Banking On Outsourcing

Other giant banks in recent weeks and months have announced outsourcing or services arrangements as well, such as ABM Amro with EDS, Deutsche Bank with IGS, and Fleet Financial with AMS, though on a much smaller scale. But the Bank of America and JPM Chase deals, along with last year's gigantic American Express $4.5 billion outsourcing pact with IGS, underscore a new wave of services arrangements, where banks are hoping to score more variable, usage-based pricing to their data centers rather than fixed IT costs.

"As our business fluctuates by region [and] by business, we will be benefiting from the variability within this agreement, more so than if we had done the work ourselves," says JPM Chase managing director Michael Sztejnberg, who negotiated the deal with IGS.

Banks, in particular, are demanding such variability given the undeniable pressure they're under to reduce operational costs and risk during the economic downturn. That pressure has increased because financial services firms have had to write off huge losses on bad investments, such as debt issued to Enron and WorldCom, leading to significant earnings declines and, as a result, erosion of share prices during the past six months. JPM Chase, specifically, has been trading in the mid-20s of late, down from the mid-30s last year.

Overall, financial services outsourcing started picking up a year ago, says Coley Clark, president of EDS Global Financial Industry Solutions. This year, external IT spending will grow from nearly $50 billion to $60 billion within three years, confirms the TowerGroup, an IT consulting firm focused on banking and securities. Globally, it will grow from $120 billion to $142 billion over that same time period, according to TowerGroup.

By moving to a more demand-based pricing model, banks are hoping to have more control over key operational costs. To that point, in a speech during a Forrester conference in November 2002, American Express chairman and CEO Ken Chenault said while his company's IT infrastructure investments in the late 1990s helped provide key operational savings, the current volatile business environment calls for a more variable cost structure that could rise and fall. He described his company's outsourcing deal with IGS as a key effort toward joining its online and offline operations and being able to move quickly as business needs shift, without making huge capital investments.

"We didn't have a flexible and adaptable architecture," Chenault said. "You can't make [major] changes in a quarter."

Terms of the Deals

JPM Chase's transition from a fixed to variable cost arrangement is perhaps Big Blue's most significant outsourcing deal to date, and certainly for the banking industry as a whole, says Eric Ray, vice president for the financial-markets sector at IBM. JPM Chase will also gain access to key technologies under development for IBM's On Demand architecture, he adds. For example, over time, JPM Chase will deploy technology under development, called utility management infrastructure (UMI), that will tie together the bank's various servers and storage devices without requiring apps for each separate system.

"We're going to do resource virtualization for them," Ray says.

Under terms of the JPM Chase deal, 4,000 IT employees will join IGS, where they will continue running the bank's data center operations. IGS will assume ownership of the bank's systems, but the bank's IT management will still control the infrastructure deployed. The deal took a year to negotiate, according to Ray. Among the reasons was the shifting of an existing outsourcing arrangement between the former JPM Chase and the Pinnacle Alliance,which included J.P. Morgan, Computer Sciences Corp. (CSC), Accenture, AT&T Solutions and Verizon,prior to its merger with Chase Manhattan Bank in 2001.

The new IBM pact doesn't replace the Pinnacle Alliance, formed in 1996, however, it is set to expire next month, JPM Chase's Sztejnberg points out. That arrangement covered application development and desktop support, neither of which is covered under the IGS outsourcing deal. While the JPM Chase agreement questions what went wrong with the Pinnacle Alliance, Sztejnberg argues that it served the pre-merger JPM Chase well, and while Pinnacle was considered for the outsourcing deal, in the end the combined organization needed a huge services organization.

"Pinnacle definitely provided a significant amount of benefits over the past six or seven years," he says. "[But] the combined bank is obviously much larger than the heritage Morgan."

However, at least one member of the Pinnacle Alliance will continue to work with JPM Chase. IBM this month said it will retain CSC as a subcontractor in a deal worth approximately $500 million.

IGS will handle JPM Chase's mainframe systems, distributed-computing environment, help desks, and voice and data network infrastructure. Sztejnberg declined to comment on whether its PC support and application-development business will also be put out to bid or brought in-house. As IGS turns JPM Chase's IT resources into an on-demand infrastructure, it will need a less expensive architecture and "will run better" as a result, predicts Forrester analyst Christine Ferrusi Ross.

Like JPM Chase, Bank of America turned to outsourcing to reduce its operational costs, but it has different goals in mind. Having made more than 100 acquisitions during the past several years,ranging from very small banks to its mega-merger with NationsBanc in 1998,Bank of America wound up with a hodge-podge of networks with a common data architecture that it tasked EDS to replace.

EDS this month has begun transitioning about 1,000 of Bank of America's network administrators and is in the process of deploying the backbone. In addition to undisclosed service-level agreements, EDS will offer visibility to the network to any Bank of America employee.

While such giant deals may be far and few between, banks are clearly farming out more work overall. For example, business-process outsourcing is expected to grow at a compounded annual rate of 11 percent, notes Gartner analyst Avivah Litan. "Banks are anxious to get rid of any resources that aren't core to their business," she says.