NEEDHAM, Mass. -Vendor consolidation and a shrinking client base has resulted in a handful of nationwide operators now controlling most of the processing technology market for this sector of the financial services industry in the United States. Are we talking about credit unions? No, it's the core outsourcing market for community banks and thrifts, and the major players include some familiar names. According to a new TowerGroup report, about 40% of the nation's community banks and thrifts choose to outsource their core processing rather than license an in-house solution. Of that market, Fiserv has a 34% share, while Fidelity Information Systems (through its Aurum Technology and ALLTEL acquisitions) has 17%, Metavante (through its Kirchman Bankway acquisition) has 14% and Jack Henry has 10%. And as in the credit union space, those four firms, along with BISYS (6% market share) and a group of mostly smaller, regional competitors are competing for the affections of fewer clients than in years past. There now are less than 9,000 community banks and thrifts, compared with more than 18,000 in 1984, notes the report from the Massachusetts-based research and advisory firm. Only about 5% of those institutions change core vendors each year, a number similar to what analysts says happens among credit unions, but there are about 150 new banks and thrifts created each year, and about half of them will choose to outsource their core processing operations over licensing an in-house solution, the report says. Still, the going is tough for those in charge of winning new clients. "Although de novo banks and thrifts present new opportunities for outsourcers each year, it is difficult for vendors to gain significant market share through sales efforts alone," says the TowerGroup report's author, analyst Robert Hunt. "Outsourcing contracts typically cover a five-year period and industry renewal rates exceed 95%," Hunt says. "Consequently, core systems outsourcing market share is generally gained through acquisition of other outsourcers." No one has done more of that than Fiserv, which Hunt calls the "New York Yankees of outsourcing." "The firm continues to build its dominant market share through acquisition, following up with the cross-selling of other Fiserv services to realize the full benefit of the acquired customer base," Hunt says. "Perhaps more important, by its strategy of retaining the acquired vendors' key management and continuing to support the systems, Fiserv minimizes client loss following acquisitions," the TowerGroup analyst says, noting that Fiserv recently added to its service bureau core product offerings by picking up Precision Computer Systems and adding the PCS Vision platform to Fiserv unit ITI's offerings. Interestingly, TowerGroup doesn't expect consolidation to lead to a reduced number of core products. Price and logistics, plus the high satisfaction rate with existing systems, are powerful barriers to competitors seeking to convince a bank or thrift to change platforms, regardless of its corporate owner. In fact, while the number of vendors has decreased, the number of core systems has increased. Hunt says that's because outsourcing options through service bureaus have been added to the lineup to accompany systems that had been available only as in-house solutions. And while retiring existing platforms, or sunsetting, does occur occasionally, it can open the door for competitors, and vendors who do retire a platform tend to offer incentives to banks and thrifts to switch to another platform the vendor is continuing to offer and support, the analyst says. "Outsourcing vendors have learned the potential impact of declaring their core systems obsolete and will raise the barriers for sunsetting announcements," Hunt says. Also adding to the number of solutions required to serve the market is the fact that "thrifts prefer real-time posting of dollar transactions while community banks prefer to memo-post cash-out transactions in real time while performing account balance updates in a batch process," Hunt says, so different core processing solutions are required to serve those disparate needs. Therefore, "although TowerGroup projects a continuing consolidation among vendors, we reject the conjecture that vendors will consolidate the number of core products offered to their clients," the analyst says. And despite the competition and the dominance of the largest players, others are joining the fray. "Two more vendors, John Harland and Fair Isaac Corporation, have recently entered the core systems outsourcing market through acquisition," Hunt says. "These well-established banking technology vendors will, logically, seek to grow their core outsourcing business market through further acquisitions." Harland bought community bank processing specialize SPARAK Financial Systems in 2002 and Fair Isaac recently acquired London Bridge plc. Newcomers aside, Hunt expects the playing field to continue to shrink. "The core systems outsourcing market will continue to consolidate as new business opportunity diminishes and the economies of scale increase as new banking products are introduced," he says. "We expect several of the regional providers and one or two of the smaller national outsourcers to sell their business over the next two to three years." -

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