Differentiating Core and Utilitarian Functions

Front Offices, Product Management, Trade Initiation, Business Intelligence, Risk and Quality Management are some of the functions that financial institutions have rarely outsourced.  They are core to the success of the companies and in many cases define the companies when it comes to customers and stockholders.  Investments to enrich them, innovations to differentiate them and focus to continuously tune them make the leading industry participants agile and adaptable to changing market conditions.

When the functions that fall in this category are taken out, left are functions that are considered utilitarian in today’s market.  These are open to the changing business models that are more aligned to the industry-wide market dynamics than those prevailing at a given company.  The current market economy is forcing us to be more open-minded than ever before to evaluate what functions are non-core, making them candidates to move to alternative execution models.  Trade Execution, Account Receivables, Collections, Call Centers, Data Centers, Telecommunications, Desktop Support, Email, Provisioning, Payroll, Market Data and Shareholder Documents are some examples of this category.

Let’s look at some of these.

Common Utilitarian Functions:

A lot of decision support and matching logic goes into program and customer-initiated trades and their aggregation prior to the trade execution.  This is a core function for a financial services firm.  But once the trade is ready to go, it enters the utilitarian world, where the exchanges, execution and settlement activities are primarily measured by speed and accuracy which are driven by technical and process-engineered solutions.  These and the post-execution back-office operations are essentially commodity functions.  We expect them to function well and in a pre-determined way.  We count on these processes to be repetitive and predictive.

Bill Pay, Lock Box functions and Collections have been serviced by trusted outsourcing companies on behalf of a large number of businesses for a couple of decades now.  So are tier 1 Call Centers.  So is Market Data.  While the printing and dispatching of shareholder documents have been the norm for a long time, third-party handling of customer statements is also not uncommon any more.  We take the one-offs from our processing factory and move them to partners to save money, while not relinquishing the control on the overall process.

Capital Market firms are what they are today because of past investments in technology.  While working on the Street, I used to believe that as technology and business innovation leapfrog each other, I was part of a value chain that was transforming global capabilities at unprecedented speeds.  Technology is behind the nanosecond responses and complex logic executions with precisions undreamt of in the past.  Bleeding-edge technologies were driving data centers, networks, desktops, handheld devices and huge data stores to orchestrate the answers faster, cheaper and with superb accuracy.  Capital Market firms needed technology, and did a very good job to build intellectual property using proprietary and large-scale outfits.

Let us examine it in the light of where today’s technical enablers are further leading us.

Cloud Computing has created a layer of abstraction for technical services.  Companies like Amazon, Google and Salesforce have created business models which provide a technological framework that their customers do not care about, as the abstraction helps these consumers to focus on what they really need to focus on – their transactions, their data, their research and their customers.  Tomorrow’s data centers will mostly live in the cloud.  Why would anyone want it otherwise, when one can still manage it with any level of granular information, pay for it only by usage, provision all resources just in time, and not have to manage it?

Many leading financial industry companies have outsourced their data centers, networks, telecommunications and desktop support by now.  During the downturn of the industry in the recent past, this was widely embraced as a cost cutting measure and a way to downsize without giving up capabilities.   Outsource service providers have responded by bringing strong process engineering, metrics and transparencies to this mix.  They injected virtualization and green initiatives to deliver the services, promising to use leading-edge technologies just in time for continuous improvement of services.  Servicing multiple companies and specializing in their respective service areas, they offered Demand Management and Co-hosting solutions with elegance and versatility.

Trends with Utilitarian functions:

So what do we do with the utilitarian functions?  To find the right partners to lean on is important.  It is a journey which begins with a careful inspection of what to outsource and how.  How to manage the interfaces with the outsourcing partners?  How to make sure that the data is secure?  How to monitor the trust so that unexpected things do not happen?  It is a journey which requires a team effort between the buyer and the seller to come to a common understanding and create a custom framework for the operation.

There are two interesting side effects of doing non-core functions through partners.

First, it opens up the opportunities to pair up with like-minded financial companies to form consortiums.  Utilitarian work is non-differentiating, so partnering with competitors for these is not uncommon.  Industry alliances emerge to work with vendors and educational institutions to create future solutions better and cheaper.  This can also give rise to joint ventures offering sets of commodity services that are resalable.

Second, the technology companies use their wealth of experience to use open source software to deliver enterprise-class solutions.   This is not the forte of capital markets companies.  This is too risky to get into, but when left to the outsourcing service providers this allows the capital markets companies to participate.  It is widely accepted that the open source movement has come of age.  By consuming open source products gives capital market companies the elevated role of collaborators.  In a way, it is a corporate social responsibility, fulfilled.

How to Create and Protect IP at the Core:

Now let’s come back to the core functions - risk management, products, custody, account opening, CRM and so on.  These are defined by tight integration with other functions and customized metrics that are designed to change frequently.  These have multi-dimensional reach.  These are institutionalized and specialized.  These are complex and mostly driven by proprietary tools configured just right to fit the firm’s business strategies.  We can use alternative hosting strategies for these, but we typically keep these in-house.

What methods should be used to keep these refreshed and continue to be true differentiators?  How do we know that they are protected during employee attrition, during which ideas can travel beyond corporate strongholds?  We do so by creating and implementing strategies supported by custom workflows, expert systems, collaborations and implementations leveraging sophisticated business partners.  Ideas can travel but complex and proprietary implementations do not.  In the seventies Merrill Lynch created the multi-disciplinary Cash Management account.  Google created their differentiators by starting with commodity chips but assembling them in unforeseen manners using cardboard and Velcro.   Walmart created an entire supply chain for many products based on RFIDs well ahead of any competitor.   If protecting intellectual property is as important as its creation, then investment is necessary to package its implementation and add value by its integration with the corporate ecosystem.  Building a company requires creating and sustaining competitive advantage, so all the money and energy saved by running utilitarian functions using an alternative model need to be diverted to create and retain differentiating value at the core.