Client Alert

Something Old, Something New: The Global Sourcing Market in 2005

3/15/2005

The global sourcing market continued to grow in 2004 and various sourcing consultancies and publications have already made bold predictions for 2005. However, in talking about global trends a number of important regional and market differences are often overlooked. This update draws upon the extensive sourcing project experience of Morrison & Foerster’s Global Sourcing Group across our offices in the key US, European and Asian markets, and provides our view of where we see the market moving in 2005.

Offshoring

This remains the most talked about strand within global sourcing, and 2004 saw the continued growth of India as well as the emergence of other centers such as China, the Philippines, Singapore, Eastern Europe and even South America. However, to talk about offshoring as a single phenomenon misses the point. Offshoring means different things in different markets and a closer analysis shows that it is part of a more complex sourcing picture.

From the customer’s perspective, offshoring does not necessarily mean putting all eggs in one basket. Many companies often include an offshore element within a complex sourcing transaction (for example, some helpdesk and ADM functions may be performed offshore), although the majority of the transaction may still be provided locally (i.e. on-shore).

Hype and reality need to be disentangled. Offshoring and globalization are politically sensitive in some markets. There is far more media and state-level political opposition to offshoring in the USA than, hitherto, in the UK or elsewhere in Europe. Furthermore, much of the opposition is confined to the public sectors or to certain industries where moving jobs overseas is seen as unpatriotic and a threat to local stability.

Even in the US market, the public debate about offshoring hides a more complex reality. In many cases, the job losses blamed on offshoring have been shown to be more apparent than real. Despite the political controversy surrounding offshoring, announcements of offshoring deals are often used by companies to impress analysts that actions are being taken to trim costs and re-engineer the company. In any case, many US organizations have been sending ADM work to India since 1998 and continue to do so discreetly.

What changed in 2004 was the amount of BPO work that went offshore, and the increasing use of multiple locations to perform inter-related functions. The media may talk of China now being a threat to India – and, indeed, we do see our clients beginning to route some services offshore to China – but the reality is even more interesting. Indian providers such as Wipro and Tata have set up their own operations in China and the Philippines to enable them to arbitrage the costs and skills differential between different locations. Accordingly, Indian vendors continue to emphasize their high skills in programming and some business processes like insurance claims, but they use the lower unit costs of countries like China to perform some support functions and the English language skills of Manila to run the helpdesk. This trend will continue, whether the supplier is an Indian company or a global provider such as IBM or Accenture.

Take the outsourcing of insurance claims administration as a case in point. An insurance company may be based in London or New York and the company seeks a solution to its IT and back office processes. The ADM support may be moved to Bangalore or Shanghai, although it is likely that some capability will be kept onshore. The help desk may be in Delhi or Manila and the insurance claims processing may be in Bangalore. However, onshore domain expertise will continue to drive the process. Furthermore, if a global provider is used, different processes will often come from multiple jurisdictions.

Although the media attention in the offshoring debate tends to focus on the threat to local jobs, the larger picture is more dynamic and local job losses in one area may be offset by new jobs elsewhere. It will be interesting to see how potential legislative and regulatory developments in certain markets, notably the USA, affect the dynamic in offshoring deals.

BPO and Business Transformation

2004 saw this market grow rapidly and various industry-wide surveys show that Europe replaced the USA as the biggest market, with the UK and Germany leading the way. The media headlines have concentrated on contact center jobs moving to offshore locations but this is only part of the story. 2002 and 2003 saw the rapid growth of the outsourcing of horizontal functions such as HR, and finance and accounting. This involved both onshore and offshore solutions and companies such as Accenture and Hewitt have gained market share by offering standardized solutions, substantial costs reductions and global roll-outs.

2003 and 2004 saw more vertical business processes being outsourced such as back office functions. These types of process are more complex to provide and are less standardized than the horizontal functions. Specialist providers such as Xchanging and Xansa are now competing with global providers such as Accenture and IBM and nearly all solutions have an onshore and offshore element. From the transactions which Morrison & Foerster is seeing, 2005 will see a further growth in sourcing of banking and insurance processes. However, BPO is becoming part of a wider business transformation outsourcing in which a process such as insurance claims is re-engineered and outsourced with substantial cost savings and improved performance and efficiencies. We will examine the new wave of business transformation sourcing in a subsequent alert.

Deal Realignment

Deal realignment gathered pace in 2004 and will continue in 2005. It is driven by a number of factors, not least that many of the original deals of the mid to late 1990s are now coming up for renewal. We have seen that organizations are using the renewal process to examine their sourcing strategies and to realign deals. There is a clear divide between the private and public sector here, since most private companies are not obliged to conduct a formal re-tendering exercise.

We have noticed that many organizations are trying to learn from the mistakes of previous transactions. These include:

  1. Speed and costs of procurement. Many companies believe that a competitive procurement process takes too long and is not cost effective. So companies are balancing the leverage gained from competition against speed to market. However, rather than the issue being sole source versus competitive procurement, companies are looking for more complex and innovative solutions, such as having a smaller panel of vendors, an improved solution and early wins in exchange for not re-tendering a transaction.
  2. Relationship management. Many companies consider that the original 1990s deals did not concentrate enough on relationship management. Too many deals were negotiated in an adversarial manner and it was assumed that price, scope and performance were all that mattered. We are now seeing clients spending more time on the governance model and greater emphasis is being placed on how to manage the long-term relationship.

One-Stop Shopping or Best of Breed?

We have seen the re-emergence of the old procurement debate. Is it better to have a single vendor supplying all functions or should a number of specialist vendors be chosen for each function? Sophisticated purchasers now seem to be following a best of breed solution, whereby they manage a number of different vendors. We consider that this trend is driven by a number of factors, including:

  1. Risk mitigation. Customers do not want to rely on one supplier when that supplier might get into financial difficulties or suffer systemic failures.
  2. Relationship management. As we discussed above, customers are now more confident in their abilities to manage the relationship. In addition, customers believe that they have more leverage with multiple vendors than with one dominant supplier.
  3. Domain expertise. Customers prefer choosing specialist providers and query the value of one-stop shopping for complex IT and business processes.
  4. Knowledge transfer. Customers believe that they can better control knowledge transfer by using multiple vendors.

We see this "best of breed" trend continuing in 2005. Many companies, however, still find it difficult to manage multiple vendors and the correct contractual and organizational structures need to be put in place and managed for this approach to work.

Conclusion

The global sourcing market will continue to grow in 2005. Offshoring is now deeply rooted and will continue to form part of many transactions. In fact, it will mature into an element of the solution rather than being seen as the solution. BPO will be the fastest growing area but more organizations will look to business transformation rather than traditional outsourcing. However, although BPO and business transformation will grab the headlines, the day-to-day issues of vendor management and deal realignment will continue to occupy most companies and their advisers

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