11/06/2007

2008 FAO Forecast

The FAO market is in for a wild ride next year. Here is a list of changes that are occurring at mach speed:

The Suppliers:

  1. FAO outsourcing will cleave in two. The Indian suppliers will dominate version A: transaction-based outsourcing. Version B: FAO with business insight. David Poole, Vice President and Deputy Chief Executive of Global Business Process Outsourcing, Capgemini, says this version focuses less on taking out cost and more about improving the value of the business through more efficient processes. He says the traditional providers and some of the Indian players will move up the value chain to participate in Version B.

    Rich deMoll, Global Managing Director, BPO, HP, sees a bigger separation between the Tier-1 suppliers and the other tiers. "2008 is going to distinguish the Tier-1 players from the rest of the pack," he says.

  2. There will be more supplier consolidation. Poole, head of NA BPO, predicts large suppliers will acquire niche players who have the needed specialization skills or software as a service (SaaS) players who have the desired applications. "The goal is to broaden their scope of services," says the Capgemini executive. The Everest Research Institute says "captives, technology providers, and niche suppliers will be the prime acquisition targets in 2008."

  3. Buyers want suppliers who specialize. Suppliers that can add value to a buyer's top line have to specialize in verticals since many of them have unique challenges. Financial services companies have different concerns than energy suppliers, for example. Martin Cook, GSO, Outsourcing, Capgemini, says vertical specialization "will emerge as a key differentiator for Tier-1 suppliers."

    The need for specialization will enforce the sector's continuing consolidation, continues Cook. "Suppliers will augment their solution portfolio through acquisitions," he says. He points to Capgemini's purchase of Kanbay as an example of this trend.

  4. Suppliers will increasingly target the higher end of mid-market buyers, companies with annual revenue ranging US$2-5 billion points out Katrina Menzigian, Vice President for FAO, Everest Research Institute. "These buyers are actively exploring FAO options and present a large market potential," she says.

  5. Suppliers will evolve their delivery models, especially in the area of platform-based technology solutions, in order to create viable business cases for serving this segment of the market. Menzigian predicts 2008 will see increased market discourse on the viability and appeal of platform-based FAO solutions. "The drive towards building FAO platforms will further fuel merger and acquisition activities as suppliers build out their capabilities," she says.

    Gianni Giacomelli, Head of BPO Strategy and Marketing at SAP, points out that many suppliers, irrespective of what segment they are in, are already starting to change the way they deliver services. He says they are increasing automation to reduce their dependency on "now often exhausted" labor arbitrage.

  6. The Buyers:

  7. CFOs will worry more about how outsourcing can grow their businesses. Poole says buyers now tell him they want to grow their businesses three percent a year instead of asking him to take out one percent of cost. He says the new focus will make outsourcing more valuable; however, suppliers still need to take out cost because the savings fund the business transformation.

    Giacomelli adds that innovation is the key for business growth, and labor arbitrage alone does not get buyers there. Reengineering processes and related systems will, and buyers are waking up to this.

  8. Buyers are divesting themselves of brick-and-mortar assets like shared services centers. DeMoll says they are trying to sell them to outsourcing suppliers, especially in India, or private equity partners. Another option: keeping them but having them service government entities.

  9. Buyers will focus on sustainability. DeMoll says next year labor arbitrage will just be the entry price. Buyers want more than just cost savings; the HP executive says buyers want to change their business model. Suppliers will have to demonstrate they can sustain the business case for outsourcing.

    Anoop Sagoo, Accenture, agrees. "We're seeing a distinct shift in focus to a more sophisticated value proposition focusing more on business outcomes," he reports.

    "Buyers definitely want to build on their initial cost-savings-centric engagements to drive additional savings and enhanced business performance," adds Menzigian. However, she says "it's not clear the extent to which buyers are willing to trade their customized solutions for platform-based solutions which could potentially deliver the additional functionality and performance they desire in a cost-effective manner." The buyers will start to work out this conundrum next year.

    Giacomelli says this shift will "emphasize seamless process integration across towers." Their focus will be on designing processes and systems to do so. However, the SAP exec points out "suppliers will still need economies of scale to be sustainable and will continue pushing some level of standardization around their own best practices."

  10. The Deals:

  11. Mature FAO buyers are beginning to seek out more integrated solutions for key process areas such as Order-to-Cash (O2C) and Procure-to-Pay (P2P), observes Menzigian. She says the goal is "to target a larger cost base, while also driving greater business performance through pre-integrated solutions designed to provide increased visibility and effectiveness across the end-to-end process."

  12. Big-Bang deals will be fewer. Menzigian predicts the market will see a rise in the number of deals that surgically target opportunities to drive value in terms of both operational and strategic gains. O2C/P2P serve as an example.

  13. Current FAO buyers will move up the value chain. "Buyers are asking us, 'What else can you do for me?'" DeMoll reports. New services that build sustainability include analytics for decision modeling and data mining. "Buyers who have gotten past the transactional savings now want an analytic platform with tools and brain power in a low-cost environment," DeMoll reports.

    Sagoo says FAO is becoming more complex. Buyers now want to outsource more complex aspects of the FAO process than in previous years. He points out Accenture is managing the information around BT's profitability data. "A few years ago people would have laughed at the possibility. Today, buyers want to outsource to get high-performance finance."

    Or they want to cover multiple geographies. For example, Accenture's FAO engagement with Microsoft includes 92 geographies. The Everest Research Institute predicts suppliers will diversify their location portfolio next year. Good choices: Tier-2 Indian cities, Eastern European locales, Mexico, China, and the Philippines. Next year the FAO market "moves towards a truly global sourcing model," says its 2008 Forecast report.

  14. Buyers will want bundled solutions that include finance and accounting. Sagoo says buyers are realizing finance and accounting is really just the back end of a bigger process. "We're seeing buyers looking across processes," he says. The most obvious combos are procurement and HR.

  15. To get more value from transaction services, suppliers are using more electronic flow through. Cook says buyers who have already realized significant savings through labor arbitrage now look to automation to achieve greater savings. DeMoll adds buyers and suppliers will share the gains as improved way of doing things provides more business value, like improving business metrics like day sales outstanding.

  16. The Influencers:

  17. Cook says process innovation and business insight will begin to replace labor arbitrage as the key drivers for FAO. They require a mix of onshore/offshore delivery to deliver higher level value, he explains.

  18. Buyers will start to look at the integration of process change with technology change. DeMoll says in the past when buyers wanted to change a process from end-to-end, the suppliers bumped up against the internal IT department. HP solved the problem by bundling the two; "we deliver process change as a service," he explains.

  19. The FAO value proposition will expand beyond outsourcing. Sagoo says some buyers want to partner with their FAO supplier "to create a go-to-market portion of the deal. Buyers are beginning to think out of the box," he says.

  20. Buyers will create a number of internal shared services, which they will turn into captives or transition to BPO. "The momentum is building for hybrid service delivery, which will prompt a lot of rethinking of how to deliver such services. People who understand both the business and technology side of things will be in high demand," says Giacomelli. This will encourage BPO providers to look for help in the software vendors and will expose those software vendors who are not able to proactively help.

  21. The Market:

  22. FAO will continue to grow in 2008. DeMoll says HP is seeing "increased demand. This was the busiest summer I've had in my outsourcing career," he says.

    One reason: FAO has a proven track record. "This reinforces the model and encourages more companies to try it. Success is driving the increased demand," he adds. Fear of hard times in 2008 is helping, too; cost containment pressures are building. And many are trying to take advantage of the global business model, he continues. Another driver: The Everest Research Institute reports US$600 million of FAO contracts are up for renewal in 2008.

  23. Human capital management is a key contributor to the continued growth of the FAO market. "As in-house departments continue to struggle to hire and retain qualified finance and accounting professionals and IT departments continue with similar challenges, the value proposition offered by experienced FAO suppliers gains in appeal," says Menzigian.

ITO Forecasts for 2008

Cost is still "a major factor" in IT outsourcing. But, according to Sergey Karas, Vice President, Global Strategy at Luxoft, Russia's largest ITO service provider, "globalness is the main driver today, along with access to skills not available in house."

The size of ITO contracts continues to be smaller because of multi-sourcing. Karas predicts that by 2008 multi-sourcing even among offshoring deals will be mainstream such that buyers will pass over providers offering delivery from only one country.

Pat Adamiak, Vice President Portfolio Marketing and Alliances, Outsourcing Services, HP, says the main trend in ITO today is "a lot of pressure from customers to deliver a lot more innovative ways to do ITO." He cites two examples. Today, most data centers are still architected on a deal-by-deal basis. "But in the future, there will be a world-class center based around blades, world-class architecture, etc., which will allow transfer of data center deals to move faster."

Desktop services are another example. Today, the desktop is very multi-tower and cobbled together. "In 2008, we will see a much more integrated desktop offering. It will focus categories more on end-user perspectives and needs instead of today's desktop, with categories that are by process," she says. For example, the desktop of 2008 will be more advanced for mobile people, along with the categories for standard needs. The desktop needs of a clerical person or call center person are different from a road warrior.

Another reaction to client demand is that 2008 will also bring a move toward automating how service providers deliver services, Adamiak states. This will bring a lot of provider consolidation to allow more leverage. HP purchased Mercury and Opsware this year to have a stronger software services arm. IBM made several similar acquisitions in 2007. "Combining automation with the trend of local delivery makes it easier to move to a sophisticated global delivery and move services around," he says.

Market Growth

According to Everest Research Institute, the overall IT Outsourcing (ITO) market will continue on a steady mature growth. Everest's analysis shows that ITO penetrates the Fortune 100 by about 80 percent already. Ross Tisnovsky, Vice President, Research (ITO), says this penetration suggests that most of the ITO activity in 2008 will be happening in the mid-size (e.g., Fortune 1000) client segment.

"We are also likely to see further decline in mega-deals, both in terms of number and the size," Tisnovsky predicts. "As fewer mega-deals get announced, most of the play in the mega-deal segment will shift to renewals and re-competes. These trends are likely to intensify competition resulting in additional pricing pressure across ITO."

Although the small and medium business (SMB) segment remains largely under-penetrated in terms of ITO, Everest Research Institute does not predict major changes and efforts coming in this market segment. Everest expects it to remain under-leveraged, due to the issues of low-scale of outsourced processes and the provider's high cost of the sale. "Both are hard to overcome in the SMB market," Tisnovsky explains.

Infrastructure

Infrastructure outsourcing (IO) will continue growing at a sustained pace in line with the rest of the IT industry. "Under the calm surface of the market, we will see significant share shifts as the Remote Infrastructure Management Outsourcing (RIMO) model continues gaining market share, growing at 60 to 70 percent," Tisnovsky predicts. As RIMO gains share, the traditional model of IO will start to show a declining trend around 2010.

Tisnovsky advises buyers looking to make decisions in the next two to five years to investigate whether RIMO is good or bad for them. "Some will find that RIMO is not cost-effective for them. Others will want to get rid of assets, and RIMO won't work in that case."

A shift toward asset-light deals in both RIMO and traditional models will result in revenue deflation as assets start getting excluded from the scope of IO engagements. "We estimate that the asset-light deals are usually 60 to 70 percent smaller than the corresponding asset-heavy deal. Thus, the shift toward the asset-light deals is likely to result in improved margins, but will affect the top-line growth, says Tisnovsky.

He adds that aggressive adoption of labor arbitrage by both RIMO and traditional providers is also likely to add to the pricing pressure in the IO industry.

Karas of Luxoft predicts that the strong adoption of ITO in European companies in 2007 will continue in 2008, with companies actively seeking services delivered by a nearshore, Eastern European provider. But not all locations--nearshore or offshore--are equal, and value depends on expertise as well as other cost factors.

He points out Eastern Europe is not a good location for application maintenance, for example, because it requires more expensive skill sets. China is great, he says, for low-complexity, large projects where communication and time zone differences are not critical (as they are in application maintenance). In application development, where project specs and architecture may not be very clear, the location of the development team is critical because interactions need to take place in real time.

"New regions, such as Russia and Ukraine are now included in Gartner's "leaders" tier; this allows companies to fight for sending work to providers in these regions. Outsourcing to a service provider in a non-mainstream region still sometimes raises eyebrows because of common stereotypes and perceived risks," says Karas.

But he predicts that labor arbitrage will inevitably go away as the market becomes more efficient and hourly rates for certain skills become the same.

Application Development and Maintenance

According to Everest Research Institute, demand for ADM services is likely to continue slowing down, resulting in a more sustainable pace of growth of about seven percent (down from its 12 percent growth in the last couple of years).

"We estimate that the penetration of offshoring into the ADM headcount of IT services companies is approaching about 40 percent and is likely to start showing signs of saturation," says Tisnovsky. Most buyers are already comfortable with their current ratio of offshore work.

This maturation of the offshore trend will result in a shift of value in ADM from labor arbitrage into more complex areas of ADM (e.g., process improvement and application portfolio rationalization). Tisnovsky predicts this value shift will result in buyers' driving consolidation of their service provider portfolios and push toward more partnership-based relationships.

Luxoft's Karas says software performance and product testing has recently made its way into the outsourcing arena. He says in 2008 the scope will broaden beyond traditional functional and system integration testing to also encompass overall system performance and scalability, usability, and security, thus bringing higher value to the client organization. This will require suppliers to offer new outsourcing services in the market in the areas of system performance engineering, test automation, and regression testing efficiency.

Karas says, "Providers providing ground-up software product development and engineering support for client offerings will pick up steam in 2008 as transformational and innovative outsourcing grows, especially in the automotive, industrial, electronics, and telecommunications equipment industries."

He predicts that Agile, which started taking root in the development community and in outsourcing engagements during 2007, will see greater adoption in 2008, as a strong tool in helping to speed time to market. "It will be critical to have a provider that has mastered Agile," Karas states.

He also points to a trend of major multinationals selecting providers other than the large Indian players "when there are a lot of parameters around the criticality--such as mission-critical applications, and real-time transactional systems." Deutsche Bank, for instance, chose Luxoft over large Indian players for its global CRM application. "Some companies feel they will have more leverage, more control, and more escalation power with a mid-size provider," Karas says. "Deutsche Bank communicates directly with our senior executives, and that level of relationship takes on a tremendous role in achieving value."

"The economy is changing pace and it's a global world, so competition is tighter and companies need to replace their applications with minimum risk," states Keras. He predicts companies in 2008 will "do even bolder moves with outsourcing and it will become more like an ecosystem."

He notes another trend: verticalization. Karas predicts it will become an important provider-selection criteria. "Service providers with certain domain expertise that can speak the language of the business, think and talk like the client, and thus react more quickly will easily differentiate themselves from other providers," he explains.

ITO in Health Care

Siemens has noticed a trend of fewer large outsourcing deals in the healthcare industry. Further, the provider notes that most deals are shrinking from longer historical contract term lengths to five to seven years now. While both of these trends can signal a strategy toward best-of-breed multi-sourcing deals, Jim Way, Vice President Managed Services Operations, Siemens Medical Solutions, says they signal a different phenomenon in healthcare outsourcing.

"Potential clients are saying to us, 'Come in and do a good job on our pain points; and if you do well, we'll give you more work,'" says Way. He explains this demand arises from two areas. First, many healthcare organizations are still dipping their toes in the waters of outsourcing.

Second, more and more CIOs are now involved in the outsourcing decision, not just the CEO and COO, and fewer CIOs are losing their jobs to an outsourcing provider. "This frees them to consider using outsourcing solution instead of a threat to their jobs," says Way.

Still, the CIOs currently have a comfort level with doing only pain-point deals. The main pain points areas today are: (1) help desk, (2) application support (legacy systems, implementing and supporting new systems, and (3) the one-time project of improving the network infrastructure (enabling implementing new advanced systems).

Way notes that the clinical concentration for systems now is not financial. It's implementing new systems, transitioning from old systems, and also outsourcing the help desk. He adds that "at Siemens, we're changing the way we support some services, such as the help desk, because more and more incoming calls are from physicians and clinicians who don't have time to troubleshoot anything."

Finally, the Siemens executive says, "Our potential customers are now demanding 'What are you going to do to help my business?' and 'How can IT enable what we want to do?'"

Buyers and providers, more than ever, need to remember that relationship management is critical for outsourcing success, he warns. "It's the key to ensuring a satisfied client and extending the contract."

Lessons from Outsourcing Journal:

  • Cost is still a major factor in IT outsourcing, but globalness is the main driver today, along with access to skills not available in house.
  • By 2008, multi-sourcing even among offshoring deals will be mainstream such that buyers will pass over providers offering delivery from only one country.
  • 2008 will see a much more integrated desktop offering. It will focus categories more on end-user perspectives (such as mobile workers) and needs instead of today's desktop, with categories that are by process.
  • ITO penetrates the Fortune 100 by about 80 percent already. This penetration suggests that most of the ITO activity in 2008 will be happening in the mid-size (e.g., Fortune 1000) client segment.
  • Although the small and medium business (SMB) segment remains largely under-penetrated in terms of ITO, this market segment is expected to remain under-leveraged, due to the issues of low-scale of outsourced processes and the provider's high cost of the sale.
  • The remote Infrastructure Management Outsourcing (RIMO) model continues gaining market share, growing at 60 to 70 percent. As RIMO gains share, the traditional model of IO will start to show declining trend around 2010.
  • A shift toward asset-light deals in both RIMO and traditional models will result in revenue deflation as assets start getting excluded from the scope of IO engagements. Asset-light deals are usually 60 to 70 percent smaller than the corresponding asset-heavy deal.
  • The strong adoption of ITO in European companies in 2007 will continue in 2008, with companies actively seeking services delivered by a nearshore Eastern European provider.
  • For ADM, major multinationals are selecting providers other than the large Indian players when there are a lot of parameters around the criticality--such as mission-critical applications and real-time transactional systems.
  • Agile, which started taking root in the development community and in outsourcing engagements during 2007, will see greater adoption in 2008, as a strong tool in helping to speed time to market. It will be critical to have a provider that has mastered Agile.
  • Verticalization is another ITO trend and will soon become an important provider-selection criteria. Service providers with certain domain expertise that can speak the language of the business, think and talk like the client, and thus react more quickly will easily differentiate themselves from other providers.
  • In health care outsourcing, more and more CIOs are now involved in the outsourcing decision, not just the CEO and COO, and fewer CIOs are losing their jobs to an outsourcing provider. This frees them to consider using outsourcing solution instead of a threat to their jobs.
  • Health care CIOs currently have a comfort level with doing only pain-point deals. The main pain point areas in health care today are: (1) help desk, (2) application support (legacy systems, implementing and supporting new systems, and (3) the one-time project of improving the network infrastructure (enabling implementing new advanced systems).

2007's Landmark Events and What They Auger for 2008

What a year! Wipro set up shop in the United States. This year's subprime mortgage mess will actually help outsourcing next year. And non-traditional suppliers won some big outsourcing deals. Here's what it all means and a guess at how these events might impact the industry in the next 12 months.

1. The Indian pure-play suppliers solidified their place in the global marketplace.

David Poole, Vice President and Deputy Chief Executive of Global Business Process for Capgemini, says this year they signed a number of large infrastructure deals "that are the bread and butter of the traditional players. We watched as they tried to mitigate the slaughter."

Martin Cook, GSO, Outsourcing, Capgemini, agrees that the Indian suppliers "have changed the face of the market." But he predicts they may face difficulties in 2008. One relates to growth. "As they get bigger, they have to have bigger contracts," he explains. And they will have to change their market position; "once you compete on price, how to you create value?" Cook asks. He says the only way to do that is to grow. "They will have to make some dramatic moves over the course of the coming year," he says. 2009 might even be the year the industry hears a profits warning from an Indian Tier-1, he posits.

2. Software-as-a-Service (SaaS) will continue to gain traction.

Cook says this year's growing acceptance "is the first step in a long march." Capgemini, for example, is working with Google on the enterprise level of Google applications; it's providing wraparound services to handle things like migration, integration, and the authority to use the software. Cook points out Capgemini has also developed a SaaS solution using SAP for one of its key markets, utilities. "We are betting there is an advantage in embracing it first," says Cook.

Poole, the head of NA BPO, says ITO buyers "don't want to pay as much as they have in the past for software services." And they are tired of paying to make improvements in their ERP systems, he adds. Today, "buyers want their applications overnight, even in HRO and FAO," he says.

Poole says next year buyers will grow "increasingly tired" of managing the application infrastructure that supports specific business processes. He predicts BPO suppliers will partner with or purchase SaaS companies to service this emerging requirement.

3. Wipro expands its global footprint in the United States.

First, it bought Infocrossing. This contributes to the continuing trend of four to five mega players and then a lot of successful small niche players in ITO, says Pat Adamiak, Vice President, Portofolio, Marketing, and Alliances, HP. "This signals the aggressiveness of the Indian players," he says.

Ross Tisnovsky, Vice President, ITO Research for the Everest Research Institute, says this acquisition signifies "a departure from the Indian's conservative attitude toward IT assets abroad." He says this apparent willingness to engage in asset-heavy transactions "will open a new chapter in the competitive dynamics in infrastructure outsourcing."

Then, Wipro set up a small software development captive in the United States, creating US jobs. "Five years ago, many American jobs went offshore to India. We will see a reversal of this in the years to come, as some of these jobs will return back to the United States," says Michael Beygelman, Senior Vice President, Adecco North America. In addition, Indian suppliers want to tap into the US's excellent infrastructure. He believes the US real estate and outsourcing employment markets will benefit in 2008 and 2009 as more Indian suppliers set up shop here because they are discovering it might be cheaper to operate in US secondary markets rather than to do everything from India.

4. China becomes not only the home of service providers; it becomes a multi-million-dollar outsourcing market.

Cook says suppliers are inking deals to service Chinese companies. "The Chinese market is too big and too rich to do it all in-house," says Cook.

5. Standardization takes hold.

Adamiak calls this "services productization." He says the major suppliers have been creating standardized building blocks for services to automate processes. He likens this standardization to the auto industry. "The industry will start to see the benefits of standardization in 2008," he says.

Pat Goepel, President of HR Services for Fidelity Investments, agrees. "Lift and shift is dead," he says. "Standardization will be the hallmark of more deals going forward."

6. Consolidation continues in the human resources (HRO) and recruitment process outsourcing (RPO) world.

Three important transactions occurred this spring. In May Beeline purchased Employer Services Corporation. Then in June Kenexa purchased StraightSource (after acquiring BrassRing in November 2006); and FutureStep, the RPO arm of Korn/Ferry, purchased the Newman Group. In August Hewitt Associates purchased RealLife HR. Then Adecco purchased TalentTrack.

"There are too many RPO firms trying to get RPO market share," says Kim Davis, former President of TalentTrack and now an Adecco Senior Vice President . He says smaller firms will increasingly become challenged as the larger firms continue to build infrastructure and regain the competitive advantage away from the smaller pure-play RPO firms. "They have found out how difficult it is to compete on a national or global playing field given their size," he says. Today, most buyers want to work with RPO providers that they can grow in to, with a global reach, not service providers they can grow out of. "Because the world is flat, TalentTrack as a standalone couldn't compete in a global environment," he continues.

In the HRO world, Northgate purchased Arinso International in June and Mouchel Parkman purchased HBS in August.

As for the big players, the Adecco executive says a mixture of three reasons is driving the buying spree: the need for product extension, the desire to enter a new market, or the necessity of acquiring infrastructure that would take too long to build.

7. Tier-2 suppliers may face a challenge next year.

Cook mentions the woes of LogicaCMG, the union of a British and Dutch company. It sacked its president because of a series of disappoint results. Six month later it still can't find an appropriate candidate. "They can't find a celebrity to take over," says Cook. "Tier-2 companies are having a difficult time finding their place and becoming a Tier-1." He suggests some may be good candidates for the Indians suppliers to purchase.

8. The megadeals are disappearing.

"The first three quarters of 2007 show the megadeal segment of the market-deals with $1 billion in total contract value or $200 million in annual contract value-- is in a long-term decline," says Tisnovsky. These deals dropped in both number and size. He says this continuing trend "is reshaping the outsourcing industry."

Jim Way, Vice President of Operations for Managed Services, Siemens says the trend today is to do pieces of a function, not everything. "Third-generation buyers are scared because they didn't get what they were promised in the past. They don't want to hand over all the keys to the kingdom. Today they just want to outsource their pain points," he explains.

9. Non-traditional suppliers win big deals.

The biggie is the US Army's training deal with Raytheon. Cook says Raytheon, a non-traditional outsourcing supplier, captured a $11.2 billion deal by leveraging its market domain expertise. (That, he says, is how traditional suppliers can compete with their Indian counterparts.) Telecommunications services providers also won many large deals this year. Cook asks, "Are they morphing into broader-based competitors in both ITO and BPO?"

10. Supplier switching is happening at a record rate.

Way says experienced buyers today are disgruntled and want to go in a different direction with a new supplier. "Buyers like the concept of outsourcing but haven't been pleased with their current suppliers," says the Siemens executive. "Even though they have a bad taste in their mouths, they don't want to take the function back in-house." He predicts the industry "will see more of that in 2008."

11. Suppliers will find innovative ways to get paid.

Poole predicts next year buyers and suppliers will increasingly align key interests to enable suppliers to share in the financial impact buyers realize from improved processes.

12. 2007 was the best year ever "for private equity firms to goggle up suppliers and release value," observes Cook.

He says outsourcing suppliers are a favorite of private equity firms because "they have significant revenue locked in over time."

The only failure this year was Atos and CSC. "But they got closer than ever before," he says. He thinks someone "will crack the code" by 2009.

The current credit crunch in the private equity market may hamstring outsourcing suppliers next year. Goepel says hard-to-find capital will slow down some of the merger talks "at a time when long-term investment is critical to outsourcing's success." Cook agrees, saying, "I think there will be a lull next year."

13. The subprime fallout will help outsourcing.

The credit crunch may benefit the industry next year because merger and acquisition activity will be lower. "We will see a positive blip in the outsourcing marketplace because outsourcing is a positive alternative to mergers and acquisitions. We'll enjoy growth," says Cook.

14. The US election will bring healthcare into greater focus for HR suppliers.

Goepel says the election and the recent GM/UAW contract negotiations made everyone more aware of the costs of healthcare. That will drive more companies to outsource their benefits and change the way HR companies handle healthcare. He predicts buyers, "who are no longer paternalistic," will turn to their suppliers to help employees figure out their healthcare options. "HR suppliers are on the front lines and have expertise in providing the support that employees need to make important decisions around their healthcare and benefits."

15. On another healthcare front, Way says healthcare outsourcing used to be a strategic decision.

This year healthcare providers were more focused on cost. "They want us to provide better service at half the cost," he says with a laugh. Siemens tries to provide better service that's budget neutral, he adds.

16. Consolidation occurred in the outsourcing advisory industry.

Information Services Group purchased TPI in October. EquaTerra purchased Morgan Chambers. "These changes will affect how deals get done," says Adamiak.

17. Offshoring is still an emotional issue for the C-suite.

Way says some of his prospective buyers are "torn between trying to make a good business decision and protecting their image." Siemens has some customers that have a clause in their contracts that allow them to pull out if they Siemens offshores any services. He expresses surprise, considering the cost and quality the supplier can provide from India.

18. The United States remains the largest outsourcing marketplace.

The Dutch market is "hot," according to Cook. But the big surprise is France is becoming an outsourcing powerhouse. "French multinationals are realizing they can't do business without outsourcing," says Cook. He predicts some big deals will come out of France next year.

Labor will be the driving factor that changes outsourcing in 2008. How companies determine who to hire and where they will work will affect the indust

Labor will be the driving factor that changes outsourcing in 2008. How companies determine who to hire and where they will work will affect the industry in two ways.

First, labor arbitrage is undergoing a metamorphosis. In the past, the megatrend was to use labor arbitrage wherever possible. Buyers found they could enjoy cost really significant savings with no impact on quality if their suppliers used labor in low-cost areas. The equation was simple: tasks that could be done remotely moved offshore.

Today, that equation is changing. Today buyers want to alter how they use employees. But now it's not just sending them offshore. Now buyers want to change other services in which labor is a component. This is changing the fundamental way suppliers provide services.

For example, how the industry thinks about providing IT infrastructure is changing dramatically. First, a component of IT infrastructure labor is moving offshore. But more importantly, other components of the labor equation are transforming because of the advantages provided by the offshore model. This is enabling a completely different kind of IT infrastructure outsourcing. 2008 will be the year remote infrastructure management outsourcing (RIMO) takes deep root.

Offshoring Leads to the Rise of RIMO

The RIMO model facilitates an asset-light outsourcing deal. Now the necessity of transferring assets has vanished. In fact, transferring assets can be a detriment in this kind of outsourcing. RIMO is moving the industry away from a one-size-fits-all model that's all inclusive to an offering comprised of a series of components suppliers can use in a plug-and-play world to optimize their infrastructure environment.

Buyers of traditional IT infrastructure deals had to buy into a trade-off of loss of control and up-front investment while hoping for a long-term cost reduction. In the RIMO world, buyers still retain control of their IT assets. For some buyers, retaining control gives them more corporate flexibility. However, now there is more management responsibility.

In most cases the cost savings are the same or greater when comparing the RIMO model versus the traditional one. So the decision is: how do you want to manage IT assets?

The Offshore Equilibrium

Trend two: outsourcing is starting to see the limits of labor arbitrage. Until now, the industry experienced an unconstrained movement of work offshore. If the supplier could document the process so someone else could perform it, off it went.

Ever since offshoring began in 1991, we have wondered just how far businesses can extend the offshore model. How many applications and what business processes can cost less through labor arbitrage? Where is the boundary between what companies can and can't offshore?

Until now there were no boundaries in sight. The stellar performance of the Indian offshore sector seemed limitless.

Now, however, we are beginning to see restrictions. We see early signs that large, experienced corporations with mature relationships are discovering limits to what they can offshore. These companies have tried to push work into remote management either by fiat or by contract. But the work somehow repurposes itself. No amount of contractual guarantees or organizational determination seems to solve the problem. That's because they've butted up against offshore equilibrium, which determines the percentage of work that outsourcing buyers can offshore, either to a third party or their own captive.

In 2008 buyers will begin to seriously bump up against those limits.

What are these limits? We have found two things always affect the offshore equilibrium:

  • Buyers only face the equilibrium's challenge in mature relationships
  • Each buyer has different, idiosyncratic factors that change the equilibrium percentages

Three things constrain the amount of work buyers can send offshore. They are:

  • The buyer's corporate culture
  • The buyer's industry or vertical
  • The buyer's internal organization. For example, is its IT centralized or federated?

Historically, pundits posited that the equilibrium would follow Pareto's Principle or the 80/20 rule: buyers could send 80 percent of their work offshore and retain just 20 percent. We have found that equation is too aggressive for offshore equilibrium.

Industry Implications

This equilibrium has an important implication for the future of the outsourcing industry. It suggests that offshoring will hit a wall. We predict its growth will start to slow in the next 12-18 months.

Once again, offshoring will have to look for transformational opportunities, just like it did in the IT infrastructure management space. The nature of work will focus more around transformational opportunities rather than just lift and shift.

Labor used to be the transformation. Now it is becoming the transformer.

Outsourcing in China, Only for the Strong!

Implications: Now that “everyone” is outsourcing to India, the next big thing is outsourcing to China. The first rule is China is not the same as India. Chinese outsourcing can be necessary for survival, or it can be a money-pit for the unwary.

Analysis: Many companies have already successfully outsourced to India. Virtually every large company, and many that are not so large, have now figured out how to make Indian outsourcing work. True, wage inflation and employee turnover are an ongoing problem, but overall it is working for most companies. With that behind them, the next frontier is China. Many see China as the solution to the turnover and wage issues in India. Ironically, even many of the large Indian firms (Wipro, Infosys, Tata) already have a presence in China. Many large US technology firms, such as Cisco and Oracle, have large installations in China.

China is most definitely not the same as India. The most obvious issue is the language barrier. It is relatively easy to find skilled Indian personnel who speak English. Because India has so many dialects, many Indians use English as a common language even among themselves. This is not true in China, which has far fewer English speakers. Finding skilled technical personnel who speak English is not easy in China.

The culture and history of China are more alien to Europeans and Americans. India was a part of the British Empire for a long time, and during that time many elements of the two cultures commingled. India is a democracy, which is a familiar model to Westerners. China is not a democracy and does not have the close relationship with the West that India has experienced. Consequently, cultural issues are much greater than in India.

Economic issues abound in China for prospective outsourcers. The Chinese economy is growing rapidly and enjoys a huge trade surplus with the US. The local companies, such as Huawei, are becoming multi-nationals competitive with US or European companies. Jobs are plentiful for Chinese technical workers, both with foreign and local firms. Many large US companies have had a major presence in China for many years. Such large companies are ideally positioned to hire the best and brightest.

Costs are escalating. While it is true that salaries are much lower in China than in the US, salaries are only one piece (admittedly usually the biggest piece) of the cost pie. Real estate costs in the more desirable areas are more than in many locations in the US. For example, desirable tech park locations near Beijing command lease rates significantly higher than in the best areas of Silicon Valley. Communications costs to anywhere in China are quite high. It is common to pay 2-3x as much as for data lines in China than for comparable lines in the US.

Overall, outsourcing to China is something that everyone should probably consider, but the decision is not a simple one based solely on lower salaries. Overall costs must be taken into account, along with whether or not the amount of money to be committed to China is enough to gain critical mass. China is not a virgin territory waiting to be plundered! On the contrary, it is more like the Wild West, where entrenched powers are already in place and the unwary get fleeced.