Community banks continue to look for ways to control expenses. One effective way to minimize overhead costs is to outsource non-critical or non-differentiated tasks to third party vendors who are able to perform the function cheaper and/or faster. Banks have increased the breadth of outsourced processes and functions: everything from check processing, website management, payment solution and even some underwriting analysis and sales leads. Outsourcing makes sense where a vendor can perform the tasks cheaper than the bank and the bank can still retain the strategic and differentiated decision-making in the business. Many banks struggle with defining what function or process is critical and differentiated to the bank (to retain in-house) and what function or process is generic and can be a candidate for outsourcing.
However, it is important to realize the importance of a bank vendor. Since the selection of a bank vendor can touch so many different core processes, systems and customers, they are integral to bank operations. Vendors should be selected more carefully than banks select their customer. Because of their importance, they should be treated just as you would treat a customer since the relationship should be very two-way. While you pay a vendor money for their product and services, they need to give you support, feedback, industry information, training and ongoing intelligence to help you excel. Having the right vendors with a strong relationship can give your bank another competitive edge against a bank that does not have much respect for their vendor relationships.
While each outsourced function or process has its own set of requirements, specifications and timelines, we would like to highlight some of the high-level parameters that community banks should consider in analyzing and awarding vendors with their outsourced business. While each outsource decision is different and must be considered on its merits, there are several high level factors that we would like to discuss that are common to each vendor selection process.
Community banks must consider the quality and ability of the vendor’s line staff to deliver the solution. It isn’t enough that the CEO or sales person has charm or panache. The CEO or the sales person will probably not be the ones delivering the service. A good rule is to review resumes of the front line employees who will work with the bank. Consider whether they have the requisite skills and experience to perform their tasks. Just like a baseball team, you want a vendor with a deep bench, not just one with a fancy mascot.
In the process of choosing a vendor, it is important to consider the vendor’s profitability. A profitable vendor is the market’s validation of value (if customers did not perceive value in the vendor’s services, they would not pay for them and the vendor would become unprofitable). This analysis must be done in the context of the industry – if the industry average ROE is 10%, then a vendor with low profitability, say 2% ROE, is underperforming and this may be a reflection of market avoidance of that vendor. In today’s super low interest rate environment and the resulting artificially monetary stimulated business, few vendors lack profitability. However, when the business cycle turns, the ability to differentiate on ROE becomes an important vendor selection criterion.
Another sign of a successful vendor is their rate of growth (either growth in assets, coverage or revenue). Successful vendors continue to attract new customers, while unsuccessful vendors struggle to bring in new business. Growth must also be considered in relation to total industry growth. If the industry is growing at 5% per year in sales, or asset size, a vendor that is lagging the industry average may well be challenged for various reasons – lack of capital, lack of professional talent, poor management. None of the above explanations reflect well on a laggard if the general the industry demonstrates high growth numbers.
One of the most important aspects to consider in a vendor is market share. The leading market share vendor may not necessarily be the best solution for a community bank. However, in a consolidated industry the smaller vendors, unless they are start-ups or disrupters, are probably not the long-term successful competitor. Especially in a commoditized industry, small competitors are rarely long-term survivors. There may be room for thousands of tech startups in a developing and growing industry, but the same cannot be said for core system providers or national accounting firms. Larger market share is also a reflection of customer acceptance and validates the vendor’s value proposition.
Insiders know more about a company than anyone else. The largest contingent of insiders is the front line employees of a company. Employees are the canary of the business coal mine. Unsatisfied employees or high turnover of employees is a very strong indication of a vendor in trouble. Interestingly, most employees are willing to share their thoughts and experiences as it concerns their employer. But bankers must ask the question the correct way: employees are much more forthcoming about their employer’s business if the question is framed to gauge the employee’s level of individual satisfaction with his company. If you ask the employee direct questions about the employer, s/he will give you a guarded response. For example, if you ask a sales rep “What is the quality of service that I will receive if I buy your company’s service?” s/he will give you the rote, company line answer. However, if you ask, “How do you feel about the level of support and strategy you receive from your employer?” you you’ll get a very forthright answer with a more telling understanding of that vendors true value proposition.
Depending on the industry, the size of the vendor can be a significant factor for a community bank. If the vendor competes in a capital intensive industry, and a long-term relationship is critical, then asset or operational size can be a very important consideration. Studies consistently demonstrate that larger competitors have a much higher survival rate. If your bank is looking for a consultant, the size of that vendor may not be critical – the quality of the individuals performing the work is paramount. However, if the bank is looking for a core system or “renting” the balance sheet of the vendor, size is a good predictor of stability. This has been demonstrated especially in the banking industry.
While the vendor selection process is specific to the task being outsourced, there are some very simple and common criteria that community banks should consider. A vendor is a vital part of the bank team and so those vendors that perform mission critical tasks or one with high switching costs, need careful due diligence and selection to ensure you are satisfied with them thoroughly before bringing them into your family.
Submitted by Chris Nichols on May 11, 2015