How changes in the outsourcing world will affect outsourcing in 2007

January 26th, 2007

20To paraphrase Robert Kennedy, we live in interesting outsourcing times. As we face 2007, two forces are gathering speed like hurricanes brewing in the ocean. I foresee major changes occurring as these trends blow through the marketplace.

Trend No. 1: A Dramatic Increase in Demand
The first change is the dramatic increase in demand for outsourcing. One stimulus for this increased demand is buyers have discovered the value of labor arbitrage and now understand how to use this powerful business advantage. Those vaunted savings are real! And outsourcing has become (finally) an accepted business practice, shortening the learning curve and the sales cycle.
For example, the Everest Research Institute predicts demand for Applications Maintenance and Development (ADM) outsourcing will expand by at least 2.5 times in the next three years. Currently, total demand totals $7.7 billion which will grow to at least $18.62 billion by 2009.
At the same time, applications outsourcing provides a powerful springboard for buyers to expand their engagements to include BPO, which further deepens the market.

Trend No. 2: Major Changes in the Supplier Landscape
Increased demand should be great news for outsourcing suppliers. But the second major change is mitigating this. The number of suppliers has exploded. There used to be three major global suppliers with half a dozen second-tier organizations plus a handful of niche players. No more. Currently the Everest Research Institute reports there are more than 4,000 outsourcing suppliers; 3,200 are in India alone.
Now, more than ever, it’s become trickier to select the right supplier since there are so many to choose from. We believe there are now too many suppliers, so their numbers will contract. That adds another variable in the dating game.
Then add another layer of complexity: location proliferation. In the old days (two years ago), buyers interested in offshoring would tell us they wanted to send their work to India. They had no other locations to consider.
Today, the Everest Research Institute tracks over 150 cities to determine the most attractive location for our clients. In keeping with the industry’s new direction of specialization, different locations around the globe have chosen to become experts in specific types of outsourcing. For example, Eastern Europe has become the low-cost support area for European languages. It offers a better cultural fit than non-European locations. Central and South America have become convenient spots for real-time processing for North American companies. India is still the leader in overall BPO support.
Buyers have a third option: setting up their own captives instead of sending the work to an offshore provider. We predict the number of captives will continue to expand in 2007 because of low entry barriers, the desire to capture supplier margin, and the need to establish a base to grow local market presence. In addition, many companies want to bank the offshore savings on their balance sheets but still maintain control over customer contact. A captive allows them to do just that.

What These Changes Mean to Buyers and Suppliers

In 2007, suppliers stand at the door of a brave new world. The proliferation of suppliers has spawned new risks in the once-stable supplier base, which will change supplier behavior. Margin compression and industry consolidation will be the hallmarks of 2007.
Last year we saw margin compression for “pure-play” offshore suppliers, which we believe will become more pronounced next year. Several factors are contributing to fewer dollars or rupees flowing to the bottom lines.

First, price competition from offshore and traditional suppliers will continue to increase in the coming year. Offshore providers now have more overhead in higher-cost locations; they have increased their onshore presences and created vertical marketing and sales organizations, which add cost to the balance sheet. Finally, labor rates are becoming more difficult to contain.
Industry consolidation is another certainty for 2007. There are just too many suppliers.
We see a large number of sub-scale suppliers with undifferentiated offerings who have “sticky” books of business. Their client rosters make them good acquisition candidates.
At the same time, Tier-Two suppliers are looking for opportunities to be acquired or to form partnerships while the traditional players need to expedite the growth of their own offshore capabilities. MphasiS’s agreement with EDS last March is a good example of a trend we see accelerating in 2007. This agreement extends EDS’s reach in India and gives MphasiS access to a major player’s clients.

Outsourcing buyers face equally complex challenges. First, deciding how to proceed has become much more difficult than when India was really the only choice. Second, buyers have to change they way they think about outsourcing strategies.
Just as difficult, buyers in 2007 now face enterprise issues as well as the project issues when they send work offshore. For example, governance becomes especially tricky. How do you monitor risk? Manage the transition? In addition, buyers now have to identify synergies that become available as they outsource more processes. And managing risk, historically always present in outsourcing relationship, becomes trickier yet. These changes will force buyers to develop new supplier engagement models.

The good news for buyers is that they probably will pay less in 2007 than they would have for the same services in 2006.
Of course, if I could accurately predict what will happen in the outsourcing market (or the direction of interest rates), I’d be skiing all winter in Aspen before heading to the Caribbean. I do know for sure that next year will produce interesting times for all outsourcing players.
Lessons:
Two trends will change the outsourcing marketplace in 2007: the increase in demand for outsourcing services and the changing supplier landscape. That includes the proliferation of suppliers–there are now over 4,000–and the increase in offshore locations. In addition, the number of captives will continue to grow.
Suppliers face margin compression due to price competition, an increase in overhead, and rising wages.
Buyers face tougher outsourcing decisions since there are more choices. They also will have to rethink how they create relationships with suppliers. The good news: prices are falling so they will be able to pay less.

17 Nov 2006
By Peter Bendor-Samuel, CEO, Everest Group

Source: Everest’s Outsourcing Center
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