The engineering services industry saw some large deals signed in the last two quarters:

• Meggitt-UK signed an estimated $50 million five-year engineering management outsourcing contract with HCL in January 2010. HCL will provide routine engineering services for Meggitt's global operations.
• Infotech Enterprises and Hamilton Sundstrand Corp signed a four-year multi-million dollar avionics contract in January 2010 to provide embedded software and electronic engineering design services worldwide.
• Mahindra-Satyam and Saab signed an estimated ten-year $300 million contract in November 2009 to develop solutions in India for the global defense and homeland security market.
• QuEST Global and Belgian aerospace major SABCA announced in November 2009 that they signed a ten-year deal worth $100 million to manufacture metallic parts and provide assembly work for Airbus A-350 XWB aircraft’s flap track structures.
• In August 2009, Bombardier announced its decision to outsource engineering services worth $200 million overseas over the next few years.

Such deals are indicators of a strong growth potential for the engineering services outsourcing (ESO) industry in the years ahead. Several research firms have estimated the market size for engineering services globally:

Exhibit 1: ESO market size estimate by research firms

Research company Report released Market size potential estimates ValueNotes 2006 US $1 billion by 2010* (Indian ESO market) CRISIL Research 2008 US $7.5 billion by 2012-13 (Indian ESO market) Frost & Sullivan 2008 US $40 billion by 2015 (Indian ESO market) Nasscom and Booz Allen Hamilton 2009 US $50 billion by 2020 (Indian ESO market)

Source: ValueNotes Research

*Only automotive design and engineering offshoring to India

On the backdrop of new deals being signed and several market size estimates being published by research firms, ValueNotes decided to do a reality check on the situation by conducting an industry-wide survey, ESO survey 2010: 'How does the engineering industry feel about outsourcing?'. The purpose was to assess the global reaction to outsourcing in the engineering services segment - to gather perspectives on the engineering industry in terms of its challenges, outsourcing experiences, favored outsourcing destinations, cost savings and future proclivity to outsource.

The survey was taken by over 200 participants globally, across industries. The participants included engineering service buyers (manufacturers), service providers and industry analysts.

Exhibit 2: Survey participants

Source: ValueNotes report - Engineering Services Outsourcing: Perception vs. Reality

Key challenges faced by buyers

We identified some of the major challenges faced by engineering manufacturers. They were asked to rate the following challenges as key challenge, manageable challenge or not a challenge:

• Adapting to new technologies
• Addressing new geographies
• Pressure from competitors
• Supply-chain issues
• Identifying key vendors/suppliers
• Cost/margin pressures
• Lack of in-house capabilities

Exhibit 3: Buyer challenges

Source: ValueNotes report - Engineering Services Outsourcing: Perception vs. Reality

It was no surprise that the survey indicated that cost/margin pressure was a key challenge. Pressure from competitors was another major challenge, followed by issues in supply chain. Interestingly, in-house capability (in terms of resources) was not a constraint for most buyers. Outsourcing being well-entrenched in the engineering industry is probably the reason for this. This was further highlighted when buyers were asked which of their major challenges could be most effectively mitigated via outsourcing.

Exhibit 4: Buyer perception on challenge mitigation via outsourcing

Source: ValueNotes report - Engineering Services Outsourcing: Perception vs. Reality

• While 28% of the buyers said that the lack of in-house capability was not a challenge, 50% said that this lack could be addressed by outsourcing.
• A further analysis revealed that out of the above 28% buyer category, only 8% addressed the issue by outsourcing, primarily when they had less specialized in-house resources or when there was a resource crunch. Another 8% didn't think that they could address any challenge via outsourcing.
• While pressure from competitors was a major challenge, buyers did not perceive outsourcing as a solution to mitigate this challenge.
• Cost savings was a major challenge, but there was a strong belief that it could be mitigated by outsourcing. However, our survey revealed some insights on the varied perceptions of cost savings.

Cost savings – a reality check!

A significant disparity existed between the perception of buyers and service providers on the actual cost savings via outsourcing.

Exhibit 5: Buyer vs. service provider perception on cost savings via outsourcing

Source: ValueNotes report - Engineering Services Outsourcing: Perception vs. Reality

While a significant number of buyers believed that there were 'no cost savings' due to outsourcing, service providers had a more optimistic view. While 62% of the service providers believed that outsourcing resulted in cost savings between 15-40%, only 44% of the buyers agreed with this.

Will outsourcing grow?

Some findings from the survey on service providers’ perceptions indicated that:

• Almost three fourths (76%) of the service providers claimed that their customers were repeat buyers.
• Most of them believed that their key strengths were domain expertise, service quality, and understanding of customer needs.

Interestingly, satisfaction levels of buyers did not corroborate this perception of service providers. Only 14% of buyers were highly satisfied with their outsourcing vendors, 59% were moderately satisfied and believed that there was scope for improvement, while 27% indicated low satisfaction levels on account of poor vendor execution. A majority of buyers believed that there was still scope for improving the overall service experience. The reasons for outsourcing were not purely the perceived cost savings but also work quality. Buyers who were not particularly keen on outsourcing believed that the ‘inability to maintain the promised quality standards’ was one of the key reasons behind their decision to not outsource.

The ValueNotes ESO survey results indicate that despite issues, a significant majority of manufacturers that already outsource will continue to do so, and will even increase outsourcing by 25% in the next two to five years. India, China and Eastern Europe will be the most favored outsourcing destinations. The flurry in recent contracts activity goes further to substantiate this. We believe that engineering services outsourcing industry is here to stay and will grow at around 20-25% in the next two years and beyond.