Global Offshore Services Market Snapshot | Market Insights™
June 30, 2016
Global services market, 2010-15, and distribution of global services market by sourcing model, 2015
Global services market, 2010-15, and distribution of global services market by sourcing model, 2015
I’ve been blogging about why certain companies such as Accenture, ADP, and TCS are such successful service providers. In contrast, let’s look at HP and examine why it’s breaking up.
I’ve explained in prior blogs that the most successful companies have six operational elements aligned, as shown in the Everest Group assessment framework below.
In successful companies, their promise is consistent with their business model, their talent model is consistent with their promise and model. Their investments align with the talent and business models, and the portfolio they end up with aligns with the other components. In addition, they tune their go-to-market approach to maximize their advantages in these components.
HP, as much talked about, is breaking up, separating its printers and PCs division from software and services. Printers and PCs are late-stage, mature devices and represent a market that is commoditized, mature, and saddled with slow growth. Software and services give the promise of growth.
HP is taking the first steps to create better alignment in both their businesses between the functions of brand, go-to-market, investments, and the other components of the framework illustrated above.
HP’s printers and PCs business is well aligned in terms of its brand promise of high-quality, cost-effective end-user devices. Its go-to-market approach is consistent for both printers and PCs, and the portfolio is rationalized around those devices and the warranty services that support them. Its investments can focus on maintaining market share. The firm can harmonize talent to ensure it’s appropriate for a mature business. And its business model and supply chain are consistent across their offers and can be further refined and focused. So I see the break-away from software and services as a no-brainer.
HP’s software and services area is a more complicated story; here, I think they have further to go. A smaller, more focused organization will allow HP over time to refine its brand to focus on large enterprises. Its go-to-market approach can be more easily integrated. Its portfolio, which is still very diverse, will probably need further refinement over time.
Although they clearly don’t have all six components harmonized for the software and services business, the break-up gives HP a much better fighting chance to work through that. They have further work to do across all these areas – particularly in brand and portfolio. As they get a crisper brand promise into the market and a portfolio aligned with that brand, the firm’s business model, go-to-market approach, and investment choices will become clearer.
HP is still early in this reformatting of the company. But history tells us that, as they succeed in getting these aspects clarified and aligned, the firm’s performance will improve.
Photo credit: Flickr
I’ve blogged extensively on how the industrialized arbitrage market is maturing rapidly. One of the many frustrating aspects of a maturing services market is that a dominant portion of procurements for larger opportunities come through RFPs. These RFPs require sophisticated and elaborate responses with large deal teams and solutioning teams working at the provider’s expense to create a compelling response. This cost is growing, and what’s worse is that it’s not unusual for providers to lose 66 percent of these costly bids.
In the large-deal segment, it’s not uncommon for service providers to spend $1 million – and in some cases as much as $10 million – to respond to the RFPs. These costs are often disseminated through the service provider and not easily recognized; they are borne by the individual delivery teams and therefore can creep up or grow unmonitored by the service provider. When viewed objectively, the costs amount to a substantial amount of money.
At Everest Group, we’ve done a significant amount of work on competitiveness and improving providers’ win rates. For world-class performers, the win rate is around 33 percent of their opportunities – which means that they lose 66 percent. Let’s take the low end of this range as an example. If it costs $2 million to respond to an RFP and solutioning for a winning bid, it costs $6 million for a deal the provider doesn’t win.
These unreimbursed “dead deal” costs are an increasing drag on providers’ profitability and are a significant contributor to service providers’ growing cost of sales.
The implications of this are very significant for service providers seeking to maintain their growth by bidding for larger transactions.
Yes, there are numerous solutions. One is for providers to pursue only the opportunities that they have a realistic chance of winning.
Can the industry shift away from these dead deal costs, instead giving solutioning free to the client in the RFP response?
Effectively, the provider would move to a more consultative structure in which the highest value is not given away in a free solution but is paid by the client in consulting services.
These are intriguing thoughts. This structure would be difficult to accomplish – but well worth the journey if it can be changed.
Analytics has been a bright spot in the services world, particularly for the Indian service providers as their analytics practices have grown faster than the rest of their organizations. They often are able to command premium pricing in this space, and it holds the tantalizing promise of transforming other service lines such as ITO, apps dev, and BPO. However, I’m making a bold prediction: The analytics practices are going to quickly hit maturity and the rate of growth will quickly slow.
We at Everest Group observe three maturity characteristics now happening in this space, so the “recipe ingredients” are in place for this market to start maturing.
As we analyze this issue, we believe there are three areas where analytics providers can build distinctiveness:
As already explained, we expect the market for providers whose practices are built on capability will slow rapidly. But we see substantial opportunity where a provider combines proprietary data and proprietary tools with capability that focuses on a specific business problem.
An example of a scaled analytics program that has achieved billions of dollars in this way is OptumRx. This solution includes a proprietary data source, proprietary tools and capability focused on a business problem that serves the healthcare industry at scale. And it generates billions – not millions – in revenue.
We believe that providers that transition to a model of creating proprietary data and customized tools combined with capability to solve a business problem will enjoy ongoing and potentially explosive growth.
But those that stay focused on providing capability and data scientists are doomed as they face a quickly maturing marketplace. It’s not that this space will go away; it’s just that it won’t grow fast and pricing pressure will start to take hold.
Although we believe the analytics market maturity will happen in the next two years, we think a lot of room and potential remains for providers that combine the three analytics components (data, tools and capability focused on a specific business problem).
In reviewing the DeepDive Equity Research report for Q1, it’s clear that this year’s first quarter was a bit of a disaster for the services industry. Contrary to industry expectations at the beginning of the year, the report evidences that growth is decelerating. What happened to the expectations?
This report heralds what I’ve been blogging about for more than a year – the services industry has been rapidly moving to a mature state and is now at an inflection point. The results: slower growth, pressure on pricing and margins plus accelerated industry consolidation. In the Q1 report, Rod Bourgeois, founder and head of research and consulting at DeepDive Equity Research, presents analysis of the quarter’s results for 15 leading service providers.
The report (“IT Services: Whoa! What Happened in Q1 Results of 15 Services Firms”) is well worth reading. It reveals that nine of the 15 providers posted bad earnings results, two had mixed results and two were incomplete. Only two providers posted good earnings results. Only two – and these results are despite the accelerated GDP and more favorable economies in North America and the UK.
A caveat: as Rod points out, one quarter doesn’t make a trend. But it is troubling. And it certainly fits with my thesis of a rapidly maturing market.
What are the implications?
First, this means that the underlying growth assumptions on which the labor arbitrage market is based are no longer valid. Second, tensions around pricing and margins will heighten.
The challenge for providers is growth. The winning strategy will require moving from an industrialized arbitrage focus to one of differentiation and achieving a leadership position in new growth areas.
But the buying enterprises also have a challenge in a maturing market: don’t get trapped by vendor lock-in.
Photo credit: Flickr
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.
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.
As to the implications for the industry, we see this split as playing into the industry’s ongoing story of maturing and playing also into the theme of industry consolidation and industry realignment.
Over the last few weeks, we saw “bad news” about massive layoffs at IBM (100,000) and TCS (25,000), two of the industry’s largest services companies and market leaders. Those numbers proved to be overstated, but clarification on the real numbers isn’t what’s important. The numbers distract from the real issue. Attention-grabbing news headlines and social media’s frequently salacious, overhyped comments created a “fog” around the true picture of layoffs at both companies. So let’s cut through this fog and look at the truth of what is happening and the real issue for services providers and customers.
Social media and irresponsible reporting allowed initial numbers that later turned out to be significantly over-stated. The official number for TCS was less than 5,000 and IBM called the 100K number “baseless” and “ridiculous.” But even the subsequent clarifications on numbers distract us from the real issue – the fact that the services industry is witnessing a fundamental discontinuity and is in need of massive reskilling to meet customer demands.
Layoffs at IBM and TCS are not signs of companies in distress, and neither company is leaving the services space. Rather, these are two market leaders proactively dealing with the major disruptive transition now happening in the services space. IBM and TCS have been market leaders, IBM the undisputed leader in infrastructure services and TCS the largest provider in the arbitrage and offshore space.
Both companies recognize that they don’t have enough of the new skills needed for the new digital services markets and both have too much talent in the skills that made them leaders in infrastructure and labor arbitrage – services segments that are now diminishing as customers switch to digital services and new consumption-based models.
From our discussions with both companies and with some of their customers, it’s clear that their customers are demanding they take steps to acquire the necessary new skills so they can serve customers’ new demands. For example, providers’ reskilling efforts may need to include such talent as creative UX experts and data scientists.
As leaders, both companies understand that the services market is changing fundamentally. Services and technology leverage are shifting from being an efficiency/cost play to one generating revenue and growth for customers. Both are simply taking necessary steps to ensure they stay relevant and retain their leadership positions as the market evolves and customers demand new skills to address their needs.
IBM’s recent moves appear to be radical and more significant, but that’s because its acquisitions are larger (such as acquiring SoftLayer so it can compete on AWS’s level for cloud services) and it’s also divesting the kinds of business (such as voice services and chips) that could hold Big Blue back from continuing to be a leader in meeting customer expectations.
All organizations using third-party resources these days should ask their existing and/or future service providers what steps they are taking to ensure relevance and necessary talent to deliver services in new business models and new technologies.
We at Everest Group believe the reskilling actions of IBM and TCS are a harbinger of things to come for all service providers – ongoing rolling waves of disruption affecting talent needed for the fundamental changes happening in the services space. I’ve been blogging about these changes (growing maturation of services, pricing pressures, lower demand for labor arbitrage and shifts in customer demand) for more than two years. With the proactive steps of IBM and TCS, the industry now has tangible proof that the landscape is indeed changing.
The contact center outsourcing (CCO) marketplace is mature. It’s a large market, and companies across a wide number of industries and geographies use the services. The market is now $70-75 billion, which is approximately 20 percent penetrated by third-parties vendors and 80 percent by in-house captives. Now that this space is mature, what will happen to the industry? I believe that there are three likely directions.
As in similar mature marketplaces, customers are looking to extract more value from the service. One way to optimize it is to embrace new disruptive technologies such as social media and analytics.
Alternatively the market is increasingly recognizing that not all work should be in low-cost locations. Consequently, they’re repatriating some of the work from low-cost locations such as India back onshore and matching it with workloads that demand more intimate services with better language skills or local knowledge requirements.
As the CCO market further matures, I believe providers have three choices.
Providers that choose to stay the course will need to meet customer demands by continuing to refine the model through actions such as embracing the multi-channel social media and integrating analytics. They will also need to add more value to the existing offer base and further optimize it. In this world, providers can expect ongoing pressure on margins and on price, increased requirement for investing in technologies and also can expect slow growth.
This is a fractured industry now with few large players, and the large players control only a small portion of the total volume. So I expect industry consolidation. Providers will get big or sell and go home. I also expect that several players will execute a roll-up strategy where they build economies of scale and economies of presence.
The third possible direction for the mature CCO space is to be disruptive. I believe a segment of this market will follow the path that data centers have gone in that there will be a cloud or cloud-like as-a-service offering that will bring a different business model to this segment.
New providers coming in and disrupting the space will likely capture high rents far exceeding those of the first two alternatives. Like their cloud and SaaS counterparts, they will operate very different business models with much more focused value propositions. These business models will deliver similar as-a-service benefits that SaaS and cloud deliver. However, they will accomplish this not by building a multi-tenant platform but by turning every aspect of the supply chain into a consumption model. This service model will be much more finely targeted at a customer’s needs rather than the service components such as people and technology, and it will allow customers to move away from the FTE take-or-pay model that currently dominates the industry.
2015 will be an interesting year for contact center outsourcing, as we’ll see segments of this market diverging on all three paths.
Click the image to enlarge
Location maturity: breadth & depth of services offered; arbitrage: fully-loaded cost per FTE; potential: availability and quality of talent, and risk pool
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