In today’s marketplace, technology develops at lightning speed, and the payments technology market is evolving especially fast. Financial institutions’ payment solutions need to keep up with this pace, yet many FIs cannot move nimbly to new capabilities because they are locked in with vendors through long-term contracts. A five- to seven-year contract with a slow-to-innovate vendor is not usually worth the discount that comes with it.
Why the lock-in?
Banks get locked into these long contracts for several reasons. First, they usually receive a discounted price if they sign a longer contract. Second, they become comfortable with their current vendor and are reluctant to undertake the trouble and expense of changing vendors/solutions. Third, they find themselves stuck with a vendor whose proprietary standards and services make it difficult, if not impossible, to move to another solution. And fourth, some banks have had the same vendors for so long that they are not even sure how to look for new ones.
The down side
Vendor lock-in can be extremely detrimental to a bank in the long term. The financial institution becomes a hostage. If they are stuck with a sluggish vendor that takes months or even years to make a change, they are sure to fall behind more forward-thinking competitors. That discount for a long-term contract may look attractive now, but the cost of losing market share and missing out on future opportunities can be much greater. Moreover, being locked in often means being at the mercy of any changes the vendor decides to make to the solution. Bank of America, USAA, and Wells Fargo, for example, have been able to come out first with innovations in digital banking in part because their competitors were too dependent on vendors and as a result, slow to innovate.
How to unlock and keep moving
As it gains traction in the industry, open banking will help banks avoid this scenario. Having standard APIs into their back-office systems will make it easier for banks to adopt new applications and capabilities and to keep moving forward with innovation.
Until then, financial institutions can avoid vendor lock-in the old-fashioned way: by shunning long-term contracts for digital products, conducting extensive due diligence on prospective vendors and then soliciting competitive bids from several of them. Banks should always carefully evaluate potential vendors, spend time talking to them, and clearly understand the benefits and potential shortcomings of their products and services. Bankers should constantly compare their own vendors’ solutions to competitive solutions available on the market. The process of selecting a new vendor should begin at least 18 months before a current contract ends, particularly since it can take up to a year to implement a new application.
Always have an exit strategy. Once a vendor has been chosen, the bank should begin planning an exit strategy even as it plans the implementation, and this strategy should include expected costs. As a further precaution, banks should design applications to be flexible and loosely integrated. Data should be formatted to be as portable as possible.
With shorter-term vendor contracts, smaller FIs can better keep up with their bigger competitors. The knowledge that they are going to be re-evaluated every couple of years should keep vendors on their toes and encourage them to be more innovative. If that’s not feasible, include performance clauses that allow you to exit, not just for things like availability, but for keeping up with changes in the market. For financial institutions, avoiding vendor lock-in does not have to be complicated; it just takes a bit of effort and a commitment to looking ahead.