The NY Times did a story today on EDS’ earnings announcement. While earnings are down from the same quarter last year, new contract signings are up strongly, reflecting EDS’ best quarter since 2002 as far as new contracts go. The company signed $5.6 billion in contracts in the first quarter, including 12 that were worth $100 million or more, and a new $1 billion deal with Royal Dutch Shell. In uncertain economic times, contract signings tend to slow since it is more difficult to craft long-term contracts in the face of significant business volatility. This announcement validates the view that IT outsourcing is a mature and desirable sourcing strategy for many companies. In my view, the economics of outsourcing are getting ever more compelling as vendors build out their global delivery platforms.

Amit K Singh

Partner, Stradling Global Sourcing 

In many meetings with service providers and analysts, I have often been asked to predict how will things shape up for them in 2008 and beyond. It is a tough call, but here are some thoughts.

The time of labor arbitrage, some have suggested, is over. I disagree with that. In a recent conversation with the CEO of a Tier I offshore service provider, we looked at some recent price rate card data of their hires in India, a couple of other offshore destinations and locally in US. The difference at entry level costs is still startling, primarily due to the differences in costs of living in the two countries. This difference might narrow down as one moves up the organizational ladder, but it persists.

However, the days of labor arbitrage as a competitive differentiator between what were erstwhile “pure play” offshore service providers and “mainstream” service providers based in the US are numbered, if not already at an end. In the last few years, the US based Tier 1 and many Tier 2 service providers have made rapid, significant investments offshore to catch up and indeed, effectively compete on the labor arbitrage play. One point that comes across in my discussions with clients and service providers alike is that the competitive differentiators are now more traditional than ever - quality of personnel, fit of the solution, executive commitment etc.., much more than a pure cost differential, since most of the service providers are building in comparable offshore components to their solutions and prices.

And that brings me to a question I have been thinking about…given that the offshoring industry, both in ITO and BPO spaces is fast maturing and the competitive differentiators are getting fewer, is it time for providers to look at strategic acquisitions or mergers to create more value for their shareholders?

It certainly seems plausible. 2008 is shaping up to be an interesting year. I wrote about the subprime meltdown and its impact on ITeS providers sometime back. With the US economy in recession and the US Dollar depreciating, the coffers of service providers will be impacted and that may impact capacity expansion plans negatively. I do not see this to be a consideration for large Tier I players at this time but some of the Tier 2 and Tier 3 firms may look at this trend and explore the potential of an M&A possibility. Also, this may also open up the opportunities for acquisition that the large service providers, with strong balance sheets and cash have been looking for.

 Let me know your thoughts.

BusinessWeek, in its April 9th issue, has an article titled, “Amazon Takes on IBM, Oracle and HP.” The focii of Amazon’s efforts are:

“The company won’t be making computers or selling software to corporations. Instead it’s offering companies the ability to tap into the vast computing capabilities of Amazon’s own data centers, in a manner almost as easy as buying the latest best-seller. Companies pay only for the computing they need, avoiding the cost of buying and operating their own gear.”

This is yet another instance of “on-demand” computing, popularized by IBM and others, and now offered in a new incarnation as cloud computing. The idea is that companies can buy computing resources on an as-needed basis, paying for what they use. Amazon and others have huge economies of scale, and selling capacity at low marginal cost is an economically attractive model. The question is whether this approach will be successful in terms of making a meaningful dent into IT services outsourcing as currently offered by IBM, CSC, EDS, ACS, HP etc.

My initial reaction was that this is a low end service meaningful to small business, and to groups within larger corporations who are building specific service offerings and want to launch quickly and don’t want to wait for IT to get them the capacity they need. But then I got to thinking. This is exactly how disruptive technologies launch. They start small, appeal to a different set of users from the mainstream with different performance criteria. But then, they get better and better, and move into the more sophisticated markets. This raises several questions in my mind.

First, if you are a CIO, do you use “cloud computing” as a resource for infrastructure? What are the opportunities and concerns?

Second, if you are a services provider, should you be offering “cloud computing” services? For the most part, even when co-located, due to client concerns, the large IT services vendors isolate one client’s infrastructure from another’s. This allows for some economies of scale, but not at the same level as would be available if they could integrate infrastructure. BPO service providers and ASPs on the other hand, particularly those that offer services from a single platform, are attempting to exploit cloud-like economies of scale.

Finally, what will the IT architecture of the future look like? A typical company will have some internal IT infrastructure and applications, externally sourced IT services, BPO services, and some use of the cloud. How will all of this be integrated and yet provide a company with the flexibility and agility that it needs at a reasonable cost?

Let us know how you are addressing “cloud computing” in your sourcing and delivery strategy.

Racheal King has an interesting article on BusinessWeek.com on the new economics of outsourcing. She focuses on offshore outsourcing, rather than outsourcing generally. Her main point is that with the plummeting dollar, wage inflation in India, higher costs of doing business in India, time zone challenges, and changes to the tax code, India is becoming a much less attractive destination than before. One important dimension of her findings is that providers are increasingly developing a global footprint to be able to deliver services from multiple delivery centers moving work around based on the economics at the time.

This is much the same argument that I made in September 2007 on this blog and so of course, I agree fully. Moreover, her examples are very instructive. The major vendors are working hard to build these global delivery platforms.

I would however add that there is still considerable time before the Indian cost advantage ends (if it does end). A common mistake that forecasters make is they assume that trends will continue indefinitely and do not reflect dynamic adjustments by outsourcing firms. So just as wages rose faster than many anticipated, now I believe that wages will rise more slowly than anticipated since outsourcers are acutely aware of the bind that they are in and will be increasingly reluctant to offer salary increases. Even within India, second and third tier cities are becoming hubs for outsourcers as a means to manage salary pressures. Also, it is by no means certain that the exchange rate will stay at its current level. Once the credit crisis passes, we may see a shift in favor of the dollar.

If you are currently outsourcing IT services, we’d be very interested in hearing how you think about your strategy for outsourcing, and specifically, on your country strategy for where you want to locate the work.