Consider the Source

Who Will Source The Sourcer?

Today’s guest blog on procurement outsourcing comes from Bill Huber, Director, TPI.

Procurement outsourcing is positioned to drive some of the most dramatic bottom-line benefits to corporations. Yet of all forms of sourcing, it is broadly misunderstood by both procurement and outsourcing practitioners and has achieved a slow rate of adoption.

Recent research by the Aberdeen Group (sponsored by TPI), Procurement Outsourcing: A Strategic Imperative, showed the top four reasons for not outsourcing procurement:

• Procurement a core competency: 44 percent
• Prior investment in procurement applications: 43 percent
• Unclear benefits/value of outsourcing: 38 percent
• Perceived loss of control: 29 percent

As a former Chief Procurement Officer (CPO) for a very large company, these four reasons have aligned with my thinking at various times in my career.

Originally, I was committed to the following premise: a company’s ability to transact efficiently and effectively is absolutely a core competency which differentiates the agile from the maladaptive. So, if my company were to outsource procurement, wouldn’t we be giving up this competency? Who will source the sourcer?

After continuing to sty the trend and speaking with very intelligent peers at other companies, I came to three realizations.

The first: Developing strategic relationships, determining contract and decision-making standards, and establishing a risk management and governance framework are all strategic activities. Managing transaction processing is not. The sourcing of desktop computers, office supplies or airport transportation is commodity focused and stimulates operational efficiency and cost-savings only. The bottom line: Best practice procurement is about understanding strategy and acting accordingly.

The second: With prior investment in procurement applications, it is normal to migrate application investments to a third-party outsourcing provider. It is a matter of a business case. But procurement managers tend to be very conservative regarding spending and maximizing investment value. An occasional write-off and migration to a model with a better business case is without a doubt the role of a good manager.

The third: Unclear benefits and loss of control are a function of education and analysis. A well-structured outsourcing transaction will always have a clear business case and structure. The issue is that companies do not have sufficient resources to focus on sourcing strategy and execution, risking the loss of control throughout the life of an engagement.

Many outsourcing experts do not understand procurement and see its efficiency play around transaction costs, similar to finance and accounting. At most companies the potential cost savings from a pure transaction efficiency perspective is comparatively unexciting. This is why procurement outsourcing needs to be considered holistically.

The benefits of procurement outsourcing come through long-term business relationships, not via transactional burdens associated with a purchase. What drives millions to the bottom line is mature transaction efficiency, market intelligence, category sourcing and higher spend compliance. Procurement Knowledge Process Outsourcing (KPO) is one example, enabling companies to perform market and risk analytics quickly and cost effectively, supporting the strategic capabilities of the agile CPO.

Avoiding outsourcing can become an impediment to achieving set objectives, both from a cost and a change management perspective. Had I come to this realization earlier on, I would have been left with a larger chunk of my budget for more strategic-minded talent. But looking ahead, the future for procurement depends on the use of strategic outsourcing to its advantage.

From your perspective, what do you see as the future for procurement? How can companies use strategic outsourcing to their advantage?

 

Reversion to Mean

Today’s guest blog on the future of India-based service providers comes from Dinesh Goel, Project Director, TPI.

The law of ‘Reversion to Mean’ is finally getting applied to leading India-based service providers. (For those who many have forgotten, it’s the statistical phenomenon stating that the greater the deviation of a random variant from its mean, the greater the probability that the next measured variant will deviate less. In other words, an extreme event is likely to be followed by a less extreme event.) Much ink and newsprint has been consumed during the last six months on speculations about the future top-line and bottom-line growth rates of these providers.
 
We have to look further than the headwinds of the weak U.S. dollar, potential tax implications after 2009, and offshore wage pressures, to examine the future performance of these providers. The performance some of these providers have enjoyed so far is rather exceptional (and not reflective of normal business scenarios). A bunch of factors drove it: smaller scales relative to large multinational providers, highly under-penetrated market in primary service segments such as application development and maintenance, favorable tax regime in the country of operation (India), and business model affordability of growth over 35-40 percent annually with U.S.-centric demand and India-centric delivery. 

All that’s set to change and had to change at some point since it wasn’t a sustainable level of performance. It’s the ‘Reversion to Mean’ coming into play. 

It’s true that the rise of the rupee, increasing wage pressures, and scheduled, or in view of lobbying, “potential” expiry of Software Technology Parks of India (STPI) tax exemptions have taken their toll on providers’ market capitalization during the last 12 months. But more fundamentally, I argue that their business model must change, and this change will result in their financial performance reverting to more normal levels. 

The current headwinds can be managed to a degree and will be weaker than predicated. For instance, I can’t imagine the rupee strengthening more than 12 percent every year. Wage pressures didn’t surface for the first time in 2007 either – we have been hearing that since 2003. Tax exemptions have been a long-time factor, which can be, at least partially, offset through the new Special Economic Zones (SEZ) scheme, while extension of the STPI scheme can’t be ruled out just yet. 

From the business model perspective, however, these providers are facing certain imperatives to compete for large transactions in the marketplace. It’s through these they’ll grow and sustain business performance as leading global providers of outsourced services. Here are some imperatives breathing down their necks:

• Spread of geographic presence for both sales and delivery
• Hire of foreign (non-Indian) nationals in greater proportion
• Compete for large deals
• Operate and have strong credentials in all service segments (Testing, Infra management, KPO, BPO, etc.)
• Invest in R&D (develop new market offerings, deliver innovation to clients)
• Delegate greater authority down the line
• Assume more risks in contracting processes
• Lose India-centricity (although they can still remain headquartered in India)

To what extent will the above impact business performance? Your guess is as good as mine. But it isn’t a gloom or doom scenario. I believe these providers will continue to grow and be highly profitable relative to the industry average. They have the potential to continue to outsmart their multinational peer group simply because they are starting from the other side of the mountain to embrace the world.

Message to shareholders: Past performance is truly not indicative of the future.

Signs of Things to Come … on the Provider Side

I recently shared a snapshot of the trends and topics we see influencing the client tendencies affecting outsourcing and offshoring. These are the high level directions we believe will play out during the next three years. 

So, what about the provider side of the balance sheet?

It’s actually much easier to gauge the changing areas of emphasis on the part of the companies that are applying outsourcing and offshoring than it is to get beneath the covers of the industry service providers. This is because, to a fair degree, one must make judgment of the level of perceptivity and management acumen that exists within the service provider firms to react to the changing buying habits. 

So, what the following list points to are the characteristics we feel will epitomize the winners in the growing outsourcing and offshoring market. In essence, if I were directing a service provider today, I’d … 

1. Adopt outcome-oriented and industry-aligned service models; depth matters. The time is right and the demand is there. Focus on services that are recognized by industry-oriented buyers (the folks chartered with winning in their specific segments) and commit to achieving meaningful results. That’s not to say that there isn’t still a market for lowest-cost commodity services, but during the next three years we’ll be seeing much more demand for differentiation around industry specialties. 

2. Ensuring comprehensive infrastructure, Enterprise Resource Planning (ERP)/applications, and operations proficiency; maximum value potential. The era of integration is returning. Unify as much of the technology and operations scope as possible. Give clients the option of buying a turnkey solution. Sell this on the basis of … 

3. Building resilience into all facets of the global delivery network; risk is real. Remove the concerns relating to access to capacity, business continuity, workforce unrest, and all of the other dirty issues that affect the ability of a business leader to rest at night. Notably … 

4. Stepping up to the challenge of data privacy. This is the biggest paradox facing the industry. Is it a risk to the continued adoption of outsourcing and offshoring, or is it the reason to do so? The answer is yes. Today, it’s a radioactive topic that is increasing in concentration. The winning service providers will manage a solution. It’s the demarcation between … 

5. Choosing between a narrow component orientation and business value creation proposition. It takes focus to win. The choices being made now are the ones that will define the landscape for 2010 and beyond. There will be those who compete on the basis of lowest unit costs, and they will be relegated to chasing talent in the farthest corners of the globe. Then, there will be the value-oriented providers – the ones we call the 3C Providers. They will balance cost/capability/capacity to create new value for their clients. The survivors will know which market they’re in – and will be focused. As for the dance card … 

6. Consider strategic combinations or acquisition of captive operations to fill out the portfolio. Fortune favors the bold. We’ll see some remarkable deals in the coming years – deals that will create new and ambitious offerings. The venture funding is in position and the inherent belief is strong: standardization and automation of people-intensive work is common sense, and outsourcing and offshoring is the way to achieve this.

 Providers will be positioned to win the deals of the future if they:

• Invest, organically and through acquisitions, in deep domain expertise for attractive market segments; most likely people-intensive work processes that leverage the benefits of automation, standardization and scale, or …
• Elect to be the lowest-cost provider of "componentized" services.

 Winners will:

• Be focused – avoiding the temptation to be all things to all people
• Place profitability far ahead of revenue growth
• Create deal structures that reward these behaviors – choosing expertise over abundance of staff

Ultimately, we think that sourcing becomes mainstream during this period. We’ll see the inclusion of sourcing and the management of sourcing in the academic curriculum. It will be an accepted management discipline worthy of a seat high in the corporate ladder. This heightened appreciation for the science of sourcing will fuel the provider community to think much differently about their offerings.

More on these observations to come …

Three Little Words for 2007

Many times “Less is more” has proved to be an empty catchphrase. But I’m happy to say those three words accurately describe outsourcing trends in 2007: Despite downturns in many readings of the market, there’s ample evidence of opportunity for both sourcing providers and their partner clients. Momentum is strong.

TPI’s Index for the final quarter of last year shows that while total contract value (TCV) for all of 2007 registered the lowest level in five years, annualized contract value, or ACV, came out strong. ACV matters, because it strips out the ambiguities introduced into any measure of the market by contract durations. ACV totaled $15.2 billion for the year, just a notch below the five-year average of $15.3 billion. And the fourth quarter’s ACV was the best three-month reading since the middle of 1996. Yup, best in the past eleven years! 

Indeed, the fourth quarter was strong overall, as we anticipated: Even though TCV for the year of $80.4 billion was a decline of some $4 billion over 2006, the fourth-quarter reading of $27 billion was the highest TCV we’ve seen in a quarter since the first quarter of 2006.

OK, so there’s no getting around the fact that overall volume of deals was down. The effect was also seen in a decline in the number of service providers that won a deal – 12% fewer than the number of providers that won in 2006. The question is why?

The simple answer: quality. Providers are shifting their focus from new scope transactions to stabilizing the business they already have. And, clients are moving beyond tactical cost-oriented arrangements to ones that have the legs to run for many years and through more hurdles. That means not only more selectivity, but also more of an effort to partner in meaningful relations that encourage and reward innovation over simple labor/cost arbitrage.

Proof that successful relationships are being extended came in 2007’s doubling of business-processing outsourcing (BPO) deals that contract for multiple functions. These kinds of deals barely registered in prior years.

Other noteworthy shifts seen in 2007: Europe, the Middle East and Africa (EMEA) accounted for more than half of global BPO TCV and both the number of contracts and TCV in EMEA exceeded those measures in America for the first time ever, India topped the list of countries outsourcing in the Asia Pacific region, and China signed a few large outsourcing contracts. Translation: it’s a truly global industry, with buying and service provision being country-neutral.

In the year ahead we’re telling clients and market contacts to expect selectivity, diversity, competitiveness, and regional momentum to continue as corporate leaders realize the value of addressing the global dimensions of their business strategies. We expect continued growth of the outsourcing industry in the year ahead, likely surpassing the 7.3% Y/Y growth in annualized revenue we counted in 2007.

Bottom line: The industry is showing positive signs of quality being exchanged for quantity. Less really is becoming more.

How to Freshen Up Your ITO

Technology is constantly changing. IT outsourcing (ITO) strategies need periodic refreshing, too.

While it was once quite common to award a single contract to a service provider for a broad range of IT services, multi-sourcing is the preferred approach today. The two or more providers engaged usually have similar capabilities. In turn, that creates continuous competitive tension, which is a good thing as the providers strive to satisfy the client.

Application-services units were an early adopter of multi-sourcing, using multiple providers in an effort to get the best of the best. The allocation of work factored in business unit alignment, geographic orientation and technical acumen. Infrastructure services also sometimes separate computing services from data center and network services.

When considering a second-generation ITO relationship, organizations need to consider the value of the relationship they’ve previously formed with providers and make an honest call about the importance of that relationship to operational capabilities.

We generally tell our clients that their company-wide IT sourcing strategy should reflect the lessons of prior sourcing endeavors, but emphasize the future need of individual business units and corporate functions. Factors relating to concentration of operational risk, access to added capacity, and attainment of competitive tension frequently lead to a multi-sourcing outcome.

The IT sourcing landscape for most companies is much more complex today than ever before, demanding some serious governance expertise and commitment.

2008 – And Beyond

Happy New Year. I’m adding my voice to the year-ahead punditry – but taking a different approach by looking further out. The views are based on a look through the end of 2010 and represent my own thinking as well as the input of several of my colleagues. I’ll be concentrating primarily on demand trends today, with more thoughts on provider trends in a later post.

With those parameters in mind, here are the top six issues to watch in services sourcing in the months ahead. We know these are already on the minds of many corporate executives.

1.   A desire to address the global dimension of the business strategy – i.e, the land of tomorrow’s customer:  More companies are talking about outsourcing and offshoring -- almost interchangeably -- as part of an overall globalization agenda.  Cost savings still matter, of course, but the desire to participate in emerging new economies is also gaining import.  This, in turn, is affecting the time horizon of the initiatives.

2.   A growing preference for selecting sourcing alternatives within the context of a multi-year strategic agenda. We’re already seeing fewer acts of desperation in the sourcing initiatives being launched. To many of us, this implies that the low-hanging fruit of labor-based sourcing has been harvested.  Companies are now looking for more partnership-minded relationships. (Yeah, many of the words are the same, but the contracting tactics differ).

3.   A push to evaluate sourcing options through the 3C paradigm; total value orientation. I’ll write more about the “3C Framework for Sourcing” in a coming post, but suffice to say it’s the balanced consideration of costs/capability/capacity.  The prior overemphasis on near-term cost reduction is giving way to a new equilibrium.  Providers that won under the former rules may not be positioned for the future orientation toward total value.

4.   Assessment of existing service delivery relationships for alignment with strategic direction – i.e., not a tactical move. Many of our clients tell us that they have awoken to find a veritable nest of service provider contracts existing within their companies. It seems that each business unit and corporate function has two to three different providers doing work for them. A serious rationalization is in the offing for the coming quarters, with a weeding out of the cost-only providers for those that align with the strategic direction of the client. This, of course, gives rise to …

5.   Considering outsourcing options for all technology-enabled, people-intensive work processes i.e, go big and fast. Looking hard at work and asking whether activities couldn’t benefit from scale and automation. We’re seeing wall-to-wall reviews of work processes and serious scrutiny of the efficiency of the delivery models. There is no slowdown in the consideration of sourcing alternatives.

6.  Looking at the role and value of captive offshore operations. Captive centers are showing great value, and we see expansion plans being deployed for those operations in the coming quarters.  While the make-versus-buy decision is complex, we’re sensing a continued desire to move knowledge-based work to locations that offer lower costs and greater capacity, with equal or better capability.  Look for a continued desire of some larger conglomerates to monetize their captive operations, but those will be a handful, at best.

Unto the (Data) Breach: A 2008 Topic

Concerns about data privacy are rising in the sourcing industry, and I expect the issue to get a real workout in 2008.

Which is fine. But first a couple of points: From the earliest days of outsourcing there have always been third parties involved in processing client information. More to the point, data breaches can and do happen with in-house operations, too.

Still, the data issue is gaining traction in light of legislation aimed at protecting financial and medical data. Both clients and providers are feeling the heat.

The sourcing industry has already adopted safeguards and best practices to protect information, but the question remains in the mind of many: Does sourcing mitigate or exacerbate data risks?

Companies are calling us seeking advice on the capabilities of service providers to help reduce the perceived risks relating to data protection. At the same time, providers are starting to squirm at contractual terms aimed at allocated damages due to breeches in data security policies.

We shall see whether the sourcing industry is a source of extra risk or solution. But there are two things we already know: Whether data are processed in country or offshore doesn’t matter, so don’t believe in headlines about “outsourcing” as a culprit. And the market can and will play a regulatory role, as it always has, because reputations and bottom lines will suffer if customers suffer.