The US economic slowdown will lead buyers of IT services to consider increasing the percentage of their labor in offshore, lower-cost locations. India will remain the dominant location for IT offshore services for North American and European buyers as a result of its scale, quality of resources and strong presence of local and traditional service providers.
With concerns that the US economic slowdown could extend to other geographies, organizations are refocusing on IT cost reduction and taking steps to accelerate the use of offshore labor. Buyers of IT services will shift from cost containment goals to a greater focus on cost reduction and productivity increases in their sourcing decisions.
This will lead to a steady increase in the adoption and expansion of offshore services – primarily from India, but increasingly from other countries as well.
Factors that will give India the edge over other offshore locations are scale and quality of labor. North American and European buyers of IT services have been the force behind a growing offshore services market and India is central to almost any discussion of offshore services delivery for these buyers.
Two possible scenarios are seen that will have an impact on offshore services adoption in the coming months: temporary economic downturn (best case scenario) or a more sustained recession (worst case scenario). In the best case scenario, buyers will aggressively seek cost-saving measures by accelerating offshore delivery or, for first time users, moving IT services to offshore locations.
In the worst case scenario, if a more sustained economic slowdown leads to a prolonged recession in the US, a more-aggressive movement to cut IT budgets can be expected.
While the recent appreciation of rupee and rising wages have made some of the benefits of India’s offshore services’ cost competitiveness less predictable, the more sophisticated providers have made critical process investments, thus minimizing the impact of wage increases alone in their final price of services to buyers.
IT companies are devising new strategies to ward off pressure on bottom lines due to recessionary trends in the US. They are now looking at non-linear growth models to shore up revenues.
It means that instead of deploying more manpower, the focus will be on raising output by offering high-value services and acquiring expertise in niche areas. The new model could trigger consolidation in the market and ensure better pricing of products and services.
Clients are looking for solutions that would help them automate discrete business processes or aspects of product development.
IT and product development service providers are, hence, developing solution accelerators, which are pre-developed software that technology and services firms use to automate a particular business process. Around 30% to 70% of the code can be reused across clients.
In their effort to build solution accelerators, companies will look at mergers and acquisitions. This will help them acquire specific processes and domain expertise that plug the missing gaps. Some companies such as Infosys and HCL may adopt an acquisition strategy to gain ready-made expertise available.
Another factor that could trigger M&As is the aggressive growth targets set by some of the firms. IBM plans to produce 25 solution accelerators a quarter and HCL’s eyeing $100 million to $150 million revenues in two to three years. Most big companies are targeting 30% revenues in the next 3 to 5 years from solution accelerators.
While the non-linear growth is seemingly coming into vogue with Indian IT services providers, it is simply the result of the fact that continuing on a linear path would mean lower growth.
Companies such as TCS, Infosys and Satyam can’t hope to continue growing their headcount as it would be unmanageable. Besides, the supply of manpower is also a problem. So, an adjustment to the business model is necessitated. We are already seeing attempts to move into higher margin business such as consulting and a push into services such as remote infrastructure management.
Another route is through inorganic growth, with a marked increase in M&A activity by top tier providers in India, a trend that may continue through 2008. Infosys Technologies, for instance, is planning to acquire companies in Europe and Japan for $200 million to $300 million to move away from linear-business model.