Established IT outsourcers are getting squeezed at both ends of the competitive spectrum. According to the annual offshore outsourcing survey conducted by Duke University's Center for International Business Education and Research (CIBER) and PwC, incumbent India-based and U.S. IT service providers are under pressure from outsourcing upstarts in other countries that are stealing market share from them and from existing clients demanding price reductions. \nMeanwhile, Indian and American IT outsourcing providers are entering new markets with both low-end, commoditized services\u2014a highly competitive field with few barriers to entry\u2014and higher-end services where market entry is more challenging, say the researchers. It all adds up to a perfect storm for many large IT outsourcers, says Arie Lewin, director of CIBER and professor of strategy and international business. \nThe survey of 620 service providers from 50 countries revealed that all providers, regardless of size, reported a decline in profit margins between 2009 and 2010. Large providers experienced the biggest decrease, from an average 23 percent profit in 2009 to 18 percent in 2010. \nIndian providers in particular have been struggling with profit erosion for a longer period of time, according to the research. Their profit margins dropped from 25 percent in 2007 to 20 percent in 2009 to 17 percent in 2010. \nThe study also revealed an uptick in "nearshoring," with service providers expanding operations to move closer to their clients. \nThe shift away from India\u2014the offshore outsourcing center of the universe\u2014isn't happening overnight, however. Less than five percent of U.S. companies were moving work from India to another country, and two percent were relocating work from India to the U.S.\nBut new IT outsourcing activity in India has slowed. "India still has major market share," Lewin says, "but the growth rate of new commercial deals between 2010 and 2011 shrunk by around 60 percent." \nShrinking growth could mean trouble for the IT outsourcers who made large investments in the country. "U.S. firms may be saddled with the legacy effect of early offshore locations in India before closer Latin American locations were established," Lewin says. \nLewin was surprised by the intensity of global competition in the offshore outsourcing industry that this latest study revealed. "Countries [are] aspiring to emulate the success of India and are adopting national policies for attracting the business services outsourcing industry," Lewin says. "China is one example. But other countries such as Chile also recognize that attracting the business services outsourcing industry can be an important new lever of economic development." How Outsourcers Need to Compete in the Future\nWhen respondents were asked which factors were most important to attracting new outsourcing clients, workforce skills and training (63 percent of respondents), depth of industry knowledge (56 percent), and customer service (46 percent) topped the list. \nWhile low costs continued to be an important factor (it was ranked number five), just 38 percent of respondents said it was important to winning new business, compared to 45 percent the year before. \nThe growing importance of skills and industry knowledge is consistent with clients' expectations that outsourcers go beyond labor arbitrage to create real business value, the researchers say. \nThe survey results suggest that the offshoring vendors who've competed on price have a lot of catching up to do. "For India this means moving from a 'body shop' pricing model to establishing value-adding relationships where the provider is initiating and contributing solutions rather than reacting to client requests," Lewin says. "Access to new markets; integration with growth strategy; diversifying their ability to coordinate multiple providers, geographies and functions [have all] become very important." \nAs a result, Indian providers reported shrinking margins over the last three years, while large international non-India-based providers\u2014who tend to do higher-end work\u2014reported three years of growing profits, according to the study. "It is not just a cost story," says Lewin. "It is about being able to offer multifaceted value propositions." Outsourcers appear to be investing in such higher-end services: The CIBER study found that between 2009 and 2010 large providers dramatically increased the number of employees involved in analytical and knowledge services. In 2009, large providers had an average of 213 full time employees working in analytical or knowledge services compared to 1,583 today. The average number of full time employees devoted to product design grew from 125 to 1,476 over the period. And the average number of full time employees dedicated to research and development shot up from zero to 933. \nTo succeed in the future, outsourcers will need to better define themselves rather than try to be all things to all clients. New service offerings, learning how to profitably deliver services to the mid-market, and developing a core competency in delivering from high-risk countries could all be a source of competitive advantage, says Lewin. \n"It is all about differentiation and the business model for going to market," he says. "[The outsourcing market] will increasingly value total process reengineering and optimization. But very few providers can really deliver."