Offshore Outsourcing and Economic Recession: Impact on Global, Indian and European Outsourcers (part 2)

An updated financial analysis of the impact of the U.S. recession so far on offshore outsourcing firms based on reported revenues and bookings.

Recently, I decided to take a look at the impact of recession on offshore outsourcing: that the players will face pricing pressures, reduced profitability and less growth compared to the golden times, and that there will be an imperative to deliver tangible business value to customers. I looked for evidence in the quarterly results of outsourcers and, despite the absence of the predicted boom, I found that they had held on pretty well. And I decided to reexamine the results after another quarter passed.

First up, the global outsourcers. In its latest quarter, Accenture's outsourcing revenues were up 7 percent year on year and its outsourcing margins increased due to more work shifting offshore. Management said that they have not witnessed any change in cancellations or deferrals, and now see the period of indecision starting to break loose. They also see an increased demand for BPO and application outsourcing services. The growth rate, it should be noted, is half of the previous quarter. IBM's strategic outsourcing business saw a 3 percent decline in revenues but an improvement in margins. On a like-to-like basis HP's services revenues declined 15 percent, but like IBM, it did see an increase in margins. HP saw a significant decline in its application services business as discretionary project work fell away. CSC also saw its outsourcing revenues decline by 13 percent, attributed to client delays and pull back of discretionary projects. Outsourcing bookings during the quarter were also down 50 percent, but like the others, it did improve its profitability.

Overall, since last quarter, the exuberance about revenue growth has become quite muted now. On the positive side, companies are improving profitability and streamlining their operations, including increased reliance on offshoring.

In the European outsourcers category, Capgemini saw its quarterly organic outsourcing revenues increase by 3 percent year on year (overall growth was 1 percent), but its outsourcing bookings declined by 37 percent. During the last quarter it increased its offshore headcount by over 1,200 (compared to an increase of 50 for onshore). Profits improved marginally but the company said that it can't see business with any real confidence beyond June, guiding towards a modest first half 2009 revenue and a margin decline. Logica's Q4 revenues went down 11 percent, and its operating profit for the full year declined 22 percent. It has been making aggressive strides into offshoring and boosted nearshore and offshore headcount to 5,000 (2009 target is 8,000), adding 900 employees in six months at its new India center. Logica sees good demand with more, larger outsourcing opportunities in the pipeline, but has forecast flat first-half sales. Atos Origin's Q4 revenues declined 9 percent, and it expects a slight decrease ("roughly minus 2 percent or something like that") in 2009 revenue. It also plans to increase offshore headcount by 1,000, while reducing onshore headcount.

Muted growth, operational streamlining and increased offshoring are the common themes.

Next let's move on to the Indian Offshorers.

We'll begin with the Tier 1 players. TCS' quarterly revenues remained flat year on year, in sharp contrast to the 25 percent growth last quarter and its statement that it does not expect revenue to be impacted by the turmoil. Net profit declined 18 percent. It is witnessing pricing pressure on new contracts, but on a positive note, net employee addition was more than 8,500—its highest in the past few quarters.

Infosys' quarterly revenues grew by 8 percent compared to 19 percent the previous quarter, and it added about 2,800 employees. Management stated that the velocity of business has come down, decision-making is slow, budgets are not finalized and scrutiny is higher.

Wipro reported a 12 percent annual increase in IT service revenues and its margins diminished. It also reduced its IT services headcount by more than 1,000 employees.

HCL technologies saw an 11 percent revenue growth, boosted by acquisitions. Net income was down 9 percent and total employee count was almost flat. HCL stated that "the pricing environment is quite bad and customers are saying that we should contribute and help in reducing their spend on IT".

The best performer was Cognizant which reported a 25 percent increase in revenue and a 34 percent increase in profits. It even saw a 19 percent increase in its financial services segment, and added 2,200 employees during the quarter. On the flip side though, the company's outlook for 2009 is a 10 percent revenue growth and broadly flat margins.

It is a significant shift from the position last quarter. Tier 1 players have seen their growth rates tumble (Cognizant is an exception here) and visibility become poorer. Operationally though, they are adjusting well and focusing on working with customers to address their challenges. Currency fluctuations remain a cause of concern for them, and 'constant currency basis' is the new buzzword.

Moving on to the Indian Tier 2 players. Growth rates for the leaders last quarter has come down from 30 percent plus to 20 percent for Mindtree and 17 percent for TechMahindra. Mindtree suffered significantly on the profitability front with a 88 percent decline in profit after tax. Talking about variability in performance, Polaris saw 32 percent revenue growth while Patni saw a 1 percent revenue growth, and a 45 percent decline in profitability.

Finally, the Indian Tier 3 players. Hexaware saw flat reported revenues but a significant improvement in operational efficiency and resulting profitability. It continued on its headcount reduction spree with 300 reductions last quarter, taking the tally to about 1,000 reductions over two quarters. Sonata, whose revenues rose by 25 percent and who did not foresee any adverse impact, saw its growth come down to 7 percent, even though profitability increased 27 percent.

So high variability in Tier 2 and 3 segments but they are now feeling the full impact and their irrational exuberance is fading away. Realistic growth rates, pricing pressures, currency effects, project cancellations/deferrals and longer sales cycles are being evidenced among the players.

How does all the evidence compare with my original assertion five months ago? Well the evidence broadly supports the assertions—players are witnessing pricing pressures, reduced profitability, (much) less growth compared to golden times and an imperative to deliver tangible business value to customers.

However, I do recognize now that there are exceptions and in some cases, the ability to withstand the macro environment and make corrective adjustments has been, frankly speaking, quite impressive. Special mention must be made of the increased use of offshoring by global and European outsourcers, and the emphasis on productivity and delivering value by select Indian players. We will see an increased use of offshoring, no doubt, but in a rational, rather than blind, way. It's fair to say that the recession is wiping away the inefficiencies of the system. Those who recognize and adapt will be the real winners.

Arpit Kaushik runs the London-based outsourcing service design firm, Crystals, that helps forward-looking companies to realise the promised benefits of outsourcing.

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Copyright © 2009 IDG Communications, Inc.

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