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| Oct 6, 2008 | Global sourcing by fund managers - the road ahead and how to manage it | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Martyn Cuff Head of Operations Allianz Global Investors Europe | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
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Martyn Cuff is Head of Operations for Allianz Global Investors Europe. The Operations team covers Mutual Funds, Segregated Accounts and Fund Registration and is based in a number of key European locations. Martyn has 21 years experience within the investment management industry. During this time he has operated within both the front and back office at private client and institutional fund managers. Prior to joining AGI Europe, he was a founding partner at a boutique investment consulting company, CSTIM, and before that he worked at Ernst & Young. His early career was spent at Barclays. Martyn is an active member of the European Fund Industry, contribution to various forums and publications. ABSTRACT From where fund management companies obtain their operational support has become a more complex question over the past twenty years. To a large extent this is simply a reflection of developments seen in the broader business world in terms of changes to business models and the need for operating models to keep in step. Allied to this is the greater range of sourcing options now open to companies, largely on the back of the technology revolution. It is clear that further change lies ahead with business models becoming ever more specialised and collaborative. Coping with these developments puts a lot of pressure upon fund managers to ‘glue’ together these more fragmented operational elements to achieve control, efficiency, risk management and output yet maintaining sufficient flexibility to adapt an ever increasing pace of business and consumer change. Not all operational departments are equipped with the sufficient competencies and processes to undertake proper supply chain management and thus get the most out of these new sourcing options. This article firstly looks at the broader sourcing environment and then considers what fund managers need to have in place to cope with the business and operating changes that are taking place. Keywords: fund management, operating models, collaborative, supply chain management, sourcing options. INTRODUCTION Companies are made up of individual functions that must not only be successful in their own right but also work in an aligned fashion or ‘glued’ together to deliver on the corporate objectives. This kind of total system thinking, or to use the more formal description of supply chain management, is key to achieving world class operations. The problem is that this thinking is not always valued within fund management companies particularly where outsourcing has taken place. Instead, fund managers have been known to point their finger at that their outsource partners where results are not as desired. Whilst there is undoubted evidence that the service provider community need to improve the quality of their services, fund managers also need to look at themselves to see whether they are taking the lead to put in place the right mindset and tools that promotes the appropriate environment. Over the last twenty five years there have been a range of approaches adopted to answer the question of ‘How best to arrange our sourcing’ within fund managers. In the 1980s, the sourcing question was not top of the agenda, since the majority of fund management companies did most things themselves. Even where it was considered, thought did not stretch much further than outsourcing of custody. Since that time, there has been an exponential increase in the rate of sourcing consideration. In the early days in fact it was not ‘sourcing’, the description was simply ‘build, buy or outsource’. Nowadays the in-vogue terminology is ‘sourcing’ i.e. ‘what is your global sourcing approach?’ Figure 1 represents in simple terms how this trend is accelerating.
The asset management industry is at the leading edge in some subjects such as allocation of capital to maximise return, however it is not always first to test out new ways of running its own businesses for maximum efficiency. Therefore it is worth looking at the wider business environment to identify any indication about the future development of sourcing - Dell1 and Vodafone2 are useful examples. Like most computer manufacturers, Dell is more of an assembler and marketer than a producer. In response to customer demand, they create personalised computers, based upon a standard set of components. These items, such as the central processor, screen, graphics card, hard drive, battery etc, are produced by a range of suppliers, typically at least fifteen, and sometimes over thirty, dispersed geographically around the world. These are then assembled, quality controlled, packed and shipped. Usually the shipping is itself outsourced. Therefore, this is a multi-linked supply chain, as shown in Figure 2.  Such a supply chain has been twenty years in development and is still evolving. For example, it is worth noting that in response to customer demand, Dell has now turned its attention to its sales chain through the introduction of sales through retailers, something which of course would have been unthinkable over twenty years ago when the company was founded on the direct sale approach. This shows that world class companies are willing to cull ‘sacred cows', if necessary. Secondly, Vodafone, the world's leading mobile telecommunications company with a significant presence in Europe, the Middle East, Africa, Asia Pacific and the US through subsidiaries, joint ventures, associated undertakings and investments. Vodafone does not really manufacture anything itself. In 2006/7 they spent more than £20bn on purchasing products and services. They source equipment for their networks and the handsets they sell from third party manufacturers who themselves source components and assemble products from their suppliers. This is a huge procurement process the success of which, in terms of cost, quality and timeliness, can have a significant impact upon the overall corporate results. One way they handle this is to only have a direct relationship with their prime suppliers and in turn they expect their prime suppliers to manage the downstream chain. Comparing the above examples to the early days of modern business such as Ford Motor Company or GE, where most, if not all, of the supply chain was fully in-house, it is clear that in the space of a single lifetime, business has come a long way to the point that supply chains are global and consist of multiple actors. On the one hand this brings the benefit of specialisation and scale, as predicted by Adam Smith, the Scottish eighteenth century economist. His theory3, ground breaking at the time, was that division of labour (and hence specialisation) would bring significant increases in production and of course, this theory has been since well proven. On the other hand, as the supply chain is broken down into smaller and smaller pieces how is it possible to manage the resulting chain in an effective and efficient manner? Further evidence has recently emerged that there will be an increased focus upon a networked and interconnected environment in the business world of the future. This is in the form of collaborative working, which has been termed ‘Wikinomics' by Tapscott and Williams in their book of the same name4. This is exemplified by the likes of MySpace, YouTube, Linux and Wikipedia and shows the power of millions of people from around the world working together. It is not clear where this will lead, but one thing is for sure, modern leaders and managers will require the key business skill of managing interconnectedness. Therefore the evidence is clear fund managers will be operating within an ever increasingly complex and multi-sourced world. To borrow a term from the internet revolution, it could even be called Sourcing 2.0. Operational specialists must be very comfortable with managing such an environment. SOURCING WITHIN THE INVESTMENT MANAGEMENT INDUSTRY The level of disaggregation of the investment management supply chain partly depends upon the region of the world that we consider. In general, it is accepted that the US is most advanced in the use of outsourcing, followed by both Europe and the Middle East with Asia the least developed. Therefore it is not easy to give a one model fits all. However, Figure 3 shows how the functions of a new investment management company could be practically sourced today. The definition of sourced used for Figure 3 is that the fund manager can ask a separate company, not linked to the fund manager to actually undertake the activity (rather than just provide the technology platform).  The first point to note from Figure 3 is that even at this simplified depiction, there are a number of functional steps that need to be conducted. This already requires a level of competence to glue all this together, even if there were to be no more progress of extending the supply chain. Secondly, it is probably not surprising to see that so far there has been greater penetration into the back office for the use of outsourcing. There has been demand and supply at work here. The often quoted leading demand arguments5 are that from the perspective of the fund managers they are likely to:
These third party securities processing companies are themselves considering what is core to their business and what in turn they should outsource. They are increasingly recognising that pure processing is not the only future battle ground and that to a certain extent they are ‘information brokers'. This is analogous to the Dell and Vodafone examples mentioned earlier where Dell and Vodafone only deal with their prime suppliers. The fund manager outsources activities to their prime suppliers e.g. global custodians. In turn, they then expect these prime suppliers to work out how best to deliver. Either the prime suppliers produce the goods themselves or they look to others eg they outsource, offshore. Within the fund industry this environment is less developed than the likes of computer and telecoms business. However, there is no obvious reason to suggest why the fund industry will not develop in a similar fashion. If this does happen, then this will result in an even further extended supply chain for fund managers to consider. MANAGING THE SUPPLY CHAIN However the sourcing picture looks in the future, it is uncontroversial to say anything other than it will look different to the past. As such, the importance of managing the supply chain (or providing the ‘glue') is both clear to see and becoming an increasingly important competence in running a modern fund management company. The military have always known the importance of supply chain management. In any form of advance, lasting success can often come down to how well the supply chain has been set up to support the forward parties. A poor design or execution and the front line can quickly find themselves in difficulty. Business has adopted this mindset and it becomes a source of competitive differentiation. Before looking at the tools that can help manage the supply chain, it is important to first deal with the fundamental subject of Mindset. Figure 4 shows three example mindsets.  There is no simple answer as to which mindset to adopt, it is situational. However, the thought process should always consider all three. Too often, Mindset 1 is adopted, even though we know that Regulators do their best to encourage at least Mindset 2, through their often quote maxim of ‘You can outsource the activity but not the responsibility'. Furthermore there are pressures from other directions that encourage a move towards Mindset 3. For example, the need to demonstrate Corporate and Social Responsibility has seen significant focus over the past five years. Therefore can a fund manager that outsources some of its activities really afford to close its mind to the full supply chain that sits behind the scenes? In today's world, the answer is simple – No. Therefore as fund managers slowly outsource more and more activities, hollowing themselves out as described by Ridderstrale and Nordstrom6, it is almost inevitable that Mindset 3 will become the predominant choice. This will demand change and hard work from fund managers and of equal importance, a willingness from service providers to be more open than they have been in the past. TOOLS Over the past several decades a whole industry and associated tools have grown up around the supply chain industry. Some companies, such as Coca Cola, even have functions called Supply Chain Operations. Business experience is growing but it is not clear that this practical experience is permeating (through the movement of ideas and/or employees) into the investment management industry at any real speed. For example, The Supply Chain Management Institute7 recommends a process that consists of eight elements:
To borrow a theme from Maslow8, there is a hierarchy of tools that can be used by fund managers to cope with this hollowed out operating model. These are shown in Figure 5.  When a fund manager undertakes an activity itself in one place, it can be said, or believed, it is has full control. When the same fund manager starts to source activities from third parties or geographically dispersed locations then the nature of control over the activity changes. This results in reduction and addition, meaning:
The tools described in Figure 5, are described in greater detail starting from the bottom and working upwards:
Stage: Legal contract between fund manager and supplier
Stage: Service level agreement and operating memorandum between fund manager and supplier
Stage: Performance Indicators (PIs) and Key Performance Indicators (KPIs)
Stage: Key Risk Indicators (KRIs)
Stage: Regular governance and oversight
Stage: Benchmarking
Stage: Extend influence beyond prime tier suppliers through to sub-tier suppliers
Stage: Partnership culture
VENDOR MANAGEMENT UNIT (VMU) It is worth saying a little more about the VMU. Experience of outsource deals over the past ten years shows that typically the importance of the VMU is undervalued at the start of an outsource relationship. With the passing of time, the fund manager and the service provider both recognise the VMU's importance. This is the unit that is part of the fund manager and functions between the fund manager and the service provider, see Figure 6.  Its focus is to be the champion of the supply chain process and will have prime responsibility for utilising the tools described in Figure 4 with the ultimate objective of ensuring that the quality of output from the downstream supply chain meets expectations. . An analogy for the VMU is the tow bar between a car and a caravan. It is part of the car, and though small in size it fulfils a vital role to keep the caravan linked to the car and both going in the same direction. It offers flexibility and firmness combined. Typically, the size of the VMU is around 5% - 10% of the business that the VMU is monitoring. One of its key focuses is data, both transactional data since this is what typically flows between the fund manager and the service provider plus management information. At the heart of a professionally run supply chain, measurement is key in maintaining the degree of control that a fund manager should or wants to have. This theme runs throughout Figure 4 and is all about gaining transparency. The old maxim of ‘what gets measured gets done' is as relevant today as ever before. As such, the VMU is ideally placed execute this measurement and to contribute to ensuring the full Control Environment is functioning properly. Staffing the VMU is a challenge since it is necessary to have people who understand the full supply chain even though they are not undertaking all of the activities. Also, since the VMU is typically small in size it does not give much opportunity for the direct management of staff. Instead there is a greater need to be able to utilise more sophisticated forms of influencing people, i.e. through the use of a high EQ – emotional intelligence. Therefore finding staff who have the combination of technical knowledge and emotional competence is not easy to come by and need to be rewarded accordingly. Having explained the role of the VMU, it is important to recognise however that other key functions of the fund manager must have healthy relationships with their opposite numbers at the service provider. Example functions are Compliance and Risk Management. This will help to ensure that the broader Control Environment, as shown in Figure 6 is achieved. This would be complementary to the daily operational control and communication undertaken by the VMU. OFFSHORING Offshoring is a phenomenon that has grown in significance over the past ten years. The fund management industry has not been immune to this development. For example, India and Poland are just two countries that have benefited from the move of some functions from countries such as Ireland, Luxembourg, the US and the UK. However in general terms, the approach to managing an offshoring should be largely the same as that for an outsource. Looking at Figure 4 it can be argued that it in such a situation it is even more important to adopt Mindset 3, i.e. to look through the complete supply chain. This is especially so given the relatively early stages of offshoring within the investment management industry. Maybe in twenty years time greater experience and comfort will have been gained with the concept of offshoring, but for now it is probably appropriate to take a prudent and measured approach. OUTSOURCING WITHIN THE SAME COMPANY Often outsourcing within the same company is viewed differently from appointing an external firm. This should not be the case. In can be tempting to say that because the activity is undertaken within the same group then for some reason it is acceptable to take a more relaxed approach to getting the most out of the relationship. However, that mindset does not follow the maxim of ‘survival of the fittest' since it potentially allows lower standards to become the norm which ultimately does not lead to world class service to end clients. Since this deterioration can sometimes take a while to show up, it is quite possible to experience push back when attempting to install a regime equivalent to that for an external outsource. CONCLUSION Business, in general, has come a long way in the last one hundred years from a model where everything was produced and manufactured within single companies to a distributed sourcing model that stretches the globe. During the seventeenth and eighteenth centuries, production was very fragmented and there were few entities where a product was completely produced within one organisation. To a certain extent the Industrial Revolution can be thanked for leading to the amalgamation of activities within single companies, and this of course continued with significant growth in the early twentieth century. Therefore outsourcing is simply taking us full circle to a situation where supply chains are once again made up of a number of different parties. Today, as Peter Drucker says, ‘In this emerging competitive environment, the ultimate success of the business will depend upon management's ability to integrate the company's intricate network of business relationships'9 There is a whole range of sourcing strategies spread across the globe. Barriers to global sourcing have indeed significantly reduced, as described by Thomas Friedman in his book ‘The World is Flat'10. There would seem to be further scope to dis-aggregate the current business of fund managers, even for those most adventurous ones who are way ahead of others. There is little evidence to suggest that as an industry the point where dis-economies are encountered has been reached. As such, the message must be that there is further yet to run on achieving the optimal global sourcing strategy. Irrespective of whether these sourcing trends are viewed as threats or opportunities, fund managers must embrace them in one way or another. What evidence that does exist suggests that there is some distance yet to travel before fully professional supply chain management is being practised through the fund management community. There are a range of tools available and fund managers must increasingly recognise that one of their core competencies should be the ability to manage a fragmented network of service providers. However, this is not a case of painting by numbers. Their needs to be a fundamental mindset appreciation of supply chain management. Only then will the tools be most effective. REFERENCES 1. Information gathered from publicly available information including www.dell.com 2. Information gathered from publicly available information including www.vodafone.com 3. Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, 1776 4. Wikinomics by Don Tapscott and Anthony D Williams, 2007 5. Global Investor Operational Outsourcing Survey 2005 6. Jonas Ridderstrale and Kjell Norstrom, Funky Business Forever 2008 7. www.scm-institute.org 8. Abraham Maslow, A Theory of Human Motivation, 1943 9. Peter F Drucker, Management’s New Paradigm, Forbes Magazine, 1995 10. Thomas Friedman, A Brief History of the Globalised World in the 21st Century, 2006 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
© 2008 Henry Stewart Publications LLP No reproduction without consent |
