“Troubles at the largest financial institutions have put downward pressure on the IT services vendors' growth and margins,” Aite Group's Gwenn Bezard said. “As a result, the large IT services vendors have been forced to go down-market and chase smaller deals from smaller financial instituions-precisely the space where core banking processors reign.”

Until recently, large IT services vendors were on their way to swallowing up the large financial institution market-they were building financial services domain expertise, developing their own software assets and building an impressive portfolio of large clients along with the ability to deliver results globally, Bezard said.

But for core banking processors, consolidation in their market of small and midsized financial institutions has already pushed them to explore other options, and in the near future, changes in the U.S. banking industry will propel both vendor types to shift toward one another, he said.

“The new question for [core banking processors] is: Where should they go next?” Bezard said. “One of our answers is the IT services market, with its higher growth and margins. This crossover collision path-IT services vendors moving down-market and core banking vendors into IT services-will contribute to industry economics, competitive dynamics and mergers-and-acquisitions activity for the next few years.”

The report from the Boston-based think firm summarizes a study of 26 different technology vendors that offer IT services to financial institutions around the world in the banking and payments, securities and investments, property and casualty and health and insurance sectors.

While studying the client engagement activities of the vendors-grouped into the four categories of large IT services firms, midsized IT services firms, core banking processors and software/hardware vendors-Bezard and his colleagues came to the conclusion that not only is the collision described above imminent, but acquisitions among the IT services firms may occur as well.

“Some large IT services vendors will likely make a move to acquire one of the smaller U.S. core banking processors,” Bezard predicts. “Meanwhile, some large core banking processors will probably shop for mid-size IT services vendors.”

While the report forecasts a diminishing customer base and increased competition for large IT services providers, it also presents what Aite Group argues are viable solutions for this sector: Aside from working the market below their typical clients, the secret may lie in acquisitions, expanding outside their usual geographic area and beefing up their services.

The research firm also sees opportunities in alignments with large software or hardware providers, acquisitions of core banking processors, placing focus on commercial software and/or advanced IT services and exploring an untouched geographic area-Latin America. In addition, business process outsourcing and business consulting within the banking vertical is an under-explored area with much opportunity.

“They have developed deep domain and country-level expertise that rivals the related expertise of leading software/hardware vendors and U.S. core banking processors,” Bezard said of large IT services providers. “They could do more with it, however. Given the wide expertise across regions, types of offerings and banking areas, one would expect their revenues to be significantly higher.”

For core banking processors, exploring mergers and acquisitions should be on their to-do lists as well, in addition to easing up their focus on sales and taking their services through the roof. “Core banking processors should launch an IT services unit dedicated to working with clients and non-clients of their software and processing offerings,” Bezard said. “That unit should focus on the opportunity to help healthy banks rapidly absorb the hundreds of U.S. banks set to fail this year. They should also make a priority of helping their customers better manage IT.”

The two other types of vendors studied by Aite Group-midsized IT services firms and software/hardware vendors-face many of the same threats as large IT services providers and core banking processors, but they have options for escape routes.

Like large IT services firms, the midsize ones could explore acquisitions, build their commercial software portfolio and expand to Latin America, but they could also develop niches of expertise and pursue alignments with small core banking processors. Software and hardware vendors may need to do a little research: Do the best opportunities lie in sticking with their niche or expanding their offerings? Once they have the answer, they should pursue that arena in full force, Bezard said.

As vendors become more and more scrutinized by financial institutions, carving a path to success and following it is more vital for them than ever.

“One challenge is affecting all vendors: Financial institutions' tendency to not just shelve projects, but to delay decisions,” Bezard said. “Each deal is becoming more high stakes than ever for both decision-makers and vendors.”

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