value sourcing in ˜nancial services

Across the �nancial services sector, executives are seeking ways to manage costs so that they do not creep back into the system. External spend is one category of spend that is �rmly in their cross-hairs. For the average �rm, external spending typically represents 20-40 percent of its cost base and an aggregate spend estimated at upwards of $500 BN. To this end, �nancial services �rms are implementing Value Sourcing management – a long-standing approach successfully used in other industries.

Value Sourcing in �nancial servicesEliminating internal barriers, harnessingsupplierrelationships

Financial Services

2 Copyright 2008 © Oliver Wyman

Value Sourcing not only applies traditional techniques, such as volume bundling and e-procurement, but also envisions innovative ways to optimize the long-term value contribution from supplier relationships and the procurement function. By incorporating sourcing techniques early in product architecture decision-making, firms can better integrate supplier capabilities with their core internal operations. In addition, Value Sourcing seeks to break down internal barriers in order to realize the full potential of an integrated value chain.

Our experience suggests that when led from the top, Value Sourcing can deliver sustained incremental savings of 5-15 percent of total external spend, with much greater savings in individual spend categories. Further, by leveraging the changes in the supplier landscape to build an extended value chain beyond the confines of the organizational boundaries, executives can enhance the efficiency of the firm.

Cost reduction is becoming a high priority for senior executives in the financial services sector. External spend is substantial (see Figure 1 below), and Oliver Wyman believes that many financial institutions are still not harnessing the full potential of sourcing. Rather, sourcing is often relegated to a central procurement function that is given the mandate to attack only a portion of the spend categories, with ‘buy for less’ as the primary savings lever. To overcome this stagnation, executives must elevate the procurement function so that it becomes the organization’s Value Sourcing engine.

Figure 1. Representative financial services spend map

Insurance/Other Financial Services, 15%

Marketing/Advertising, 10%

IT, Data, Telco, 30%

Professional Services, 15%

Print/Distribution, 10%

Occupancy-related Services, 10%

Office, 5% Travel/Other, 5%

Source: Oliver Wyman analysis

3Copyright 2008 © Oliver Wyman

Value Sourcing is an approach that applies tools and methods to create a foundation for sustainable cost savings over several years. This requires building a procurement organization with the right sponsorship, skills, structure, management processes and tools. Having this foundation in place serves to create a culture that is keenly aware of the best approaches to modularizing the design and distribution of products and services. Additionally, executives are made aware of the overall spend baseline as well as the options available to control total spending on both internally sourced and externally purchased goods and services.

The benefits of our approach have been tested and proved through our long-standing history of helping clients build a Value Sourcing capability in a broad array of industries. These successful methods and techniques, which have been honed in sectors where purchased goods and services represent a very high proportion of total costs – such as aerospace, automotive, media, telecommunications, transport and utilities – have translated well into the financial services sector.

Better cost managers – Better cost savings Over the last several years, the financial services sector has enjoyed strong growth and a benign credit environment. However, economic pressure across all financial sectors (see Table 1) once again is forcing institutions to initiate true cost management programs. Because firms often do not address the underlying cost drivers, costs are moved around or deferred rather than eliminated permanently. The “shell game” that firms play to ostensibly cut spending ends up being detrimental in the medium- to long-term, as these costs inevitably reappear over time.

Table 1: Mounting pressures to reduce the cost base

Retail Banking Investment BankingInsurance/ Asset Management

Mortgage origination �

volumes and lending profits declining

Deposit growth likely �

reverting to the mean – resulting in lower profitability

Slowing consumer debt �

growth given current debt service ratios and tightening lending standards

Worsening delinquencies �

M&A volume starting to �

show signs of potential decline, as pipeline slows

Equity underwriting and IPO �

volumes trending downward

Credit crunch resulting in �

dramatic drops in revenue and large write-downs on fixed income derivatives held on books

Interest-rate environment �

and flat yield curve detracting from both investment income and product attractiveness (e.g. annuities)

Premium income relatively �

flat while claims’ losses seeing an uptick

Net new money growth �

for asset managers slowing overall

In the current marketplace, short-term reductions of external costs are demanded each year and must be delivered. Senior executives must also take the lead in rethinking how their firm can cut costs in


a more sustained way so that these costs do not return in subsequent years. Value Sourcing is one weapon in the executive team’s arsenal that must be deployed more broadly.

However, the required changes cannot be driven from the bottom up since they usually entail redefining the role of sourcing functions within the firm. Rather, they must be driven top-down by senior executives who have a clear vision of where the firm stands now in terms of procurement sophistication, as well as where the firm needs to be in a year’s time.

Maturing the sourcing capability – Redefining the procurement role We categorize sourcing practices into four major levels: buy for less, buy better, consume better and integrate/sell (see Figure 2 below).

Figure 2. The four major levels of sourcing practices (percentage of external spend)

Level 0Rogue spend

Lower (5-10%)

Savings/complexity

Higher (≥20%)

Level 1 Buy for less

Level 2 Buy better

Level 3Consume better

Level 4 Integrate/Sell

In terms of their sourcing capabilities, financial services firms lag behind their counterparts in product-intensive industries such as aviation and manufacturing. Although some financial institutions still suffer from a high degree of rogue spend (Level 0), where few sourcing professionals are involved and spending is largely uncontrolled, most firms perpetually stagnate at Level 1 or Level 2. Below is a brief summary of each level:

Level 1 firms have some success in ‘buying for less’ through �

consolidating volume, understanding supplier costs, creating more supplier competition and optimizing contract maturities. Essentially, however, Level 1 firms passively accept how their sourcing environment is defined – they largely negotiate around upfront price and terms. At this level, firms tend to have consolidated their technology spend (e.g. PC purchases, phone plans, telecom infrastructure) and commodity products (e.g. office supplies). In addition, processes are in place to provide professional oversight of all key service levels and agreements.


Level 2 firms take a wider view of supply and price. When making �

a sourcing decision, for example, they try to ‘buy better’ by looking at the total cost of ownership, rather than at the price alone. Total cost of ownership includes the cost of managing the relationship, the transactional costs of buying and paying, as well as the cost of any associated operational risks. These firms also routinely analyze in-source vs. outsource options to consider ever-changing market conditions. Moreover, they objectively account for capabilities across the enterprise and processes to maximize internal capacity before approaching external suppliers. Level 2 firms also recognize that improving their communication with suppliers through better forecasting and feedback can help the supplier push down costs. As an example, firms at this level have been able to effectively manage their internal and external capacity for printing statements and marketing materials across the enterprise. They also have been able to take activities that were previously in-sourced (e.g. branch infrastructure support) and develop cost-effective outsourced options. At this level, firms have extended their sourcing approach from traditional technology and commodity products to other spend categories such as the purchase of insurance or rewards programs targeted to end-customers, and to functions such as legal, where the supplier landscape is helping to greatly improve productivity.

Level 3 firms apply this more active approach to shaping the �

firm’s demand for sourced services by ‘consuming better’ through simplifying specifications. As a result, the services that the firm needs can be “commoditized.” Examples of what banks and brokers have done at this level include rationalizing the suppliers of market data (e.g. Reuters vs. Bloomberg) and evaluating options to review alternatives such as e-statements. Insurers are adopting e-policies and building repair networks in collaboration with manufacturers. Level 3 firms also implement ways to control and provide incentives based on how services are consumed, such as reimbursing bills only from approved suppliers and further only for those purchases that follow established policies. In addition, these controls extend outwards to the suppliers; an example of this includes Property & Casualty insurers that are actively tracking and controlling fraudulently inflated repairs in the claims network. Likewise, firms look more creatively at joint division procurement, rather than simply consolidating volume. They ask themselves, does it make sense to spend all that money building individual brands, or would it be better to secure a single, less costly deal with an agency to promote an umbrella brand?

Cross-industry case studies – Our approach, their results

Universal bank – Developed a �

multi-pronged plan to increase cost savings by over $700 MM across the entire spectrum of goods and services and to re-engineer the procure-to-pay process. In parallel, sourced specific service categories that delivered annual cost savings of over $40 MM

Major US financial institution – �

Designed and implemented an enterprise-wide Value Sourcing initiative that focused on indirect cost and administrative overhead costs; together delivered cost savings of 12–25+ percent for individual cost categories

Global airline – Undertook a �

comprehensive transformation of procurement functions using Value Sourcing techniques that extracted more than $1.5 BN in ongoing cost savings, as well as highlighted revenue growth opportunities through a more effective business design

Leading telecom carrier �

– Defined a blueprint for an enterprise-wide procurement function that encompassed all key categories of network infrastructure, equipment, terminal devices, services and indirect costs; the Value Sourcing initiative identified aggregate annual savings of 15 percent

Major power company �

– Implemented end-to-end procurement and supporting processes, contributing to $2 BN in cost savings over three years


Level 4 firms deepen and integrate their relationships with �

strategically important suppliers to jointly develop products, services and markets. They accomplish this by setting up joint ventures or by working with other industry participants to create or participate in “process utilities,” as has been done often in the payments, collections and claims management arena. At this stage, the procurement function even serves as a conduit to generate revenue by selling best-in-class services internally across business units and externally to peers or third-party suppliers.

While financial services firms do need to develop high-level capabilities in all external spend categories, the sourcing levers and the focus on spend categories utilized will often vary by line of business, geography and scale. This segmentation of sourcing requirements by line of business is driven by type of spend, supplier base fragmentation/expertise and business appetite for cost management. In an investment banking and capital markets environment, for instance, demand management levers may provide greater benefits than pure supplier price compression. In a retail environment, on the other hand, developing an integrated service delivery model with key suppliers can be critical in spend categories such as telecommunications, infrastructure technology and branch build-out.

Senior executives, therefore, should identify where the firm would benefit most from sophisticated approaches, and then reorganize the procurement function to quickly exploit those opportunities.


Seizing opportunities today – Capturing savings tomorrowOur experience indicates that firms can make substantial savings even across expense categories that are already considered ‘“managed” by the firm – Table 2 below shows select opportunity areas available to firms. We can see that significant reductions are still available, especially in areas that might traditionally not fall under the procurement management umbrella. These include spend categories such as legal expenses and temporary staffing, as well as sourcing of components or whole functions such as payments, mortgage servicing and loan processing. In these particular areas, new technologies, globalization and supplier or utility solutions have redefined the marketplace.

Table 2. Identifying and exploiting select opportunities

Expense category Sample sectors Potential savings range

Information technology

Hardware, software, telecom, �

information services8-15% �

Marketing Marketing, advertising, �

promotion materials9-15% �

Insurance Health and plan administration �

P&C and product related �

(e.g. debt forgiveness)

10-40% �

Professional services

Financial, accounting, �

payroll administration

Consulting: Management and tax advisory �

Training, recruiting, relocation �

Legal: eDiscovery �

Legal: External legal costs �

Temporary staff: General and IT-focused �

4-20% �

60-70% reduction �

for discovery

10-20% general fees �

5-15%; 40-60% on �

applicable offshore development and maintenance

Occupancy Facility operations – security, janitorial, �

utility management5-7% �

Office services Equipment, supplies, services, mail/ �

distribution, auto fleet10-20% �

Travel Air, hotel, rental car, agency fees, �

special events6-20% �

Source: Oliver Wyman analysis

Capturing and sustaining the savings shown in Table 2 is not easy and cannot be achieved by traditional, short-term approaches to cost cutting, such as one-off price concessions or sharp temporary declines in headcount.

Rather, our experience suggests that a radical re-make of the procurement function is needed. While today’s central procurement functions were designed to manage certain spend categories, the next generation of procurement must develop a comprehensive, center-led


set of competencies and capabilities and then deploy these new skills within the business lines. These sourcing competencies are outlined in Figure 3 below.

Figure 3. Improving and streamlining sourcing competencies

Level 1: Buy for less

Level 2: Buy better

Level 3: Consume better

Level 4: Integrate/Sell

Process and performance management

Leadership

People/Skills

Organizational structure

Systems/Tools

1. Leadership and strategy: Leadership from senior business executives, such as the CEO, COO and CFO, is essential if firms are to create a culture that is conscious of external spend and that applies all the relevant spend management tools. The first step is to build a comprehensive strategy based on a factual understanding of spending within the institution – a blueprint that executives can communicate and that the institution can rally around. Next, the firm must elevate the role of the sourcing function to enable more proactive cost management. This role must be given the decision-making authority necessary to leverage supplier capabilities and to create the right mix of internal and external spend.

2. People and skills: To implement a structured approach to Value Sourcing, executives likely will find that they require a heavier mix of senior talent – more vice presidents and directors, fewer middle-management and general staff – than is traditionally available in procurement functions. Furthermore, deep content expertise in the major spend categories, including real estate, legal and marketing spend, will help the function to build rapport and credibility with senior business executives and procurement peers within the divisions. Retooling and upgrading staff skills in key areas – such as


data/statistical proficiency, IT systems literacy, research and analysis, negotiations, contract development and project management – will help to professionalize the sourcing function as well as attract, and retain, top talent within the firm.

3. Organizational structure: Essentially, there are three potential organizational constructs for procurement functions – decentralized, centralized and center-led. In a decentralized model, businesses work directly with their suppliers with little to no cross-company coordination other than perhaps adherence to general purchasing policies. By contrast, in the centralized model, a substantial portion of a company’s total spend is managed through a formalized command-and-control structure that usually assigns experts to manage specific spend categories. Center-led structures are a kind of halfway house. Rather than report through a single command-and-control structure, they are governed by a central body that makes policy, coordinates planning and actions, and aggregates reporting.

While centralized models increase the probability of achieving greater savings results, they are less flexible than decentralized structures; therefore, they are not appropriate for all companies. Regardless of the organizational structure chosen, it is critical that sourcing functions ultimately report to executive management.

An emerging trend in financial services firms, borrowed from manufacturing conglomerates, is the ‘embedded’ model. Here, division-level sourcing leaders report both to the head of their business division and to the executive team. Sourcing leaders are responsible for identifying opportunities, defining new strategies and developing deployment plans. Oliver Wyman believes that a version of this model will prove to be the next-generation organizational solution for delivering improved sourcing to financial services firms.

4. Systems and tools: To manage different aspects of the sourcing process, firms will need to make key investments in technology. These might include integrated databases on spend information, tools to analyze the data and to prepare management insights, as well as automated core transaction processes and user-driven requisition processes to maximize straight-through processing.

If executives are to focus continuously on spend management, they will require access to relevant, useful information on all the different spend categories. This means that tools must capture spend data at the source rather than rely on post-transaction entry, and must do so at a sufficient level of granularity to be able to support meaningful decisions. In addition to the firm’s total spend on insurance, for


example, decision makers likely will need to know how much is spent on each type of insurance – and they may need to drill down to specific policies.

Moreover, different categories of spend may require different solutions. For instance, it can be easier to manage spend in the “temporary labor” category if the firm’s solution has an integrated workflow, from managing the distribution of specifications to select providers through the recruiting and selection of candidates.

On the other hand, firms should rationalize systems within spend categories wherever possible. Today, it is not uncommon for different divisions of firms to use disparate systems to manage the same spend categories. Since this makes it challenging to build a central view of spending, firms should build a common procure-to-pay transaction platform to automate and streamline sourcing and transaction processes.

5. Process and performance management: Building the right culture, in terms of staff attitude, is not enough, however. To assure that employees make the right spending decisions on the front line, firms must set out clear policies. They must also build a set of disciplined and standardized processes with protocols, templates and tools that steer employees in the right direction as they negotiate internal procurement processes and the supplier interface. The sourcing function itself will need to develop sophisticated sourcing methodologies for key categories, including models that build an understanding of the total cost of ownership of a purchased product or service. Regular communication, ongoing training and up-to-date documentation will play essential roles in ensuring that stakeholders and employees clearly understand the sourcing methodology and its processes. Firms will also need to put in place various control and monitoring processes to ensure that spending complies with firm policy, and that employees know when they can – and cannot – make an exception to the rules. Having access to good, quality information is crucial in understanding, managing and controlling spend; therefore, clear data stewardship processes are required.


Maximizing Value Sourcing potential – Next stepsHow can senior executives begin to realize the benefits of the Value Sourcing approach? The best way to begin is by moving through a series of pragmatic steps:

Build a comprehensive view of all your external spend categories �

and spend drivers rather than just traditional procurement categories, and ensure that it is granular enough in key categories

Relate each spend category to an appropriate level of procurement �

sophistication and centralization

Benchmark the skills and capabilities of your existing sourcing �

function against the capabilities that the function will need to address each sourcing category at the appropriate sophistication level

Map out a comprehensive strategy based on this analysis to extract �

the best value from suppliers and effectively manage spend drivers

Begin communicating the executive team’s new sourcing strategy �

and emphasize that managing external spend is a top focus for executive management

Reorganize your firm’s sourcing function so that it can effectively �

implement the strategy and efficiently build new strategies into the future

Ensure, in particular, that the sourcing function has the talent and �

authority to leverage supplier capabilities as well as to address the cost base that remains in-sourced

Although these steps can be challenging and daunting to put into practice, financial services firms that act now will have the opportunity to unlock significant cost savings today, while achieving a sustained lower spend base. Not only will these procurement functions create long-term shareholder value, but they will also help to set up the company for future growth.

Oliver Wyman is the leading management consulting �rm that combines deep industry knowledge with specialized

expertise in strategy, operations, risk management, organizational transformation, and leadership development.

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The information and opinions in this report were prepared by Oliver Wyman.

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