Investment banking is a high-octane pursuit filled with rewards for the swift and risks for the inexperienced. Victory goes to those who know their game inside and out and can focus on it to the exclusion of all else. But while this approach can lead to great success in the global capital markets, it can also lead to great inefficiencies in the information-technology world. Over time, those inefficiencies can begin to add up.
According to Gartner Group, investment banks typically spend twice as much on information technology (IT) as do their commercial and retail counterparts.
The common perception is that the higher IT costs are due to the information-intensive and technology-dependent nature of the industry. But the reality is more prosaic: global-investment banks are inherently unable to manage technology efficiently.
This inability is rooted in the product-centric culture of investment banking, which operates on wide profit margins and values speed and flexibility over operating efficiency. Investment banks tend to be managed by product executives, who make technology decisions based on the optimized needs of individual product teams rather than seeking shared solutions across products.
As a result, front-to-back technology "silos" are typical for individual products, often with unique solutions for different geographies and duplicated solutions as a result of partially integrated acquisitions.
The net effect is higher technology and support costs, not helped by the fact that these support resources are often located on some of the most expensive real estate in the world.
Barriers to achieving a more efficient IT model are enormous. Adopting common technology solutions and transforming to a more efficient IT model requires large-scale, multi-year, global initiatives that, although will generate significant savings, will take years to break even. These types of projects are anathema to the investment banks that excel at action-oriented, short projects with quick paybacks.
Moreover, investment banks are highly leveraged and capital-constrained and therefore reluctant to invest in non-revenue-generating areas like new, large-scale IT initiatives.
In the booming 1990s, such inefficiency could be tolerated. But today, profit margins are shrinking fast and lean new competitors using low-cost technologies are putting additional pressure on prices.
But the same market conditions that are weighing so heavily on the investment-banking industry also present a unique opportunity for the farsighted to break away from the competitive pack.
Rather than wrestle with IT in-house, smart investment banks are beginning to farm out parts of their IT structure. But this is not enough. A fundamentally new IT model for the investment-banking industry needs to emerge comprised of an external shared IT organization with its own governance structure. If investment banks can't afford to build state-of-the-art IT capability internally, they must find it outside their walls.
An Alternative Model
The technology challenge facing the global investment banks cannot be addressed within the framework of the current business model. The only viable alternative is a business model with IT as a fully external entity with a new governance structure linking the business and the external IT organization. This goes far beyond a traditional outsourcing solution. The strategic importance of IT demands a very different approach, a strategic sourcing "alliance" to fundamentally transform a bank's technology.
The three key attributes of the new business model are the external IT entity, governance, and a strategic-alliance partner.
First, the external entity or operating company must have an independent management structure and potentially, a separate financial structure with the ability to raise capital. Building capabilities, standardizing platforms and rationalizing application solutions require investments and long-term commitments that are probably incompatible with the investment bank's financials, philosophy and balance sheet.
The separate operating company has the advantage of being able to make upfront investments to improve efficiency and to execute the longer-term transformation to lower-cost structures. External financing would be employed to smooth the IT costs for the bank, potentially providing an immediate cost savings.
Secondly, a new governance model is necessary to fully define the relationship between the bank and the IT operating company. This is no trivial task and it must start with a long-term commitment and shared vision about the objectives of the relationship and the longer-term aspirations, in other words, the outcome of the transformation. The overall structure of the relationship must include both the short-term service-delivery objectives, as well as the longer-term transformational goals with appropriate performance incentives.
The relationship between the bank and the operating company should be based on the services to be delivered, not headcount or for specific technology solutions. This enables the IT operating company to seek lower-cost solutions, such as the use of offshore resources or implement new, lower-cost technologies.
The final key piece of this new IT business model is an alliance partner that can provide business management and leading IT practices to industrialize the delivery of information-technology services. The investment banks have some excellent technology personnel, but their strengths are in understanding the bank's business and meeting their IT needs, not running a financially sound business, developing world-class IT capabilities, or maximizing efficiency and productivity.
This new model is much more than a conventional outsourcing arrangement. The shared strategic objectives, the need for flexibility in the relationship and the need for financial and performance transparency all point to a very non-traditional outsourcing agreement that has more of the characteristics of a strategic alliance.
In fact, the alliance partner may well be an equity investor in the external operating entity and must bring a track record of delivery to the entity that will be valued by potential lenders.
The benefits that investment banks can expect from establishing this IT business model include:
- Immediately reduced IT costs through the use of external financing to transform to a more efficient IT-service-delivery model, employing both onshore and offshore resources.
- Significantly lower long-term cost structure through a multi-year program to implement standardized global-product and cross-business solutions.
- Enhanced technology capabilities and services through an industrialized, best-practice IT organization.
- Greater flexibility through the combination of capabilities of the service company and alliance partner.
- Improved technology-enabled business capabilities as a result of implementing simplified technology architecture, standard-application solutions and eliminating complex legacy systems.
What Will It Take
There is no denying that establishing an external IT-business model is a challenging undertaking. The risks are enormous and the potential for failure is significant. The following points are critical to achieve success and, without appropriate attention to these issues, the endeavor is unlikely to succeed.
1. Obtain Executive Commitment. As with any strategic alliance, board-level approval is necessary. The support of the CEO and a majority of senior executives is essential. Obtaining this commitment will require convincing investment-banking executives, familiar with a command-and-control environment, to appreciate the benefits over the risks.
2. Establish an Alliance Relationship. The investment bank must identify an alliance partner with the capabilities and scale to help establish and manage the external IT-services company.
3. Create a Shared Vision. The primary objective is to end up with a far more cost-effective IT capability. All parties need a clear understanding of the long-term vision and the measures of success. Agreements and financial arrangements must align incentives with overall success criteria.
4. Redesign IT Governance. Careful attention must be given to obtaining the support and commitment of business executives and involving them in the redesign and implementation of new governance processes. This may ultimately determine success or failure of the endeavor.
5. Transform the Technology. The technology-transformation program will be a multi-year program with two primary objectives: creating the industrialized IT-services company and rationalizing tech platforms supporting the business.
ABOUT THE AUTHOR
William Andrews is an associate partner in Accenture's Global Financial-Services group specializing in the capital-markets industry.