PwC and Duke surveyed 620 service providers at 1,850 companies from over 50 countries and found that the shift in the outsourcing industry is having an impact on incumbent India-based and U.S. firms that are caught in the “perfect storm.” Today’s competitors are entering new markets with both low-end, commoditized services with few market-entry barriers, and also with high-end, value-added services that drive higher margins but where market entry is more challenging.
Meanwhile, Indian and American IT outsourcing providers are entering new markets with both low-end, commoditized services—a highly competitive field with few barriers to entry—and higher-end services where market entry is more challenging, say the researchers. It all adds up to a perfect storm for many large IT outsourcers, says Arie Lewin, director of CIBER and professor of strategy and international business.
The survey of 620 service providers from 50 countries revealed that all providers, regardless of size, reported a decline in profit margins between 2009 and 2010. Large providers experienced the biggest decrease, from an average 23 percent profit in 2009 to 18 percent in 2010.
Indian providers in particular have been struggling with profit erosion for a longer period of time, according to the research. Their profit margins dropped from 25 percent in 2007 to 20 percent in 2009 to 17 percent in 2010.
The study also revealed an uptick in "nearshoring," with service providers expanding operations to move closer to their clients.
“Given the current market condition, the days of relying only on low cost and labor arbitrage is no longer a successful strategy,” said Dr. Charles Aird, U.S. and Global Leader of PwC’s Shared Services and Outsourcing Advisory Practice. “To gain a competitive edge in today’s dynamic and increasingly global marketplace, it is critical that providers go beyond the third-party service-delivery relationships of the past and find ways to become valued business partners.”
According to the report, there is a driving trend toward nearshoring, with service providers expanding their global footprint to move closer to their clients. The areas where most large buyers are located – the U.S., Western Europe and Japan – are especially attractive nearshoring target locations. Thirty-six percent of respondents say they have headquarters located in North America, while 26 percent report headquarters in Western and Eastern Europe. The survey also found that China, Latin America and Eastern Europe are quickly emerging as new magnets for outsourcing firms looking to expand.
To address the need for frequent interaction with clients and extensive use of collaborative technologies in fields such as innovation services, firms are seeking offshore locations closer to their clients’ headquarters. “U.S. firms may be saddled with the legacy effect of early offshore locations in India, before closer Latin American locations were established,” said Arie Lewin, professor of strategy and international business at Fuqua and director of CIBER.
As noted in the survey, the importance of workforce skills and training has increased since 2009, becoming the most vital criteria in the client’s decision making around the selection of service providers. Companies are planning to make aggressive investments in training centers for internal staff – especially in functions involving a high level of client-specific knowledge and frequent interaction with clients, such as R&D and design services – enabling them to get closer to the client’s core competencies.
“The global sourcing industry is undergoing significant changes,” said Lewin. “Clients expect providers to contribute value beyond just cost savings. Global sourcing is becoming a more competitive environment all the time. Service providers now must offer more than just cost savings; they must add value to their client’s business processes.”
Further notable findings in the report include:
Internal training and development of staff for client-specific capabilities - More than 56 percent of providers plan to invest in new areas of expertise with Cloud or Service Oriented Architecture (SOA) and Centers of Excellence (COEs) as their main focus.
Seventy-seven percent of service providers rated innovation services as being highly sensitive to specialized knowledge and skills, while only 57 percent cited time-zone dependency.
Growing organically and/or by M&A - Seventy- four percent of service providers indicate plans to continue growing organically, primarily through increasing the scale and scope of their services. Mergers and acquisitions account for 13 percent of service providers’ plans over the next three years. Further, seven percent of service providers indicate a desire to become an acquisition target.
“Going forward, providers need to make a conscious decision about which markets they want to enter,” continued Lewin. “To that end, they should focus on growing markets where demand for a given service is strong, and where they have superior capability and a competitive advantage over their rivals.”
“As providers seek new ways to increase the scope and scale of their service offerings and expand their global footprint, we are seeing both organic growth and growth by acquisition,” added Dr. Aird. “We expect the M&A trend to continue over the next few years. Leading providers are preparing today to win in the marketplace of tomorrow.”