Amit K Singh

Partner, Stradling Global Sourcing 

In many meetings with service providers and analysts, I have often been asked to predict how will things shape up for them in 2008 and beyond. It is a tough call, but here are some thoughts.

The time of labor arbitrage, some have suggested, is over. I disagree with that. In a recent conversation with the CEO of a Tier I offshore service provider, we looked at some recent price rate card data of their hires in India, a couple of other offshore destinations and locally in US. The difference at entry level costs is still startling, primarily due to the differences in costs of living in the two countries. This difference might narrow down as one moves up the organizational ladder, but it persists.

However, the days of labor arbitrage as a competitive differentiator between what were erstwhile “pure play” offshore service providers and “mainstream” service providers based in the US are numbered, if not already at an end. In the last few years, the US based Tier 1 and many Tier 2 service providers have made rapid, significant investments offshore to catch up and indeed, effectively compete on the labor arbitrage play. One point that comes across in my discussions with clients and service providers alike is that the competitive differentiators are now more traditional than ever - quality of personnel, fit of the solution, executive commitment etc.., much more than a pure cost differential, since most of the service providers are building in comparable offshore components to their solutions and prices.

And that brings me to a question I have been thinking about…given that the offshoring industry, both in ITO and BPO spaces is fast maturing and the competitive differentiators are getting fewer, is it time for providers to look at strategic acquisitions or mergers to create more value for their shareholders?

It certainly seems plausible. 2008 is shaping up to be an interesting year. I wrote about the subprime meltdown and its impact on ITeS providers sometime back. With the US economy in recession and the US Dollar depreciating, the coffers of service providers will be impacted and that may impact capacity expansion plans negatively. I do not see this to be a consideration for large Tier I players at this time but some of the Tier 2 and Tier 3 firms may look at this trend and explore the potential of an M&A possibility. Also, this may also open up the opportunities for acquisition that the large service providers, with strong balance sheets and cash have been looking for.

 Let me know your thoughts.

BusinessWeek, in its April 9th issue, has an article titled, “Amazon Takes on IBM, Oracle and HP.” The focii of Amazon’s efforts are:

“The company won’t be making computers or selling software to corporations. Instead it’s offering companies the ability to tap into the vast computing capabilities of Amazon’s own data centers, in a manner almost as easy as buying the latest best-seller. Companies pay only for the computing they need, avoiding the cost of buying and operating their own gear.”

This is yet another instance of “on-demand” computing, popularized by IBM and others, and now offered in a new incarnation as cloud computing. The idea is that companies can buy computing resources on an as-needed basis, paying for what they use. Amazon and others have huge economies of scale, and selling capacity at low marginal cost is an economically attractive model. The question is whether this approach will be successful in terms of making a meaningful dent into IT services outsourcing as currently offered by IBM, CSC, EDS, ACS, HP etc.

My initial reaction was that this is a low end service meaningful to small business, and to groups within larger corporations who are building specific service offerings and want to launch quickly and don’t want to wait for IT to get them the capacity they need. But then I got to thinking. This is exactly how disruptive technologies launch. They start small, appeal to a different set of users from the mainstream with different performance criteria. But then, they get better and better, and move into the more sophisticated markets. This raises several questions in my mind.

First, if you are a CIO, do you use “cloud computing” as a resource for infrastructure? What are the opportunities and concerns?

Second, if you are a services provider, should you be offering “cloud computing” services? For the most part, even when co-located, due to client concerns, the large IT services vendors isolate one client’s infrastructure from another’s. This allows for some economies of scale, but not at the same level as would be available if they could integrate infrastructure. BPO service providers and ASPs on the other hand, particularly those that offer services from a single platform, are attempting to exploit cloud-like economies of scale.

Finally, what will the IT architecture of the future look like? A typical company will have some internal IT infrastructure and applications, externally sourced IT services, BPO services, and some use of the cloud. How will all of this be integrated and yet provide a company with the flexibility and agility that it needs at a reasonable cost?

Let us know how you are addressing “cloud computing” in your sourcing and delivery strategy.

Racheal King has an interesting article on BusinessWeek.com on the new economics of outsourcing. She focuses on offshore outsourcing, rather than outsourcing generally. Her main point is that with the plummeting dollar, wage inflation in India, higher costs of doing business in India, time zone challenges, and changes to the tax code, India is becoming a much less attractive destination than before. One important dimension of her findings is that providers are increasingly developing a global footprint to be able to deliver services from multiple delivery centers moving work around based on the economics at the time.

This is much the same argument that I made in September 2007 on this blog and so of course, I agree fully. Moreover, her examples are very instructive. The major vendors are working hard to build these global delivery platforms.

I would however add that there is still considerable time before the Indian cost advantage ends (if it does end). A common mistake that forecasters make is they assume that trends will continue indefinitely and do not reflect dynamic adjustments by outsourcing firms. So just as wages rose faster than many anticipated, now I believe that wages will rise more slowly than anticipated since outsourcers are acutely aware of the bind that they are in and will be increasingly reluctant to offer salary increases. Even within India, second and third tier cities are becoming hubs for outsourcers as a means to manage salary pressures. Also, it is by no means certain that the exchange rate will stay at its current level. Once the credit crisis passes, we may see a shift in favor of the dollar.

If you are currently outsourcing IT services, we’d be very interested in hearing how you think about your strategy for outsourcing, and specifically, on your country strategy for where you want to locate the work.

The easy credit bubble of 1990s saw the housing prices soar across wide swaths of United States. In a hurry to benefit from the easy credit and low interest rates, lenders progressively lowered lending criteria and started giving loans up to 100% of home assessed values, which were at a historically high.  On top of that, lenders aggressively pursued the American consumer to open and utilize additional home equity based lines of credit, which enabled the consumers to use their houses as an ATM. In markets such as California, the median prices of homes jumped more than 30% every year with the result that an increasing majority of prospective buyers, with limited buying capability, had to resort to what is called as “Subprime” mortgage terms. These terms essentially allowed the lenders to loan to people with less than good credit at low introductory rates that then would convert after 3 or 5 years into much higher rates.

 The debt leverage did not stop there. In the way that US securities market works, all such mortgages were then chopped, repackaged as bundled securities and resold, multiple times, to investors all over the world. This essentially obliterated all ability to trace an investment to individual mortgages that it comprises.  

When the market finally started cooling off, it suffered a double whammy. When the low introductory rate time period expired, many home owners found that they could not afford the much higher rates they converted to. The rate of foreclosures, especially in red hot markets, has been inching up in an increasing sign of consumer distress. The ATM that many consumers counted on to and indeed used to pay other debts stopped paying out cash. At the same time, in the securities market, the demand for securities that were secured in, a significant part, by subprime mortgages, went down. This meant the mortgage companies that had done a lot of business in subprime or even Alt-A mortgages suddenly had commitments they could not meet. In a short period of time, Countrywide, the largest mortgage company in United States had to be sold to Bank of America, Many other large lenders declared bankruptcy and almost all large mortgage companies faced liquidity or credit problems. This spiraled upwards into investment banks with the result of several large investment banks including Bear Stearns, Citibank, Lehman and several hedge fund holdings suddenly lost so much value that they needed outside cash infusion to keep operating, get sold in a distress sale or had to shut down completely.   

There has been a lot of buzz lately, with many service providers, especially those that provided business process outsourcing to the financial industry having to adjust their financial performance guidance. Along with other recession related topics, the impact of subprime meltdown has been a hot topic of concern to service providers.

I believe that the fall-out of this phenomenon on the outsourcing industry will be three-fold:

1. The “keep the lights on” technology maintenance outsourcing such as data centers, networks, core applications should be least impacted from this housing & subprime downturn unless it is an acquisition situation where the acquirer would look at synergies in maintenance processes and thus pare overall maintenance costs. In fact, I would argue that in the short to medium term, this segment may witness some growth, especially from an offshore perspective as an increasing number of companies would look for lower cost solutions. One segment that may witness leaner times is helpdesk & desktop support since there has been a lot of personnel reduction in this sector in the last six months.

2. We are seeing and I expect to continue seeing a very dramatic fall in the new investments being committed by financial businesses in IT applications, new technologies and processes/productivity improvement tools.

3. From core business process outsourcing perspective, there has been some significant impact on service providers that had focused on clients with large subprime portfolios such as Greenpoint, Ameriquest etc… In the medium term however, I believe that BPO will become even more mainstream as more companies look to spread their costs on a more variable basis and focus on their core competencies. I also expect to see more knowledge processes such as business analytics being outsourced from a cost leverage standpoint.

Amit K. Singh | Partner | Stradling Global Sourcing  
asingh@stradlingsourcing.com | www.stradlingsourcing.com

As organizations look at options to become leaner and focused on their core competencies, outsourcing of non-core services is increasingly seen as a competitive advantage in achieving desired business efficiencies.  The strong growth that outsourcing has enjoyed in recent years suggests that global organizations are undergoing a fundamental shift in how they operate and deliver value. However, even though outsourcing has often succeeded in reducing direct costs, its record can be mixed when one looks at the total cost and complexity of managing outsourced functions including costs of selection, transition, training, ongoing governance and termination.   

Amit K. Singh | Partner | Stradling Global Sourcing  
asingh@stradlingsourcing.com | www.stradlingsourcing.com

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I recently returned from a trip to the Indian School of Business in Hyderabad, India where I taught a class to CEO’s titled, “The CEO’s IT Agenda: Creating Value With Information Technology.” A brief summary of the programs on ISB’s website.

The New York Times has a very interesting article on how Indian outsourcing firms are building delivery capabilities by hiring talent in their clients’ home countries.

Here is a key quote from the article:

Such is the new outsourcing: A company in the United States pays an Indian vendor 7,000 miles away to supply it with Mexican engineers working 150 miles south of the United States border.

Clearly, the trends highlighted in the article provide evidence of the impact of the changing economics of offshoring to India. A few years ago, you could get around 49 Indian Rupees to the dollar. Today, a dollar fetches under 40 Rupees, a decrease of approximately 25%. In addition, the salaries of Indian professionals are increasing substantially every year and will probably continue to increase in the near term as demand exceeds supply. So why should a US or European company consider outsourcing services to an offshore provider today?

I believe the answer has more to do with core competence than with the immediate costs of service delivery. Service providers are capitalizing on their scale to build capabilities that few clients can match. They have built expertise in software methodologies and business process disaggregation, and are now moving to leverage global resources in a variety of geographies. Software services, and for that matter, many IT-enabled services, are increasingly requiring a global delivery platform. Providers have economies of scale and scope that clients do not. Since the delivery platform allows providers to service existing clients and new clients in the countries in which they have developed capabilities, they can reduce the risk of building capabilities in these countries, but more importantly, allow for a changing allocation of resources between countries. A client, on the other hand, is more likely to be able to make bets on one or two locales that will not provide it with flexible options if market conditions change. The scope of a provider’s delivery platform will, of course, depend on its scale and the geography of its clients. To that end, it is not just the Indian providers who are developing global platforms, but the big US players (e.g. CSC, IBM) as well.

While the cost differentials may narrow, the overall economics of outsourcing may actually be getting more compelling if the value of the service is taken into account.

Watch Kevin Parikh’s interview with Paul Ward on lawcast.

All outsourcing services deals end at some point. The rapid pace of technological change makes it almost certain that a contract today will be substantially superceded or terminated within 5 years because the enterprise will undergo a major change in direction and today’s technology environment will be out­dated. What is required, therefore, is to build a detailed exit plan into the contract at the ini­tial negotiations stage. Defining how an enter­prise unwinds a relationship is as critical as defining how it begins a relationship.The exit plan defines the enterprise’s strategy and identifies the processes required to trans­fer the contract’s operational and organiza­tional components from the provider to the enterprise. Typically, an exit plan includes the following: 1) a set of exit strategy documents, including what assistance will be provided, by whom and when, what will be transferred and at what cost ; 2) Business and technology impacts of early termination; and 3) a hierar­chy of critical processes, assets and resources.Another issue to consider is the retention of assets used to provide the services under the agreement. There is no single approach to asset ownership, transfer and management. Some organizations prefer to retain some or most of their assets and pay for maintenance directly. Other organizations build the cost of the assets into the deal and allow the provider to own the assets. Regardless of which approach is chosen, organizations must retain the ability to transition the assets in the event of termination.

Ravi Mahalingam, Esq.

Stradling Global Sourcing, LLC

(949) 737-4780