Strong long-term demand seen for outsourcing: Tholons

The worldwide market downturn will impact the growth and margins of IT companies for the first two-three quarters of 2009 before picking up and ending the year on a stronger note as clients seek to cut costs and generate more revenues, indicates the latest report of Advisory and Research firm Tholons. But despite the uncertainty, there will be a strong demand for outsourcing over the medium- to long-term.

The report says though 2008 was a tumultuous year for outsourcing and clients should remain cautious in the year ahead, there are opportunities and potential still very much evident in the market. The outsourcing industry will develop in the coming years to become more mature, efficient, dynamic, and ultimately more resilient. With prudence, heightened focus, and a more adaptive approach towards outsourcing – 2009 can in fact be a watershed moment for the global outsourcing industry.

Allen Kilgore, principal at Tholons, said, “The US domestic market will see an increase in domestic sourcing to take advantage of the available talent pool at an attractive cost with incentives by local government.”

Because of decreasing margins and headcount, providers will have to better utilize existing resources by implementing new technologies efficiently. Clients, with reduced IT budgets, will be forced to be more selective – demanding far more stringent SLAs, greater contractual flexibility and output/result based payment schemes.

Besides, the report says that there is already an increased focus by vendors towards large (and growing) domestic markets of India, China, Argentina and Brazil in which the customer support and back office services for retail, telco and financial services verticals will be among the hot spots for providers looking to tap the surging local demand of outsourced services.

Another trend that the report cites is that near-shoring will come up as a low-cost alternative to domestic sourcing for processes requiring the same time zone presence. Latin America with superior cost dynamics will emerge as a near time zone alternative to Europe / US business adding Spanish language capability. In the near-term, the top Indian firms are predicted to expand global footprints and open delivery centers in China, Latin America, Eastern Europe and North

America. Cairo, Sao Paulo, Buenos Aires and Dalian will be some of the emerging destinations. However, large India-based providers are expected to see EBITDA margins plunge below 20 per cent over the next three years, as they move more IT projects offshore (mostly to India) and struggle to balance operations with rising wages. The situation could aggravate if the rupee continues to appreciate in this period.

“Also, the average deal size has almost halved in 2008, compared to 2007 numbers and we anticipate the deal sizes to be depressed due to lack of fresh capital coming from the PE route. However, firms will continue to look for small tuck-in acquisitions to plug gaps in their portfolios and gain client proximity,” says Nishant Verma, vice-president at Tholons Capital.

For the financial sector, analysts say that consolidation is inevitable due to the global financial crisis and this will create M&A opportunities which will generate further business for LPO firms. A large proportion of sub-1,000 (employee) companies will either close shop or be acquired. Mid-market customers are expected to expedite outsourcing decisions, which have been lying on the backburner. This will be driven by cost pressures and is a step in the battle for survival across the segment. This client sector will prefer being serviced by SME service providers.”

With financial institutions such as Lloyds TSB/HBOS and Bank of America/Merrill Lynch merging, service providers will also find themselves bidding against incumbent transnational rivals like IBM, Accenture and HPEDS for several large-scale integration contracts.