Disruptive technology jolts Indian IT outsourcing
May 01, 2012 (Menafn - Mint - McClatchy-Tribune Information Services via COMTEX) --A decade ago, who could have imagined that Google Inc. or Amazon.com Inc. would compete with Indian and multinational information technology (IT) service providers in the outsourcing space?
After all, Google is the world's biggest online search engine that derives most of its revenue from online advertising, while Amazon is the world's largest online retailer.
But with the help of cloud computing--also known as a non-linear or non-headcount-related technology--companies such as Google, Amazon Web Services, Hewlett-Packard Development Co. LP, Microsoft Corp. and Salesforce.com Inc. are threatening traditional IT outsourcing (ITO) models by increasingly hosting the IT infrastructure of large enterprises and especially small- and medium-size businesses in their own data centres, and reducing the IT costs of their clients by at least 40%.
A survey released by PricewaterhouseCoopers last October stated, "They (ITO service providers) have, after all, profited handsomely by taking on their customers' highly complex, one-off collections of IT assets and finding ways to manage them more efficiently than their customers are able to. But the essence of cloud computing is a move towards highly standardized racks of commodity servers and a software environment that together make for a highly efficient use of resources. Where's the ITO opportunity in that?"
Cloud computing, which comprises three broad service delivery models, is just one non-linear technology that is disrupting traditional IT outsourcing with a pay-per-use or subscription model. The three delivery models are infrastructure-as-a-service, software-as-a-service (SaaS) and platform-as-a-service.
Other non-headcount related initiatives include automation, offering templates to industry verticals that can be reused with minimal customization, reusing assets and codes, offering platform solutions and tools, besides value-added services such as analytics and intellectual property.
These new technologies, coupled with the popularity of social media tools and the use of personal mobile devices in enterprises (the bring your own device trend), are giving rise to new models.
The NasscomStrategic Review 2012 report released in February acknowledged that changing technology--such as automation and cannibalization of existing services due to new technologies (such as SaaS replacing production support)--presents a potent risk.
It predicts that the future of the technology services industry will lie in a combination of services, solutions and platforms. For instance, it forecasts public cloud services spending to outpace growth of overall IT spending by about four times between 2012 and 2015.
With the core US and UK markets for IT service providers continuing to remain weak and the duration of IT contracts getting shorter, coupled with protectionism and regulatory hurdles in the core markets, linear growth--or growing by just adding employees--will pose formidable challenges to both Indian and multinational IT firms.
The tier-I Indian IT firms have close to 100,000 employees or more each. Wages in India are rising by 10-12% annually, which will make Indian IT firms less competitive in the next few years.
By 2015, the competition will only get tougher, according to analysts and industry experts.
"There will be a new set of platforms. Most of them will be largely mobile ones in enterprises," said Sid Pai, partner (global resourcing and India operations) at Information Services Group (ISG), a research and advisory services company.
"There will also be a set of new players who will pose a threat to traditional outsourcing models since there will be a change in the balance of delivery. A lot of delivery that was once enterprise and chief information officer (CIO)-oriented, will now become business-oriented. In other words, if employees bring their own mobile devices to office, one need not wait for a CIO to deliver services," he added.
Smaller and mid-size Indian IT firms may have to rely on headcount-related growth in the foreseeable future, according to Arup Roy, principal research analyst at Gartner.
But tier-I Indian IT companies will face many challenges with their increasing employee strength. "It may result in them being less agile, besides having operational and bottomline challenges, since wage costs of India-based employees are increasing 10-12% annually, while companies are unable to increase pricing significantly because of increased competition in a slowing economy," said Roy.
According to the Nasscom report, the Indian IT-BPO (business process outsourcing) sector crossed aggregate revenue of 100 billion (around '5.3 trillion today) in fiscal 2012, generating direct employment for more than 2.8 million people.
Further, the industry's growing capabilities around transformative services, new business models and services around disruptive technologies such as cloud, analytics, social media and enterprise mobility, along with the focus on operational efficiencies and non-linearity, have resulted in the growth of India's market share in the global sourcing arena to 58% in 2011 (51% in 2009, and 55% in 2010).
Non-linear technologies are forcing Indian IT companies to rethink their strategies and move up the value chain by also sharing financial and business risks with clients with more outcome-based and output-based pricing, and adding consultancy services to their portfolio--thus becoming partners in business.
For instance, many tier-I indian IT firms such as Tata Consultancy Services Ltd (TCS), Infosys Ltd, Wipro Ltd, HCL Technologies Ltd and NIIT Technologies Ltd, are leveraging their own capabilities in light of these new changes and are planning a host of non-linear initiatives, which, in turn, are expected to increase their operating margins per employee, while simultaneously reducing capital expenditure for their clients.
"Going forward, IT services will be delivered in different business models. While the core standard model will remain, cloud technologies will become common as a delivery mode. It is but natural, then, that a new set of companies will emerge as competitors," admitted N. Chandrasekaran, chief executive officer and managing director of TCS, India's largest IT services provider, in an interview to Mint after the March quarter results.
TCS, with 238,000 employees as of 31 March, was the first to identify and invest in various non-linear opportunities, namely software products, platform BPO and SaaS, as well as a focus on unit-priced contracts, according to Macquarie Research Equities analysts.
A case in point is its deal with the UK's Pearl Group, for which it developed a life and pensions platform that it re-engineered for the UK market. The company has also sharpened its focus on non-linear revenue measures with a cloud-based initiative for small and medium enterprises called iON, and a platform-based BPO.
Infosys's product efforts, for instance, are centred on Finacle--its core banking solution.
Similarly in the BPO space, Wipro offers transaction-based pricing (for processing, payment per invoice, claims, etc.). NIIT is also adding to its non-linear business by making acquisitions to secure platforms, offering platform-based services and planning to offer all this in SaaS package.
HCL BPO, too, has moved to an outcome-based pricing model from its current input-based model.
Multinational IT companies are no exception.
"Non-linear business is the holy grail of IT services because it's very difficult to scale up a business that is just based on bodies," Erich Clementi, who heads global technology services as a senior vice-president at International Business Machines Corp. (IBM), said in an interview in March. "Intellectual property, whether software, applications, tools or extreme automation like on the cloud, is clearly very beneficial to the economy and delivery. Cloud computing does to IT what Toyota did to the car-manufacturing process--a disciplined application of engineering to the supply chain of IT."
IBM is the world's largest IT services business by revenue.
To stay competitive, IT service providers will, however, have to increase non-linear revenue to around 35-40%, from less than 10% now, said Roy of Gartner.
Non-linear initiatives, according to Nasscom, pay dividends. The software testing services market, for instance, is expected to generate revenue of 2.7 billion in fiscal 2012, growing at 19% over fiscal 2011.
Non-linear strategies of Indian companies will also address domestic requirements with IT adoption in the small and medium business sector, accounting for nearly 25% of the total IT spending in India.
"These mega trends will present a new set of opportunities in the form of largely untapped markets and customer segments, which can propel industry revenues to 225 billion by 2020. However, these opportunities will also bring along with it added set of risks in terms of increased protectionism and regulatory control from sourcing markets, and increased competition from new and emerging countries," according to the February Nasscom report.
On the compliance front, the Statement on Auditing Standards 70 audit reports were not designed to be used by service organizations that offer co-location, managed servers or cloud hosting services.
They were focused on internal controls used for financial reporting. Data centre operators will now have to factor in more stringent compliance standards such as Service Organization Control (SOC) 2 and SOC 3 audit reports, according to Rick Borelli, principal (audit and enterprise risk services) at Deloitte and Touche LLP.
"The offshoring (outsourced work done in India, for instance) business adds additional risk. Hence, we recommend an integrated compliance model," said Borelli, who pointed out that the trend has become more important since IT contracts that typically used to be for 10-15 years are now for three-five years and are "being continually renegotiated".
"This entails higher regulatory compliance," he added.
An analysis of historic market data by ISG also indicated that the number of outsourcing transactions has increased dramatically over time even as the average duration of contracts has declined.
ISG's TPI Index data shows a record 570 outsourcing contracts worth at least 25 million were scheduled to expire in 2011, and record contract expirations are expected again this year. ISG anticipates the number of contracts restructured will rise 20% in 2012.
"IT service companies need a global sourcing model. Indian IT service providers need to open more centres in more geographies to become global companies. If they do so, it will also address the allegations of immigration and visa misuse that they typically face. They also need to make strategic acquisitions to achieve scale, besides opening up more near-shore centres (in countries closer to clients)," said Sanjoy Sen, senior director at Deloitte.
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