Offshoring of Business Processes by Banks from Switzerland

Table of Content

1 Introduction
1.1 Current Situation
1.2 Objective
1.3 Structure of Analysis

2 Business Process Offshoring
2.1 Definition of relevant terms
2.2 Organizational options
2.3 Main offshoring locations

3 Offshoring by banks
3.1 Drivers for market growth in business process offshoring
3.2 Benefits
3.2.1 Cost savings
3.2.2 Access to new talent pools
3.2.3 Market access
3.2.4 Process optimization
3.2.5 Further benefits
3.3 Risks
3.4 Potential business processes for offshoring
3.4.1 Criteria for selecting processes
3.4.2 Processes offshored by banks
3.5 Strategic options for banks

4 Specific challenges for offshoring banking processes from Switzerland
4.1 Legal restrictions to offshoring from Switzerland
4.2 Regulatory restrictions to offshoring from Switzerland
4.3 Potential strategies to deal with the legal and regulatory restrictions
4.4 Impact on reputation
4.5 Language barriers

5 Current status of business process offshoring by banks
5.1 Status of business process offshoring by banks globally
5.2 Status of business process offshoring by banks from Switzerland
5.2.1 Overall status of offshoring by banks from Switzerland
5.2.2 Offshoring at UBS
5.2.3 Offshoring at Credit Suisse
5.2.4 Offshoring at other banks

6 Summary and outlook

7 Appendix

8 Literature

List of Figures

Figure 1: Structure of this paper

Figure 2: Combinations of offshoring and outsourcing

Figure 3: Labor cost in key offshoring locations compared to Zurich (gross income in USD 2006 indexed to Zurich)

Figure 4: Costs and benefits in knowledge-process offshoring

Figure 5: Core processes in banking

List of Tables

Table 1: Key risks in offshoring

1 Introduction

1.1 Current Situation

The global banking sector is currently undergoing fundamental changes. Banks face new challenges created by socio-economic and political developments and the potential of new information and communication technologies. Competition has risen to formerly unknown levels and active management of costs has be- come an ongoing tasks.

Unlike the manufacturing industries most banks still cover large parts of their value chain by themselves. Lead by Anglo-Saxon institutes global banks have started in recent years to use the advantages of globalization by splitting up their value chains and by offshoring selected functions to countries offering wage dif- ferentials. According to experts banks have just started to create their global sourcing model, so that the offshoring volume is projected to increase further.

While most banks have started their offshoring initiatives with IT functions, business process offshoring and even knowledge process offshoring have now become the main drivers of the move to the key offshoring locations like India, China and Eastern Europe.

Banks from Switzerland have been spectators to the global move towards a global delivery model for many years. Only its two large global banks – UBS and Credit Suisse – have started offshoring initiatives yet trying to catch up with their global competitors. They face challenges especially from the legal and reg- ulatory side, which are specific to offshoring from Switzerland, and have to bal- ance cost discipline with keeping the high standards in quality, security and con- fidentiality, which are the base for the high reputation of the Swiss banking market.

1.2 Objective

The primary objective of this paper is to give an overview on the current status as well as on trends in business process offshoring by banks in general and on offshoring from the Swiss banking market specifically. As Swiss institutes lag the global offshoring trend, the specific conditions for offshoring from Switzer- land will get analyzed.

Secondary objective of this paper is to give a high-level introduction to the key issues in business process offshoring:

- What are the organizational options in offshoring?
- Which banking processes are suitable for offshoring and what are the criteria for identifying them?
- What are the main offshoring locations and criteria in the site selection?
- What are the drivers, but also risks and benefits of offshoring?

The focus of this paper is on the reallocation of banking processes from Switzer- land abroad, as banks offshoring from Switzerland face specific circumstances. However, many banks located in Switzerland operate globally and do not dis- close information on the country of origin of offshored roles. If information on offshoring from Switzerland is not available, offshoring by Swiss banks is used as a proxy in this paper. The reader should note though that especially the two large Swiss banks have major parts of their operations outside Switzerland, so that they are rather imperfect proxies. The combination of analyzing the status of offshoring both at the two large Swiss banks and at their local peers gives a good indication on the status of offshoring from Switzerland though.

By focusing on business process offshoring this paper does not investigate off- shoring of IT processes in detail. However, once again the reports by banks on their offshoring activities rarely differentiate between these offshoring types, so that some data on offshoring contain both business and IT processes.

1.3 Structure of Analysis

This paper is structured in six chapters as shown in figure 1:

Figure 1: Structure of this paper

illustration not visible in this excerpt

Source: own figure.

After a short introduction in this first chapter, the second chapter introduces the reader to the key terms in offshoring and its main organizational options regard- ing e.g. the distance of the offshore site and its governance. As offshoring can be combined with outsourcing, which is frequently yet incorrectly used as syn- onym, the differences and similarities will be described in detail. A bank has to make an explicit decision for a new location when going offshore. The criteria for the site selection and the status of competition between major offshoring tar- get locations are described in the third part of chapter 2.

While the second chapter describes business process offshoring in general, the following chapters focus on the current situation in offshoring of business processes by banks. The third chapter starts with an identification of drivers that

led to the emergence and strong growth of the offshoring market. The paper continues with a description of risks and benefits in offshoring. As not all bank- ing processes are suitable for offshoring, this paper goes on with defining crite- ria for process selection and an assessment, which processes have been off- shored most by banks so far. Chapter three closes with a description of potential strategic options for banks regarding offshoring.

Chapter four focuses on the specific challenges that banks face in offshoring from Switzerland. The main restrictions are on the legal and regulatory side, which are explored in detail. The paper continues by proposing potential strate- gies for dealing with these limitations. Chapter four closes with a short analysis of reputational as well as language barriers in offshoring.

The aim of chapter five is to present the current status of offshoring activities by banks globally on the one hand and by banks from Switzerland (UBS, Credit Suisse and further banks) on the other hand. The analysis will show a significant difference in the volume of offshoring between banks from Switzerland and their global competitors.

The summary recapitulates key findings and provides a critical assessment of potential factors for the gap between the offshoring level from Switzerland and globally. Looking forward the paper closes with a personal evaluation of the fu- ture of offshoring and its relevance for banking from Switzerland.

2 Business Process Offshoring

This chapter lays the foundation for the further analysis by defining key terms, introducing the reader to organizational options in offshoring and outsourcing and by giving an overview on the main offshoring locations and potential crite- ria for the site selection.

2.1 Definition of relevant terms

There are no scientific definitions of offshoring yet and the term is used incon- sistently in literature.^[1] Offshoring occurs, when companies move processes and productive factors abroad, whether they are conducted by separately owned sup- pliers (offshore outsourcing) or by fully owned (captive) subsidiaries. Almost always work is moved to locations with lower costs.

Some authors differentiate between nearshoring, i.e. receiving services from a nearby country (e.g. a Swiss bank receiving services from Poland), and offshor- ing, which they reserve for overseas deployments only.^[2] For practical reasons however, this paper treats all sourcing from foreign countries as offshoring. However, this definition does not include inshoring, which is used for sourcing from low-cost locations in the same country (e.g. New York banks receiving services from the South of the USA). Offshoring reports of some banks also in- clude this domestic sourcing option though.

Business process offshoring refers to the relocation of entire business functions or individual business processes. It thus differentiates itself from IT offshoring.^[3] At the higher end of the value creation, business process offshoring becomes knowledge process offshoring, which is about getting high-end, value-added work done by specialized resources.^[4] It includes business-critical and judgment- based complex processes in core functions. Typical banking functions in know- ledge process offshoring are e.g. equity and financial research and analytics. For the sake of simplicity, this paper will use the term business process offshoring as defined above, i.e. including nearshoring and knowledge process offshoring without further differentiation.

2.2 Organizational options

The term “offshoring” is often associated with “outsourcing”, but neither im- plies the other. The Basel Committee on Banking Supervision defines outsourc- ing as

a regulated entity’s use of a third party (either an affiliated entity within a corporate group or an entity that is external to the corporate group) to perform activities on a continuing basis that would normally be undertaken by the regulated entity, now or in the future.^[5]

Outsourcing, the acronym for “outside resource using” reflects the decision of an organization to contract-out or sell its assets and/or activities to a third-party supplier, who in exchange provides and manages assets and services for mone- tary returns over an agreed period.^[6] Outsourcing therefore involves specializa- tion as firms switch from sourcing goods and services internally to sourcing them from separately owned suppliers.

Although different categories, offshoring and outsourcing can be combined re- sulting in the offshore outsourcing model shown in figure 2.^[7] The two domestic options – keeping processes internally in the country of origin and domestic out- sourcing – will not be analyzed further in this paper.

Figure 2: Combinations of offshoring and outsourcing

illustration not visible in this excerpt

Source: Dressler, p. 125.

In captive offshoring processes are transferred to fully owned subsidiaries abroad. The main advantage of the captive model is that direct control over all aspects of the operations remains with the management. Processes can be changed without coordination with vendors thus avoiding time lags. In the cap- tive model companies need to invest into setting up operations abroad, but also profit from wage differentials directly, as they avoid paying margins to middle- men. Companies have become increasingly willing to send more sophisticated, higher-end work offshore. As many outsourcing vendors are currently unable to cope with knowledge-based processes, these processes are likely to be managed in captive models.^[8]

Large institutions that have the ability to scale tend to go for the captive option, whereas smaller institutions tend to partner with vendors in offshore outsourcing to take advantage of their economies of scale.^[9] For offshore outsourcing the management must be willing to outsource and processes must be suitable.^[10]

Outsourcing contracts usually have long durations (often longer than 5 years), so that the outsourcing company may become dependent on the vendor and loses flexibility.^[11] Processes might need to get changed or could become obsolete meanwhile. The competence of the vendor to serve needs in five years time is unknown beforehand. Coordination with the vendor creates transaction costs (Coase theorem) for

- search and information,
- bargaining and decision and
- policing and enforcement,

which need to be considered in the offshore outsourcing business case.^[12] Due to potential principal-agent problems offshore outsourcing requires a detailed defi- nition of services and escalation modes in service level agreements.^[13]

Next to these risks the offshore outsourcing model also offers a number of ad- vantages. It allows the company to adapt the workforce size flexibly to changing market conditions and to focus on its core competences. It also offers theoretical cost advantages for small companies capitalizing on the vendor’s increased scale of operations from servicing multiple clients, which can in some cases outweigh the vendor’s profit margin.^[14]

Hybrid approaches combine the captive and outsourced model, e.g. by hiring a vendor to establish an offshore operation and to get it running smoothly before taking ownership (“build-operate-transfer”).^[15] In another hybrid form the off- shoring company extends its organization by specifying the required quality of service, working closely alongside providers and monitoring them to get this quality. In these hybrid models the offshoring company reduces the risks en- tailed in setting up infrastructure and operations at the target site, but also usual- ly reduces its cost savings potential by adding the vendor’s margin and transac- tion costs.

In 2005 the hybrid model dominated in financial services offshoring. In a survey by Deloitte Touche Tohmatsu 49 percent of all offshoring companies in finan- cial services adopted a hybrid model followed by the pure offshored (37 per- cent), the pure captive (12 percent) and the joint venture models (2 percent).^[16] The majority of companies that have adopted a hybrid model have been offshor- ing for at least three years – gradually evolving from a pure approach to a mixed approach, as they expanded their offshore operations from a single function to multiple functions. Vendors respond to this trend by offering contracts, where the offshoring counterpart starts with the hybrid model, but has full flexibility of moving processes into the pure captive or outsourced model.

Banks should match their offshore organizational model to the needs of the spe- cific processes. Processes, which are critical for competitiveness, require a high capability level offshore and show high operational and structural risks should remain captive. Commoditized processes with low risks are suitable for offshore outsourcing in general.

2.3 Main offshoring locations

Moving operations offshore is mostly motivated by wage differentials. Howev- er, to make the right decision for the target offshoring location, companies should assemble detailed information on a number of further factors:^[17]

- Cost: next to current average wages for the required skills and expected wage increases, the cost of infrastructure, real estate and taxes, but also po- tential incentives for investments need to be considered in the business case.
- Availability of skills: the offshore location does not only need a sufficient labor pool with the required skills, but staff also needs to be available. In some countries like India competition has become fierce for skilled em- ployees suitable for offshore jobs. A sizeable and experienced vendor land- scape, which is available especially in India, may facilitate recruiting in the hybrid and offshore outsourcing models. Requirements of specific language and/or cultural skills can limit the choice of potential offshoring destinations significantly. Business processes requiring German skills are therefore often offshored to Eastern Europe, where skilled labor with German skills is avail- able.
- Environment: strict labor laws, bureaucracy, corruption and regulatory bur- dens can all be potential obstacles for offshoring. In addition soft factors like cultural and ethical fit, living conditions for expatriates, health and crime situation and accessibility (time difference, travel time) need to get assessed.
- Risk profile: experience of offshoring pioneers has shown that the main risks lie in disruptive events (political instability, natural disasters), security, sta- bility in the regulatory and macroeconomic environment and in the protec- tion of intellectual property rights.
- Quality of infrastructure: availability and reliability of power and telecom lines, scale and quality of transport infrastructure (roads, railway, airports) and availability of appropriate real estate.

Most site selections are driven by wage differentials as key factor. As figure 3 shows, wage differences between Zurich and the leading offshore target loca- tions are significant. Next to the Philippines, Indian locations offer the highest wage differentials even before China. Eastern Europe already operates at higher wage levels, while the traditional offshoring locations such as Singapore and Dublin have lost much of their former cost advantages.

Figure 3: Labor cost in key offshoring locations compared to Zurich (gross income in USD 2006 indexed to Zurich)

illustration not visible in this excerpt

Source: own figure based on UBS 2006, p. 27.

Despite current high wage inflation rates in the offshoring hot spots (e.g. 13.9 percent p.a. 2004-2006 in India),^[18] offshore locations will continue to be attrac- tive financially for a long period of time due to the high absolute wage differ- ences and an expected stabilization of wages over time.^[19] Offshoring companies already react to rising pricing in the key offshoring locations by selecting second tier cities offshore (e.g. Credit Suisse choosing Wroclaw in Poland and Pune in India),^[20] where the general price level and labor attrition rates are lower than in first tier cities (as e.g. Warsaw and Mumbai).^[21]

[...]

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^[1] For a discussion on the use of the term see e.g. Gross et al., p. 26.

^[2] Klingebiel, p. 499.

^[3] IT offshoring will be touched at several instances, but is not the focus of this paper.

^[4] Technology Partners International, p. 4.

^[5] Basel Committee on Banking Supervision, p. 4.

^[6] Franze, p. 10.

^[7] Dressler, p. 125.

^[8] Deloitte Touche Tohmatsu 2005, p. 11.

^[9] Deloitte Touche Tohmatsu 2007a, p. 19.

^[10] Klingebiel, p. 501.

^[11] Klingebiel, p. 501.

^[12] Coase, p. 386 ff.

^[13] Klingebiel, p. 501.

^[14] Deloitte Touche Tohmatsu 2005, p. 11.

^[15] Klingebiel, p. 501.

^[16] The following information is based on Deloitte Touche Tohmatsu 2005, p. 10.

^[17] Farrell, p. 88.

^[18] Operations Council, p. 6.

^[19] Deloitte Touche Tohmatsu 2007b, p. 3.

^[20] Rohner 2007, p. 10-11.

^[21] A.T. Kearney 2007a, p. 8.