Offshoring functions save companies millions of dollars a year, and as the practice matures, financial institutions are moving to the next stage of optimizing their offshoring operations, according to Deloitte & Touche's fourth "Global Financial Services Offshoring" report, based on interviews with 36 financial institutions in eight countries.

"Offshoring is maturing at a rapid pace, but in the future, the best offshoring strategies will not and can not, be based on labor arbitrage alone," said Chris Gentle, associate partner and author of the study.

In 2001, less than 10% of major financial institutions moved processes offshore, compared to 75% in 2006, Deloitte noted. Offshoring offers a tremendous amount of saving opportunities. The financial industry will save $9 billion this year, up from $5 billion a year ago, Deloitte found.

Ashish Mittal, president of New York research firm 3iAnalaysis, said he is seeing a trend of mid-tier and smaller financial institutions seeking to offshore operations.

Specifically, more fund companies are becoming interested in offshoring options, especially as they move into more exotic instruments and are squeezed on research options, Mittal said.

Functions such as back-office operations have traditionally ruled the offshoring world. Now more business process outsourcing (BPO) and knowledge process outsourcing (KPO) functions, as well as human resources tasks, are starting to be offshored, said Marc Mancher, a senior manager within Deloitte's outsourcing and offshoring advisory practice.

KPO involves functions that require advanced information, such as analytical, interpretation and technical skills, as well as judgment making.

Last year, over 80% of offshore activity involved a full range of business processes, Deloitte states. The average number of staff each financial institution has employed over the last four years has gone from 250 employees in 2003 to 2,700 in 2006.

Mancher, who helps clients decide whether they should offshore or not, said that while offshoring will continue, firms need to establish criteria to ensure their offshoring business is effective.

When a company first decides to offshore tasks, it is usually due to economic arbitrage, Mancher said. In this stage, companies make decisions such as to build or outsource operations to a third-party vendor and weigh their appetite for risk.

Now, financial institutions are moving into phase two of offshoring operations. In this phase, the first objective is to increase absolute returns by expanding the scope and scale of the operations. The second is to re-engineer the relocated business and maximize savings, Mancher said.

Companies that have made offshoring a part of their long-term strategy from the beginning are typically successful, Mancher said. They are now moving to the next phase where they can save money and make traction with the business, he said.

Companies that have five processes or more offshored see cost savings of 55%, while companies with only three processes offshored save 32%, according to the report. More than half of firms surveyed are saving 40% for each business process offshored, according to Deloitte.

Close attention has to be paid to the transaction process and functions maintained. Companies that are not committed to the space, have not had the most success with offshoring, Mancher noted. In fact, some institutions that have failed to apply the best practices have experienced a decline in their operational performance, the report noted.

The third phase of offshoring involves releasing the maximum value of the operations. "Typically, institutions spend an initial couple of years on a learning curve, aiming to build scale and capture efficiency gains," the report noted.

India remains the largest location to offshore processes, however, other areas are gaining in popularity. China is becoming more popular, and this is likely to continue, especially as more of the nation's population learns English, Mancher said. Almost 200 million Chinese people are learning English.

Increasingly, companies are looking to China, especially for technology operations, Mittal agreed. Latin America is an up-and-coming potential alternate, as well, he said.

As China competes with India for market share, it may dampen salary inflation among Indian offshoring industry workers. Also, there are growing concerns over supply in India, as only 10% to 15% of Indian college graduates are considered suitable for direct employment in the offshoring industry, the report said.

The U.K. and the U.S. have led the way in employing offshoring functions, but there is growing interest among companies in Eastern Europe, Mancher noted.

The biggest challenge with offshoring is having a vision and effective strategy and then executing the whole function, Mancher said. "All three need to be aligned." The company needs a global vision, the strategy needs to be long-term and someone needs to execute and bring the offshoring capabilities to life, he said.

"It is not that much different then a merger of two companies. You need governance, capital and have to pay attention to all details," he said.

(c) 2007 Money Management Executive and SourceMedia, Inc. All Rights Reserved.

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