Shifting landscape of IT outsourcing

The sudden upsurge of Indian IT firms early this decade made the highly fragmented global outsourcing industry look like a battlefield between David and Goliath. Indian firms looked like underdogs before outsourcing giants such as IBM, Accenture, HP/EDS, Xerox/ACS and CSC which dominated the industry. IBM Global Services, Big Blue’s largest division which deals with outsourcing, earned an annual revenue of little below $60 billion in 2009 - an amount comparable to earnings of the entire Indian IT industry.

But Indian IT firms sold their Global Delivery Model - a mix of offshoring, labour arbitrage and lower prices - so successfully, they disrupted the outsourcing industry. Prices came down and offshore delivery gained wide acceptance, forcing almost all major outsourcing MNCs to set up huge centres in India, emulating their younger rivals.

Multi-year mega contracts started shrinking in size and tenure, and market share started realigning. MNCs  lost market as Indian firms gained. According to sourcing advisor TPI’s sample, in 2000, 2 per cent of the total number of outsourcing deals worth more than $25 million, went to Indian firms. Their share increased to 27 per cent in year till date (YTD) in 2010. The MNC share dipped from 65 per cent to 42 per cent YTD 2010.

While Indians impressed everyone with their growth, large customers continued to treat them as small players, who were not to be invited to bid for big-ticket deals, which remained the exclusive preserve of the larger MNCs. But that limitation now seems to be easing substantially.

Many analysts say outsourcing deals have shrunk in size making most of them accessible to Indian firms. TPI’s third quarter report  notes that the average size of deal has fallen by more than a third — from $358 million in 2000 to $105 million in 2010. Deals worth between $25 million and $199 million are becoming the battle ground between MNCs and Indian firms, says TPI.

More flexible

TPI also notes a related trend; this year restructured deals have already accounted for 34 per cent of the total value of contracts signed so far, compared to typically about 20 per cent over the past three years. As deals get restructured, they also tend to get broken down into smaller parcels.

TPI India Managing Director Sid Pai says that the first generation of large, multi-year deals is coming up for renewal. Instead of outsourcing all their requirement to a single vendor, clients are choosing best-of-the-breed solutions from different vendors. Wipro Joint CEO Girish Paranjape thinks that the rise of new technologies such as cloud computing and SaaS (software as a service) are accelerating downsizing of deals.

Customers want to know how they can best use the new technologies and are not keen on getting locked in with any vendor for long term, he says.

As the playing field becomes level, analysts say Indian firms and MNCs will reach a head-to-head competition. Ovum’s lead analyst Surya Mukherjee says, “Smaller deal sizes could help Indian vendors compete on an almost level field in terms of delivery.”
In case of several factors which make a deal tick, such as price, brand, risk, onsite presence, capability, track record and sales, Indian firms have made substantial progress or even hold a slight edge. Wage inflation has made Indian firms more expensive than before. But as EquaTerra’s Global Research Director Stan Lepeak says due to their typically higher offshore mix Indian firms are still cheaper. “If a deal requires them to increase onsite presence, then the price advantage goes away,” he notes.

But Indian firms have weaker marketing muscle. Lepeak says, given the nature of the IT work they do, Indian firms mostly deal with CIO. But with outsourcing decision-making shifting to CFOs and CEOs, they now need to extend their reach. Indian firms have got the message and changed their marketing pitch accordingly.

Low brand pull

Each one of them now focus on ‘transformation deals’, which typically require them to reduce the cost of running IT or a business process and even increase revenue. This is the kind of talk that gets them the attention of a CFO or CEO.

Their brand is weaker when compared to Accenture, HP/EDS or IBM which precede them by decades in the market and have much larger presence. Some customers in the US know about the Indian firms but may not be able to tell them apart, says Lepeak. The brand of Indian firms are now comparable to smaller MNCs such as Capgemini, he adds. But analysts note that rather than the individual brand strengths, it is the competitive terms offered in a bid that matters more. While point-to-point comparison shows Indian firms playing catch up with the MNCs, the relative positions vary with the market segment. In segments such as application development and maintenance (ADM) and finance and accounts outsourcing (FAO), Indian firms have closed the gap. But in segments such as infrastructure and networking, they lag.

The expanding Indian role in the implementation of enterprise software such as ERP, which constitute the brain of enterprises, give an idea on how Indians firms have grown their capabilities. In large ERP deals, traditionally MNCs were preferred for higher value planning or design work, while Indians were called in for the grunt work to reduce the cost of the project.

This, Pai says, is a thing of the past. Lepeak agrees and says MNCs have an advantage only where they have known the client for long. Indians may also lose out in some deals which require deep industry knowledge or strong presence in select geographies such as Asia Pacific, he adds.

Not global enough

To further gain market share, there are areas of concern Indians need to address. The MNCs run true global operations providing efficient local delivery in different geographies for large clients who are spread all over. Under heat from Indians, they rushed to build large delivery centres in the country emulating the offshore capability pioneered by Indian firms. A large proportion of their employees are based out of India. “The India-based offshore capability of Accenture is in no way inferior to Infosys,” says Pai.

Indians may have added buzz to the term, global delivery. But what they have meant so far by that is India-centric delivery. They have far fewer delivery centres abroad when compared to MNCs. Where they have centres abroad, they have usually opted to send Indians to run them. A little above 10 per cent of TCS employees, the most globalised Indian firm, are foreign nationals.

Hiring abroad

But now Indian firms are expanding and hiring abroad. The number of foreign nationals at TCS rose from 4,000 in 2006 to over 10,000 in 2009. Fifty percent of Wipro’s employees stationed abroad will be foreign nationals in the next two years. Infosys chairman Narayana Murthy recently emphasised that Indian firms should hire Englishmen in England, Americans in the US and Brazilians in Brazil.

Pai says Indian firms are three to four years behind MNCs in building local presence in different countries. They have not yet made the strategic decision to develop a matching global footprint as it will erode their margins, says Pai. As outsourcing spreads to smaller companies in the West, advantage may shift to MNCs such as IBM and HP which have built  grass-root-level sales networks.  MNCs also acquire routinely to gain expertise or market share.

Indian firms remain conservative in making acquisitions. the other worry is that many of the services we offer are getting commoditised and Mukherjee says Indian vendors need to differentiate themselves by developing proprietary products and services, expertise in fast-growing niche markets, and by making strategic acquisitions.

He also says larger, above $500 million, deals may not completely phase out over the next five years. However, there will undoubtedly be more opportunities in the sub $500 million deal sizes, he adds. While the MNCs and Indian firms are locked in a tight race, many analysts say the rise of cloud computing may rewrite the rules of the outsourcing industry.

A Vice President at IDC, David Tapper says cloud-based outsourcing is underway to replace traditional outsourcing. Business Process as Service would replace BPO, Software as a Service would replace application development and Platform as Service would replace network outsourcing, he says.

MNCs with strong infrastructure capabilities such as IBM and HP are building entire cloud stacks from hardware to applications, while Indian firms are following their natural instinct and focusing on services.

Will the MNCs with their broader engagement gain advantage or will Indian firms manage to put together alliances that will give them strategic edge? That is a question nobody is willing to answer at the moment.

Vice President at NIIT Technologies, Vijay Ghei says cloud services were a greenfield area and there was a huge amount of learning to be done by the service providers. “Every day we are falling and picking up ourselves and it is too early to say what will succeed on the cloud,” he says.

In sum, how would the market share  of Indian firms and MNCs look over the next five years? Sid Pai says when deals get restructured the incumbents will benefit as they will just have to drop their prices to hold on to the account. But with market dynamics changing with the rise of cloud and the coming in of Fortune 5000 customers, it is hard to predict how the market will shape, he says.