Controlling operational costs:
choosing the right IT strategy to manage costs
Many investment management organisations are responding to the harsher global financial climate by focusing resources on short-term tactical solutions to control their operational costs. Those with a more strategic approach to cost management are assessing a range of more sustainable alternatives to introduce long-term cost savings. Drawing on contributions published elsewhere in this issue, this article outlines a number of strategic approaches and software solutions designed to help contain costs over the longer term, and not least the impact on opportunities for growth.
by Michael Metcalfe, Co-Editor of Journal of Applied IT and Investment Management
As the financial crisis rumbles on across the globe, investment management companies find themselves operating in a more hostile environment in which they face a number of significant challenges. Of these, perhaps the most pressing is that profit margins are being squeezed and likely to remain so in the foreseeable future.
The reasons for this are twofold. First, revenues are down and increasingly difficult to forecast. And second, a more complex and highly regulated market is pushing operational costs up. High fixed costs and variable revenues make for a dangerous cocktail. Given the difficulty of ensuring persistent outperformance in returns, costs and their containment have emerged as a critical competitive element that is high on the agenda of most investment management companies.
With IT operational costs widely viewed as the most strategically important cost to consider as a means to maintain a competitive cost position in increasingly complex global investment management operations, companies need to put into place the right IT cost management strategy – supported by the right financial software solution – in order to exercise control over the operational cost base.
Here the difficult question is how to establish a clear and transparent cost overview, as examined in greater detail by Ulrik Modigh, Head of Asset Management Operations, Nordea Asset Management, in the article 'Operational cost processes: cost management as a strategic tool'. To obtain a sufficiently effective cut in total IT expenditure, it is paramount to first identify the major cost areas. Among the winners in the industry will rank those companies that have the ability to accurately assess, gauge and monitor their operational costs with the support and assistance of suitably applied investment management systems and processes.
As a relatively high proportion of the traditional investment management company’s IT budget is spent on internal staff and external consultants, trimming some of the staff costs could hence be attractive. A financial software solution with fewer integration points and enabling a fully automated workflow allows staff costs to be lowered. To measure the effect of the cost-savings, a normal return-on-investment (ROI) analysis can be performed for the automated components, putting the savings on staff in relation to the cost for the automation. In the same way, the ROI analysis can be conducted for savings in integration costs.
According to Peter Ellis, Managing Director of investment management consultancy Investit, it is crucial to take a value-based approach to this analysis. Cost containment is a key consideration but it should not necessarily be the sole one. “There is no point in having low operating costs if the service delivered by the operating platform is unacceptable,” he notes. Also, scalability can be more important than cost, in the sense that delivering more for the same cost may prove more important than reducing costs in an absolute way.
With mounting pressure to ensure competitive operational costs in the long term, pursuing a course of ‘business as usual’ is no longer an option. If companies are to succeed in increasing – or at least protecting – revenues, they need to reappraise their operational setup, consider the option of acquiring an up-to-date and fully supported investment management system with running upgrades, or perhaps seek out a new breed of solutions; just carrying on with the current operational setup is unlikely to be sufficient to ensure survival for all in the long run.
STRATEGIC APPROACH AS PREFERRED CHOICE
In assessing the alternatives available for introducing operational cost control, what would be an investment management company’s best approach? Should it be strategic in nature or more tactically based?
Whereas a tactical approach looking at isolated processes can help to mitigate short-term disturbances and disruptions, for long-term cost containment, a strategic, holistic view, which looks at the entire value chain, is imperative. In a volatile environment like the current one, quick wins are a tempting trap to fall into, but the winners emerging from this troubled period will be the companies that take the bull by the horns and aim for a clear and sustainable cost control strategy.
One of the problems with pursuing a tactical approach is that it tends to impede future growth potential by cutting skilled staff and other resources needed to promote expansion. In conditions where increased pressure on IT expenditure prevails, it is important to identify areas with the least impact on future growth and take the appropriate remedial action. This enables the company to build up a strong balance sheet and still have an agile organisation in place. In a rapidly changing world, those investment management organisations that are agile are more likely to emerge as winners because they have the ability to outmanoeuvre their less agile rivals when growth prospects eventually brighten.
This is one of the main conclusions of the report ‘The Agile Asset Manager’, published in 2011 by management consultancy KPMG, which cited replacement of legacy platforms to improve responsiveness and agility as a key factor in re-engineering core processes from the operating model perspective. “By putting in place more agile operating platforms, processes and structures, important benefits include not only increased operational efficiency and effectiveness, but also increased control over key value drivers and KPIs such as cost, profitability and capacity,” the report noted.
In another report, ‘Going for Growth: The Role of Price and Cost in Driving High Performance in a Volatile Global Economy’, also published in 2011, management consultancy Accenture found that in an economic environment that is still volatile and uncertain, understanding and maximising the factors that drive growth becomes even more important than during more predictable and robust economies. “Specifically, companies must identify and build on those things that differentiate themselves from competitors from a revenue (or demand) and cost (or supply) perspective, and that enable them to more strongly connect with fickle customers before other competitors do,” the report commented.
So the best approach to controlling operational costs clearly comes out as a strategic one. “The first thing companies need to do is stop thinking in a disconnected way about systems and the business processes they support,” observes Peter Ellis. In his opinion, operating platforms is the way companies need to think, where an operating platform comprises an integrated collection of business processes, organisational structures (teams, responsibilities, and ownership), systems (applications and infrastructure), and data management processes (governance, collection, validation, storage, and distribution).
INTEGRATED OPERATING PLATFORM
However, the reality looks a little different, with a fragmented operating platform appearing to be more the rule than the exception among investment management companies nowadays. Business processes, people, systems and data management processes are all structured as silos, each of which is aligned along a vertical business function. In the past, this has allowed individual business functions within investment management companies to develop their operating platforms in parallel, and so move their businesses forward quickly, at the same time, on a number of different fronts.
But, according to Peter Ellis, the cracks are beginning to show in this strategy. As individual components of best-of-breed system architectures are upgraded to support new functionality, the time and effort required to consolidate data and maintain the cohesiveness of the whole operating platform have increased significantly. And as the need to support more complex investment strategies has increased, the need to have greater integration within operational processes has grown.
So, at a time when the pressure is on investment management companies to reduce the time to market, as well as the cost of supporting new capabilities in investment, distribution and operations, many are finding that the opposite is happening. The costs of operating platforms are escalating and the ability to adapt and enhance them quickly is diminishing.
These trends confirm the need to think more strategically to reduce the fragmentation in operating platforms. Required is a move away from best-of-breed architectures towards more integrated systems and data architectures. Standing still on the ‘burning platform’ is no longer an option, as explainded in more detail in the contribution by Investit’s Doug Neill 'Making the leap from IT platform to safe cost haven: how standing still is not an option'.
CONSIDERATIONS TO MAKE ABOUT SOFTWARE SOLUTIONS
In choosing from the various financial software alternatives with the aim of better controlling cost, be it through new service delivery mechanisms, such as cloud computing and Software as a Service (SaaS), or by means of IT outsourcing, offshoring and managed services, it is crucial to look at the entire value chain. It is not enough to buy a state-of-the-art system that only covers some isolated part of the value chain. A need for add-on systems means more integration points, which in turn mean higher maintenance costs and risk of errors.
As Ulrik Modigh stresses in his article: “Obtaining a clearer insight into which links in the value chain are absorbing the main resources and costs to produce the different product offerings is a categorical cost imperative that the industry simply cannot ignore in the present difficult circumstances.” With the right financial software solution in the form of a fully integrated and automated front-to-back solution installed for core operational processes, the required valuable data becomes more transparent, facilitating the task of clearly identifying and estimating the cost drivers across the entire value chain of the operational process.
Another important consideration is the upgrading frequency. In the article 'To SaaS or not to SaaS: the question of choosing Software as a Service to deliver cost efficiencies', SimCorp’s Klaus S. Arfelt makes a case for more frequent upgrading with the use of an on-demand software solution like SaaS. In his view: “The key value driver for SaaS is the fact that the service provider constantly updates the solution in order to accommodate changes in the business or technical environment. Traditional software providers deliver upgrades and leave it to the buyer to install and implement these on-premises. With SaaS, this becomes an out-of-the-box functionality, which reduces overhead and shortens time to market.”
Notwithstanding the risk issue associated with SaaS transferring operational risk from the investment manager to the service provider, adopting an on-demand solution like SaaS can also save money by saving time. For instance, managers are relieved of the need to allocate time to overseeing operational processes, and instead can focus on more important areas of the business such as customer relationship management, business analytics, and decision-making.
On the other hand, choosing in-house IT development may look tempting for some. But generally the cost of developing and maintaining systems consumes a large amount of time, attention and resources – not to mention the dependency on individual employees, all of whom have unique expertise, and which might be lost if they leave the company. The result in many cases is a patchwork of typically complex software, hardware and process environments that require cohorts of IT staff to operate.
STRATEGIC APPROACHES TO ADOPT
Having considered the key aspects of integration, automation and upgrading, three alternatives essentially emerge to choose from among the various strategic approaches investment management companies can adopt to control their cost of operations.
In the first instance, a company can rationalise its number of system and data components. However, while this allows an incremental approach to be taken in which efforts can be prioritised in the most important areas, it may take time to deliver significant improvements and incur high costs in the long term.
The second alternative is to replace the fragmented system and data components with a single, fully integrated platform. The upfront costs of this can appear daunting and it requires a big-bang approach, which can appear risky. However, it can prove more cost-effective over the lifetime of the platform and it can deliver significant improvements sooner.
The third strategic option is to increase the degree of outsourcing of the operating platform. Operating platforms can be entirely internal or outsourced to some extent. According to Peter Ellis, there are two approaches to an internal platform solution: 1) best of breed, which entails multiple systems and data management components; and 2) integrated, which is characterised by a single system and a unique database component.
BEST-OF-BREED SOLUTION AS ALTERNATIVE
The best-of-breed approach has proved very popular with investment management companies, mainly owing to the nature of the internal processing opportunities in this type of setup. A best-of-breed solution has typically been adopted by investment managers, who invest in different asset classes and who have to be able to process these different categories in fundamentally different ways.
Despite the solution’s popularity, going for a best-of-breed solution can pose challenges, such as increased staff training and support, complex interfaces with other systems, duplicate and error-prone manual data entry, and redundant data storage.
INTEGRATED SOLUTION AS ALTERNATIVE
On the other hand, choosing an integrated, automated and fully supported internal investment management system based on a single database can reduce the amount of costs and time spent on both integrating different areas and on upgrading, which is done on a frequent and guaranteed regular basis.
Achieving the benefits of an internal integrated approach does not mean that the investment management company needs to compromise, for example, on the coverage of asset classes, as described in a more detailed account by Edmond de Rothschild Asset Management’s Cédric Le Moan and Laurence Adam in the article 'Cost strategy in action: harvesting the benifits of an integrated financial software solution'.
OUTSOURCING THE OPERATIONS COMPONENT
As discussed earlier, the degree of outsourcing may vary among investment management companies. “The more that investment management companies use outsourcing services and system providers in their operating platforms, the more they are able to transfer some of the responsibility, and long-term costs, for ensuring that their platforms continue to support current market needs in a cohesive and consistent way,” explains Peter Ellis. The main benefits of this are: 1) service and system providers operate in a competing marketplace and so there is commercial pressure on them to maintain the cost-competitiveness of their offerings; and 2) they are able to spread the costs of achieving this across multiple clients.
The most common component of the operating platform to be outsourced is the operations component. This is because the business processes in operations are largely generic across different investment management companies. In other words, they are industry-standard rather than company- or client-specific. To this effect, service providers can execute higher volumes of processing, without operational errors, in a more cost-efficient way.
TOWARDS A SINGLE INTERNAL SYSTEM
When evaluating the attractions of outsourcing, the overall trends appearing in the investment management industry need to be taken into account. To manage growing operational complexity, yesterday’s operating dashboard is insufficient to support tomorrow’s business operations, as illustrated in more detail by TowerGroup’s Rodney Nelsestuen in the article 'Making the right strategic cost choices: sourcing, resourcing or outsourcing operations'. “With the addition of discrete cloud services under a hybrid model, companies will need an integrated view of many more components of their operations,” argues Rodney Nelsestuen.
As the public cloud becomes mainstream, in his opinion, the challenge of integrating all services will grow exponentially. Certainly, outsourcing providers will continue to offer large-block services for the foreseeable future. But as they begin to parse these larger services into smaller, on-demand cloud-based options, companies will find themselves connecting to more – not fewer – service providers.
The whole task of controlling operational costs becomes even more complex and arduous when companies have outsourced several functions, because not only are there multiple systems, but systems that the company does not own, and which are operated by a variety of providers under different approaches. This creates an opaque situation when what in fact the company needs is clarity in execution, operation and approach. Moreover, a single provider can offer essentially the same service in any of these functions and systems or in integrated combinations.
In a research study entitled ‘Business Trends: Buy-side Technology Investment Strategies’, published in October 2011 by consultancy company Ovum, one of the main findings indicated that investment management companies are beginning to move away from outsourcing and towards upgrading, improving, or changing their IT platform.
Increasing efficiency remains the primary driver behind IT strategy in 2011, although institutions have a greater focus on supporting revenue growth, with regulatory demands also cited as a stronger driver (see Figure 1).
The Ovum study also indicated that the increasing maturity of sourcing-led strategies, such as business process outsourcing (BPO), means that IT goals have shifted toward systems standardisation and simplification initiatives, although security remains the top primary goal.
Figure 1. Increasing efficiency remains the primary driver behind IT strategy in 2011. Source: Ovum. Study based on 67 interviews with investment managers and hedge funds. Regions: North America (34%), Europe (40%), and Asia-Pacific (26%).
KEY COMPONENTS IN SYSTEM STRUCTURE
A combination of adaptability, speed of execution, reliability and versatility comprise the key components in a software system’s structure to best assist the company in its cost of operations. It has to be adaptable in the sense that as a company organisation changes, client demands change or regulatory requirements change, the structure’s modularity makes it possible to plug new functional products into the already implemented solution. In other words, a company can purchase and implement the functionality it needs as dictated by changing operating conditions.
CLEAR VALUE PROPOSITIONS TO CONTROL COST
To thrive in today’s harsher business climate, investment management companies must be able to derive greater value from existing and future-planned investments, while continuously improving their quality of service. “In creating a permanently low-cost, efficient and scalable operating model, organisations should remember that cost is not simply a by-product of doing business, but a vital weapon for competitive advantage,” observes management consultancy Ernst & Young in its report ‘From cost reduction to cost optimisation’.
“When a company develops a deep understanding of how its different customers and customer segments perceive value in what the company offers, and then uses that insight to variablise its cost structure so costs can remain in synch with revenue and value, it is better positioned to grow profitably in what is likely to remain a volatile economy for some time to come,” notes Accenture in its report.
The importance of convincing clients that operational cost control – and the investment management software system supporting it – lies close to the heart of an investment manager’s strategy, is surely more crucial today than before the financial turmoil set in. This dimension of investment management lies at the core of any credible and durable strategy in this industry, and one that will translate into an equally convincing growth profile for the company that chooses to go down this road.
Winning the race to the finishing line will be those investment management companies that have stolen a march on their competitors and already embarked on a course of action to promote cost-effectiveness with the careful and calculated choice and implementation of a single, agile and fully supported internal investment management system, bolstered by the secure alignment of the system with business and IT strategies over a longer horizon.
Michael Metcalfe is Co-Editor of the Journal of Applied IT and Investment Management. A financial journalist by profession, he has worked for such publications as The Economist, Financial Times and International Herald Tribune. Based in Germany, he also worked in the Luxembourg financial sector for 10 years, including tenures with Nordea Investment Funds S.A. and Lombard International Assurance S.A.
