How the financial crisis will affect the outsourcing industry – Economist.com
SOURCE: Economist
DATE: Oct 9th, 2008
Mohit Soapbox:
Infosys results in this market turmoil were mostly ignored for the positive news they had on growing their revenues year over year by the fact that they reduced their growth expectations for 2009. The effect on the outsourcing industry is already happening. TCS-Citi and HCL-Axon deal are more an exception than a norm now. We are seeing a number of smaller deals in the marketplace and those will continue as firms with cash are willing to shop and buy companies at good valuation. The effect of the financial crisis is already being felt by the Indian IT stocks, recruitment efforts by outsourcing firms, growth of realty firms building centers for IT firms, pricing contracts, slowdown/cancellation of projects, M&A activities. Effectively in all possible areas. Interestingly the effect is more on pure Indian players vs the likes of Accenture, IBM which have again had better results because of more diversified global footprints and a foot in the door of the C suites.
These are tough times for all firms and specially the ones which rode the globalization wave – the IT/ITES firms and will continue for the near term.
IN ONE respect it has been a record couple of weeks for “outsourcing”. Around the world, governments and taxpayers have agreed to help ailing financial firms offload their toxic loans and resolve their liquidity worries. Banks are not the only ones hoping that this will help keep them afloat. The multi-billion-dollar outsourcing industry that runs computer systems and other things on companies’ behalf is keeping its fingers crossed, too. After all, financial giants have helped drive the industry’s stellar growth in the past few years. Now they threaten to undermine it.
Huge outsourcing deals involving banks are still being done—on October 8th Tata Consultancy Services (TCS), a big Indian firm, announced a $2.5 billion, nine-year deal with America’s Citigroup—but they are getting rarer. TPI, a consultancy which tracks outsourcing deals worth over $25m, says that in the first nine months of 2007 financial-services firms signed 132 such deals, worth a total of $17.9 billion; in the first nine months of 2008 there were only 101, worth a total of $10.8 billion.
Some outsourcing folk claim that the financial crisis could ultimately help their business, even though it threatens to harm it in the short term. For one thing, they say, banking survivors that already use outside contractors will give them more to do as they cut costs. For another, banks that have hitherto shunned outsourcing will have to embrace it to protect their margins. And those with their own offshore activities will be more likely to turn them over to specialists. As part of this week’s deal, Citi is selling its Indian back-office operation to TCS for $505m. “This deal sets the stage for a lot of future revenue,” says Subramanian Ramadorai, TCS’s chief executive.
Other industry bosses are more cautious about forecasting the impact of the banking debacle. “It’s like driving blind at the moment,” says Girish Paranjpe, co-chief executive of Wipro, another leading Indian outsourcing firm. As they struggle for survival, many banks have put discussions about outsourcing contracts on hold or just cancelled them altogether. Once the dust settles there will be far fewer financial institutions around, so competition for the remaining contracts will be stiffer.
American outsourcing giants such as Accenture and IBM will suffer from all this too, but India’s behemoths are particularly exposed. Unlike their American rivals they do not have other activities, such as consulting, to fall back on. NASSCOM, a body that represents India’s outsourcing firms, reckons that financial-services work accounts for 30-40% of the industry’s activity. To make matters worse, other areas such as back-office operations for airlines and retailers are also slowing. Hence predictions that contract prices charged by Indian firms are likely to drop. CLSA, a brokerage firm, predicts they will fall by 3-5% in the next fiscal year, starting in April 2009.
Faced with tougher times, more outsourcing firms sitting on piles of cash will turn to acquisitions as a way to boost revenues. Infosys and HCL Technologies, two other big Indian companies, are already locked in a battle for control of Axon, a British firm that provides outsourced computer services. On September 26th HCL bid £441m ($813m) for Axon, trumping an earlier offer of £407m from Infosys.
As they chase new revenues, outsourcing companies will also need to clamp down on costs. These have been soaring, especially in India, where a ferocious war for talent has driven up wages and led to very high staff-turnover rates. But now companies are hiring new staff only once deals are in the bag, and turnover rates are falling, says Mr Paranjpe. That is good news, but it signals trouble ahead.
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