IT Outsourcing - Options

IT matters! Most conglomerates are tech savvy and use IT (Information Technology) to gain a competitive advantage. Most companies are spending a substantial amount of their revenue on building IT capabilities. Big Indian IT companies termed as SWITCH (Satyam, Wipro, Infosys, TCS, Cognizant, HCL) are the “cost efficient experts” in low cost countries. These companies excelled in delivering state of the art IT solutions at low cost. However, there have been numerous changes in this industry over last few years and the business environment has become challenging. Some of the changes are:

1. Indian IT biggies looking to move up the value chain.
2. Global IT consulting companies like Accenture now  offer end-to-end solutions by operating in India.
3. There is a high demand of IT professionals while the supply of labour is low. This has increased the wages dramatically and the labour arbitrage is slowly diminishing.
4. Low availability of skilled labour has caused companies to compromise on quality.
5. High competition has led to pressures on billing rates and the margins are decreasing even further.
6. Companies unable to manage high growth leading to quality and security related issues.

Within buyers of IT services, there is an ongoing debate on whether to outsource or instead go the captive centre route. While outsourcing is cheaper and usually a necessary step to retain a competitive edge, there is no discretion in team selection and no visibility into the Software Development Life Cycle processes. Captive units on the other hand negate most of these disadvantages but most companies fear making the high investment commitment required to set up a captive unit in a new country. A case in point is Apple’s development centre in India, which was closed a month after it opened.

The captive unit business model will become a big threat to SWITCH companies. Most of the critical work will get assigned to the captive units and vendors will be used to compensate for spikes in business or for delivering the less critical and lower margin tasks. To compete in this changing environment, SWITCH companies should take the lead in establishing a new business model.

To accomplish its IT business, there are various options that any company can use. There are obvious advantages and disadvantages of each option. While accomplishing IT work in own premises might be most beneficial, it might not be the most optimum option. With the emergence of knowledge centers like India, which provide the similar or better services at a much lower cost, outsourcing and offshoring are becoming extremely important in any CIO’s agenda. Following are the options that a company can use to accomplish its IT business.

1. In-house IT department
   1. Onshore Captive Unit
   2. Offshore Captive Unit
2. Third Party Out-sourcing
   1. Near-Sourcing – location is near to incumbent’s location.
   2. Far-sourcing – location is far (e.g. American company outsourcing to India).

Within the offshoring strategy there are various options in which the IT business can be structured and accomplished. There are essentially six different offshore models. The two models at the extreme are:

1. Captive Center – Completely owned by the company for its own use.
2. Supplier Direct – Completely owned by a third party offshore supplier.

There are also a few more models which are lesser known but slowly and surely gaining importance. These are:

1. Dedicated Center
2. Joint Venture
3. Third Party Transparent
4. Build-Operate-Transfer

Captive Center: Under this model the company sets up its own offshore captive center. It starts from ground up, sometimes, in a totally new country where it has no earlier presence or outsourcing relationship.

Supplier Direct: In this model, the work is outsourced to a third party who provides both low cost advantage and special skills, while allowing the company itself to focus on its core business.

Dedicated Center: A dedicated center is a further extension to Supplier Direct model. This is also operated by an offshore supplier, but the staff, equipment and facilities are all exclusively dedicated to the company. This model has some shared processes, shared risk and shared ownership.

Joint Venture: In this model generally a company partners with an offshore supplier in a joint venture relationship and they share the revenue. A joint venture can also be between two or more global companies, with or without local partners, to build an offshore center with multiple owners. This way they share the cost and risk.

Third Party Transparent: In this model a third party builds and maintains the offshore presence.

Build-Operate-Transfer: In this model, a third party builds the captive center ground up, and transfers it to the company once it is operational. The time for which the third party maintains it can vary.

SWITCH companies currently operate in the Supplier Direct Model. This model became popular because of labor arbitrage available in India. With it huge pool of English speaking skilled population available at low wage rates, this model was highly successful. Most companies used Supplier Direct model to outsource their IT services work while some use hybrid models like having both a captive center and outsourcing some work to third party IT vendors.

In the long term, any company needs to invest in what it considers the core. If some work is clearly not the core and hence not of long term value it should be outsourced if it makes economic sense. On the other hand, if the work is strategic for the longer term then the continuity of the work and the people (after all, it is a knowledge economy) is required and investments have to be made. With this reasoning, some companies operate their own captive centers and outsource the low value work to third party vendors in low cost countries.

With no distinction between any two third-party IT services vendors, cost became the only distinguishing criteria. As competition heated up, there was a huge pressure on prices and the billing rates reduced dramatically. At the same time, some of the IT consulting companies like IBM and Accenture also expanded to low cost countries to make use of labor arbitrage and provide end to end services to their clients. This forced the IT biggies to rethink their strategy as the current strategy was clearly not sustainable. The Indian companies aligned their businesses along verticals and put a strong emphasis on building domain knowledge so that they could move up the value chain.

The IT businesses have expanded at a dramatic pace and some companies have not got enough time to adapt themselves to their explosive growth. The demand for labor has gone up multifold, while the supply has been more or less constant. This has affected the quality of labor and therefore the quality of work delivered. There have been a few instances of security breaches in handling sensitive data. Most companies now believe that their India strategy is very important and a lot of time is spent of formulating this strategy. IT biggies are facing a new competition from increased number of captive units being started. As more captive units come up, these companies would start losing their clients and moving up the value chain strategy would remain incomplete. There is also an additional risk of big captive centers like GE building capacity and competency to service other clients from their captive centers.

In this highly dynamic market, a new wave of IT evolution has to gain momentum. IT vendors need to rethink their strategy to survive and excel in the future. This scenario presents SWITCH companies with both an opportunity and a threat. I believe that to compete in this changing environment, the business need for these companies is to adapt quickly to this new wave and position themselves to take maximum advantage of this opportunity. In Thomas Friedman words the situation can be summarized by the lines, “Do it before it gets done to you. The change itself is inevitable”.