The New Focus on the Midmarket: Why Buyers and Suppliers Are Excited About the New Possibilities | Article

holy grail of midmarket outsourcing“The midmarket is the next Holy Grail of outsourcing,” says Gianni Giacomelli, head of Strategy and Marketing, SAP. “There’s a great buzz,” adds Arthur Mazor, senior vice president, Offering Management and Marketing, Fidelity HR Services.

Why? Because of “the immense potential,” says Giacomelli. The Everest Research Institute estimates the midmarket has the annual revenue potential of around $25 billion. “That equals the big company market,” says Rajesh Ranjan, research director, HRO, Everest Research Institute.

Three reasons why the midmarket is hot

Why is the midmarket hot now? Three reasons.

First, the demanding economy. “As the economy struggles, cost leadership is becoming more of an issue,” observes Rick Tober, head of the North American IT outsourcing practice for Capgemini. “Midmarket companies are struggling to remain competitive in a global marketplace. There’s more pressure to look at outsourcing seriously.”

Adds Mazor, “In HR, the midmarket has to improve the process and attract talent even more effectively than bigger companies. But these companies don’t have the budget to maintain the basics of HR technology. So they need to outsource,” he explains.

Second, increased supplier options. The Capgemini executive says suppliers have finally figured out successful models to serve this market. He says early relationships in the midmarket “lacked some of the contractual fundamentals for success, leading to a lukewarm reception of the sourcing model.” Despite mismanaged expectations, the midmarket still wants to expand its use of outsourcing, he believes.

Mazor adds “midmarket companies wanted to shed the expense and headaches of their legacy systems, but didn’t have that many outsourcing options. Now there are more outsourcing solutions available.”

Ranjan reports midmarket buyers have more choices because more suppliers have entered the market. Three years ago in the HR space he says only ADP, Ceridian, NorthgateArinso, and Logica in the EU/UK served this market. Buyers had limited choices since many of these were only offering proprietary solutions. And prices were higher because of the lack of competition, he adds.

Today there are at least 10 suppliers in the marketplace including Accenture, which purchased Savista two years ago to play in this space. Last year, Ranjan says, Capita in the UK, ACS and Fidelity in the United States, and Infosys in India announced they would have midmarket HR offerings. “The market now has at least 10 serious players,” he says.

The third reason: success stories. Katrina Menzigian, vice president, FAO/PO, Everest Research Institute, says midmarket buyers now understand the finance and accounting outsourcing (FAO) value proposition and can study a number of success stories in this segment. At the same time, the FAO solutions in the market are beginning to more aggressively target the requirements and needs of midmarket buyers, creating stronger FAO affinity with this buyer segment.

The buyers

Tober says it’s buyers who are “driving the market.” Adds Monica Barron, vice president, HR, Everest Research Institute, “Today we are seeing a lot of pent-up demand now that suppliers are coming up with great alternatives.”

Giacomelli adds buyers are eager to adopt midmarket offerings. “They just want to see they can save money and that they can govern the relationship easily.” He says processes too people or judgment intensive that aren’t easy to standardize “won’t work as well in this market.”

Buyers have to realize midmarket offerings are a good thing “as long as they accept standardization,” says the SAP executive. That means they will “have to put more effort into the assessment” to make sure a standardized offering is “really suitable for them.” He says a typical buyer’s default stance is “to want it my way.” However, history has shown the client organization “has often adopted faster than imagined to new ways of doing things.”

Capgemini’s Tober says midmarket buyers must “clearly establish the fundamentals of the relationship” to insure the success of their outsourcing deals. What services is the supplier actually going to provide? What levels of support does the client expect? What happens when there’s a breakdown? Tober says this is important “because most midmarket buyers don’t have the in-house expertise and have historically found it cost-prohibitive to use a third-party adviser to help them.” Fortunately, there are more options for cost-effective sourcing guidance in today’s midmarket, he adds.

What is the supplier going to do? What levels of support will the supplier get? What happens when there’s a breakdown? This is important because most midmarket buyers can’t afford a third-party adviser to help them.”

Fidelity’s Mazor adds buyers have to be sure of their supplier’s commitment to invest and develop options for this sector. “Check out their platforms and their long-term sustainability,” he suggests. “Don’t focus on the near-term solution. Understand the broad future ahead” because buyers will need “continuous enhancement and development.”

Everest Research Institute’s Ranjan adds “buyers today need to choose their suppliers wisely because they may need to scale up through geographic expansion or acquisition in the future.” He says buyers shouldn’t “get locked in a model that is not flexible.”

The suppliers

Ranjan says suppliers now find the midmarket attractive “because of the revenue potential.” The price point is higher in the HR midmarket, he points out. Currently large enterprises typically pay a provider $400 per employee per year. But the average cost in the midmarket is $600. Overall, he says suppliers today “can achieve a profit margin that’s better than the large market.”

This trend holds true for FAO as well. Menzigian explains, “FAO deals involving midmarket buyers often involve a broader scope of processes, along with a greater degree of up-front consultative support from suppliers. The additional cost associated with these components drives up price points.”

Large HRO deals in the past have had total contract value of up to $1 billion, says Ranjan. “But the suppliers have found it has been difficult to make money doing them. “If the suppliers create a standardized offering where they can sign a significant number of buyers, they can make the same money,” he explains.

Giacomelli says suppliers “have to convince buyers their offering is the best for them.” Fortunately, Ranjan says midmarket buyers “are more willing to accept and adopt a standardized solution,” which allows the supplier to pass on the cost savings the midmarket companies need to make the numbers work.

The SAP executive also says suppliers will need subject matter experts (SMEs) to help them build a workable midmarket offering. “They need someone who lives and breathes F&A or other G&A (general and administrative) functions to help them build the financial processes that will work for their next 300 buyers,” he explains.

Suppliers may begin to market their midmarket offerings by industry, unless the process is really the same for all industries, Giacomelli continues. He adds that SMEs know the process economics; for example, they understand how much the cost per unit goes down when the buyer doubles the volume. “In the midmarket suppliers don’t have the luxury of adapting their services to fit buyers. They need to build something that makes sense for a broad audience,” the SAP executive adds.

Having SMEs helps the buyers because the SMEs built the process from industry best practices “which the supplier can scale up to reap economies of scale. Apprentices cannot do that,” he points out.

Giacomelli predicts next year the venture capitalists will fund more pure plays and spin-offs focused on the midmarket. “Midmarket BPO requires a different, more technology-savvy approach. This is the typical turf of the venture capitalists (VCs).”

He adds established suppliers will spin off subsidiaries focused on the midmarket because “standardized offerings are sometimes at odds with the culture, structure, and expertise of the large-market incumbents. Or, suppliers will have two different divisions selling BPO services to either large enterprise or midmarket markets “because the offerings are so different.”

The offerings

Barron says in the past HR suppliers required their buyers to run their HR transactions on the supplier’s platform. But many midmarket companies needed to use the PeopleSoft or SAP HR module. “No one supported SAP HR,” she says. Today, at least five of the suppliers do. “We’re not only seeing an increase in supplier capacity. We are also seeing a true increase in capability,” she says.

Menzigian predicts there will be an increased focus on technology, specifically platform-based BPO. “Buyers like platform-based BPO because it removes that level of responsibility in the organization,” she says. Platform delivery models offer buyers many benefits, but the big two are: getting up and running quickly, usually in weeks as opposed to months, and significantly lower implementation and transition costs.

Tober says suppliers will have to “take their standard outsourcing model and think outside the box using non-standard tool sets” to deliver value to the midmarket. He mentions Capgemini’s relationship with Google as an alternative to MS Office as an example.

Mazor says that employers of all sizes and complexities “are looking for similar outcomes.” However, the midmarket buyers realize they have to accept “a much more limited set of defined standards so that the model works sufficiently and the financials work effectively for both sides of the equation.”

The Fidelity executive says midmarket HR companies typically want “an end-to-end HR solution that covers processes from start to finish.” In addition to processes like payroll administration, next year midmarket companies’ needs demand business analytics and business support too. “They want to manage their workforces better just as larger companies do,” he explains.

Mazor says Fidelity is developing its midmarket program by taking the lessons it learned from its large complex buyers and its small payroll buyers and weaving them together to avoid excess complexity. “We gave our large enterprise offering a fresh look. We’re carefully designing our offer to serve mid-sized employers effectively,” he explains.

Ranjan says the midmarket solutions have lower implementation and operating costs. He says a standard offering at a large enterprise can take 18-24 months to go live. The new offerings allow the buyer to give live in just six months.

In 2009 the “as a service” concept will expand from software to other parts of IT, such as strategy and architecture. “Enterprises are determining they can source higher end functions as well,” says Tober.

Ranjan agrees. He thinks some innovative suppliers will create service offerings around the Software-as-a-Service (SaaS) technology model to decrease the total cost of service delivery for the buyer. “This model gives buyers access to lots of options at an attractive price, “he says.

Clear patterns are emerging within sub-segments of the FAO midmarket. Buyers in the small-to-medium (SMB) segment (less than US$1B in revenue) have a greater propensity than those in the upper-end of the midmarket (between US$500M-$5B in revenue) to go the way of standardized solutions, observes Menzigian.

The Everest Research Institute executive notes that currently the use of offshoring in the midmarket model “is quite low.” Large companies that have signed contracts have an offshore component in 68 percent of their deals while the midmarket only has 23 percent, according to the Everest Research Institute Ranjan predicts that number will change and the use of offshoring will increase.

“The tough part is in the definitions,” says Mazor. “There is still such a big difference of opinion of what the midmarket is that it’s important for buyers to take care in understanding the differences across providers.”

Everyone seems to have their own definition. Capgemini, for instance, defines the midmarket as companies with annual revenues of US$350 million-$1 billion; SAP says its companies with annual revenue below US$500 million. Fidelity uses two parameters — size and complexity — to define the midmarket within HR. The size range is 100 to 20,000 employees. But the companies must also “have a high willingness to adopt best-practices solutions,” says Mazor. “A company with 8,000 employees but very complex HR processes wouldn’t be a good candidate for a midmarket HR solution.”

Everest Research Institute also uses two parameters for HR: the midmarket is companies with 3,000-15,000 employees and outsourcing three or more HR processes.

“How will the solutions really stack up?” asks Mazor. He predicts there will be a growing consensus by 2010. That’s when he thinks there will be a big jump in the adoption rate “once the solutions solidify.”

The future

Ranjan posits over the next few years offering prices will go down because of the increased activity. He also predicts the midmarket will grow faster and have more deals than the large market. And he says he “wouldn’t be surprised if the big names in the large market” announced some acquisitions next year, given the excitement surrounding this market segment.

Midmarket companies have also made a strong showing in the procurement outsourcing space, accounting for 41 percent of active signed deals. Menzigian says midmarket companies are exploring procure-to-pay (P2P) solutions delivered in a platform environment.

Lessons from the Outsourcing Journal:

  • The immense potential of the midmarket is making it the next Holy Grail of outsourcing. The annual revenue potential equals that of the large enterprise market.
  • The midmarket is hot now because of the demanding economy, increased supplier options, and success stories.
  • The buyers are driving the market. They are willing to accept standardized offerings now available.
  • The suppliers need subject matter experts to help them build workable midmarket offerings. They are studying the lessons from buyers of all sizes to build craft their offerings.

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