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Modern Today, Legacy Tomorrow: The Nature of Fast-Changing Skill Demand in IT Services | Sherpas in Blue Shirts

By | Sherpas in Blue Shirts

It is no hidden fact that the outsourcing industry is on the cusp of change. While the labor arbitrage model and legacy ERP applications ruled the 1990s and 2000s, digital has become the heartthrob of the current decade, and you can see enterprises entering new forays to keep themselves relevant in this fast-changing business landscape.

In this context, even the demand for technical skills has changed tremendously over the past few years. Some skills that used to have the largest pull have become obsolete, and others are struggling to keep their hold in the IT services industry.

Specialist skills losing leverage against generic skills

Consider the case of SAP on-premise business solutions. Until recently, SAP as a skillset had been very attractive among fresh graduates and lateral hires alike. High market demand coupled with supply playing catch up meant higher wages and easy to switch options in the ever-competitive outsourcing market. But over the past few years, on-premise ERP and factory-led offshoring have matured to the extent that once premium technical skills such as ABAP or Basis no longer command the same leverage over generic skills such as Java, .NET, and COBOL. Even functional skills such as finance controller (FICO) or sales and distribution have seen their premium declining over the last few years.

Specialist skills such as Cognos, Informatica, and IBM Websphere are also facing the heat in large outsourcing deals, where high competition and enterprise awareness have forced service providers to utilize a common, generic rate card irrespective of the complexity or diversity of skills involved. Also, organizations such as NetSuite, Salesforce, SuccessFactors, and Workday provide a viable option with consumption-led pricing models, which make them highly attractive. The level of competition and clear buying trends are forcing even behemoths to come to the table with cloud-based, integrated business solutions. Think SAP with S/4 HANA, which is pushed aggressively by the company’s account sales teams.
With the change in the business landscape, there’s increasingly a clear preference for new age phenomena such as big data analytics, hyper-automation, and the Internet of Things (IoT).

The impact of IoT, digital technologies, and automation on skill demand

IoT is one area in which organizations are investing large sums for either cost optimization or revenue generation, depending on their business models. And it is one area in which hardware, firmware, mobility, cloud, and analytics specialists are in extremely high demand to address its hot growth. While the likes of Angular JS and Swift are being used to develop mobile applications, Hadoop and Spark are seeing a huge demand in data analytics. Even firmware and hardware engineers are being required to work in an agile fashion using DevOps methodology, a phenomenon never seen before in industrial manufacturing.

Another big area in which significant investment is being made is Service Delivery Automation (SDA). It is being looked at as a viable alternative to labor arbitrage. Enterprises are looking to automation to reduce costs and streamline business processes. Service providers and enterprises alike are scouting for Robotic Process Automation (RPA) developers and DevOps engineers for onshore/GIC/service provider operations to significantly downsize the low-level tasks performed offshore.

Overall, the current market is in a state of flux as digital takes precedence and legacy becomes less prominent. But the demand for digital services across enterprises is clear, regardless of existing market shares.

The Widening Gap between Customer Satisfaction Perception and Reality | Sherpas in Blue Shirts

By | Sherpas in Blue Shirts

Not surprisingly, every service provider claims to have exceptionally high customer satisfaction ratings from their enterprise clients. Yet, we see anti-incumbency rising and deal size dwindling.

To assess enterprises’ satisfaction levels in IT services engagements, we conducted a deep dive study of 30 service providers and 130+ of their clients. We largely focused our analysis lens on six vital parameters of service delivery – technical expertise, domain expertise, talent management, commercial models, client management, and strategic partnership.

Enterprise customers are dissatisfied with service providers

The results, presented in our recently published report entitled, “Customer (Dis)Satisfaction: Why Are Enterprises Unhappy with Their Service Providers?” were quite disturbing. They indicated that nearly 50 percent of IT service buyers are not satisfied with their providers, feeling that they fall short in many areas of service delivery.

enterprises not satisfied with service provders 1

We investigated the reasons behind the huge gap between buyer expectations and current service delivery and arrived at the following insights:

  1. Early-stage differentiating factors have become table stakes: The value propositions of labor arbitrage and low-cost delivery are no longer compelling. Instead, enterprises want service providers that can create a positive impact on their core business functions.
  2. Inability to meet the unspoken demands of customers: Enterprises expect their service providers to have evolved from “order takers” to “collaborators” capable of effectively partnering with them in strategic decision making. They want their providers to go beyond the project ask and demonstrate transformative skills, even though such expectations are largely unspoken.
  3. Limited understanding of clients’ businesses narrows down business opportunities: Visibility into enterprises’ business dynamics and priorities are critical for service providers to align their offerings and strategy to client needs. Yet their margin obsession and hesitation to make new technology investments have precluded them from taking a futuristic approach to IT engagements.enterprises not satisfied with service providers 2

How service providers can turn the tide

So how can service providers turn the tide to have a more positive impact on existing and future engagements? Here are Everest Group’s top three recommendations.

  1. Shift from an operational to a strategic mindset: Service providers need to go the extra mile to proactively identify enterprises’ business drivers and must develop capabilities to offer innovative solutions. Just delivering on the agreed upon SLAs does not elevate service providers to the level of service partners.
  2. Innovative engagement: With rising competition, it is imperative that service providers walk the talk. While they cannot avoid investing in new technologies, they can share the adoption risk with their enterprise clients. Newer engagement models like outcome-based, risk-reward sharing, and output-based give enterprises the necessary confidence to take the leap and engage service providers for a next generation technology adoption initiative.
  3. Invest. Automate. Improve: Two-thirds of the enterprises are gearing up for large scale process digitalization, and they expect their service providers to be able to technologically support their objectives. Service providers must strategically invest in automation to improve efficiency, reduce costs, enable faster time-to-market, and deliver process improvements in order to offer a compelling solution.enterprises not satisfied with service providers 3

With anti-incumbency risks, anti-offshoring rhetoric, and clients’ propensity to adopt a digital arbitrage model looming large, service providers cannot afford to lose customer confidence. They must, today, start looking through a clearer lens to evaluate where their relationships with their enterprise clients stand.

For details on the areas in which service providers must smooth their rough edges, polish their existing skills, and develop new skill sets, please read our report, “Customer (Dis)Satisfaction: Why Are Enterprises Unhappy with Their Service Providers?

How Low Can They Go? Pricing and Margin Pressures Abound for IT Service Providers | Sherpas in Blue Shirts

By | Sherpas in Blue Shirts

The business environment in which today’s IT service providers are operating is one of the most challenging in recent times. A host of buy- and supply-side factors are impacting the prices they can feasibly and competitively charge their enterprise clients in the U.S., and their margins are being constricted at every turn.

On the buy-side, ongoing commodity slowdown led to overall softening in the global services market in 2016. Uncertainties created by Brexit in mid-year and the U.S. elections in Q4 delayed decisions on new sourcing contracts and temporary cuts in discretionary spending in SI type engagements.

The quantum of large application outsourcing (AO)/systems integration (SI) deals (>US$100 million annual contract value, or ACV) as a percent of total deals fell from 3.3 percent in 2015 to a low of 1.7 percent in 2016, reducing the pricing cushion typically afforded by large deals. And because enterprises continue to maintain a portfolio of preferred AO vendors to foster price competitiveness and innovation, resulting in a price war for deals, the average ACV in AO deals dropped by ~20% in 2016.

Most enterprises are optimizing their portfolios of contracted relationships to reduce overall TCO by improving nomenclatures, rates, service levels, T&Cs, productivity, etc., leading to a dip in realized revenue per FTE for providers.

Additional downward pressure on realized revenue per FTE has resulted from an increase in brownfield automation, especially in compete situations and second generation renewals. And renewals fell sharply, from 55 percent in 2015 to just 27 percent in 2016, driving price wars among providers.

On the supply-side, although resource utilization increased for Tier 1 service providers from ~80 percent in 2015 to >82 percent in 2016, it is beginning to max out as a delivery optimization lever. Consequently, providers are trying to achieve higher efficiencies and sustain margins via better project planning, DevOps, agile staffing, and proactive use of automation.

 

Pricing pressures and automaiton and digital solutions for IT enterprises and service providers

There is extreme competition in most rebid and re-compete situations, which has led to an overall decline in pricing. We saw an average dip of 1-2 percent in AO /SI FTE rate cards, but bigger dips in overall account-level TCVs. And per rate cards, some enterprises have pushed for single onshore rate card that doesn’t delineate between local and landed resources, leading to cheaper onshore rates. That said, the new U.S. government may push for more onshore hiring and localized presence, including sanctions on landed resources. This may push onshore rates higher, marginalize the landed resource model, and put additional margin pressures on service providers in the second half of 2017.

All this paints a pretty gloomy picture for IT service providers. However, they have started pivoting towards a digital first future, which can help stem their margin and profit erosion, and reverse the worrisome growth deceleration. Most are growing their top line and/or capability portfolio inorganically. Most are also investing in and pitching automation capabilities in a bullish manner. While this may led to a near-term cannibalization of their traditional offerings, in the medium- to long-term it will help sustain their margins in a price competitive landscape.

Do you believe that a digital first pivot will help service providers get back to double digit growth rates?

New Paradigm in ER&D Services: Convergence of Engineering and Technology – Part 2 | Sherpas in Blue Shirts

By | Sherpas in Blue Shirts

In New Paradigm in ER&D Services: Convergence of Engineering and Technology – Part 1, we talked about the emerging trend of convergence of engineering services and new technologies, and why it is important for enterprises to deliver an enhanced customer experience. Now, let’s turn our attention to the steps and measures enterprises and service providers are taking to tap into the trend and enhance their value proposition.

Engineering Services and Technology ER&D

  1. Access talent with hybrid (technology + domain + design) skills: Service providers and enterprises are increasingly looking at hiring people not just with the right domain knowledge, but also with cross-functional expertise. There is heightened demand for engineers with niche technology skills, such as IoT and artificial intelligence. For instance, Altran, one of the world’s largest engineering service providers by revenue, has an innovative way of recruiting talent. It filters talent through case studies based on its own real-time projects, such as “connected car” and Solar Impulse . This enables it to select candidates who have both the right skill sets and an innovative mindset, which has become critical for people in the industry.
  2. Capitalize on data to drive business value: New technologies and social media have led to a gush in the amount of consumer data that can be tracked and mined to deliver a better customer experience. Players in the engineering services space are realizing the value of customer data, and taking steps to build infrastructure for analyzing it. For example, ALTEN Calsoft Labs, a global engineering service provider, recently announced that it will acquire ASM Technologies Ltd’s software business division to augment its cloud, analytics and mobility capabilities.
  3. Reimagine product development: With shrinking product lifecycles and ever-changing customer demands, the focus is on providing end-to-end solutions rather than just point solutions. Service providers are partnering with clients to deliver solutions in an as-a-service model. Customer expectations are putting pressures on product lifecycles, and enterprises are trying to innovate and create newer and smarter products at warp speed.
  4. Move towards co-innovation model: The shift in technology complexity and consumer demand for a “connected” ecosystem is increasing collaboration between enterprises and providers for innovation and new product development. For example, Jaguar Land Rover is partnering with Altran to develop and market a unique software platform for vehicle internet connectivity, driver assistance systems, autonomous driving, and analytics. The partnership is aimed at delivering increased customer value by combining Jaguar’s automotive experience and Altran’s expertise in providing solutions for the automotive sector.
  5. Drive efficiencies in design to deliver cost savings: New technologies and methodologies in software development and testing are transforming the product development landscape for enterprises and they are increasingly adopting automation tools to accelerate time-to-market for products. For example, Wipro has a defined test automation framework (Wipro Endur Test Automation Framework) that can help clients reduce overall TCO of test automation by as much as 45 percent.

Implications for the industry
So what does this all mean for the ER&D services industry outlook, and for players in the domain? As it becomes increasingly crucial for enterprises and service providers to gain new capabilities in engineering and technology, there will be increased merger, acquisition, and partnership activity. Enterprises will look at partnering with niche technology firms or innovative startups for new product development. Service providers will pursue targeted acquisitions, and try to strengthen their value proposition for clients by increasing investment and focus on the segment. It will be exciting to see what happens in this space in the next 5-ten years.

For more insights and information on the ER&D services industry, please refer to our latest report, “The Evolving Demand Paradigm in the Engineering and Research and Development (ER&D) Services Industry.”

3 Strategies for Measuring the Impact of Innovation | Sherpas in Blue Shirts

By | Sherpas in Blue Shirts

For today’s leading companies, innovation is no longer optional. The imperative to transform your offerings while simultaneously driving productivity and cost savings continues to grow more urgent as the pace of technology accelerates. But while innovation is a key component of any modern business plan, it also enjoys a singular status among most organizations’ critical strategies: it’s the only one that is not consistently and rigorously measured. Read more at Cecilia’s blog.

How to Future-proof Your Transformation Project | Sherpas in Blue Shirts

By | Sherpas in Blue Shirts

I recently came across an observation about parenting that I think is wisely applicable to business decisions: “When we make assumptions, we contribute to the complexity rather than the simplicity of a problem, making it more difficult to solve.” It’s a trap that companies often fall into at the outset of a digital or business transformation initiative aimed at achieving breakthrough performance. Read more at Peter’s CIO online blog.

CBS Misses The Mark On American Job Loss And H-1B Visa Issues | Sherpas in Blue Shirts

By | Sherpas in Blue Shirts

A segment of the March 19 CBS “60 Minutes” TV show reported on the H-1B visa program. The show shed light on the pain and suffering of Americans losing their jobs to foreign low-wage workers and the indignity in the way it happens. Interviewees pointed out that companies exploit the H-1B visa program as a strategy for acquiring cheaper labor rather than higher talent skills – and that’s absolutely true. The show focused the spotlight on American companies “hijacking” the H-1B visa program, using it in a way that was not intended when the legislation was written. The segment ended with an interviewee’s doomsday-type projection that American job loss to companies in India won’t end. That’s where I believe CBS and “60 Minutes” missed the mark – there is absolutely a pathway out of this situation, and many American companies started on that path over a year ago. Read more at Peter’s Forbes blog.

The Philippines: Future Foe or Long-term Friend? | Sherpas in Blue Shirts

By | Sherpas in Blue Shirts

With the uncertain political situation in the Philippines and the comments President Duterte has made about distancing from the United States militarily to align closer to China and Russia, many are concerned about what this means for the relationship between the Philippines and the U.S. And rightfully so – this would be a major shift, and over time could be a cause for concern.

At the same time, the Philippines has been quick to point out that the commercial and social relationships between it and the United States are very strong, and that it wants and expects those to continue.

And therein lies an important point… a rebalancing of military relationships does not automatically lead to poor commercial and social relationships between countries.

In a quick exercise to demonstrate how countries can have a variety of types of relationships with the United States, I did a super simple comparison of several military and social dimensions in the graphic below. In addition to the Philippines, I chose India, Malaysia, and Turkey to represent a cross-section of countries near Russia and China that have some level of meaningful connection to the United States. Turkey is a member of NATO, India is a major trading partner for services and goods, and Malaysia is an interesting mix of relations with China and the U.S. (not to mention the Malay flag looks very similar to the United States flag).

I looked at language, religion, sports, and use of NATO-sourced fighter craft (both trainers and actively deployed.) Those without NATO-sourced fighter craft tend to attain theirs from Russia or China. Most countries not in NATO and near Russia have some mix of fighter aircraft.

Philippines U.S. relationship

Based on this very simple comparison, many in the global services industry might be surprised to see that India appears to be the least well-aligned to the U.S. on most dimensions. In particular, India depends primarily upon Russia for various types of military equipment, beyond just aircraft, and India is an important export market for Russia.

By contrast, the Philippines is very closely aligned to the U.S. on all dimensions, which explains why the average Filipino has a hard time with the concept of weakened commercial and social ties to the U.S.

Time will tell what actually happens. But we should all remember that military, commercial, and social ties can operate somewhat independently. Relationships between most countries are complex and multi-faceted, so a change in one area may be slow to impact the overall relationship.

Break-ups are Painful, Difficult, and Costly; The Current Insurance Payer Merger Saga | Sherpas in Blue Shirts

By | Sherpas in Blue Shirts

In July 2015, two mammoth players in the U.S. health insurance market decided it was time to form even bigger entities, similar in size to UnitedHealth Group (which held 17 percent of the market.) First it was Aetna deciding to merge with Humana, primarily consolidating the Medicare Advantage market. A few days later, Anthem and Cigna, with a relatively more complementary membership base, decided to merge.

By the end of 2015, shareholders of all four insurers had approved the deals. However, the Department of Justice and several states (mostly Democratic ones) opposed and appealed against the mergers. In early February 2017, the federal court ruled both anti-competitive and blocked them, citing increased concentration.

Had the mergers been approved, Anthem-Cigna would have led the market with highest share of the entire insured population, followed by UnitedHealth and Aetna-Humana. In Medicare Advantage (MA), Aetna-Humana would have surpassed UnitedHealth to become the market leader.

Insurance payer mergers

Let’s take a look at what transpired in both cases.

Aetna and Humana
On February 14, 2017, the two companies mutually decided to end the merger agreement, rather than appeal the antitrust decision. Due to a contractual clause intended to ensure both parties remained encouraged by the merger prospect, Aetna will have to pay Humana a break-up fee to the tune of US$1 billion. This massive financial hit does not include various other expenses Aetna had to incur in order to prepare for the deal, including legal and accounting fees, bonds issuance fees, interest to be paid while repurchasing the bonds, and the premium it has decided to pay for bond repurchases. All told, the total cost of the merger that didn’t happen will be around US$2 billion for Aetna. This is a relatively straightforward scenario, albeit very costly for Aetna.

Cigna and Anthem
This is a much more complicated situation. Since the merger was first announced, a lot of animosity has grown between these two insurers. Cigna has gradually changed its stance from being pro-merger to anti-merger. In fact, Cigna has gone to the length of filing a lawsuit against Anthem, and asking for $13 billion in damages. This does not include $1.85 billion that Anthem owes to Cigna as a termination fee. Anthem, however, appealed this, claiming that the merger deal timeline is valid until April 30 – and it is still hopeful for merger activity.

Unless Anthem and Cigna accept the ruling without appeal and carry on with business as usual, I see two possible scenarios here:

  • Convince the new administration that the deal will have a positive impact on consumers, and get it approved with the help of the new head of the Justice Department
  • Accept the ruling, and use the money (planned or already raised) to fund acquisitions of smaller payers without triggering the antitrust regulations

The first option seems less likely. However, since the new U.S. president’s swearing in ceremony, we have seen that extreme events cannot be explicitly ruled out with the new administration. Additionally, Trump’s and Republicans’ plans to repeal and replace Obamacare will require support from the industry…and who better to support this than two of the top three publically-listed payers? Another key element in favor of these mergers being approved is that the new administration is more lenient when it comes to antitrust matters than the previous administration, as evidenced by the possible approval of the Bayer and Monsanto deal.

The second option would result in Anthem paying a hefty amount for failure to be able to complete the deal.

The high termination fees for these deals gone bad will likely negatively impact Aetna and Anthem (if indeed the Anthem/Cigna merger doesn’t happen.) For example, per the latest filings, Aetna’s net margin has declined from ~5.9 percent in 2011 to 3.6 percent in 2016, while Anthem’s was 2.9 percent in 2016, down from ~4.4 percent in 2011. As a result of the lawsuit filed by Cigna, Anthem will end up shelling out even more than Aetna, as even if we the decision is in favor of Anthem, it will still have to pay litigation expenses.

Insurance payer mergersThe road ahead for these payers is filled with uncertainty, especially for Anthem and Cigna, since they are embroiled in a legal battle. Yet one thing we can be certain of is that Aetna and Humana are watching from sidelines, potentially resuming merger talks if the Anthem-Cigna deal is approved. While it remains to be seen how the new administration reacts, things should get clearer in the coming months.

H-1B Visa Reform Impact on IT Outsourcing Deal TCV | Sherpas in Blue Shirts

By | Sherpas in Blue Shirts

In a recent blog entitled, “Is rising costs the only impact immigration reform bills will have on the services industry?” our colleagues wrote about a variety of potential effects Representative Zoe Lofgren’s (D-CA) “High-Skilled Integrity and Fairness Act of 2017” H1-B visa proposal would have on numerous parties.

Let’s look squarely at the potential impact of these changes on total contract value (TCV). Some of the key IT service providers, especially Cognizant, HCL, Infosys, TCS, and Wipro – all of which rely heavily on “landed” resources to provide IT services in the U.S. – would have some major decisions to make, ranging from tactical, such as recruitment strategy, to business strategy, such as margin cuts.

If passed, the bill would most likely take away the landed resources cost advantage. Having assessed numerous IT ADM contracts in the last 12 months, Everest Group conducted a simulation to represent a typical three-year IT AM deal, using industry standard offshoring, staffing pyramids, and local-to-landed resource ratios. Our simulation showed that the removal of the difference in pricing of local and landed resources alone would result in a 5-6 percent increase in TCV, not taking into account any auxiliary impact on service providers’ cost (recruitment, organizational restructuring, etc.)

H-1B Visa Reform impact on TCVAlready pressed for margins, IT service providers would try to pass the TCV impact on to their enterprise clients. As it is very unlikely clients would be willing to bear the cost increase, it would remain with the providers. As a margin decline of 500-700 basis points would significantly disrupt any company’s financial standing, the providers would need to deploy countermeasures to mitigate this impact.

To reduce the impact on margins, service providers could use levers such as degree of offshoring and staffing pyramids. Our simulation showed that increasing offshoring by about 2-3 percent resulted in a 50 percent decline in the impact of TCV (essentially lowering the increase from 5-7 percent to 2-3 percent) for a typical three-year ADM deal. While the impact on more complex deals might not be easy to mitigate, our simulation demonstrates there is hope for service providers who play smartly and are proactive in adopting strategies to counter the potential impact of any negative reforms.

Another way service providers can drive down their costs is through automation. For example, key aspects of onshore resources’ work include coordination with offshore resources for alignment of work and managing timelines and quality objectives. If automated, these aspects could significantly nullify the impact of onshore cost increases. And with 300-400 basis points at stake, providers might finally have the motivation to adopt automation at the enterprise level, rather than as a deal- or client-specific objective.

It will be very interesting to see if service providers are able to convince the enterprises to share some of the increased cost burden. What’s your guess?