Business Accent

Is the domestic Indian outsourcing market poised for rapid growth?

Vipul Taneja analyses the prospects of the domestic outsourcing market

Vipul Taneja

Indian client organizations are increasingly looking at comprehensive outsourcing to meet the needs of a fast-growing economy and a shifting business environment. So is the market finally ready to embrace outsourcing in a big way?

Notably, Indian organizations are behind the curve on sourcing maturity. At just $8.2 billion (FY 2007, NASSCOM estimate), the domestic Indian sourcing market is less than 2% of the global market. Most outsourcing contracts have been for project-based work, such as Enterprise Resource Planning (ERP) implementation, rather than comprehensive outsourcing initiatives. In addition, while some Indian providers have become leading global suppliers of outsourcing services, they have looked only opportunistically at the local market.

This landscape is changing, however, and fast. In 2007, the average annual contract value of new deals in India was almost double that of new deals in 2004-2006. In fact, deals increasingly are exceeding $50 million in contract value, and the majority of these large deals in 2007-2008 had IT infrastructure components and business-critical applications in scope.

The key question is whether this trend is sustainable. EquaTerra believes the answer is yes, due to four major developments which reflect a fundamental, irreversible shift in the Indian outsourcing market.

Adopting global best practices

Indian companies are going global in a big way. The Tata Group, for example, has transformed into a major global brand, with about 38% of its revenue in 2006-2007 coming from outside of India. Just as local companies are becoming more global, established global players are entering the market. In the automotive industry, global leaders like Ford, General Motors, Honda and Toyota have an established presence in India, and BMW, Audi and Porsche are among the newer entrants. In addition, all major global insurance companies have operations in India, and retail giants such as Wal-Mart are on the way. This frenzy to enter the buoyant Indian economy will only increase in the next few years.

Amid this activity, the market is increasingly exposed to global best practices, and domestic organizations must adopt them to stay in the game. Outsourcing is a key strategic investment. It enables Indian organizations to leverage operational efficiencies while accessing providers’ industry experience and exposure to global best practices.

Outsourcing can lead to strategic benefits beyond cost savings:

• Increased focus on core business: Best-in-class organizations worldwide have outsourced transactional work so their retained organizations can focus on the core business. For example, an IT organization that outsources technical work such as application coding and maintenance can instead focus on supporting the evolving business needs.
• Driving standardization: As Indian organizations increase their global footprint through acquisitions, outsourcing can help standardize processes and systems across the business entities.
• Access to expertise: Outsourcing can provide access to process and technology expertise that is unavailable in-house. As providers gain global experience across many sectors, they can share relevant expertise with Indian client organizations.
• Access to new software tools and IT capability: Accessing the latest tools and technologies through an outsourcing provider can be more economical than regularly upgrading in-house platforms. Human Resources (HR), for example, is often last in the queue for capital investments in technology, so organizations may have multiple standalone HR applications that make simple processes very inefficient. That’s why access to new technology is one of the most important drivers of HR outsourcing.
• Ability to scale: Finally, service providers can provide scalability that is difficult to achieve in-house, especially in sectors with exponential growth rates.

Increasingly, global organizations are entering the Indian market with a lean and mean setup that’s focused on the core business, thanks to the outsourcing of back-office operations. To remain competitive, the Indian incumbents will also have to evaluate outsourcing.

Early adopters have proven the model

A few large, comprehensive outsourcing deals in the Indian market have already passed the test of time. In 2004, for example, Bharti took the lead in the telecommunications sector by signing a multi-process deal with IBM covering data centers, IT help desks and a number of IT applications. Following another deal with IBM for developing a single customer services platform, Bharti outsourced all its customer service operations to a consortium of four business process outsourcing (BPO) providers.

Bharti’s activity sparked outsourcing throughout the industry. Tata Teleservices outsourced its IT infrastructure to TCS in 2005. Idea outsourced infrastructure services and applications to IBM in 2007. BSNL signed a call center deal with Spanco in 2005 and an IT deal with TCS in 2007. Vodafone Essar outsourced its IT operations to IBM in December 2007.

Organizations in mega-growth sectors like telecommunications are finding it increasingly difficult to scale up their back-office operations, which is prompting them to consider outsourcing. Meanwhile, other sectors such as insurance and retail will continue to grow despite the recent global slowdown. In this rapid-growth environment, incumbents and new entrants that do not actively consider outsourcing for back-office operations may compromise the growth of their core business.

The value of outsourcing depends largely on the structure of the relationship, and Indian transactions are undergoing a major shift. They are evolving from short-term, project-driven engagements to longer-term, comprehensive outsourcing initiatives.

Following are the different models for outsourcing engagements:

• Staff augmentation: In this setup, the least evolved model, the supplier provides resources that can temporarily satisfy the requirements of the buyer organization. The engagement is mostly priced at time and materials, and its limited scope allows for little leverage.
• Project-based: In this model, the provider’s role is limited to one or more specific projects, such as an ERP implementation.
• Comprehensive outsourcing: These are multi-year deals with a clearly defined scope driven by Service Level Agreements (SLAs). If structured well, these deals enable providers to create operational leverage and pass efficiency gains to the client. The buyer organization, accordingly, can rid itself of transactional work and focus on higher-value goals like supporting the business and driving customer satisfaction.
• Transformational relationship: Here, the buyer and provider work as partners to transform the client organization. Such deals are “consulting-led” and rely largely on shared goals. Payback can be significant in terms of transformational results, but complexity and risks are also much greater.

Over the next few years, comprehensive outsourcing engagements will increase as the Indian market matures and as buyers become more sophisticated and demanding, deals will become more transformational. Amid this evolution, it’s important for buyer organizations to ensure well-structured deals. Critical factors include clear definition of scope, roles and responsibilities; structure and processes for the governance organization; structure and roles for the retained organization; and SLAs and pricing models.

Service providers’ domestic focus

Until recently, Indian providers focused primarily upon the North American market. Even within Western Europe, the majority of clients were UK-based, with limited revenue from continental Europe. Asia-Pacific, likewise, was only a minor contributor for most major suppliers, and the local domestic Indian market has been largely insignificant. After all, due to lack of an “on-site” component (that has higher revenue contribution) and pressure on billing rates, any Indian deals were viewed as mere training grounds rather than strategic relationships.

Now, however, with the ongoing dollar depreciation and a looming economic crisis, Indian suppliers are working hard to minimize dependency on the US market. In addition to focusing on less-penetrated markets like continental Europe and Asia-Pacific, suppliers are looking strategically at the rapidly expanding Indian market. Indeed, all Tier 1 and Tier 2 Indian suppliers now have business units targeting the domestic sector. This increased supplier focus will have a positive influence on the client side.

Billing rates and outsourcing inertia

As Indian buyers and suppliers evaluate outsourcing, they still face challenges. One is billing rates, as Indian buyers seek prices that are significantly lower than those for exported services. In addition, solely cost-driven deals may not be as successful in India as in other markets (as there is no labor arbitrage) and non-financial benefits will require higher executive support within a buyer organization (both for concept selling and execution). Finally, there remains some outsourcing inertia, especially in sectors that are not yet facing an onslaught of foreign players. As a result, buyers’ long decision cycles may increase costs for suppliers’ deal pursuit teams.

Nevertheless, India is set to become a large buyer’s market for outsourcing services and we can expect to see significantly more deals in the next few years.

EquaTerra, a world leader in sourcing advisory services, helps clients achieve significant cost savings and process improvement with internal transformation, shared services and outsourcing solutions. At Equaterra, Vipul Taneja is responsible for managing client relations in India. He has advised a number of Fortune 500 clients on sourcing constructs and has worked extensively across Asia, North America and Europe. He can be reached at Vipul.Taneja@EquaTerra.com