Tag: Services Industry

Services Prediction: More Mega Deals Coming | Sherpas in Blue Shirts

An interesting trend is developing in the services industry, reversing the trend we’ve seen for the past five years. I predict that this year, and for the next few years, we will see a modest rise in mega deals – deals with $500,000,000 or more in Total Contract Value (TCV). Where are those deals coming from?

At Everest Group, we watch services transactions closely. Over the last five years, the industry experienced a big move away from mega deals, preferring smaller and smaller transactions. This was then exacerbated by digital rotation where customers were interested in digital pilots – which are small deals. But this year we note a renewal of interest – in some specific situations – for large deals.

Here’s my take on three forces driving mega deals now.

Force #1: IP-Plus-Services Model

One force driving mega deals is where the service provider wraps services around the intellectual property (IP) platform the provider owns. TCS’s book of business of large deals is a good example of this. TCS has an IP platform around insurance and mega deals tied to that platform. The $2 billion-plus TCS transaction with Transamerica earlier this year is a good example. What makes the deal so large? The customer is modernizing its IT by jettisoning its legacy technology and transferring it to TCS for modernization through the TCS platform.

As the services industry pivots to digital models, IP ownership plays an increasingly important role. Automating work diminishes the importance of labor arbitrage, and the profit pool reconfigures around IP owners. The nature of the IP-plus-services model allows mega deals to happen. I expect more of this kind of deal to happen at TCS as well as at providers like Cognizant, which has a similar platform in the pharmaceutical healthcare space with TriZetto. Both TCS and Cognizant are using their investments in IP platforms to differentiate their offerings and capture large contracts.

Where service providers own important IP platforms, I see those as the basis for some very large deals.

Force #2: Leveraging the Balance Sheet

Another source for large deals is providers leveraging their balance sheet to finance a customer’s large-scale IT modernization. HCL and Wipro are good examples of providers using this approach to create very large deals. They use their balance sheets to fund expensive IT modernization deals, including taking over a customer’s legacy assets. This strategy accelerates a service provider’s growth, and I expect to see more mega deals using this strategy.

Force #3: Digital Transformation Programs

This year, we’ve seen digital transformation move out of the pilot phase into full-blown transformation programs. The amount of money customers spend on these transformations is staggering, often hundreds of millions of dollars. The large availability of enterprise funding for transformation is likely to encourage larger deals.

The net result of these three forces? I believe we will see a modest increase in mega deals, and in certain areas, larger deals for the remainder of this year and next year.

I’m not claiming the entire services market is moving to mega deals. In fact, two size-diminishing secular trends that were well underway continue: (1) decomposing the legacy, multi-tower deals to single towers and bidding those out (2) the move from managed services to systems integration and digital work. These trends will continue to create a fabric of smaller transactions.

However, some large deals are emerging. I believe the three forces I described are working against the well-established trends for smaller deals we saw during the last five years.

Are Rising Costs the Only Impact Immigration Reform Bills Will Have on the Services Industry? | Sherpas in Blue Shirts

When U.S. congressmen Darrel Issa and Scott Peters at the very beginning of 2017 proposed a bill that would increase H-1B visa holders’ wages to US$100,000, experts in the industry were positive that IT service providers would be able to manage it, as they were already bearing costs between US$75-85K. But less than a month later, U.S. Congressman Zoe Lofgren’s introduction of the “The High-Skilled Integrity and Fairness Act of 2017” – a bill that aims to double the minimum salaries for H-1B visa holders to minimum US$130,000 – eroded 5 percent of the Indian IT service providers’ market.

Although U.S. President Trump’s subsequent congressional speech talked about merit being the criteria for visa allotment – and many businesses rejoiced that he made no mention of minimum wage as the deciding factor – it’s fair to assume that the minimum wage might still end up near US$130,000 in a merit-based lottery system.

But cost is only one of the possible impacts of visa reforms on the parties directly and indirectly involved in the services industry. Let’s take a look.

Impacts on service providers

A landed resource might continue to be indispensable for projects when his or her role is primarily that of liaison with between the client’s business units and the provider’s offshore resources (due to time zone differences and established comfort levels) or if he or she was engaged for unique skills or insights. Landed resources serving as liaisons for business units could more easily be replaced by local resources.

H-1B visa reforms are expected to trigger a refocus on driving efficiencies through automation and digital process transformation. This will accelerate the transformation in service providers’ years’ standing talent acquisition operations and processes. The requirement for different skill sets, coupled with cannibalization of traditional revenue streams, paint a less than rosy picture on falling traditional revenues and increasing costs.

We might also see higher consolidation in the outsourcing industry, especially for mid-sized firms, as service providers may look at economies of scale and inorganic account expansion to counter slowing growth and keep cost of operations in check.

Impact on enterprises

U.S. companies might have to bear the brunt economic impact of the demand-supply mismatch. Enterprises today use H-1B resources for a variety of reasons, some to manage their GIC operations. A raise in the average wage will cause inflationary pressure on IT resource costs, restrict supply of talent, and create increased poaching of resources between companies. In other words, enterprises might be forced to hire landed resources at a cost much higher than the perceived value, or lose out on business efficiency and growth, thus creating a vicious cycle that the current administration hopes to break.

Impact on the education sector

The education sector might be most immediately impacted by any stringent visa reform going through. Enrollment of non-U.S. nationals in Master’s programs could plummet, given the likely challenge in finding jobs after graduation. This situation has already been observed in the U.K., where tight visa guidelines have compelled students to return home once they are done with their education. The rest of Europe, which has relatively less stringent visa requirements, might become a hot destination for the Indian student diaspora as demand for technical expertise increases significantly.

In India, it’s clear industry veterans and current leaders are questioning their own hiring tactics and the sustainability of the low cost model. While some have expressed that retraining their current force is difficult as people in senior and middle management are low quality, others have condemned the IT industry as a whole by accusing them of carteling to keep wages low.
This might not float well with new graduates, who increasingly look for jobs at start-ups entering the disruptive digital space. These new companies are offering higher wages and a culture more suited to millennials than do IT service providers.

While it will be wait and watch until we know what clauses in the proposed bill become law, it’s clear that any combination of the above and other impacts will force providers and enterprises to make some major decisions to remain at the top of their game.

Services Industry at Inflection Point in 2017 | Sherpas in Blue Shirts

As I recently blogged, 2016 was a disappointing year for the services industry as discretionary spend was not robust and growth in labor arbitrage services is now flat. I see an industry desperate for growth in 2017. Here is what I believe will happen.

I think we’ll see more acceleration in adoption of the new business models associated with digital technologies – cloud and automation especially. We’re already starting to see this. The growth in the services industry will be entirely in this space. At the same time, I believe providers will experience revenue compression in their existing book of business. How much compression? Let’s do the math.

The length of most service contracts is three to five years, so 20 – 30 percent come up for renewal/competition every year. Let’s take the best case – 20 percent of revenue comes up for renewal in 2017. Half of it will be hit with a 30 percent pricing drop due to automation and other digital technologies creating greater efficiencies. That means providers can expect a three percent compression for their existing book of business. And that’s a conservative perspective. Put another way, providers will need to add three percent more business just to keep the same revenues they now have. When you combine this with a fast decelerating growth in new opportunities, the prospects for growth in 2017 become a lot more troubled.

This translates into an industry at an inflection point. The challenging prospects for growth translates into a hyper-competitive environment and intense pricing pressures as providers try to capture each other’s scope. To offset these growth issues, 2017 will find providers increasingly looking to acquisitions to replace organic growth.

On the organic front, providers will attempt to accelerate their move into segments with strong growth such as digital and cloud. Unfortunately, these moves will require increased investments and experimenting with new business models. Not all players will be equally successful, which will create further daylight between the haves and the have-nots, thus accelerating the pressures for further industry consolidation.

All in all, I believe 2017 will be an intense year for the services industry.

2016: The Disappointing Year in the Services Industry | Sherpas in Blue Shirts

As many executives are focusing on the changes that may occur in their business in 2017, I think it’s important to take a moment to review what happened in the services industry in 2016.

At the outset of this year, we at Everest Group believed the U.S. economy would continue to grow and that discretionary spend would build. We realized—and I often blogged—that the labor arbitrage model was mature and growth was slowing, but we believed the model still had more to play out.

However, the reality as it played out over the past 11 months is that the labor arbitrage market matured much faster than anticipated and discretionary spend was less robust than we expected. Consequently, earnings and growth disappeared for most of the providers in the services industry. The labor arbitrage business is flat and has effectively stopped growing.

Because of maturing service models, the year also brought a great deal of pricing pressure and providers’ growing by taking each other’s share.

But there is also good news. Almost all service providers’ growth in 2016 was in cloud and automation, and these areas are growing at a rate of almost 22 percent.

The industry is also showing early signs of revenue compression, and I believe it will be 40 percent or more over the next few years. Digital technologies such as automation, analytics, cloud and cognitive computing allow providers to do existing work much more efficiently. In many service categories, there is a 40 percent or more opportunity to eliminate FTEs. This year clearly showed providers integrating automation into their contract recompetes as well as in aggressive productivity performance.

The pace of cloud and automation adoption in services picked up significantly this year. In my next post, I’ll discuss what this means for 2017 as well as other predictions for the coming year in services.

The Services Industry is Changing in Radical Ways | Sherpas in Blue Shirts

The times they are a changing, as the old Bob Dylan song said. In a recent post, I blogged about the dramatic changes we’ll see in the services industry over the next two or three years. Let’s look at two more forces driving industry change.

A major force is the maturity of the labor arbitrage model in services. Ten years ago, it was very difficult and intimidating for a company to set up facilities in India (or another low-cost location), hire Indian teams to run it and build the policies and processes that enable operating with excellence. But the market has matured, and that’s no longer the case. It is now much easier for companies to build offshore capabilities themselves rather than relying on third parties. Today there is a ready-made pool of facilities that they can rent, management teams they can hire and well-understood offshore policies, programs and tax rules that can be applied.

So the do-it-yourself barrier has dropped as the market has matured, leading to the current growth and capability of GICs, which I described in my recent blog. When you combine this with companies’ desire to shift from unit/service component value to business outcome value, it creates a dramatic shift to bring outsourced work back in house to internal GICs. I expect this trend to continue.

A third factor driving change recently emerged but is already making an impact by giving services customers more choices in models. This change is based on the AACC technologies – automation, analytics, cognitive and cloud. The service models coming with these technologies favor small, cross-functional teams that are aligned directly with the business users around producing business value. Moreover, the teams are organized around end-to-end services. The result? Businesses are no longer looking for large offshore factories of labor.

As the AACC technologies and capabilities become more mature, I believe they will also shift the balance, at least in many areas, toward a do-it-yourself model over a third-party service provider.

So times are changing. I’m not saying that the third-party service model will be eliminated. I’m just saying that this model is about to change in some radical ways.

Forces Driving Change in the Services Industry | Sherpas in Blue Shirts

The outsourcing industry is at an inflexion point. It reminds me of Bob Dylan’s hit song from the 1960s, “The Times They are A-changing.” I believe the industry will undergo dramatic change over the next two to three years.

Three forces are driving the change. The first is a shift in user and company expectations. I’ve blogged before about the watermelon phenomenon. Although performance dashboards indicate green for service levels and KPIs, the true picture is often red when it comes to user satisfaction with IT services.

Why is the satisfaction indicator red? One reason is a shift in users’ perception of what value is. Companies historically thought about value as a function of quality and cost. Quality was defined in service levels. Cost was defined as unit costs (per hour, per transaction, per server, etc.). But user’s focus on value has shifted from to the value of the business function.

As an example, consider the business function of employee onboarding. Value used to be viewed as the cost of providing the applications and the quality of the apps (reliability and resilience, and whether they provide the necessary functionality). But the perception of value shifted. For example, now it could be tied to how the new employees view their onboarding experience and whether or not the process results in employees that are well prepared to work in the company. It used to be viewed as the cost

Another reason the user satisfaction indicator is red is the dimension of speed. Companies have always been aware of the need for speed, but historically quality took precedence over speed. Increasingly we find users value speed more. It’s not speed in developing an application; it’s the speed to change the business functionality (such as the employee enrollment system in the example above). It doesn’t matter how quickly an IT group or a third-party service provider can make a change to the application or server; it’s how quickly they can change the functionality.

Users no longer associate value with the delivery components that make it up (such as the infrastructure uptime).

This shift in user’s perception of value is a fundamental reason why the services world is changing, and it’s driving different behaviors and decisions.

One way the change is manifesting is that companies that have outsourced processes now want to bring the work back in house so they can better focus on the business value and less on the service delivery components. The preference for insourcing and GICs is gathering momentum. This is evident in statements of leaders at leading companies such as:

  • “Shell is clearly on a path to insource our project delivery capabilities.” (Jay Crotts, CIO, Shell)
  • “We believe having our own center and doing more of the work ourselves will lead to lower turnover of people, we’ll have people who really understand our systems, people who are passionate.” (Therace Risch, CIO, JCPenney)

Historically, GICs or captives performed only low-cost delivery work. But they’re now gaining share in the marketplace for sophisticated work. Companies are investing in their GICs as they recognize the need for stronger alignment between IT and business users to drive value. The GICs are still located offshore, but the functions are back in house instead of performed by a third party.

The times, they are a-changing. In my next blog post, I’ll discuss two other forces driving change in the services industry.

How Does DevOps Change the Services Industry? | Sherpas in Blue Shirts

DevOps is changing the services industry, especially in the people model. Here’s an important question for service providers in the Digital Age: Can you achieve the same impact in a distributed DevOps environment as you can in a collocated DevOps environment? Clearly, because of where the industry makes money, the industry would like the answer to be distributed. It’s a well-known fact that industry profit margins are much higher when services are delivered out of low-cost locations. But let’s look at this issue more closely.

The focus of DevOps is aligning services with the business and achieving speed (that is, agility and continuous improvement). This suggests that the most effective way to do DevOps is to collocate a provider’s engineers with the business or in close proximity to the business. In the distributed model, providers typically get around this by having a portion of the engineers (the product manager) sit with the business and the engineers sit offshore.

Yet, as we look at the early and best use cases – for example, Microsoft Azure – we find that companies prefer to collocate the product manager and the engineers in the same small team. The collocated model stresses the need for speed as the core of the move to DevOps. There is no doubt companies can reduce costs by moving people offshore; but do they give speed and business alignment when they do that?

When the product manager is a customer or is believed by the customer to be essential to the customer’s knowledge, that makes the practicality of the offshore model more difficult. In many cases, some companies will choose not to take the work offshore. All this portends to significant changes in how customers and providers define and manage their talent model in a DevOps environment.

Having said that, there simply isn’t enough talent in North America and Europe to move all the application development people on shore. So customers and providers will need to come to some accommodation. It’s clear that the services industry will need to break up work differently including customers having more responsibility and accountability offshore than historically.

The Best is Yet to Come in Services … or is It? | Sherpas in Blue Shirts

My wife and I are like the service industry, particularly the arbitrage-based talent service industry – maturing rapidly. These days, while we think about how we’re moving into our golden years with the prospect of being surrounded by loved ones and hopefully grandchildren, I think the prospect for the service industry is quite different. Sure, our income slows as we age. But we’re aging gracefully, and my wife seems to get sweeter every year. But I feel the prospect for the service industry is different.

There is no doubt that, as the service industry matures, there are some very unpleasant aspects. We see profit margins being squeezed, particularly as they face the difficult challenges of shifting to different business models, driven by digital and automation. We’re seeing signs that the Indian service providers that have been flexible and highly attentive are now displaying less-pleasant attributes. Facing slowing growth and shrinking margins, they are pushing back on their clients and adopting some of the less-savory attributes of their more mature cousins, the MNCs. Their behaviors remind of a line in the Dylan Thomas poem – “Rage, rage against the dying of the light.”

I think all industries struggle when they start to mature. But automation technologies will have a huge impact on the service industry and force it into a different service model. My wife and I in old age face less vigor and a series of challenges. But we view this period in our lives similar to lines in a Robert Browning poem: “Grow old along with me! The best is yet to be ….”

So is the best yet to come in services? The industry’s challenges are substantial, and it remains to be seen whether, like a butterfly, the industry can go into a cocoon and come out as a different business model. That is what we hope for. However, any kind of metamorphosis is painful and difficult. That level of metamorphosis is not done easily, and we now see the early stages of the industry wrestling with this challenge.

I think the twin forces of markets maturing and disruptive technologies forcing changes point to a turbulent and painful few years ahead.

Services Industry Awakening to Three Business Models | Sherpas in Blue Shirts

I recently blogged about three stories of the way business is unfolding in the Indian services arena due to dramatic changes driven by automation and digital technologies. Here’s another page-turner from NASSCOM’s February conference: there are three possible or probable business models for moving forward.

The first model is the existing labor-based model in which the service providers are compensated for the labor in the form of FTEs or hours. I think this model will continue to play some role.

Second, there has been a lot of talk about charging for outcomes/results. I think that is certainly possible, although it’s very hard to do. The reason is that often the service provider is not the only factor driving the business result. Hence, you end up with a misalignment between the services rendered and results generated. This is a problem for the service provider, which may not be paid when it has done good work. But it’s also a potential problem for the service consumer paying for the services, who doesn’t want to pay for results to an entity or organization that didn’t create the results.

I acknowledge that this is certainly what the industry has been talking about – the shift from FTEs to results or outcomes – and I see that as a possibility. In fact, in some instances, it’s a good idea. But I don’t think that it will be the dominant shift.

The third alternative is a shift to a consumption-based model. The current model is built on a capacity basis; clients pay for the hours whether they use them or not. As we at Everest Group look at the new models, we think clients seem to want to move to more of a SaaS model, which is a consumption-based model. In this model, clients pay for what they use, not what they don’t use. And they pay for it, on some basis other than FTEs. Pricing could be based on seats, usage (as in data or activity), or through some other well-aligned metric that measures the usage.

And the winner is …

I don’t think that any of these three will become the dominant model. At least I don’t see signs of that yet. I believe what we’ll see becoming dominant is some combination of the three models.

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