Responding to a Slowdown
Companies have traditionally responded to a recession by cutting spending on discretionary projects, tightening operational expenses, and resorting to layoffs in some cases. It’s a short-term reaction to minimize exposure. This time around, the basic response would remain the same. “A lot of companies would respond the same way, but some will take this as an opportunity to accelerate projects that have a strategic benefit, and this may include outsourcing and offshoring projects,” says Julio Ramirez, Managing Director, The Hackett Group.
The benefits of outsourcing and offshoring extend beyond labor arbitrage. In a recession, companies ask, how do I reduce my receivables? How do I manage my payables? How do I improve the velocity of my inventory? Service providers who can directly attack such problems would be able to deliver value to their customers in a slowdown. This can come in the form of better working capital management, better forecasting accuracy, better asset utilization — all of which are great operating levers for companies in difficult economic conditions. The direct implication is that the large Business Process Outsourcing (BPO) companies, especially the ones handling processes like procure-to-pay, accounts receivables would have a great opportunity in the slowdown.
“Companies would want to reduce their cost base and reduce the variability of costs. That’s when the senior executives would pull the outsourcing levers. But in general, they would go with existing relationships and deepen them,” says Peter Allen, Partner and Managing Director, TPI. The way this would play out is interesting. Companies with existing outsourcing relationships would tell their service providers, “I need the spending to go down; I am willing to give you more work, if you can decrease my total spend.” This calls for tightening at both ends (customer and service provider), but it will optimize the whole process. The year “2008 would be the defining year for outsourcing in which companies would look for more value out of their outsourcing relationships, and providers who can provide that will thrive,” adds Allen.
For the service provider, this translates to both pressure and opportunity at the same time. On one hand, they would be unable to get any price increase, but on the other, they will have increased scope from existing relationships. This would lead to some very interesting changes in operating business models. For example, it would motivate both the customer and the service provider to shift from a staff augmentation-based model to an outcome-based model. To do this, service providers will have to be able to manage risks and resources for margin preservation.
Of course, it depends on the maturity of the company in handling outsourcing whether it decides to deepen its relationship with existing service providers or defer the project with new scope. Those who don’t have continuing relationships with service providers are unlikely to go ahead during this period because of the upfront costs involved and the lag in realizing the benefits of outsourcing or offshoring. There are no immediate benefits to be gained here.
Similarly, the impact on a specific service provider would depend on the portfolio of customers it has. Growth from existing customers would be the best bet because new customer acquisition will get tougher. This also means that providers who are trying to get into new areas — for example, an IT-services company trying to grow their FAO or a company, trying to build a new vertical — would find it difficult.
Opportunities and Challenges
It is interesting to note how an economic slowdown throws up opportunities. During the growth phase, businesses are more involved in pursuing growth opportunities at any cost, they usually don’t fix things, if they are not broken, and they frequently end up with a lot of mismatched point solutions. Then, when the economy takes a downturn, the usual course is to “optimize” what they have. For the outsourcing industry, this will translate to a lot of activities hitherto unseen. “It will result in a never-before-seen pipeline for IT services. And, this time it will not be driven by skills alone; there’s going to be lot of automation involved in handling these opportunities,” says Kurt Potter, Research Director, Gartner. Companies like IBM and HP cannot compete any longer based on labor arbitrage alone; technologies like virtualization, BPM, composite applications, and others will change many rules of the game.
When the economy is down, the Chief Financial Officer (CFO) gets into the driver’s seat, and the plans may get revisited. Even in areas like IT services, the CFO’s role is still powerful in determining cutbacks in spending. But technology has become so aligned with business that CFOs would not have IT on top of their chop lists. According to Global CFO Survey coducted by The Duke University and CFO Magazine , CFOs of U.S. companies expect technology spending to increase to 5.4 percent this year, and the financial-services companies would have an above-average rise of 6.5 percent in technology spending. The forecasts, which were upward revisions of earlier forecasts, were made in Dec. ’07, when economic downturn had already set in.
Dozens of service providers that we spoke to maintained a positive outlook for the year, despite the economic slowdown in the U.S. Some of them reported signs of sluggish activity in some areas; others are seeing an even better pipeline of deals, and even accelerated sign-ups. Of course, the economic slowdown comes with its advantages and challenges. It is up to providers to target the right opportunities to not only survive but also thrive during the next few quarters. There are no tidal waves that threaten to wash away the whole industry. But surely, the prizes are not for everyone.
