Organizations buy services from a wide variety of service providers — ranging from managed services for IT applications and infrastructure, contingent labor to supplement gaps in skills and availability, cloud services, business process services, and more. We at Everest Group looked at the administration of these contractual relationships and discovered that most organizations leave tens of millions of dollars on the table. Why does this happen and what is the answer to this dilemma?
Companies today hold all business functions to a mandate for innovation. Innovation should create business value (a better experience for employees, customers, and partners). It should create agility and speed. It should make business functions more easily adaptable, easier to change. And it should also lower the cost of the functions over time. The benefits are clear and obvious. But the truth is innovation is illusive and hard to get.
As corporate technology leaders pursue their digital transformation strategies, many are looking to IT service providers as potential partners in those change efforts. However, a one-size-fits-all approach to outsourcing providers is not likely to serve CIOs well in meeting innovation goals. In fact, bigger doesn’t necessarily mean better in the digital change era.
“Traditionally, size was a good proxy for capability, especially when technology was viewed fundamentally as an enabler of efficiency,” says Jimit Arora, partner in Everest Group’s IT Services practice.
As summer quickly fades from our memories, and we turn our attention to the end of 2018 and planning 2019, Everest Group conducted a survey of service providers to gather their thoughts on where the market has been, where it is, and where it’s headed. The results were expected … and surprising.
The services industry is in disruption, pivoting from highly profitable but mature labor arbitrage factories to a rapidly growing, immature new market based on automation and software-defined market with digital platforms generating value. Most large companies have outsourced numerous IT and business process functions and now depend on the supply chain of services. However, I’m forecasting a services industry consolidation and substantial change in the supply base. Enterprises should seriously consider the impact and risks this market consolidation means for their business.
The must-haves and differentiators for service providers according to Multi-process HR Outsourcing (MPHRO) buyers
Recently, Infosys appointed Salil S. Parekh, formerly a Group Executive Board member at Capgemini, as CEO and MD of Infosys. His selection was a surprising choice. He lacks the industry profile of Infosys’ prior CEOs and has no prior experience as a CEO. But I believe he is a talented executive who is well positioned to continue the existing Infosys strategy and is committed to building the next generation of Indian services. He understands all that an Indian talent base can offer while also understanding the need to broaden the global talent base and lead Infosys into a becoming a digital transformation leader. I believe the following perspectives are critical when evaluating the impact of this new leader at Infosys.
The Advantages He Brings to Infosys
As I blogged in August 2017 when Vishal Sikka resigned as CEO, the new Infosys CEO will need to make bold, decisive moves to position the company for the future. Specifically, I think he brings the following advantages to Infosys:
- Strong credentials and deep practical knowledge in using a consulting-led approach to build a global transformation services business. Under his leadership, I expect Infosys to strengthen its consulting capabilities and use them to position the firm as a first-choice digital transformation company. Prior to joining Capgemini, he was senior partner at E&Y and used that financial services consulting team experience to help Capgemini into one of the fastest-growing financial services practices in the services industry. He understands how to blend consulting and delivery in a fast-changing industry will be powerful for Infosys, which must master a more consultative transformation approach if the firm is to emerge as a leader in digital services. Sikka had deemphasized the consulting practice at Infosys.
- Successful track record in business turnarounds and managing acquisitions (including Capgemini’s acquisition of iGate). In October 2017, I blogged about Infy needing to aggressively acquire digital companies is a key component of its digital transformation strategy. His influence in leading Capgemini’s charge to acquire iGate indicates he understands the necessity of a strong Indian delivery component in the future mix of services.
- Deep experience in the financial services market, which is Infosys’ largest and most lucrative market segment.
- Notable experience in working in a global context outside of an Indian firm. Salil’s outstanding leadership capabilities were notable at Capgemini.
- Deep understanding of the Indian/Bangalore culture along with demonstrated outsourcing industry experience. He will fit well into the Infosys culture and, thus, is a safe choice as CEO.
I think Infosys chose an external candidate to lead the firm to avoid some of the friction and issues lingering from the friction among the board, management and founders. Infosys now needs a steady hand, a more low-profile approach to building its future. Although Sikka raised the firm’s profile in the digital transformation space, he didn’t manage to bring the founders and the rank-and-file employees along. Parekh has the skills to focus on executing on the digital strategy. He will bring a fresh perspective on how to continue Infosys’ drive to remake the firm into the next-generation of services companies based on digital technologies and business models. I also expect he will be instrumental in changing the board composition over the next 18 months to ensure he has a unified board and can heal any ongoing rifts with the firm’s founders.
The fact that Parekh will be based in Bangalore is significant, as it will better position him for deeper understanding of the Infosys culture and enable him to build internal support for the difficult journey ahead in a challenging and changing marketplace.
In Salil, Infosys has found a capable executive that fits the Indian culture, yet brings the consulting and global perspective the firm needs. Thus, he should be able to build alliances in and outside the firm without creating the pushback that Sikka experienced.
What about Other Changes in Senior Leadership at Infosys?
The industry and media are abuzz with speculation on the amount of executive turnover as a result of Parekh’s selection. Every new CEO brings in new executives, and he won’t be an exception to this rule. It’s important to realize that Infosys has plenty of room to remove executives without removing existing talent. Some in the senior ranks had stayed to create stability after Sikka’s departure, but they will now be free to move on. Other senior talent had stepped up on a temporary basis and can now move back to a more sustainable role. That said, I don’t expect a wholesale removal of the firm’s senior leadership. It will be a case of streamlining the leadership team and restructuring some layers.
Should the Infosys Strategy Change?
Together, Parekh’s experience and the Infosys board’s forward-looking statements indicate that the existing digital direction and strategy that Sikka was driving will continue. I believe the firm is well positioned to participate in the consolidation of the legacy, high-margin labor arbitrage-based business. This is already taking place in the services industry, and I expect Infosys will capture a significant share of this work. However, I believe the primary goal is still to continue the digital transformation journey.
In the effort rebuild Infosys to lead in the digital marketplace, I suggest Infosys take the following five steps:
- Build strong support from the board/founders and internal organization, A house divided will fall, and we have already seen what this will do to the organization. As I mentioned above, this will probably require changes to the board and some changes in senior leaders as well as taking a more low-key approach (at least at the outset).
- Reset investor expectation on margins. The previous strategy’s fatal flaw was maintaining the expectation of industry-leading margins. To become the leader in the digital space, Infosys needs margin flexibility to experiment with new models and capture growth at the all-important start of the cycle.
- Focus on understanding and building a new digital delivery model that is different from the factory arbitrage model. It’s important to recognize that this new model has yet to fully emerge in the services industry; therefore, if Infosys can be the first major firm to build such a model, it will become the industry leader.
- Keep the commitment to aggressive pricing established under Sikka. The market will not tolerate a premium pricing position at this time.
- Focus on its clients instead of the firm. Infosys has traditionally been introspective. Parekh looks to be capable of changing this characteristic and influencing the firm to look outside to its customers and their needs. Now, much of Infosys’ messaging is on how Infosys is changing. This needs to change to focus on how its clients are changing.
For all the above reasons, I believe Parekh is notably able to grow Infosys’ business. I don’t think he will bring clients with him, but I don’t think this is necessary. Infosys has all the clients it needs. The challenge for Infosys today is to become the digital transformation partner of choice for the clients it already has. If he can help achieve this objective, I believe Infosys will become a clear leader in the new emerging services market.
The effort around reforming H1B work visas in the global services industry has been dangling for years, entrenched in a political battle in Congress. But there’s movement again, and dark clouds are gathering on the horizon, signaling a coming storm. Five days ago, the US House Judiciary Committee passed HR 170 (Protect and Grow American Jobs Act) with solid, bipartisan support, and it carries onerous policies aimed at India’s outsourcing service providers – as well as problems for their clients. It hasn’t passed into law yet; but it could happen in 2018. Here’s my assessment of the situation.
Proposed Requirements
As I’ve blogged several times since May 2013, reform focuses on service providers whose business model depends heavily on a large percentage of H1B workers placed at US clients. HR 170 raises the classification of H1-dependent firms to 20 percent, rather than 15 percent of workers. Providers would be required to pay higher wages to their H1B workers – with the minimum salary tied to the average occupational wage in the US. That’s a raise from the current $60k up to, and potentially surpassing, $135k.
The bill adds authorization for the US Department of Labor to conduct investigations of H1B-dependent firms – without first having to establish reasonable cause – and provides for a $495 fine to be levied on the firms for the investigations.
HR 170 also would require US clients to provide attestations and “recruitment reports” attesting that no US workers were displaced by H1B workers. This would add the burden of new management and compliance processes.
Impact
Obviously, the onerous requirements are targeted at Indian service providers that heavily use H1B workers (especially Cognizant, Infosys, TCS, Wipro). The provisions would raise their costs. They would not be able to pass those costs through to clients, so it would reduce their margins. Making it more onerous to use H1B workers would also negatively impact the Indian providers’ business models, which rely on the high-margin “factory” structure for talent provision.
Is it a Long Shot?
Although HR 170 was passed with bipartisan support by the House Judiciary Committee and has yet to pass the full House. If that were to happen, the bill would still face bipartisan battle in the Senate. We’ve seen that play out this year in efforts to repeal healthcare laws and now in tax reform efforts.
However, it may not be a long shot. The bill’s main sponsor, Darrell Issa, the Republican representative from California, will face re-election battles next year and is likely to push harder for a win in visa reform. And don’t overlook the fact that California’s Silicon Valley firms would benefit from onerous visa regulations targeting India’s firms.
My Takeaway Warning
India’s service providers are already struggling in an uphill battle aside from visa reform. They struggle to gain competence and market share in evolving to the digital world. Investments in rotating to digital raise providers’ costs, take time and often lead to battles with investors and other stakeholders who want to maintain the current margin levels. In addition, margins in the digital models are low, for at least the short term.
H1B visa reform’s dark clouds gathering on the horizon for the Indian service providers will only heap new burdens on providers already struggling with margins and new business models in trying to become leaders on the digital space. I believe the bill, if passed into law, would inhibit their growth.
US clients, which want more valuable digital services from third-party firms – but want to pay the low cost they have enjoyed with offshore providers for many years – must recognize that strategy is no longer in the playbook. They also need to be mindful of providers changing their business model and delivery practices to accommodate the requirements of H1B worker provisions when the reform passes into law and how the provider’s decisions will impact the client’s work.
As their enterprise clients move to digital business models, which are clearly superior in productivity, business alignment and speed, legacy service providers seek to shift their offerings to the new digital world too. Seems like a great match, right? So, what’s the problem? The problem is the service providers are accustomed to a very profitable offshore factory delivery model. Inconveniently, the new digital business models don’t align well with this old tried-and-true mainstay. Even more disturbing for the service providers is that the new delivery models look to be less profitable than the mature offshore talent factories. I foresee increasing pressures on margins and some potentially unrecognized consequences that will impact clients.
Two reasons for the margin paradox
As the services industry rotates from the old labor arbitrage model to digital business models, service providers expect to achieve higher margins than their typical 40 percent gross margins. Why? Because the digital models deliver a higher level of value. They are better aligned against clients’ business results and are delivered at a faster rate. So, why are providers shifting to digital not getting even close to maintaining the margins they enjoyed in the labor arbitrage space?
One reason is the price of digital talent. The skillsets for the disruptive technologies are rare and command a higher price. Plus, there is a scarcity of talent with skills and experience in implementing the new models.
A second factor is the difference in teams doing the work. The digital world requires persistent teams that remain over time and are located onshore; the arbitrage world depends on low-cost labor in offshore teams that churn over time.
Digital is driving dramatic changes to the contact center outsourcing (CCO) industry. Indeed, our recently completed buyer study – conducted over three years via surveys with more than 140 organizations and a large number of executive interviews – made it abundantly clear that outsourcing drivers are shifting away from the traditional (such as cost savings) to a digital orientation for capabilities such as analytics, access to better technology, and multi-channel solutions. Buyers now expect a lot more from their CCO engagements to delight their digitally-savvy customers.
While the importance of digital drivers has risen, service provider performance has remained below par on the new-age KPIs such as innovation, better insights, and proactiveness. As enterprises are now looking to associate with providers that are customer-centric, innovative, flexible, and able to serve as long-term strategic partners in their growth, providers must differentiate themselves by focusing their attention on improving their performance in these areas.
So, what do providers need to do to cater to these changes in buyer expectations and, in turn, survive in the fast-evolving contact center outsourcing industry? Here are our three key action steps:
- Invest in new-age digital offerings – First, they should invest in new-age technologies and the required processes, roadmaps, and consulting capabilities to support buyers along their adoption paths of these tools. These investments will go a long way in ensuring that they are well placed to meet the expectations of prospective clients.
- Be proactive in solutioning – Buyers have highlighted proactiveness as an area of improvement for providers, irrespective of their size. Strong focuses on prescribing and implementing innovative solutions that help buyers achieve their overall business goals can create differentiation and improve buyer satisfaction levels.
- Adopt a consultative approach – With innovation and better insights among the top capabilities buyers are seeking from their providers, a consultative engagement approach is critical. As discussed in our previous CCO blog, adopting this type of partnership will assist in providing a seamless customer experience across multiple touchpoints.
To learn more about the evolving contact center buyer expectations and the corresponding provider performance, please read our recently released CCO Market Report 2017: “How Good are CCO Providers in Providing Digital Customer Experience.”