Bernard Madoff’s last minute honesty will not be the last disclosure to be prompted by the harsh realities of the current financial climate. Clients need reassuring and that means providing greater transparency so that they know bad news is flowing with the good. Madoff’s funds were being executed and cleared by his own business so there was no independent custodial or prime broker reporting of the value of the funds. Regulators and the market will put pressure on this kind of arrangement but funds providing their own execution and clearing or with multiple brokers are left with a lot of integration work which it is difficult for them to manage internally and they are often reluctant to resort to hearsay reporting of positions to a prime broker.

Leveraged funds will to some extent be driven to disclose fuller details to their lending brokers because without a true prime broker arrangement there is not visibility of the full fund and trust is no longer sufficient to allow lending to the level of leverage that the funds had enjoyed. A lesson that was taught by the Long Term Capital experience where multiple lenders were unaware of the extend of borrowing and exposure from other brokers.

The greater significance of transparency gives added leverage to Prime Brokers and Custodians to offer reporting services and increase the premiums people are willing to pay for more regular or better integrated reporting. The challenges of integrating derivative workflows in order to provide greater confidence in the valuation and reporting process will also continue to be differentiators.

Doing something well or everything well enough?

At the moment the majority of smaller outsourcing businesses have very unfocussed marketing strategies conveying expertise in a wide range of technologies, Typically .NET, Java and C++ and a wide range of business functions (Verticals). This offers little focus for the sales staff who must inevitably decide to focus on a particular industry sector. For some this is a strategy of opportunism which has some survival benefits. When there is growth in a particular industry it becomes a focus and when there is a contraction it is deprioritized. The opportunism element really plays out in working with networks of contacts as almost anything is able to look like a lead where as a better defined target customer requires a structured search.

When it comes to trying to sell higher valued work or demonstrating experience the pitch is undermined by the broad positioning of the brand. Several outsource businesses begin the sales process with cold calling which does require a selection of prospects but even for companies of very modest size the range of businesses and skills being pitched is extremely broad and fluctuates from quarter to quarter. The focus initially should be on growing within existing clients through consultative selling or selecting similar or adjacent businesses. Beyond existing customers a decision needs to be made to place the focus on a particular industry or specialized skill. The advantage of selecting particular industries is that it assists with managing the cost of the sales process. You know which industry to build a network within and your case studies will support the pitch. These prospect selection decisions can not be made on a case by case basis as the resulting brownian motion will not form something which can be defined as a coherent brand positioning. With a specialization on a technical skill rather than a vertical the focus needs to be on demonstrating leadership and assisting new clients in finding you.

It is possible that a generalized outsourcing business could thrive by continuing its ‘jack of all trades’ positioning by having a deep sales network in a geographic market. This would be by having established competence by reputation locally and therefore not being judged so closely on its applicable experience. This appears to be the accidental strategy of many but there is a lot of evidence from the number of small outsource businesses with little organic growth, that this results in clinging like a limpet to one or two clients and a failure to cost effectively grow the client base.

The answer is to develop a market positioning before a diverse inexplicable range of clients emerges and all but takes control out of one’s hands. Once in that position one needs to forma strategy and stick with it going forward. Focus marketing and sales effort long term potentially by selling off or exchanging some clients who are no longer core.

Despite articles to the contrary IT outsourcing  is not disappearing. There is some apprehension regarding regulatory winds causing a different view on tax or immigration and putting outsource relationships under uncontrollable change but that will settle down within the first couple of months of the year. The economic drivers for outsourcing still exist and they often drive policy in practice and are likely to continue to do so. The cost savings from outsourcing of simple business processes or calling centers are overwhelming because the activity can occur almost completely offshore.

The cost saving when outsourcing more expensive tasks such as software development to India or China are only 15 to 20% due to the larger onsite and integration management component. A saving of 15 to 20% is considerable for a major IT department and this lower percentage doesn’t mean that the savings are wiped out by potential currency or cost swings in India or China. The offshore proportion of overall development outsourcing cost is relatively small. The onsite teams and employee relationship management and interaction are all onsite costs in the buyer’s own currency. The offshore component of the cost has overwhelming economic advantages far in excess of the 15 to 20% of the overall cost of the operation. If offshore costs rise by even 20% then the overall benefit of offshoring only diminishes by a couple of percent. Significant to the vendor’s margins but not to the overall rational for the process.

The other advantages of the scale of the skilled staff pools offshore and ability to ramp up and down team sizes in a very dynamic market remain completely in favor of outsourcing. As a result most large corporations are likely to want to continue to want to have the majority of their IT development staff in outsource arrangements. The BPO and KPO areas are going to account for higher growth rates and will also result over time in the complete outsourcing of the related IT support.

The significant barriers remain political but politics inevitably eventually follow the economic drivers. We will just need to see if there will be any barriers put in place.

By presence we mean knowing that somebody is available is if they were present. Colleagues in the office seem more engageable because we can see their availability, or the lack of it, and determine how interruptible they are. For those away from the office either on travel, in the field, or in a home office a common complaint is that people don’t contact them. Around a building when people are away from their desks we could contact people with a mobile phone but don’t because we don’t know if they are in a meeting. We could use corporate instant message tools if they are at a desk or SMS as a slightly more polite form of interruption, and the under 30s often do, but for good reasons, many don’t use SMS or mobile phones in general because the recipient may be in a meeting.

To some extent people can be encouraged to use SMS more often but there is still a strong need for presence to indicate if people are available. We can have people’s calendars but that misses the point. It is their availability that presence information tells us. The setting and delivery of the information preferably should be a mobile device.

In a corporate environment we don’t want to be mixing with many of the existing social networks and firewalls prevent use of commonly available tools so until more professional tools, possibly LinkedIn or Skype are offering the kind of presence / status information that face book provides we need to encourage the use of SMS without presence information and look out for tools like Skype and LinkedIn or others providing it on portable devices. Some major corporations are using internal messaging applications but a are generally lacking mobile integration due to cost. The business need is strong and the functionality will break out from the current implementations on mobile phones of Facebook integration or the Microsoft Live tools currently in the consumer market out into tools more acceptable in the corporate market.

What tools are you seeing people using in an office environment?

There has been much discussion of U.S. competitiveness lately. Michael Porter of Harvard has had the front cover of BusinessWeek and the New York technical community is a buzz with how it needs to save the economy. This comes after the demotion of media, advertising and financial services which are all undergoing structural change that has shaken their institutions and hasn’t stopped shaking them. The Hi-Tech industry in New York is smaller than that of Boston and has had difficulty achieving economic scale, particularly when it is compared with California, Tokyo, Taiwan, Israel, Bangalore or the UK. The strongest remaining business in New York is Health Care and that is not something on which the economy can be based. The surrounding area does have significant Pharma businesses and it is noticeable how many service businesses are trying to re-orientate themselves to serve the Government and Pharma businesses. You just can’t export the Health Care services and to the extent that you can their price would not be competitive.

The call for government strategy is partly in denial of the fact that the economy makes more decisions than politicians do, but there are things over which politicians do have influence. For example there is a need to better understand the impact of the split between federal and state government. The federal and state split in the US starves the funding of education and social services, as compared to defense, due purely to which side of the government tax structure they fall under. We have competition between states which drives down our education and social programs to the extent that many children have so many issues in their homes that they can not focus in the classes that are available to them. The problem is further exacerbated by the provision of so much educational funding at the township level so that wealthier towns pay only for the education of their children and not those of the adjacent poorer town.

The strategy of a strong military to control the resources that we need, rather than a skilled workforce to provide economic strength, is a strategic decision which we would do well to re-examine. Imperialism is part of our past, as with many countries, but it isn’t acceptable as part of a modern, communicating, flat Earth.

America has enormous strengths due to scale and having the world’s reserve currency. Both of these advantages, for our industry and our government, put the US economy head and shoulders above any other. Our companies can be more specialized and more efficient in their chosen market purely due to the scale of our economy and this higher level of specialized experience puts them at a huge advantage to competitors in smaller economies. Europe, as the closest competitor in scale, is in reality a series of markets fragmented by language, media, culture and law. Europe and China are however becoming better integrated and catching up.

The use of the USD as the global reserve currency allows the US government to borrow in its own currency without devaluing it. Other countries have a limited ability to borrow without weakening their currency and having resulting difficulty in repaying loans in foreign currency. This single factor will allow America to spend its way out of a recession more cheaply and to a greater extent than any other Country can safely achieve. One strategy that US governments have consistently followed is to maintain the U.S. Dollar as the global reserve currency. It has driven policy over many spheres, from the creation of the IMF, to the support of oil rich governments. While the vast majority of global trade is valued in U.S. dollars less than 18% of it is with the U.S. itself. The largest single chunk of that global trade is due to the pricing of oil in US dollars. Much world trade is also in oil derived materials, energy and transportation which inevitably track the price of oil.

Michael Porter’s article over plays the strength of the US economy having been based on our brilliance in technology, finance and the brilliance of our institutions while it ignores the advantages of sheer scale. Even issues such as U.S. companies being able to sell almost all of their product in their own currency and not having to cope with foreign exchange risks to the same extent that other nations’ businesses do, have a significant benefit across economic cycles.

The claim that America lags so heavily in access to University education is dubious. When we compare university education in different countries and across different decades we are not comparing apples with apples. America has very broad access to university education with much better access to funding than in any other region of the world. One has to note that Michael Porter is a Harvard academic.  I would suggest that U.S. university education is probably more constrained by the educational standards of those entering university than by financial constraints. Michael Porter appears to agree with this assessment of public education. The problem with this and social investment by governments, as a strategy, is that it takes fifteen years for us to start receiving the benefits and we have been soft peddling for far too long.

After any serious hurt there is a call for immediate action in the political sphere. People look to politicians to protect them, and politicians are happy to encourage the notion. This rush to action overlooks the fact that even the management of the investment banks hadn’t understood the situation in time to avert their own losses. They are all very capable, highly functioning individuals but were unable to play out the head game of managing the risks effectively. There is little reason to think that regulators are better able to understand the issues and we have seen that the regulators both in the US at the SEC and in the UK with Northern Rock have failed to understand the pending emergency or to act. This does not prove incompetence but primarily points to the misplaced expectation that they would be able to.

There are more modest and specific areas which can be codified such restricting the scale of bond insurance / credit default swaps (CDS) for a given level of reserve. This would in reality restrict this market to a fraction of its prior scale but would make bond insurance a realistic private business. CDS contracts are not independent events and market slumps inevitably result in failures of those over selling insurance via CDS contracts. The staggering number and value of these contracts, given the level of reserves of the companies writing them, mean they are not enforceable as written and do not really have the value described without recourse to government bail outs.

The scapegoat of short trading is a cosmetic political issue similar to restricting profit taking on building supplies during a Florida storm. Its main purpose is to avoid news stories and resentment and its main effect is to reduce the motivation to assist in running an effectively priced market. People don’t like to hear that anybody has profited from a downturn but this can’t be confused with addressing the causes of the bad news.

With Lehman and Merrill Lynch joining Bear as past proud names of Wall Street, and contracting their businesses, it is apparent that there is a significant contracting of US institutional finance. The government financed support of Fannie Mae and Freddie Mac resulted in the government financing of over half of the US mortgage business. The next two largest players in the mortgage market were Lehman and Merrill Lynch. For scale it is worth noting that the amount of debt held by just Fannie Mae and Freddie Mac was greater than the total value of the UK economy.

There are now only two remaining independent US investment banks. Goldman Sachs and Morgan Stanley. This will hurt the US economy significantly because when investment banking services operate within a retail banking group they are subject to severely constrained risk limitations.

The remaining global investment banking players are: Goldman Sachs, Morgan Stanley, Citibank, Deutsche Bank, UBS, Bank of America (With Merrill), Credit Suisse and Nomura.

Unfortunately there will inevitably be a contraction for those who provide services to Merrill Lynch,  Lehman and Bear Stearns as the consolidation of everything from custodial services to data contracts will result in greater bulk pricing and fewer relationships. This is likely to further effect the custodian banks though with less dramatic exposures as it is a pure service model and not an investment exposure.

There will also inevitably be a knock on effect to portfolios as there has now been a significant loss of market value for the US financial sector.