Tag: pricing

Three Ways Services Customers Can Switch to as-a-Service Model | Sherpas in Blue Shirts

As the services industry begins moving into the as-a-service era customers look for providers that change their traditional services to make them elastic or consumption based. We at Everest Group have spent some time studying this, and we believe there are three key ways to change take-or-pay (fixed costs oriented) services and make them elastic (pay as used). One or even a combination of all three ways are present in the services model that customers now demand.

1. Multitenant sharing

Customers benefit from a provider sharing its capacity among multiple clients. AWS and Salesforce are classic examples of this elastic type of service. They redeploy servers or capacity when not in use to other customers and therefore achieve an extremely high utilization rate. In fact, arguably, AWS has over 100 percent utilization rate because it can charge customers for capacity when they’re not using it, yet can use that capacity for other clients. The model is much like an airline selling more seats than its actual capacity.

2. Automation

Repeatable process automation (RPA) or robotics spins up a virtual robot to do the work and then shut it down again. This fundamentally aligns a customer’s costs with usage and thus makes the service elastic.

3. Change purchasing method

The third way customers can have elastic services is to change their purchasing so that they only buy services as they use them. An example of this would be changing the way a customer acquires software, switching from enterprise licenses to consumption-based licenses where the customer pays for the software only as they use it. A note of caution here for customers: Although this makes the service elastic to you, there may be a stranded cost to your provider, and that cost may be embedded at a higher cost to you in your cost structure. So be careful about overly using the purchasing mechanism to make a component of your IT service stack be elastic.

Although customers can use these three methods separately, it is also beneficial to look for service providers that use a combination of all three methods to make a material difference to an entire service line to make the service far more flexible and consumption based to meet your needs.

We have not uncovered other mechanisms to make a provider’s service line elastic, but we are very interested to know if you have discovered another way to achieve elastic services. Please post your comment and share your experience.


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Q1 2015 in Services Industry Reveals Heightened Tensions | Sherpas in Blue Shirts

In reviewing the DeepDive Equity Research report for Q1, it’s clear that this year’s first quarter was a bit of a disaster for the services industry. Contrary to industry expectations at the beginning of the year, the report evidences that growth is decelerating. What happened to the expectations?

This report heralds what I’ve been blogging about for more than a year – the services industry has been rapidly moving to a mature state and is now at an inflection point. The results: slower growth, pressure on pricing and margins plus accelerated industry consolidation. In the Q1 report, Rod Bourgeois, founder and head of research and consulting at DeepDive Equity Research, presents analysis of the quarter’s results for 15 leading service providers.

The report (“IT Services: Whoa! What Happened in Q1 Results of 15 Services Firms”) is well worth reading. It reveals that nine of the 15 providers posted bad earnings results, two had mixed results and two were incomplete. Only two providers posted good earnings results. Only two – and these results are despite the accelerated GDP and more favorable economies in North America and the UK.

A caveat: as Rod points out, one quarter doesn’t make a trend. But it is troubling. And it certainly fits with my thesis of a rapidly maturing market.

What are the implications?

First, this means that the underlying growth assumptions on which the labor arbitrage market is based are no longer valid. Second, tensions around pricing and margins will heighten.

The challenge for providers is growth. The winning strategy will require moving from an industrialized arbitrage focus to one of differentiation and achieving a leadership position in new growth areas.

But the buying enterprises also have a challenge in a maturing market: don’t get trapped by vendor lock-in.


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RPA Breaks Link between FTEs and Service Transactions | Sherpas in Blue Shirts

Robotic Process Automation (RPA) is becoming a big deal in the services industry. For the last 10 years, the Indian IT industry attempted to affect pricing by breaking the link between FTEs and the services they provide. They tried outcome-based or transaction-based pricing. As I have blogged in the past, although this is interesting and has some utility; but it has both positive and negative consequences. And it’s an incomplete answer to severing the link; it prices the services differently, but it still maintains the link between the services and the people who do the work. But software accomplishes the goal with RPA. Here’s why it’s a big deal.

At Everest Group we’ve studied the impact of RPA’s disruption on BPO services. Automation and RPA break the link by replacing people with a piece of software sitting on a virtual server, which can be spun up at any time and then shut down when the work is done.

Great efficiencies come from RPA breaking the link between FTEs and services. Another significant benefit is that it enables delivering services in a consumption-based pricing model. Providers can match their costs against consumption. In the traditional FTE model, the people continue to be an inflexible cost over time, even after the provider switches them to work on another task or another client’s work. And reassigning them to other work draws out inherent friction and the problems of a learning curve.

In Silicon Valley, software firms used RPA to move from having 30 to 50 virtual servers per person five year ago to now having over 100,000 (and climbing) virtual servers per person. I believe the same potential lies in the services industry through leveraging RPA.


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Perspective on Wipro’s Cost Reduction | Sherpas in Blue Shirts

Wipro is reportedly looking at headcount and cost-reduction exercise in the realm of $300+ million. Why are they doing this? Is it a good idea? Of a few possible interpretations for wringing out costs, here’s my opinion – starting with my belief that this undertaking was inevitable. The more important question is how will they do it?

Wipro’s action comes on the back of similar news about TCS and IBM and is predicated by the pricing pressures hitting leading service providers. As I blogged recently, pricing pressure has become acute with existing clients looking for significant cost reductions.

In addition, the market is changing and clients are more insistent about requiring onshore resources; this raises operational costs for the Indian firms, which need to invest in a richer set of capabilities on shore. These resources located close to the customer are substantially more expensive for Wipro and other providers than their India-based resources.

It’s a case of when push comes to shove; if Wipro and other providers are to maintain reasonable margins or be competitive, something has to give. That “something” is the necessity to take out costs to allow them to meet the pricing pressures and allow them to hire the onshore resources that clients increasingly insist upon.

How will they achieve the cost reduction? 

I think Wipro and others will move further into the industrialized factory model, which relies on an ever-widening pyramid that pushes work down to lower-cost resources and eliminates middle-management roles.

However, I think the strategy of moving deeper into the pyramid model raises the risk of further commoditizing the space and increasing churn. And clients are more and more intolerant of churn. The likely result is that it will open the door for firms like EPAM and others that differentiate around persistent teams of experienced engineers.

Is the Services Industry in Decline? | Sherpas in Blue Shirts

Information Services Group (ISG) publishes a quarterly “ISG Outsourcing Index,” which is widely read in the services industry. Q1 2015 wasn’t a pretty picture. The Americas saw a modest 10 percent gain in ACV, and India/South Asia showed strong. But the rest of the world took a bullet, so to speak; EMEA’s ACV declined by 25 percent, Asia Pacific by 45 percent, and Australia/New Zealand had one of the weakest quarters in a decade. So the modest gains are dramatically offset by large losses elsewhere. This is further evidence of what I’ve been blogging about for some time – the industry is at an inflection point and preparing to shift. Let’s look at where the shift is headed.

But, first, a word of caution. We at Everest Group stopped publishing our index based on publicly announced deals many years ago because we found the data was inherently flawed. If all you use is publicly announced deals, you’re only looking at the large transactions and only some of those because many deals are not published. The next-generation deals and smaller deals are typically not announced. So the data is inherently noisy. Having said that, there is some value to looking at what’s happening in publicly announced deals. As such, the ISG Outsourcing Index is as good as any.

Four themes in today’s market 

The services industry is now in a mature state. As such, it has four major characteristics or themes in what’s happening:

  1. Affected by economic cycles
  2. Brownfield deals
  3. Pricing pressures
  4. Shift toward smaller transactions

Cyclical impact. As a mature industry, the services business is affected by the cyclical economy to a much larger degree than it has been in the last 15 years. To wit, where we have a growing economy in North America, the industry has share increases; where there are struggling economies in the rest of the world, the industry has share and ACV decreases.

Brownfield deals. The services world now is largely defined as brownfield deals in that the majority of activity is recompeting existing scope rather than capturing new scope. In this world, awards are smaller transactions for shorter durations.

Pricing pressures. In a recent blog post, I detailed the pricing pressures now hitting service providers and resulting in a major downward spiral and pricing wars. The ISG data also reported the downward-pricing situation. Brownfield deals also exacerbate this situation as they’re hinged on winning recompetes with existing customers, which are intent on driving prices down.

Shift toward smaller transactions. In addition to the brownfield impact there is an uneasiness in the market due to customers’ desire to break up current deals and shift to next-generation models that are automation based, as-a-service or digital. We see this movement clearly as we look at the unannounced deals that we track at Everest Group. Our observation is that these unannounced deals are taking share but with small ACV awards.

This phenomenon is particularly prevalent in the infrastructure martketplace, where there has been a secular shift from large, bundled, asset-heavy transactions to asset-light, unbundled transactions with shorter duration. The emerging markets of cloud computing and as-a-service accelerate this movement. Finally, we see tangible evidence of enterprises preparing to make large-scale shifts to cloud by adopting shorter, more flexible transaction structures for their legacy infrastructure and applications.

Bottom line

The industry faces the prospect of a maturing market impacted by economic cycles, pricing pressures, brownfield focus, and customers shifting to new models. The good news is that the new models and technologies are growth areas for the industry. However, these deals are smaller and are not usually announced deals and therefore don’t show up in the ISG Index.

Price Takes a Beating in the Services World | Sherpas in Blue Shirts

What I’ve predicted for several years is now happening and the global services industry is experiencing a pricing war. The industry’s core arbitrage marketplace is moving from modest pricing competition to an intense pricing war. Providers’ prices are coming down not by 3 to 5 percent but in some cases by 20 to 30 percent. I’ve blogged about this inevitability for some time, and the last six months showed rapid movement in a downward spiral. Pricing disciplines that providers previously exercised are collapsing. Why has pricing become so precipitous?

Who is driving the intense pricing competition?

Mature enterprise clients, which are on their second or third generation of sourcing, are instigating this market move. They themselves face unrelenting cost pressures and point to providers’ high margins as proof that there are plenty of gains to be had. At the same time as they eye the margins, they are convinced that the next generation of cloud, automation, and as-a-service offers provide breakthrough cost advantages; and they seek to combine all this into step-change gains.

With these raised expectations also comes a willingness to switch providers and a realization that the barriers to switching have been greatly reduced. This is evident in our statistics, and I blogged last year about the increasing anti-incumbent bias.

Factors exacerbating the downward spiral

In addition to enterprises’ effort to drive pricing down, other market forces add to the momentum toward a pricing war. As enterprises’ willingness to switch providers increases, incumbent service providers are increasingly in an untenable situation. Investors reward firms that demonstrate growth; so providers can’t afford to have lower-priced competitors capture large chunks of their existing revenue. In addition, the maturing arbitrage market no longer gains share from traditional models at the same rate.

As the prospect of losing existing customers becomes increasingly painful, a retain-at-all-cost dynamic is increasingly the tone forcing account teams to drop price for existing customers while encouraging providers to use lower prices as the way to win new customers.

All these actions create a downward spiral that feeds the enterprise customers’ belief that pricing must come down. And voila! We have gathering momentum on a pricing war.

Industry implications

I think the implications for the industry are very significant. The days of relying on contractual switching costs to protect providers are over. Switching costs have eroded and providers are left with no choice.

I think the new normal will be much more competitive pricing – certainly for mature clients, but also it will spread to new clients. Clearly the idea of getting COLA adjustments is an uphill climb.

I’m not saying there is a race to the bottom in all market segments. Certainly providers in the growth areas such as as-a-service models and digital technologies and value-added areas will be able to command high margins. The challenge for the industry is that the core of business is in the quickly commoditizing spaces with a customer base that is unwilling to pay a premium. We must accept that this is happening.

It brings to my mind words in a Dylan Thomas poem: “Rage, rage against the dying of the light.”


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Service Providers are Killing the Goose That Lays Golden Eggs | Sherpas in Blue Shirts

I blogged last year about the growing anti-incumbent bias in the services industry. That’s not to say that clients are biased against incumbent providers, but there are more clients who want to switch out providers than there used to be. This is true across every segment of global services (applications, infrastructure and BPO). We can trace at least some of this client mindset back to providers’ actions that are similar to the farmer in Aesop’s Fable who killed his goose that laid golden eggs. In their haste to get more golden eggs (more profitability), providers unintentionally kill the golden substance inside their goose (existing client base).

At the heart of the issue is providers’ wrong view of their clients. As a result, they take actions that cause clients to believe the provider exploits them, as the actions benefit the provider’s revenue. When a client believes the provider is only interested in maximizing its revenue, the client no longer sees the provider as a trusted advisor.

Here are three examples I’ve observed in which providers appear to act for their own interests, which results in clients no longer trusting them.

  1. The provider moves from an FTE-based model to a transaction-based model, but the provider’s revenue stays the same. Basically the provider finds a way to charge the client more for volume, which wouldn’t need to happen under the FTE-based model. Clients see through that, and the provider loses its trusted position. Clients realize the provider is exploiting them rather than serving them.
  1. The provider moves to a productivity model, promising to support portfolio apps at lower cost through a managed service. What actually transpires? The provider nickel-and-dimes the client, which ends up paying more money over time. Functions that were delivered in the FTE model are now a la carte, outside of the new model; so the client actually pays twice for the service.
  1. The provider flattens out its factory model and optimizes it to use junior resources instead of senior resources. The net result for the client is churn in the provider’s resources, so the provider doesn’t build client or industry knowledge. On top of the churn, the client actually ends up with lower productivity because junior people now do what senior people were doing.

And that’s how providers kill the goose that laid golden eggs.


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