The pivot of third-party services firms to digital is disrupting the entire services industry. Times of disruption always give rise to new competitors, and challengers among service providers can shift share. This is clearly happening now in the demand for digital transformation services. The Big 4 accounting and auditing firms – Deloitte E&Y, KPMG and PwC – are emerging as formidable challengers to Accenture, IBM and the Indian service providers. Here’s what’s happening and what it means for competitors and enterprise customers.
Two champions have emerged among service providers in digital transformation: Accenture and TCS. Accenture is driving business transformation, and TCS is doing a marvelous job of driving IT modernization. TCS’ recent acquisition of W12 Studios, a London-based digital design agency, is worth noting for its implications in the digital marketing space.
W12 will be part of TCS Interactive, TCS’ digital design division. Digital marketing is an attractive, high-impact growth area in digital transformation. It is pivoting toward greater and greater use of technology, clearly calling out for technology companies such as TCS to participate in it more fully. Accenture is building big business in this space quickly. Even so, this acquisition is surprising.
Unlike Accenture, TCS has not driven its success by acquiring companies. But the digital marketing space is growing very quickly, so TCS felt it needed to break its mold and gain a foothold in the space by acquisition. The increasing need for sophisticated technology such as AI and automation to execute well in this space makes it more attractive for TCS. This technology sophistication is well beyond the capabilities of customers for third-party services.
Two factors may be growth hindrances that affect TCS’ strategy for entering the digital marketing space.
First, TCS is late to this party. Companies such as Accenture, Capgemini, Infosys and others already created very large, formidable businesses in this space. Accenture is the prime example and has a big lead. TCS historically proved effective at closing market gaps once it established a foothold. But the firm has a big gap to close in digital marketing. It seems unlikely that TCS will succeed in closing this gap purely without further acquisitions.
Overall, the Indian services firms are late entries and are losing share to Accenture and the domestic players. For the Indian players to challenge for leadership, they will need to invest heavily and continue to grow inorganically.
The second possible growth hindrance involves the delivery model. It seems reasonable that much of the support of digital marketing technology can be delivered from an offshore model. But it’s not clear that the creative aspects are best delivered from a remote location. However, given that the technology and technology support is growing in importance it makes sense that TCS distributed model will work well for this part of the equation. Despite a growing and rich source of creative talent in India, I am skeptical that customers will move their creative work offshore. Why? Because proximity to the business and cultural emersion are critical aspects of the delivery.
I think it’s important to recognize that TCS’ goal may not be to enter digital marketing in a big way. At this point, there is such a fundamental disruption happening in the space that even capturing a small part of this marketplace might be a welcome and lucrative component to the broad portfolio that TCS offers. Even with a small market share, TCS can create a nice book of business given the growing market and secular trend toward technology.
The US Labor Department’s recently announced new regulations for H-1B and L1 work visas focus on the Trump Administration’s ongoing effort to tighten regulations and increase administrative hurdles. Viewed individually no new regulation is a show-stopper; but it’s clear that, collectively, they will have a more material effect. Here’s my take on the significant issues for service providers and their customers.
I believe we’ll see significant changes in the third-party services industry in 2019. The coming year will bring some major movements and trends, along with disruptions and bumpy roads.
Bumpy Roads in Digital Transformation
This year has been a move from digital transformation pilots to programs, which led to a full-on wave of IT modernization to support transforming to digital operating models. The question we must examine going forward is whether this wave will survive a recession.
It seems likely that the global economy will slow and even the US economy will come down off its heavy heights. If this happens and the economy decelerates, less capital and less discretionary funding will be available to fund companies’ modernization goals. If this happens – and the question is not if it will happen but when – I think it’s likely that it will start to happen in 2019.
The jury trial in a lawsuit against TCS, filed by US workers alleging discrimination against US-born workers, opened this week. The suit claims TCS shows a preference for hiring Indian workers through H-1B visas when hiring locally in the US, even when trained US citizens were available. I believe this lawsuit is hugely important for the entire service provider industry, not just TCS, but not because of a possible settlement or the amount of damages. In fact, I believe whether TCS wins or loses the lawsuit is almost irrelevant. There’s a bigger implication: the services firms are in a no-win situation that they must now address. Let’s look at why this case is so significant.
Today’s US Workplace Environment
First, let me point out that TCS is not the only service provider firm to be sued for discrimination. In US companies, diversity is not only desired, but it is increasingly unacceptable to have a non-diverse workplace. Therefore, it’s perfectly understandable that the service provider firms, which have historically organizations which heavily utilize Indian talent, are easy targets for lawsuits claiming discrimination.
Litigants may not need to show specific examples of discrimination – only the results from a pattern of hiring or promotion. It really doesn’t even matter whether the lack of diversity was intentional or not. It’s just a fact of today’s US workplace that non-diverse hiring practices (for employees, middle managers and leadership) are now problematic. And the scrutiny that the service provider firms face is growing because of the difficult political environment.
It is quite understandable how services firms came to be in this position, and that they got into this situation honestly. They are great firms that were built with integrity with large work forces in India. As they grew, it was natural for the service firms to use H-1B and L1 visas to bring their own employees to the United States for the following reasons:
- They trust these employees
- The employees do high-quality work
- The employees have a strong cultural affinity and are thus comfortable in an Indian environment transported to the US operations
- They have the connections back into the talent factories in India and elsewhere
- It costs less than having to hire in the US.
The natural advantages combined with the economic advantages of importing Indian labor and hiring H-1B workers, resulted in a demographic dominated by Indian labor – but not necessarily a result of discrimination. However, this is a difficult argument to make when the statistics clearly show a skewed labor force.
Clearly, the service firms are at risk and, in all likelihood, will need to address these issues. The demands both ethnic and gender diversity in workplaces. Given the US political environment that now exists, the third-party service industry will likely face increasing demands to change the status quo.
They face a difficult set of choices, since they don’t want to discriminate against their current work force, yet they may need to take significant action to address the appearance of favoritism as well as change parts of their corporate culture, employment policies and benefits structure to bring them more in line with US expectations. If the service firms don’t address these issues, they run an increasing risk that a growing number of companies won’t do business with them.
But it will be difficult and expensive to address the issues. It likely will cause rising costs in the US. The cost to remedy the demographic makeup of the work force is quite high and likely will adversely affect competitiveness and margins. Addressing the issues is also likely to create additional morale and legal issues. They can’t fire people to bring about a more diverse workplace. They must take the interests of existing employees in mind while they move to diversity. Moreover, addressing these changes will take time.
And then there’s the reputation factor. At this time of great sensitivity to discrimination and jobs moving offshore, service provider firms face the prospect of increasing pressure to address these issues. But while doing so, they are still open to lawsuits, and these lawsuits would be expensive to litigate or settle. They can afford the litigation and possible judgments and settlements, however high the costs are. But they can’t afford damage to their reputations, brand and public image.
The biggest mistake a company can make in digital transformation is starting the transformation journey without first getting the necessary commitment and support. Senior leaders and business stakeholders must commit to rethink and change organizational boundaries, policies, processes, talent and organizational structure as necessary to achieve the strategic intent or vision.
If they’re not committed to doing that, the digital transformation effort will fail.
Unfortunately, many companies get only lip service from leaders rather than long-term commitment to change. Company leaders can have a great meeting and talk about the need for change and a digital environment to create new competitive positioning, but not get real commitment to change.
IBM’s $34 billion cash acquisition of Red Hat announced early this week has far-reaching implications for the IT services world. IT is modernizing, moving from a legacy world with data centers, proprietary operating systems and proprietary technologies to a digital environment with cloud, open-source software, a high degree of automation, DevOps and integration among these components. IBM’s legacy assets and capabilities are formidable, but the firm was not well positioned for IT modernization and struggled with digital operating models. The Red Hat acquisition is significant as it repositions IBM as a vital, must-have partner for enterprise customers in IT modernization and evolving digital operating models. This is a very intriguing acquisition for IBM. Let’s look at the implications for IBM and enterprise customers.
An interesting trend is developing in the services industry, reversing the trend we’ve seen for the past five years. I predict that this year, and for the next few years, we will see a modest rise in mega deals – deals with $500,000,000 or more in Total Contract Value (TCV). Where are those deals coming from?
At Everest Group, we watch services transactions closely. Over the last five years, the industry experienced a big move away from mega deals, preferring smaller and smaller transactions. This was then exacerbated by digital rotation where customers were interested in digital pilots – which are small deals. But this year we note a renewal of interest – in some specific situations – for large deals.
Here’s my take on three forces driving mega deals now.
Force #1: IP-Plus-Services Model
One force driving mega deals is where the service provider wraps services around the intellectual property (IP) platform the provider owns. TCS’s book of business of large deals is a good example of this. TCS has an IP platform around insurance and mega deals tied to that platform. The $2 billion-plus TCS transaction with Transamerica earlier this year is a good example. What makes the deal so large? The customer is modernizing its IT by jettisoning its legacy technology and transferring it to TCS for modernization through the TCS platform.
As the services industry pivots to digital models, IP ownership plays an increasingly important role. Automating work diminishes the importance of labor arbitrage, and the profit pool reconfigures around IP owners. The nature of the IP-plus-services model allows mega deals to happen. I expect more of this kind of deal to happen at TCS as well as at providers like Cognizant, which has a similar platform in the pharmaceutical healthcare space with TriZetto. Both TCS and Cognizant are using their investments in IP platforms to differentiate their offerings and capture large contracts.
Where service providers own important IP platforms, I see those as the basis for some very large deals.
Force #2: Leveraging the Balance Sheet
Another source for large deals is providers leveraging their balance sheet to finance a customer’s large-scale IT modernization. HCL and Wipro are good examples of providers using this approach to create very large deals. They use their balance sheets to fund expensive IT modernization deals, including taking over a customer’s legacy assets. This strategy accelerates a service provider’s growth, and I expect to see more mega deals using this strategy.
Force #3: Digital Transformation Programs
This year, we’ve seen digital transformation move out of the pilot phase into full-blown transformation programs. The amount of money customers spend on these transformations is staggering, often hundreds of millions of dollars. The large availability of enterprise funding for transformation is likely to encourage larger deals.
The net result of these three forces? I believe we will see a modest increase in mega deals, and in certain areas, larger deals for the remainder of this year and next year.
I’m not claiming the entire services market is moving to mega deals. In fact, two size-diminishing secular trends that were well underway continue: (1) decomposing the legacy, multi-tower deals to single towers and bidding those out (2) the move from managed services to systems integration and digital work. These trends will continue to create a fabric of smaller transactions.
However, some large deals are emerging. I believe the three forces I described are working against the well-established trends for smaller deals we saw during the last five years.
Disruptive technologies enable dramatic new ways of doing work and delivering value to customers. Understandably, companies are rushing to implement disruptive technologies to change their business so that they can better serve their customers, employees, partners with new value and lower their total cost of ownership. Achieving this goal necessitates assembling a digital platform. However, few companies have the resources to build and maintain a platform alone, so they need to contract with third-party service providers. Here’s the problem: the classic procurement approach for third-party services doesn’t work with digital transformation.
In meetings with companies undertaking digital transformation or IT modernization, I often hear executives talking about advice they’ve received from their consultants and advisors on how to plan and manage these initiatives. I consistently hear different versions of three points. “We must have a detailed road map of our transformation journey.” “We will need to replace most of our existing talent.” “We’ll need mountains of money.” Sound familiar? Consultants and systems integrators (SIs) consistently preach these practices, warning companies that their transformation won’t play out the way they hope unless they follow this advice. But compare that advice with the real-life experience of CIO Toby Buckalew.