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The old model of outsourcing – “We will do your mess for less” – has run its course. The traditional practice of labor arbitrage, in which buyers conceive and develop system designs internally and hand them over to low-cost operators, is ineffective in today’s financial services market.

Faced with more nimble, nonbank application developers providing financial services, banks require digital innovation to compete. Finding agile and effective ways to transform existing systems as well as mine the mounds of data in them, requires deep knowledge and the technical ability to develop digital systems for internal and customer use.

With the right outsourcing partner, the knowledge and expertise required for digital transformation can be unlocked through outsourcing models that emphasize innovation. Where cost savings were once the only goal in an outsourcing relationship, providing innovative systems has become a main focus of the outsourcing relationship.

This new model, known as outcome-based managed services, is based on an old principle: both buyer and supplier invest in the relationship and share the rewards of success. Both bank and vendor have skin in the innovation game, sharing both the costs and benefits of digital transformation.

Innovation Replaces Labor Arbitrage

The focus of outsourced technology services departments must shift from paying less for more work to investing more in profitable outcomes.

As the sophistication of technology systems accelerates at a breakneck pace, productivity gains are happening through innovation. Making fast improvements to systems and business processes require that companies develop a relationship with their technology vendors as innovation partners.

“By capitalizing on their relationships and bringing customers value from partners, banks will strengthen the customer relationships that are the foundation of their business,” according to research and consulting firm Celent in its recent report, “No Bank is an Island: Adapting Retail Banking Business Models to Thrive in a Rapidly Changing Ecosytem.”

Outsourcing agreements based on outcomes instead of labor boost business performance. And companies are starting to wake up to that fact. Just look at the numbers.

European consulting firm Aecus found in a recent survey that two-thirds (63%) of senior outsourcing buyers have incentives built into their outsourced operations to encourage and reward innovation, according to Aecus’ February 2015 “Innovation Reality Report.”

Likewise, more than two-thirds (65%) of buyer organizations surveyed about adopting new technologies prioritize “measurable impact to business performance” and are willing to pay a premium price for that impact, according to a Gartner report, “Outsourcing Buying Trends and Drivers for Sourcing Strategies for 2012 and Onward.”

The Imperatives to Outsourcing Innovation

A typical bank spends 70% of its IT budget on running the bank and 30% on changing the bank. The fast-changing digital landscape means financial institutions need to reverse that ratio, spending 30% on operating the bank and 70% on innovation.

This shift can be accomplished through innovation partnerships, which work when both buyer and supplier combine their efforts to innovate and are both invested in the outcome. An outsourcing partner with deep industry knowledge is essential to sorting out large-scale, mission-critical legacy systems that have been compromised by years of customizations and new systems integrations.

In many outsourcing relationships, however, a vendor has multiple teams customizing a large system over a multi-year agreement. As an individual team member becomes more experienced, they move on to other engagements, leaving low-level customization work to less experienced developers who cost both bank and vendor less.

Under this old outsourcing model, engagements can become longer. Vendors make money through system change after system change, always staffed by the lowest cost developers.

In the new outcomes-based partnership model, the vendor’s interests are aligned with the client. Compensation for engagements includes both risk and reward, where the vendor is compensated based on agreed-upon outcomes, rather than headcount and hours. Sharing in the rewards of innovation, vendors will ensure that their most experienced team members stay with a client.

Indeed, the only way innovation can be successful within a complex financial systems environment is if the vendor partner really is a multi-faceted expert. A vendor-partner must invest in training its consultants and developers so that they have expertise with your systems, processes, and customer interactions; and they must be have innovation experience to make connections between industry trends and your capabilities.

This shift in outsourcing models is especially critical, given how the competitive landscape is changing in financial services. Financial technology startups are circling the traditional products and services provided by financial institutions and finding new ways to serve customers with innovative user interfaces, data channels, and mobile delivery.

The best outsourcing vendors today are helping their clients by forging long-term relationships focused on fostering innovation. They are investing in their employees and providing a long-term commitment to their customers based on compensation structures that reward agreed-upon innovation outcomes. When both buyer and supplier have some skin in the game, success is inevitable.

About the Author

Stephen Holmes is Senior Vice President & Head - High Productivity Outsourcing at Polaris Consulting & Services Limited. The practice has a three-pillar approach to providing clients with the benefits of a co-creation innovation partner:
1) establish an academy to train associates on the client’s unique environment so that they can identify key insights and discoveries;
2) establish an innovation lab that enables both organizations to experiment and invent new approaches; and
3) provide a performance guarantee, which bases the compensation model on measurable performance gains.

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