While the IT and business process services industry continued to grow through 2016, that growth slowed over the course of the year and could fall to less than 2 percent by 2019, according to a recent report from IT and business sourcing consultancy and research firm Everest Group. Read more at CIO online.
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.
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.”
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.
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.
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.
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.
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.
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:
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.
The 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.
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.)
Already 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?
Research from the Everest Group, a Dallas consulting firm, estimates that organizations can save as much as 12 percent in recruitment costs by adopting an integrated talent approach. The Randstad survey supports that finding: Nine in 10 respondents who’ve embraced an integrated talent model say they are very satisfied with the decision. Read more at SHRM.org.
Sarah Burnet, Chair of BCSWomen and Reseach Vice President at Everest Group: “I believe lack of awareness among technical women about opportunities and the varieties of jobs that are available in data centre and network management is a problem. Read more on page 26 of the online magazine by Inside_Networks.
In the heat of battle in the services industry’s rotation from labor arbitrage to digital, Genpact made a significant move today that signals to everyone it’s playing to win. Genpact announced it signed an agreement to acquire Rage Frameworks, a leader in enterprise Artificial Intelligence (AI) and automation technologies and services. Genpact moved the cheese.
Three aspects of Genpact’s acquisition of Rage are especially significant.
Among the top 20 providers, growth for arbitrage-first providers actually shrank last year. As we look forward two more years, we think it will further decelerate and go to just under two percent.Accenture has rotated into digital faster than other providers, and already has the highest percentage of work in digital. It’s the biggest and is blowing other providers away. Of note, it’s the only provider that has succeeded in growing its margin while moving into digital. As I’ve recently blogged about the dilemmas at Infosys and Cognizant, for example, the rotation into digital stresses providers’ margins. The faster they grow in digital, the lower their margins are, which is very inconvenient.“Change is inevitable, but growth is optional,” wrote John C. Maxwell, leadership expert and best-selling author. With its Rage acquisition, Genpact bypasses the dilemma other providers are facing and demonstrates its seriousness and its commitment to growth in the digital space.Requirement for Digital Rotation Success
When an arbitrage company such as Genpact thinks about its rotation into digital, it must focus on managing three constituencies: shareholders, internal constituencies and customers.
The Rage Frameworks acquisition helps Genpact manage across all three constituencies, as follows:
Genpact’s bold move is important to watch. How many other arbitrage providers will follow this path of serious investment to accelerate their journey to become digital-first service providers?
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