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CHAPTER 6: THE IMPACT OF GLOBALISATION ON ICT DELIVERY - OFFSHORING AND GLOBAL SOURCING DELIVERY - OFFSHORING AND GLOBAL SOURCING

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Service Contract

CHAPTER 6: CHAPTER 6: THE IMPACT OF GLOBALISATION ON ICT DELIVERY - OFFSHORING AND GLOBAL SOURCING DELIVERY - OFFSHORING AND GLOBAL SOURCING

Introduction

The provision of services from locations in other countries (the core definition of offshoring) is not a new phenomenon. In fact, the importance of offshoring as an element in a global strategy was already mentioned by Stopford and Wells (1972). Essentially, there are two approaches to provision of services from locations in other countries, either through outsourcing the provision of the service to an external service provider or through an organisation setting up its own service operations in other countries and managing these as remote service sites.

The latter approach is typically termed a captive operation and was especially popular in the airlines and financial services sectors during the 1990s. As examples of this, American Express started offshoring various back-office processing tasks to India in 1994 and GE Capital followed suit by opening its GE Capital International Services (GECIS) division in India in 1997 (as an aside, GECIS was sold to private equity in 2005 and is now a third party offshore service provider called Genpact. Many other organisations have followed suit since then and sold off captive operations to external service providers). In the past decade or so, delivery and shared service centres in lower cost European countries, such as Poland, Romania, and the Baltics have also been established as Western European companies, as well as Indian service providers, have realised the benefits of these in terms of cultural affinity, language capabilities and time zone alignments.

As for offshoring via external service providers, this really only took off in the very late 1990s. During the 1990s, an important part of the business of many service providers or service divisions of large ICT vendors was delivering "turnkey" projects, where a large proportion of the work was software development, IT customization and integration work.

This work was typically undertaken by locally based consultants and specialists and delivered under fixed price/fixed time agreements. Another important part of the business of many vendors was to provide lower-level support functions, such as hardware break-fix and different levels of software support - again typically quite "people heavy" processes.

Outsourcing at the start of the 1990s was still at its infancy with low adoption levels across many European countries but with the UK leading the trend. These outsourcing engagements were also typically fulfilled using locally based staff, frequently transferred from the outsourcing organisation to the service provider. Towards the end of the decade, many large international companies began experimenting with getting some of all this work, mostly programming work, undertaken in India (as a continuation of the captive wave described above).

However, at the start of the twenty-first century, several factors came together to create the perfect storm that set the foundation for ICT and business process offshoring, which today is part of the global sourcing value chain. Against a backdrop of a busted economic bubble, a

"discredited" IT sector following the dot.com era and the Y2K debacle, and anaemic US and European economies, customers were looking to find ways to lower IT services and processing services costs. In addition, improved communication technologies and price points enabled the offshoring trend.

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While service providers responded by expanding the types of services they would undertake, some also started to establish or acquire, in particular, Indian operations to enable them to offer lower cost services through labour arbitrage. In addition, these extra geographical footprints also enabled them to offer "follow the sun" development and support processes, whereby employees would work on a project in Europe or the United States during the local daytime, and at night, work would pass to offshore-based colleagues, mostly in India but increasingly also in the Philippines, Malaysia and Latin America. Due to language capabilities, this trend benefited especially English and Spanish speaking economies. These changes opened new opportunities for offshore headquartered – again spearheaded by India – companies to address Western customers directly. What was later called the offshore industry was born.

Offshoring in the past decade

While initially the key driver for offshoring was to reduce cost, this has quickly developed to include other objectives. Consequently, the types and scope of work that is offshored is becoming more complex, but with cost savings as an expected outcome. Figure 63 below, adapted from IDC research (Gere, 2003) illustrates these customer needs and the skills and expertise that are required to fulfil these needs at a high level.

Figure 63: Enterprise objectives and offshore skills needed (Source: Adapted from IDC, 2003).

Figure 63 shows that there are two main types of objectives that are driving the use of offshore resources: operational efficiency (i.e. the ability to operate some status quo aspect of the business at lower cost to improve business efficiency) and transformation (i.e. changing aspects of how the business is executed to gain both cost and performance advantages).

Another determinant factor for the work, and hence the skills that are needed offshore, is the complexity of the processes that are offshored. The simplest form of offshoring is a low complexity process where the objective is purely to gain operational efficiency. This is labour arbitrage and is where most offshoring activities were aimed at the outset.

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However, as service providers have become more experienced in running offshore operations, have developed better tools, improved delivery processes (e.g. through CMMI certification), and increased their ambitions, increasingly they have taken on driving operational improvements of complex processes and transforming and standardizing processes for their customers.

A perfect analysis of these changes is difficult to undertake, since much of the work that has been done in offshore locations over the years has been "under the radar". Reasons for this are typically that the customer has been worried about the potential image repercussions of

"moving" jobs offshore – or simply because the offshore element has been an integral part of the full delivery in a global supply chain (see Skills in the Offshore Value Chain section below). Grossman and Rossi-Hansberg (2006) also describe the difficulty in documenting the extent of offshoring but with a focus on how official statistics on imported inputs and outputs, for example, do not disclose the levels of detail needed to understand the extent of offshoring.

This leads to the question of how to assess the extent of offshoring, the types of activities that are most affected and, hence, the types of skills that are impacted. It is important to underline that this study considers full-time, part-time and free-lance employees - the starting point for the study is the demand for offshore ICT skills - no matter (at the outset) how these are sourced. Since the data on offshoring cannot be obtained directly, two possible approaches to assessing this are suggested – both with their limitations – but they will at least provide indications of the type of activities that are being offshored:

 Analysing publicly available services contracts in the past decade to establish when services are delivered from offshore and the type of services that are affected. The limitations of this analysis are that it pertains to external engagements (i.e. not captive services delivered offshore) and only to contracts that are in the public domain.

However, the source for this analysis (IDC's BuyerPulse Deals Database) contains more than 27,000 contracts signed in the years 2002-2012 in Europe and North America – the most important regions for analysing the offshore phenomenon.

 Analysing the revenues of the major India-based offshore providers to understand how these are segmented by different types of services and how they have developed over several years in order to establish a trend and set a basis for discussion of how this may develop in the next decade. The limitation here is that the analysis is focused only on the India-based offshore providers and does not include a view of the services delivered from offshore by major, Western-based companies, such as Accenture, IBM, HP, Capgemini and CSC – all of which have extensive global delivery networks.

However, since these companies do not report a segmentation of their revenues into offshore versus onshore delivery, including these players in the analysis is not possible. There are, nevertheless, other data points that show the extent of the major Western-based companies' offshore resources and how quickly these are growing. As an example, Accenture has approximately 80,000 employees in India (nearly a third of its workforce) and 35,000 in the Philippines and the company is expanding these numbers (Tejaswi, 2012). Another example is IBM, which reportedly has more employees in India (125,000) than in its US home base (100,000), (Mishra, 2012).

However, even with the abovementioned limitation, the analysis still provides supporting evidence of the trend.

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Offshoring – analysis of contracts

When isolating the publicly available contracts signed in Europe and North America in the ten-year period from 2002 to 2012 and where offshore delivery was a reported part of the engagement, out of the 27,000 contracts only 684 contracts at a total contract value (TCV) of approximately €76 billion explicitly mentioned an offshoring component. This indicates that the extent of offshoring in external service engagements relative to all service engagements has been quite low. However, it is likely that there are more contracts with offshore delivery but the customer has not been interested in this information reaching the public domain due to possible backlash (Mankiw and Swagel. 2006). Nevertheless, it is still possible to see trend developments from this number of contracts.

IDC captures and classifies contracts based on the main reason for the engagement in what is termed foundation markets (there are 14 foundation markets, such as IT consulting, systems integration, and IT outsourcing), as well as several sub-markets. However, an analysis at this level would be too detailed to show trends. Consequently, for this analysis the contracts have been grouped into five categories, which are also relatively aligned with categories used by others studying the offshore market, such as The Conference Board (Lewin et al, 2009):

Applications: includes Custom Application Development, Application Management, Hosted Application Management, Software Deploy and Support, and IT Consulting and System Integration contracts where the main purpose is design and implementation of application solutions

Infrastructure: includes Information Systems Outsourcing, Network and Desktop Outsourcing, Network Consulting and Integration Services, Hosted Infrastructure Services, Hardware Deploy and Support, and IT Consulting and System Integration contracts where the main purpose is design and implementation of hardware or network solutions

BPO: includes HR, Finance and Accounting, Procurement, Customer Care and Industry-specific Business Process Outsourcing

Innovation: includes R&D, and Product Engineering

Other: includes pure IT and business consulting engagements and IT education and training services

It is important to note the following:

 Contracts for growth areas, such as Big Data, mobility, social, cloud (the four pillars of what IDC calls the 3rd Platform) and security will typically be captured in either Infrastructure or Applications, depending on the nature of the undertaking. For example, if a customer wants to build a private cloud infrastructure in the company's data centre, then this could be done either on a project basis (IT consulting and/or system integration) or during the course of an outsourcing engagement. On the other hand, if the customer wants to prepare and move the company's application environment over to the existing cloud infrastructure, then this could be done either on a project basis (IT consulting and/or system integration) or during the course of an outsourcing engagement.

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 A contract is captured only once in one of the categories so that there is no overlap between the five groups. If a contract is complex in nature and spans several categories, the contract has been placed in the "bucket" where the biggest part (from a value perspective) of the contract belongs.

 A contract is only counted or valued in the year in which it is signed. Hence, a four- year contract, for example, is counted only in year one.

 The analysis below is based on number of contracts rather than value of contracts. The reason for this is that it is difficult to establish from a value perspective the proportion of a contract that is offshore delivered. In some contracts, this would be only a fraction of the contract value (such as in a data centre outsourcing contract) whereas in others it could be most of the contract (such as in a custom application development contract). Hence, a value-based analysis would show a more skewed picture than analysis based on the number of contracts that have offshore delivery elements.

o To illustrate this, in value terms, the TCV of Infrastructure contracts represents the largest proportion of the €76 billion of total TCV for analysis (€33 billion), followed by BPO (€27 billion), Applications (€14 billion), Innovation (€1 billion) and Other (€26 million).

o In terms of number of contracts, the largest portion of the 684 contracts is Applications (267), followed by BPO (212), Infrastructure (174), Innovation (26) and Other (5).

In order to see the pattern of the type of work that is most often offshored over the period, the proportions that these five segments constitute of the total number of contracts in a given year have been calculated. The result of this analysis is shown in Figure 64 outlining contracts signed in North America and Europe. As can be seen, application-related work is the most common for offshore work. This harmonises with where the offshore trend started (see above). However, over the years, there has been an increased tendency towards infrastructure- related work and business process outsourcing so that, relatively speaking, there was little difference in the proportion of contracts for these three segments in 2012. Innovation and

"other" consistently account for the smallest proportion of contracts over the period.

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N=684 contracts signed in North America and Europe. Source: Analysis of publicly available contracts in IDC's BuyerPulse Deals Database, 2013

Figure 64: 2002-2012 North American and European contracts with offshore elements by type of work

Figure 65 is focused on contracts signed in EU countries only and presents the cumulative percentage of contracts by type of work over the period. It is also clear here that applications- based engagements represent the majority of contracts with offshore elements and that both infrastructure and BPO contracts have been increasing their share (even if the share of BPO contracts has tapered off towards the end of the period). This picture is in line with findings from other sources (Lewin et al, 2009), hence validating the approach.

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N=402 contracts signed in European Union countries. Source: Analysis of publicly available contracts in IDC's BuyerPulse Deals Database, 2013

Figure 65: 2002-2012 Contracts signed in EU countries with offshore elements by type of work

As discussed above, when considering contracts signed with Western-based service providers, the offshore elements can be a small proportion of the overall engagements, or they can be the main delivery approach. However, if looking specifically at contracts with the India-based offshore providers (where typically minimum 80-90% of the delivery is offshore), some interesting variations emerge as shown in Figure 65. Firstly, applications-based contracts represent a higher proportion of the overall contracts, which fits well with the heritage of the majority of the Indian offshore providers. Secondly, it is clear that infrastructure and BPO are becoming a higher proportion of the overall number of contracts for these vendors, which is also in line with the strategies that the vendors are pursuing. Many of them are boosting their skills and increasing the offerings they are taking to market in these areas as they are trying to be perceived as more full-scale service providers competing head-to-head with the major Western-based service providers. In particular, capabilities in the Infrastructure space have been seen as a weakness in their service portfolios. Finally, innovation represents an area targeted for growth for the Indian vendors. For many of the vendors, R&D has been a business line from the start, pulling heavily on the large number of master degree level (or above) skills available in the Indian ICT labour market. This is also reflected in Figure 66 below, where it can be seen that Innovation is a larger proportion of contracts for the Indian vendors than for vendors overall.

N=228 contracts signed in North America and Europe. Source: Analysis of publicly available contracts in IDC's BuyerPulse Deals Database, 2013

Figure 65: 2002-2012 Contracts with Indian vendors by type of work

Figure 66 shows the comparison between the types of work undertaken by India-based providers compared to all vendors in the analysis, underlining the dominance of application-

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based work in offshoring.

N=684 contracts signed in North America and Europe during 2002-2012. Source: Analysis of publicly available contracts in IDC's BuyerPulse Deals Database, 2013

Figure 66: Comparison of type of offshore work in contracts with Indian vendors and all providers, 2002-2012

Revenue analysis – top India-based offshore providers

While the above analysis has been focused on number of contracts, it is also useful to look at the relative amount of money spent on offshoring of the different segments. As part of its on- going research into the global IT and business services markets, IDC tracks and estimates the revenues of hundreds of services companies worldwide, among which are the major India- based offshore providers. So, when looking at the aggregate revenues of these vendors, does the picture and the trend change? This could be the case if, for example, the application-based contracts were all of smaller sizes than, for example, the BPO contracts.

Figure 67 shows the proportion of the aggregate worldwide revenues of the top Indian offshore companies generated from application, infrastructure, BPO and "other" engagements (innovation is included in the "other" category as no further splits are available). It is clear that application-based engagements represent the lion's share of the vendors' revenues, albeit declining slightly over the period to represent just over 60% in 2012. The proportion of revenues from BPO and "other" is stable over the period, while infrastructure is increasing slightly.

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Source: IDC analysis of reported revenues by leading offshore providers: Cognizant, HCL, Infosys, Patni, Tech Mahindra (incl. Satyam), TCS, and Wipro. Aggregate revenues of $40.6 billion in 2012

Figure 67: Worldwide revenue distribution of main offshore providers by type of work, 2006-2012

This representation shows the relative value of the types of work. A look at the absolute values and the development in these provides an indication of the uptake of offshoring over the period. Figure 67 shows this analysis but for European revenues only. As can be seen, the aggregate revenues of the India-based providers has increased rapidly in Europe from 2006 to 2012 at an average annual growth rate of 17%, while the overall IT and business services market in the period declined by 1.5% according to IDC data as a consequence of the economic crisis. However, to put it into perspective, in 2012 the aggregate revenues of the India-based providers reached an estimated €7.4 billion, while the total IT and business services market was valued at €212 billion according to IDC estimates, hence they represented only 3.5% of the market. Application-based engagements represent almost 70%

of the India-based providers' revenues in Europe, higher than the worldwide proportion, while BPO is slightly more favoured (7% of revenues compared to 4% worldwide in 2012).

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