Downsizing outsourcing

A recent cover story in BusinessWeek proclaimed we have entered an era in which global outsourcing is quickly becoming a prerequisite for multinational corporations. The article described how corporations of all sizes are outsourcing to providers in India, China, Eastern Europe and elsewhere to satisfy their business needs. Yet escalating competition is also fundamentally changing the outsourcing industry.

For instance, IBM recently announced a 5% decline in its fourth-quarter Global Services revenue. The same day Wipro, a leading offshore outsourcer, reported it is having trouble matching the margins of its India-based peers despite a 25% rise in its net profits.

There is no question the profit margins of IBM, Wipro and other outsourcing companies are being strained by rapidly expanding their global operations while fending off intensifying pricing pressure. But there is an even more subtle problem with the fundamental structure of today’s outsourcing business: customer downsizing of outsourcing contracts.

Numerous industry studies have reported that the size of outsourcing contracts has been dropping for the past two years. IBM experienced a 32% drop in major, or strategic, signings in the fourth quarter of 2005. This contraction is due to corporate disenchantment with the rigidity of mega-outsourcing contracts and the high percentage that fail to meet business and service-level objectives.

To avoid the risks associated with traditional outsourcing, corporations are reducing the scope and duration of these agreements. They also are relying on more providers to perform more-specific tasks, rather than be at the mercy of a single outsourcer for everything. This is a trend that I began calling out-tasking a decade ago, and it is even more common today.

The two fastest-growing examples of out-tasking are managed services and software-as-a-service. Oddly, the major outsourcers have been slow to restructure their antiquated operating models to capitalize on the rise of these out-tasking alternatives. For the most part, they have underestimated the significance of managed services and software-as-a-service or have been unable to convert their traditional outsourcing business models to sell and deliver more-targeted managed services and software-as-a-service solutions.

There has been a misconception that managed services and software-as-a-service are primarily aimed at small and midsize businesses. In reality, managed services were pioneered by major telecommunications carriers more than 20 years ago to help their largest customers manage their networks, and many software-as-a-service providers have a surprisingly large installed base of Fortune 500 companies.

A clear indication of the shift in the outsourcing landscape is a new partnership between Indian outsourcer Tata Consultancy Services and Salesforce.com, in which TCS will offer new call-center and other services based on the software-as-a-service applications in Salesforce.com’s AppExchange.

Large-scale outsourcing isn’t going to go away, but enterprise business and IT leaders no longer need to make big bets on long-term agreements to achieve their business objectives. Instead, they can now enlist more-narrowly focused managed services and software-as-a-service solutions to address their strategic business requirements.