Tag: margins

Service Providers Basing Margin Expectations on Flawed Math Assumptions | Sherpas in Blue Shirts

As legacy service providers excelling in the labor arbitrage-factory model look to participate in the digital world of cloud, automation, agile, DevOps and AI technologies, they are basing their prices on flawed mathematics assumptions. They expect that they not only will be able keep the same margin structure they now have but also that those margins will increase. Their thesis is that digital work is more valuable and worth more to clients; therefore, they should make more money for doing the work.

Inconveniently, this assumption is flawed. Margins have very little to do with the value a company creates; they have everything to do with the underlying market structure.

New Digital Work Will not be at a Higher Margin

I think it’s fundamentally unrealistic that the new digital work will be at a higher margin. It may be at a higher price person, but not a higher margin. There are many reasons for this including:

  • The providers’ inability to utilize offshore factory, as digital environments demand close collaboration of business and IT teams that are located onshore close to a client’s business
  • The talent required to deliver these digital services is much more expensive than the talent base in the old factory model
  • The more automation a company introduces, the more the client captures the financial benefit, not the service provider.

New Margins at a Lower Rate

All these and other reasons suggest that the new natural margins for digital services will be at a lower rate than the margins of the offshore factory model that currently dominates the marketplace.

I also want to point out offshore margins are structurally higher for services than we’ve seen in previous generations. So, it shouldn’t be surprising that the new model would be lower because this is an aberrant model to begin with.

So, why should service providers’ clients care about this issue? I believe service providers are likely to exaggerate their DevOps, agile and other digital capabilities yet not make the system changes necessary for delivering these services. They won’t make the changes because they’ll make less money. Delivering digital services requires a fundamentally different business model. If they do not make the necessary structural changes and business model changes, they will under-deliver services in the new digital models.

 

Marginal Margin Impact from H1-B Visa Reforms? Maybe Not | Sherpas in Blue Shirts

On 25 April 2017, U.S. President Donald Trump moved one step closer to instituting new regulations for granting H-1B visas. At the same time, many IT service providers – especially those of Indian-heritage –moved one step closer to realizing their worst fears! The threat of visa reforms became real when President Trump ordered an inter-departmental review of the H-1B visa program, which would ensure formulation of regulations for hiring only the most skilled or the most highly-paid professionals and “would never replace American jobs.”

While it is universally acknowledged that a stricter visa regime will negatively impact most service providers’ onshore margins, particularly the offshore-centric providers that follow the “landed” resource model (i.e., a delivery model that hires resources from offshore centers to work in the U.S.,) it is important to examine the true nature of this impact. The exhibit below indicates the possible impact on onshore margins under various visa reform scenarios.

Scenario-based H1-B visa reform impact assessment on onshore (U.S.) margins

H1-B Visa Reform impacts onshore and offshore margins

Even in a situation where the visa reforms do not translate into full-fledged regulation (the most ideal scenario for Indian-heritage service providers) we expect far greater scrutiny of H1-B visa applications, leading to fewer visa grants. Even in this scenario, we expect more onshore hiring by IT service providers to meet their talent requirements, leading to reduction of service provider margins by 2-4 percentage points.

The probability of the above happening has become more dubious, given recent developments, and it is highly likely that visas will be granted based on either skills/merit or minimum wage requirements of US$130,000. In either case, service providers will need to hire a much higher share of local resources. This further complicates the situation for Indian-heritage providers, as they have a smaller foothold in the U.S. talent market than do the global providers. Whether Indian-heritage or global, hiring landed resources at some/all levels of the delivery pyramid at the minimum salary levels of US$130,000 could drop service provider margins by as much as 14-16 percentage points, resulting in negative returns on onshore deals, at least in the short-term.

While none of the scenarios paint a rosy picture for service providers, the impending visa reforms may act as a catalyst for them to develop more automation solutions and front-end technology products and restructure their talent hiring and value proposition. Interestingly, while onshore resources will increase in U.S.-based contracts, the overall portfolio-level offshore ratios may also marginally increase with providers pushing the offshoring lever to protect their overall margins.

Everest Group has simulated the potential impact on onshore margins using key input variables around existing cost structures, rate cards, staffing pyramid, and onshore-offshore resource mix. Please see our viewpoint on the above topic: “Impact of Changes to H-1B Visa Program on Service Provider Margins” for more details.

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