Sunil Chitale, Senior Vice President, Patni Computer Systems, a global IT consulting and services provider headquartered in India, sums up what's happening with offshore outsourcing--"It's changing dramatically."
Here are seven trends among the dramatic changes that every large enterprise and mid-size business needs to understand when considering offshore outsourcing in 2007.
Trend #1: Service Providers Face Game-Changer Challenges
Challenge: New Competition. "For seasoned companies and new players, the shrinking barriers of the globe are proving to simultaneously be an opportunity and a challenge," states Bret Allinson, Senior Vice President, Global Delivery, HP Services.
Mark Fulgham, Vice President, IT Outsourcing, HP, says "we'll probably soon see the Big 8 or Big 10 of instead of the current Big 5 or Big 6 outsourcers." This change is due to the fact that some pure-plays coming out of India are becoming hybrid players, complementing and competing with some of the traditional players. Fulgham believes the current trend of alliances and acquisitions will continue to grow. "There is a need to bring forward a larger playing field that not only has a services orientation but also upstream application acumen as well," he explains.
But that's not the only competitive play happening in offshore outsourcing. Offshoring is now an integral component of most outsourcing deals, so the big US-based players such as IBM, Accenture, HP, and Unisys (as well as UK-based BT) are scaling up dramatically in locations such as China and India, each adding thousands of people among their offshore resources. Companies looking to offshore service providers can now consider the US- and UK-based providers along with the local providers that are native to a particular country.
"This changes the game dramatically," Chitale comments. "The US-based providers already have a great hook in the US market; have the business relationships and can do the golf-course rounds, etc.; and now they can bring to the table a local country proposition too. So Indian companies are now competing with large US companies for services delivered out of India."
But Nikhal Rajpal, Vice President, Everest Research Institute, says the entire global market is up for restructuring. "There is a lot of new competition and a lot of the market is up for grabs." He predicts "the global market will look very different two years from now and offshore players will have a large market share."
Everest Research Institute currently estimates there is around $88 billion in outsourcing deals up for renewal during 2006-2008. "This is a huge opportunity for restructuring with a different set of winners and losers," says Rajpal.
Challenge: Talent Supply Chain. Recent headlines in the US media reacted to NASSCOM reports indicating a potential shortage of talent in India that could be severe in the next four years. Indeed, the industry now faces threatening talent wars.
The impact of the US-based providers puts a strain on the supply chain for talent, Chitale says. "Earlier when we went to campuses for recruiting, we would find someone from IBM or Microsoft there too. But now we find that the Who's Who of the IT world is in India recruiting." Talented Indian workers now have many more employment opportunities.
New provider competition is not the only source of the talent supply chain challenge. Rajpal says the root of the talent war is not just that BPO and ITO are growing very fast in India but that the overall Indian economy is growing very fast at the same time.
"There are hundreds of thousands of new businesses created in India daily--car companies, retail stores, airline and taxi services, companies such as Nike, etc.--causing the need for a huge number of employees and providing a huge number of very good jobs in the country," Rajpal explains. He notes that fewer than one million jobs for India's one billion people are related to outsourcing; similarly, outsourcing accounts for only an approximate US$30 billion of India's US$600-700 billion economy.
"The talent wars are only going to intensify and all the big players now have huge issues with this," reports Rajpal. Thus he says "the big crunch for talent" is forcing providers to look elsewhere, to Tier-Two and Tier-Three cities in India and to Southeast countries such as Vietnam, Thailand, and Kuala Lampur. This is primarily relevant to BPO services, as ITO has for the most part already moved to alternative locations.
"Moving to Tier-Two and Tier-Three locations means the providers' risks will go up," predicts Rajpal. In addition to the poor infrastructure (power, roads, transportation, buildings, etc.), he says "the quality of the talent will drop, so the providers will be forced to invest in training and management in these locations."
"The talent shortage definitely is an issue, and providers have to get smarter about how they deal with this," states Tony Viola, Vice President, Marketing at Patni Computer Systems. He says the critical talent availability challenge can partially be resolved in the area of education.
"Providers are now getting much more involved in the education process within the country," says Viola. "Providers are pressing government to make reforms relative to ensuring that there is a deep talent pool available in the country by relaxing and/or accelerating some of the laws that govern private investment in educational institutions in India."
"We have seen examples of providers partnering with local universities and colleges to introduce curriculum changes," says Anand Ramesh, Senior Research Analyst, Everest Research Institute. "Especially in the smaller cities, where employability levels of the workforce are low, providers are driving changes that improve IT readiness and BPO readiness."
As a result of the talent wars, providers now need to invest in ways to deliver their services so they are not dependent exclusively on people. Many of the larger Indian providers, Viola says, "have business models that depend entirely on manpower to deliver their core competencies. "The ability to deliver more and more services in an automated fashion allows the provider to drive down its costs of operation, passing some of that along to clients as well as improving the provider's margins." (For another aspect of this discussion, see "What You Need to Know to Avoid Outsourcing Risks in 2007" in this issue of Outsourcing Journal)
However, Viola points out it's difficult to shift away from a people-based model. "And there is also a struggle in India around social consciousness--having an obligation to put people to work." Smaller companies, he says, can more easily adapt to other delivery techniques.
Challenge: Differentiation. The quickly growing pool of employment opportunities for talented Indian workers presents another challenge for providers. "Indian companies now need to know how to differentiate their companies in order to get more employees and retain them," says Chitale. He warns that attrition rates are high and heavy pressure will be felt on the supply side of talent for the next couple of years as the big players continue to scale in India.
Differentiation of the Indian outsourcers comes into play on another competitive front. Buyers looking to outsource and attending the dog-and-pony shows of potential providers in the US are finding the process is not so simple in India.
"Buyers do what I call the 'pilgrimage of India,'" Chitale says. "They visit six suppliers in six days, go through similar presentations (including the history of Indian outsourcing, etc., six times) where you could delete the provider's name from the presentation slides and substitute another company's name and the presentation would be identical and still work for both companies. The guy at the sixth company on the pilgrimage has a tough job."
In the current hyper-growth mode--where most Indian providers are growing at 30-40 percent--there is a flavor of commodity. A commoditization mind-set is evident when customers ask: "We need 200 people in Java; can you provide them six weeks from now?"
"If we are to maintain our value propositions aside from commodities, we will have to figure out what value we bring and how we're different from each other," states Chitale. "Differentiation is becoming another big challenge right now."
Viola says one way that providers can differentiate themselves is delivering services in a way that is "not exclusively tied to cheap provision of good people."
Trend #2: Buyer Expectations Moving Away from Low-Cost Solutions
Chuck Pol, President, BT-Americas, points out that companies today are not as focused on chasing labor arbitrage benefits as they have been. "Labor arbitrage, be it offshoring or rightshoring, is a fundamental business strategy that many organizations have employed over several years. But the location for lowest-cost labor continues to shift as new markets emerge," says Pol.
He adds, "Trying to keep up with the lowest cost is not commercially feasible. Obviously, you want to take advantage of low-cost markets, but chasing them can be a very cost-intensive way of doing business."
According to Pol, BT (British Telecom) notes that its clients are focusing more now on driving competitive advantage and optimization through process efficiency and leveraging new technologies (such as converged voice and data infrastructures) rather than through labor arbitrage.
Trend #3: Market Segmentation
The scope of customers for Indian services has grown, Chitale reports, with mid-sized companies getting into the game. But their needs and expectations differ from the larger enterprises.
Large enterprises, for example, query Indian providers with something like: "Can you help us with the supply chain challenge we have?" Mid-size buyers come with requests such as: "We don't have the capability or skills to execute and meet the business needs that are required for our supply chain process, so why don't you run this business process for us (or maybe even host it) and also tell us how it can be improved."
Currently, providers typically try to meet the needs and expectations of both buyer groups, though Chitale reports they are beginning to segment within their companies how to manage the resources that need to be deployed to meet the two sets of divergent needs, as well as the governance that needs to be in place.
Segmentation is also occurring because the buyers decide they are more comfortable with a larger provider or a mid-size provider, either because of expertise and resources or because of wanting to ensure the buyer won't be lost in a large provider's portfolio of clients. It also happens because newer players are entering the market with niche services. There is, for example, a trend of providers doing only verification and validation services for application testing. Segmentation also is beginning to occur around providers with vertical domain knowledge (i.e., insurance industry expertise).
Trend #4: Knowledge Management
Large companies are "pushing more and more work in the outsourcing model today but are also trying to get more and more control of what they are outsourcing," says Chitale. So the governance structure is expanding, and there is a much closer watch on the providers.
Sarbanes-Oxley brought to light the need for companies to know whether they have the right people on the job, whether they have gone through background checks, whether their knowledge is preserved in some sense, as well as how much of the knowledge resides in employees in the US or the UK and how much resides with service providers in another country. This trend arose from buyer's fear of losing control over the process knowledge.
"There can be a risk for buyers where the process knowledge (not necessarily intellectual property) resides, for example, in a team in India or China," Chitale acknowledges. "There is a sense among buyers that they will, perhaps, lose their knowledge base through outsourcing--and then what would happen if they need to bring the process back in house," he explains.
In the early days of outsourcing, where the work was often still performed on the buyer's premises and employees were re-badged, a buyer could easily bring a process back in house. That's not the case with processes offshored thousands of miles away with support from people who were not originally the buyer's employees. (For advice on mitigating the risk of knowledge loss, see "What You Need to Know to Avoid Outsourcing Risks in 2007" in this issue of OutsourcingJournal.)
Trend #5: Globalization of the Workforce
Fulgham at HP notes that "companies are starting to really grasp and appreciate that there are certain things that are worthy of exploring in a global kind of sourcing model. Global companies today want the best availability of the best skills across the globe to deliver the highest value at the best unit price."
Pol at BT agrees. "We see a trend toward right-sizing--that is, global footprint structuring to leverage the advantages of the global economy." Large enterprises want a consistent look and feel for services throughout the global environment. They also want increased flexibility and operational excellence.
The trend of globalization is also impacting decisions about where the outsourcing service providers locate their delivery centers. Just as Accenture, HP, Unisys, BT, and others have set up camp in India, the Indian service providers are starting new delivery centers in locations outside India. Patni, for example, has development centers in the US and UK and is exploring other low-cost country options.
"Both India-based and global multinational providers are expanding their delivery network in other regions," comments Ramesh. "Over the past year, there has been an increased interest in Eastern Europe. We expect to see continued interest in Eastern Europe and the emergence of Latin America as important centers of offshore activity."
There are two angles for Indian offshore providers moving to other low-cost countries. First, the providers' large global customers with operations in China, for example, want to service their China needs with a local entity because of the language and regulatory issues. Secondly, it mitigates the provider's talent-supply-chain risk in India by tapping talent in Eastern Europe, China, and other locations.
"We are finding that to be a global provider today, one has to hire more and more local teams," Chitale says. Patni, for instance, recently opened several small development centers in the US to tap US talent and establish a local US presence. Such global dimensions change the near-future workforce composition dramatically. The largest providers, such as IBM, already have employees of nearly every nationality on their teams, and client demand is driving other providers to have a more global workforce composition.
Trend #6: Captives
Captive offshore operations is a trend that continues to grow. According to Rajpal, "more companies have established captive offshore operations during the past three years than ever before because there are companies that still feel the need to control their work happening 10,000 miles away."
But the captives trend is also changing in two respects.
First, Rajpal notes that the offshore captive operations of many companies--such Dell and American Express--are now more mature. "As they mature," says Rajpal, "they do more high-value work, such as securities analysis or engineering, in their captive centers and outsource work such as accounts payable to outsourcing providers."
Second, Viola at Patni, however, comments that some companies with captive centers have found they underestimated the substantial investment of capital and management effort that are critical for success. In addition to the costs of continuing to maintain best-of-class operations, he says that "competing for talent is a significant challenge that takes a lot of intestinal fortitude that many companies underestimate when they start out to set up a captive."
As a result, Viola says some companies are turning to Indian providers like Patni to take over the captive operations. They are exploring what he says the industry is calling "virtual OEMs." In this model, the enterprise maintains its name on the outside of the facility but "an Indian company is actually running the whole shebang on the inside."
Trend #7: New Process Growth Areas in Offshore Outsourcing
Recent trends highlight three primary areas where outsourcing will quickly grow in offshored processes in 2007 and 2008.
Infrastructure Management. Beyond monitoring Web servers and networks remotely for customers over the last five or six years, there has been little traction in outsourcing infrastructure management to Indian providers in the past (those deals went to US-based providers). But that is changing. Because buyers' trust level of Indian expertise has increased, they now see advantages to moving remote management of infrastructure--including entire data centers--to Indian providers.
To date, though, few Indian companies have jumped on board for this work without a partner. "Buying the facilities, re-badging employees, and running the whole operation is a capital-intensive play that not many Indian companies have ventured into yet," reports Chitale. "But it is happening. An Indian provider may not be able to acquire a customer's data center on its own, but it can accomplish the value proposition jointly with a US partner."
We're in the early phase of this trend of buyers asking the Indian providers to take on infrastructure management, Chitale says, although there were a couple of mega-deals of this sort during the past year.
Back-office IT Platforms. A second area of growth is outsourcing the platforms that run back-office processes. "This is a completely different scenario from just business process outsourcing," explains Chitale. "Customers are saying, 'We want out of IT. We want you to take our business process application and infrastructure and manage it and the licenses, etc. and let us pay for your service per use' ("by the drink"). So we as the provider wouldn't just have people doing the process; we would also own the platform that runs the process."
There are some examples of these types of deals recently, and Chitale believes this trend will continue and produce some mega-deals within the next two years.
Product Engineering. "This is happening out of India and China, and it's an area that is really growing rapidly," states Chitale. What's driving this growth? Companies in today's highly competitive arena know that arriving first at market with new innovative products is a huge competitive advantage. Consequently, companies are looking to shorten their product-development cycle. Chitale explains the value proposition of the offshore strategy: "Clients can introduce products faster because there is more talent working on an idea at the same cost."
"Smaller companies in a variety of offshore locations are exploring ways to speed up the development process, gaining an IP edge and building a knowledge base in their respective offshore locations," says Allinson at HP. "Not weighed down with legacy infrastructure, these companies are delivering products faster with as high or higher quality than the bigger companies and for less cost, which is creating a very aggressive market."
Thus, low-cost labor is a driver for growth in this area, but Chitale comments that "many customers have no problem paying top dollars for top-notch work. This work is very different in that it requires highly skilled people who are focused on innovation and new-product development."
Buyers view this outsourcing strategy as expanding their innovation capability globally. Innovation that used to be sitting in only one place now comes from collaboration of teams that are spread all over the globe developing the same product.
Some providers also reap bounty from an offshoot of offshored product-engineering outsourcing. In this scenario, the provider also supports a client's products that will be introduced in a couple of years. "When their field engineer visits their customer and has a problem, or when the customer calls, we service those calls and solve the problem," explains Chitale.
Viola at Patni says there are three other significant areas of growth in offshore ITO. "High on the list for meeting our customers' demands are investments in Service-Oriented Architecture (SOA), Web services, and business service management," he says.
Business service management is something clients add to the scope to a relationship over time. The provider not only maintains applications but also provides information to the client's business managers about the business transactions enabled by the applications. "Clients need the ability to see and understand their business flow trends that a particular application set represents," explains Viola. "Given their knowledge of the underlying application architecture, providers are in an ideal position to deliver this type of information as well."
According to Viola, this activity has been occurring in the past year and is growing. The fact that buyers are turning over their business service management functions to an Indian provider demonstrates a growing level of trust in offshore providers' capabilities. As Viola says, these types of services indicate a business-oriented relationship beyond a body shop. "Once clients see a clear track record of meeting and exceeding business requirements, they look at us as more of a strategic partner and open up more sophisticated business opportunities for partnering," he says.
Joe Hogan, Vice President of Strategic Outsourcing Programs, Unisys, says the only real issue remaining in offshore outsourcing is "how to do innovation more effectively in that environment." He believes the key will be real-time communications. "As soon as somebody figures out how to economically put in place networks that enable real-time communications in multiple countries at the same time, it will create a real advantage for clients," says Hogan. "Service providers will be able to apply the best intellectual capital real time at multiple locations worldwide to a client problem around application, process, or infrastructure."
Lessons from Outsourcing Journal:
- Because offshoring is now an integral component of most outsourcing deals, the big US-based players like Accenture, HP, Unisys, and BT are scaling up their people resources dramatically in locations such as China and India. This means that companies looking to offshore service providers can now consider the US companies along with providers native to a particular country..
- Because of a huge volume of employment opportunities emerging, attrition rates are high among provider resources in India, creating pressure on the supply of talent. All providers need to better differentiate their companies in order to get more employees and retain them.
- Providers in India are moving to establish operations in Tier-Two and Tier-Three cities as well as Southeast Asian countries. This strategy has risks due to poor infrastructure and lower quality of talent, which will necessitate investments in training and management.
- In the hyper-growth mode India now enjoys, clients are taking on a commoditization mind-set. Providers are facing the challenge of differentiating their services from each other and demonstrating value that is not viewed as a commodity.
- Low-cost labor locations shift as new markets emerge, and chasing low-cost locations can be a cost-intensive way of doing business. Alternatively, value can be achieved by driving optimization through process efficiency and leveraging new technologies
- Buyers face a risk of losing control over their process knowledge when the process resides thousands of miles away. Sarbanes-Oxley highlights the need for companies to fully understand which part of their knowledge resides in the home country and which resides with outsourcers based elsewhere.
- The trend of globalization is changing the service provider workforce composition, and providers need to hire more local teams to meet their clients' expectations.
- Currently, companies are rapidly seeing the competitive advantages of shifting three processes to offshore providers: product engineering, ownership of IT platforms supporting back-office processes, and remote management of US or UK data centers from India.