These are challenging times for the outsourcing industry. The mega-deals of the 1990s seem to be gone forever. And while companies are outsourcing like never before, they are giving out smaller contracts, for shorter time periods. That means service providers are having to fight tooth and claw for business, while developing new strategies to ensure that they have business models that will carry them successfully into the future.
The back end of 2006 was the worst fourth quarter for new outsourcing business in the last five years. True, there was a record number of contracts agreed in the year as a total – 350 compared to 341 the year before, according to the regular index produced by outsourcing advisory firm TPI. But the value of new contracts on the market fell by eight percent in the fourth quarter.
That is in part due to an underlying trend highlighted by the index. Companies are assigning shorter and smaller contracts, combined with more specialist and single process deals. “Outsourcing providers are obliged to compete more often in order to secure the same level of business,” says Duncan Aitchison, Managing Director of TPI in the EMEA and Asia-Pacific region.
At the same time, competition has been heightened with more providers competing for market share. The number of providers winning contracts has increased by 64% in the last four years, from 55 in 2002 to 90 in 2006. The Big Six of outsourcing (Accenture, ACS, CSC, EDS, HP and IBM) are winning a decreasing proportion of those deals valued at over $50m and their share of market globally by total contract value has fallen from 71 percent in 2002 to 46 percent in 2006.
“In general terms, this increased competition is clearly good for buyers,” says Aitchison “However, greater diversity and specialisation amongst suppliers, combined with more frequent tendering, does mean more complexity in both the procurement process and the management of outsourcing contracts.”
Those service providers head-quartered in India, such as Wipro, Tata, and Infosys are reaping the benefits of the trend towards single-process and specialist deals. These providers, alongside the Big Five in Europe as well as other smaller and niche providers, are encroaching upon the Big Six’s market share. In 2006, the India-based providers achieved seven percent of the total market share. This is a massive increase compared with their 2002 market share of less than half a percentage point.
The India-based service providers are particularly successful in the Applications Development and Maintenance (ADM) sector, having grown their market share from 8% in 2003 to 36 percent in 2006. In contrast, the Big Six have seen a decline from 76% of the ADM market in 2003 to just 38 percent in 2006.
“The figures clearly show a maturing of the India-based service providers, as they challenge the established players by taking an incremental approach and signing a large number of small, specialist contracts,” says Aitchison. “In the ADM space, for example, the difference between the market shares of these groups is now marginal. India-based providers are clearly considered an attractive and credible alternative to traditional players and over the next few years we expect to see them competing directly with the Big Six for larger value contracts.”
Despite the overall decline in new outsourcing contracts, demand in a number of individual industries is going from strength to strength. In Europe, the financial services sector represents an increasing proportion of the overall market, with both the volume and value of contracts let in 2006 up 26 percent and 20 percent respectively on 2005 levels. The European telecoms industry is also experiencing significant growth, with its share of the total European market increasing from 14 percent in 2005 to 21 percent in 2006.
These figures support the argument in a new book from management consultants Booz Allen Hamilton that the outsourcing industry is entering a transitional period. The most sophisticated suppliers and customers are shaping the structure of the business-to-business service environment worldwide, according to Managing Business without Borders. The book highlights the speed at which the outsourcing industry has evolved and makes some forecasts about future corporate outsourcing strategies and service provider solutions. “Every business will eventually be plugged into a network of interoperable, interwoven processes, and tapping this network will be an absolute requirement for success,” the consultants say.
Leading outsourcing players are globalising their operations, which is in turn eroding the distinctions between Western and offshore vendors, such as capabilities and pricing, the argument runs. Like their clients, providers have expanded beyond India, China and the Philippines to make the most of international diversity, balancing the capabilities, languages, cultural affinities and cost structures of a variety of regions. And just as multinational companies are developing standardised processes and systems globally, outsourcing leaders are adapting to meet these emerging needs.
“In place of the mega deals of the 1990s, today’s service providers are building robust, highly tailored offerings that deliver economic, strategic, operational and human resource benefits,” says Booz Allen. “The menu of sophisticated end-to-end services continues to expand in human resources, finance, and procurement, along with clinical trials, research and analytics, advanced customer care, product development and innovation.”
Many providers are also differentiating their offerings by standardising business processes within industries to meet customer demands for cost savings, as they will no longer pay a premium for custom-built processes. The consultants says that the firms most likely to prevail are the large, full-service vendors that work on a global scale with multinational clients and immense resources, as well as the specialist firms that serve niche markets, like animation production houses for media companies.
Even so, there are a number of challenges that will continue to inhibit the industry. Among them are the need to demonstrate credibility and reliability, particularly for knowledge-centric work, ample security safeguards and a clear labour sourcing strategy, along with global training and workforce management programmes.
“Outsourcing any business activity is still not a guaranteed safe choice, but companies that do it right can capture significant value,” says Vinay Couto, Vice President of Booz Allen Hamilton and leader of the firm’s work in outsourcing advisory services.
“We have seen the industry’s growth attract new entrants with exciting new business models forcing established suppliers to revitalise the strategies that made them so successful. Corporate customers are more enthusiastic and aggressive in expanding their outsourcing strategies, as they navigate this constantly evolving landscape,” he adds.
The book suggests that an evolving set of skills is coalescing into a body of best practices as the industry matures. It argues that certain key trends will shape the future of successful service delivery.
The globalisation of operations, for example, will erode distinctions between Western and offshore vendors, such as capabilities and pricing. The increasing sophistication of the contracts that companies are assigning will lead more service providers to differentiate their offerings by standardising business processes within industries to meet customer demands for cost savings, as they will no longer pay a premium for custom-built processes.
The need for interoperable, commoditised services will drive further standardisation, which in turn will give rise to a more accessible market. In the future, instead of committing to a five- or ten-year agreement, companies will be able to plug into services for short-term needs. But for this to happen, vendors will need to build capabilities around a common set of standards.
As for the companies buying outsourced service, the book identifies five key factors that help firms to get outsourcing right. First, they should commit from the top and move quickly. Outsourcing requires explicit resolve from senior management, and the most successful programs are enacted quickly. “Aside from the operational and cost virtues, executing swiftly and deliberately sends an unmistakable message of resolve,” say the consultants. As one executive quoted in the book argues: “The biggest risk of all is indecision. Know what your strategy is as an organisation, align with it, know what you’re accountable for delivering, and then make some decisions and move forward.”
Second is to have a clear understanding of why you’re engaging in outsourcing and to articulate those reasons clearly. The decision to outsource must have a compelling business rationale, be it cost reductions, optimised processes, better service levels or innovation, and those priorities must be kept in mind in evaluating options. Equally critical, outsourcing decisions should be based on a business case that is built on hard analysis. “Getting that baseline straight was a very intense and very important effort,” says Kris Hillstrand, chief information officer and senior vice president of business operations, at energy company TXU, who is quoted in the book.
Third is to be a partner, not just a customer. Executives who reap the most benefit from their outsourcing arrangements have built relationships of mutual trust with their vendors. “Enlightened companies have figured out the right balance between rigor and flexibility so that they don’t micromanage and at the same time they don’t ‘turn over the keys’ to the outsourcer,” says Ashok Divakaran, principal at Booz Allen. He added that these companies rely on clearly defined decision rights from the executive level down to day-to-day users of the service.
Fourth is to embrace complexity and learn to manage it. Outsourcing used to represent a fairly limited menu of options, but complexity has crept in, in terms of the number of vendors, the number of countries from which they can deliver services, delivery models (onshore, nearshore, offshore), scope of offerings and variety of contractual models. “You have significantly less control than you would have with people reporting directly to you and salary management control, performance reviews, and other tools at your disposal,” according to Filippo Passerini, chief information and global services officer at Procter & Gamble, where he oversees $4.1bn in outsourced services. “This new model is more challenging, and more demanding to manage, but it is significantly better for our business.”
The final factor identified by Booz Hamilton is to be a visionary. “As outsourcing becomes more strategic, so too must the role of business leaders who control IT and business process outsourcing,” they argue. “The new generation of outsourcing leaders is always thinking beyond the boundaries of their own function, and in some cases, even beyond the boundaries of existing market capabilities.”
One consequence of this transition is that companies need to work harder than ever before to ensure their outsourcing arrangements are debated at board level: this is now a strategic governance issue. Smart companies have risen to this challenge. “They are looking beyond service levels or generic guidelines and want details on the best ways to achieve and demonstrate value to their business,” says Shawn McCray, partner and practice leader for service management and governance at TPI. “If client organizations get outsourcing governance ‘right,’ they exponentially increase the value they realise through outsourcing,” says McCray. “If organisations get it ‘wrong,’ the risks are high and there is a downward spiral of poor results.” Ultimately, he says, the costs of poor performance in governance are significantly higher.