Wall Street and the global economy are in turmoil, but the outlook for the outsourcing industry is far from gloomy. Buyers are looking to make good deals—fast.

by Peggy Cope

With the global economy in a tailspin and an American president-elect who has gone on record as promising tax breaks for companies that “don’t send jobs overseas,” it’s easy to understand why corporate executives might feel some anxiety about taking on new finance and administrative outsourcing initiatives—despite the proven ability of outsourcing to save on costs and improve processes. Surveys confirm companies paused to take a breath in the third quarter of 2008, with some slowing in the signing of large deals.

But all signs point to renewed growth in FAO and BPO heading into 2009, as CFOs fine tune their plans and look to outsourcing to help push urgent agendas through. Many organizations are likely to enter new engagements sooner than they had originally planned, as a need for speed to realize immediate cost savings kicks in. Some providers say potential clients are coming to them, skipping the RFP process. The big differences will come in the size and make-up of deals.

Last year, as fears of a recession gave rise to bleak mutterings in the marketplace, advisory firms predicted that outsourcing would be recession-proof. Now, it appears that while many companies will pause to reflect on their strategies, the best course of action for many will be to shift their outsourcing strategies, rather than abandoning them altogether or deferring them indefinitely. 

According to the TPI Index that was released 15 October, the third quarter of the year was marked by an absence of large deals, a decline in total contract value in the Europe/Middle East/Africa (EMEA) region in particular, and the lowest ITO performance by TCV since the first quarter of 1996. However, TPI partner and managing director Peter Allen points out that this is not unusual, even in a more normal fiscal year.

“EMEA was driving strong activity during the first half,” said Allen. “In Q3, EMEA saw a drop that was significant, with 25 percent fewer contracts, and contracts that were much smaller in size. But third quarters are typically the weakest quarters in any given year.” Looking at industry-wide contracts with a TCV of more than $25 million, he said, the Americas outperformed EMEA in TCV on a quarterly basis for the first time in nearly two years.

Despite drops in HRO, however, BPO has recorded increases in the number of awards, as well as TCV and average contract value (ACV). Allen anticipated that the fourth quarter of 2008 would come back strong in all areas, with some weakness in such verticals as the beleaguered financial services industry, but growing strength in outsourcing in healthcare and pharmaceuticals, as well as manufacturing and telecom.

TPI anticipates that 2008 will play out strong, reflecting deals that had already been in the pipeline before the full extent of the financial downturn began to reveal itself. Allen thinks early 2009 will start out soft in terms of contract awards, reflecting a culmination of contract initiatives started in the summer.
“Companies are focusing on existing outsourcing deals. They are reducing the consumption of services and making more use of existing service level agreements. We believe we will see people fine tuning, cutting back in some areas but adding others,” he said. He also expects companies to continue seeking cost improvements and to leverage existing benefits.

“There are two edges to the outsourcing sword. Everyone focuses on new awards, and that’s where we see some softness for Q1 and Q2 in 2009. The other edge is revenues that are realized through existing relationships. If contracts are well constructed, it will give clients leeway in dialing up or down the services they receive. For now, they are trying to dial down.”

Feeling Bearish?
EquaTerra’s third-quarter 2008 Pulse Survey showed 43 percent of advisors cited increased demand, up 5 percent compared to the second quarter, albeit down 8 percent year over year. On the provider side, 41 percent cited increases in new deals in the pipeline—down 11 percent quarter over quarter, but up 3 percent year over year.

Thirty-nine percent of providers noted the economic climate is driving more outsourcing, and 55 percent said buyers are looking to outsource as a way to reduce or hedge energy costs.

Overall, 38 percent of providers and advisors indicated economic conditions were causing buyers to slow or rethink outsourcing plans. But the report hastened to clarify that this means deferring, not canceling, outsourcing initiatives. The deferrals are, in most cases, a result of other events occurring in a buyer organization that impacted the sourcing process, rather than because buyers changed their minds about outsourcing.

According to EquaTerra, the financial crisis is damping enthusiasm for immediate outsourcing activity in several ways:
• It is challenging for many organizations to make any sort of large cash outlays; e.g., to invest in information technology or to fund change initiatives;
• Organizations are deferring capital expenditures and pulling back on research and development investments because capital, either debt or equity, is harder to access;
• Organizations are looking for ways to reduce costs and map costs to their shrinking top lines;
• There is renewed interest in making costs more flexible by turning fixed costs into variable ones;
• Organizations are demanding short-term and realistic ROI on any new initiative; and
• Buying and decision-making processes are complicated and delayed by larger corporate and market events.

Pause Before the Plunge
According to Stan LePeak, managing director of global research at EquaTerra, the hesitation reflects uncertainty on the part of executives about just how bad the economy was going to get and reluctance to enter new arrangements prematurely. “They were hoping for a quick bottoming out. Now they recognize that’s not the case, that things are pretty bad. They were getting into budget planning cycles at mid-year. Now, we’re seeing some resignation that things aren’t going to get better soon, and a need to execute on savings initiatives,” said LePeak.

“Things were put on hold because people couldn’t make up their minds to pull the trigger. They weren’t comfortable yet that this was the reality of the market for ’09,” he said. Now they recognize they can no longer hold off on change initiatives, as it has become clear within organizations what things will look like next year in terms of the need to make headcount reduction, and the need to take money out of corporate budgets. “Companies have to address those facts. They can’t wait around any more hoping things will get better,” LePeak added.

But even as corporations move to reduce headcount and cut costs, they need to get the same work done as before. That’s where outsourcing comes in. A company that cannot hire new employees can get the help it needs from a third-party provider. Outsourcing enables corporations to take operational costs out, and a portion of that goes to the bottom line, but some new investment can be made; e.g., system upgrades or selective new hires—elements that are not on the table until a company can take out some costs.

The challenge in F&A, said LePeak, is that most companies are operating pretty lean in this area, as more concerted effort over the years has gone into driving down costs. In some respects, cost reduction has already occurred, with process improvements and automation, so outsourcing becomes inevitable as the next step for continued improvement, because companies have done all they can do within their own four walls. In Human Resources, most groups are still relatively inefficient, said LePeak, so there is more room to do some cost cutting internally. But in F&A, companies are at a point internally where there’s not much more they can do to save costs, so they have to look at the fundamental delivery model.

George Evans, managing director, Outsourcing Partners International, had seen most corporations, until about a month ago, sitting on the sidelines, believing that this economy was bottoming out and that it was going to turn the corner. Now, he said, most feel a long-term recession is starting, and the writing is on the wall as to whether or not outsourcing is a lever they need to consider. This creates a sense of real urgency.

Companies that have had an event where earnings or sales are down have an incentive to move, and move faster than they would have done previously. Firms that were previously just starting to poke around, for education as well as need, are now accelerating the sales cycle, and deals that would have taken a year to 18 months to come to fruition in the not-very-distant past could now take just a few months.

As companies move to realize immediate savings, Evans noted some things they should not lose sight of in their haste. “When you enter into an agreement with a BPO provider, make sure you are not locked in,  in terms of size and cost. Build in some flexibility to go up and down based on the situation. Also, in due diligence, look at the entire operation and the service level agreements. You will be in a better position to understand where you can continue to pull levers.” And do your homework. “Due diligence prepares everyone for content and knowledge transfer—which is important,” he added.EXL Services president, co-founder, and chief operating officer Rohit Kapoor noted that while the economic crisis will have a significant impact on outsourcing in general, it should affect different areas in different ways. He anticipates that companies will hold IT spending to the same budget as 2008, or cut it back. However, he said BPO has a lower penetration rate, particularly in offshored services, and given that and the immediate gains that can be garnered from BPO, he expects companies to approach BPO more aggressively. The provider is signing contracts now for 2009, and Kapoor has noted that clients are making decisions more quickly, sometimes even without an RFP process.

 Kapoor said EXL is seeing interest in outsourcing a lot more back-office work as opposed to voice work, which he said had already moved across. He noted that more complex processes are being offshored, too, accounting for more core functions than were outsourced previously.

“With all the financial mess that is taking place, companies anticipate a lot more regulatory oversight and control,” he said. Enterprise risk management is becoming more key, and companies are preparing themselves to be compliant under Sarbanes-Oxley as well as maintain good risk management. Many organizations will not have the right tools in-house to implement effective monitoring and reporting mechanisms.

Re-thinking StrategyHRO might not fare quite as well as FAO during this economic downturn. Cay Gliebe, global accounts executive at NorthgateArinso, said companies will re-think whether HR remains a strategic area to continue to outsource in the short term. “The business case for HRO presents a challenge in the best of times. We have seen that companies are re-examining whether to take on as much as they had originally planned. They may fall back to a different position to look at what the most important areas or countries are where they really need solutions first. It will be important for them to prioritize,” she said.

Also, according to Gliebe, the days are gone when a company would look to a single provider to answer all its outsourcing needs. “The long-term trend will stay focused on getting the core solutions, then finding niche players to address separate individual process areas,” she said.

“These deals start very big, but it is the rare case where a client can make a business case to support doing it all,” noted Gliebe. “Once they find out what the price points are, they will scale back and focus on most important issues first.” Buyers will look for their pain points and buy what they really need.David Poole, North American leader of Capgemini’s Business Process Outsourcing unit, agreed, “Sure, a number of companies at this time are budgeting for next year and will take quite conservative approaches for next year. But as they do that, they will realize they are creating profit gaps they need to fill. People are thinking about aggressive programs as we go into the New Year.”

Predictably, the financial services sector is being hit hard, creating more opportunities. Poole said, “Banks are going to be in turmoil now, they are looking very much at what to do around their back offices next year. What’s interesting is that captives in particular are struggling because a lot of the trade in them has disappeared, particularly for certain types of transactions. Large captives have people sitting around twiddling their thumbs.” He noted we should expect to see more deals like the acquisition of Citi Group’s banking shared service centers by Tata Consultancy Services.
The Need for SpeedLike other experts, Poole expects a rush to BPO, albeit a well-considered rush. “We aren’t feeling it today because the scale of decline is recent news. A lot of people are cautiously thinking about next year, and we should start seeing IT deals declining and BPO emerging, with bundled deals. There will be some concerted action where executives will take rapid decisions they might have been thinking about for a slightly longer horizon,” he said.

He also predicted a trend toward nearshoring. “The North American market will want to see things done closer to home, in the same time zone, at good cost. There will be a rapid increase in demand for Latin American services. They offer a stable rate against the dollar, as well as close proximity, particularly for voice activity, because a lot of customers have been concerned about call centers from India. In this time of uncertainty around consumer demand, we will see an increase in outsourcing, but closer to home so they feel more secure.”

At one end of the spectrum, Janssen noted there is a need for speed where companies seek solutions fast to alleviate a current pain point. But, he said, “You can do a big deal that takes everything in one swipe, or you can go after smaller deals and negotiate properly, taking smaller chunks at a time.”

The key for providers trying to attract new buyers in this market will be playing to their strengths, according to the experts, whether that means providing good solid administrative solutions for a number of countries that meet language requirements as well as cultural needs, talent management solutions based in strong technology, or leveraging learning organizations that have been acquired, as at Accenture and IBM.

In addition, across all outsourcing towers, even as companies turn up the volume on their need to achieve labor arbitrage savings, processes will still need improvement. “You can’t do the same things in the same way with fewer people. Something has to change,” said Gliebe. “If you don’t look at doing that, you are liable to miss the very strategic things you should be doing because you are bogged down in the administration. One way or another, businesses have to attack that problem. It’s just the nature of the beast.”