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Outsourcing and Offshoring 2013 Part 1: The supply side perspective


The acceleration of innovation is driving an IT skills shortage and reshuffling the outsourcing and offshoring landscape. In this context, well managed outsourcing - including to countries such as India - will likely be a key part of the IT strategy of most large organizations in the coming years.

In the first note of this two part series, Daniel LeBourhis analyses this new services market dynamic from the supply side perspective.


Outsourcing and Offshoring 2013   Part 1: The supply side perspective
The European outsourcing market paused in 2012, with flat or slightly declining activity, depending on the source. That was to be expected, considering the current economic climate.

Despite constrained budgets and resources, IT needs to address a host of issues, from traditional legacy care to imperative, profound evolutions driven by technological innovation as well as economic and societal change.

Competition imposes fast adaptation and business innovation, almost always involving an essential information technology element.

These challenges will be impossible to tackle solely with internal resources and, in any case, an all-internal approach would be far from cost effective.

Pressure on IT to “do more with less”

In the recent past, IT typically struggled to optimize the cost of legacy care in order to “free up” discretionary spending resources for new projects. This effort often led to third party maintenance or operation of legacy systems and infrastructures.

Today, as pressure increases on IT to “do more with less”, the effort will certainly accelerate, leading to more aggressive optimization of application portfolios and system decommissioning, while new infrastructures and applications must be provided.

Capitalizing on technological innovation is an enormous challenge for IT. The combination of cloud computing, mobility, big data, social networks and machine-to-machine communications spells a totally renewed vision of enterprise information technology infrastructures, requiring new skills and driving profound organizational transformations.

In addition, with a growing part of the overall technology spending being funded directly by business line budgets, demand for resources to carry out innovative projects will grow and compete for qualified human resources with “traditional” IT tasks.

Critical skills are in short supply

With these innovations spreading at an unprecedented pace, a skills shortage is inevitable, and already shaping up in developed countries.

According to recruitment group Hays Information Technology, a lack of IT talent is already a global issue. A 2012 report from the European Commission also underscored the seriousness of the problem.

It will be technically and economically impossible, for many organizations, to adapt the in-house teams’ skill sets rapidly enough while having to cope with day-to-day operations and existing systems and applications maintenance and evolution.

This situation is already revealed by the current pressures on compensation for some competencies, a striking example being the market for mobile application developers. As a side observation, this skills shortage is also visible in the “legacy” world, with zOS resources being in short supply….

In many cases, organizations will have no other choice than an increased reliance on outsourcing to cope with these challenges. This applies to new development projects (the “build” side of outsourcing) as well as operations and third-party application maintenance (the “run” side).

The issue, then, is whether the outsourcing industry is prepared to properly address this situation.

Evolving demand and increasing competitive pressure

Despite continued growth on a worldwide basis (mainly fueled by explosive growth in Asia Pacific), the outsourcing supply side is in transition as demand evolves, competition intensifies and prices come under pressure.
Over the last several years, the experience of customers with very large contracts, as well as economic constraints, has resulted in fewer mega-deals and more limited –more manageable – projects. Customers are also more reluctant to sign very long-term contracts.

Extreme decisions, such as GM’s cancellation of its mega-deal with HP-EDS, do not represent any major trend towards a reversal to “insourcing”. These types of decisions, however, do indicate a determination to regain control of the most strategic aspects of IT for the company … and maybe frustration over costs.

Even so, the “mega-deal” era is over, as customers realize that contract management and governance are much easier and more effective with smaller, more focused agreements.

In this context, true global players such as IBM, Accenture or CSC no longer neglect smaller size contracts or lower margin deals. New second-tier players increasingly win contracts at renewal time by accepting lower margins, notably, but not only, among Indian offshorers.

Another effect of this context of economic tensions and skills shortage is the increased reliance on subcontracting by outsourcers, with large players extensively using smaller firms to execute on their contracts. This of course does not always go without problems…and users need to be careful about this point.

Continued restructuring in Europe

After the 2011 acquisition of Siemens SIS by Atos, 2012 saw CGI, a Canadian services firm with formerly limited presence in Europe, acquiring Logica.

In the case of Atos-Siemens SIS, the potential synergies were clear, and the merger a key step towards Atos’ objective to establish itself as a leader in Europe. Whilst the company states that integration is going well, it will not (yet) put Atos on a par with true global players.

CGI’s acquisition of Logica is a very different story, which has met severe criticism and numerous skeptical comments. Critics cited many objections, ranging from questions on the real value of Logica to considerations on cultural issues that might complicate integration. Indeed, there have been recent examples of North American IT firms failing to effectively integrate European acquisitions – HP’s experience with Autonomy, albeit in a different field, being one of the worst.

It is true that Logica was, prior to the acquisition, a patchwork of companies, itself resulting from multiple acquisitions. Nevertheless, for a company such as CGI, seeking a substantial acquisition to boost its European presence, there were very few, if any, other potential acquisition targets available! In addition, CGI’s particular management style is more likely to accommodate and integrate the various flavors of Logica’s corporate culture than many other industry players.

Despite the inevitable transition difficulties and some possible synergies not materializing, acquiring Logica was the short path to CGI’s growth objectives in Europe. Logica’s previous business difficulties were due to organisational and managerial issues, not to its technical and professional capabilities. Provided sufficient corporate management attention and commitment are applied to it, which is more than likely considering the relative size of the two companies, CGI has a good shot at establishing a strong European presence out of this acquisition.

Overall, while these sorts of mergers can help create more viable players, they also require a substantial integration effort that may complicate or delay the supplier’s efforts to adjust to the new market conditions.

Economic performance varies among key players

In these changing conditions, exacerbated by the context of economic crisis, performance varies among the key players:
• Accenture shines in a depressed European market;
• Indian offshoring giants post diverging results with Infosys and Wipro struggling while Tata Consultancy Services (TCS) or HCL-Tech largely outperform their industry, as do fast growing second tier players like Cognizant;
• HP continues to display poor performance and struggles to articulate its services strategy amid organizational and corporate integration issues.

Success now requires more than just a low cost base, even if cost-effectiveness remains an entry and survival condition in this industry. A key point is that successful players have diversified and developed their offerings and innovation capabilities, and they continue to rapidly evolve to address the new challenges and opportunities.

At least as importantly, over the last 15 years, all of the successful players (with the exception of IBM, which was already a mature marketing machine) have evolved from the relatively primitive marketing capabilities of traditional services companies to well organized, customer-intimacy-focused organisations. In other words, they have learned to understand their customers’ expectations, needs, decision processes and organizational models.

A key caveat here is that the primary motive for building customer intimacy is that it represents the best way to effectively sell to customers. As discussed in the second part of this series, it does not automatically warrant that the service delivered will be optimal: this also requires a symmetrical effort from the customer to properly manage the supplier…

Nevertheless, these two factors - offer maturity / innovation and customer intimacy - appear to be key to success in retaining customers and (possibly) commanding some kind of limited premium on contract prices.

As the original “inventors” of the outsourcing model, suppliers such as IBM and Accenture can sustain healthy development supported by their ability to innovate and bring leading edge solutions to their customers. IBM’s unparalleled R&D capabilities as well as strong large-customer relationships set it apart, while Accenture has always had a tradition of high value-added service and deep, top-level customer intimacy stemming from its consultancy roots.

Critically, both organizations have recognized the continued importance of costs in customer decisions, as well as the importance of securing skilled workforce availability. As a result, they continue to substantially develop their offshore presence, notably in India.

India retains a unique position

Despite a trend towards offshoring location diversification, mostly driven by a quest for lower costs and a desire to mitigate geopolitical risks, India retains a unique position as no other offshoring country can offer a comparable, numerous and well-educated IT workforce.

As a result, it continues to attract global outsourcers, as well as large companies establishing or developing “IT Global In-house Centres” or “GICs” (previously known as “captives”). Meanwhile, large and medium Indian IT services companies continue to evolve and develop their capabilities.

The example of Tata Consultancy Services

Among the Indian outsourcing giants, Tata Consultancy Services (TCS) is an interesting example of most of the changes that are happening on the supply side of outsourcing in Europe.

The company built its initial growth on a “pure” offshoring model centered on cost. Over the last several years, it has vastly improved its customer proximity and support capabilities with the development of a global support centers network program, a permanent focus on customer intimacy, and aligned management and reporting policies.

In addition to developing poles of expertise centered on all major new domains of technology innovation, TCS has been able to structure a credible offering to accompany corporate digital transformation projects, notably supported by a serious program of co-innovation with customers.

The company realizes that it is still far away from matching global and local players’ presence in Europe, and has displayed its intention to enhance its capabilities through external, non-organic growth while also developing its local workforce and relying on focused alliances. Proper execution of this acquisitions and alliances strategy will be key to TCS’ ability to service its customers in Europe, and to establishing itself as a true European player. Indeed, the proper articulation of an augmented European structure with TCS’ India-based resources will be another key success factor.

Globally, the company is on the right track to evolve its positioning into a real, full-fledged global player, able to accompany customers on strategic transformation initiatives.

Supply side boundaries are blurring

As can be seen in the example of TCS, the boundaries between different categories of suppliers are blurring: among global players (IBM, Accenture, HP-EDS, CSC, Cap Gemini…), offshorers (TCS, HCL Tech, Wipro, Infosys, Cognizant…) and regional players (Atos, CGI-Logica…).

The number of truly global players remains limited, but a growing array of suppliers from different categories can effectively address customer’s needs that would have previously been “reserved” to those global players.

A major driving factor in this supply side market evolution is the changing nature of customer requirements and, in particular, the need to address a new wave of strategic customer projects focused on leveraging information technology to achieve business innovation.

However, for a specific project, real capabilities will vary among potential suppliers – often independently of the category they belong to. There are huge discrepancies in strategies, quality of execution, organizational choices, and actual skillets and experience among players of all categories, forcing discerning customers to assess each potential supplier on its specific merits for a given project.

Conclusion

Despite the current economic conditions, innovation is accelerating and technology and societal changes are driving the transformation of IT architectures and information systems. Truly skilled resources and service teams with a real capability to execute are, and will be, in short supply through 2015-2016 at least.

The outsourcing industry is evolving to address this situation, but careful sourcing and supplier management by customers (the “demand side”) is critical. This will be the subject of the second article in this series.

Tuesday, October 20th 2015
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