EquaTerra study points to a bright future for outsourcing across the board as companies seek to stretch their influence around the globe.

by Peggy Cope

EquaTerra’s recently completed survey of the second quarter of 2008 confirms what the firm predicted last fall—that outsourcing would prove to be very nearly recession-proof. In fact, the survey showed that worldwide demand for outsourcing is being driven inexorably upward as slowing Western economies and globalization continue to challenge corporations. The sourcing advisory firm anticipates that demand for business process and IT outsourcing (BPO and ITO) this year will exceed 2006 and 2007 levels, based on projections and pipeline forecasts that are indicative of deals that will typically close over the next two to three quarters.

Service providers have characterized their 2Q pipeline for BPO and ITO deals as rising 10 percent to 52 percent, a 14 percent increase over last quarter. Projections for next quarter were only slightly less optimistic, with 45 percent of providers polled expecting continued growth in demand, down from 50 percent last quarter. EquaTerra estimates there were more than 150 outsourcing deals in 2Q08 with an average total contract value (TCV) of $270 million. This compares to 120 deals in 1Q08 with an average TCV of $120 million.

At the heart of the organization’s 2Q08 Pulse Study were the results of a globalization study by EquaTerra’s Economist Intelligence Unit. According to that group, today’s global sourcing model is akin to an intricate manufacturing supply chain. Organizations are increasingly building and utilizing complex services supply chains to lower costs and address the emerging opportunities and perceived threats of globalization

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Layers of Complexity
“Services supply chains have steadily become both more diverse and more widely distributed, with large organizations forming hundreds of different relationships with hundreds of different service providers worldwide,” noted Stan Lepeak, managing director of research for EquaTerra. “Ongoing globalization is accelerating that process and adding new layers of complexity.”

EquaTerra co-founder and executive director, corporate development Mark Hodges said, “Globalization is fundamental in its impact on outsourcing. One way that corporations are globalizing is by outsourcing services.” The increased language capabilities, extended service delivery footprint, and geographic diversity of offshoring are irresistible. “Why build factories if you can get a service provider?” Hodges asked.

Buyer Challenges
The study also found that most organizations still aren’t doing a good job of arranging relationships with service providers. Buyers’ overall skills at developing quality outsourcing business cases didn’t impress the advisory firm, particularly when it came to assessing total costs to achieve desired improvements from outsourcing and attendant indirect or shadow costs. Respondents to the 2Q08 Pulse believe the two most useful metrics for building a solid outsourcing business case are current performance levels (75 percent) and current direct costs (74 percent), yet the study found many buyers don’t accurately capture even these most important measurements.

The ability to optimize and manage global services supply chains on the back end is proving equally challenging. 2Q08 Pulse respondents rate buyers as poor to mediocre across a variety of governance activities, including their ability to measure service level agreements (SLAs) and end-user satisfaction. While these problems are not new, they are exacerbated as organizations do more global sourcing.

Creating complex services supply chains is intrinsic to globalization, and struggles to develop the tools and skills needed to manage them are to be expected, according to Lepeak. “It took decades for manufacturing supply chains to mature. Now, organizations are steadily migrating from those vertical integration models to horizontal specialization.”

When corporate clients are debating between shared services and outsourcing, they point to other corporations that have successfully implemented shared services. Said Hodges: “We remind them that those companies sited centers in Europe in Amsterdam, Brussels, and Manchester. In the U.S., they went to Houston or Tucson. In Asia, they sited in Singapore and Hong Kong. Ten to 20 years ago, those were low-cost areas, but they no longer are. Manhattan moved a lot of support to northern New Jersey, but it’s not so cheap now.”

Hodges noted that manufacturers open and close centers all the time. “If you think of a finance and accounting shared services center as an administrative factory, you have to be in the business of designing, building, and opening those administrative factories for different markets on a regular basis. That’s difficult for most corporations to do because it’s not their core business,” he said. Outsourcing skirts that difficulty neatly.

What are companies seeking when they outsource in this new, more mature market? Most are still interested in outsourcing’s flexible cost and operating models. An earlier study conducted by the Economist Intelligence Unit on behalf of EquaTerra and World 50, which polled more than 200 C-level and other senior executives from 19 industry groups worldwide about the benefits and challenges of globalization, reported that more than 54 percent of respondents said the number-one response to globalization was a greater emphasis on improving business process efficiency and effectiveness. Almost half, 47 percent, said their firms were investing in new or existing operations in foreign markets, including third-party outsourcing relationships and the establishment of captive offshore operations. A little over a third, 35 percent, said they were also investing in IT applications to become more competitive and reduce costs.

The Top Findings
• Demand for business process and IT outsourcing (BPO and ITO) is expected to exceed 2006 and 2007 levels. Pulse demand projections and pipeline forecasts are indicative of deals that typically close over the next two to three quarters.

• EquaTerra advisors (38 percent) indicated demand levels were up for 2Q08, down 12 percent from 1Q08 but up 8 percent over 2Q07.

• Service providers characterized their 2Q pipeline for BPO and ITO deals as rising 10 percent to 52 percent, a 14 percent increase over last quarter. Projections for next quarter were only slightly less optimistic, with 45 percent of providers polled expecting continued growth in demand, down from 50 percent last quarter.

• Outsourcing efforts with short-term return on investment or that deliver quick cost savings are going forward, often at an accelerated pace. Not surprisingly, efforts focused on complex process transformation or that require significant upfront investment are more likely to be slowed or on hold.

• Demand and supply increased for emerging knowledge process outsourcing functions such as engineering, research and development, financial modeling and analytics, and legal process work. There was also growth in areas like document services, facilities and real estate management and logistics services.

• EquaTerra estimates there were more than 150 outsourcing deals in 2Q08 with an average total contract value (TCV) of $270 million. This compares to 120 deals in 1Q08 with an average TCV of $120 million. These numbers exclude deals not publicly announced or announced without publishing deal details. FAO