Is the death knell being sounded for IT out sourcing? "The boom years for growth have come and gone," says Tom Weakland who leads the outsourcing advisory services practice at DiamondCluster, a management-consulting firm. "This should serve as a wake-up call for outsourcing providers that all is not well with their customer relationships and that they need to refocus on quality, clarity and measurement. IT outsourcing seems to be losing steam and the boom is now slowly coming to an end. Hence, companies who are regularly outsourcing their jobs, will now taste the water prior to outsourcing their jobs in one shot, believes William Lehman.
"The outsourcing market is maturing in fundamental ways", says Tom Weakland. Buyers are learning to adopt selective and strategic ways to approach outsourcing decisions, which is tempering the buying process. Inspite of being at the fag end of outsourcing contracts, buyers are not focusing on new initiatives but instead believe they have captured the low hanging fruit and are slow to seek additional opportunities.
As the IT boom is declining, onshore providers are facing new pressures, and companies are outsourcing more strategically and selectively, according to the '2006 Global IT Outsourcing Study' published by DiamondCluster. While a majority of buyers - 64 percent (offshore) and 50 percent (onshore) remain committed to increase their purchasing, these numbers represent a significant decline from prior years.
Comparing results from previous outsourcing studies is telling. In 2004, none of the study participants said they would decrease the amount of outsourcing they were doing. This year, nine percent of the buyers of onshore services and eight percent of offshore buyers said they plan to decrease their levels of outsourcing in 2006.
On the other hand, despite a spate of bad press for offshore outsourcing, TPI says a record number of outsourcing transactions are currently under negotiation, although there is no accurate breakdown on the balance between onshore and offshore. But TPI, which is currently advising a quarter of the commercial outsourcing market, believes that 47 per cent of all transactions involve offshoring or 'global service delivery'. At the same time last year, offshoring accounted for just 28 per cent of all transactions and the current level appears to represent a new high.
"Companies are reining in outsourcing for three reasons," Weakland explained. Either they mistakenly outsourced a process or function that is core to their business and are now bringing it back in-house; their provider over-promised and under-delivered; or the complexity of managing and measuring outsourcing projects and relationships overshadowed the benefits.
BPO: An Attractive Growth Strategy
This year’s findings suggest that industry consolidation is likely. "The large, tier one IT outsourcing firms can be expected to look towards mergers and acquisitions as a means of building scale, tapping into the global pool of talent, and adding to their current suite of offerings. In particular, adding Business Process Outsourcing (BPO) capabilities may be an attractive growth strategy." Mergers and acquisitions await large, tier one IT outsourcing firms in order to tap the global pool of talent. Business Process Outsourcing (BPO) seems to be gathering strength as an attractive strategy. "We should also expect to see fewer successful new entrants. Second tier and smaller firms may have to face a hard choice between being acquired and building deep industry or functional skills to differentiate themselves from the outsourcing behemoths. Onshore firms in the U.S., many of whom have already established substantial operations in lower cost countries, may further consolidate their resources outside the U.S. to achieve the obvious cost advantages that offshore operations provide," Weakland added.
"Industry consolidation will create another set of challenges for buyers," said Weakland. "Buyers told us that increased management complexity is the major risk they face in outsourcing and having to manage providers that are going through a merger or acquisition only adds to that complexity."
Outsourcing and Enterprise Risk
In addition to importing risk from external organization via links through your Enterprise Resource Planning (ERP) and Supply Chain Management (SCM) systems, perhaps the fastest growing source of importable risk is from outsourcing partners. At this time, the quantity and scope of enterprise risk attributable to outsourcing is expanding exponentially. IDC estimates that business process outsourcing (BPO) will grow to an estimated USD 1.2 trillion this year, up by more than a factor of 40 in just three years. Just slightly further back along the curve, IT services outsourcing is following the same track of rapid expansion.
Failure to evaluate the risks from an enterprise risk management perspective can lead to an accumulation of risks far greater than the monetary or risk savings offered by the outsourcing arrangement. On the other hand, taking an ERM approach to managing risks arising from outsourcing enhances the profitability and security of not only your company but the outsourcing party as well, who face a lower level of risk from interacting with your well-run organization.
There is a drastic change visible in the companies’ approach to outsourcing jobs. Many multinational companies are going for 'backward integration' by blending efficient employee staff onshore, hiring an efficient outsourcing provider at a competitive price, third-party processors and establishment of efficient co-ordination between onshore and offshore outsourcing resources.
Additional highlights of the study indicate that:
- Onshore providers must shape up or ship out: The latest DiamondCluster study reveals some troubling signs for onshore service providers. For example, less than one in three buyers of onshore services reported that all their expectations are being met, compared to 47 percent of the buyers of offshore services.
- India holds tight to title; Canada makes inroads; China hot on the horizon: 75 percent of deals are being outsourced to India, but Canada is making headway as a haven for outsourcers now. U.S.-based buyers apparently believe that the higher cost of outsourcing to Canada is worth the gains in proximity, language and culture. China has simultaneously emerged as the contender to challenge India in the years to come. The number of buyers that expect to offshore to China has soared 48 percent since 2004. In addition, more than half of the offshore providers currently operating in India expect to grab market share in the burgeoning Chinese economy. India’s outsourcers are also looking to China as a means of alleviating their growing labor shortage.
- Global turmoil concerns buyers of offshore services: Geopolitical conditions are a primary concern for companies. While tensions abroad may be cause for concern, employee backlash has abated as employers have realized that it is more effective to find new, higher-value creating roles for employees that otherwise would have been displaced by outsourcing.
- One-stop outsourcing in?: The percentage of buyers that say they partner with a single provider that can cover all their needs has increased to 28 percent in 2006, it’s hit the highest level since 2002.
- Still plenty of room for improvement: Overall, this year’s DiamondCluster IT outsourcing study reveals an industry that continues to mature but there is still plenty of room for improvement on both sides of the outsourcing equation. "Considering how much buyers stand to gain, it is surprising that they often fail to think strategically about outsourcing," Weakland said.
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