Global Outsourcing Industry changed significantly in 2012, continue to change in 2013

According to KPMG Global IT-BPO Outsourcing Deals Analysis, 2012 is a year when the global outsourcing industry recovered from a comparatively bad 2011 but it still has to regain the level of performance that the industry saw in the year 2010. The report also highlights Worldwide in 2012, 1,244 ITO contracts worth USD 118.3 billion and 226 BPO contracts worth USD 19.5 billion were signed and 120 IT-BPO Bundled deals were signed in 2012 with contract value worth USD 12.7 billion. The number of deals also has improved compared to 2011 but it did not reach the 2010 or 2009 levels which show that the industry is being affected by the European Sovereign Debt Crisis and the economic volatility in the United States. 2012 saw a healthy growth in terms of number of deals (9% YoY) and Total deal value (24% YoY).

Geographically companies in Americas dominate the outsourcing industry with TCV of US$ 95.8bn followed by Europe, Middle East & Africa with US$ 36.0bn and Asia Pacific with US$ 18.7bn. Europe has seen a fall in terms of deal value by 21% courtesy the ongoing European Sovereign Debt crisis which is having a significant effect of the Europe as a whole and most of the countries have been drastically affected by the crisis. Asia is also gaining as companies in most of the Asian countries are also outsourcing to cut costs and increase their profitability.

Most of the deals worth US$ 64.9bn are in the range between US$ 100mn – US$500mn but the companies are still doing big deals that are more than US$ 500mn but less than US$ 1bn with a TCV of US$ 50bn. But overall the contract values of the deals are coming down when the deals are coming up for renewals. Companies are renewing deals at a lower value than previously outsourced. Companies are looking for significant discounts in pricing for the renewal deals and are also changing the outsourcing vendors if necessary which is leading to vendor churn in the industry. Less than US$100mn deals are with a TCV of US$ 35.5bn.

The Deal tenure has also come down as in the initial stages of outsourcing most of the deals were signed for 7-10 years and this trend has changed in the last two years when most of the deals are being signed for tenure of 1-5 years and the TCV is US$ 96.9bn. Deals with tenure of more than 5 years are also being signed and the TCV is US$ 52 bn. The deal size which most of the companies are looking at is around 4-5 years and less than 1 year deals are very small.

Pricing too has seen a significant change where in most of the deals (97%) are based on Fixed pricing and Hybrid pricing. Hybrid pricing deals are more complex hybrid pricing structures that combine input based pricing, output based pricing, and occasionally business outcome-based pricing mechanisms. In fact Hybrid pricing deals have significantly increased in the last three years as companies want their outsourcing vendors to not only reduce cost but also provide them more value based and outcome based services that will directly affect their business outcomes. 

Indian Outsourcing Vendors - Non Linear Revenues critical for growth

For Indian Outsourcing vendors non-linear revenues have emerged as a new growth area for keeping the revenue growth engine running. These revenues account for only 10%-15% of revenues currently for large IT companies and they are planning to increase these revenues to be 20% of total revenues in the next three years and 1/3^rd of total revenues in five years. Non-linear pricing models result in higher revenue productivity per employee and improved margins for companies. According to Morgan Stanley Research, a 5% shift of overall revenues to non-linear revenues that have higher EBIT margins of ~50% vs company average of 24-30% and can add 90-110 bps to the overall company margins. All companies have a margin gain of ~1% for every 5% move to non-linear revenues, assuming they are able to generate ~50% EBIT margins on the non-linear revenues.

Large Indian vendors have started signing big deals based on the non-linear pricing and models since couple of years and they are very confident to sign more such deals in future. Infact non-linear has become focus of these vendors and they feel that non linearity is essential for surviving in the highly competitive and commoditized outsourcing industry. All the vendors consider products, platforms and cloud offerings as non linear offerings. They have been investing on the platforms for almost a decade and recently started investing significant resources in cloud computing. Products like TCS Bancs and Infosys Finacle focusing the BFSI segment, the dominant focus vertical for these vendors are the only product offerings. Vendors also invested significantly in the R&D and have innovation labs and involve employees at all levels in innovation.

Tata Consultancy Services Limited

TCS non-linear strategy includes Financial Solutions that are End-to-end universal banking and insurance products and solutions. TCS BaNCS platform, developed in 2006, is a scalable platform that provides improved customer service through a high degree of straight through processing. Recently TCS Diligenta bagged the $2.2 bn Friends Life deal in UK and will deliver IT infrastructure and IT services with some policies migrating to TCS BaNCS Insurance, a globally recognized insurance platform. Since the Pearl Group deal in 2006, TCS had developed a platform in the U.K. to integrate multiple legacy systems on a single platform and these now functions on the cloud paradigm and TCS will migrate the policies of Friends Life to this one over the next 2-3 years. TCS is currently working on a suite of products targeting small and medium businesses (SMBs). Its ‘bank in a box’ offering for rural and cooperative banks has met with encouraging success in the Indian market.

TCS iON a cloud-based offering for small and medium enterprises and offers SMBs convenient options for businesses that are looking for cost-effective solutions to their IT needs. Also offer Application Cloud that is Software/Solution for end-to-end Business-IT application requirements for clients. On the BPO front it is offering Platform BPO which is vertical as well as horizontal platforms (HR, F&A). Currently for TCS, non-linear initiatives contribute about 5.5% of the total revenues with asset leveraging solutions contributing about 4%. The management has reiterated its target of generating about 10% of the incremental revenues through non-linear model by the end of this fiscal year. TCS is betting big on SMBs and platform based offerings as their non-linear initiatives.

Infosys Limited
IP, platforms and pricing models based on unit of work form the three broad areas of Infosys’ non-linear initiatives. Finacle, its traditional banking product suite leads their non-linear Initiative in IP based revenues. In expanding its IP based product portfolio Infosys launched cloud based business platforms and applications for functions like HR, procurement, social commerce, digital marketing. Cloud based offerings include a mobile app store platform Flypp, iEngage for social media and TalentEdge, a cloud platform for enterprises to streamline HR function. Aircel is using Flypp to develop its appstore. Infosys plans to increase the non-linear revenue contribution from under 10 per cent in 2011 to 33 per cent in next five years.

Another non-linear play is changing pricing models which is to transform the basic pricing model from competitive & commoditized rate card (Time & Materials) to per transaction (in BPO), per device (infrastructure management), per ticket (maintenance) and to a limited extent on business outcomes (e.g., uptime, cycle time reduction, share of revenue generation). Platforms are a major non-linear strategy for Infosys and it has more than 20 clients on platforms. Infosys’ biggest BPO platform play is its FY10 acquisition, McCamish Systems (a platform-based insurance processing solution provider). Smaller platforms such as Newspaper-in-a-box, HR outsourcing (Hire-to retire), Shopping Trip 360 (retail analytic solution) generate very limited revenues. 

Wipro Limited
Wipro has adopted four methods to drive non-linear revenue growth which is IP-led, shared services models, expanding its partner network, and leverage outcome-based models. Wipro is emphasizing on shared services which is servicing multiple clients simultaneously using common resources. Shared services drive over 50% of Wipro’s non-linear revenues and has been servicing its India infra management clients under this model from its Global Service Management Centre in India for nearly four-five years now. Platforms wise Wipro has an order-to-cash platform for manufacturing companies that it monetizes based on the number of concurrent users. Wipro has a ready-to-market hospital management solution on SAAS model.

Wipro deal with Unitech Wireless (linking Wipro’s revenues to the success of Unitech’s cellular network roll-out) is another non-linear initiative more outcome-based model. Flex Delivery’ is a non linear delivery model that Wipro uses to provide managed services to customers who require post implementation support for their enterprise applications and addresses the key pain areas of application management outsourcing. Wipro non linear thinking is more towards delivery innovation and shared services rather than products and platforms. Wipro plans to achieve 15% of revenues from non-linear pricing modes in next one year from current 11%.

HCL Technologies

HCL is focusing to become $10-billion company and it is planning to achieve this target through services such as transformation ideas, more business IT alignments, non linearity in the business model, on-site presence and less dependence on freshers. HCL Technologies drives ~12-13% of revenues from non-linearity which is higher than their Indian peers. Its focus on non-linearity is through transformation deals, investing in BPO platforms, products and end-to-end services. The company signed 20 transformation deals in Q1FY12 in manufacturing, media and publishing, telecom, BFSI and retail. HCL non-linear offerings include infrastructure management services and platforms related to telecom expense management and life insurance, which it had acquired post the buyouts of Liberata Financial Services and Control Point Solutions in July and August 2008, respectively.

Non Linear Revenues Challenge

Marketing of the non linear offerings have to be done by the vendors as they had not marketed these services earlier. But last couple of years with client’s budgets getting tougher and clients asking for more business value from vendors these offerings have started to pick up. The risk involved in non linear offerings is one of the factors that deter these vendors. Non linear models involve domain expertise, lateral hiring and need specific infrastructure and technologies. Vendors need to invest significant amount of resources and the non linear models need time to deliver and clients were not ready to wait for the ROI. Monetizing of non linear initiatives is a big challenge. Vendors have to be careful in terms of non linear models and offering outcome based-pricing models that are tying up revenues to specific business outcomes. Business outcomes can be influenced by other external environment and economic variables and in such case Vendors will loose billing and conflicts arise. Clients and Vendors have to work together for non linear models development and their success.

Vendors should understand client’s business and clients should give access to other parts of organization not only the IT department. The relationship is very crucial for the success of non linear models. Sales teams should be encouraged to sell more non linear pricing and increase its share in the total sales. Dedicated sales force for selling the non linear pricing solutions is another option. Sales and marketing teams along with the management should come up with the right mix for the linear and non linear models. The mix is critical because overall revenues will get affected when the billings get delayed or scrapped or conflicts arise in outcome based- billings. Vendors have invested in platforms for almost a decade and they have seen success in platform offerings in the past couple of years. But do not contribute significant revenues. Some vendors have even acquired smaller companies abroad for their platform based offerings and they are signing deals in this area. But Indian vendors have realized the necessity of the non linear revenues and are planning to increase the share of such revenues to 30% of total revenues in next five - seven years.  

Discussion points:

1. What is the best mix of non linear to linear revenues should Indian vendors target?
2. What are the risks involved in the non linear models and how to tackle?
3. Are Indian Vendors investing for non linear revenues & what should they do for success?

Natural Disasters affect on Business - Impact of Thailand Flooding on HDD, PC and Storage Supply

Natural disasters are flood, hurricane, volcanic eruption, earthquake, etc and they lead to financial, environmental or human losses. Governments, International Relief Organizations and Businesses across the globe develop and implement Disaster Management and Response plans to minimize losses in terms of human, financial and environmental. Natural disasters cannot be controlled and the only way is to try and predict and prepare for the disaster. Businesses and Governments before setting up factories and plants take into account the natural disaster vulnerability of the areas. There is no escape from the natural disasters and most of the times the losses are so huge it takes years to recover from them.

Natural calamity risks are assessed based on the historical data available about a particular geographical area. Natural disasters have caused major losses and recovery from such a disaster requires huge resources in terms of human, financial and infrastructure. Natural disaster cause lot of emotional damage to the people affected. There has been some major disaster in the recent times like Earthquakes in Japan, Haiti, Turkey, hurricane Katrina in US, Indian Ocean Tsunami etc. These disasters have caused significant losses and people, businesses and governments are still struggling to overcome.

Thailand Flooding Case

Thailand’s worst flood in 50 years has swamped more than two-thirds of the country, shutting down many factories, businesses have been impacted and hundreds of lives have been tragically lost. Thailand is the world's second-largest producer of HDDs and accounts for 45 % of worldwide hard-drive production, after China and is a major supplier of hard drive parts too. The major hit has been to 2.5in drives produced in Thailand and typically targeted at the notebook, rather than the larger 3.5in drives more commonly produced in Malaysia or mainland China facilities. Seagate, Western Digital and Toshiba have extensive production facilities in Thailand that are affected. . Nidec supplies more than 70 percent of all global HDD motors, to major manufacturers.

Technology Research Firm’s View:

According to research firm IHS iSuppli, HDD shipments in the fourth quarter will decline to 125 million units, down 27.7% from 173 million in the third quarter, resulting in an increase in price of about 10 percent compared to third quarter prices. Disruption to shipments is not expected in 2011 as there are sufficient stockpiles to last through the fourth quarter but the shortage could impact notebook PC production in the first quarter of 2012. Digitimes Research reported that the flood will create a 12% HDD supply gap in the 4^th quarter of 2011 and the gap may increase into 2012 and estimates the 4Q11 hard disk drive shortage to reach 19 million units. For detailed charts please click here: Digitimes Research Charts 

Gartner currently estimates that 50 million HDDs will be taken out of the planned 180 million-unit 4Q11 production runs, and there may be an additional 50 million HDDs taken out of the projected 175 million-unit build plans in 1Q12. According to IDC, major part of PC production for the fourth quarter had already been shipped and it expects the negative effect of the flood on PC shipments to be limited to 10% lower than earlier expectations. For the first quarter of 2012, the firm expects total PC shipments to be slashed by more than 20% from previous forecasts.

Manufacturer’s view:

Seagate's hard drive and component assembly factories in Thailand were not submerged, but manufacturing has been curtailed due to external component supply constraints. It now expects to report a total production of 41-45 million hard drives for its December 2011 quarter, compared to the 48.9 million in the fourth quarter of 2010. Samsung, Hitachi Global Storage Technologies and Toshiba are also affected by Thai floods.

All Western Digital's hard drive and component manufacturing facilities in Thailand have been shut down since the week of October 10. Company expects its hard drive shipments during the December quarter will be 22-26 million units in contrast to the 58 million units shipped in the September quarter. Company expects the suspension of its operations in Thailand and that of some of its suppliers will continue into the March quarter and possibly beyond and is exploring alternatives to maximize existing capacity in other locations, including its Malaysian hard drive assembly facility and a third-party slider fabrication facility in the Philippines.

Original Equipment Manufacturer’s View:

Drive prices have increased 20% since the flooding started .Dell has warned its revenues could be hit by a worldwide shortage of hard drives and warned that the company may have to raise computer prices as HDD prices rose. Lenovo believes it can source enough hard drives to meet customer demand and try to manage the cost situation with minimal impact on profitability. Samsung and Acer have said that PC supplies will be lowered due to shortage of HDDs and subsequently prices will rise. For NetAPP, low hard-disk drive production, and revenue growth is slowing and difficulty in forecasting revenues and big impact will be felt in second half of 2012. Goldman Sachs lowered its expectations of Microsoft Windows revenue for both 2011 and 2012.

Viable Options for Industry

Current scenario is not expected to improve till March 2012 and supply constraints of HDDs will lead to rise in prices. To improve supply to certain extent HDD manufacturers are trying to move production capacity to their plants in other countries and Taiwan, Malaysia and China manufacturers can increase production. Increase prices of the products and pass on the increased cost of HDDs onto the consumers. Another suggestion is adoption of Solid State Drives in place of HDD. But SSD are very costly right now and there is still couple of year’s time further for its adoption. These are the viable options for the manufacturers and OEMs until the scenario improves in second half of 2012. Manufacturers and OEMs are not scared and are confident enough to tackle the situation which highlights the preparation that businesses have to tackle such disasters.

Discussion Points:

1. How to improve Natural Disaster Risk Assessment and predict their affect on production facilities?
2. How to prepare for and tackle the production shortages due to Natural Disasters?
3. How to prepare for the business losses that arise and how to tackle and survive?
4. What lessons are to be learnt from Thai Flooding?