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Outsourcing

A White Paper

© 2009 – Clear2Pay NV – All rights reservedClarity in Payments

An Exploration of the Outsourcing Market

Clear2Pay White Paper2

Table of Contents

1. Executive Summary 3

2. Introduction 4

Nothing New Under the Sun 4

Types of Outsourcing 4

Application Service Provision (ASP) 5

Business Service Provision (BSP) 5

Information Technology Outsourcing (ITO) 6

Business Process Outsourcing (BPO) 6

Shared Service Centre (SSC) 6

3. A Market Perspective on Outsourcing 7

It’s not all Bad News 7

Changing Payment Servicers 8

The Need to Increase Payment Volumes 8

4. Drivers in Outsourcing Strategy 9

The Strategic Sourcing Market 9

Triggers to Outsourcing 10

Outsourcing Tipping Points 13

Barriers to Outsourcing 14

5. What to Outsource? 15

Outsourcing Elements of the Payments Value Chain 16

Decoupling the Enterprise Payment Business 17

Where to Make Efficiencies with Reduced Revenues 18

Business Analysis 19

Step-by-Step to Outsourcing 20

6. Conclusions 21

Credit: Garerth Lodge, Sr. Research Director Payments Europe, TowerGroup.

3Clarity in Payments

1. Executive Summary

While nobody can deny that payment outsourcing is experiencing a widespread resurgence in popularity,

especially in Europe, outsourcing remains an inexact and ill-defined science. With a plethora of buzzwords and

acronyms, outsourcing represents various things to different people. With multiple potential strategic smart-

sourcing models, the choice depends on two critical factors which run to the heart of a bank’s long-term goals;

core payment processing strategy versus the customer value proposition. Rarely are banks faced with such a

potentially seismic decision. Are you a payments oriented bank or do you prioritise a stronger customer focus?

In reality, it is not such a clear-cut either/or decision, but at some point a bank needs to focus more on either

more efficient payment processing or improved services to customers.

Overshadowing these important decisions is the current global financial crisis. While outsourcing does not

directly impact the functioning of the global financial markets, it evangelises great improvements in processing

efficiencies that affects all banks’ bottom-lines, as well as facilitating an improved customer focus; all this at a

time when money and customer trust are in short supply. It is worth reminding ourselves that the blame for the

current crisis, at least in the minds of many citizens, is perceived to lie exclusively with the banks. Outsourcing

offers some respite in the form of cost savings and the impetus to rebuild customer relations in order to regain

consumer trust - the core to closer and more mutually advantageous relationships.

Banks are facing an increasingly competitive marketplace, and in the absence of a surplus of funds to tide us

over until better times, banks must refocus on core strategy and differentiate themselves through improved

services. Customers are mostly uninterested by who physically processes any given transaction, and they

are largely oblivious to the implications. Of greater interest are the price and the quality of services offered.

Therefore outsourcing is not simply about processing payments as cheaply as possible, bank strategy must

guide any realignment of core activities, and this strategy will determine the outsourcing potential, the preferred

outsourcing model and the ideal outsourcing partner.

Another repercussion of the financial crisis is the ever-present threat to its resolution; the fear of a widespread

outbreak of nationalism and protectionism. More amicably known as National Airline Syndrome where each

country must have a national airline despite the fact that they perennially lose money. Payments is perceived

in a similar light and is a classic historical case of the syndrome with smaller national banks determined to stay

in the payments business despite revenue concerns and the fact that larger players are undercutting and also

offering extensive revenue generating services.

The old maxim remains relevant; when times are hard, banks must focus on their core business while eliminating

tasks that are outside their realm of competence. Whether a bank has ambitions to become a leading payment

processor generating strong revenue from large volumes, or whether a bank refocuses on customer service

preferring to relinquish their modest payment volumes to an insourcer, the readiness, efficiency and flexibility

of the payment processing system is pivotal. Banks looking to insource and banks outsourcing to partners both

need to ensure the downstream payment processing infrastructure is up to the task and that it is flexible enough

to adapt to future market conditions. But the facts remain, outsourcing offers many tangible facilities to enable

and deliver on these goals.


2. Introduction

While no one is claiming that outsourcing is a new idea, is the furore surrounding it justified? Can outsourcing

live up to the promises? Will all institutions be forced to outsource some elements of their business in order

to offer anything approaching a ‘complete service’? If it is inevitable as we have been told, who will be the

winners? And just who will own the customer relationship; the marketer of the service or the one who does

the physical processing?

Outsourcing takes place when an organisation transfers the ownership of a business process to a supplier.

The key to this definition is the transfer of control. This definition differentiates outsourcing from business

relationships in which the buyer retains control of the process or, in other words, tells the supplier how to

do the work. It is the transfer of ownership that defines outsourcing and often makes it such a challenging

process. In outsourcing, the buyer does not instruct the supplier how to perform its task but, instead, focuses

on communicating what results it wants to buy through service level agreements (SLAs); it leaves the process

of accomplishing those results to the supplier.

In this document we try to understand the payments outsourcing rationale; why are banks looking to outsource

core services, which processes are considered candidates, what is the business case for outsourcing with its

associated cost and savings implications, and which issues surround it?

Nothing New Under the Sun

Outsourcing in the modern sense dates back to the eighteenth century at least; outsourcing was discussed in

the ‘competitive advantage theory’ propagated by Adam Smith in his book ‘The Wealth of Nations’ published in

1776. However, the industrial revolution left many industries unhealthily vertically integrated to such an extent

that large car companies owned vast tracts of fields on which they grazed their own sheep to produce wool for

their car seats. Such excess was widespread in all sectors with the labour force itself tied to a company for their

housing, medical and entertainment needs.

In the 1970s, industries realised that they simply could not be good at everything. Inefficient sectors began to

consolidate, converge and sell off those parts of the business that could be better sourced externally, especially

where external suppliers could generate greater economies of scale by supplying multiple manufactures. Initially,

only non-core business was hived off, but subsequently, in the early 1990s, companies began outsourcing

strategically significant functions such as manufacturing, logistics and other innovation-related activities.

Outsourcing thus became a critical management tool, a management philosophy, a business management

style and a restructuring model. In banking during the 1980s and 1990s, under the influence of a new vision

on competition and the potential virtues of the free market, the walls surrounding the finance sector gradually

crumbled. As a result of this liberalisation of the finance sector supervisors relaxed restrictive license systems

and new financial services providers emerged – a wakeup-call for banks.

Types of Outsourcing

With outsourcing a long-standing tradition, it may not come as a surprise to learn that the payments business

has actively outsourced for far longer than many other banking sectors including IT. One could consider

correspondent banking networks, agency agreements, multi-bank electronic banking systems, etc. as forms of

outsourcing. These arrangements were for business-driven services targeted at meeting specific niche market

needs, and often on a small scale. Over the past few decades, the sourcing market in payments has jumped to

the large scale, but typically as business-agnostic services in IT.


While the traditional model and IT outsourcing continue to be useful business tools, competition is likely to

drive other sourcing models in future. With the majority of outsource propositions available to bankers today

essentially business agnostic, large scale services are anticipated that offer a far more business driven service.

Going beyond IT application maintenance, data entry or data centre management, future outsourcing anticipate

fully white-labelled services, customised to bank needs across a broad array of business needs (treasury,

eBanking, ACH, etc.)

In conjunction with many financial sectors, especially when combined with an IT element, outsourcing is rich in

acronyms and loose definition of terms being the norm. Below we attempt to define terms in a pragmatic fashion

and uncover the sliding scale of service the different outsourcing strategies can take.

Application Service Provision (ASP)

The Application Service Provider (ASP) model over recent years has tended to be an IT-only play and allows

the institution another dimension to its traditional ‘build versus buy’ decision. By effectively renting space on

the provider’s platform, it is possible to develop a ‘pay as you go’ approach that provides greatly reduced costs

and complexity of IT support. Licensing costs as well as upgrading costs are drastically reduced and offer the

promise of far more scalability due to the need to support increased volumes.

The ASP model has its limitations and challenges. Most notably, integration with existing infrastructure and

processes, coupled with close dependencies on 3rd party implementations. Relations with the 3rd party need to

be contractually sound and creating an effective SLA can be problematic.

Business Service Provision (BSP)

The Business Service Provider (BSP) model augments the ASP offer with business specific processing alongside

technology. Utilising a BSP allows the institution to gain access to relatively low-cost proven and fully integrated

environments for business operations. BSP operations offer extensive scalability to support future volume growth

without the need for direct investment. Pricing under the BSP model is often flexible and allows greater control

of the variable cost base, and allows the bank management to focus their attention on revenue generation.

However, BSP suffers from similar issues as the ASP model, coupled with other factors. Boundaries between

the service provider and the outsourcer are blurred, especially where client contact may be involved, which is

such an important issue in current times. Couple this with the reality of widespread cultural resistance to new

organisational and control structures, and a necessarily more complex exit strategy means there may always be

some resistance to BSP.


In other guises, BSP is sold as Software as a Service (SaaS) and as Managed Services - the classic example being

the SalesForce.com business model. Exponents of SaaS have found fertile ground in the financial/payments

arena, and can deliver appropriate services on a 3rd party box but heavily tailored to bank needs. Managed

Services enable the outsourcer to run and manage the service with no bank staff, often on the bank’s premises.

This has been a popular option for tier-2 and tier-3 banks. SaaS and Managed Services are frequently combined as

IT companies increasingly meld their network management expertise (managed services) with their application

deployment knowhow.

Information Technology Outsourcing (ITO)

Information Technology Outsourcing (ITO) removes the IT management headache from institutions. Banks

are free to focus on their business needs without concerns for technology fashions and developments; the 3rd

party ITO handles all technology infrastructure issues on behalf of the banks. ITO is often not a blanket IT

outsource, and usually involves an external service provider who manages specific applications, including server

management, network administration and software development/upgrades for part of the entire business.

Business Process Outsourcing (BPO)

Business Process Outsourcing (BPO) is a natural extension of changes driven by the success of Information

Technology outsourcing (ITO) and a more sophisticated business environment. Business Process Outsourcing

(BPO) involves the technology, the business processes and also the people to operate the service. It is a

compelling concept with the entire line of business removed from the bank’s concern. The results show that

implementation risks may be lower as there is greater continuity, also, the service provider’s expertise in running

and changing the business over time should lead to reduced operating costs.

The biggest challenges with BPO lie with the creation of a contract and service level agreement (SLA), which

enables, if not guarantees, continuous improvements over time at an appropriate price. However, BPO is rapidly

becoming recognised as a strategy offering a compelling business value proposition for companies as a means

to gain operational efficiency, focus on core expertise, save time and potentially reduce costs. BPO is relatively

independent of economic cycles and is therefore valid in difficult times when companies want to cut costs as

well as times of profit when companies want to focus on growth.

Shared Service Centre (SSC)

Shared Service Centres (SSCs) come in many flavours, but their creation rationale is similar; centralisation (the

US way) or shared decentralisation (the EU way). Fully standardised processes can be centralised or even off-

shored into talent rich, low-salary and fiscally interesting regions. However you cut it, SSCs require reduced

staffing levels to achieve the business case; SSCs are effectively the pooling of activity and/or transactional

volumes on shared assets – and so the SSC is born.


3. A Market Perspective on Outsourcing

Payments outsourcing (and therefore insourcing) is well established with a small number of banks processing

the vast majority of payments. This trend looks set to continue with payment specialist banks actively insourcing

payment volumes. Hence, smaller banks will seek to outsource payments processing and, instead, concentrate

on the distribution of services towards their own client base.

It’s not all Bad News

Good news just doesn’t sell as many newspapers as calamity, resulting in media outlets seemingly revelling

in the doom-mongering, leaving the rest of us with an understandably pessimistic outlook. But is the whole

situation as bad as our journalists would have us believe? While no one is suggesting that we have never had it

so good, and it is clear that bank lines of business are less profitable (if at all), but different business lines have

experienced different performance levels, and some banks within the more troubled sectors are still returning

a profit.

Source: ECB, TowerGroup

Overall, the general payments business remains good, but the recent turn-down will probably have a significant

effect on card payments. The wholesale, transaction services and wealth management sectors remain positive,

but these are offset by bigger issues within the retail, capital markets and investment management business.


Changing Payment Servicers

Across the globe, but primarily in the more convergent European and American payments markets, outsourcing

payments to specialists is widespread; more so in the USA but Europe is catching up fast. The more fluid

European market highlights the strong shift towards outsourcing of basic payments services.

Source: Capgemini

Europe currently has around 30 main payment processing banks (0.4%) that process 60 billion transactions

(80%) from a total of 75 billion; this disparity looks set to continue into the next decade. Predictions vary from

the total remaining relatively constant (taking into consideration that new entrants will try to gain market share),

to a radical global shake-up leaving a small number of global financial institutions (possibly below 10) processing

all payments.

The Need to Increase Payment Volumes

While payment volumes are changing some traditional sectors have been badly hit, but other payment arenas

are growing. The European market has seen considerable investment over the past decade as banks strive to

accommodate regulatory changes often resulting from currency and political integration coupled with merger

and acquisition activity. Europe’s infrastructure, while not yet homogenised, is in a comparatively efficient state

with costs already reduced in readiness for falling payment revenues (not volumes) across the territory. Globally,

cashless payments see continuous growth.

Over the past decade, paper based payments have declined relentlessly. Even in the US where cheque payment

remains strong, volumes are reducing as customers and banks move to the more efficient, cost effective and

faster electronic channels. There is a tangible need for banks to increase their volumes if they intend to remain

in the payments market. Positions in volumes will be challenged by contrasted market trends and competitor

initiatives to gain higher payment volumes.

Without increased volumes, banks will not benefit from increased revenue. Once a critical mass of transaction

rates is reached, the revenue increases accordingly; keep volumes low and payment processing is a loss

making business.


4. Drivers in Outsourcing Strategy

In complex economic times, banks are restricted on expansionist strategies and must instead focus on core

business. This entails eliminating superfluous tasks that are realistically beyond the scope of a core competence,

whilst demanding increased accountability from vendor partners and plugging revenue deficiencies. This goes

someway to confirming the widely held sentiment that outsourcing as a strategy is relatively immune from

economic boom and bust. But, if outsourcing is to offer more than simply a mechanism to aid concentration it

must satisfy multiple goals.

When organisations started considering outsourcing, the primary targets were non-strategic functions, such as

payroll, IT maintenance, facilities management and logistics. The goal was to reduce costs and overheads. If an

organisation does not have the time, money or skill to do the job themselves, or if there is a function that is a

burden or detrimentally affecting other parts of the business, outsourcing is the standard response. However,

today there is a wide range of reasons to contemplate outsourcing core operations to third-party specialists.

Improving speed, service and efficiency

Improving operational performance

Immunised from costly ‘technology chasing’

Avoiding capital expenditure

Reducing overheads and operating costs

Saving on manpower and training costs

Free to focus scarce resources on time-critical projects

Access to specialised skills

Increased efficiency through consolidation and centralisation

The Strategic Sourcing Market

The desire to outsource payments processes is driven by many factors with four main environmental goals in

mind; performance, globalisation, regulation and market restructuring.

PerformanceTo succeed in today’s tough market place demands astute decisions on both financial and operational grounds.

The need for capital efficiency reinforces the drive to value from every aspect of the business. Specialisation

coupled with greater economy of scale enables an outside vendor to provide services at a much lower cost that

in turn reduces a bank’s operating costs and increases its competitive advantage. Third-party providers make

extensive investments in technology, methodologies and people, which provide banks with a wider range of

capabilities. Freed from devoting their energy to areas that are not within their expertise, banks can now focus

their resources on meeting customers’ needs.

Globalisation Payment volumes are increasing as the world’s markets open up with a proliferation of open account trading.

Consequently the competition is intensifying and changing in profile. Off-shoring offers potential arbitrage

benefits based on a global labour market making the switch more palatable as the market evolves. However,

outsourcing ensures that banks receive higher quality, better ‘on-time’ delivery access to world-class skills, fast

project start-up, industry best practices and even benchmarking information about similar financial institutions.

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RegulationGovernment regulations, financial conditions and technologies all change rapidly and outsourcing providers

who make investments on behalf of many clients are better equipped to handle the resultant risks. Regulatory

control looks set to increase as trade and economic sanctions increase, but there are many initiatives expressly

designed to open up the market, especially in international cross-border payments (e.g. SEPA, HKMA and other

single currency initiatives). Taking advantage of these initiatives comes at a cost if handled internally.

Market RestructuringThe banking market is seemingly increasingly volatile; bank consolidations and mergers are widespread, and the

payments industry is no exception especially in Europe. The rules governing payment processors are changing

and as a result we see many strategic alliances between banks, payment service providers and ACHs. The

underlying driver currently is basic economic survival, but outsourcing offers excellent consolidation potential in

a rapidly changing market.

Triggers to Outsourcing

Below we outline some significant triggers that may provide a tipping point for banks to move into the realms

of outsourcing.

The Revenue TriggerBanks face a battle on all fronts; costs are spiralling due to the silo nature of their payment systems; the

duplication of infrastructure; people and processes; outdated technology that needs constant maintenance and

strategic change due to new customer demand; and regulatory convergence. In the past a significant proportion

of these cost have been borne by customers. This cannot continue as regulators and watchdog organisations

monitor banks and their charge structures far more diligently and demand greater transparency in charges

reflecting the true costs.

Payment volumes may be growing, especially in the more efficient electronic channels, but fees are reducing.

With the new cross border landscape, many banks see an opportunity to grow their market share quickly

through insourcing payments from others, hoping to attain economies of scale to a point where payments

becomes profitable. Banks have been joined in this volatile market by new competitors such as the Automated

Clearing Houses (ACHs), and the ensuing battles have resulted in ‘loss-leader’ offers to the market; payment

insourcers have unrealistically reduced fees, or even offered them for free, in the interests of building market

share and removing the competition. This looks set to continue for the next five years or so resulting in bigger

and more far-reaching implications for payment fees.

Transaction fees across Europe vary as each country typically has its own pricing scheme with clear distinctions

between high-value low-volume and low-value high-volume. The advent of SEPA has changed this rationale and

effectively trumps established domestic idiosyncrasies replacing lucrative cross-border banking with low-charge

no-border banking.

The Recession TriggerThe current unstable financial market adds formidable weight behind the need for radical rationalisation of

the entire sector. With costs being trimmed and process efficiency essential, the current financial climate may

force banks into centralising diverse operations and moving towards outsourcing. Why maintain and support

separate payments systems for low and high value payments? Is the differentiation on value justified? Is the

service offered so radically different? The current climate demands banks re-evaluate such duplication. There is

widespread public perception, correct or otherwise, that the banks themselves are the root cause of the current

financial crisis. As such, the ubiquitous trust enjoyed by both bank and customer has been shattered. Banks are

faced with the reality of having to reconnect with their customers and uncover their true needs. This process

will assist in the defining of the bank’s long-term goals.


Over the coming years, and fuelled by the current financial instability, we can expect many more bank mergers

and consolidations globally, but especially in Europe. However, recent government moves towards nationalisation

of banks and centrally funded bank protection may dampen market consolidation, especially across domestic

borders. Current market conditions predict an increasingly thriving future for the more risk-averse top tier-2

banks than the larger tier-1 banks or smaller tier-2 and tier-3 banks.

The SEPA TriggerThe prospect of a single low cost scheme replacing the previously lucrative cross-border payments market

has caused many to consider the justification of large-scale investment for a relatively low volume channel.

SEPA (Single Euro Payments Area) has proved a useful toe-in-the-water test for European payments which has

resulted in most banks being ill prepared for the transition; couple this with the fact that the regulations and

timelines have been fluid and we see a lethargic picture and an understandable reluctance to throw cash at

the issue.

In Europe, SEPA has potential to be fertile ground for outsourcers. With deadlines fast approaching, banks have

limited choices; invest in systems upgrades, discontinue the service, or outsource. Given the current financial

climate many banks are reticent about spending large sums on the new market and are looking to outsource to a

bank or a specialist outsourcing company. With SEPA volumes starting low but increasing, outsourcing seems the

likely option for financial institutions that do not specialise in international or SEPA payments as they could never

generate the critical mass to make the service pay. An outsourcer however has a good window of opportunity to

take advantage of the economies of scale offered by consolidating payments from many sources.

A more important consequence of the SEPA initiative is the eventual demise of European domestic payments.

SEPA is incorrectly perceived as a low-cost cross border payment solution when it is in reality a low-cost

borderless payment solution (for the eurozone). It is predicted that all domestic payment infrastructures will be

obsolete within six to eight years, so SEPA is not simply an optional service, it will become the only payments

game across the eurozone.

The Consolidation TriggerPayment systems have been growing in a diverse manner over the last 30 years. In the developed world,

Automated Clearing Houses (ACHs) were created in the 1970s to process low-value high-volume payments.

These systems were then, and still are today, batch based with clearing cycles that can in some cases take up

to three days. In more recent times we have seen the introduction of low-volume high-value payments often

referred to as Real Time Gross Settlement payments (RTGS). While RTGS and ACH payments have a significant

overlap, this has not prevented banks and clearing houses alike in creating a duplicate set of infrastructure

consisting of new technology and people to handle what is to all intents and purposes is just a different payment

type; after all, both systems simply require one account to be debited and another account to be credited.

The duplication of payment infrastructure was further compounded by banks setting-up unique payment

systems to support different customer segments; retail, corporate, inter-bank, etc. Add to this exclusive payment

environments for diverse payment types (low-value, high-value, direct-debit, cheques, etc.) and the complexity

is soon exponential.

ACH and RTGS payments are both domestic systems that are unsuitable for cross-border transactions. Although

in essence a cross border payment enables an account to be debited and an account to be credited, albeit for

accounts that are held in different countries and different currencies, a completely separate infrastructure has

been created within banks to handle International Funds Transfer or cross border payments via SWIFT and

correspondent banks.


Over recent years we have seen a significant amount of consolidation through mergers and acquisitions within

the Banking Industry. One could assume this may have been an opportunity to rationalise diverse infrastructures

but instead the problems have been compounded. Mergers have not been the catalyst to merge infrastructure.

Simplistically, if two banks merge with separate infrastructures for ACH, RTGS, SWIFT and cards, it is not

unusual to see the combined entity having 2 ACH systems, 2 RTGS systems and at least 2 card systems. When

one considers this picture it is not hard to understand that although Banks generate 35% of all revenues through

payments, they also incur 40% of their total cost (according to the Boston Consulting Group). Without a major

rationalisation of infrastructure, many banking groups will be unfit to react on strategic decisions. Payments,

instead of bank-rolling strategic expansion will inhibit growth and constrain developments.

Outsourcing to a third party offers great potential for consolidation of diverse architectures. Modern

architectures are more payment agnostic than the custom-built solutions of the past; consolidation benefits

from treating all payments in a more intuitive manner and from a single consistent system. A clear boundary

between bank and payment processor removes the complexity inherent in the diverse payment platforms we

see at many larger banks.

The Technology TriggerMost payment systems were designed and built either prior to the advent of electronic payments, or at a time

when the growth of electronic payments was not anticipated to reach the levels that we are experiencing today

or will do in the future. The consequence of this is that current payment systems are starting to show their

advanced age. This is a cause of great concern as a bank failing to provide guaranteed uptime of its payment

systems will have consequences including the associated loss of revenues, penalty costs and most importantly,

the loss of customers. Business continuity is therefore high on the agenda of most managers involved in

payment systems.

The consequence of out-dated systems are manifest through support complexity given that many are on

technology platforms that are, or will soon be, no longer supported. These problems translate into a variety of

issues that include:

The inability for a bank to make changes to payment systems quickly

The inability to make information available to the customer

The inability of the bank to process payment related information such as purchase orders, invoices and

remittance advices

The inability to have an integrated view on the customer over different channels and track & trace payments

end to end

Silos require similar changes to be made in more than one place

A very high cost of ownership

A lack of available key skills to support dated technology

Outsourcing offers the opportunity to utilise modern payment systems offering flexible and transparent services

without the need to maintain constant vigilance on current technology trends and requirements; or outsourcing at

least pushes the problem onto someone else whose core business it is to maintain excellence in service levels.

Customer Expectations Value Added ServicesIn a world of growing competition, often from new entrants unencumbered by legacy considerations, banks

need the flexibility to be able to offer new competitive products to their customers quickly. Increasingly, this

requires the bank’s technology platforms to be configurable, flexible and adaptable to ever changing demands.

The reality of the situation is that existing payment platforms were just not built to cater for this model.

Consequently, making changes to cater for customer demand is becoming increasingly more difficult, time

consuming and costly.

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Technology platforms designed for a more stable world, coupled with outdated processes have led to poor

market response, a lack of visibility, non-STP and an inability to process payment related data. All of this has

led to overall customer dissatisfaction with banks that simply cannot cater for the customer’s service level

expectations. In the past, the costs of developing new service offerings resulted in costs being passed on to

the customer, an issue which has also caused an increasing rate of customer dissatisfaction. However, more

recently the regulators, corporations and industry watchdogs have been pushing themes of transparency and

harmonisation in pricing which is inevitably forcing banks to justify the costs for services.

With fee structures effectively removed as a tool to offset development costs, banks are facing the uncomfortable

realisation of offering more for less. And be in no doubt that increased customer service in the shape of value

added services is many faceted. Taking vanilla payment processing as the baseline, effectively a commodity

service, banks can differentiate themselves in parallel with customer requirements by exploring the provision

of value added services. These can transform the offering from simply satisfying the current customer baseline

(vanilla payment processing) into true target-customer retention through the provision of advanced cash

management alongside increased payment information management services. Customers can no longer be

relied on for brand loyalty, and the banking sector has taken significant body blows over recent years in terms

of trust and credibility, maintaining and growing the business requires improved market offerings.

Outsourcing Tipping Points

Outsourcing is increasingly considered by banks as a way of managing costs, investments and the need for

flexibility. Payments outsourcing is currently top of the list of banking outsourcing targets with fifty-eight percent

of banks already or planning to outsource part or all of their payments activities (World Banking Report 2007

Capgemini, ING & EFMA). With a plethora of valid strategic triggers fuelling the consideration of outsourcing

of payments services, what is the reality? With many banks voting with their feet (and wallets), what was their

tipping point?

Source: ECB, TowerGroup

Unsurprisingly, costs are the primary driver; whether in saving on processing costs or saving on technology

re-investments. With payments becoming an increasingly unprofitable market given the reducing costs and

increased volumes, coupled to the fact that banks need to offer a basic commoditised payments service to

customers, there seems little or no appetite to remain in the market long-term.


Barriers to Outsourcing

With outsourcing a demonstrably ancient sector, especially in the banking and payments arenas, why is it not

more ubiquitous? The answer is that there are many reasons banks are reluctant to outsource more of their

operations. These issues vary across the globe and encompass cultural hesitance as well as the lack of market

standardisation.

The outsourcing industry is currently focussed on the European market as predictions suggest this is the market

with the biggest growth potential. The USA has embraced outsourcing more readily than Europe which is

unsurprising given the size (scale) of the standardised single US market compared to Europe’s fragmented

mosaic. But Europe is transforming into an increasingly homogeneous landscape with standardised protocols

and charges. In contrast the Asian, African & Middle-Eastern markets are currently too fragmented and diverse

for large scale international outsourcing operations to take root.

It is clear that many Europeans have a deep-seated cultural reluctance to payments outsourcing, and some have

even pulled back from outsourcing projects to maintain their own service provision (often due to outsource vendor

failures). But it is not just the European banks themselves that are driving this reticence, many corporations and

retail customers are unhappy with banks outsourcing. The perception is that if a bank is outsourcing something

as fundamental as payment processing, then it is not a true bank; maybe we all have to re-evaluate what makes

a true bank.

But concerns go further than entrenched perceptions. How can a bank guarantee service levels if they do not

control the process? Which party is liable for errors or drops in service? And most fundamental of all, who truly

owns the customer? Outsourcing can blur these definitions and give rise to uncertainty in the minds of customers

as well as the banks themselves. In a GT News Payment Outsourcing survey, 20% of corporate customers were

so concerned about these issues that they would use another bank if their existing provider decided to outsource

their payments operation. A further 56% of companies would have serious concerns over liability issues – and

the banks agree; only 25% of banks would have no outsourcing concerns at all.


5. What to Outsource?

After a turbulent period, the financial markets must resist the temptation to enter a period of intense navel-

gazing; there is seldom a time when excessive introspection or a single issue focus is appropriate, instead,

now is a opportunity to re-examine core functions. The distinction between core and non-core is slowly fading,

thereby increasing the number of functions that could be outsourced.

We are now way beyond the time when banks simply outsourced non-core processing and IT. Over the last

decade this has been extended to high-end functions; banks worldwide are responding to market pressures and

competition by outsourcing cash management, research, analytics and other processes once considered core.

In the USA where outsourcing has reached far higher levels of acceptance, around half of the banks questioned

outsourced not just functions such as credit card processing, human resources and IT, but also finance and

accounting functions, such as general ledger, tax accounting, fixed-asset accounting, accounts payable and

receivables, accounts management, reconciliation, treasury and capital management (Accenture survey of 30

retail & commercial banks over USD 3bn assets).

In Europe there is more reluctance to outsource core functionality. While European banks readily outsource

their hardware, software and cards processing, there is greater reluctance in outsourcing other functions such

as accounting, clearing, call centres and marketing, and virtually no outsourcing of client account processing or

human resources.

Source: ECB


Outsourcing Elements of the Payments Value Chain

Outsourcing does not facilitate a simple yes or no response; a seemingly simple decision to outsource payments

necessitates strategic decisions on which processes in the payments value chain to outsource; put another way,

the bank needs to determine what parts of the process to retain. With cost not always the critical factor, banks

entering the outsourcing market need to consider the value proposition they make to their customers. This will

lead the strategy on which processes to keep in-house, and what can confidently be outsourced.

However, outsourcing large chunks of the payment process does not insulate banks from risk, and no bank

should consider outsourcing as a risk mitigation tool. Banks must make strenuous effort to ensure enterprise-

wide symmetry of service levels. Bank customers have long standing tangible expectations as well as formal

service level agreements (SLAs) and as such the formal SLAs dictating the outsourcer liability and responsibilities

must exactly mirror the SLAs with bank customers to ensure liability continuity.

Outsourcing Value Chain – Paying BankThe graphic below gives an overview of the payments value chain (in this case for SEPA Direct Debits).

Taking this overview as a guide, banks must prioritise their strategy. The likely targets for outsourcing

would include the payment capture, account management, payment processing and exception management.

Billing and reporting may, initially be retained in-house, but treasury services may also be high on the list of

potential outsourcing.


Outsourcing Value Chain – Beneficiary BankSimilarly, the beneficiary bank in the equation may consider outsourcing likely targets of data importing, account

management and payment processing.

Decoupling the Enterprise Payment Business

For decades, banks have proudly proclaimed their payments processing operations as major market differentiators,

but no longer; processing of payments is the most basic expectation of clients. Product development, however,

offers true differentiation to the corporate and retail markets, and no one makes any connection with the nuts

and bolts of payment processing. The back office is no longer regarded as an engine room that must continually

strive to deliver processing efficiencies.

While outsourcing of back office operations has continued with the aim of reducing costs, the impediments to

an efficient payments operation are typically still in place. They usually take the form of operations silos and an

inefficient use of technology. In response to these inefficiencies, banks targeting a long-term future in payments

(possibly as insourcers) look towards developing new operations and technology models across the payments

enterprise in a practice known as enterprise payments (aka manufacturing). This involves reengineering

payments operations and technology to create a more efficient processing environment where costs can be

reduced in an effort to preserve margins.


Where to Make Efficiencies with Reduced Revenues

At this point it is worth reminding ourselves of the main goals of the task; how best to respond to significant

revenue decline by reducing costs, increasing volume and adding value to payments.

It is an accepted fact that as the number of payments processed increases, the processing cost per transaction

falls. This implies a cut-off volume of transactions that must be attained to return a profit. We are not searching

for that comparative transaction rate here as it will vary greatly dependant on many factors (processing efficiency,

domestic factors, market size, etc.), but it is a useful exercise when considering long-term payments strategy.

High unit cost per payment processed

In an unprofitable line, consider the value of investing in order to fix, compared to outsourcing

Medium unit cost per payment processed

With profitability tentative, determine if more effective to outsource or aggressively insource to grow

volumes (with a partner?)

Low unit cost per payment processed

Costs per transaction can be further reduced with higher volumes (insourcing) and more effective STP;

process added volume at a very low marginal cost

The reality may be that only banks with a comparatively low unit cost today can become a long-term player in

the payments market. It is worth considering what it would take to be a significant player; based on volume

projections for 2012, and assuming a significant player’s market share is considered to be around 5%, being

among the top 10 banks in 2012 will probably require a bank to process at least 5 billion transactions a year.

Volume is not Enough - Outsourcing ReadinessWhether a bank has ambitions to become a leading payment processor generating strong revenue from large

volumes, or whether a bank refocuses on customer service preferring to relinquish their modest payment

volumes to an insourcer, the readiness, efficiency and flexibility of the payment processing system is pivotal.

A large tier-1 bank with an established track record and high transaction volumes may see itself as an ideal

candidate to become an insourcer of payments from smaller players. But they need to ensure their own house

is in order before embarking on large-scale insourcing. Chasing larger volumes in order to gain from economies

of scale will back-fire without the modern infrastructure to facilitate it. Without ultra-efficiency in payment

processing the costs per transaction will not fall, and couple this with the need to be able to adapt to new and

innovative products in an increasingly customer focussed market and we see that without modern agile payment

systems the large-scale payment insourcer has an uncertain future.

Similarly, banks looking to outsource their unprofitable payment processing need to ensure that their chosen

partner has the infrastructure in place to be able to adapt to changing market demands and the efficiency to

handle the projected volumes. It is only through the provision of a modern enterprise-wide payments model,

centralising diverse infrastructure with flexible and adaptable payment processing, that the volume cost-benefits

can be realised.

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Business Analysis

Outsourcing or insourcing is categorically not a one-off issue. Rather, it is a long-term strategic discussion with

a supporting vision defining a sound payment strategy. This point is often overlooked in the quest for short-

term wins; the position of a bank’s payments in their business strategy needs greater prominence, especially

for the mid-sized and smaller banks. In order to consider a more sophisticated approach to outsourcing, it is

vital that banks disaggregate all the processes in the payments value chain, and consider the possibility of

reintegrating them in different ways. Try to inspect all the business processes one-by-one and identify the

critical components. With consideration of the bank’s long term strategy, determine which processes need to

be kept in-house as core to operations, and which can be outsourced, then design a new business architecture

accordingly. The target is to put components in the best place possible.

Creating Value from PaymentsValue, or more accurately revenue, comes from a full rationalisation of current costs and a long term plan for

future costs. With fees down, the only response is increased volume through insourcing, or outsourcing to

a specialist; strategic sourcing of business components. When considering the route forward, where is the

next generation of revenue coming from? Service provision must increase (cash management, information

management, FSC integration, etc.) and new delivery channels (mobile payments, Internet, etc.) must be

pursued. The major payments processors need the power and commitment to expand market share.

So how does this translate into strategy? Below is a basic overview of likely options facing the banking sector

with possible scenarios.

Tier-1 and large tier-2 banks

Insource - optimise ROI by greatly increasing the volume of payments processed

Keep payments workflow in house

Invest in technology of payment processing facility

Attract knowledge to build / optimize processes

Increase efficiency of supporting services

Insource volumes

Attract business via customer facing services

Tier-2 and large tier-3 banks

Outsource - replace high fixed costs for low volume of payments with variable costs

Select outsourcing partner (ASP or BSP)

Use payments workflow of service provider

Attract knowledge to build / optimize processes

Increase efficiency of supporting services

Attract business via customer facing services

However, many mid-sized and smaller banks are successfully competing with bigger banks in the small and

medium sized corporate segment. Many of these players are opting for lighter payment platforms with their

associated lower cost and a less disruptive transformation. In this manner, proven cost savings can be reinvested

across the payment value chain to offer value to small and medium sized corporations enabling competition with

top tier banks in chosen customer segments.

While SEPA has proven to be a catalyst to galvanising strategy for the long-term, it is not the complete story.

Mid-tier banks have to face the reality that they have reduced SEPA capability and are aiming to acquire it

(buy or build). It is very likely that this type of bank will not be convinced by outsourcing that only offers basic

capability and look towards full capacity outsourcing services from the outset.

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Step-by-Step to Outsourcing

So you have considered outsourcing components of your payments processing; how best to identify potential

partners? Accepting that this document has championed the notion that payments processing is not necessarily

a ‘core function’, it remains central to the definition of a bank and so outsourcing decisions should not be taken

lightly. Below we outline the critical steps in moving towards an outsourcing strategy. Each experience will be

unique, but from experience, most financial institutions will recognise this process.

Step 1 - Spend AssessmentThe first step is to identify the current spend on payments processing; what is the total cost of ownership of the

entire payments business processes? It is important to include all supporting services. Couple this with planned

or projected future spending which may include initiatives like SEPA/PSD and investment in new Value Added

Services. Often banks operate two or more payment systems across the enterprise incurring the additional costs

inherent in duplication.

Step 2 - Marketplace and Smart-sourcingIt is vital to gain proper and full knowledge of the market; what outsource services are available at what cost

and what risk? After a full market analysis it is possible to consider options such as outsourcing to a tier-1 bank,

join a shared service centre or opt for a non-bank specialist. The bank must decide which critical components of

the value chain should be kept in-house and which can be outsourced.

Step 3 - Partner SelectionGiven the critical nature of payments, any outsource partner must demonstrate an absolute commitment to

the transaction banking business and to offering world-leading transaction banking solutions. With payment

transaction types growing in various customer segments, partners should offer a full set of payment types

with the capacity to expand as regional markets dictate. With payments processing an IT heavy discipline, the

ideal partner could demonstrate a track record of investment in technology coupled with an operations base

that supports your global needs. Regulatory issues carry liability concerns so any partner must understand

the demands facing the institution. Many outsource specialists can offer additional services wrapped around

payment solutions which extend the basic offering allowing for market differentiation and product specialisation

not readily available without an outsource partner.

Step 4 - ImplementationPutting the plan into action requires as much care as the preceding process. Is a big-bang approach preferred

or a gradual handover involving duplicate/parallel system maintenance? It is vital to remember the impact the

changes may have on the organisation whether it be the implementation of new architecture, decommissioning

of old, or training and redeployment (possibly to 3rd party premises). Above all, risk management remains

paramount. Full contingency planning is needed to ensure business continuity, all safeguarded by cast-iron

service level agreements and liability issues contractually resolved.


6. Conclusions

Traditionally, the route to reducing operations costs was through large-scale outsourcing and/or off-shoring

operations and technology. Although this form of business process outsourcing (BPO) is still an option, smart-

sourcing of payments functionality has also emerged. BPO is the practice whereby costly but commoditized

payment functions may be outsourced as part of an enterprise payments strategy. However, differentiating

processes or client tools are retained as internal payments capital.

Again, the enterprise payments model comes into play by allowing banks to smart-source payments processing.

Banks will increase the use of cost analysis tools to determine what business line to leave or to outsource.

Banks will insource functions that are of strategic benefit but outsource commodities. This bifurcation will allow

banks to retain internal elements such as product development to build value-added products that generate

fee income.

Conversely, the outsourcing of certain operations or technology functions will reduce processing costs of the

back office. The net aim is to increase margins. Banks will continue to investigate and invest in the enterprise

view and in the integration and business intelligence functionality required to achieve a smart-sourcing model.

They may adopt universal payment standards to facilitate interoperability of third-party payments services.


Notes


Clear2Pay NV/SA

Schaliënhoevedreef 20AB-2800 MechelenBelgiumP: +32 15 79 52 00F: +32 15 79 52 01E: [email protected]: www.clear2pay.com

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