The next bubble? The inevitable shakeout in the outsourcing industry could leave your offshore operations stranded - Management

Chief Executive, The, Jan-Feb, 2004 by Rebecca Fannin

How do you know when another bubble is about to burst? The signs of an overinflated tech boom were evident back in the late 1990s but no one paid much attention until it was too late and millions of dollars were sunk in ill-fated ventures.

Now another peak and valley are on the horizon--not in Silicon Valley but far away in India, and not among dot-com startups but among providers of outsourcing services, from call centers to software development houses. As experts and the media hyped offshore outsourcing as the Next Big Thing, the industry ballooned with new and expanding players eager to get their share of business.

But CEOs who have outsourced operations in India to save costs during tight economic times should heed the signs of pending consolidation.

Already a shakeout is occurring as some outsourcing competitors go out of business or get gobbled up by bigger rivals in a power play for market share--and survival. CEOs who are not especially clever at picking and managing a good outsourcing provider could find themselves left empty-handed just when their operations have been moved offshore. They may be forced to temporarily halt production, research and development or customer service. Or, if they team up with a provider that suddenly expands to take on new, bigger clients, they could find themselves shoved aside.

Yoshiaki Fujimori, president and CEO of GE Asia in Hong Kong, is thinking ahead about how to mitigate the risks. GE has one of the biggest outsourcing operations in India, which has saved the company millions of dollars, he says. Some 11,000 workers from India handle back-office processing, such as payroll for the company, accounting for annual savings of $300 to $400 million. And its information technology arm in India saves the company another $500 to $600 million each year.

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GE is being careful, however, not to place all its orders with any one vendor just in case "one goes away," says Fujimori. GE, like other large firms that outsource IT and business processing, is considering moving other operations to China as an alternative. It has already formed a joint venture there to see if it can achieve more savings in China versus India, he says. The venture, based in Dalian, churns out software in Korean, Chinese and Japanese, "and probably knows Japanese better than I do," quips Fujimori.

With costs for software developers reaching $150 per hour in India, the China option does look attractive. "When you have those kinds of rates, that's not even an advantage over Silicon Valley," points out Harry Sarwari, chairman of outsourcing firm OneBPO in Freemont, Calif.

Companies having new and cheaper options for offshore outsourcing may be just one of the telltale signs that this sector in India is headed toward a correction. Another is the great speed with which the outsourcing market is growing. Indian software and services exports are projected to grow 26 to 28 percent in 2004, weighing in with revenues of more than $12 billion, according to India's National Association of Software and Service Companies (see table, page 18). This follows a 26 percent increase in 2003. Broken down by category, information technology products and services are forecast to reach $8.4 billion, or 17 percent growth, on the heels of an 18 percent climb last year, while business process outsourcing will grow by 54 percent to $3.6 billion in 2004, following an increase of 59 percent last year. What's more, NASSCOM is predicting that India's outsourcing sector will employ 1.1 million people by 2008, up from about 650,000 today. It's the kind of growth CEOs dream of, but also the kind that cannot be sustained.

Venture capital to support all this outsourcing continues to pour in. Palo Altobased Charter Ventures is starting a fund to invest solely in outsourcing companies in India, and Charter is building a facility to house 10 to 12 of these portfolio companies in Bangalore, one of the key cities for outsourcing. Still, Sumir Chadha, founding managing partner of Westbridge Capital Partners, predicts rapid consolidation in the sector, to four or five major players in the next few years. Last summer, his Silicon Valley-based firm put $4 million into Indecomm Global Services, a health care and financial transaction outsourcing player, while another firm in his portfolio, FirstRing, was absorbed by ICICI One-Source. Now Indecomm is on the prowl for two more acquisitions, says CEO K.P. Ponnapa, who boasts, "We aim to be a $100 million player in a short time."

Another firm jockeying for competitive advantage, iGate Global Solutions in Freemont, Calif., has acquired three companies that offer specialized services in outsourcing, Bangalore's Quintant Services being its latest. "Outsourcing is becoming more mainstream and companies are saying they can't live without it," says CEO Phaneesh Murthy, also one of the founders of the Indian outsourcing giant Infosys. He points to potential cost savings of 30 to 35 percent from outsourcing as one key driver for the explosion in outsourcing, and predicts that the field will consolidate ever more rapidly, leaving room "over the next few years for 15 to 20 reasonable size companies."