In the past couple of years, the financial-services industry (FSI) in the US has seen an increase in mergers and acquisitions (M&A). M&A activity is not new to the US FSI as banks have been acquiring each other since 1990s, mostly in the southeastern region, where 11 states permitted inter-state bank M&A.

Some of the early M&A activities include Wachovia’s takeover of South Carolina National Bank in 1991, Chemical Bank’s merger with Chase Manhattan in 1995, and BankOne with First Chicago NBD in 1998. But since global outsourcing was at a nascent stage, the M&A activity had little impact on it.

The scenario is different today. First, the Glass Steagall Act that hindered bank M&A was repealed in 1999. Second, M&A in the financial services space has a direct impact on global outsourcing as the acquisitions are getting bigger and outsourcing too has grown in size. Recent M&As include the BankOne and JP Morgan Chase merger, Bank of America’s takeover of FleetBoston Financial, and Washington Mutual-Providian merger, which are multi-billion dollar deals. In addition, most of the banks in play today have outsourced globally at various levels.

More M&As in the FSI are inevitable as there are over 8000 banks in the US, which analysts think are far too many. So the questions that arise are-

• What is the impact of M&A on outsourcing in general?

• What happens to outsourcing vendors after a M&A?

• What happens to the outsourcing initiatives on the buy-side?

Impact on Outsourcing

The most obvious benefit of M&A is the spreading of the outsourcing phenomenon. According to R. Ravishankar, CEO, international operations and business development, I-Flex Solutions, “M&A activities will further act as a catalyst for increased outsourcing activity as companies seek to gain synergies from the merger, and rationalize the cost structure of combined companies.”

Citibank has been a predator in the FSI space. According to a Citibank official, after most of their acquisitions the outsourcing of IT functions of the acquired financial institution is a way to cut costs and improve efficiencies.

Jerry Norton, Director, Strategy, Global Financial Services, LogicaCMG concludes that the FSI industry consolidation will result in two drivers for outsourcing services. “First will be the need to support the transition and transformational change programs to effect the integration,” he said. During the merger period itself, organizations will need the help of a specialist IT merger partner to realize available short-term cost savings available, he added.

Speaking of the second driver, Norton said, “After the merger, larger organizations will look to achieve cost and value benefits, which are likely to drive further outsourcing of back-office services, including application and potentially BPO.”

Financial services companies merge for several reasons such as access to new markets, market domination through size, business synergies, and cost rationalization. It is in the area of cost rationalization that IT outsourcing plays a role. Large financial services companies were the early adopters of global sourcing to cut costs and improve operational excellence by gaining access to a large talent pool in cost-effective countries. As they acquire smaller banks, the practice of outsourcing is inculcated into the smaller banks to rationalize costs.

Ravishankar says, “As one of the key IT service and product providers to the FSI, we will see an increase in our business due to M&A.”

Vendor Impact

Even though M&A benefits the outsourcing trend, individual players are impacted differently. Take various situations in the past. In September 2004, after the BankOne and JP Morgan Chase merger, the latter cancelled IBM’s $5 billion IT outsourcing contract. Under the contract, IBM handled major IT tasks for JP Morgan, ranging from running its data centers, and help desks to handling data processing. JP Morgan Chase decided to service its IT needs in-house, a strategy consistently adopted by BankOne.

In a different case, HSBC acquired Household International. Household’s IT vendor Kanbay International benefited. Kanbay continues to be HSBC’s IT vendor today along with the bank’s captive outsourcing center in India. HSBC has continued to increase its commitment to outsourcing.

The Bank of America – FleetBoston Financial is another classic example where the outsourcing vendor benefited. As part of the deal, EDS was tasked to integrate FleetBoston Financial’s communication infrastructure into Bank of America’s voice and data network. In this deal, outsourcing won as nearly 150 of FleetBoston’s IT workers moved to EDS.

Except in cases such as BankOne, which does not believe in outsourcing, and brought the processes back in-house, M&A activity generally benefits outsourcing as seen by the examples.

Buy-side organizations find it prudent to retain existing outsourcing relationships for a variety of reasons. First, it is difficult to immediately throw out an existing vendor due to knowledge transfer and change management issues. Second, having a list of vendors to provide IT services gives buy-side organizations greater flexibility in terms of pricing and availability of expertise. A recent report by market research firm, DataMonitor, revealed that customers were splitting deals to smaller pieces and farming them out to best-in-class providers.

Third, the financial services business is technology driven. Online banking, online stock trading, ATMs, and telephone banking to name a few touch most customers. Changing vendors immediately after a merger can cause technology disruptions, which will eventually hurt customer service-a sure way to lose market share.

However, it is inevitable that some vendors will lose out post merger. “In the short term, FSI players retain vendors of both companies especially during the merger integration process. Longer term, vendors with strong implementation record and those that bring strong domain capabilities will continue to see their businesses grow,” says Ravishankar of I-Flex. The winning combination for vendors to stay in play is proper blend of technology and FSI expertise. Also, vendors with country specific expertise in terms of local regulations and business processes are likely to be retained after a global M&A.

The fate of the vendor can also be tied to specific technology. In case, a customer chooses one existing technology over the other, some vendors are bound to lose. However, the vendor contracts are unlikely to be terminated immediately as it could disrupt the system migration process.

Norton points out, “Basically, the acquiring company needs to examine every existing contract to understand the terms and conditions that the company may be tied into. The organization then needs to match these to its own existing contracts to make the decision on whether to keep it, terminate it, or rationalize it with existing arrangements.”

All is not lost to vendors after a customer is acquired. The recent trend of multi-sourcing is expected to benefit the vendor community.

However, working with multiple outsourcing companies raises several vendor management issues for buy-side organizations. Says Glenys Martin-Perry, Senior Consultant, Quantum Plus, a UK-based independent outsourcing advisory firm, “An M&A deal ushers in a period of re-structuring and intense appraisal at all corporate levels. This is a serious opportunity to re-assess future sourcing strategy to drive competitiveness for the merged organization.”

Ravishankar feels that post merger, there is increased scrutiny of incumbent vendor’s capabilities, their domain experience, and an increased focus of tracking service level agreements (SLA).  There are also instances where financial institutions will initiate a price re-negotiation exercise with incumbent vendors of both companies after post merger technology integration activities are completed, he adds.

The Citibank official says that price renegotiationis are no brainier. After assessing the vendor of the acquired company we try to get better price, based on the cost of the other vendors. Given our buying scale, we are able to cut prices.

Customer Impact

The greatest benefit that an M&A brings to FSI players is the ability to multi-source, which enables buy-side organizations to get the best of breed services and technology. But the icing on the cake is pricing. Not only can the customer re-negotiate with existing vendors, but can also get very good terms with new vendors. According to Norton, “A merger enables leveraging the combined purchasing power to gain better and broader terms and conditions from the vendor community.”

Customers face additional issues of managing multiple vendors and are often forced to put in place robust vendor management processes. They often have to put in place new SLAs that lie in the tripartite rules of engagement between multiple vendors and the client.

Then comes the challenge of integrating different technology systems. Says Norton, “It’s likely that the merged parties will have different legacy systems, especially true in mergers spanning a number of geographies. These companies must introduce one common platform, one application should be used everywhere so that resources can be shifted to core business activity, and fixed cost shifted to increase flexibility of decision-making.”

This requires delicate vendor relationship management to get the outsourcing companies to work together as partners. It also means that all incumbent vendors will be in play, at least during the integration phase. Post integration, the fate of vendors depends on the strategy of the client. If the client adopts multi-sourcing, more vendors will remain in play. If not, some vendor rationalization is inevitable. But at the end of the day, the outsourcing phenomenon is bound to spread due to M&A.