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Saturday, September 18, 2004

Outsourcing strategy after the failed J.P.Morgan deal via David Kirkpatrick

The future of outsourcing in general and in financial services in particular—it remains vibrant.IBM itself continues to sign new deals. For example, in April it won a five-year extension to an existing contract from investment bank Morgan Stanley, worth $575 million. Other new deals have been signed with Merrill Lynch, ING, and Deutsche Bank. IBM's seven-year, $4 billion deal with American Express has chugged along peacefully since it began in February 2002.
Dimon, the heir apparent at J.P.Morgan rejecting outsourcing could have the salutary effect of getting more companies to ask, "What exactly is non-core for me?" Big outsourcing deals were very appealing to banks during the economic downturn, when the banks' expensive infrastructures were being used for fewer transactions. Outsourcing, especially the "On Demand" sort promoted by IBM, allows a company to pay for services as it needs them. But that is less appealing in a recovery, when transactions are increasing. So now, with things looking up, banks are more likely to want fixed costs. Analysts say many banks don't even really know what they spend on IT, because the many activities of their different departments are so vast and diverse. It is extremely hard,for banks even to know what they might save from outsourcing.As outsourcing spreads to more and more functions and the work gets sent more and more different places, managing it carefully will become one of the top responsibilities of senior managers everywhere.For a financial services company as big as J.P.Morgan, such a move can make sense. J.P. Morgan is essentially a new company of vast scale whose overall IT operations well exceed $5 billion per year. That's bigger than most IT services companies. And banking is an industry in which IT plays an even more important role than elsewhere. Financial services is the most sophisticated of all industries in its use of IT, and competition is fierce among the many super-wealthy players to do things faster, more efficiently, and more cleverly. When the industry baseline is so high, and J.P. Morgan's IT activities so vast, the company itself can develop innovative applications and achieve economies of scale not dissimilar to what IBM aims for when it takes over operations like this. That eliminates much of the rationale for outsourcing. You may have noted that IBM says, ironically, that the cancellation of this deal will have a positive effect on this year's earnings. That's because in long-term IT outsourcing deals, almost all the profit comes late in a contract. IBM has said that since the deal remained in its early stages, it was still "investing." Up to now this deal has been a cost for IBM, not a source of profits. While neither company has confirmed it, you can be sure that IBM's contract requires some form of major compensation for early termination. This reverse move needs to be assessed on atleast three counts.
A. Whats the economic gain that J.P.Morgan is expected to get out of this.
B. From an assessment perspective, the business drivers that favoured outsourcing (outside of cost), how do they look after the reversal.
C. With this big decision, whats J.P.Morgan's plan to offer better services to its customers.
D. How would this move influence J.P.Morgan's ultimate desire to overtake Citi(Known for outsourcing heavily) to become global No.1 bank.
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