What Is the Investment Profile of Your Service Provider? | Sherpas in Blue Shirts

Posted On August 29, 2012

Like many financial investors over the past decade, my portfolio resembles a buoy floating on ocean swells. Most of the “ups” have been offset by painful “downs,” and the real growth has come simply from saving more money. At this point, I often wonder if I am actually investing, or just riding out a storm and hoping for the best. I fear the same is true of many organizations and the relationships they are continuing with their service providers.

Those of you who attended last week’s Market Vista webinar will recall that we spent some time looking at the service provider landscape in banking applications outsourcing. One of the key takeaways from our assessment of this competitive landscape (one of the largest outsourcing markets, with over US$6 billion in annual revenue) is that the players most improving relative to their peers have targeted their investments on technology (e.g., HCL with Capital Stream, Polaris with Intellect, and TCS with Bancs).

At the risk of sounding like a broken record, the market must find ways of creating more value beyond just labor arbitrage. First, yesterdays or today’s successes get no credit next year – competitive pressures require moving forward. Second, the arbitrage-centric model is okay, but not great. Maintaining satisfaction – let alone improving it – is elusive. Quite simply, it is too dependent upon too many people, and people are not as reliable and consistent as we would like to believe. Think about it: do you prefer a switchboard operator or your personal contacts directory in your smart phone?

My strong, strong belief is that users of third-party outsourcing services need to pay increasingly close attention to the investments their service providers are making, and re-align their relationships accordingly. This applies primarily to technology-related capabilities, but also to other areas such of geographic scope, domain knowledge, partnerships, and others.

But haven’t we been investing already?

While there have been some investments, many of the hard-dollar investments to date have really just been in creating fungible scale – seating, recruiting pipelines, sales organizations, and training for resources that could be used in multiple ways. They were largely about how to expand the existing business into new, but roughly similar markets. Few of the “investments” were hard choices between one or more options to create meaningfully different and new types of value. For example, having a building for employees to work in is only a question of estimating demand and therefore size of the space, not whether a building is required.

Other than a few acquisitions of Global In-house Centers (GICs or captives), such as Citi’s by TCS and UBS’ by Cognizant, there have been few larger scale bets on enhancing capabilities. Many service providers have been incrementally optimizing capabilities with an extra million dollars here and there. Occasionally, a firm has bought a technology capability for tens of millions of dollars. HCL’s acquisition of Axon, (£440 million), is the largest capability expansion that comes to mind in the past five years – and it was a bet on combining two different, but seemingly complementary, types of value propositions (Note: I consider HP’s mammoth acquisition of EDS to be industry consolidation, not fundamental capability enhancement. The pending US$2.6 billion acquisition of Logica by CGI is both consolidation and capability enhancement).

Overall, the investments have been very tightly aligned to expected revenue streams that could create fairly quick pay-off, and often just mimicking what others were already doing rather than boldly breaking the mold or venturing into truly unknown territory.

What can break the mold, and how it changes everything

If service providers continue to largely mirror each other’s capabilities, we will continue to end up with 10, 20, or more service providers that largely do the same thing, and are not particularly differentiated. To create true and sustainable differentiation, an organization must be able to do things that others simply can’t do (i.e., it’s not a question of “getting the right team”).

Technology is the strongest lever for creating defensible differentiation, but it tends to be a big and sustained bet. Done correctly, leveraging investments in technology across multiple clients generates powerful economic returns not only for a service provider but also for its clients who can ride a rising tide of capability as network effects take hold and more investment is added to the solution.

I don’t want to suggest that big bets on technology will be appropriate in all areas. However, technology investments in areas in which they will make a difference will in turn drive a radical alteration in the service provider landscape. So instead of 10 or 20 service providers, we’ll be down to two or five – far fewer of these types of investments will be able to create a positive ROI, so there will be fewer providers that try, and fewer that are successful. Quite simply, the world does not need 20 service providers building and maintaining a core banking platform or 10 running a global payroll system. Further, when considering big bets on technology, the world suddenly breaks into hundreds of possibilities, and no service provider can afford to pursue and sustain more than a handful of them.

The implications of technology investments for clients will be that some of their service providers will look increasingly dissimilar, and no longer considered interchangeable. This is both a good and a bad thing. Clients will be able to gain greater value and have more types of solution models to choose from, but they will have fewer choices within the higher value solution models. The fundamental economics of investments dictate that any high investment service will naturally restrict the service provider landscape.

Client implication #1: be thorough in your understanding of how service providers are investing, and in what type of solution you want now and ideally in the future.

Client implication #2: implication #1 applies both to your existing service providers and others you may not be using – are you aligned with the providers investing in the direction in which you want to go for your priority services?

Client implication #3: implication #1 also applies to your existing providers’ service delivery areas that you are not currently using – is your industry or function receiving priority investment, or is it an after-thought?

If you want the extra value, it will require extra investment by service providers; and that will lead to less choice within a particular solution type. This means we will move from a sea of service provider options to lots of smaller ponds tightly organized around well-defined service delivery capabilities.

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