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Outsourcing is Taking Three Forks

Traditionally, outsourcing has been IT oriented. Today, however, outsourcing is taking three different paths. I see outsourcing falling into three distinct categories: the traditional IT suppliers,† the application service providers (ASP), and the business process outsourcing (BPO) suppliers. Different currents are buffeting each sector.

Historically, IBM, EDS and CSCformed the top tier of the IT outsourcing suppliers. They offer a broad spectrum of technology services in a global setting. The contract size sets them apart from the Tier 2 suppliers, who tend to focus on specific areas. Examples of this group include AT&T Solutions which focuses on network management, ACS and Marconi who concentrate on IT infrastructure, and ENTEX which specializes in desktop solutions.

After a long and sustained period of dynamic growth, the traditional IT market has reached maturity. Although there will be pockets of rapid growth, overall I expect this market to grow about five percent this year.

That number might increase to as much as 10 percent if the economy spirals into a recession. Historically IT outsourcing has grown as the economy slows. When profitability becomes a challenge, buyers focus on restructuring and cost savings. They view outsourcing as a necessary strategic tool to accomplish these corporate goals. In this case, IT outsourcing will be influenced by the rhythms of the economy and faces a brighter future.

In addition, the new Bush administration is more inclined to pursue outsourcing as a way to improve the operation of the federal government. I predict increased growth in federal government outsourcing. And state and local governments will follow suit. The trend toward government outsourcing will continue as the industry builds success stories.

Internet and Ecommerce-Based Outsourcing

Outsourcing’s second segment is Internet and ecommerce-based outsourcing. Last year the market saw explosive growth in this sector, which was driven by the huge infusion of venture capital. The wealth of capital served as a magnet attracting a horde of new entrants.

These new companies had a business plan which based their profitability on economies of scale. Because the business plan required a large roster of customers to make the numbers work, vendors offered extremely aggressive pricing. Too aggressive, as it turned out.

At the same time, the Internet euphoria ruled the stock market during the first half of the year. Then investors shunned these stocks during the second half. Some ASP stocks lost as much as 90 percent of their value from the March high.

This aggressive pricing stance along with a surfeit of suppliers has created a shaky situation for some ASPs. 2001 will see a significant consolidation in the ASP market. ASPs that focus on point solutions will have the best chance of surviving. The strong ASPs will raise prices to survive and thrive. The weaker firms will have to join hands to avoid becoming casualties of the shake out or simply fail.

That said, 2000 proved that the ASP model is a viable way of doing business. The consolidation will winnow out the weak, not discredit the system.

The ASP model is viable because the reason buyers outsource in the Internet space is different than the motivations for traditional IT outsourcing. Speed to market is the driving force behind ecommerce and Internet outsourcing. Buyers outsource so they can have their Internet-based capabilities up and running as soon as possible.

In addition, the Internet outsourcing solution is not as permanent as the traditional IT offerings. Today companies don’t want to spend millions of dollars and take a year to implement an IT solution that they will have to replace in six months. They want the best available right now. The flavor of outsourcing in this space is different.

Because the need to join the ecommerce fray is so great, buyer demand will underwrite continued heavy growth in the Web-enabled market despite the temporary risks. But the fear of vendor failure will hamstring that growth somewhat until the stable and profitable vendors emerge. In fact, I predict this year buyers will evaluate a vendor’s profitability and longevity during their outsourcing selection process.

The inherent risk of doing business with a company that may fail gives an advantage to the established traditional IT vendors. They need the help because they have been relatively unsuccessful in this space so far.

Breakthrough Year for BPO

Hidden behind the surge of interest in the Internet is another important trend: the rise of business process outsourcing. The drive to BPO is happening because companies now believe outsourcing is an essential business tool.

2000 was a breakthrough year for BPO. Last year the big transactions happened in the BPO space. Big companies like Nortel, General Motors and Bank of America embraced the concept and signed multi-year, multi-process, multi-country contracts valued at over $1 billion.

I expect BPO to continue to grow as companies realize they can’t be good at everything. I see no limit to the depth of the BPO value proposition. When a company outsources an entire process like human resources or finance and accounting, the supplier can become accountable for true business results. There is less interdependence between buyer and supplier. Suppliers can assume more control, leveraging their economies of scale, process expertise and access to capital more effectively. I predict every non-core process will have a wealth of BPO providers eventually.

I believe BPO outsourcing will enjoy rapid and explosive growth this year. Gartner Dataquest estimates that BPO will have an annual growth rate of 21.21 percent for each of the next five years. The firm estimates BPO revenue worldwide will reach $543.5 billion by 2004.

And these are still the early days of BPO outsourcing. I believe revenues will eventually level out above† $1 trillion.

This year some BPO providers and ASP vendors moved from the far ends of the spectrum to meet in the middle. They created a new hybrid, the business service provider. I define BSP as a service provider that offers scalable BPO services through the Internet. BSP appeared on the landscape because buyers wanted their ASPs to take over the entire process, not just the applications. BPO providers wanted to control the applications to improve the process. The BSP provides the total solution.

Going Global

This year a significant amount of growth will take place outside of† North America. I see outsourcing surging in Asia, Australia, Europe and South Africa. Globalization is taking place in all three areas of outsourcing. Some of the best BPO thought leadership is coming out of Europe, especially from PricewaterhouseCooper’s London operation.

What do these trends mean for vendors? I believe the traditional IT players will have to get into the BPO and the Internet space. Their size and profitability will be an advantage. But they must learn to focus on an impermanent solution which is different from their traditional mindset. So far Tier 1 and Tier 2 companies are starting to succeed in their moves in this direction.

A much more difficult challenge awaits the IT vendors who move into BPO. Their branding centers around their ability to deliver technology. Buyers, however, want process expertise. These vendors have to prove they can deliver the process and not just technology. To date these vendors have not been able to overcome this buyer distrust.

The specialized IT vendors have fared better. ACS, for example, has been successful in crossing this chasm. It will complete over $1 billion in BPO transactions this year. It became a leader in BPO by creating a completely different division and running it separately from its core business.

The difficulty the big boys are having entering the BPO arena has created an opening for new pure play entrants like Exult and LeapSource.

Buyers in 2001 face a tremendous untapped opportunity for value by outsourcing their business processes. In today’s competitive environment they need to focus on process expertise, not elegant IT solutions.

Lessons from the Outsourcing Primer:

  • The traditional IT market has matured but may grow if a recession occurs.
  • The ASP market will consolidate this year.
  • Successful ASPs will raise prices this year, eschewing the aggressive prices of their early days.
  • The major transactions occurred in the BPO space last year. BPO currently offers the deepest value proposition for buyers.
  • All markets will enjoy an increase in business from global buyers. Thought leaders are also coming from abroad, especially from Europe.

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