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A little more than two years ago, JP Morgan Chase & Co. signed a $5 billion, seven-year agreement with ibm for computer services. Under the outsourcing pact, 4,000 members of the bank’s technology staff would go over to ibm.

Twenty-one months later, in August 2004, the bank canceled the contract. The outsourced employees would return at the start of this year.

Why? The company’s CIO, Austin Adams, said at the time: “We believe managing our own technology infrastructure is best for the long-term growth and success of our company … to become more efficient.”

What really changed things was the July 2004 merger of JP Morgan Chase with Bank One, which had gained a reputation for consolidating data centers and eliminating thousands of computer applications. JP Morgan Chase would now switch from IBM to self-sufficiency to take advantage of BankOne’s cost-cutting know-how.

Bank One has to date delivered a remarkable performance. The bank reduced head count 12% from 2000 to 2003, while raising revenue 17% to $16.2 billion. By contrast, JP Morgan Chase reduced its head count only 6% in the same period while revenues grew just 1%, to $33.3 billion from $32.9 billion.

For further comparison, the average compensation of a Bank One employee in 2003 was $66,928; a JP Morgan Chase employee took home $125,147. Returns on shareholder equity also were materially higher for Bank One.

The more cost-efficient Bank One then swallowed the underperforming JP Morgan Chase. Bank One also reaped a 14.5% gain in the appreciation of its stock. Executives of the consolidated firm called for at least $2.2 billion in annual cost savings to justify the expense of the merger.

Which goes a long way toward explaining why JP Morgan Chase brought its computing back in-house. It’s not because IBM was not doing its job. In-house management of a technology infrastructure is unlikely to be more efficient than that delivered by a well-run global information “utility” with ample capital for technical innovation, reliability and load sharing.

No, the objective was to perform radical surgery on the unfavorable economics of JP Morgan Chase. From 1999 to 2003, the bank’s shareholders got a return on their investment of 9.45% a year. By comparison, shareholders at Bank of America, Citicorp, Wachovia and Wells Fargo got an average return on investment of 15.79%. JP Morgan Chase’s average compensation per employee was twice that of the other banks. And its spending on technology, per employee, was more than double, at roughly $28,300 a head, compared with $12,700.

How much cost cutting should JP Morgan Chase do?

Banks include their technology expenses in their audited financial statements. In the case of JP Morgan Chase, theses expenses grew from $2.18 billion in 1999 to $2.84 billion in 2003.

Comparable data was obtained for Bank of America, Citicorp, US Bancorp, Wachovia, Wells Fargo and other banks. A model that “explains” the banks’ I.T. spending levels after taking into consideration how the banks differ in revenue, profit, salaries, assets and head count was then constructed (see “Estimating I.T. Spending for Banks,”

Compared to 30 other technology budgets (i.e., five years of data for each of the six banks), JP Morgan Chase should be spending $2.11 billion—in 2003. Its spending should not be any higher than in 1999.

Only a drastic restructuring in the bank’s organization can reduce that huge disparity. One step is to cut way back on technology spending, whether to ibm or to an in-house staff. Or both. In any case, the bank’s own excessive spending is what really doomed the ibm outsourcing contract.

Cost Comparison

When JP Morgan Chase looked at itself in the mirror, it saw excess spending.

MEDIAN VALUES, 1999-2003 I.T. spending per employee Compensation per employee Return on shareholder equity
Bank of America,Citicorp, Wells Fargo, Wachovia $12,729 $55,057 15.79%
JP Morgan Chase $28,297 $110,702 9.45%

Source: Strassmann Inc.