New Players Enter the Field to Service Buyer's Competitive Needs
Last year buyers using offshore suppliers in their outsourcing mix garnered international attention and some heated political debate in virtually every developed nation. Like many foreign media, the American media woke up to a juicy story: an approximately $15-20 billion industry has been growing explosively, reportedly at the expense of America and American jobs, since the Y2K crisis.
The story was virtually the same in the United Kingdom, Japan, and other major economies. Here's our report:
Trend 1: Companies Must Consider Offshoring to Remain Competitive
What exactly is the story? Offshoring gained a strong foothold last year; Forrester reports, for example, 400,000 American jobs had gone offshore by June 2003. The research firm predicts 3.3 million American jobs will have moved offshore by 2015. Again, a similar trend is happening in other developed nations.
Like it or not, offshoring is becoming a requirement to remain competitive at home. Many large corporations have told us they must send some of their jobs offshore because their competitors have already done so.
But it's more than that. We believe offshoring is a good thing. We are convinced offshoring actually helps a developed economy by freeing up capital businesses can put to more productive use, be it new products or services, investment in new plants and equipment, shareholder dividends, or merely more competitive pricing they can pass to their customers. Our clients report savings up to 50 percent when they move back office processes offshore; and that number goes as high as 70 percent when the supplier reengineers the process for them. An August 2003 study by the McKinsey Global Institute conservatively estimated the US economy nets 12 to 14 cents for every $1 it sends offshore.
Some of the jobs going overseas are low prestige and low paying; however, they are highly valued overseas. Everest's surveys have shown that companies often receive better service when they offshore because the recipient employees are thrilled to have that job. The recipient employees have an opportunity to work in a position that offers an opportunity for future development, have access to a previously unknown sense of relative economic well-being, and have an improved political standing.
Offshoring certainly helps the offshore countries, providing more jobs, education, and opportunity in their part of the world. And, it is wildly more effective than charity or economic aid.
What about the newly unemployed American worker? Data shows that 69 percent of the workers whose jobs migrated to India found a job in six months at 96.2 percent of their former pay, according to an August 2003 McKinsey Global Institute study.
Unemployment is always tough, but change and regeneration are deeply woven into the capitalist system and the flexibility of the labor force is a competitive advantage that over the last 15 years has helped the US turn from an economic laggard to the head of the class.
The benefits and risks of offshoring apply equally to most developed nations. The wage differential of 10x from US to India is not dissimilar to that found in Africa, Brazil, Ecuador, France, Portugal, or Spain. With the notable exception of the United Kingdom, though, most developed nations lack, for better or worse, the labor force flexibility necessary to take advantage of offshore labor arbitrage.
Trend 2: New Players Appear
In 2003 we saw offshore capabilities expand rapidly. Now there is competition -- country versus country and firm versus firm. We saw other countries building their capabilities to win the work away from the current leader, India. Up-and-comers include Bulgaria, China, the Czech Republic, Nigeria, and South Africa. In general the main players in these developing markets are actually traditional suppliers implementing a "best shore" model or otherwise adjusting to client requirements (e.g., multilingual support).
India, the current leader, began to look abroad itself last year. For example, Tata, a large service provider, established a large presence in China (whether this is a multi-year bet, a response to a customer need, or simply offshoring work from India to China is unclear). We predict multi-country delivery will continue to grow this year.
Concurrently, traditional outsourcing service providers like ACS, CSC, and EDS, woke up to the new game and decided that they should market aggressively too. Many bought Indian suppliers or created their own captive companies to handle offshore work. For example, Exult, a human resources (HR) service provider, opened an office in Mumbai, India. We suspect that they decided it was better to cannibalize their business lines while TCS (Tata), Infosys and Wipro were billion dollar companies rather than ten billion dollar multinationals.
Trend 3: Price Deflation and Stock Market Woes
Two factors are causing price deflation for the providers. First, the aggressiveness of traditional suppliers and of offshore sub-scale players (i.e., the approximately 800 Nasscom members that are under $50 million a year in revenue and thus find it difficult to sell to Global 2000 companies) mean that the top tier of offshore providers must hold rates steady in spite of currency pressures. Secondly, the still large gross and net margins (in spite of costly practices such as resource shadowing) are not supportable over time.
The stock market has recognized these pressures. Most notably, Infosys (and many of its direct competitors), a publicly traded Indian service provider, lost 40 percent of its market capitalization last April. At the same time, the rupiah (India's currency) strengthened against the dollar, weakening profits and making offshore suppliers worry about hedging exposure.
Trend 4: IT Becomes Mainstream; BPO Gains Stream
By 2003 sending IT development work offshore was old news. Now offshore IT application and development has entered the mainstream. The trend started in 1997. There weren't enough programmers in the U.S. to handle the Y2K scare, so IT development firms sent coding work to India. They were pleased with the work product and the price and continued to use these service providers. The project work that first went to India in the nineties has changed; the work going to India now looks like long-term American outsourcing engagements in 2003.
Gartner states that IT service providers with resources in India continue to be the dominant choice for U.S. enterprise buyers; the firm estimates Indian providers delivered more than $10 billion of IT services in 2002.
BPO pilots began to take off in 2003. Call centers, human relations, and finance and accounting initiatives began to take hold. McKinsey estimates BPO offshoring totaled $32 to $35 billion in 2002; that's less than 1 percent of the $3 trillion BPO market. But that's fixin' to change, as they say in Texas. The word is spreading about BPO results; that's why McKinsey expects the BPO offshoring market to increase 30 to 40 percent each year over the next five years.
What's Ahead for 2004
We predict the big Indian service providers will move up the value chain, taking on more long-term outsourcing arrangements and strengthening their move into BPO. We have segmented BPO into rules-based transactional outsourcing, judgment-based transaction processing, and full-service business process outsourcing. Offshore firms have been increasingly playing a part in the rules-based transactional outsourcing over the last several years. This would include examples like payroll processing and some forms of claims processing.
However, the big news in 2004 will be the significant move by these firms into judgment-based transactional outsourcing - such as credit card authorizations -- and, on a limited basis, full-service business process outsourcing, which includes revenue cycle management. Infosys, Satyam, and Wipro are companies to watch.
In addition, we predict the Indian suppliers will gain more vertical (industry specific) knowledge as well as more horizontal (process) expertise, knowledge which will allow them to increase the sophistication and breadth of their offerings. That will make them stronger competitors, given their beneficial cost structure.
At the same time the other trends will continue. More countries will enter the marketplace seeking to emulate the success of India. While China has already sent a strong message of market entry with environmental enhancements ranging from intellectual property reforms to tax breaks for foreign direct investment, look for emerging players within eastern Europe, central Africa, and Asia. The traditional players will sell more sophisticated offerings, less sophisticated offerings will cascade to lower cost labor pools, and increasing pressure will come to the cost structures of non-market facing operations located in developed nations. And prices will go down even more, thanks to the competition.
Emerging countries will win market share through traditional outsourcers such as Accenture and IBM, capitalizing on their existing global presence. This is a key advantage that the 'pure play' Indian service providers cannot quickly replicate.
While admittedly US-centric, 2004 is an election year in the US. We predict job losses due to offshoring will be an issue in the presidential campaigns. We don't think the legislative threats will materialize, but they will continue to create anxiety for both buyers and suppliers.
Predictions for 2004:
- New players continue to appear, creating competition.
- Multi-country delivery will continue to grow as suppliers seek the best labor arbitrage.
- Prices to buyers will fall thanks to the competition. This will impact the stock prices of the suppliers.
- Sending IT work offshore is now mainstream; the engagements have moved from project work to outsourcing engagements. BPO is heating up.
- More sophisticated offerings will emerge; less sophisticated offerings will cascade to locations with still lower cost labor pools.
- The Indian suppliers will gain both vertical and horizontal knowledge, making them strong competitors given their beneficial cost structure.
- Job losses due to offshoring will be a 2004 US Presidential election issue.