Insourcing: A Bridge Too Far
News | 20 Jan 2014
As the outsourcing industry has matured over the past several decades, it’s now becoming clear that its original advantages, such as labor cost savings, have begun to fade. In fact, it seems that our laser-like focus on cost has impacted innovation and service quality, and now the pendulum is swinging in the opposite direction. Taking back control of business functions that have been outsourced for many years—a trend commonly known as insourcing—is definitely changing the dynamics of the outsourcing industry, but is it here to stay?
The Outsourcing Center sat down with some frontrunners in the industry to see what’s going on—and what we can expect in 2014 and beyond With the IT outsourcing industry now experiencing its third generation, says Michael Marzullo, Offering Manager, Worldwide Applications Management Services at HP, “the client’s attitude is ‘Outsourcing has gotten our IT stabilized, so let’s invest in strategy and innovation. Our processes are mature, so let’s shift more work to a lower cost center.’” The new deals signed include one with an access equipment manufacturer, while another is a large vendor consolidation agreement with a billion-dollar network equipment vendor. "Our strategies for new client acquisition in the US region have begun to show significant traction helping provide the necessary boost to sales," Zensar Chief Executive and Head (Enterprise Transformation Business) Nitin Parab said.
Prior to 2008 and the global recession, the huge, multi-year IT outsourcing contracts were growing less efficient. Innovation had stalled. As the global economy began to recover from the recession, organizations became obsessive about getting more for their money. CIOs were suddenly expected to deliver far beyond the expectations of the past—with much smaller budgets. According to Vijay Iyer, Senior Vice President and Global Head of Consumer Goods, Retail and eCommerce at HCL Technologies, “When the business pushes on the CIO, the CIO pushes on the providers.” Suddenly, Iyer says, “providers were expected to not only be conversant with all of the intricacies of several technologies in the IT landscape but also have a comprehensive understanding of the organization’s business and consistently show that they were adding a business benefit at a much lower cost.” That’s a lot of pressure for IT outsourcers whose job description used to be keeping systems up and running. Now, they suddenly had to be experts at their customers’ business and continuously improve it with IT. It was a tall order for many, and the landscape changed.
What’s driving the insourcing trend? Enter the insourcing phenomenon. What exactly is it? According to Michael Alfonsi, Managing Director at BancTec, insourcing is essentially skills-based routing of business processes. “Insourcing is appealing if you want to control specialized pieces of your business, rather than entrusting them to someone outside,” he adds. Alfonsi identifies three broad drivers of the insourcing trend. “First, we saw candidates in U.S. national elections accusing opponents of supporting the shipment of jobs overseas,” he notes. “Also, we were suddenly dealing with a lack of labor arbitrage, coupled with flattened technology that enables the distribution of work to anyone, anywhere who is able to do it.” He pegs the third driver as surplus cash. “Companies sitting on a lot of cash began to suspect that they could get a higher ROI by investing in a big, internal project, rather than some other ‘safe’ investment. And that’s insourcing.” Lalit Dhingra, President of North American Operations at NIIT Technologies, declares that “the main reason for the rise of insourcing about three years ago was that quality was suffering in BPO and call centers, mostly due to cultural issues. They were the first functions to be insourced.” Dhingra explains that over time, in big deals where organizations had outsourced very aggressively, they discovered that the quality of certain outsourced functions decreased, rather than increased. “Of course, they were trying to squeeze as much as 70 percent of the cost out of the work, which really pushed hard on the vendors, so quality did suffer.” Another major factor that is currently driving the decision to insource is the fact that the vast majority of those big, pre-recession outsourcing contracts are now winding down. Customers face three choices. They can renew, retain the same provider but demand a reduced rate with higher output and shorter contract duration, or award pieces of work to multiple providers, while bringing some back in-house. “If a company has drawn the conclusion that outsourcing has done more harm than good to certain aspects of their business, it’s time to insource,” Iyer says.
IT outsourcers are receiving a smaller slice of the pie. So how hard is this hitting the big outsourcers? Are they in pain? Gasping for air? Hardly. But they are adjusting their sights, Marzullo admits. “It’s true, we became accustomed to big deals with a duration of seven years or more, whereas now, we generally won’t see contracts longer than 3-5 years. But we’re not really losing business; we’re taking the huge offerings customers wanted previously and adjusting them to scale better to shorter durations and/or decreased scope.” He adds that HP’s response has been to build out some aaS and consumption models, as well as offer tiered services and other types of managed service models. But according to Iyer, the big, “do-it-all” outsourcing companies are losing business as a result of the shift, while smaller, more nimble companies that typically win smaller contracts of shorter duration and lower total contract value are doing well. “HCL has renewed a lot of contracts and won new ones,” says Iyer, but he agrees that “the terms now tend to be 3-5 years, with more modest value, because currently organizations are much more interested in buying specialized services of the highest quality.”
Work that is insourced does not necessarily always come back home. Another fairly recent development is the phenomenon of captive insourcing, in which ownership of work that was formerly outsourced is reverted from the IT outsourcer back to the organization but is not returned to the organization’s home country. In the past three years, some organizations have begun looking for a low-cost destination like India in which to create a captive insourcing unit. As Aamod Wagh, Chief Executive of the Insourcing Services Division of Zensar Technologies, explains, “If a U.S. company creates a captive insourcing center in India, you have instant access to a talent-rich environment that you also can afford, because talent that would cost $150K-$200K in the U.S. could likely be obtained for $30-40K in India.” Wait. Isn’t that outsourcing? It is not, because the resources working in the captive unit become the company’s employees. “Thus, no third-party or outsourcing contract factors into the equation at all.” Cost reduction is not the primary driver for captive insourcing. Rather, the primary drivers are global talent acquisition, clear focus on innovation, business transformation and driving positive business outcomes. Wagh notes that, in a captive environment, “employees are devoted exclusively to the parent organization, managed based on business outcomes and aligned with corporate goals. Thus, their singular goal is to support that organization’s success with focus and commitment.” Captive insourcing is most often reserved for work of a strategic nature. Projects requiring access to sensitive data or intellectual property or those that could have a significant impact on an organization’s top and bottom line require greater control and oversight by the parent organization that does transactional work. Such work might be better suited for outsourcing contracts. “For example,” Wagh notes, “with retailers, innovation is the name of the game. They only remain competitive by making their store omnipresent for their customers with web technologies, rich media, social media, big and fast data, mobile technologies and high-end analytics.” He notes that retailers may be reluctant to turn over precious customer information to a third party, so this model helps keep the innovation function and all allied systems in-house. “If you need to build a highly skilled analytics team with 100 employees scaling to 500 in one year, you may not find them locally at an affordable cost, so captive insourcing solution could be the best solution.” Wagh estimates that there are currently about 450,000 employees and more than $14-$15 billion worth of revenue being generated by captive insourcing units in India.
So does captive insourcing have a down side? Dhingra points out that those captive workers have essentially no growth opportunity, whereas if they work for a big outsourcer, they can broaden their skills by moving to a different vertical or mastering a different technology. “Also, in India, the captive units already took advantage of the tax incentives seven or eight years ago, so the cost savings are now beginning to dry up. Only new business falls under the tax holiday, plus organizations are learning that it takes a disproportionate amount of time to train and manage captives.” Despite that, says Wagh, “There are currently 760 captive insourcing units in India—70 were established in 2012—and approximately 20-30 percent of Fortune 500 companies have set up captive units.” So where are we headed? How will this all shake out in 2014? Dhingra is confident that the big outsourcers will feel a pinch. “At present, most of them don’t even know how to do a small deal. They’ll be forced to change their expectations, modify processes, consolidate, and maybe buy other companies to acquire specialized skill sets—because the days of the long, multi-year contract model are over.” Iyer points out that many CIOs have begun to adopt collaborative sourcing strategies that enable clear demarcation of retained, collaboratively performed and outsourced functions. He adds that, “HCL’s co-sourcing model balances the CIO’s need for cost savings, higher control and better visibility, while allowing adjustments for changing technologies or business needs.” Marzullo predicts that we’ll see a lot of CIOs learn a lifecycle lesson the hard way in the next couple of years. “They’ll maintain a stable environment for a while, but ultimately, they’ll be right back in that first-generation boat: their user base will grow, their data volume will grow and their systems will stagnate. So it’ll all come full circle.” Marzullo adds that unless organizations have invested in the skills and expertise to maintain best practices, master knowledge of new tools and migrate to them at the right time, “that bubble of IT chaos will just get bigger and bigger. Plus the CIO’s lifespan is shrinking, so in about three years, the current CIO will be gone, and the new CIO will scurry to address the inherited gaps through outsourcing—and that may look and feel like a first-generation outsourcing engagement.”
Déjà vu all over again. What’s going to matter most to organizations pondering an insourcing vs. outsourcing decision? “Organizations in 2014 are going to identify the cost of mediocrity and error and factor it into their decision,” says Alfonsi. “Skills are going to be the value going forward, as in ‘I want the right skills no matter where they are, I want them at the lowest price and I want the best quality,’ as opposed to ‘I just want it cheaper.’ We’ll see people insisting on getting it done right and achieving a high-quality result.” Iyer flatly states, “The only way you can continue to compete going forward is by impacting the business. HCL has developed a new value proposition called ‘alternative application support and maintenance’ or ‘ALT ASM.’ Iyer asserts that ALT ASM kills two birds with one stone by proactively reducing support spend and simultaneously impacting the business performance. Marzullo also points to HP’s Predictive Pricing and Business Outcomes models: “They provide transparency into why application support costs what it costs and directly link IT processes to business results, so clients can readily recognize the value they’re getting and quickly adjust support as the business changes. So I expect what we’ll see in about three years is a lot of renewals and expansions of these shorter, more nimble contracts.”
What else is coming? Alfonsi predicts that the roughly two percent of companies that currently insource will double, going to 3.5 or 4 percent in 2014. “That’s not a big climb overall—if we saw it jump to, say 6-7 percent in 2014 going into 2015, that would be a trend worth watching. Of course, to an outsourcer, it’s definitely significant in terms of lost or renegotiated contracts." Dhingra believes that “since a mature, captive insourcing unit doesn’t provide the cost savings or tax benefits initially expected, we’ll see a lot of captives sold in 2014-2015—organizations will offload entire captive units to big third-party outsourcers.” Wagh completely disagrees. He feels strongly that “by 2020, every Fortune 500 company will have a captive unit in India or some other location.”
The good news is that the insourcing trend is opening the door to a new kind of job skill: Alfonsi predicts that “the financial planning and analysis skills that can accurately cost out the comprehensive business case of insourcing vs. outsourcing will be in very high demand the further we go into 2014.” In the end, all of our experts agree that going forward; contracts will be structured to guarantee specific business outcomes. An IT outsourcer will be expected to clearly demonstrate the value of IT in enabling the business, rather than simply restrict itself to keeping systems up and running or taking less than ten minutes to fix them. That’s how outsourcing companies can expect to be measured in 2014, and if they don’t measure up, they may hear their customers say, “We’ve decided to insource.”