AO Transaction Size Drops as Buyers Experiment with Digital Technologies | Market Insights™
June 30, 2015
The number of large AO contracts plummets as buyers experiment with digital technologies through smaller AO transactions
The number of large AO contracts plummets as buyers experiment with digital technologies through smaller AO transactions
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Banks’ emerging priorities have implications for IT service providers
As much has already been written about Cognizant and its Trizetto acquisition – including Everest Group’s take: The New “Big Blue” of Healthcare IT? – it is time for us to do a post-facto check on Cognizant’s healthcare IT services business, and ruminate on the state of the healthcare IT market.
Let’s put Cognizant’s numbers into perspective with our growth estimates for the overall healthcare IT industry. With the healthcare industry set to grow at a CAGR of 12 percent through 2020, and given what we have seen since we published the following in 2013, the market size projections for healthcare appear well on track to humble the pessimists among analysts.
While services spending growth has been steady, especially for the payer and provider markets, the innovation side of healthcare IT has been sulking for a while. Yes, “sulky” is the word that comes to mind when you sit listening to a panel discussion on digital innovation at #AHIPInstitute2015 and not one panelist cites an example of innovation from the healthcare space. They either talk Uber or Airbnb. This is unfortunate.
Despite the huge numbers up for the taking, a big spike in the booming healthcare IT market will not come by unless there is a dawn of new and nimble technology start-ups that change the game of healthcare enterprises looking to move away from bespoke solutions to as-a-service models that reduce their time-to-value exponentially. For good or bad, the healthcare industry in the U.S. has always had an umbilical cord connection closer to Washington D.C. than to Silicon Valley. That is probably what curbs innovation in this industry from breaking out of its shackles to produce its own Ubers and Airbnbs. In my opinion, except for a few fitness/therapeutic/diagnostic wearable-focused investments, little causes titillation in the healthcare technology start-up space. Despite all the brouhaha on the B2C shift, consumer-focused investments are coming more from the enterprise IT side than from third-party innovation. Frankly, do we want to be in a world where Ford not only makes the cars but also drives the cabs? Hence, the question is – in a world dominated by technology vendors (Epic, GE, McKesson, and Philips) are we ready to declutch third-party innovation and let it bloom?
There was a reason we titled our blog about Cognizant’s acquisition of Trizetto, “The New Big Blue of Healthcare IT?” The simile was not to herald the dawn of a new behemoth, but to provoke the sort of nimbleness and courage in healthcare IT industry that IBM (the original Big Blue) has shown over the last many decades to stay relevant in the overall technology industry. In an industry with a muffled voice of innovation (few exciting start-ups), a few big bullies (large technology vendors, EMRs, etc.), and well-meaning presiding deities (government and legislatures), the push for change will have to come from outside.
Why did I harp on Cognizant while writing this blog? It was a rank outsider in the healthcare technology industry (well, almost, given its offshoring, pure play service legacy). Even if it becomes a US$4 billion healthcare enterprise, it will still be a fraction of the market. Via its investments, growth, and outlook, what it has given the industry is a peek into the kind of bravado that can make this market rock. We require more of this bravado. But, if it is going to be just once in a blue (pun unintended) moon, it will be rank boring. So, as the Joker would have said, let’s put a smile on that face!
This is the first in a series of blogs Everest Group is publishing on exciting opportunities and implications to watch out for in the healthcare IT services market.
Rumor mills are buzzing over the potential acquisition approaches made by suitors United Health and Anthem for Aetna and Cigna, respectively. The Affordable Care Act (ACA) and the growing focus on consolidation to drive health insurance premium/cost rationalization have led to these tactical maneuvers. While the equity analysts and investment banks have already started to split hairs on the potential implications for capital markets and stocks, our focus here is on the implications these mergers may have on the IT/BPO services market.
These four companies – Aetna, Anthem, Cigna, and UnitedHealth – are star accounts for some of the largest IT service providers that focus on the payer industry. Some service providers have so much revenue exposure to these accounts that their healthcare revenues can take a hit of over 200 basis points, simply as a consequence of IT budget realignments or vendor consolidation.
These potential mergers may lead to the following key transformational IT implications:
The following image illustrates the current exposure of key service providers in these four entities. As you see, these mergers may be beneficial for most of these large service providers. However, a few, such as Infosys in UHG-Aetna, CGI in Anthem-Cigna, and IBM in both UHG-Aetna and Anthem-Cigna, may have at-risk portfolios given competitive underpinnings and systemic maturity of the acquirers.
We’ll be reporting our views on this story as it unfolds, so keep watching this space.
Contact center, IT, and judgment-oriented business process services are the most common functions delivered by North American domestic service centers
Today, Capgemini announced the merger agreement to acquire IGATE for $4.04 billion. IGATE is a US-listed technology and services company headquartered in New Jersey with US$1.27 billion in revenue in 2014. The sale of IGATE has been in the offing for a while after private equity company, Apax Partners, which financed most of IGATE’s US$1.2 billion acquisition of Patni Computer Systems in 2011, converted its debt into equity in November 2014 (becoming its largest shareholder) and also filed with the U.S. Securities and Exchange Commission to have the option to sell its stake. The combined group will have nearly US$13 billion in annual revenue and 177,000 people globally. Capgemini aims to realize revenue synergies of US$100-150 million (through cross-selling and account farming) and cost savings of US$75-105 million over the next three years. The deal’s size and cross-ranging implications make it one of the most significant transactions in the IT-BPO industry. Capgemini is paying a premium for its North American ambitions, over 3x revenue multiple. It outstrips other such deals in the marketplace, notable CGI-Logica (2012) and IGATE-Patni (2011), indicative of the scale and urgent imperative driving deal rationale.
Major acquisitions in the IT-BPO market (US$ million)
Prima facie it gives Capgemini a sizable foothold in the North American market, the biggest IT outsourcing market in the world. North America becomes a significant market for the combined entity, comprising nearly one-third of 2015 projected revenue, up from 20% for Capgemini earlier. Europe will still account for over half of the combined revenue. The North American region contributed nearly 80% to IGATE’s revenue in 2014, with marque clients such as GE and Royal Bank of Canada. This had increasingly become important for the company since its French-rival Atos bought Xerox’s North American ITO business late last year. That deal also made Atos the primary IT services provider to Xerox (~US$240 million annual revenue) and also have the right to first refusal on collaborative opportunities with Xerox.
It enhances Capgemini’s delivery presence in offshore/low-cost regions specifically India, where most of IGATE’s 33,000-strong workforce is based. Capgemini had earlier acquired Kanbay in 2006 with a focus on increasing India operations. It also bought Unilever’s India GIC – Unilever India Shared Services Ltd (UISSL) – in parts over 2006-2010. Around two-fifths of Capgemini’s global workforce of 144,000 employees is based in India, with the combined group having an offshore leverage of nearly 55% by the end of 2015, comprising over 90,000 people.
The move adds greater definition to the verticalization maneuvers Capgemini had been driving of late. IGATE’s strong BFSI client roster (CNA, Royal Bank of Canada, MetLife, UBS, Morgan Stanley), comprised over two-fifths of its revenue last year. Similar synergies are expected in manufacturing, healthcare, and retail sectors.
Capgemini’s functional spread stands to gain on account of IGATE’s mixture of IT and BPO services. Specifically, Capgemini has been looking to grow its ADM and BPO business, as enterprise clients exhibit a preference for integrated services stacks led by an expanding As-A-Service economy, combine infrastructure, application, and business process service needs. This is the driving force behind IGATE’s business model – ITOPS or Integrated Technology and Operations, which will help Capgemini position itself as a fully integrated service provider. The deal also holds Capgemini in good stead, bolstering its industrialization play. As the value proposition in the global services space moves beyond labor arbitrage, service providers are looking at non-linear IP-driven revenue sources through products, platforms, and solutions. IGATE has monetized the ITOPS value proposition through productized applications and platforms – IDMS (for BFS), IBAS (for TPA clients), and SIB (for retail customers) – which are distinct P&L-plays for the company. Capgemini is also likely to receive additional tax benefits from the deal, as it is carrying a large deferred tax asset in the U.S.
The adage “culture eats strategy for breakfast” couldn’t be truer for this merger. There is a stark cultural tension with a Europe-heritage firm struggling with offshoring trying to integrate an Indian IT service provider with a strong North American client roster. Plus all is not rosy with IGATE. One of its largest clients, Royal Bank of Canada, has been facing problems for its use of IGATE services while GE’s contribution to revenue has been falling. CEO Ashok Vemuri’s hire-for-growth plan witnessed a bump when Q4 2014 headcount actually fell by about 900 employees. IGATE registered an annual revenue growth of just 10% to $1.27 billion in 2014, lagging other IT peers. On the executive front, the merger means uncertainty for Ashok Vemuri, who left Infosys specifically to take over as CEO after Phaneesh Murthy left. His dream of staying a CEO might be curtailed, and he will be tempted to move on, as he wouldn’t want to occupy a role similar to what he held at Infosys, with even less leverage with the leadership. This potential void in leadership could pose a major hurdle for the integration process.
The move is indeed a bold one by Capgemini to catalyze growth, plug delivery/regional/vertical gaps, and streamline operations. IGATE is the right size for Capgemini to absorb – not too small so it does not have a tangible impact but not so big that to create an integration struggle. The sizable deal size could spur U.S. giants to action. Given Capgemini’s European legacy, other regional service providers could mull their options in a bid to expand their operational footprint. We have already seen recent activity in Europe with the Steria-Sopra merger last year. MNCs struggling for growth and looking at globalizing delivery could start thinking of mid-sized players as possible targets. Some of these players have growth issues, significant PE investments, scaling problems – all of which make a good rationale for a merger with a bigger player. On the other hand, the deal lacks some specific attributes when it comes to next-generation technology tenets such as cognitive computing, automation, digital, and analytics. Moreover, Capgemini will need to bridge the inherent disconnect between two different cultures, systems, processes, and people, to make this integration successful. The deal is certain to spark further consolidation and conversations, as service providers witness pricing pressures, evolving engagement models, and increasing anti-incumbency, in a bid to adapt to the As-A-Service construct.
Photo credit: Capgemini
Though the analytics segment constitutes a tiny sliver of the global sourcing market, it’s revenue growth outstrips other established services’ growth
Enterprises move more workloads to the cloud as they become more confident in cloud-based delivery
Three stoplights. Well, eventually four by the time I moved away in 1985. Also, a line of people each night around the new McDonalds for several days after it opened in the late 1970s. This was the situation in my hometown of Maryville, Missouri with a population of just less than 10,000 people at the time.
Small, rural town, right? Yes, it was in many ways. But it was also home to a university, Northwest Missouri State University, which was the first college in the U.S. to put PCs into every dorm room and a student population of about 5,000. The area was packed with PhDs and farmers quietly living the pleasant life in the middle of the country.
As the buzz about rural and domestic outsourcing has increased over the past five years, I have often wondered “Is this type of location a good candidate for a service delivery center?” To the best of my knowledge, it does not have a service delivery center of any notable scale.
To help answer questions like these, Everest Group is the research partner for RevAmerica, to be held in New Orleans on May 5-7, 2015. This is the only event focused on domestic sourcing in the U.S. and Canada.
The research report that we release at the event will analyze the trends in domestic outsourcing, looking at variations by location type across different functions (IT, business process, contact center), type of service provider, and other factors.
Although we are currently deep in the middle of collecting responses to RFIs and conducting interviews, we have been able to glean a few initial insights from the database of approximately 350 cities, which range from small, rural communities to tier 1 cities. Some of these insights include:
We invite you to join us in New Orleans as we roll out the findings of this important study. We look forward to hearing your experiences.
With the rise of smart machines and robotic technologies replacing labor arbitrage, multi-sourcing becoming a norm, and “as-a-service” models increasing in adoption, the IT services (ITS) market is undergoing radical change. And it could wreak havoc on – or mean opportunities for – ITS providers nearing deal renewal time.
It’s abundantly clear to us that multiple hunters over the last few months have been eyeing big portions of the US$76.3 dollars in IT services contracts soon to be up for renewal. And if they’re not careful, it could mark the end of millions or billions worth of business for several companies. The verticals primarily at stake are BFSI, Healthcare, and Energy and Utilities, which have a combined share of more than 55 percent of the total pie.
But before we talk about how these providers can fend off their attackers, let’s take a quick look at the state of the market, per our recently released Report on Upcoming Contract Renewals (ITS) – 2015:
With so much renewal money up for grabs, who will win the hunting game? A David versus Goliath story is currently playing out in the deal renewal industry. Incumbent service providers want to expand their footprints across clients and fend off the attacking competitors. Attackers are desperate to penetrate newer opportunities by eating away share from the incumbents.
The reality is, the incumbents have a lot more to lose than the attackers. Given high anti-incumbency sentiment in the deal renewal market (~40 percent of deals are not renewed with incumbents), these providers need to take a serious look at their traditional deal renewal strategy, taking into consideration:
At the same time, attackers can’t reduce their efforts and investment in winning new clients. Despite all the challenges with incumbents, enterprises typically default to them fearing cost of change management and disruption. The onus lies on the attackers to demonstrate value beyond niche positioning or price aggression. Attackers need to invest early in building credibility with the enterprises. They need to communicate value in tangible terms beyond cost savings. And they need to make themselves visible to gain mindshare of their target clients. It’s a cultural overhaul where attackers must promote both their vision and their delivery capabilities in the market.
It is difficult to predict what lies ahead in this hunting game. But there will certainly be winners and losers. If you’re an IT service provider, will you be one of the winners?
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