Analysis of back‐office outsourcing contracts for financial services operations

Managing back‐office operations for financial services is a challenging task because of highly volatile and dynamic demand requirements. Lack of service inventories, the inability to backlog demand and significant shortage and overage costs complicate the problem. In such situations, outsourcing all or part of the demand to third‐party vendors provides a viable and cost effective option for the firm. Motivated by the remittance processing operations of a Fortune 100 company we examine the usefulness of complementing in‐house staffing with different outsourcing arrangements. We study capacity‐based and volume‐based contracts between a financial services firm and an outsourcing vendor. We examine the impact of demand characteristics on the parameters of contract choice. Through extensive numerical analysis, we ascertain that neither contract is universally preferred, but cost and revenue structures along with demand characteristics determine contract choice.