How to evaluate your service providers in 2017

The third-party services industry faces a dilemma over profits and its future path.

quality rating score card
Thinkstock

In a video discussion, General Electric’s CEO Jeff Immelt discussed digital transformation and stated that companies must “either embrace the future or you’ll find yourself not able to satisfy your customers.” Third-party IT and business service providers also face a changing market and are taking steps to align themselves with the new business realities and new market opportunities — which is what brings me to the discussion in this blog post. You need to understand the current debate in the service industry and how the providers’ decisions can affect your company.

Every major company now has an established dependency on offshore vendors in their portfolio mix of services delivery. Noisy public debates are taking place among some providers’ founders, boards and activist investors/shareholders as to which strategy is right for driving their future growth. I recently blogged about this dilemma at Infosys and how it is evolving at Cognizant. The dilemma I described in these posts faces all providers in the Indian services industry.

As I explained in the Infosys and Cognizant posts, the discussion revolves around whether an arbitrage-first vision or a digital-first vision is the best growth strategy. Here is a high-level view of both visions:

  • Arbitrage-First Vision. In this strategy, a provider would seek to maintain the robust margins it has enjoyed from labor arbitrage services. Despite the arbitrage market’s maturity, slowed growth and declining margins, such a provider would try to become a leading player by consolidating the market.
  • Digital-First Vision. In this strategy, a provider would transform into a digital company to create a new source of value for its customers. The new digital business models would involve a new talent base less dependent on labor arbitrage.

Hybrid Strategy. You should keep in mind that most service providers will choose a third option: a hybrid strategy, espousing a focus on both arbitrage and digital. They may tell you they are executing on both while they really execute with a focus on labor arbitrage. I believe firms that try to execute both are likely to fail and then will revert to an arbitrage-first strategy.

Implications for your company

It’s important that your company understand the arbitrage-first and digital-first visions boil down to a choice between current profits versus transformation. It’s clear that all Indian service providers will face increasing pressure to return cash to shareholders, and the firms will need to balance this pressure against their strategy for investing in acquisitions and technology.

As the industry players consider their profitability options, their decisions will shape their investment strategies that affect their customers’ businesses. Therefore, I believe you should thoughtfully evaluate your existing and future service providers against the following framework:

  1. If you work with a provider taking a hybrid or arbitrage-first approach, the provider chooses to focus on its profitability. You can expect the following factors to affect your services:
    1. The focus will be on protecting its margins and gaining more share of the arbitrage market. The provider will attempt to achieve similar margins in the digital area of its “hybrid” approach as it enjoyed in its arbitrage-based business.
    2. Your services will be delivered from an offshore rather than onshore location.

This type of provider might not be your best choice as a digital partner but would continue being a great labor arbitrage partner.

  1. If you work with a provider taking a digital-first approach, the provider chooses to focus on its transformation. You can expect:
    1. The firm will be more aggressive on pricing for digital services.
    2. Pricing will align with digital models, which are more outcome-based and results focused rather than focusing on FTEs.
    3. Your services will have a higher onshore component.
    4. The firm is likely to deploy its cash into investing in technologies, acquiring new digital businesses, transforming its culture and mastering the new digital business models, which will allow the provider to bring you a different kind of team than you currently have in your arbitrage-first team.

As you think about your company’s services delivery portfolio and making provider selections, you will benefit by using the framework above to ensure you use the right services approach for your company’s needs.

This article is published as part of the IDG Contributor Network. Want to Join?

SUBSCRIBE! Get the best of CIO delivered to your email inbox.