Setting

The BBC was very clear about the characteristics it required of its suppliers, which were:

To be able to demonstrate how they would optimise the delivery of services

To adopt a partnershipapproach to working with the BBC

To be innovative in their solution, initially and in the long-term.

The BBC felt strongly about re-enforcing this message, and so adopted the words optimise,partner and innovate within a logo for use in all communications related to the procurement,including the website and briefing documents. Furthermore, at the final stage of theprocurement, bidders were asked to respond to requirements structured around these threethemes.

Knowledge Sharing

Throughout the procurement process, the BBC ensured that accurate, appropriate and helpful

information was made available to the bidders, and that the same level of information wasavailable to all bidders (except where specific to their own bid) to ensure fairness. Knowledge-sharing took the following forms:

Regular distribution of procurement information on CD

Workshops with BBC specialists

Q&A non-confidential Q&As from bidders were turned around quickly and shared with allother bidders

Access to specialists bidders were invited to meet BBC specialists one-on-one to testideas; these sessions were monitored to maintain uniformity of the process.



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Mentoring

At the final stage of the procurement process, the BBC assigned a personal mentor to each ofthe shortlisted bidders. The role of the mentors was not to act as a champion for their biddersbut to:

Provide a single point of contact for the bidder

Provide answers to specific questions on the current TV licensing operation

Facilitate feedback on ideas the bidder wished to incorporate in their bid

Arrange and coordinate briefing sessions, site visits, etc.

The BBC also used the mentoring process to assess how the bidders responded to businessissues, and to see whether the promises contained in their bids were reflected in theirbehaviour.

Real Life Testing

The BBC set the shortlisted bidders a real business problem to solve, based on the BBCs

licensing business. Bid teams were asked to propose how they would reduce the rate of licenceevasion and, while they were given time to prepare, they were also asked to respond to newscenarios without warning. The objectives of the test were to assess the bidders in terms of:

Their ability to respond to a real life situation, and to adhere to a specific brief

Their understanding of the business were they able to get beneath the skin of the BBCslicensing business?

Teamwork were they able to present a coordinated end-to-end solution to the problem?Also, different people on the team were asked the same questions to assess individualstrengths, and to see if the team had fully communicated the issues amongst themselves

Response to questioning and negotiation did they take time to understand the BBCsperspective, and demonstrate mature negotiation skills, or become defensive and cover

their position?

The bidders were also brought together to work in teams so that the BBC could assess theirability to cooperate and integrate with other suppliers. At this stage, the BBC had not yetdecided whether one or more bidders would be selected to provide the service

Vendor Selection

The procurement process reduced the initial 72 bids to 17, then to a shortlist of seven, whichincluded BT, Capita, Centrica, EDS and a consortium from the AMV group.

Each shortlisted vendor was assessed and scored against detailed criteria, including:

Robustness of technology

Operational capability could they actually run the different elements of the collectionbusiness?

Ability to handle the transition, including TUPE transfers.

The BBC tested the bid papers against references from clients. After detailed evaluation andcomparison of the bids, the BBC decided to select two of the bidders as their preferredproviders:

Capita chosen to provide the Operations & Customer Services and Field Sales,Enforcement and Prosecution services

AMV consortium, led by Proximity London (the direct marketing operation) chosen toprovide the Direct Marketing, PR, Advertising and Media Planning & Buying services.

No single vendor satisfied the BBC that it could deliver the entire range of services. However,Capita was selected on the basis of its track record in call centre outsourcing and itsoperational capability, while Proximity was considered to be best able to provide the mix ofmarketing services required for the licence collection business.



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The suppliers were also selected on the basis of:

Their willingness to adopt a partnership approach to their dealings with the BBC

Their ability to demonstrate how they would optimise service delivery

The degree of creativity shown in their approach to solving the problem

Their ability to cooperate and work well with each other.

However, the selection process was not without hurdles. Specifically, the BBC had to overcomethe following issues:

Internal reaction to negative press surrounding the failure in 2001 of Capitas housingbenefits contract with Lambeth Borough Council

The Post Office (then Consignia) had been in the running for the contract, but failed tomake the shortlist. As the incumbent of some 80 years standing, there was considerablesensitivity around this issue.

The BBC considered the first of these issues as only a minor distraction, and focused ondemonstrating the strength of Capitas bid and its broader track record of success in business

process outsourcing.Regarding Consignia, the BBC was reliant upon their ongoing cooperation in the run-up to, andduring the transition to, the new arrangement. This meant that Consignia would have tointerface with Capita over a period of time, to transfer knowledge of current processes. TheBBC led a series of workshops involving Consignia and Capita, to cover each key aspect of thebusiness being transferred.

Contract Negotiation

The BBC pre-defined the main service contract, and issued this to the preferred providers withan Invitation to Negotiate (ITN). The key issues for the BBC at this stage were:

Being able to negotiate pricing terms that provided strong incentives for the suppliers, and

that incorporated an element of gain sharing between the BBC and the suppliersStriking a deal that it believed would last for the full 10 years, but that did not lock the BBCinto the new supply arrangement (in the event of it failing for whatever reason).

Exhibit 1 shows the fee structure for licence fee collection that was negotiated between theBBC and Capita.



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Exhibit 3

Fee Structure For BBC Licence Collection Service

Time

Sales()

Incentive

fee=x

+y

perlicen

cesale

Basicfe

e=xp

er

licences

ale,aga

inst

arising

salesta

rget

Rebate back to

BBC for belowtarget sales

Profit from

sales above

this level

shared 50/50

Time

Sales()

Incentive

fee=x

+y

perlicen

cesale

Basicfe

e=xp

er

licences

ale,aga

inst

arising

salesta

rget

Rebate back to

BBC for belowtarget sales

Profit from

sales above

this level

shared 50/50

The fee structure has the following elements:

A basic fee per licence sale set against a rising sales target over time

An incentive fee, composed of the basic fee plus a further amount for each additional saleup to a defined limit

A 50/50 share of super profit

A built-in rebate system, whereby the BBC is refunded should Capita fall short of the basicsales targets.

The BBCs main concern in the negotiations was to get the incentivisation plan right, so thatCapita would strive to maximise licence sales. This was seen as a vital element of the newarrangement.

The BBC also considered it important to draw up a cooperation agreement between Capita andthe AMV consortium. While this is not a legally binding document, it does reflect the BBCsinterpretation of the agreements it holds with both parties, and provides a commonunderstanding of what Capita and AMV should be undertaking on behalf of one another. Also,the fee structure within the AMV/Proximity agreement incorporates bonus payments above thesame sales targets defined in the Capita agreement.

While the details of operational service level agreements (SLAs) were important, the BBCmaintains that these were easily agreed upon by both parties, and that very little time is spentin monitoring these; instead, the focus is on revenue targets. SLAs cover all the key areas ofthe business, including customer service, payment processing, and field operations.

The BBC believes that an important factor in the negotiations was being aware of howimportant the new contract was to the incoming suppliers, and making that awareness pay. InCapitas case, the BBC knew that the deal was Capitas biggest ever business processoutsourcing contract, and took into account the following factors:

The prestige value of the contract

The likely impact of the contract on Capitas cashflow, profitability and future growth.



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Result

In February 2002, Capita was awarded the contract for TV licence administration, a 10-yeardeal worth 500m.

The existing call centre and field operations, including 1,500 personnel, transferred to Capita inJuly 2002. Capita also harnessed the facilities of some of its existing business centres,including one in Glasgow, and a centre in Blackburn that Capita had established through itscontract with Blackburn with Darwen Borough Council.

After just four months, the BBC is satisfied that the transition is going well, but stresses thefollowing key factors in making sure that the new arrangement gets off to the best possiblestart:

Senior management on both sides leading by example by demonstrating a partnershipapproach to managing the new arrangement

Ongoing knowledge transfer to the new suppliers, to enable them to fully understand theBBC culture and what motivates the licence collection business

Making sure that the service teams are motivated to deliver the new service targets. Anearly sign of success here is that call centre staff sickness rates have dropped from 15% to6% in just three months.

One senior BBC manager reflected on the smoothness of the transition by commenting whatdo I manage now? The answer is that the BBC is setting even bigger targets for revenuecollection than originally planned, including almost halving the licence evasion rate in the nextfive years, from its current level of 7.8% to 4%.



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7Case Study: Deutsche Bank

IntroductionDeutsche Bank was founded in Berlin in 1870, and today has 1,500 branches in Germany andbranch networks in Italy, Spain and Belgium. Deutsche Bank offers a broad range of personalbanking products (in areas such as payments, credit, online banking and personal investment),and corporate banking services (including payments processing, corporate finance, IPOsupport and M&A advisory). In addition, the bank is active in international foreign exchange,money market, fixed-income and derivatives trading.

The bank has 92,000 employees in over 70 countries, and has more than 9 million customers.In 1999, the banks net income was around Euro 2.6 billion.

This case study looks at the challenges faced by the banks money market division that led it tooutsource its back office processing under a joint venture arrangement.

Business Challenge

By 2000, Deutsche Banks back office operations were considerably disjointed, following aseven-year period of acquisition (notably, Morgan Grenfell and Bankers Trust) that had seen aproliferation of legacy systems and physical locations. Hence, Deutsche Bank faced thechallenge of having to re-engineer its back office systems and processes.

However, like other banks, Deutsche Bank also faced the following back office challenges:

Increasing investment costs, particularly related to industry-wide initiatives such as themove to next-day (T+1) settlement in equities markets

Market pressure for lower transaction costs. The drive towards T+1 settlement is largely

dependent on the ability to achieve high straight through processing (STP) rates, wherebyincreased transaction volumes can be handled at lower unit cost

Demand from investors to include international securities in their portfolios, increasing therange of products and types of processing that back offices have to support

Increasing responsibility for risk management (and hence for regulatory reporting) in theback office, brought about by the Basle II accord; the accord allows banks whose backoffices minimise operational losses to achieve more effective capital utilisation.

These factors combined to make cost reduction the overarching objective behind the banksdecision to re-engineer its back office operations.



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Solution

A number of parallel initiatives were started within Deutsche Bank to address the issue ofconsolidating and re-engineering back office operations, including:

A traditional systems selection process aimed at implementing a new system for moneymarket operations

A broader discussion regarding a possible outsourcing arrangement for back officeoperations.

Coincidentally, both of these initiatives involved discussions with Wall Street Systems, atechnology provider for global treasury operations, and hence they were soon combined.

The banks approach was technology-led, as it wanted to be certain that any new system wouldbe capable of meeting the following requirements:

Scalability the ability to handle large increases in transaction volume

Flexibility the ability to encompass a variety of trading products, and to accommodate

new productsIntegration the ability to integrate with other essential technology components easily; forexample, with workflow software, middleware (messaging layer) and the web front-end.

The bank evaluated Wall Street Systems against a number of other technology solutions(including MMPCA, Opics from Misys, Citadel from Demica, and internal Bankers Trustsystems), independently of any discussions about an outsourcing arrangement.

Having satisfied itself that Wall Street Systems could meet its technology criteria, DeutscheBank entered into broader talks about the nature of the sourcing arrangement for the new backoffice service, including the ownership structure and governance model. The bank saw thepotential of outsourcing back office operations for a range of trading products, using its moneymarket division as a pilot.

By now, the traditional reluctance of banks to consider outsourcing the back office wasbeginning to soften as a result of front office initiatives such as trading portals for foreignexchange and derivatives. Also, back office outsourcing was already starting to happen with,for example, the J.P. Morgan spin-off Arcordia offering an ASP-based platform for back officeprocessing of derivatives.

Hence, Deutsche Bank began to look at its back office operations in an entirely new way, andasked itself the following questions:

Despite historical and cultural influences, do we really want to keep operations in-house?

Would outsourcing the back office really affect the banks core activities of trading, riskmanagement and research?

The answer to both questions was no, with the banks rationale including the following

observations:

In-house operations are very resource-intensive and costly

Transaction (trade) processing operations are not fundamentally core to the banksbusiness, and hence are not a required in-house competency

Keeping operations in-house would involve yet another internal system build. The bank didnot want to pay six-figure licence fees to another software provider for a solution that wouldsimply add to the legacy problem.

Furthermore, these discussions led the bank to look beyond its fundamental requirement for alow-cost back office solution, and ask whether an outsourced back office might be used as apotential revenue generator in itself.

For its part, Wall Street Systems was open to discussing alternative business models thatwould enable it to move beyond its traditional role as a software provider.



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These discussions led Deutsche Bank and Wall Street Systems to consider setting up a newcompany, owned on a 50:50 basis, that would:

Provide the bank with a low-cost back office solution for money market (and other productsin future)

Be able to take on the back office operations of other financial institutions, to provide futureeconomies of scale, and

Provide a potential source of new income for both parties.

The joint venture, called Settlement and Operations Clearing Exchange (SOCX), wasestablished, with a CEO appointed at the end of 2000. A commercial arrangement was also putin place for Deutsche Banks London money market division as the first customer of the newcompany, based on a service level agreement.

Result

The SOCX service caters for the full trade lifecycle, from trade validation and matching, throughto settlement. The service level agreement is based on targets for processing trades with as

little manual intervention as possible (i.e. processed straight through). Consequently, thepricing of the SOCX service is exception-based, whereby:

A single, low charge is made for each trade that requires no manual intervention (i.e. isprocessed straight through)

A structured set of higher charges is applied for trades that require different levels ofmanual intervention (e.g. enrichment or repair); difficult trades may be as much as five orten times the cost of STP trades, depending on the time taken to reach settlement.

Progress of transactions through the trade lifecycle is completely transparent to the bank. Thesystem monitors the progress and success of every trade, and presents the bank with ananalysis of exceptions plus a breakdown of related charges. The transparency of the processalso enables the bank to allocate costs directly to their traders and counterparties.

This contrasts with the old in-house situation, where the bank had poor visibility of the progressof trades through the back office, no idea of the actual cost of each trade, and no way ofallocating those costs to traders or counterparties.

SOCX estimates that it has reduced the banks trade processing costs by 50% since May 2001,and anticipates that even greater savings will be possible in future, as SOCX continues to focuson improving STP rates.

For SOCX, lowering STP rates further means that it will require fewer people to manage itsexceptions, and the chance of human error incurring penalties will be minimised. Through aContinuous Improvement Programme, SOCX conducts risk assessments on exception events,showing not only the manual costs of processing these exceptions, but also the associatedoperational risk; a simple example might be to highlight where a particular client of the bank

sends multiple paper confirmations for the same deals.

In terms of staff numbers, Deutsche Bank was able to reduce its London money market backoffice workforce by 50%, the remaining staff transferring to SOCX. SOCX employs a total of 30people, nine of whom support day-to-day operations for Deutsche Bank; other staff areemployed in management, finance, business development, IT and sales and marketing roles.Following the roll-out of the SOCX service in its London money market division, Deutsche Bankhas since implemented the solution in New York and in Australia. Furthermore, SOCX nowsupports a range of other financial products for Deutsche Bank, including certificates of deposit,treasury bills, commercial paper, bills of exchange, and medium term notes across a number ofcentralised security depositaries (e.g. Austraclear and Bank One) and international securitiesdepositaries (e.g. Euroclear).



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SOCX has yet to sign up any new customers, though it claims to have non-disclosureagreements in place with a number of Tier 1 and Tier 2 banks (as at November 2002). Thebiggest challenge is to convince a still cautious industry to follow the radical example set byDeutsche Bank. In particular, SOCX faces resistance from other banks in the following forms:

Residual cultural resistance to outsourcing back office operations

Concerns about downsizing

Uncertainty over transfer of operational risk

Concern over entering a shared service arrangement with a competitor, particularly onethat has a major stake in the service organisation.

Deutsche Bank was very conscious of this last concern, and agreed at the outset with WallStreet Systems that both parties would aim to dilute their share of the business over time. It ishoped that some future clients will become shareholders in SOCX.

57 key lessons in bpo procurement

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