FSN: Global outsourcing market falls back, but BPO on the rise

Global outsourcing market falls back, but BPO on the rise

30th October 2006
The size of the global outsourcing market has shrunk for the first time ever according to the TPI index, The quarter ended in September was the worst quarter for outsourcing deals since 2002, yet the BPO market has grown by further 10% and India-based providers have increased their market share. Gary Simon, FSN's managing editor reports talks to industry watchers who confirm that outsourcing is going through structural change.

2006 has seen a decline in outsourcing across the globe, according to the latest quarterly index from TPI. The last quarter has been the worst in four years for the total value of major contracts (those greater than $50 million) awarded. The value of contracts let in the first three quarters of the year is down 2% on the same period of 2005, and some 11% down on 2004.

The fall in contract values is partially due to an ongoing trend towards shorter contract terms and does not in itself necessarily indicate market decline, says TPI. However, TPI's data also points to an actual reduction in expenditure on outsourcing, with the firm predicting a 1 per cent fall in outsourcing providers' annual revenues in 2006.

Not all market participants are calling a decline as much as a change in market conditions. Peter Moller, partner in charge of UK outsourcing advisory services, at Deloitte, the accounting and consulting firm, told FSN, “ I do not see this by my view of the market is not comprehensive and so it may be true. If it is true one reason could be that in certain areas, for example Business Process Outsourcing (BPO) in the finance function the top providers have won so many deals in the last 18 months that they are becoming resource constrained to successfully migrate any new business into their delivery centres. They can hire new graduates but are starting to lack the more experienced managers to manage their processing teams and manage new migrations. As a result they are carefully screening any new work to ensure they can deliver it. This could be contributing to any market slowdown.”

Michael Arben, Business Development Director within financial services at LogicaCMG was also not totally convinced that the market is shrinking. He told FSN, “Rather than an overall slowdown in activity it can be seen more as a change in focus on where spending is made.”

One feature of the market that most observers agree on is the shift from traditional IT Outsourcing to BPO (Business Process Outsourcing). TPI expects a 3.6 per cent reduction in IT outsourcing (ITO) across the year but the BPO segment to have grown by almost 10 per cent. July to September has seen more BPO contracts awarded than in any previous quarter, totalling some $4.5 billion (€3.5 billion).

LogicaCMG's, Arben was not surprised. He told FSN, “IT outsourcing doesn't appear to be bringing all the expected benefits, yields on these deals for the supplier can be small and in financial services particularly the issue of VAT only serves to exacerbate this problem. With regards to BPO, organisations are looking to reduce costs and increase efficiency and suppliers are looking for new outsourcing opportunities to supplement IT outsourcing. Involvement on BPO can be seen as closer to the business than IT and therefore is a greater "value add".

Duncan Aitchison, Managing Director of TPI, said, “The growth in BPO market and decline in ITO are not unrelated. As organisations place more and more processes in the hands of third parties they no longer require the associated infrastructure and hence have less IT to outsource.”

But Deloitte's Moller believes that the BPO and IT Outsourcing markets are simply at different stages of maturity. Commenting to FSN he said, “ITO is a relatively mature market whereas the BPO market is still relatively new and hence growing at a higher rate.”

Interestingly, despite the overall shrinkage of the outsourcing market, deal activity remains buoyant. The number of major outsourcing contracts let in this year to date is more than ever before but they are generally smaller and of shorter duration.

TPI says this apparent dichotomy between a shrinking market and the best ever year for new contracts lies in part in existing deals being terminated and in part in a growing prevalence of second-generation contracts, which tend to be of lower annual value.

Deloitte's Moller believes the market is moving to shorter less comprehensive contracts for several reasons. Remarking to FSN he said, “Buyers are becoming more sophisticated and are shopping around for best of breed solutions in different areas, for example, finance, HR, and IT rather than assuming one provider should do it all. There are more providers out there in each of the different functional areas and so the choice of provider is better, and customers therefore feel more confident they can split up their outsource contracts and award them to different functional providers. Furthermore, the outsource providers are now more experienced than they used to be and make far better use of labour arbitrage in their contracts. As a result they are able to make money on a five year or in some cases three year deal when previously a seven year deal or longer was required, to meet their profit objectives and yet provide an adequate payback to the customer as well,”

Michael Arben of LogicaCMG agrees. He told FSN, “There does appear to be a shift in the market away from the very large deals and I would identify several reasons for this. In the main experience and learning accounts for the change as these larger contracts have developed organisations have realised the importance of increased governance and less risk, both of which are easier to achieve on a smaller scale. The better information available to companies and individuals through experience has opened up a range of economic options and changed the shape of the deals now being made and it would seem that smaller means more manageable.”

As the market changes it appears to be the Indian service providers who are benefiting. As in other recent TPI Index reports, Indian service providers continue to increase their market share. This year they have secured 4.3 per cent of total headline contract value, up from little more than 1 per cent two years ago.

TPI's Duncan Aitchison says, “While the India-based providers' new contract wins are in themselves impressive, they do not show the full scope of their expansion. Many of these providers have adopted the strategy of “growing from within”, often signing small deals and then incrementally increasing their value as their capabilities grow. This approach lays the foundations for them then to compete for larger contracts and is often a very effective way of gaining muscle as they exploit the levers of familiarity with their clients' businesses and established relationships.”

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