In the UK, as in the rest of the world, outsourcing remains a buyer's market. Increased competition from service providers at all levels enables customers to pick and choose their preferred outsourcing route with increasing flexibility. Rather than risking whole business lines with a single service provider, smaller value and shorter transactions allow customers to spread operational risk and develop new relationships.
Although this increases the governance burden for customers, this seems a price that they are willing to pay - and there has been a sense, over the past 12-18 months, that previous deals that involved handing over a broad set of service requirements to one single service provider often did not work as well as had been hoped.
On the service provider front, niche players are winning more deals at the expense of both the Tier 1 and mid-range service providers and the sub-Tier 1 mid-range providers. While the UK outsourcing market continues to expand rapidly enough that the larger service providers can protect their earnings even with a reducing market share, the potential losers are likely to be mid-level service providers who have not come up with a good strategy to overcome this problem.
This has had a couple of significant effects. Firstly, traditional big service providers are changing their focus to try and win more of the smaller deals and, secondly, some of the traditional offshore service providers (especially Indian-origin vendors) are bulking up their onshore UK presences.
At a macro level, the UK continues to fare well in the global outsourcing market. While the recent downturn in 'mega-deals' has disproportionately impacted the US market, the UK market has continued its steady growth. And despite growing take-up for outsourcing - especially of business processes - on the continent, the UK still leads the way in Europe. Leading outsourcing consultancy TPI has reported that the European market out-performed the rest of the world in the first half of 2007, accounting for more than half of the total contract value of outsourcing business awarded.
But one concern must be the prospects for homegrown outsourcing services providers. The UK market has always proved fertile territory for large overseas providers. But no UK service provider has really broken through into the big leagues (despite an honourable mention for the long-term success story of Capita); and many UK companies have either continued to struggle on in the face of eroded margins and stronger Tier 1 opposition (or, more recently, offshore opposition) or have been swallowed up by bigger non-UK competitors (from Fujitsu's buyout of the former ICL right up to Groupe Steria's recent bid for Xansa). It remains a puzzle why, despite the strong success of the outsourcing market in the UK, there aren't more strong indigenous outsourcing providers with genuine critical mass.
Outsourcing structures
The current trend for multi-sourcing began a couple of years ago in the US - driven by a landmark General Motors deal. The trend has been picked up and reflected in the UK, to the extent that multi-sourcing has now become the favoured sourcing strategy for large outsourcing projects.
Customers feel that it is not realistic for one service provider to be good at everything, and concentrating on best-of-breed is more likely to deliver value. This strategy comes with a cost because customers now need to spend more time and money managing their various service providers. However, many customers still struggle to manage their deals properly and project management will need to improve if multi-sourcing is to achieve its goals.
There are, of course, exceptions to this trend. Big deals are still being signed by the Tier 1 service providers - see Accenture winning the recent $1.5 billion Unilever HRO transaction. The difference is that these large deals are now concentrated in fewer sectors and many larger deals are being broken up when they come up for renewal.
As deals become smaller and customers focus more on governance issues, deals are taking longer to close. There is a clear difference in approach between offshore-origin service providers (who remain fleet-of-foot and prepared to meet customers' expectations in order to close deals quickly) and larger (especially Tier 1) providers (who appear to have developed increasingly protracted and convoluted sign-off procedures and are reluctant to move away from their own pre-determined policy positions). Service providers in this latter group will need to ensure that they have factored their increased cost of sales into their bids and that they set realistic market expectations about their projected revenue streams.
Offshoring becomes global service delivery
Over the past two years, the onshore and offshore outsourcing markets have begun to converge. More and more deals now involve an element of offshore delivery and we have also seen key offshore service providers coming onshore to win business. In fact, many of the Indian-origin service providers now have delivery centres in all the key geographies. This has helped them win more deals from the Tier 1 service providers and to move beyond their typical strengths in applications development and maintenance (ADM).
Increasingly, service providers will be distinguished from each other - and selected by customers - based on the robustness of the global service delivery model i.e. by their ability to source services delivery from the right place at the best price.
In terms of offshore locations, although India retains a cost and language advantage, China closes the gap year by year and is making major strides to close the significant skills gap for many types of outsourcing. Analysts have recently claimed that 5-10 per cent of US and European IT software outsourcing will be diverted from India to China in a few years' time.
Certainly most of the major Indian service providers are already established in at least one of the major centres in China (Shanghai, Beijing and elsewhere), as are some of the US service providers. Despite a regulatory regime that remains less friendly to business interests than that found in India, the Philippines and other popular sourcing destinations, more companies are sending ADM work to China where the cost advantages over India are greatest.
India seems likely to continue to be the largest offshore centre for at least the immediate future, and more complex work will still be performed there for the moment. China will begin to attract more lower-value work, especially ADM, and in particular in respect of non-business-critical software. Research firm IDC has recently predicted that Chinese cities will unseat those in India and the Philippines as favoured offshore delivery centres by 2011.
Companies seem also to be considering setting up their own development centres in China, usually as a joint venture with a Chinese partner, and this is done for traditional offshoring work as well as positioning companies to attack the Chinese domestic market. Operating in China still remains complex and we advise clients to invest enough time up-front to make these ventures work.
Data security
Data privacy and security are now established as major concerns in outsourcing, especially for large global companies who have become concerned that their outsourcing contracts did not fully protect them from security breaches and the various breach notification requirements under US state laws. Much more effort now needs to be put into ensuring that data security requirements are met and that customers are quickly informed of any security breaches by service providers.
Conclusion
Overall, the outsourcing market continues to grow, albeit more healthily in Europe than in the US, and with smaller deals and a greater emphasis on BPO. The merging of the offshore and onshore delivery models continues and service providers will continue to search for more competitive solutions in order to win customers.
As growth has slowed, service providers have found it harder to maintain margins, and it remains a buyer's market. Service providers are having to develop better offshore delivery models and seek more valuable services. But, as The Economist said recently: '...the race to the bottom on price threatens both the quality of service and profit margins'.
Key features of the outsourcing market are:
- a continued trend towards smaller, shorter deals as clients focus on individual processes instead of large, complex institutional transactions;
- increased reliance on global service delivery models;
- data privacy and data security issues becoming ever more important to outsourcing customers;
- increased offshoring to Asia as clients become more confident about doing business in China;
- the UK remaining a buoyant outsourcing market, out-performing the US and leading the way in Europe;
- large Japanese companies beginning to adopt recognisable elements of information technology outsourcing (ITO) and business process outsourcing (BPO) models into their traditional contract partnering modes of operation.
Alistair Maughan is chair of Morrison & Foerster's Global Sourcing Group.
