Q4 2014 Global Services Mixed Bag | Market Insights™
February 11, 2015
New GIC set-ups grew across industry verticals while incremental outsourcing demand was sluggish
New GIC set-ups grew across industry verticals while incremental outsourcing demand was sluggish
What could be the implications for global services from President Obama going to India?
It’s clear what the United States wants. We want to sell technology and nuclear equipment to India. And the U.S. wants to move India out of the China camp geopolitically into the U.S. camp. The U.S. wants trade and joint efforts in the areas of climate change and energy.
What does India want? They’re also focusing on trade. One of the key flagship industries for India has been outsourcing and global services. Of particular interest is protecting the spectacular growth of the Indian heritage firms such as Infosys, TCS and Wipro and allowing the next generation to flourish. In that important area, what could they ask of Obama?
It’s clear that with two years left in Obama’s term without a Democratic congress, there is a limit to what President Obama can agree to. But there is something big he could agree to that’s within his administrative powers. He could agree to direct the U.S. immigration service to be more flexible in how they interpret the visa laws, specifically around H-1B and L-1 visas.
As written, the immigration laws include a great deal of ambiguity, giving much discretion to the immigration services on whether to grant visas and the degree of freedom that companies or individuals have in what work they can do under those visas.
This is an area that is clearly within Obama’s ability to affect, and it would be a substantial win for India. So, Mr. Modi, I don’t know if you have asked for this – but you should.
And in no way would such a move hurt the U.S. It would not only help India but also help the U.S. economy with competitiveness. There simply isn’t enough U.S. tech talent and we have to rely on Indian talent if we’re going to be competitive in driving cloud and other new service models. The agreement could even be constructed to fit in with Obama’s ongoing pressure on Republicans to reform immigration laws.
So it’s a win for both countries.
Last week both Serco and Capita announced their interim results. Not only did the two companies show a widening gap in terms of financial performance, but they also highlighted diverging business strategies.
Firstly, their financial performance in H2 2014 to date was very different:
Operating margin:
Secondly, the strategic directions of the two companies are diverging:
Interestingly, both companies have also announced changes to their boards:
Serco’s tale of woe began in 2013 when the British government discovered that it had been overcharged by Serco for offender tagging services to the Ministry of Justice (MoJ). The company is still recovering from the fallout more than a year after the issue first came to light, and having repaid more than £68 million of fees and gone through several reviews and management changes. It is ironic that Serco’s new board has chosen to focus on B2G services only, given that the troubles began in a government contract. That said, front line government services is and has always been at the core of the company’s business.
Serco has suffered from failures of governance and risk management. As it rebuilds itself, it will seek to enhance these significantly. In terms of business strategy, it will target growing opportunities in the government sector, as the pressures from aging populations and rising demand for services pushes governments to outsource more. Serco will seek to differentiate itself with its international approach, as part of which it will give its businesses a portfolio of services to go to market within specific regions of the world, to share experience and expertise.
Capita boasts of robust financial and governance structures and highly selective approach to opportunities that it pursues. Robust governance is highly needed given Capita’s aggressive acquisition strategy that has seen it take over more than a dozen companies a year for many years. Even with robust governance problems can still occur. For example, in its eagerness to win more government clients, in 2012 Capita acquired Applied Language Solutions (ALS), which had been awarded responsibility for courts interpreter services in England and Wales. For a while service delivery was less than smooth leading to the MoJ withholding fees in some instances and bad publicity in the press. Overall though Capita has benefited from many niche and strategic acquisitions that it has fully internalized, and which have largely created value and revenue.
There are lessons to be learnt from the performance of the giants of UK outsourcing. Today, one thing that is common to both is the belief that bid and governance structures have to be robust and maintained at all times.
Everest Group research has analyzed the impact that automation will have on the services industry. Our opinion, which we refer to as the 40-40 Rule, is that 40 percent of all outsourcing contracts are ready to be impacted by automation and the average impact in the amount of labor to do the work will be a drop of 40 percent. We believe the 40-40 Rule affects BPO, applications outsourcing, and infrastructure.
If we’re right, this is a very substantial disruption to the services industry.
What makes a contract “ready” for automation (e.g., scripts and robotics)? The contract must be close to termination and/or the customer is open to or interested in driving an automation agenda. In saying that 40 percent of all outsourcing contracts are ready to be impacted by automation Everest Group believes that 40 percent of all contracts have the potential to be affected over the next 18 months. But it won’t stop there; this party will keep going.
The average impact on the reduction of headcount for after automating the work per contract will be about 40 percent reduction of FTEs to perform the same functions or oversee the same amount of transaction processing. The headcount reduction will range from 20 percent at the low end to 80 percent at the high end. Individual experiences will vary; but as an impact on the entire industry, we think that it could be as high as 40 percent.
This is a huge impact, but it’s not all bad news for service providers. In the early situations where we’re seeing service providers take the initiative, they are able to capture — particularly in their existing accounts — higher margins by participating in some of the benefit of the reduced headcount. They can participate in two ways:
This is exhilarating in that it has the opportunity for potentially higher margins to offset the ongoing drumbeat of the demand for lower cost.
Margin uplift is all very well. But if the provider has a labor-based business and takes a 40 percent hit to its revenue, that’s a very difficult gap to overcome. And it’s even more difficult in today’s world where growth is slowing across the industry and it’s becoming harder to find new work that hasn’t been outsourced.
Everest Group sees the services industry into a brownfield in which service providers must take work from other providers rather than take work from the customer’s in-house functions.
Any kind of automation strategy enabling a provider to capture part of the benefits of the automation requires that the provider make up-front investments. Of course if the client is pays for the automation, it is not reasonable to expect that the provider participate in the uplift in margins. But if the provider funds or partially funds the investment, it’s more reasonable to assume that the provider will capture some of those benefits for itself, at least in the short run. So we believe there will be a significant uptick in investment intensity.
However, such investment carry a negative implication: it will cause an uptake in risk held by the provider because it will have a stranded asset that needs to be paid for even if customers’ needs or desires change over time. If the customer moves away from that automated platform, the provider may find itself straddled with an unamortized investment.
If we are right about the 40-40 Rule and that automation will be this powerful, we’re looking at a very substantial impact on the service industry. And I think the acceleration will be quite fast. We’ve found in the past that any disruption that changes the cost equation by over 20 percent for a specific client achieves rapid adoption. Therefore, we think customers will very aggressively seek the 40 percent reduction of labor, in which case the industry is in for a significant change and challenge.
The ideas are not new – for many years people have been sharing spare capacity or capabilities with each other, for example carpooling, holiday home swaps. etc. New channels, such as Airbnb, which enable sharing on a larger scale, have drawn the attention of governments, which in turn are looking for new ways to boost their economies. For example the UK’s Department for Business, Innovation & Skills (BIS) is currently running an independent review of the sharing economy led by Debbie Wosskow, CEO of Love Home Swap. I expect some aspects of the model to be deployed by BIS to help startups.
The question is can the sharing economy get a foot hold in the business-to-business (B2B) world? Other concepts such as e-commerce marketplaces have crossed the business-to-consumer (B2C) and the B2B divide. We have had sharing of resources and capabilities in the enterprise world for decades too, from shared service centers to shared office facilities. Cloud computing and the various “-as-a-service” models are also about sharing. What is different about the sharing economy is the many-to-many relationships. For example, through Airbnb many home owners offer rooms to many guests. While there will be some many-to-many examples of sharing in the enterprise too, the prevailing model in outsourcing is one-to-many, one service provider pooling its resources and capabilities to deliver services to many clients.
The sharing economy concept could lead to enterprises doing more sharing among themselves, offering their spare capacity and resources to each other. This could potentially reduce demand for outsourcing to service providers, in certain scenarios, for example sharing of resources for common business functions with partners. The trouble is that setting up such arrangements could be complicated and there would need to be solid governance procedures in place to ensure performance. It would be different if there were channels through which formal sharing arrangements could be made easily. This represents an opportunity for outsourcing service providers to augment their own services by providing such a channel.
There is already one operating in the UK: The Liberata owned Capacity Grid connects 140 local authorities in the UK to provide spare revenue and benefits processing capacity to each other. Liberata provides the network and the connectivity and charges a fee on the transactions performed. It also offers its own processing services to local authorities on or off the grid. It is looking to expand its Capacity Grid portfolio.
Looking at the company’s financials, it has got over a pension-liability black hole which dragged it down for a few years before it was acquired by Endless in 2011. Today it reports steady revenues of circa £90m per annum and an operating profit margin of 7% based on its 2012 and 2013 results. Capacity Grid has helped it maintain its revenues and Liberata is looking for complementary acquisitions that add to it. In September 2014 it acquired Trustmarque, a UK-based IT services provider. The additional IT capabilities are likely to boost Capacity Grid’s infrastructure. The acquisition also boosts Liberata’s public sector clients, including UK government and the National Health Service (NHS). There are many common services across swathes of the public sector, e.g. primary care administration in the NHS, where the enterprise sharing economy is likely to get more traction than in other sectors.
The Capacity Grid shows that a sharing channel can work in the government-to-government (G2G) setting where the parties are not in competition with each other. There are also many complementary businesses in the private sector, such as partnerships, where the model could work in a B2B setting. This could see large enterprises, or their global in-house centers, or new entrants create a marketplace for overflow business capacity. Many service providers already have the network connectivity and the platforms to enable this kind of capacity or resource sharing. The model could also open the market for services to small and medium companies that make up more than 90% of businesses.
The traditional outsourcing market is already under pressure from other disruptions such as the business process as a service model (BPaaS) and automation. Pricing and delivery models are already changing and the enterprise sharing economy could add an alternative to the mix.
With digital transformation helping an increasing number of portions of the economy better match demand with capacity through sharing mechanisms, it would appear to be only a matter of time before enterprises are applying this to some of their business needs.
Photo credit: Carlos Maya
It’s a sign of the times. Understandable and predictable. But unfortunate. The Massachusetts Democratic gubernatorial candidate and the media are hammering Republican opponent Charlie Baker for an outsourcing award presented in 2008 to Harvard Pilgrim Health Care and service provider Perot Systems. Baker was Harvard Pilgrim’s CEO at the time, and the turnaround from bankruptcy involved moving some jobs to India.
It’s a sign of the times that the highly populist agenda in North America and Europe increasingly dominates politics to the point that an award given to a company six years ago is now used to denigrate a politician.
In and of itself, this will not move public opinion or change policy. But the populist desire to at least soft play the moving of work to low-cost locations in other countries doesn’t bode well for the global services industry or immigration reform. The services industry needs to be aware that it is clearly operating in a much more sensitive and emotional environment.
Election times are always difficult. And outsourcing and global services is an easy dog to kick. I think service providers need to be aware of this and work to lower their profile in these difficult times and focus on investments that can help offset this growing populism.
Photo credit: Coralie Mercier
In a recent blog I shared Everest Group’s prediction about the short-term nature of the global services market in the Nordics. Germany is also a bright star in the global services arena. However, in contrast to the Nordics, we believe Germany’s market will not mature quickly.
Germany is relatively early on in its adoption of global services. As is the case in the Nordics, global service providers serving the German market are dealing with some structural inefficiencies in Germany’s labor market. Companies are increasingly using third parties to overcome some of their constraints around labor market rules. And German firms are hungry to apply technology into their businesses.
But the market differs from the Nordics because it’s significantly larger and broader. The German market is not concentrated in a relatively few large companies. It has large and medium-sized companies in a huge market that looks to be systematically utilizing global services to address labor market challenges.
Therefore, we believe that the growth of the German market will be long, projected and unlike the Nordics, which we think will mature quickly and be short lived.
For the past two years, we’ve observed rapid adoption and market growth of outsourcing of global services in the Nordics. This is well-documented and a real bright spot for a number of global services companies. The question is: how long will this growth continue?
At Everest Group, we believe the Nordics will behave much like the Australian marketplace. The Nordics are a larger market than Australia but have similar characteristics.
Australia is a market of 20 million people and has a well-educated, sophisticated population. Aussie businesses were quick to adopt a new global services paradigm, quick on the traditional outsourcing infrastructure model and quick on labor arbitrage. However, the Australian services segments grow quickly for three to four years and then mature equally quickly.
We believe the Nordics are following a similar path. This market is limited in size and scale. Just like Australia, its business is concentrated in some large companies that have a tendency to share or to think similarly. Therefore, we believe the growth in the Nordics likely will slow down and the market will move into a mature stage within 18 months to two years.
We make this prediction based on our observation of the Australian market performance which shares many characteristics with the Nordics in terms of size, business concentration, sophistication and collegiality.
There’s a big move underway, especially among the Indian firms, to rebrand away from outsourcing and BPO. The industry now prefers to use a variety of other terms such as BPM, BPS and managed service. But the immediate impact of changing the terminology on a provider’s website is that the website disappears from the search engines, effectively turning the company into stealth mode and sabotaging marketing efforts when potential customers turn to search engines to look for those services.
In the U.S. market, the term outsourcing is saddled with the negative connotation of job loss and exporting jobs. And in the Indian market, negative connotations have attached themselves to the BPO brand due to BPO workers enjoying themselves in their first job out of college and often getting into interesting escapades that appear to be an aggressive, risky lifestyle. BPO is increasingly seen in a poor light, particularly among the parents of the Indian workforce the providers seek to attract.
India’s service providers have nothing to be embarrassed about; they offer employees high-paying jobs with good career potential. But in an attempt to deal with the negative connotations, they are changing the terms “outsourcing” and “BPO” to sidestep the problematic issues. It’s quite understandable.
There’s no doubt that the industry has accumulated these difficult brand connotations, and we would all prefer not to work in an industry with negative brand connotations. However, businesses tunnel to Google for marketing and, by calling themselves by other terms, they disappear from the search engines.
Nevertheless, customers continue to believe that they’re buying outsourcing and BPO services and are confused and somewhat annoyed about these new terms they must learn. It violates the first rule of marketing, which I’ve blogged about before: it’s all about the customer.
At a time when services growth is becoming more difficult, going into stealth mode in search engines may not be the wisest course of action.
Photo credit: Daniel
Everest Group’s Eric Simonson, Managing Partner, Research, recently led a panel titled “Location Strategies: Optimising Your Operations in Growth Markets” at the 12 – 15 May SSON Shared Services & Outsourcing Week in Dublin, Ireland. Sarah Burnett, VP, Everest Group, was in the audience and shares the insights she gleaned from the discussion.
Last week I attended Shared Services Outsourcing Week (SSOW) in Dublin, where Eric Simonson, Everest Group Managing Partner – Research, ran a panel session to discuss location strategies. Taking part in the panel were:
Emerging from the debate was that change is inevitable — so location strategies cannot stay the same for long periods of time. Accordingly, Shared Services Center (SSC) organizations must be highly skilled in managing location as well as transformational change while delivering services, keeping staff motivated, and achieving ever increasing year-on-year efficiency and improvement targets.
Factors that contribute to change include:
For example, one company had moved some of its IT services offshore to India but had problems with talent retention. The quick turn over of staff made the services unsustainable and led to the company bringing its capabilities back onshore. This is the type of problem that could be exacerbated by the lack of brand awareness among the local workers who might prefer to work for an IT company rather than the IT unit of a different type of business.
Taking services back onshore can bring its own issues, such as lack of onshore skills particularly in IT where skills are expensive. Of course, changing locations does not necessarily mean bringing services onshore but likely to other locations and nearshore, particularly where the company might already have offices. Panel members had experienced moving SSCs to existing nearshore offices. Having had staff already in place in these new locations had made the moves much easier. The benefits of having an existing presence in a location had to be balanced against availability of the desired skills in that locality, for example required language skills or availability of specific technology platform expertise, such as, Oracle.
Having change management experience is essential for SSCs, not only to move locations but to modernize and transform services too. Some of the transformation challenges that panel members had dealt with included cultural resistance to change within their organizations. Their advice was to ensure good communication to engage well with stakeholders and all staff who will be affected by the change. One panel member gave the example of having to win hearts and minds to support even the simplest form of change; from paper to electronic payslips.
SSC managers also have to excel at marketing and sales in order to sell their services to the rest of the business. This activity requires performance data, monitoring and reporting, to demonstrate the value of the SSC in order to win new clients. This ties in to benchmarking and monitoring to measure year-on-year improvements.
Continuously improving performance can be very challenging, with expectations seemingly on an ever upward trajectory. This goes for year-on-year process and performance improvements as well as cost cutting targets. Consequently, panel members emphasized the need for SSC management to take a broad view of their services and how these can be improved. Some organizations have set up service optimization functions that work in parallel with the operational function of the SSC, but which are focused on achieving year-on-year improvements.
On the subject of continuous improvements, panel members believed that times of change, e.g. moving locations or bringing services back in house after outsourcing an SSC, provide good opportunities to review and improve processes, to fix them if they are broken, or to simplify them if they have become over-complicated.
Another important skill for SSC managers is good people management. The issue of staff retention has already been mentioned. Add to that the problem of staff in onshore or nearshore centers knowing that the service is very likely to be offshored at some point in the future. The SSC manager has to deal with the resulting job insecurity issues that this raises and the potential impact on staff engagement, motivation and retention. Some companies have specific HR policies to address this issue, for example, they will not take on raw graduates in the main part of the business but have career paths for their SSC staff to transfer to the main part of the business instead.
Finally, if the service is outsourced, the panel recommended that some capabilities should be kept in house, such as the operational oversight and the optimization functions mentioned earlier. This would keep some important skills inhouse should the outsourcing not work out.
Photo credit: SSON
© 2011-2022 Everest Global, Inc.