The Next Bubble?

How do you know when another bubble is about to burst? The signs of an overinflated tech boom were evident [...]

February 1 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.

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 Alto-based 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 OneSource. 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 to20 reasonable size companies.”

Quality Issues Lead to Failure

M.R. Rangaswami, who heads the consultancy Sand Hill Group, agrees, “We are seeing a hyper-market with a lot of consolidations and mergers.” He also points to some “quiet failures” among outsourcing providers, which are related to quality service issues rather than excess supply. As one high-profile example of failure due to service issues, he points to a recent decision by Dell to stop routing corporate customers to a technical support call center in Bangalore after it received numerous complaints about thick accents and scripted responses.

“We are starting to see a separation of the tier-one companies from the tier-twos,” adds Ananda Mukerji, CEO of ICICI OneSource, a leading outsourcing provider in India. “We have seen a lot of venture capital money coming into this sector, and now many of these portfolio companies are looking for an exit because they realize they are not going to be able to grow and reach critical mass,” he says, emphasizing that “scale is important.” His own company has grown from 700 to 4,100 employees in the past 18 months, he says. Seven hundred of those new employees came through acquisitions.

So what can CEOs do to make sure their low-cost job centers keep churning out products and services for them? Consultant Rangaswami advises chief executives not to underestimate the time it takes to pick and manage a good partner. The CEO needs to be committed to the project and invest hands-on time, visiting India or China to get the “lay of the land,” and becoming involved with the selection process by making final site visits and talking to customers. He says the process should take three to six months and warns against speeding up decision-making “even though some companies are under a lot of pressure to cut costs.”

CEOs also should take precautions to ensure their most talented software developers aren’t lured away with better offers and perks, as they frequently were in the heyday of Silicon Valley. One way to keep the upper hand, advises Rangaswami, is to bring a team of software developers in-house after building up an operation and offer management an ownership stake.

Joe Prang, CEO of Conformia Software in Redwood City, Calif., recommends that companies carefully match their needs with the right size partner. “I wouldn’t advise being a small fish in a big pond,” says Prang, who has worked with several California-based software developers with information technology operations in India, including his latest company in Saratoga, Calif. He also suggests that executives dole out projects to multiple outsourcing providers as a form of insurance in the impending shakeout.

The most important thing though, he says, is not the company itself but the team working on your business “and the influence and control you have over them.” Even if the company gets swallowed up in India, the team may decide to be loyal to an outsourcing customer back in the U.S. provided that company takes steps to create a bond. He advises that multinationals should pick teams that have a “strong affinity with your company.” Another way to cement the relationship despite the distances is by setting up a reserve as a bonus pool for the workers, he adds.

One more tactic is to bring the software team in-house, a move Prang has experimented with to prevent high turnover and promote loyalty. When he was head of the enterprise software development firm Aspect Development a few years ago, Prang brought his 75-to-100-member Indian software team in-house and formed a wholly owned subsidiary. That kept the team in place for a few years until the unit was recently acquired by another firm in the outsourcing business, I2 Technologies. Prang had moved on to another software development firm by then, but for him, it was just one more sign that things are just a little overheated.

As the industry rapidly transforms, CEOs too need to be on the watch for telltale signs that their outsourcing partnerships are healthy-and stay that way.