Consider the Source

Buckle Up for 2008

Today's blog on the state of the outsourcing industry comes from Peter Allen, Partner and Managing Director, TPI.

With the risk of sounding too dramatic, I think that 2008 is going to be a defining year for the outsourcing industry.

Whether the U.S. economy has entered a recession or not is still up for debate. What’s certain is that companies in consumer-oriented industries are behaving as if protection of profits and cash flow are much more important than driving growth.

How does this relate to outsourcing?

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.

The Americas’ Low Point?

It’s been a wild year for outsourcing. The pace of commercial contracts is stronger than ever in Europe and Asia.  Indeed, for the first time ever, Europe saw more outsourcing contracts awarded than the rest of the world combined.
The offsetting news is a dramatic decline in the rate of outsourcing contracts awarded in the Americas, as measured by total contract value, or TCV. Look at the trend line:

Our research spotted contracts that have shorter terms and are more narrowly focused, two factors that explain the regional differences. The average outsourcing contract award in the Americas during the quarter carried a value of just under $155M, 38% less than the average value for the same period in 2006. In contrast, contract values are climbing in Europe and Asia, as are the average duration of engagements.

What’s going on?

Discussions with the buyers of outsourcing confirm that they are tending to contract for effort – headcount and hourly wages – rather than outcomes in some infrastructure services, especially application development and business processes. This trend is apparent more in the Americas than in other regions. Clients are more often opting to award contracts for access to labor at favorable pricing, rather than go through the effort to contract for defined services. The data bear this out.

At the same time that total contract values awarded in the Americas dropped by almost 54% from where the industry stood one year ago, the major India-based providers have seen their Americas-based revenues grow by 37% on a year-over-year basis.

That stat speaks volumes: The India providers are doing well in the Americas at a time when the region is not performing as strongly as the rest of the world. The reason why is that major India-based providers are using a “penetrate and radiate” strategy very effectively: Start small with individual clients and grow the business reach over time.

From a client perspective, the ease of contracting and the appeal of low cost labor are just too strong to ignore. I should also point out that while we typically talk about this model from the perspective of India-based service providers, multinational firms have made significant investments that allow them to compete head to head in the offshore marketplace.

This film is far from over, however: We see a stronger fourth quarter and a decent pipeline of new outsourcing demand going into the New Year. Europe likely will remain the strongest market, but the demand in the Americas looks to be improving.