Key Lessons in BPO Procurement

Case Study Report January 2003

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 capability globally with particular emphasis on Europe and the U.S. NelsonHall provides market assessments and vendor assessments to both users and vendors of services. The company also provides project and consulting services. 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 management services, industry-specific processing services, procurement services, accounting services, and HR services IT outsourcing, including application management, enterprise application outsourcing and comprehensive outsourcing services IT services, including professional services, systems integration and full life-cycle services IT application demand by industry. NelsonHall provides information to its clients in a variety of forms, tailored to your specific 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 of recent 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 Road Slough SL1 4DX Phone: +44 (0)1753 701 015 Fax: +44 (0)1753 725 205 paul.connolly@nelson-hall.com

2003 by NelsonHall.

January 2003

KEY LESSONS IN BUSINESS PROCESS OUTSOURCING PROCUREMENT

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Abstract
The purpose of this study is to provide high-level advice and guidance for senior executives who are considering business process outsourcing (BPO) as an alternative sourcing arrangement for one or more of their organisations business functions. The study is based upon NelsonHalls BPO market research, including interviews with CFOs and other senior decision-makers, and identifies key lessons in each of the following 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 have adopted 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 in any 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 of NelsonHall. NelsonHall exercises its best efforts in preparation of the information provided in this report and believe the information contained herein to be accurate. However, NelsonHall shall have no liability for any loss or expense that may result from incompleteness or inaccuracy of the information provided.

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Table of Contents
1. SELECTING A SOURCING APPROACH
ADDRESSING BUSINESS CHALLENGES ASSESSING SOURCING OPTIONS KEY LESSONS

1
1 3 4

2. SELECTING A BPO VENDOR

VENDOR SELECTION CRITERIA APPROACH TO VENDOR SELECTION KEY LESSONS

5
5 6 7

3. NEGOTIATING A BPO CONTRACT

NEGOTIATING BEHAVIOURS PRICING APPROACH KEY LESSONS

8
8 9 9

4. MAKING THE TRANSITION TO BPO

MOVING TO THE NEW ARRANGEMENT ENSURING EARLY SUCCESS KEY LESSONS

10
10 11 12

5. CASE STUDY: ABBEY LIFE

BACKGROUND BUSINESS CHALLENGE SOLUTION RESULT

13
13 13 14 17

6. CASE STUDY: BBC

BACKGROUND BUSINESS CHALLENGE SOLUTION RESULT

19
19 19 20 25

7. CASE STUDY: DEUTSCHE BANK

BACKGROUND BUSINESS CHALLENGE SOLUTION RESULT
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26 26 27 28

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1
Selecting A Sourcing Approach
Addressing Business Challenges
In todays economic climate, many organisations are focused on reducing the cost of running their 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 or political 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 process outsourcing. Many organisations in these sectors, in addition to the cost pressures listed above, currently also face the challenge of improving business processes that have become disfunctional or fallen into disrepair. Banks provide the classic example here, having struggled for years with process silos that have come about due to the uncontrolled growth of legacy systems for different financial products, across different business units. Accordingly, over the last few years, organisations have increasingly begun to outsource business 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 to outsource apparently core processes such as cheque processing, mortgage processing and insurance claims administration, and also customer contact management; these areas are now seen as too important to be left to in-house legacy processes and require a combination of process and service improvement and process cost reduction Exhibit 1 lists the principal business challenges faced by organisations in different sectors.

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KEY LESSONS IN BUSINESS PROCESS OUTSOURCING PROCUREMENT

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Exhibit 1

Principal Business Challenges by Sector

Sector
Banking

Principal Business Challenges

Improvement of cross-selling to existing customers Integration of service delivery Delivery of improved value for money Development of additional distribution channels

Insurance

Reduced cost base by process improvement and outsourcing support processes Maintaining or increasing market share

Retail & CPG

Geographic expansion Streamlining supply chain Developing and launching new products

Pharmaceuticals

Building scale and distribution capability Mergers & acquisitions Retaining customers

Telecoms & media

Introducing new services Reducing operational cost of service delivery & overheads Restructuring of businesses

Utilities

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 by using external business services. However, the pattern of usage of external services will typically be driven by these basic business needs. Current levels of satisfaction with in-house processes are universally low. However, some processes (typically those associated with business critical activities such as the ability to get new products or services to market, and customer service and retention) are regarded as much more 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 critical processes 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 are assessing alternative sourcing arrangements for their business processes.

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KEY LESSONS IN BUSINESS PROCESS OUTSOURCING PROCUREMENT

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Assessing Sourcing Options

Organisations reviewing the sourcing arrangements for their business processes face the following 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 costs and 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 and customer 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. For example, if your organisation is intent on reducing management responsibility for a business function to a minimum, you are unlikely to spend much time considering the merits of retaining the function in-house, or of setting up a joint venture. This was the situation Abbey Life found itself in when it became closed to new business, and its parent Lloyds TSB Group decided it needed to both reduce the cost of the operation and introduce an element of cost certainty to the 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 it changed the sourcing arrangement for its retail cheque processing business. In December 2000, it entered a joint venture (iPSL) with rival Barclays, and Unisys, to provide a shared service 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 Systems for its money market operations (see section 7). It calculated that the new arrangement would provide the bank with a low-cost solution for money market trade processing (and for other products in future), and would also be able to take on the back office operations of other financial 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 to provide a baseline for comparison. Though the costs of in-house business processes can often be 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. 5 or 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 staff severance 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 that would be outside the scope of the contract.

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KEY LESSONS IN BUSINESS PROCESS OUTSOURCING PROCUREMENT

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Apply a perceived risk approach to model the impact of certain events that might occur downstream. For example, in the case of an in-sourced solution, model the likely impacts of losing critical members of staff and of project delays. Assess the technology options that would be available under different arrangements. Will the technology 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 to accommodate expected increases in transaction volume (and beyond), and flex to accommodate new transaction types? Also, how innovative is the technology? Some technologies may enable cost reduction on your existing cost curve, while others may be able switch your business process onto a lower cost curve altogether. In summary, unless you can establish a clear picture of costs and process performance under your current arrangement, you have no baseline for comparison of alternative sourcing arrangements and, furthermore, no baseline for negotiations when you reach the stage of selecting a vendor.

Key Lessons
It is important to understand all the drivers for change, both internal and external to your organisation, when considering a change of sourcing arrangement for your business processes. For example, the internal trigger for change may be the ineffectiveness of legacy systems; however, it is also important to factor in external market forces affecting your industry, such as market pressure for lower transaction costs Establish in-house benchmarks of both cost and process performance as a baseline for assessing alternative sourcing arrangements Use cost modelling to gain an understanding of attainable cost levels under alternative arrangements, and as a basis for informed negotiation with potential vendors Adopt a creative approach to evaluating new sourcing arrangements, and be open to new ownership and governance models Ensure that the technology underpinning the business service is flexible and scalable to future needs When considering a new sourcing arrangement for a business process that is a cost centre, consider not only whether costs can be reduced, but whether the process can be transformed into a profit centre. However, be realistic about the chances of being able to generate new business easily.

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2
Selecting a BPO Vendor
Vendor Selection Criteria
Exhibit 2 shows the most important criteria applied by CFOs in selecting a prospective BPO service vendor.
Exhibit 2

Most Important Vendor Selection Criteria for CFOs

Criterion Key Issues
What impact will this vendor have on my brand reputation? Operational Service Experience Importance of day-to-day reliability Ability to avoid project mentality Access to Best-of-Breed Applications Proven industry-specific technology Standard back-office, e.g. SAP, PeopleSoft Ability to reduce cost by: Improving staff management Cost Reduction/Price Per Transaction 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 a business function which could have a negative impact on the company brand if this is mismanaged. Hence, the potential impact of a vendor on a companys reputation is seen as highly important. Also in terms of operational behaviour, CFOs are concerned that a vendor should demonstrate day-to-day reliability, managing the business smoothly and efficiently. Avoidance of project mentality is also considered key. Successful BPO arrangements are founded on a partnership-style approach to achieving long-term business benefits, and this is not consistent with a project approach whereby the vendor reports overruns, out of scope items 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 proven ERP product such as SAP or PeopleSoft is important in the delivery of accounting services and HR services. Similarly, familiarity with, and expertise in, appropriate industry-specific application products is important in the delivery of industry-specific processing services such as loans processing in the banking sector. Not surprisingly, a vendors ability to reduce the cost per transaction is an important selection criterion 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 first instance in vendors ability to reduce costs through the more traditional means of improved staff management and processes. Indeed, it is probable in many instances that there will be greater cost reduction benefit achieved by using new technology and processes to switch to a new cost curve 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 these approaches. Other vendor selection criteria to consider include: Ability to price competitively combined with a willingness to negotiate creatively Sensitivity to people and cultural issues A partnership-style approach to doing business, including a can do attitude and a clear commitment to the long-term.

Approach to Vendor Selection

It is essential to conduct vendor selection thoroughly, and to test prospective partners rigorously. However, it is important to take a balanced approach that enables you to identify the most 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 of your requirements, and making available accurate, appropriate and helpful information to bidders throughout the selection process Vendor testing not just assessing submitted bids, but seeing how bid teams perform against a real life brief. Rather than simply issuing a request for proposal (RFP), it is first worth trying to establish market capability and interest in the opportunity, and you might consider holding a series of informal 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 is made 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 bidders response to a real-life brief. This was something the BBC did when it outsourced its TV Licensing 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 business Teamwork is the vendor able to present a coordinated end-to-end solution to the problem? What are the individual strengths of team members, and has the team fully communicated the key issues amongst themselves? Response to questioning and negotiation does the vendor take time to understand your perspective, and demonstrate mature negotiation skills, or become defensive and cover their position? Furthermore, because it was likely that more than one vendor would be selected to operate different elements of its TV Licensing business, the BBC brought together shortlisted vendors to work in teams, so that it could assess their ability to cooperate and integrate with one other.

Key Lessons
Conduct thorough market testing, using a variety of methods, to assess vendor capability and 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 message throughout the procurement process Keep the flow of communication with the bidders going, using multiple channels, to encourage active dialogue throughout the process Assess how bidders respond to business issues raised during site visits and briefing sessions, 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 the practicality and creativity of their response Where it is likely that more than one supplier will be selected, bring the bidders together to work in teams to assess their ability to cooperate and integrate with one other.

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3
Negotiating A BPO Contract
Negotiating Behaviours
When you have selected your preferred partner, getting to the best contract will only happen if both parties are open about their business and financial aims and objectives. Contract negotiations should be conducted on an open book basis. It is important to adhere to your initial objectives, which will almost certainly include elements of both cost reduction and business process improvement. When Abbey Life negotiated the deal for its life and pensions business with Unisys, it was motivated by the need to preserve its large customer base and maintain its reputation for strong service levels, but was equally motivated to reduce overall cost. Abbey Life was not prepared to compromise on either of these high-level objectives. However, Abbey Life was keen to engage in creative negotiations, and utilise the knowledge and 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 on responsibility for managing a large insurance business for the first time, despite its strength in the provision of insurance solutions. Abbey Life believed that Unisys had the ability to manage the business effectively, but also realised that this contract was an entre for Unisys to the wider market for insurance business process outsourcing. The understanding that, in the longer-term, Unisys would use the Abbey Life contract as a springboard for further business in the 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 to its preferred vendor, Capita. The BBC knew that the deal was Capitas biggest ever business process outsourcing contract, and took into account both the prestige value of the contract and the 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 incentives for 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 the negotiations. While defining the details of operational service level agreements (SLAs) is very important, the primary focus on defining the incentives means that SLAs and the details of any associated penalty clauses can be more easily agreed upon. Finally, whilst a positive, forward-looking approach to negotiations is important, it is equally important to incorporate contingency plans into the contract negotiations to mitigate the risk of any 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 of existing costs, you have no baseline for price negotiation. Your current cost model will provide an understanding of attainable cost levels using present processes and technology and can usually be extrapolated to estimate the impact of new processes (removal of cost elements) and technologies. Based on this, you can expect to negotiate 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 the vendor. For example, since revenue generation is the key metric of success in its licensing business, the BBC negotiated an incremental pricing plan with Capita, as an incentive to reach higher 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, the pricing 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 sale up 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 basic sales targets. Finally, insist upon all pricing being entirely visible and fully inclusive, to avoid hidden extras should things change downstream.

Key Lessons
Conduct contract negotiations with both parties entirely open about their aims and objectives for the contract Use the in-house cost benchmarks you established at the start of the procurement process as the basis for informed negotiation with potential vendors Use this knowledge to insist upon both improved service quality and cost reduction dont compromise 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 on getting the incentive plan right, rather than refining the details of penalty clauses associated with SLAs Understand exactly how important the contract is to the potential supplier during contract negotiations Expect to price differing service elements using both fixed price elements for one-off activities and per unit pricing for ongoing service delivery, or at least understand those one-off cost elements that are to be spread over the life of the service.

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4
Making 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 closure of the deal. Hence, when you have successfully negotiated the deal, it is important to keep up the 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 to have 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 representatives from your organisation and from the vendor. While it is desirable to avoid unnecessary bureaucracy in the running of the new arrangement, it is probably also necessary to set up a number of sub-committees to oversee each of the major operational areas such as service reviews, 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 staff communications is essential during the transition, and beyond. Set up a comprehensive, multichannel communication programme, and consider including the following components: A consultation process between staff and union representatives, supported by your HR team Drop-in rooms where staff can learn more about their new employer and how the new business 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 frequent basis, using multiple access channels. It is also important to encourage two-way communication, 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 the success of the communication programme.
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Ensuring Early Success

Continuing the communication programme beyond the transfer date to the new arrangement is important to ensure early success, as are the following factors: The senior management team leading by example by demonstrating a committed partnership approach to the new arrangement Ongoing knowledge transfer to the BPO vendor, to enable them to fully understand your culture and what motivates your business Making sure that the service teams are motivated from the start to deliver the new service targets. Early signs of success often emerge in the form of improved staff morale, and more tangible measures such as reduction in staff absenteeism and attrition rates. For example, the BBC noted that call centre staff sickness rates dropped from 15% to 6% in the first three months following the transition to the new BPO arrangement. Similarly, Abbey Life reports a fall in staff attrition 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 focus on the most important metrics for your organisation, and not to get sidetracked into measuring service levels simply for compliance. For example, the BBC monitors Capitas performance against revenue targets as the primary measure of success, and spends very little time reporting 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 a closed-book business, it was essential that every interaction with existing customers should be as smooth and incident-free as possible. Hence, for an initial period, Abbey Life conducted hour-by-hour service monitoring to ensure that the new customer call handling operation was successful from the start. Less than two years into the BPO contract, Abbey Life can report that: 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 to reallocate staff resource where necessary much more quickly than before, and to evaluate staff performance more closely, and improve incentive schemes. It is also important to conduct a thorough and independent 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 by your customers. This should be a like-for-like appraisal of satisfaction with the service, using the last customer satisfaction survey under the old arrangement as the baseline. Finally, make plans to benchmark service delivery against the outside market after two or three years of the new arrangement, and at intervals thereafter. This will ensure that the service remains competitive, and continues to match or better the cost and process improvements that might 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 effective knowledge 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 for your 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 new arrangement to ensure that the service remains competitive.

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5
Case Study: Abbey Life
Background
Abbey Life was originally founded in 1961, and established a link with Lloyds Bank in 1988 when the company, together with five financial services subsidiaries of Lloyds Bank, were brought together to create Lloyds Abbey Life plc. In 1996, Lloyds Bank merged with TSB, and in the same year the newly formed Lloyds TSB Group plc bought out the balance of the shares in Lloyds Abbey Life. Abbey Life then became a wholly owned subsidiary of the Lloyds TSB Group plc. The newly formed group found itself with a number of life and pensions businesses, none of which (including Abbey Life) could be considered market leaders. As the groups strategy was to have only market leading brands within its portfolio, it pursued a merger with Scottish Widows, a deal that was completed in 1999. Later that year, Abbey Life's client funds under management (in excess of 15 billion) began to be looked after by Scottish Widows Investment Partnership (SWIP). As part of the overall review of the Group's Insurance and Investment strategy, it was decided to close Abbey Life to new business and, in February 2000, Abbey Life's sales capability was bought out by Allied Dunbar. At that point, Abbey Life had over one and three quarter million clients still being serviced.

Business Challenge
With Abbey Life now a closed-book business, the Lloyds TSB Group was keen to further reduce its role in the day to day running of the business, and set out to find a sourcing solution that 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 existing business. However, Abbey Lifes life insurance business had been running on 15 to 18 different legacy systems, some of which were 30 years old. With no new business flowing into the company, it was anticipated that the staff situation would become difficult, with declining career development opportunities leading to a serious 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 both reduce 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 10year 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 severance payments 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 that would be outside the scope of the contract The team applied a perceived risk approach to model the impact of certain events that might occur downstream. For example, in the case of an in-sourced solution, the team modelled the likely 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-sourced arrangement (completely in-sourced or under a JV) would be 275m at best. The cost of outsourcing 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, modern technology platform.

Selecting a Supplier
While it was imperative to replace legacy systems, the clear objective by now was to outsource all business operations, and so Abbey Life looked for a partner who could both provide a new IT 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 retention problems, 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 upfront investment, and the likelihood of cumulative profit being deferred until several years into the contract) 6. Must have a can do ethos. A request for proposal (RFP) was sent to 11 prospective suppliers, of whom seven submitted proposals. 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, and consciously deselected on the basis of these. Danger signs included: Little or no knowledge of the life and pensions business, and of the type of customer service required in this business Over-aggressive pricing without a clear rationale. Having modelled the costs, the Abbey Life team was suspicious of bids that undercut their own calculations and that could not be substantiated; in particular, the team wanted to avoid getting into a low-price deal if it meant 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. The Unisys Life and Pensions Solution was a proven solution, having been implemented at another U.K. life and pensions company with in the region of 400,000 policies. Furthermore, Unisys had an existing outsourcing relationship with Lloyds TSB (Unisys, Lloyds TSB and Barclays Bank had recently formed a company called Intelligent Processing Solutions Ltd. to manage and run outsourced cheque processing operations).

Negotiating the Contract

Contract negotiations were conducted on an open book basis, with both parties making their aims and objectives very clear from the start. Abbey Life drove a hard bargain, and was motivated by the dual imperatives of preserving its large customer base and maintaining its reputation for strong service levels. However, just as important was the need to reduce overall cost. Unisys opening position was to suggest that it could deliver the same service levels at a fixed price. However, Abbey Life insisted upon improved service levels at a reduced cost, and was encouraged 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 on responsibility for managing a large insurance business for the first time, despite its strength in the provision of insurance solutions. Abbey Life believed that Unisys had the ability to manage the business effectively, but also realised that this contract was an entre for Unisys to the wider market for insurance business process outsourcing. The understanding that, in the longer-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 technology platform, 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 for up to the first three years of the contract only; these included responsibility for loans administration and other accounting functions, plus IS infrastructure and development services, and technical support.

Making the Transition

The first step in the transition to the new arrangement was the transfer of around 1,000 Abbey Life staff. Both parties were sensitive to the challenge of people adjusting from a life and pensions company to a professional service provider, and three initiatives were taken to help smooth the transition: Training programmes A 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 TSB HR professionals Drop-in rooms where staff could learn more about Unisys and how the new business would work 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 a success because: As much relevant information as possible was made accessible on a regular basis, using a multi-channel approach Two-way communications were encouraged, including a staff Q&A service Senior management commitment and accountability. Each of the communication strands was sponsored by a senior manager. The management team understood that closer and more effective monitoring of the business would 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 systems infrastructure. However, such is the scale of the operation that full migration to the new platform is not scheduled to be completed until the end of 2003. To oversee the transition to UISL, but more importantly to provide a governance structure for the 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 monitoring and managing all operational issues arising, including matters relating to systems development, compliance, claims and underwriting, complaints, service reviews and change management. As a regulated company it was important for Abbey Life to take this approach; while it was able to outsource its activities, it could not outsource its regulatory responsibilities. The entire process, from the initial decision to outsource through to the contract announcement took 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 reenergising effect on employees. In the first 18 months, staff attrition rates dropped dramatically. 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 service levels. A service credit system was established, whereby any failure to meet a service level would 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 service levels include: Service turnarounds (the time taken to handle a service request, such as a policy surrender or maturity, to completion). Previously, not all service requests were monitored to 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 requests are monitored, with 95% requiring completion within six days (98% is achieved), the remaining 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 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% 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 satisfaction levels. The survey, carried out by an independent research company, established that satisfaction levels were higher across the board than in May 1999, prior to the business becoming closed-book. From a cost perspective, Abbey Life is also very satisfied to date, with cost levels already well below 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 Life will start to benchmark service delivery against the outside market, and anticipates appropriate reviews and discussions to start at that point. Abbey Life has contractual safeguards in place to mitigate the risk of any large-scale failure by Unisys, 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 rented from Abbey Life. However, with the possible exception of some ancillary services, Abbey Life does not anticipate 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 life within UISL, but that job prospects have improved, with staff having moved from an operation that was previously headed for a staff reduction, to a stable organisation that is looking to grow and 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 under significant cost pressure as a result of the Governments Stakeholder Pensions policy whereby no provider is allowed to levy an annual management charge in excess of one per cent for their pension product (and it is believed that this approach will become the norm across a broader range of products). In this environment, Abbey Life believes that it would still have looked at outsourcing its business processes, though the decision may not have been taken until a year or two later.

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6
Case Study: BBC
Background
The British Broadcasting Corporation (BBC) has been making and broadcasting radio and television 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 longterm funding of the BBC. Revenue generation through advertising was rejected and the licence fee survived (though it was pegged to the Retail Price Index). However, the effect of the Peacock Report was to propel broadcasting in the UK towards the embrace of market disciplines. In 1991, the BBC established an internal market, whereby programme-makers were encouraged to use the services of outside companies, while in-house departments became business units with P&L responsibility. Over the next decade, the BBC underwent a commercialisation process in which it steadily outsourced more and more of its business processes, starting with non-core functions such as catering and procurement, and progressing to core functions such as programming and facilities, financial operations and licence fee collection.

Business Challenge
Driving this huge change programme was the need to raise money for the transition to digital broadcasting, which could not be funded entirely from the licence fee. Nevertheless, the licence fee remains the life blood of the BBC (currently 96% of all available funding), and hence the ongoing 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., Subscription Services Ltd. (a wholly owned subsidiary of the Post Office) and WPP Ltd.) to collect licence fees on a 7-year contract However, in 2000 the Envision agreement was terminated following system development problems and licence sales performance issues. The BBC again faced the challenge of how best to manage its licence collection service. By 2000, outsourcing was firmly established as part of the BBC culture, and hence taking the licence 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 to meet 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 following service 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 new procurement phase, then set about finding the optimum delivery vehicle for the licence collection service. The next step was to establish an approach to the procurement process that would meet the following objectives: Provide a flexible framework to ensure that the best solution is identified in the shortest time 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 from their supplier(s) Knowledge sharing making available accurate, appropriate and helpful information to the bidders 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. At the start of the procurement process, it had no preconceptions about the supplier mix that would 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 a broad approach to market testing, including: Holding a series of informal meetings with potential suppliers across all the defined service categories 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 scope and 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 to communicate with interested bidders. The website was also a repository for the key procurement 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 the exact nature of the procurement and the rules of engagement, and to demonstrate senior managements 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 partnership approach 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 the procurement, bidders were asked to respond to requirements structured around these three themes.

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 was available to all bidders (except where specific to their own bid) to ensure fairness. Knowledgesharing 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 all other bidders Access to specialists bidders were invited to meet BBC specialists one-on-one to test ideas; 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 of the shortlisted bidders. The role of the mentors was not to act as a champion for their bidders but 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 business issues, and to see whether the promises contained in their bids were reflected in their behaviour.

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 licence evasion and, while they were given time to prepare, they were also asked to respond to new scenarios 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 BBCs licensing 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 individual strengths, 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 BBCs perspective, 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 their ability to cooperate and integrate with other suppliers. At this stage, the BBC had not yet decided 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, which included 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 collection business? Ability to handle the transition, including TUPE transfers. The BBC tested the bid papers against references from clients. After detailed evaluation and comparison of the bids, the BBC decided to select two of the bidders as their preferred providers: 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 to provide 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 its operational capability, while Proximity was considered to be best able to provide the mix of marketing 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 overcome the following issues: Internal reaction to negative press surrounding the failure in 2001 of Capitas housing benefits contract with Lambeth Borough Council The Post Office (then Consignia) had been in the running for the contract, but failed to make the shortlist. As the incumbent of some 80 years standing, there was considerable sensitivity around this issue. The BBC considered the first of these issues as only a minor distraction, and focused on demonstrating 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, and during the transition to, the new arrangement. This meant that Consignia would have to interface with Capita over a period of time, to transfer knowledge of current processes. The BBC led a series of workshops involving Consignia and Capita, to cover each key aspect of the business being transferred.

Contract Negotiation
The BBC pre-defined the main service contract, and issued this to the preferred providers with an 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 suppliers Striking a deal that it believed would last for the full 10 years, but that did not lock the BBC into 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 the BBC and Capita.

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Exhibit 3

Fee Structure For BBC Licence Collection Service

Sales ()

Profit from sales above this level shared 50/50

x+y e= e f e le ntiv er Ince ence sa x p inst = c i l e r pe aga ic fe Bas e sale, target c licen g sales in s i r a Rebate back to BBC for below target sales

Time
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 sale up 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 basic sales targets. The BBCs main concern in the negotiations was to get the incentivisation plan right, so that Capita would strive to maximise licence sales. This was seen as a vital element of the new arrangement. The BBC also considered it important to draw up a cooperation agreement between Capita and the AMV consortium. While this is not a legally binding document, it does reflect the BBCs interpretation of the agreements it holds with both parties, and provides a common understanding 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 the same sales targets defined in the Capita agreement. While the details of operational service level agreements (SLAs) were important, the BBC maintains that these were easily agreed upon by both parties, and that very little time is spent in monitoring these; instead, the focus is on revenue targets. SLAs cover all the key areas of the business, including customer service, payment processing, and field operations. The BBC believes that an important factor in the negotiations was being aware of how important the new contract was to the incoming suppliers, and making that awareness pay. In Capitas case, the BBC knew that the deal was Capitas biggest ever business process outsourcing 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-year deal worth 500m. The existing call centre and field operations, including 1,500 personnel, transferred to Capita in July 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 its contract with Blackburn with Darwen Borough Council. After just four months, the BBC is satisfied that the transition is going well, but stresses the following key factors in making sure that the new arrangement gets off to the best possible start: Senior management on both sides leading by example by demonstrating a partnership approach to managing the new arrangement Ongoing knowledge transfer to the new suppliers, to enable them to fully understand the BBC culture and what motivates the licence collection business Making sure that the service teams are motivated to deliver the new service targets. An early sign of success here is that call centre staff sickness rates have dropped from 15% to 6% in just three months. One senior BBC manager reflected on the smoothness of the transition by commenting what do I manage now? The answer is that the BBC is setting even bigger targets for revenue collection than originally planned, including almost halving the licence evasion rate in the next five years, from its current level of 7.8% to 4%.

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7
Case Study: Deutsche Bank
Introduction
Deutsche Bank was founded in Berlin in 1870, and today has 1,500 branches in Germany and branch networks in Italy, Spain and Belgium. Deutsche Bank offers a broad range of personal banking products (in areas such as payments, credit, online banking and personal investment), and corporate banking services (including payments processing, corporate finance, IPO support 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 to outsource its back office processing under a joint venture arrangement.

Business Challenge
By 2000, Deutsche Banks back office operations were considerably disjointed, following a seven-year period of acquisition (notably, Morgan Grenfell and Bankers Trust) that had seen a proliferation of legacy systems and physical locations. Hence, Deutsche Bank faced the challenge 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 the move 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, whereby increased transaction volumes can be handled at lower unit cost Demand from investors to include international securities in their portfolios, increasing the range of products and types of processing that back offices have to support Increasing responsibility for risk management (and hence for regulatory reporting) in the back office, brought about by the Basle II accord; the accord allows banks whose back offices minimise operational losses to achieve more effective capital utilisation. These factors combined to make cost reduction the overarching objective behind the banks decision 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 of consolidating and re-engineering back office operations, including: A traditional systems selection process aimed at implementing a new system for money market operations A broader discussion regarding a possible outsourcing arrangement for back office operations. Coincidentally, both of these initiatives involved discussions with Wall Street Systems, a technology 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 would be 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 products Integration the ability to integrate with other essential technology components easily; for example, 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 Trust systems), independently of any discussions about an outsourcing arrangement. Having satisfied itself that Wall Street Systems could meet its technology criteria, Deutsche Bank entered into broader talks about the nature of the sourcing arrangement for the new back office service, including the ownership structure and governance model. The bank saw the potential of outsourcing back office operations for a range of trading products, using its money market division as a pilot. By now, the traditional reluctance of banks to consider outsourcing the back office was beginning to soften as a result of front office initiatives such as trading portals for foreign exchange 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 office processing of derivatives. Hence, Deutsche Bank began to look at its back office operations in an entirely new way, and asked 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, risk management 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 banks business, and hence are not a required in-house competency Keeping operations in-house would involve yet another internal system build. The bank did not want to pay six-figure licence fees to another software provider for a solution that would simply add to the legacy problem. Furthermore, these discussions led the bank to look beyond its fundamental requirement for a low-cost back office solution, and ask whether an outsourced back office might be used as a potential revenue generator in itself. For its part, Wall Street Systems was open to discussing alternative business models that would 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 new company, owned on a 50:50 basis, that would: Provide the bank with a low-cost back office solution for money market (and other products in future) Be able to take on the back office operations of other financial institutions, to provide future economies of scale, and Provide a potential source of new income for both parties. The joint venture, called Settlement and Operations Clearing Exchange (SOCX), was established, with a CEO appointed at the end of 2000. A commercial arrangement was also put in place for Deutsche Banks London money market division as the first customer of the new company, based on a service level agreement.

Result
The SOCX service caters for the full trade lifecycle, from trade validation and matching, through to 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, the pricing of the SOCX service is exception-based, whereby: A single, low charge is made for each trade that requires no manual intervention (i.e. is processed straight through) A structured set of higher charges is applied for trades that require different levels of manual intervention (e.g. enrichment or repair); difficult trades may be as much as five or ten 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. The system monitors the progress and success of every trade, and presents the bank with an analysis of exceptions plus a breakdown of related charges. The transparency of the process also 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 progress of trades through the back office, no idea of the actual cost of each trade, and no way of allocating 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 focus on improving STP rates. For SOCX, lowering STP rates further means that it will require fewer people to manage its exceptions, and the chance of human error incurring penalties will be minimised. Through a Continuous Improvement Programme, SOCX conducts risk assessments on exception events, showing not only the manual costs of processing these exceptions, but also the associated operational 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 back office workforce by 50%, the remaining staff transferring to SOCX. SOCX employs a total of 30 people, nine of whom support day-to-day operations for Deutsche Bank; other staff are employed 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 Bank has since implemented the solution in New York and in Australia. Furthermore, SOCX now supports 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 of centralised security depositaries (e.g. Austraclear and Bank One) and international securities depositaries (e.g. Euroclear).

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SOCX has yet to sign up any new customers, though it claims to have non-disclosure agreements in place with a number of Tier 1 and Tier 2 banks (as at November 2002). The biggest challenge is to convince a still cautious industry to follow the radical example set by Deutsche 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 one that has a major stake in the service organisation. Deutsche Bank was very conscious of this last concern, and agreed at the outset with Wall Street Systems that both parties would aim to dilute their share of the business over time. It is hoped that some future clients will become shareholders in SOCX.

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