Offshore outsourcing: What role will recession play?

Industry experts reverse their predictions and now warn that Indian IT providers should prepare for slower growth and lower profits

The ongoing credit crisis is a concern for everyone in nearly every industry -- fear of lost jobs, foreclosed homes, and bankrupt businesses. But those lost jobs are likely to further bolster the booming offshore outsourcing market -- so the experts predicted.

Fast-forward two months: It's time for them to eat their words. Neither are customers outsourcing more nor is the industry growing any faster. In fact, each day service providers only revise their growth estimates in the downward direction.

[ Learn more about how the financial crisis is affecting IT and the high-tech industry, plus what IT can do to help, in InfoWorld's special report. ]

Some brave analysts are finally coming out with the truth. Days after Wall Street's collapse, vice president and principal analyst with U.S. research firm Forrester, John McCarthy, said the scale of the crisis had rendered all previous studies, including Forrester's own survey released earlier this month, redundant, and that Indian IT providers should prepare for slower growth and lower profits. "It is naive to say an economic slowdown is good because cost-cutting will lead to higher offshoring. This is no longer a recession, it is fundamental restructuring of financial services that is taking place," says McCarthy.

What the hell happened in these two months?

Multiple factors are at play here -- some recent developments and some historic issues that have been building over time.

About 20 to 40 percent of the revenues of offshore outsourcing firms are tied to the financial services industry. With its collapse, companies have been forced to look to other vertical markets. In normal circumstances, that should have been enough to offset the revenue erosion. But the problem is that everyone is in the same boat and those other industries are also impacted by the crisis, fading consumer demand, and reduction in spending.

For example, the travel vertical has started seeing a rise in ticket cancellations and refunds, which has led service providers like WNS to greater conservatism on revised guidance. Hexaware stated that delayed decision-making is spreading out from BFSI to travel, and it has now reduced its annual growth estimate from 24 percent to 7 or 9 percent. Sasken is now cautious about telecom handset segment as all the top-five handset customers are seeing a slowdown in sales (a U-turn from Sasken's bullish stand on this segment a couple of months ago).

So, suddenly all players are chasing a smaller market, in which there was little differentiation among players anyway, and it will lead to pricing pressure, reduced profitability, and less growth.

It will also become difficult to generate new business (unless driven by price), which will result in generic and inefficient players rightfully getting wiped out of the market. Rather than getting upset about it, I think it's an exciting opportunity for service providers to innovate and build their differentiators. Customers, I would say, have never had it so good -- they can finally be in the driver's seat.

It's also difficult to accurately quantify the business value of offshore outsourcing. At a theoretical level, it does make sense. At a headcount level, it also makes sense. But at a business outcome level, the real and hidden costs are often ignored and many companies are left thinking, "Hey, wait a minute, I offshored hundreds of my staff...why isn't my profitability increasing?" And despite share of offshoring rising, why haven't we ever seen a reduction in IT spend? That's because offshore outsourcing has so far focused on headcount as the currency, not the business value generated. That is about to, thankfully, come to an end.

The more I think about the full value chain, the more intrigued, and sometimes scared, I get about the full impact. TCS has reduced its annual hiring estimate by about 30 percent, Wipro already reduced headcount in IT services last quarter, Polaris has resorted to just-in-time hiring, Infosys is visiting fewer campuses...what does it mean for the employment market in offshore outsourcing countries? Will wage inflations ease off? Will attritions finally come to manageable levels? Will being skilled come back in fashion compared to just having an IT diploma/degree? We'll have to wait and see...

It is the end of the golden age of offshore outsourcing, but it also heralds a new dawn -- the age of truth and rationality. Where offshore outsourcing delivers real, tangible business value, and service providers are focused on making things work for customers in unique and innovative ways.

Here's to the new age...cheers!

Arpit Kaushik runs a business redesign company in London, Crystals, that helps technology-centric companies get unstuck. CIO.com is an InfoWorld affiliate.

This story, "Offshore outsourcing: What role will recession play?" was originally published by CIO.

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