The offshore landscape – a birdseye view

SSON News and Analysis
Posted: 07/09/2012

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Business is global. And as organizations become more interconnected and complex, they search for vendors that deliver functionality at a price point that enables them to engage in IT transformation. To support their clients, vendors are investing in centers and staff in low-cost locations around the world with line-of-business expertise, language fluency and cultural sensitivity.

To help end-users make more informed decisions around IT service provider selection, TBR has profiled twelve of the largest providers to identify company-specific strategic advantages as well as best practices and trends across the industry.
While we will cover performance, attrition and utilization, and location investments in this whitepaper, we have additional information on efficiency, tools and automation improvements, and headcount metrics for specific countries that would be essential in helping evaluate and choose an offshore outsourcing provider.

Performance
While the corporate health of their vendors might not be the first metric an end-user will consider when evaluating a partner, profitability and operating margins often dictate investment in innovation and process improvement technologies as well as end-to-end solution design capabilities. TBR research indicates higher offshore leverage results in higher operating margins. As expected, Indian vendors like Infosys, TCS and Wipro achieve margins of 22% or above, while multinational vendors like HP, IBM, Accenture and Dell have margins ranging from 12% to 18%. The difference in profitability between these two groups is not based on ability to deliver or technical capabilities, but on the structure and depth of the organization.

The multinational vendors have deeper expertise and greater bench strength in consulting, which they use to engage earlier with clients, understanding pain points and custom architecting solutions. As these consultants are often senior, local hires based at the client site, this model means higher costs of doing business and lower profitability. Ultimately, this early engagement strategy, coupled with the extensive hardware offerings of many of the multinationals, provides an opportunity to seamlessly transition from design to implementation with clients and deeper integration.

The traditional offshore players, while maintaining they have consulting capabilities, rely mainly on their ability to do the technical processing of functions very well at a price point that is lower than the multinationals. They develop vertical competence and use improved functionality to cut costs at their client sites. Aside from Cognizant, which funnels a significant amount of its profits into innovation research, Indian providers tend to lag their multinational counterparts in delivering new innovative solutions and offerings.

Attrition and Utilization
An economic recovery is underway and customers are engaging in new projects requiring vendors to increase staff to support the contracted work. Vendors seek to hire the best employees for their projects; however, most of these top performers are already working for competing organizations. Therefore, this economic recovery has created an "employees market" where vendors are wooing experienced personnel with higher salaries and more perks. Employees are jumping at the opportunity for new challenges, potential for global reassignment and more money from their current employers

Attrition levels rose from 13.8% in 3Q09 to 17% in 3Q10, while utilization remained relatively flat at 76% in 3Q09 to 77% in 3Q10 for offshore employees. To combat these rising attrition levels and maintain morale with existing staff as well as hire new staff, either as a lateral or fresher hire, vendors are creating incentive packages to keep their employees satisfied.

  • ACS is utilizing an incentive-based pay structure that compensates individuals who either meet or exceed job function expectations with a significant bump in "per transaction" compensation. Low producing staffers self-select to leave based on limited opportunity for financial gain.
  • Recently, IBM announced it was giving $1,000 dollars in stock options to employees, as part of its strong quarterly financial performance and as part of its centennial celebration, which will vest in 2015.
  • Patni and iGate, in the midst of a merger, are giving the equivalent of six months of salary in stock options to midlevel management in an effort to keep employees during the integration of the two firms.
  • Infosys and Wipro are expected to give 100% of variable pay, or pay that is tied to company performance, to employees to keep morale high.
  • Most vendors are preparing to give double-digit salary hikes as well as promote existing staff in record numbers.
  • On a more negative note, firms like IBM, Capgemini and Accenture have instituted a policy stating staff must give three-months notice if they decide to leave their current firm to accept an offer from another company. The expectation is that the excessive lag between offer and start date will deter competitors from luring away junior and midlevel employees as well as give human resources enough notice to back fill spots of those employees who do decide to move.

While these retention programs, which are generally 1% to 5% of the cost of acquiring a new employee, are critical to the smooth operations of these outsourcing vendors, adding new, qualified staff to meet rising demand is also a challenge. Most of the vendors profiled in the TBR study have adjusted their hiring targets upward by several thousand individuals for the coming fiscal year. Lateral hires with competency in verticals in demand are being wooed with compensation packages 20% to 50% higher than at their current organizations. With limited need to train and on board these individuals, vendors with new books of business are able to meet demand on the fly.

Opinion
China will continue to be a focus for investment, with Latin America a close second. However the recent trend of investment in the Middle East in Africa is in jeopardy based on the current political unrest rocking the region.

Additionally, firms like TCS are also developing programs to bring freshers into the organization by fast tracking engineering students who score 70 or higher in school by allowing them to bypass the entrance exams used to select the wheat from the chaff young fresher applicants.
The battle to curb attrition within a vendor organization is going to be a challenge for Indian and multinational vendors alike, but those that find the right mix of compensation, opportunity and recognition will be more successful internally and ultimately externally as the economy improves.

Offshore Facility Investment and Locations
Offshore outsourcing historically meant sending work from developed regions like the U.S. and Western Europe to India to capitalize on less expensive resources performing both routine and mission-critical tasks. Now, as the model evolves, end-users require solutions that will not only provide cost savings, but new opportunities for growth and global coverage. To meet that end, vendors are undertaking plans for expansion of facilities and geographic coverage to meet, and even anticipate, market requirements.

To meet those needs vendors are looking outside and inside India as well as at India as a local market to drive their expansion. While TBR has seen a growing focus inside the subcontinent, such as HP realigning its’ strategy regarding India and the Indian IT providers offering more SMB services locally, there will be a much bigger bid for global dominance as the market expands to other APAC nations, Latin America and, now to a lesser extent, Middle East/Africa.

Many of the emerging regions the multinational and Indian providers are investing in, such as China, Philippines and Malaysia in APAC, Brazil, Mexico and Costa Rica in Latin America, and Kenya, Saudi Arabia and Egypt in Middle East provide cultural sensitivity and proximity to developed regions as well as entry into developing new markets. This dual focus is a value-add for larger firms to support their multinational clients doing business globally on a follow-the-sun timeframe as well as show commitment to smaller regional firms in countries or regions where they have created a footprint.

Many of the vendors profiled have talked of their commitment to China as the next big area for investment, but TBR’s research still shows a hesitancy to "put their money where their mouth is." Total headcount investment is only 2.5% of global headcount on average across all vendors profiled. However, with investments such as Dell’s $100 million into the region for their hardware play, it is only a matter of time until the IT services market catches up. What will be telling is which vendor will make the commitment to the region without the benefit of low cost manufacturing leading its charge.

Of the emerging regions, Latin America has become a must been seen location both to support the U.S. as well as customers in South America. With 4.8% of headcount globally in that geography, and almost 2% of total in Brazil, TBRs hypothesis is if a vendor hasn’t already put a stake in the ground in Latin America it might be too late to recover. Companies like HP and TCS have made early and sizable investments in the region and have ensured a seat at the table as the Latin American economy continues to build steam.

The Middle Eastern/Africa region was one TBR was watching with great interest as we saw many firms committing to building centers and hiring staff to support both Arabic customers as well as European customers. However, given the recent political unrest we have seen firms like Wipro and Infosys pull non-local hires out of the region back to their home offices and we expect this trend to continue for the foreseeable future. Egypt, once seen as a jewel in a new wave of outsourcing locations will be particularly hard hit. While the unrest will subside in time, it is still unclear whether the African and Middle has the political and economic stability to become a destination of choice for outsourcing firms.


Graph_TBR

Tools and Automation
One of the facets we studied in the Offshore Benchmark is the advancement and use of tools and automation as a differentiator. As depicted in our analysis above, the largest of the multinational vendors are farther along the path of developing tools that will push into the next tier of support than some of their offshore competitors. They tend to invest heavily into the arenas that will build their brand as thought leaders. In our opinion, the horserace to solve the issue is between IBM and Accenture, as both firms are vocal and aggressive about their technology developments. Once a firm solves the 1:1 headcount to revenue equation, we will see a new plateau of opportunity and cost savings for end-users and revenue growth for vendors.

Conclusion
TBR’s research has identified which vendors are expanding, in which locations, what are their focus areas and what strategy they are pursuing. Based on our understanding of the vendors coupled with our survey work of the landscape, we have identified what strategies we think will be successful, and which will require additional development to maintain growth from a revenue and headcount perspective.
We believe that, aside from the variables mentioned above, vendors that are investing in tools and automation to help them improve on efficiency will ultimately help reduce costs and increase opportunities of the customers they support. The race to become a global, integrated provider has never been more fierce, and consequently choosing a provider to meet company goals never more critical.

TBR will be providing additional insight and information regarding the vendors profiled to end user customers. Please contact Alison Crawford at alison.crawford@tbri.com of Lindy Hanson at lindy.hanson@tbri.com for more details or to schedule an inquiry.

SSON News and Analysis
Posted: 07/09/2012

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