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tier 1

John Mellencamp Named Honorary Everest Group Analyst of the Month | Sherpas in Blue Shirts

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“Well I was born in a small town
And I live in a small town
Prob’ly die in a small town
Oh, those small communities

All my friends are so small town
My parents live in the same small town
My job is so small town
Provides little opportunity

— John Mellencamp, Small Town (1985)

Turns out Mr. Mellencamp was a pretty good analyst when it comes to assessing global services employment opportunities in small communities. So much so, that I am officially naming him as “Honorary Everest Group Analyst of the Month.”

No, I am not smoking something.

We just completed a first of its kind analysis of the U.S. Domestic Outsourcing location landscape for RevAmerica and finally have the key facts the industry has been lacking. In short, although smaller communities are sometimes used for service delivery, the reality is that the vast majority of the market is concentrated in larger communities with populations measured in the 100,000s vs. 10,000s. In particular, tier-3 cities are the sweet spot…the largest number of centers, the largest employment, and the largest centers.

Defining the city tiers

In order to analyze approximately 250 metro cities, we segmented them into six groups – tier-1 through tier-5 plus rural. As indicated below, the city segments are characterized by differences in population size plus commercial and educational factors.

Location Definitions

Although only one dimension of a city’s potential for service delivery, it is easy and revealing to look at the differences in average population size of the city tiers. Each city tier is 20-40% of the population of the next larger city tier, which leads to a dramatic difference in the profile of cities that are 2-3 tiers different from each other.

Population of city tiers

It’s good to be a tier-3 city!

One of the most interesting findings from the research was the extent to which tier-3 cities dominate on almost every dimension. As shown in the exhibit below, they have the largest share of FTEs and delivery centers of all cities. Further, their centers are on average larger than any other city tier.

Distribution of FTEs and US delivery centers by city-tiers

Additionally, tier-3 cities have the largest portion of multi-function centers (some combination of IT, business process, and contact center) and are the centers which are expected to grow the most in coming years.

Given that tier-3 cities average one million in population, most are surprised that cities of this size are driving the growth of domestic outsourcing delivery – many would expect smaller cities to be the primary forces. So why are tier-3 cities favored?

In short, we believe this is due to three factors which work in combination with each other:

  • Sufficient cost savings: Relative to tier-1 cities, tier-3 cities offer 15-20% savings; moving to tier-4 cities may only offer 5% more savings and in many cases is either cost neutral or even higher cost than a tier-3 city.
  • Enough talent: With nearly one million in population, the installed base of experienced talent is sizeable. Further, most tier-3 cities have large colleges which produce fresh talent for the entry labor force. Combined with the life style benefits of a larger city (airport, entertainment, shopping, etc.), tier-3 cities have the ability to both keep talent and to attract talent from other cities – either smaller or larger cities. Not everyone would want to live in New York, NY; similarly, many people could not imagine living in a town of Midland, MI (a town of roughly 50,000). However, many people could be comfortable in a city of one million.
  • Accessible: Although the idea of a remote, small city may seem attractive in order to capture an isolated labor pool, this doesn’t hold up well when assessed in detail. First, even small communities have competition for talent plus limited talent pools – costs can quickly spiral up. Second, the practical logistics of transit to these small cities creates an inconvenience that most organizations wish to avoid (especially for IT service delivery, requiring more cross-center collaboration). Most tier-3 cities are connected by direct flights to other major business centers within two to three hours of flight time.

In other words, tier-3 cities have an attractive mix of cost savings and talent, while still being comparatively easy from an operational perspective. This is broadly true, but less true for pure contact center work which can more easily operate at scale in tier-4 cities and even some tier-5 cities due to the broad labor pool which can fill contact center roles.

So, would Mr. Mellencamp’s small town have been a viable service delivery location? He is from Seymour, Indiana, with a population of about 16,000 – clearly a rural community by our definition. Highly unlikely many organizations could operate an IT or business process center of 200 FTEs in Seymour, although a smaller contact center could be viable. So, yes, there might be jobs…but little opportunity…

Also check out my co-presenter Sakshi Garg’s top 10 takeways from RevAmerica.


Photo credit: Flickr

Tier-2/3 Cities’ Growing Attractiveness as Promising Locations to Deliver Global Services – Can Runners Up Be Winners as Well? | Sherpas in Blue Shirts

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The broad picture

With both buyers and service providers increasingly understanding the benefits of tier-2 and 3 cities in their quest for greater cost savings and access to additional talent, these lower tier locations are witnessing significant growth in new set-ups and expansions.

Companies typically look for at least 10-15 percent additional cost savings over tier-1 cities to justify the business case for moving to tier-2/3 locations. But to achieve their goals, they must create a sustainable business case considering both benefits and trade-offs, e.g., a decrease in operating costs versus an increase in management overhead, and entering an established market late versus entering a relatively nascent market.

Some argue that additional cost savings over tier-1 cities can also be realized by expanding into peripheral areas within tier-1 locations (e.g., Pune/Hinjewadi and Mumbai/Navi Mumbai, versus Coimbatore, Ahmedabad, Jaipur, and Bhubaneswar) or in existing tier-1 locations through scale economies. But the “right” answer here is highly context-specific, and depends on an organization’s specific needs and priorities. For example, a company battling for talent in a tier-1 city will not benefit much by expanding to peripheral locations but can access to additional talent by setting up in tier-2/3 cities.

Distribution of set-ups by Tier-1 and 2 cities

Central Eastern Europe (CEE) and Latin America (LATAM) both had more global services delivery set-ups in tier-2 cities than in tier-1 cities in 2012-2014 H1. Although increased activity in tier-2 locations is a relatively recent trend in Asia Pacific (APAC), it is fast catching up with the highest number of tier-2/3 set-ups among all three regions during 2012-2014 H1. Global in-house center (GIC) and service provider activity in APAC is concentrated in India, but distributed across multiple locations in CEE and LATAM. The above chart presents the top five tier-2 locations in each region.

India’s tier-2/3 city story

India continues to be an attractive offshore destination for global companies, given its unique combination of low cost, scalable talent pool, and breadth and depth of available skills. Tier-2/3 cities add to the value proposition by providing additional cost savings of 8 to 12 percent (for IT services), due to lower facilities and other operational costs.

With higher concentration risk in tier-1 cities, it is becoming increasingly important for enterprises and service providers to access talent from tier-2/3 cities.

For more information, download a complimentary preview of Everest Group’s recently released report, Tier-2/3 Locations in India for Offshore IT Services Delivery – Does Reality Meet the Hype?

Philippines: moving beyond Manila and Cebu as delivery locations

While the Philippines’ key tier-1 cities (especially Manila and Cebu) are becoming saturated, the proliferation of tier-2/3 cities offer a strong proposition. Emerging tier-2/3 cities – e.g., Dasmarinas, Malolos, Iloilo City, and Baguio – contribute 30 to 40 percent of the relevant graduate pool, and for IT-BPS offer a cost differential of 10 to 25 percent as compared to Metro Manila.

For more information, download a complimentary preview of Everest Group’s recently released report, Is Philippines Stepping Up to Lead the Industry into the Next Horizon of Global Services?

Dimensions for operationalizing a tier-2/3 delivery center

Operationalizing a center in tier-2/3 cities and successfully deriving the above-mentioned benefits requires a slightly different approach than in tier-1 locations:

Talent hiring strategy: Companies need effective talent strategies to meet the needs of experienced personnel who often need to be relocated. They also need appropriate employer branding to capture mindshare in local colleges and universities.

Client engagement and contract type: To optimize costs and improve profitability, tier-2/3 cities are likely better suited to deliver work for existing (rather than new) clients/modules.

Operating model:Tier-2/3 cities can serve as self-sufficient centers directly handling clients, and can also be structured as a spoke to tier-1 cities in certain cases.

Creating an ecosystem: Companies need to invest in infrastructure, the social living environment, and the delivery ecosystem in order to successfully operate a tier-2/3 city set-up.

Many tier-2/3 cities options with multiple benefits and opportunities are available across various regions and countries. But enterprises and service providers must take into consideration multiple associated challenges – e.g., scalability, lack of enabling environment, trade-offs with peripheral cities, and lesser breadth of skill sets – before setting up or expanding their operations in these locations. A commercial-driven business case may not be enough to evaluate these cities; what is needed is a risk-reward assessment!

Do Indian Tier 1 Service Providers Run the Risk of Losing Their Cost Competitiveness? | Sherpas in Blue Shirts

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An international private equity client recently asked whether Indian service providers’ cost competitiveness was eroding and, if so, whether they would be able to protect its cost advantage over multinational corporation (MNC) players. While we gave our directional point of view, this question was worth following up with a quantitative answer. And as expected, a few days (and nights!) of serious number crunching turned up interesting insights. Let me share a few.

First, let’s establish the current differences in costs and the drivers. Pricing for standard IT services (say ADM) has been under pressure due to a number of factors such as economic headwinds, maturing buyers, and intensifying competition. However, at a marginal deal level MNC Tier 1s continue to price at a 20-30 percent premium (average price per blended FTE) over Indian peers. This can be attributed to underlying differences in cost structures that translate into a 30-35 percent lower blended operating cost of the Indian Tier 1s compared to MNC peers at a marginal deal level. Key operating cost levers that result in this difference include location mix, project pyramid, employee tenure, and salary differential for the same talent profile. Across each lever, Indian Tier 1s command a competitive advantage given different starting points in arbitrage leverage and talent practices (e.g., full offshore pyramids versus partial pyramids, new versus lateral hires) compared to MNCs. In addition, the gross margin expectations differ. A key driver of gross margin difference is the SG&A spends. Indian Tier 1s on average have ~50 percent lower SG&A spends than their MNC peers due to lower corporate overhead and smaller investments in sales and support personnel.

Let us now turn the clock back a few years. The cost gap at a marginal deal level has closed by ~50 percent between 2005 and today. So, what changed in favor of the MNCs? They have improved cost competitiveness along all the drivers, particularly location mix. While the Indian players were busy expanding their overseas headcount and investing in higher skilled talent during 2007-2010, the MNCs steadily pushed the offshore lever hard, while quietly rationalizing their U.S/U.K. headcount. Over the past few years, the MNCs struck marginal ADM deals with an offshore component closer to that of Indian benchmarks though falling short by 10-15 percent. As a result today, 40-50 percent of MNCs’ services delivery headcount is global, predominantly in low cost locations. In comparison, Indian Tier 1s have ~73 percent of their headcount in India.

Going forward, which levers will experience greater convergence? And to what extent will the gap close?

Although MNCs have covered significant ground on offshore leverage, they have a lot more to cover on the rest.

Among arbitrage levers, MNCs have limited room to increase offshore leverage. For instance, achieving even 60 percent offshore leverage at a portfolio level would require them to structure all incremental work at the marginal deal level identical to the offshore-onshore mix of Indian Tier-1s. On the other hand, Indians will continue to have a head start in driving arbitrage through extensive use of Tier 2 and 3 offshore locations that are 20-40 percent cheaper than established ones. However, the Indian Tier 1s expanding location footprint into high-cost onshore markets will marginally offset some of these arbitrage gains. Pyramids differences are easier to fix through investments in offshore project managers.

Among the talent model levers, the MNCs have a lot of ground to cover, and the near-medium term opportunity for impact is high. They have already stated intentions to aggressively ramp up new graduate hiring in India. This will help reduce tenure difference to some extent, but will not erode the differential completely. For instance, even if they were to bridge the tenure difference to Indian Tier 1 levels for all new deals, the resultant impact on the average experience years at a portfolio level will be limited. Salary differential is likely to experience some erosion on the back of new visa/immigration legislation in the United States. We expect the dependence of Indian players on H1B/L1 visas – another source of cost advantage – to reduce as they look to scale up local hiring from the current 30-40 percent to ~50 percent of total onshore headcount.

The journey from here for MNCs is going to be more challenging as achieving operational efficiencies involves driving more structural changes (e.g., talent model) and associated investments (e.g., training and strategic bench). Another important driver is the impact of inflation, which MNCs will be more exposed to as they grow in offshore markets.

So, the question then becomes, can MNCs bridge the cost gap at a portfolio level to enable them to reduce the price differential to a level at which they can justify a premium of, say ~15 percent for plain-vanilla ADM work? Highly unlikely, for three key reasons:

  • Bridging the current cost differential to even sub 20 percent (through 2015) at a marginal deal level will require them to maximize all cost levers at the same time
  • The current cost differential at a portfolio level is wider than that at a marginal deal level
  • The Indian Tier 1s are increasingly playing head-to-head with the MNCs in terms of capabilities on deals, and getting entrenched in the IT services vendor portfolios of large buyer organizations

A Thumbs Up for Wipro’s Acquisition of SAIC’s Oil & Gas IT Services Business | Sherpas in Blue Shirts

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Despite the fact that Wipro announced its acquisition of SAIC’s oil and gas IT services business on April Fool’s Day, the deal will be far from prankish silliness if the integration of two fundamentally different cultures and business models is managed correctly. Here are three key reasons we give this acquisition a thumbs up:

Stronger appeal to clients in the energy industry, and separation from its Indian provider peers

Wipro is already the largest offshore Tier 1 provider in the energy and utilities sector in revenue terms, and the acquisition will provide it with broader and deeper consulting, technology, and outsourcing capabilities in the upstream business, and enhanced service capabilities in areas including digital oilfields, exploration, and production data management. The deal brings into Wipro’s capabilities a pool of onshore domain experts — nearly 1,500 — with presence in major oil and gas markets in North America, Europe and the Middle East. The acquisition should also help Wipro upshift current offshore-based ADM service delivery clients, enable up-sell and cross-sell to higher value/high margin services, and allow penetration of the SAIC client base to drive growth per an offshore-centric delivery model. The bottom line is that the acquisition will enable Wipro to demonstrate a strong, differentiated play for oil and gas clients across the entire value chain.

An affirmation of its intent to further differentiate in areas of existing strength

Let’s face it . . . 2010 was not a great year for Wipro. With financial fraud and the sub-par financial and operating performance that resulted in the ouster of its joint CEOs, there was significant conjecture on whether or not Wipro could remain competitive and regain a place among the Tier 1 Indian providers. The acquisition not only demonstrates Wipro’s commitment to investments in growth, but also should help quell concerns about the company’s future, especially for energy industry clients. Perhaps most importantly, the acquisition gives Wipro the deep domain expertise differentiation play that is becoming increasingly important for offshore providers. This should enable Wipro to both win new business and increase the size and scope of its work within existing Wipro and SAIC accounts.

Enhanced revenue growth via its earlier inorganic strategy

Major acquisitions and inorganic growth — including its purchase of acquisition of Infocrossing in 2007 and Citibank’s IT captive in late 2008 — have been a large part of Wipro’s revenue growth strategy. Lacking any large acquisition in the last couple of years has negatively impacted its comparative peer performance. But the SAIC acquisition will enable a revenue upside of at least US$150 million — assuming a revenue multiple of 1 — which will reflect in Wipro’s next financial year which ends on March 31, 2012.

Assuming this all plays out the way we think it can, we do believe the SAIC acquisition can significantly widen the gap between Wipro and the other Tier 1 offshore majors in the energy vertical.

Everest Group just released a Breaking View point on this acquisition. If you’re interested in more drill-down insights on this deal, please go to: Wipro’s Fool’s Day Acquisition of SAIC’s Oil & Gas IT Business – The Energy Pill Wipro Needed?