After all right from the very beginning, both the models have existed – insourcing in India (popularly referred to as captive organizations), and outsourcing to Indian outsourcing service providers (over the years include the offshore operations of the global IT majors as well). It was probably evenly spread in the late 80’s and the beginning of the 90’s. Then when Indian IT industry grew rapidly, there was a significant shift to the outsourcing model – we probably have had close to 80 % – 90% with the IT outsourcing providers and the rest with the captive organizations.
So every now and then when a CIO of any major corporation makes a call to insource, there’s a discussion on this. Given the size of the Indian IT service industry, it makes headlines. Recently when the retain chain Lowe decided to insource, it again hit the Economic Times headlines. Along with that you would hear some service industry leaders saying this is a one-off instance.
The last twenty years have been dominated by the IT outsourcing providers. We all know that twenty years is a very long period in the tech industry for anything to stay on. In many ways, I believe there’s a lot of similarity between the fashion industry and the tech industry. [More about that in a future blog.] So, it would be worth looking at the whether insourcing could increase in share and muscle going forward, at the expense of the IT outsourcing majors.
So first let’s look at the major factors that help an organization (or a CIO) make a call on when and what’s to be insourced or outsourced:
- Is the IT service a differentiator for the business, at this point of time?
- Does outsourcing bring about significant cost advantage?
- What do prospective employees look for? Where do they prefer to build their career?
- Is the need for the people permanent or is it a surge/ spike?
- If you outsource, can you have a well defined contract?
- Are there possible disruptors, to the IT service majors, in the market?
So, instead of just responding to the headline, let’s look at how each of these factors are panning out currently.
IT services – Is it a differentiator?
If you look at the systems with a customer – you could bunch them into three broad categories:
- System of Record
- System of Engagement
- System of Experience.
The system of record is your core systems – be it your ERP, payroll, accounting et al… It could also be parts of some of the other systems, like CRM, SCM. If they are fairly clear and there’s no major innovation going on in those systems, then quite likely there’s a business case for outsourcing.
When it comes System of Engagement – each of them could have their own nuance. So, in a CPG company, it may have specific ways in which the extended supply chain is working with a traditional retailer. like Wal-Mart in one way, and with an online retailer, like Amazon, in another way. This interaction could be dynamically changing. The CIO probably does not want those nuances out. There could be other systems like the core CRM, where there’s defined way of working, so it may be amenable to outsourcing.
When it comes to System of Experience – whether it’s your Marketing team going Digital, or if the business is shifting to As-A-Service model, or looking at social media and responding to the micro markets, on a real time basis – an organization could know this is the real differentiator. So if you are building a true customer experience and want to manage it effectively as a differentiator – you are quite likely to not outsource it. You want absolute control, minimal leak of knowledge to competition. However, you may need a help of some high-end experts who can help you plan, strategize and define these.
So, given that the IT investments are significantly shifting to the differentiators – This factor favours insourcing predominantly.
Is there a cost advantage?
All of us who know this industry, are well aware about the great Indian pyramid model. With constant increase in IT/ technology work from India, the majority of this growth in the pyramid could not be sourced from other industries. [There have been exceptions – but the poaching from other industries contributed to only a small percentage]. With a 20x – 25x growth in head count over the last twenty years, the industry had to take fresh campus hires, train them and handle the growth that came their way.
So if the industry hired 10K campus grads this year, it would be 12K next, 15K, 20K, 26K, 33K…. and so on over the years. So if they came in as Programmers, the existing Programmers would move up to become Analysts, the Analysts would move up to Sr. Analysts and so on.
With such a wonderful model, the Indian IT service industry was able to keep the cost fairly constant.
When you look at the captives (or insourced organization), they would have scaled up in the beginning rapidly. After that, they would have reached the peak head count. So invariably, there ability to add at the bottom of the pyramid would rapidly diminish. When that started to happen, they would slowly start move from the pyramid to a cylinder or even a diamond at times in the organizational shape. Any such model would result in a higher cost, compared to the pyramid.
This could explain, why many an organization, found that a captive was not viable after a point of time. So they even sold them to the service providers – who were good as chiselling the diamonds and cylinders back to the pyramid!
Now, let’s see what’s the change that’s happening? The breakneck speed of growth, is coming down, in the IT outsourcing services industry. So the addition of head count at the bottom of the pyramid is not increasing (though it’s happening at the same level as the prior years and some times it could be a little lesser too.) The best indicator is the fact that the average age in the industry is steadily increasing.
What does this mean – the bottom of the pyramid is turning into a cylinder. Could it eventually become a diamond? This would eventually mean that the cost advantage of an outsourcing service provider is starting to move away (especially for those CIOs who have large teams – 1000+).
The CIO now looks at the additional costs that the IT outsourcing vendor charges – for the vendors’ Sales and Marketing, for their need to manage the contracts, for possibly keeping a bench, and the industry margin of say 20%. Why would she/ he want to pay that any more. Would it be better for the CIO to spend a little more on his captive staff – which can help him in retaining and motivating them more… and still have some money saved.
I think, this value proposition is getting eroded slowly. So, this factor, in the case of large corporations, can start veering towards insourcing.
So, what’s the employee perspective?
Imagine, you are getting out of a Bombay suburban train at peak hour in Victoria Terminus (this would be like the time when the campus folks finish the graduation). All you had to do was stand in the right direction, and you would be moved along, with no effort (this was akin to just getting a decent performance in college and attending the right interview – you would land a job with an IT major).
Then at the end of it, you were placed at the foot of an escalator (This is the bottom rung of the organizational pyramid). Just standing stable, you would progressive move up (akin to moving up the pyramid). If you were energetic, you could climb up a moving escalator (some of them who were on the fast track) and you reached the heights even quicker.
So, when you look at the growth the IT outsourcing industry went through in the last two decades it
was a no-brainer for many of them to join the service industry to grow.
The Indian IT service model was simple and elegant (at least as long as it works). You hire a set of young college graduates, put them through a rigorous training. Soon they were enthusiastic to show their prowess at work at the entry level. They served a couple of years at the entry level. In the meanwhile, with the growth we saw, there were even more college graduates hired with every passing year.
So everyone with 2 years experience, became a senior pro. Then those with 5+ literally started to manage the teams. At 10+ you were running large customers, multiple groups. The industry grew at over 20% CAGR for a good 15 years.
So the IT service industry was able to absorb the huge growth, thanks to the large number of folks graduating from the colleges (even after all the issues with the quality of education, we still had a large enough population available). Because of the growth, the pyramid never changed it’s composition. (We had the same ratio of the pyramid). At the same time, the growth was ensuring that the experienced folks were getting pitched into managing a team, then a project, a program, a customer… and so on.
I guess that era is slowly fading away.
So it’s moving to an era, where people are getting the opportunity to work on a focussed area. They have the time to make a difference. The measure of the pyramid that you manage, is starting to lose out as the driver. Also the risk of the folks in the middle of the IT services organization pyramid is increasing, rapidly.
Now the bottom of the pyramid is not increasing that rapidly. The folks are starting to age longer at each level. So the opportunity is getting similar to the captive organizations. When captive organizations pay better (typically), and the opportunity for growth is getting similar – there’s a case for employees to actively consider captive now.
Surges and spikes
This will always exist as an opportunity. But, most large service providers – agree to do this, only because they see this as part of the bigger outsourcing opportunity, or see this as an opportunity to penetrate and capture the larger pie down stream.
Otherwise, this would turn back into the “old body shopping” business. Clearly the margins will be low in this business and the uncertainty of the opportunity would not make it attractive to the IT service providers.
However this opportunity will always exist for service providers. Whether it stays with the IT service providers or gets more actively filled through the manpower agencies, will be difficult to say.
What’s happening to contracts?
The opportunity for the contract was large – with the work that was needed to “Keep the Lights On”. Additionally the traditional way of delivering – meant the scoping was done up front, so it was possible to price with a certain element of risk factored in. We saw the likes of TPI and others advice the customers on how to structure the contracts and SLA.
With all the automation going on in the “Keep the Lights On” business, the work is coming down rapidly. Yes, the margins are going up. This will still be an opportunity for the Indian IT outsourcing service providers, albeit a smaller business than earlier.
However, when you look at the newer systems being developed – Agile and DevOps are becoming the way of life. In this approach, signing a contract with the price fixed is not practical. So increase in the overall program costs – whether attributable to the customers never ending change or the vendor actively abetting changes to “drive more revenue” can become very debatable. So contracting in these cases is going to become more challenging, unless there’s a very high level of trust between the customer and the vendor.
Disruptors to the IT Service Majors
Nothing is permanent. It’s more true in the IT/ Tech industry. The Indian IT service industry for too long has worked the pyramid out. It has been good at continuous improvement, but the question of break though innovation has always eluded it.
However, with a whole range of next generation start up making their presence felt, there’s every possibility of these focussed niche players disrupting the IT service majors. These organization are small, nimble, focussed with few people. So, when they bring their solution to bear on a customer’s need – they are quite likely to significantly alter the business of the traditional IT service majors.
Unlike the earlier occasion, this time around the challenges of a resurgent insourced captive is definitely high. The savvy CIO, could insource “the future” of his business into his captive organization. At the same time the CIO could still leave the legacy work with the service provider, till such time it’s ready for a sunset. Or for that matter, could still use a IT service provider for “Keep the Lights On” business, after automating and reducing the recurring spend on it.
With newer ways of working – Agile and DevOps, running a captive could potentially make it more easier and aligned for the CIO. If a few of the CIOs get their strategy and execution right early on, the trend could pick up momentum thereafter.
Also the next generation start up companies are already becoming visible. By their sheer daring and break through solution, some of them are already getting embraced by the CIOs. Every one of these, will definitely make a dent on the IT service providers. Employees are starting to embrace “value” in the work as a measure of growth, rather than “the size of the pyramid” they command!
Just relying on past history, could make them also a part of history soon. Or just giving a positive “spin” about the advantages of outsourcing, which has worked in the past may not work. Nor the fear of the past captive entity issues, will suffice – in the changing world. Nor is the fear of the unknown brand – with the next generation start up going to sway many a CIO, who sees disruption as the better alternative to the slow and steady change of the service provider.
This time around the Indian IT service industry is no longer small, to make a quick about turn. It has become a very large ship. So the effort to change is substantial.
Yes, Indian IT service industry has done a wonderful job. It has probably accomplished more than any other industry in a short period of time. At the same time, yesterday is already history. So the need to relook at the paradigm for success is paramount. The change is going to rear its head rapidly without a lead time. It’s time for the IT service providers to seriously rework their strategy and execution to succeed in the changing world.
As far as the insourcing trend is concerned, on the face of it – the strategy definitely looks good, based on the reviewed parameters. The key lies in ensuring that execution stays aligned with the intent of the strategy. Otherwise, it could turn out into a costly exercise of moving back and forth.
It’s time for the IT service providers to see how they can pro-actively address this emerging trend.
Whichever side of the fence, you are – how do you see the future evolving? What are the risks on either side? Looking forward to hearing the various perspectives.