“This time is different” are often thought of as the most dangerous words on Wall Street. I’ve been in the outsourcing services industry since 1983 in the early days of outsourcing pioneer EDS. I watched the rise of the asset-intensive infrastructure space. Then I watched the rise of labor arbitrage and the enormous changes that brought to the industry. And now I’m watching the rise of automation, analytics, cognitive, and cloud bring a similar scale of disruption. I know from experience how “this time it’s different” is seductive to believe in the outsourcing industry.
In 1986 when I left EDS, its net return was 22.5 percent – very similar to the top labor arbitrage firms today. It was the height of the first wave of outsourcing. That continued to go on and the industry moved to large transactions and lower margins. That business peaked in the mid- 1990s. From 2000 on, labor arbitrage took over, and the industry went back to smaller transactions with high margins – very similar to the high margins that EDS achieved back in the 1960s and 1970s. Now we’re seeing the rise of the next S curve –automation, analytics, cognitive computing and cloud – and this space is rapidly growing and gaining share. Labor arbitrage is still growing, but it’s slowing, and profit margins are declining.
I’ve recently had private conversations with some industry executives who have been prophesying the death of labor arbitrage. Some leading executives believe the market is in for a massive shift over the next 18 months to five years in which the labor arbitrage space will be completely disintermediated. I think this is unlikely.
So is it different this time?
Like the asset-intensive space, I think the labor arbitrage space will be disintermediated. But just like in the asset-intensive space, which started in 1995-1996, here we are 20 years later, and we still have asset-intensive outsourcing. Yes, EDS was bought by HP and now is combined with CSC, and IBM is still in the game. There’s still a significant infrastructure market.
I expect 20 years from now that there will still be a meaningful market for labor arbitrage, but it won’t garner the same profits as today. And I expect the shift from labor arbitrage will be a slower move than 18 months to five years in terms of having a dramatic and drastic effect on existing workloads.
Having said that, I do expect the value will move to new areas – just as it did in the past as the market evolved. And we’re currently seeing this happen with automation and other digital technologies. Market capitalization and growth should be in the new models, just like it happened for EDS, HP, CSC and IBM.
Good news and bad news
I predict difficult years ahead for the arbitrage business but radical change to the current players. The only industry leader that successfully migrated to the labor arbitrage space from the asset-intensive space was IBM. Likewise, this time I don’t expect many existing arbitrage players to successfully migrate. We saw massive consolidation in the infrastructure space, and I expect to see consolidation in the labor arbitrage space too.
Yes, I understand this time it’s different in that minority shareholder laws in India will create more resistance to consolidation. But I think the change is an irresistible force meeting a little object. I believe that the industry will consolidate, growth will continue to slow and profit margins will come down, just like it happened in the asset-intensive infrastructure space.
At the same time, automation, analytics, cognitive and cloud technologies will shift the industry to new business models, different commercial relationships, different pricing structures, and different kinds of risk sharing – just like it happened when labor arbitrage entered the asset-intensive infrastructure space. The good news is that these new models will bring new providers into the services space. The bad news is I think these differences create a high barrier for incumbent providers when it comes to changing their offerings. So, once again, this time it won’t be different.