A quarter of the biggest providers of business process outsourcing services will disappear during the next two years, according to Gartner, so it is important to assess and minimise the risks, as FSN contributing editor Lesley Meall discovers.
Change is inevitable in all areas of business and commerce, but it is an inherent part of the information technology industry, where no single company or technology can retain its dominance indefinitely – and the business processing outsourcing (BPO) industry is not immune. So although outsourcing in some shape or form is as old as business itself, the BPO industry as we now recognise it has expanded rapidly over the past 20 years, and is now teetering on the brink of a period of contraction.
“As providers are exposed to the economic crisis, loss-making contracts, and an inability to adapt to standardised delivery models, many will struggle to survive in their current form,” suggests Robert H. Brown, research vice president at Gartner, and he predicts that a quarter of today’s top BPO operatives will not exist as separate entities by 2012. “Some will be acquired and some will exit the market completely to be replaced by dynamic new players delivering BPO as automated, utility services,” he predicts, “and many BPO providers will struggle to adapt to market realities and changing delivery and business models.”
Even if Brown is only half right, the BPO provider landscape looks set to change significantly over the next few years, and Gartner is urging enterprises to prepare for this, by getting to know their BPO provider much better, watching out for key signposts that could herald the predicted market shakeout, and shaping their BPO strategy to mitigate against the associated risks.
In the Gartner report Business Process Outsourcing Vendor Consolidations: Is Your Contractor at Risk? (ID Number: G00170475) Brown suggests that buyers should beware of the “nuances” of the following factors on the stability of BPO providers: the economic crisis, unprofitable contracts, loss of “marquee” deals, overexposure to the banking sector, capitalisation for deal pursuit, and levels of BPO contract cancellation.
Chronically unprofitable?
Some BPO providers are carrying unprofitable contract portfolios, largely stemming from “too-much, too-soon” pursuit of deals, without much thought as to how to transition them to a standardised, rationalised, profitable state of ongoing operations.
“Vendor selection teams should gain insight into prospective providers’ deals to understand how profitable the vendor is,” suggests Brown, and although he acknowledges that most vendors will be reluctant to share this information, some will not, as there is a growing awareness of mutual dependency that characterises BPO.
“BPO is a partnership,” observes the Gartner analyst, and trust is the key to success. “Being open about the profitability of their BPO business with you, as a client, can engender a mutual understanding of what it will take to be successful in the deal,” says Brown, and in the longer term, this can limit the risk to both parties.
Too much or too little new business?
According to Gartner, it is important to gain insight into the service provider’s track record of winning new business, particularly over a sustained period of two to three years – paying particular attention to recent contract wins. “Handling multiple deals at once is a necessity in outsourcing, and buyers need to know that a vendor can successfully cater to their needs,” says Brown, rather than struggling to deal with a backlog of business.
Although market share in terms of revenue may look impressive, it can be misleading. “If they're essentially running a closed book of business, it is possible that revenue may be shopped around to be sold off to competitors, or new market entrants,” warns Brown.
Gartner also advocates making sure that the vendor is able to exploit new trends, and new ways of conceiving, delivering and managing BPO services, and Brown cites as an example, being able to “use alternative delivery models such as software as a service, platforms or business process utilities”.
Influenced by logo clients?
“We have observed over the years that many BPO vendors have made a "splash" as market entrants by signing a major deal with a major ‘logo client’,” says Brown, but where these deals involved the purchase of the buyers’ systems, platforms and assets (including employees) they can potentially create problems down the line.
“The anchor tenant is likely to receive platinum-level attention from the vendor due to the strategic ‘do-or-die’ value of the revenue they represent,” says Brown, “ so beware of being a small fish in a big pond.” The loss or prospective loss of a logo client is also an important indicator, so Gartner recommends “prudent due diligence”. Ask the logo client for a reference: find out about their experiences with the vendor and assess how committed they are to the vendor.
Capitalisation constraints?
“Understand the cash position that your BPO brings to the table,” urges Brown. Some vendors that are heavily leveraged or have become cash-conservative during the recession, may lack the funds to invest in significant front-end transition activities, or bid for the sort of business deals required to maintain the critical mass that is essential for the future success of the business.
Failure to win big deals can also be a bad sign. “A vendor’s bid and proposal costs often run in to millions of dollars before the deal is even won,” observes the analyst, and if a provider has spent “significant cash and months” in deal pursuit, the loss of a large deal to a competitor can be “devastating”.
So it is perhaps unsurprising that Gartner is seeing more providers make investments in platform-intensive approaches to BPO that require buyers to adopt their standard platform and service-level agreements, as opposed to the ‘lift-and-shift’ strategy. “Heavily leveraged vendors still invested in the lift-and-shift approach are the most likely to run into problems acquiring funding,” says Brown.
Dependence on financial sector?
BPO providers that are wedded to the banking and finance sector may face a particularly uncertain future. “Exposure to the banking sector is by no means an absolute harbinger of doom,” comments Brown, but as the financial services sector accounts for around one-third of the total BPO market globally, some sourcing executives will need to be wary.
Financial services pure-plays and BPOs that generate more than 85 per cent of their revenue via financial services will be most vulnerable, according to Gartner. “Providers with significant amounts of BPO revenue from the banking sector were the first exposed to the credit crunch, then the meltdown in the financial services sector, and wider global recession where they could be the most exposed,” observes Brown.
“It is possible that the merged banking entities’ processes are being absorbed by the internal shared-service centres of those global banks that are still left standing as the dust on the global recession settles,” he says, so increased vulnerability in the longer term remains a real possibility.
Contingencies for contract termination?
Over the past two years Gartner has seen the rates for contract cancellation and in-sourcing rise sharply, and there is no reason to suppose that this trend will be reversed. So it is increasingly important for BPO sourcing managers and their legal advisors to build exit strategies into contracts, and develop contingencies for contract termination, before signing any future deals.
Gartner recommends: including clauses in the contract covering change in ownership, and using language to the effect of “in the event of a change in ownership, we can terminate the contract if we so choose” (with proper consideration given to the acquiring vendor's “forward pathway”), and taking the management of the relationship with the BPO beyond tactical operational issues.
”Set aside time through a formal communications schedule for both parties to assess the strategic health of the relationship,’ says Brown, because relationship management can help to reduce the likelihood of contact cancellation. Gartner also advises careful consideration of contractual issue escalation procedures and the exploration of all rational options, before legal termination discussions are initiated, particularly if early termination penalties could come into play.
“The cost of changing suppliers can be steep,” he observes, and nobody wants to switch service providers unless it is absolutely unavoidable or significantly beneficial. But change is an inevitable part of the business cycle, the evolution of the BPO industry seems unavoidable, and some organisations will be unable to avoid switching providers or in-sourcing their business processes at some point over the next couple of years. So now might be a good time to take steps to minimise the pain.
