Canadian financial services firms, which have lagged their global peers in terms of outsourcing and offshoring, are set to contract out more business operations in the next two to three years, industry experts say.

“This is not a question of whether they will do it. They will do it,” says Gordon Shields, partner with consultancy firm Deloitte LLP in Toronto. “Now, it’s just a question of timing.”

Outsourcing is contracting out a business process such as information-technology services to a third-party firm; offshoring refers to moving a business process to another country, on either a third-party or a “captive” subsidiary basis.

Both outsourcing and offshoring promise firms the possibility of significant cost savings, access to a wider pool of skilled employees and, often, higher-quality work.

“Canadians think offshoring is simply about cost,” says Asif Quadir, senior counsel with Bank of Nova Scotia’s strategic transactions group in Toronto, responsible for outsourcing and technology transactions. “Sure, there’s cost savings. But, in many cases, there’s also better value.”

And to increasing degree, the range of business functions that can be feasibly and profitably offshored — India remains the prime destination for offshoring — is likely to grow. Whereas most of the outsourcing was once limited to technology-related applications, it has now stretched out to all manner of business processes and beyond.

In fact, the next wave in outsourcing, already here for many global companies, is in “knowledge processes,” contracting out higher-end functions such as equity research, analysis and even legal work.

“India has a common-law tradition, the law schools are top-notch and the number of lawyers they’re churning out is huge,” says Quadir, an outsourcing industry veteran who previously was a principal at Infosys, an India-based provider of outsourcing services.

“In the U.S., the average associate has a billing rate of maybe US$250 an hour. In India, it’s about US$40-US$50 an hour for a top lawyer from a top law school,“ Quadir continues. “If there’s due diligence, discovery work to do, why not ship it to India and have the higher-end work done by a partner here?”

Shields agrees: “There’s a labour-cost arbitrage opportunity of getting really smart people in India to do, say, equity research vs paying somebody back home.”

To varying degrees, all the major Canadian banks and insurers have been outsourcing a least a part of their IT infrastructure for the past five to seven years. According to the Toronto-based Centre for Out-sourcing Research and Education, the financial services industry has led all other industries in signing large outsourcing contracts, albeit primarily with domestic third-party providers. CIBC, which CORE says is Canada’s largest outsourcer, has contracted out $7 billion worth of outsourcing since 2002, the bulk of that to Mississauga, Ont.-based Hewlett Packard, which manages CIBC’s IT services and applications development and management.

Scotiabank signed IBM Canada as its IT services provider in September in a $480-million deal that was an extension of an existing partnership with IBM dating back to 2002.

According to CORE, TD Bank Financial Group is in the middle of a seven-year, $420-million contract with Hewlett Packard to deliver IT services.

In terms of offshoring, Canadian financial services institutions have been far more conservative, industry experts say. One notable exception is Toronto-based Manulife Financial Corp. , which has established a captive shared services operation in the Philippines, where the insurer already operates. Manulife Business Processing Services in Manila provides accounting, back-office and technical services to Manulife Financial worldwide.

In contrast to the Canadian market, global financial services institutions have much more readily embraced both outsourcing and offshoring. U.S.-based firms such as J.P. Morgan Chase & Co. Inc., Lehman Brothers Inc. and Citigroup and European players such as HSBC, UBS and Deutsche Bank have all developed offshore operations over the past several years, including the offshoring of higher-end functions such as equity research.

Industry observers believe that an inherent conservatism among Canadian financial services firms, as well as the comforts of a lucrative domestic market, have contributed to their reticence to outsource and offshore.

“We just don’t have the same competitive pressures in the Canadian market as we see in the U.K. and the U.S.,” Shields says. “That’s why [foreign banks] are further ahead, frankly.”

According to Shields, most if not all Canadian financial institutions are experimenting with outsourcing and offshoring through small, one-off applications-development projects with foreign vendors, with a long-term view to step into the space more fully in the next year or two.

@page_break@“They’re all interested in the labour arbitrage opportunities [of offshoring],” Shields says. “They’re trying to determine what’s the best approach — either going to a place such as India in conjunction with an established vendor there, or setting up their own captive unit there.”

Shields says that when done right, offshoring offers financial services institutions a variety of key benefits, the most prominent of which is cost savings. The most recent Deloitte study on offshoring says global financial services institutions realized an average of 40% cost reduction by transferring services offshore. That compares favourably to outsourcing in the domestic market, which tends to yield savings in the 25%-30% range.

With offshoring, companies are also interested in accessing pools of skilled labour that, depending on the sector, can be hard to find at home. “In some cases, firms are using offshoring to free up capacity, to move their own people into more strategic projects,” Shields says, “and using the offshore partner to do more mundane tasks.”

In some cases, Canadian firms are looking for programmers who can work with outdated code, having had a hard time finding them in this country. “Some of these firms have huge, complex IT systems that form the backbone of the entire operation,” says John Simke, chairman of CORE. “They need people who can work in outdated code, and they can’t find enough people here.”

Another benefit of offshoring — at least, for those global firms that have an advanced and integrated offshoring set-up — is as a way of increasing “throughput.” Offshoring allows, for example, an offshore applications-development team to work on a project while the domestic market development team is off work. “You come in in the morning and find out what they’ve done in the other centre the night before,” Shields says, “and then you pick it up and keep going.”

Still, offshoring poses several risks for domestic firms, primary among them being security risk. “If a vendor allows sensitive information to be released,” Quadir says, “it could have a huge impact on the reputation of that client.”

There’s also the possible loss of intellectual property. “There aren’t the same beliefs around intellectual property [in some offshore jurisdictions] as there are here,” Shields says. “If someone is working on something highly secret for you, you run the risk they’ll leave and be at the next organization re-using what they learned from you.”

Quadir believes that IP risk can be overstated, particularly when it comes to IT or business-process outsourcing as opposed to manufacturing outsourcing, in which IP theft can occur: “The [outsourcing] industry has matured to a point at which the established offshore players realize that stealing a client’s IP would be like killing the goose that lays the golden egg.”

Another possible drawback to outsourcing is the risk that a firm will lose out on innovations and new ideas that could have been developed by a captive staff. After all, there’s little incentive for a vendor to share new ideas with the contracting company, says Monica Belcourt, a professor of human resources management at York University in Toronto. “When you have full-time staff who are engaged and committed,” she says, “they’ll be more likely to be creative and share innovations with the broader organization.”

Another problem is that turnover at outsourcing services providers in India is notoriously high, which results in higher costs in terms of hiring, training and overall discontinuity in the organization. Labour costs in India are rising, as well, although experts say they are still well below North American and European levels. Finally, depending on the offshore jurisdiction, issues such as political stability and infrastructure need to be taken into account.

Governance and regulatory issues are also serious considerations that have to be taken into account. In terms of governance, many domestic companies make the mistake of not creating a large enough team, or one with the appropriate skills, to manage the relationship with the outsourcer or the offshore firm.

Firms also need to make sure that outsourcing relationships are supervised at the senior executive level. Without proper relationship management, the domestic firm runs the risk of not getting as much out of the arrangement as it had hoped.

There are also regulatory issues a domestic firm needs to manage, including requirements involving the movement of customer information offshore. If the financial information is moved offshore, Shields says, approval from the appropriate governing body is usually required, including ensuring the offshore site and process is certified and compliant with domestic regulations.

Despite the risks, experts say, outsourcing and offshoring can provide Canadian financial services firms with benefits that will be crucial in order to stay competitive with global firms. According to a study released by CORE in January, Canadian firms have reached a tipping point — the benefits of offshoring are trumping the risks. Canadian firms will be forced to at least consider further outsourcing and offshoring arrangements, if only to stay in step with the rest of the world. IE