Will the Cities Lose Their Back Offices?

The location of "back office" facilities is currently receiving a great deal of public attention. Advances in computers and in telecommunications have accelerated the movement of routine data processing activities out of central city locations to suburban areas and small towns where the costs of space, labor, and energy are often lower. This article examines current trends in the location of back offices and explores ways to retain back office operations in central cities.

Front office headquarters or activities like corporate strategy, organizational development, and marketing involve frequent client contact. As a result, front offices tend to locate in central business districts. Back office activities, however, usually do not involve direct client contact. Back offices perform two basic functions: 1. processing of the firm's transactions; and 2. compiling and supplying needed information. Commonly included among back office activities are accounting services, check and security processing, claims payment, mail, and stock transfers.

Information in offices has traditionally been conveyed in person or on paper and, as a result, it was efficient to locate the front and back offices in close proximity to each other. With the widespread use of computer-to-computer communications and growing uses of the telephone (i.e., "800" numbers, stock market price quotations, credit card verification), the organization of work in back offices has undergone dramatic change. These changes include:

Emergence of information (data) processing centers as distinct units within information-intensive firms. These centers are focal points for electronically storing and disseminating vast amounts of information that no longer need to be located near other office activities. Indeed, the spatial and energy requirements of data processing centers mandate that they be housed in customized spaces apart from both front and back offices. They have become specialized back offices.

The development of new client services. In particular, facilities for telephone-based contacts with customers have converted one type of direct client contact into a back office function. For example, insurance companies advertise 800 numbers that allow clients to purchase policies over the telephone. Following a sale, the phone can again be used for customer account servicing, trade confirmation, or credit verification. No face-to-face client contact is required.

TO STAY OR MOVE OUT

The new developments in telecommunications have been permissive rather than determinative factors in office location. The fact that technology allows the decoupling of back office activities does not in itself reduce the desirability of central business district (CBD) locations. Although telecommunications systems make it possible for back offices to move out of central cities, other factors, such as the desire to retain skilled labor, make it preferable that the back offices still remain close by, in metropolitan areas.

Physical Requirements

The distinctive spatial requirements of office technology pose special requirements for back offices. Intense use of video display terminals, central processing units, and printers has led to a proliferation of telephone and electrical wires that are commonly installed under the floor, creating a need for higher ceilings. In addition, large mainframe computers must be housed in buildings capable of sustaining heavy floor loads and with floor areas of 40,000 square feet or more. Such floor size and load capacity are not commonly available in the traditional narrow office towers found within CBDs.(l) On the one hand, the use of computers and communications technology has fostered the development of buildings, sometimes referred to as "smart buildings," that utilize new engineering and architectural concepts to meet the emerging office space demands. In other cases, however, back office activities in general, and their information processing component in particular, are being moved to renovated industrial, warehouse, or retail buildings. Often such buildings are located within the city just beyond the periphery of the CBD.

Recycling Old Space

The conversion or "recycling" of industrial space within the central city can be clearly seen in New York City.(2) Citicorp and Manufacturers Hanover Trust Co. have decided to establish new information-processing facilities that utilize more than 400,000 square feet of an industrial building located on West 33rd Street in Manhattan. Men-ill Lynch currently houses its major computer center in a converted industrial building situated next to the Hudson River that has floor areas of approximately 200,000 square feet. American Express houses a major credit card processing center in a renovated Manhattan warehouse with floor sizes of 50,000-75,000 square feet. As manufacturing firms continue to leave central city sites, increasing amounts of space may be converted for back office and related information-processing activities.

Not all cities, however, have a distinctive CBD peripheral area suitable for back offices. And even in those that do, noncompetitive rents may prevent these areas from being developed for back office activities. Central city rents, even for nonprime space, tend to be 20 to 50 percent higher than those found in adjacent suburbs. On the other hand, firms within a CBD often have long-term leases for secondary space at rental rates well below market. Thus, relocation movements will be restricted in the short run by existing long-term leases.

Back Offices and Energy

The computer-intensive back offices of banks and financial service firms have electrical energy requirements of ten to twelve watts per square foot. Lighting accounts for only 20 percent of this energy load. The remainder is split between the operation and the cooling of computers. As power loads increase, energy reliability becomes increasingly important to such computer-intensive firms, and frequent brownouts and blackouts at peak-use times can diminish the attractiveness of an area. A 1984 study by the Real Estate Board of New York (3) has noted that "many banks are chary of piling more and more electronically stored information into an area relying on a single utility power grid; they therefore locate operations in the suburbs to arbitrage their electronic risks over several utility companies."(4)

While some firms are building their own back-up centers, others are using the services of independent data processing companies. For instance, Comdisco offers data recovery services for information-intensive firms located around the country; their disaster recovery sites are presently located in Wood Dale, Illinois; Lodi, California; Grand Prairie, Texas; Carlstadt, New Jersey; and Cranford, New Jersey. For computer-intensive facilities, energy costs can influence locational choices. The decision of Shearson Lehman Brothers to build a new computer operations center in lower Manhattan was in part due to a reduction in energy costs made possible by New York State. In a different situation, Dean Witter has cited lower energy costs as an important factor in its decision to move its data processing center to Dallas, Texas.

Back Offices and Quality of Labor Force

The new information technology has increased demands for a high-quality labor force. With the advent of microprocessing, large-volume single-task operations are giving way to multitask, multimachine systems that operate on-line, in real time. Such systems require skilled clerical personnel. Although the labor skills needed for back office jobs have increased, the capacity of big-city public school systems to produce qualified high school graduates has declined. Public perception of big-city school systems' failures has further strengthened the appeal of suburban and satellite city labor markets.

The Effect of Firm Size

Small- and medium-size firms do not always have the capital to install and operate the latest computer and communications technology. Nor can they take advantage of the economies of scale available to larger firms. Firms that still rely on a mix of electronic data flow and paper flow are less likely to separate their front and back office activities. However, many smaller firms are now purchasing data processing services from larger establishments or from independent suppliers in order to price their products competitively. The result is a decline in the total number of independently operated back offices. Two examples should suffice: City National Corp., the eleventh largest bank in California, supplies data processing to 202 financial institutions on the West Coast. Likewise, Securities Settlement Corp. in New York City, a subsidiary of Travelers Insurance Co., provides clearing services for securities firms throughout the nation.

The search for capital and economies of scale in data processing may be one reason for the recent trend toward corporate mergers. Largely as the result of consolidation, the number of commercial banks in the United States is expected to decline from 14,000 in 1980 to 9,600 in 1990(5) and the number of insurance companies from 1,800 in 1986 to 1,000 by 1990.(6) Because mergers are occurring across state lines or between cities within states, the economies of scale associated with information processing will lead to consolidation of operations and to the loss to some cities of many automated back office activities.

BACK OFFICE LOCATIONS IN THE FINANCIAL SERVICES INDUSTRIES

Recent deregulation of the financial service industries has increased competition among banks, securities firms and insurance companies by allowing each of these industries to enter new markets through expansion of products and services. One result has been the widening of the scope of company back office activities. But the purchase and installation of the advanced data processing functions necessary for the development and introduction of new products require the infusion of large amounts of capital. More than ever, these industries are seeking the most cost-effective locations for their back offices.

Bank Back Offices

A June 1985 Supreme Court ruling makes possible interstate banking mergers within regions sanctioned by state legislatures.(7) Now, the location of an operations center can be used as a lever to gain access to a new state banking market. This occurred in Maryland, where Citicorp's promise to build a back office in economically depressed Hagarstown was used to help induce the state to grant Citicorp the right to engage in banking activities in the lucrative Washington, D.C.-Baltimore market.

Although bank headquarters will most certainly remain within CBDs, new pressures are influencing the location of bank back offices. The growth in information technology has led to the movement of data processing and retail credit card activities to suburban locations, and in certain cases, to the State of Delaware, where Marine Midland and Morgan Guaranty have established major computer centers. Other banks, though, while moving certain functions outside the city, are also consolidating their back office operations within the central city. Exhibit I shows the location of the largest commercial banks' back offices.

In Los Angeles and San Francisco, local circumstances have resulted in contrasting back office locational trends. Los Angeles does not have a single central business district; several enclaves of business activity are linked by freeways. Moreover, renovation of existing space is difficult and expensive due to earthquake ordinances which require renovated buildings to be reinforced if they are to carry the exceptional weight of mainframe computers. Given this situation, there are several land sites within and outside the city that are equally well suited for back office development. Thus, for example. Security Pacific has moved their data processing operations to Brea and Glendale, while other back office operations are scattered within Los Angeles.

In San Francisco, an extreme shortage of suitable space has combined with high rents and legislative proposals to limit new construction to diminish that city's appeal for back office development. BankAmerica, headquartered in San Francisco, maintains a large data processing center in Los Angeles while other back office operations are located in the areas surrounding the city. (See Exhibit 1.) Nevertheless, movement out of the city should not be overstated. The majority (5,000) of BankAmerica's back office employees are still located in San Francisco.

Exhibit 1 Back Office Locations of the Top Nine Commercial Banks (Ranked by the Size of Assets)

Bank Information Processing Systems Retail Operations (Check Processing and Credit Card Operations) Other Facilities Citicorp (New York) 111 Wall St., New York, NY 20 Exchange Pl. New York, NY (multiple national locations) 111 Wall Street, New York, N.Y Huntington, L.I, South Dakota 20 Exchange Place, New York, N.Y. 399 Park Avenue, New York, N.Y. 111 Wall Street, New York, N.Y. Bank America (San Francisco) San Francisco, CA Los Angeles, CA Concord, CA (SF Suburb) San Francisco, CA San Francisco, CA Concord, CA Orange, CA Brea, CA West Choena, CA Chase Manhattan (New York) 1 New York Plaza 90 William St. Lake Success, L.I 80 Pine Street, New York, N.Y. 42 Trinity Place, New York, N.Y. 59 Maiden Lane, New York, N.Y. Manufacturers Hanover (New York) 4 New York Plaza Hicksville, L.I. 340 West Street, New York, N.Y. 40 Wall Street, New York, N.Y. 450 West 33rd Street, New York, N.Y. Morgan Guarantee 23 Wall St. Complex, New Castle, DE New Castle, DE 30 West Broadway, New York, N.Y. 23 Wall Street, New York, N.Y. Chemical 55 Water St., New York, NY Somerset, NJ Jericho, LI 95 Wall St., New York, NY 55 Water Street Jericho. L.I. (credit card) 55 Water Street, New York, N.Y. 52 Broadway, New York, NY Security Pacific Corporation (Los Angeles) Brea, CA Glendale, CA Scattered around Southern CA. Los Angeles Cypress, CA Bankers Trust 1 Bankers Trust Plaza Jersey City, NJ 16 Wall Street, New York, N.Y. 4 Albany Street First Chicago Corp. (Chicago) 1 First National, Chicago 525 West Monroe St., Chicago (the fringes of Chicago) Elgin, IL Nassau, L.I. 1 First National Plaza I North Dearborn, Chicago I North State Street, Chicago 1 First National Building, Chicago

Bank Retail Operations Move Out of Cities

The impact of technology on the location of bank back office functions is most evident with regard to retail operations like check processing and credit card operations. These were the first to be affected by computer technology, are the most standardized, involve no client contact, are high volume in nature, and are easily separated from other back office operations. Of the top nine banks surveyed, seven have located these operations in suburban or satellite city areas. However, most of these locations are within a sixty-mile radius of the city where the bank is headquartered.

Citicorp has no equal in embracing the decentralization made feasible by computer and telecommunications technology. Its data processing activities are housed in locations all around the country, and of the 12 million square feet of space which Citicorp utilizes in the United States, half are located outside the New York Metropolitan Area. Citicorp's South Dakota site, which is used for credit card processing, provides an excellent example of how traditional locational factors are now being supplemented by organizational factors that reflect the dynamics of present-day competition. Not only did South Dakota provide lower-cost land and lower operating costs and labor, but the South Dakota legislature also removed usury ceilings on credit cards. Citicorp's interest rate on credit card accounts is determined solely by corporate policy, unhindered by state regulations.

Back Offices of Securities Firms

The securities industry is geographically concentrated in New York City, particularly in downtown Manhattan. Securities firms originally had to locate near the Stock Exchange and the clearinghouse in order to facilitate the delivery of paper certificates. This requirement became obsolete when electronic processing made it possible to "clear" at any location and allowed firms to split off their data processing and back office functions from their corporate headquarters. Exhibit 2 shows that only one of the top ten securities firms has its back offices and headquarters located within the same building and only two have their data processing centers located within their corporate headquarters complex. The recent decision of Drexel Burnham Lambert, Inc. to consolidate the firm's entire activities into a new building, 7 World Trade Center, represents a significant departure from the current pattern of separating front and back office functions.

Exhibit 2 Headquarters and Back Offices for Top Security Firms (Firms Ranked by the Size of Assets) (Unless otherwise noted, all addresses are in New York, NY)

Firm Headquarters Back Offices Merrill Lynch 1 Liberty Plaza (Future location: World Financial Center) 570 Washington St. (Data processing center) Somerset, NJ Plainsboro, NJ Salomon Brothers 1 New York Plaza (Future Location: Columbus Circle, 1990) 55 Water Street (Data processing and back offices) Shearson Lehmen/ American Express 2 World Trade Center (Future Location: World Financial Center) Greenwich Street (Data processing center) World Financial Center (to be opened within one year) Dean Witter 2 World Trade Center 5 World Trade Center Dallas, TX (to be opened within one year) E.F. Hutton 1 Battery Park Plaza (Future Location: 40 W. 53rd St.) 1 Battery Park Plaza (Data processing and back offices) Goldman Sachs 85 Broad Street 85 Broad Street (Data processing center) 55 Water Street Prudential-Bache 1 Seaport Plaza 100 Gold Street Paine Webber 1285 Avenue of the Americas 25 Broad St. (Data processing and back offices) Weehawken, NJ (Data processing center) First Boston 55 E. 52nd Street 5 World Trade Center Bear, Sterns & Company 55 Water Street 2 Broadway 131 Varick Street (Data processing center)

Despite the widespread separation of securities firms' front and back offices, the prevailing trend has been for such activities, with the exception of data processing centers, to remain in the city, on the periphery of lower Manhattan's financial district. But Manhattan locations, even on the periphery, are relatively expensive, and the more capital-intensive data processing components of securities firms are considering new sites in boroughs other than Manhattan, in New Jersey, and beyond. Most securities firms are still concerned with maintaining control over their back offices, which have until recently been cost centers for securities firms, and prefer locations within the New York Metropolitan Area, close to headquarters. Of the three firms that have recently announced plans to move back office operations out of Manhattan, only one, Dean Witter, moved out of the region to Dallas. (Morgan Stanley is moving to Brooklyn and Paine Webber to Weehauken, New Jersey.)

As back offices in the securities industry become more standardized and more technologically intensive, there will be increased pressure on these firms to consider new areas where operations can be consolidated and costs lowered. As a result, the City of New York is offering a variety of financial incentives and lower energy costs to attract back office facilities to boroughs other than Manhattan, especially to downtown Brooklyn and Long Island City, Queens.

Insurance Companies

The insurance industry displays the most extensive pattern of back office dispersion from central city locations. Unlike securities firms, insurance companies had no historic need to be near the clearinghouse or stock exchange. And in contrast to banks, they were not subject to federal legislation that restricted operations to the confines of a state's borders. Thus, the insurance industry, with a geographically scattered set of agents and clients, has established a network of back offices that corresponds to the national scale of the market they serve.

In the 1970s, many large insurance companies chose to regionalize their data processing and operations centers in an attempt to minimize their overhead. These companies established semiautonomous regional units that serve as hubs for networks of branches distributed in specific geographic regions. Advances in telecommunications now enable insurance companies to centralize their data processing but to delegate their increased policy-writing to independent agents and employees located across the country. Instead of relying on a mixture of paper-bound rate schedules and telephone inquiries to design and execute an insurance policy, agents today can use a desk top personal computer to write a policy that is entered by telephone line into a main data bank.

Exhibit 3 shows that the data processing centers of the largest insurance companies are dispersed in numerous locations. For example, Metropolitan Life has its data processing centers in Greenville, South Carolina, Scranton, Pennsylvania, and Wichita, Kansas.

Exhibit 3 Headquarters And Back Offices For Top Ten Life Insurance Companies (Firms Ranked by the Size of Assets)

Firm Back Offices Data Processing Prudential Newark Parsippany, NJ Woodbridge, NJ New Providence, NJ Roseland, NJ Metropolitan NYC Madison Avenue 2 Penn Plaza Greenville, S.C. Scranton, Pa. Wichita, Kan. Equitable Life NYC Atlanta, Ga. 2 Penn Plaza 60 Hudson Street Leonia, N.J. Fort Worth, Tex. Easton, Pa. Aetna Life Hartford Elmira, N.Y. Fall River, Mass. Lowell, Mass. Hartford, Conn. New York Life NYC 51 Madison Avenue Clinton, N.J. New York City (Backup) John Hancock Mutual Boston John Hancock Place, Boston J.H. Place, Boston Marlboro, Mass. (Secondary Facility) Travelers Hartford 20 to 30 regional offices scattered throughout country Noreross, Ga. (suburb of Atlanta) Hartford, Coma.. Connecticut General Life (CIGNA Hartford) Scattered throughout country Windsor, Conn. Vorhees, N.J. Thomton, La. Teachers Insurance & Annuity NYC 730 Third Avenue 750 Third Avenue 485 Lexington Avenue 730 Third Avenue Northwestern Mutual Milwaukee 720 East Wisconsin Avenue Milwaukee 720 E. Wisconsin Ave. Milwaukee

 

CONCLUSION

The rapid proliferation of new services and products, made possible by deregulation and technological innovation, and the need to design and implement new software systems, have necessitated close coordination between front and back offices. Many firms, therefore, still place a high value on back office locations that are situated in the same city or metropolitan region as their corporate headquarters. Even when moving to locations outside Manhattan, there is a tendency to aggregate back offices within a handful of locations that have access to both the Manhattan central business district and to the suburban labor market.

Relocating to a different geographic region is only possible when the back office operations are fully routinized and are not subject to constant changes in services and products. As back office operations continue to become standardized and can function as stand-alone facilities, the locations of these back offices will begin to be determined primarily by profit-and-loss criteria. Thus, in the future. New York City and other central cities will be competing with a wider array of alternative locations that are competitive in terms of energy costs, physical size, amenities, and labor availability.

NOTES

1. A 1984 report on Manhattan office space by New York University's Sylvan Lawrence Research and Data Center noted that "half of all the buildings in the [downtown] area were built before 1929, for occupancy by small firms and trades in an era of construction technology that dictated columned space and size restrictions."

2. To the extent that larger floor areas exist, they are most often found in industrial zones such as Tribeca and Hudson Square. In these peripheral locations, rents vary from $11 to $20 a square foot. See Oser, "Hudson St. Lofts Draw Offices," N.Y. Times, March 9, 1986. This compares favorably with the $30 to $39 a square foot rentals in the mid- or downtown CBDs. See Real Estate Board of New York, Emerging Office Areas Midtown South, Aug., 1985, at 8.

3. Real Estate Board of New York, One-Third of the Market: Office Occupancy by the Banking, Insurance, Non-Bank Financial Services and Telecommunications Industries, July, 1984, at 3.

4. Salomon Brothers Inc, the investment banking subsidiary of Salomon Inc., is the latest example of a major information user engaging in energy arbitrage. According to Robert Salomon Jr., managing director of Salomon Brothers, a backup center is being built in Rutherford, N.J., ". . . in case there is a power failure or a bomb goes off in New York City."

5. "The Revolution in Financial Services," Bus. Wk., Nov. 28,1983, at 88-89.

6. Otis, "An Industry Overview: Chain Reaction Augurs Forthcoming Changes," National Underwriter, Sept. 7, 1985, at 14.

7. Northeast Bancorp Inc. v. Board of Governors of the Federal Reserve System, 105 S. Ct. 2545 (U.S. June 10, 1985).

Originally published in Real Estate Review
Volume 17, Number 1. Spring 1987
The Real Estate Institute of New York University