Experts in the global services terrain
Lewis Carroll is famous for his novel, “Through the Looking-Glass, and What Alice Found There.” In this whimsical world, everything starts out as familiar things but, on examination, turn out to be nonsense. It puts me in mind of many service providers’ sales pitches.
Perhaps my favorite part of the Looking-Glass novel is Jabberwocky, a poem in which Carroll strung together nonsense words. When put together, they sound impressive and one wants to believe they tell a story. But as you can see in the verse below, the words are just nonsense.
’Twas brillig, and the slithy toves
Did gyre and gimble in the wabe:
All mimsy were the borogoves,
And the mome raths outgrabe.
It’s like service providers’ sales teams that talk to potential clients about a transformation agenda and driving business value from IT. They throw in words such as “agility,” “flexibility” and “cloud.” Or phrases such as “consumerization of IT” and “as a service.” They even sprinkle in entire sentences such as “outsourcing will allow you to variabilize costs.”
These pitches sound wonderful and sound like there is deep thought associated with what the speaker says. But on examination, one finds the claims are largely nonsense. For instance, there is no variabilization of costs; it’s virtual, and there is little time to business value. And the supposedly agile environment is anything but agile.
It’s very easy to grasp for platitudes and read blogs and take the ideas without really understanding them.
So just like Alice, we find ourselves asking, “Which way should I go?” Well, like the Cheshire Cat says to Alice, “It all depends on where you want to get to.” Providers’ impressive-sounding presentations, on examination, are often just gobbledygook and attempts to intrigue the audience and get them to buy services. But they fall apart on close examination.
Successful sales depend upon a clear understanding about what the customer and provider will try to accomplish, how they will do it and the steps necessary to accomplish the goals. The best presentations use common, plain language to identify the issues and how to meet the goals.
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Yesterday, Computer Sciences Corporation (CSC) announced that it was splitting the company into two independent, publicly-traded entities – U.S. Public Sector and Global Commercial. The split, expected to be completed by October 2015, will be accompanied by a special cash dividend of US$10.5 per share. After the bifurcation, the U.S. Public Sector business will focus on federal, state, and defense customers within the country, and employ 14,000 people. The remaining 51,000 employees will be a part of its Global Commercial business that will focus on commercial customers, and public sector organizations outside the United States. The two businesses generated US$4.1 billion and US$8.1 billion, respectively, in annual revenue during FY2015. Everest Group’s CEO Peter Bendor-Samuel shared his top-level insights shortly after the announcement. Following is our evaluation of the different potential scenarios arising out of the split.
Last attempt to avoid a buyout?
The announcement comes after the latest set of rumors about CSC’s potential sale. In February 2015, Carlyle Group and Capgemini were reported to be in talks to jointly acquire the company. Around the same time, CSC was said to be working with Royal Bank of Canada to review buyout options. Similar reports emerged in September last year with CSC exploring leveraged buyout via multiple private equity firms, including Bain Capital and Blackstone Group. CSC’s buyout (if it had materialized) would have been the largest leveraged buyout since Dell went private for US$16 billion in 2013. However, the talks over the year fizzled out as buyers baulked at CSC’s expected valuation.
If this move is a precursor to a possible sale, the question comes around to the identity of the suitor. Rumors have floated about interest from HCL and Accenture, but things don’t add up with those two suggestions for a number of reasons. HCL already has what it needed from CSC through its alliance, and Accenture already enjoys pole positon in the consulting markets, so they would have to radically depart from their infrastructure strategy to take on the CSC asset base. Given that Accenture is integrating infrastructure with operations as part of its GTM (go-to-market) strategy, we do not see the change in strategic direction that would indicate acquisition of an asset like CSC. A more plausible candidate would be someone looking for scale in the North American enterprise market with allied economic models creating scale and IP synergies.
The decision to split can be viewed as the culmination of CEO Mike Lawrie’s efforts to revitalize this ailing company. Since his inception in 2012, CSC has witnessed firm-wide cost takeout measures as a part of the “Get Fit” phase of its turnaround efforts. Attributable to these efforts, the company managed slight melioration in its operating margins during FY2014 and FY2015. Recognizing the fact that the cost takeout measures have already liquidated as enhanced bottom-line, and in the absence of a successful buyout, the management has settled on forming two separate business entities catering to different customer segments. Increasing profitability and value for shareholders could also shore up CSC’s valuation.
Apart from catering to different customer segments, the two entities have inherently exhibited great divergence in terms of their growth profiles and cash flow dynamics. The Global Commercial business has faced strong tailwinds, with revenue in FY2015 declining due to contract completions and lack of new opportunities. On the other hand, the Public Sector business managed to maintain the figures, backed by demand for next-gen IT solutions such as cloud. As it gears up for a potential sale, the government business is potentially value dilutive, and may not find many takers. There’s also an aspect around risk compartmentalization – troubled contracts in the federal marketplace can get service providers stuck in long-drawn out lawsuits and punitive damages.
Keeping this context in mind, splitting the overall businesses can play out in a number of different ways for CSC. It can help offload the new entities of assets not core to their business, enabling them to be more strategic in serving clients and pursuing new opportunities. The new entities will be in a better situation to position themselves as specialists in their respective markets. While this may not be a pivotal factor for the Global Commercial business, it could be a turning point for the Public Sector business, wherein, organizations increasingly seek to engage with specialized technology partners. Despite the split, both entities stay as multi-billion dollar businesses, thus, ensuring that none of the two entities face any scalability issues in the market.
With its decision to split, CSC joins the league of technology companies that have lagged in adapting to the changing market dynamics (shift to mobile, cloud computing, and the As-a-Service economy), and are splitting up in response to market pressure. Last year, HP, another service provider plagued by similar challenges, announced a similar split. Two years ago Science Applications International Corp. (SAIC) went down the same path and spun off its government technology services business as SAIC and rebranded itself as national security and engineering company Leidos Holdings Inc.
While the ultimate success or failure of such a strategic move is murky at best, it is beyond doubt that a rapidly disruptive and evolving services landscape will lead providers to ponder hard choices. In the last year we have seen multiple instances of this realization translating into different maneuvers – movement towards an integrated value proposition (Cognizant-TriZetto), geographic/vertical expansion (Atos-Xerox and Capgemini-IGATE), and focus on next-generation tenets (Apple-IBM). As this continues to happen, expect more industry churn, realignment, and consolidation.
CSC announced it is splitting into two companies. One will provide service to commercial and government organizations worldwide; the other will serve the U.S. public sector businesses. What are the implications for the services industry?
CEO Mike Lawrie has been running CSC’s turnaround. The story line he drove was that he would first drive earnings and then fix growth. He has been spectacularly successful in driving earnings, but the pivot to growth hasn’t worked so well.
Certainly there were rumors that CSC was up for sale, but it didn’t transpire. We believe this split into two entities is the natural next step, especially since it comes at a time when the industry is maturing. The separation allows CSC to behave differently.
Everest Group believes the federal component will become an attractive acquisition target with both defense contractors and private equities interested in the consistent cash flow and book of business.
The commercial side may also attract interest, but from a different group. Certainly there has long been speculation that one or more Indian-based service providers may have an interest in acquiring CSC’s infrastructure-based business. It would be a large acquisition with substantial adjustments as the Indians move the book of business to their labor arbitrage model.
For both of the new entities, whether they are acquired or remain independent, the split should allow them to focus more strongly on growth at time when growth is coming at a premium.
Over the years we have seen Capita successfully expand from one market sector to another in the UK and Ireland. Since 1984 when it only served the UK local government sector, it has expanded into seven major verticals and over 15 segments of those. The latest expansion plans take it beyond the UK and Ireland borders into DACH, with Germany being a primary target market.
Capita’s new geographic growth strategy has seen it make three acquisitions in the DACH region (Germany, Switzerland and Austria) in the past year:
- tricontes – the £6.2m acquisition of this Munich-based company in June 2014 brought Capita specialist contact centre services across the retail, telecommunications, utilities and insurance sectors in Germany
- SCHOLAND & BEILING – a customer care consulting company also based in Munich, Germany
- avocis – announced in February 2015 and if successfully completed, at £157m, avocis would be one of the bigger Capita acquisitions. It would bring Capita 6,500 employees and a portfolio of customer contact management services contracts in DACH. Although headquartered in Switzerland, Germany is avocis’ biggest market, accounting for 53 percent of revenue. The rest comes from Switzerland.
Capita has a formulaic approach to acquisitions with a budget of £200m to £250m per annum. It considers many potential acquisitions each year, selecting a dozen or more that fit its formula to:
- Increase scale
- Add new expertise to enhance its propositions
- Take it into new markets.
In addition, the acquisitions have to make a Return on Capital Employed (ROCE) of 15 percent post tax return after 12-months integration into the group.
Capita recently also acquired 700 skilled, multi-lingual FTEs in Krakow and Lodz, thanks to its acquisition of SouthWestern in Ireland. It can tap into these centres to further boost its presence in DACH for outsourcing services, including insurance, finance and legal administration, and customer management.
The Drivers for DACH expansion
The key drivers for Capita’s German gambit include:
- Small growth in the UK market – we estimate that contact centre outsourcing (CCO) to be growing at circa 5 percent. Capita posted decent growth in this business, but given the overall market conditions, Capita must be looking for an alternative growth trajectory outside its comfort zone
- Continental Europe is growing – Everest Group research shows a rise in CCO adoption within Continental Europe. Germany has the largest economy in Europe with an under-penetrated and fragmented market, and only in certain verticals such as utilities, retail and telco. Germany, therefore, presents ample room for sustainable CCO growth for Capita
- The DACH region represents a large CCO market with 110m German speakers. Yet there is only small levels of outsourcing. Capita sees good opportunity for a transformational CCO partner in the region
- Ability to engage existing UK clients – this also provides Capita with opportunities to extend its existing contracts within UK with firms that have European parents and subsidiaries and vice versa
- Access to the in-house contact centre market through SCHOLAND & BEILING’s existing portfolio of enterprise clients, enhancing the breadth of Capita’s footprint in the broader contact centre market.
The three acquisitions add scale to Capita’s existing customer management services in the service-line’s key sectors of retail, telecom and utilities. We expect to see some sharing of resources and skills across country units, driven by multi-country client requirements.
The combination of both customer care outsourcing and consulting services represented by these acquisitions also bodes well for CCO clients, who increasingly look to their service partners for guidance in strategic areas, such as the deployment of multi-channel services, enhanced uses of analytics and stronger vertical industry specificity.
Expansion into German local government is a possibility with avocis that has a number of contracts in the sector. This is Capita’s founding market and Andy Parker, the CEO, has already said that he sees much similarity between the UK and German local government sectors. However, expansion into this sector will be after that of avocis’ bigger private sector market. It is unlikely to target the German local government for the first 12 months after the acquisition.
Capita’s biggest challenge is integration of these companies along with all the other acquisitions that it has made recently. In recent years Capita has spent:
- £271m on 13 acquisitions in 2013
- £310m on 17 acquisitions in 2014
- £199m spent on 4 acquisitions to date in 2015
These have been in a diverse set of companies, ranging from software and data for utilities and transport sectors to residential and commercial mortgage administration. The company is also expanding its services portfolio into new verticals such as agriculture and science services.
Managing this expansive empire while building efficiencies into services and workforce management is not going to be easy.
Yet Capita continues to deliver growth year after year. In previous years, it managed to significantly boost its CCO business with the acquisitions of Ventura and Vertex in the UK. In DACH, it has to deal with challenges of a different culture and languages as well as the usual aspects of integrating businesses, so we will be watching this space with interest.
There is no doubt that Capita is a master at business expansion. Service providers that want to expand into new service lines and geographies would do well to follow Capita’s German gambit.
The mantra of 80/20 (80 percent offshore, 20 percent onshore) has been the war cry for the services industry for the last 10 years. It has stood for the absolute sweet spot for a services player, particularly in terms of maximum leverage of offshore talent. This has been the most profitable space. Providers that approached this sweet spot have been the fastest growing and most profitable players.
It has been a thing of beauty and a joy forever … well, not really forever. Things change.
What we’re seeing in a segment of the industry is that customers now ask for 80/20 in the opposite way – 80 percent onshore and 20 percent offshore. They’re not asking for their entire delivery platform to do this. But in discrete segments they are looking for a much more intimate onshore model – more industry domain knowledge, more company knowledge and the provider’s teams stood up next to their teams or intermingled with their teams where they can drive to functionality very fast. They also want less churn.
To be clear, it’s not happening everywhere. But the desire to move to this alternative 80/20 model is happening in some of the fastest-growing and most lucrative segments of the industry. For instance, we see this model approaching in digital. We hear customers voice this aspiration in healthcare. And we talk with many large, sophisticated clients that express the desire to change the model.
They’re not looking to lose labor arbitrage completely, but they want to turn the 80/20 model on its head. And they are willing to give up some of the cost benefits of the old factory model for the speed, intimacy, and agility of the new model.
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