New IT outsourcing model boosts bottom line

Faced with increased competition and pricing pressure, global service providers have been increasing their focus on their most lucrative business segments in recent years. And that restructuring is beginning to bolster their bottom lines. During the second quarter of 2014, IT outsourcing providers saw the highest growth in their operating margins in five years, according to outsourcing consultancy Everest Group.

The average operating margin for leading global service providers was 13.2 percent last quarter, up from 10.6 percent during the first quarter of this year. (Everest Group defines leading global service providers as Accenture, Aon Hewitt, Convergys, CSC, HP Enterprise Services, IBM Global Services, Unisys and Xerox Services.)

Most recently, in October HP announced that it would be splitting into two publicly traded companies in order to increase focus and respond to the differing demands of the enterprise and consumer market.

In 2013, Michael Dell took the eponymous tech company private in order to concentrate on long-term strategy rather than quarterly earnings. IBM continues to divest itself of its lower margin businesses, such as customer care, while making targeted acquisitions to build cloud and analytics capabilities. Infosys brought in new leadership and has separated its products, platform, and solutions business from its offshore labor-based offerings to develop end-to-end solutions for the enterprise.

IT Outsourcers Reduce Costs and Focus on Profit

There has been a need for IT outsourcers to reduce costs and focus on profitable business segments due to sluggish demand in mature markets and an increased interest in setting up global in-house centers in lieu of outsourcing, says H. Karthik, a partner in Everest Group’s global sourcing practice.

“The trend around restructuring is likely to continue, driven by hyper competition and price wars. Advantages of offshore cost arbitrage have already been reaped,” Karthik says. “Leading service providers are looking for new models to differentiate themselves. Outsourcing providers are investing in social media, analytics, and cloud for future growth and aggressively pricing their services to increase market share,” he says.

Other service providers are looking to inorganic growth and collaboration to build capabilities, according to Karthik. In January, for example, HCL Technologies and CSC announced a strategic partnership to address the application modernization market.

And industry watchers expect other outsourcers to make some major changes in the near term. HP, the majority owner of Mphasis, plans to sell its stake in the Bangalore-based IT service provider. CSC has been talking to private-equity firms about a possible leveraged buyout.

“It is under speculation that CSC may split its public sector and commercial operations before putting itself up for sale,” Karthik says. “Wipro and HCL are likely to be the potential bidders for CSC’s commercial operations, which will help them to strengthen their presence in the United States and Europe,” Karthik says. “Tech Mahindra, which has been actively looking out for a midcap acquisition, is believed to be in talks with HP for acquiring its stake in Mphasis.”

Dell and EMC have been holding merger talks. Capgemini plans to move half of its global workforce to India by 2016 in an effort to cut costs. French IT service provider Atos plans to spin off its Wordline payments business via IPO and double its Indian workforce.

Customers should keep a close eye on their IT service providers to make sure vendors’ strategies and investments are aligned with their own business needs. Ultimately the targeted attention on next-generation technologies should increase competition and decrease prices, says Karthik, giving outsourcing customers more bargaining power with their providers.