The uncertain economic condition has rocked all kinds of businesses, across sectors and regardless of size or specialization. With a global recession underway, the BPO industry cannot remain unaffected. Already the crisis in the financial markets has dampened deal flow in the BPO sector. The number of BPO deals (tracked by ValueNotes) dropped from 430 in the year 2007 to 302 in 2008.

Amid all this turmoil and pessimism, BPO companies are putting up a brave front, and gearing up to face the year with innovative strategies to fight margin pressures instead of worrying over ‘who moved their cheese’.

While the first quarter of 2009 will be slow for the BPO industry, we expect increasing activity in the later part of the year. Cost rationalization will become a compelling reason for corporates to consider outsourcing/offshoring in their strategy.

We have identified some key trends that will impact the industry going forward.

Time to get lean

The immediate concern of BPO providers, irrespective of the size of their business, is to protect their profitability. Thus cost rationalization will become inevitable. The most obvious impact will be on salary hikes and executive perks.

Recruitment too is expected to significantly slow down in the next year, as service providers push up utilization rates aggressively. Aggressive hiring over the last three to four years, has added to the baggage of unproductive manpower. Given the current scenario, companies will look at this as a good opportunity to trim the flab. While recruitment will pick up again in the latter half of the year as the slack gets wrung out, employers will be much more selective and focused on cost-benefit ratios.

Companies will also look to optimize various administrative or marketing costs. Until recently, margins were never seriously threatened for Indian IT and BPO service providers leading to considerable slack in areas like transport costs, procurement, travel, telecom, etc. In the past, management attention was focused only on growth, but now, the quality of growth will matter more.

Focus on newer markets

Currently, BPOs earn a large chunk of their revenues from the US market. However, BPOs are now paying more attention to geographies like Europe, Australia and Asia Pacific. We expect this trend to intensify in 2009 as service providers make aggressive efforts to de-risk their business and diversify their client base. Alternately, the growing maturity of buyers in Europe, Middle East and Asia is opening up these lesser explored markets.

With (relatively) rapid economic growth, proliferation of technology in various sectors and an increasing number of companies going global, Asia is witnessing a marked rise in IT spend. Although Asia-Pacific constituted only a 6% share of the total global IT services market in 2006, IT spend in the region is growing at a much faster rate compared to the mature markets. IT spending is a precursor to outsourcing (of both IT and BPO) and Asia-Pac (especially India and China) will attract increased competition.

India market will shine brighter

Even as the offshore (international) BPO market faces severe pressures, the domestic BPO market is getting ready to take off. According to Nasscom, the domestic BPO revenues are estimated to be $1.6 b (Rs. 69 b) for FY08. ValueNotes’ report on “Opportunities in the Domestic BPO Market”, estimated the total market being catered to by third-party players at Rs. 18 b for FY08, and is expected to reach Rs. 77 b by FY12.

Unlike the overseas business, labor or cost arbitrage does not drive the domestic BPO market. Strategic factors such as the need to scale rapidly, focus on core competencies, enhanced productivity and reduced time to market are driving domestic demand. Going forward, we believe that there will be increased buyer awareness and adoption of outsourcing across industry verticals, which will drive the future growth. Significant scale exists amongst banks, telecom operators and government departments, and these are the most attractive segments in the near term.

Greater focus on the mid-market opportunity

While the larger companies are relatively mature in terms of outsourcing and offshoring, the mid-market segment and the SMEs have not completely explored the offshore option. Further, the SMEs have been traditionally underserved for a variety of reasons, including lack of knowledge of offshoring, unattractive deal sizes for the premium service providers, etc. However, rising offshoring maturity of early buyers amongst mid-market companies will drive their propensity to further intensify offshoring.

At the same time, intensifying global competition will encourage the larger service providers to look beyond Fortune lists. While the larger service providers will build solutions for the mid-market, SMEs may be more comfortable working with mid-sized service providers.

We believe that in 2009, large service providers will create differentiated offerings for the mid-market segment, and target this opportunity aggressively.

Shift in focus from cost arbitrage to value addition

The integration of software and BPO, to what is often called platform based BPO, as well as the emergence of “business process restructuring” into the lexicon of service providers has been underway for a while now. Several service providers are now adding the knowledge component (analytics/legal services/consulting) into the mix, in an attempt to deliver greater value.

This is an attractive opportunity for large service providers (especially IT service providers), some of whom have already integrated their BPO and IT arms. For large end-to-end contracts, knowledge services (typically analytics or consulting capabilities) will become an integral part of the selection process. The knowledge component will enable a more value-added role, in which the service provider partners, or provides services designed to directly impact the buyer's business objectives.

With greater buyer awareness about offshoring knowledge services and increasing service provider capabilities, the share of knowledge services in the overall market will continue to grow. At the same time, the nature of “knowledge” services is quite distinct from traditional IT and BPO, and viewing these merely as additional services may not work. However, that is a discussion for another forum.

Newer opportunities…newer services

Despite the current turmoil, offshoring of services to India and other low-cost destinations will continue to grow, both horizontally and vertically. While the economic downturn has reduced demand in certain segments or services, we believe it will also throw up newer and multiple opportunities across segments. So while certain specific areas will see a cutback, certain other services will witness a noticeable spike in demand. For instance litigation support, document review work within legal outsourcing and collections business within mortgages are among those where we see increasing demand.

Looking at the larger picture, the increasing cost pressures will ensure that offshoring becomes an imperative. Many services that were not offshored earlier will now open up – even as volumes in existing services might shrink. Overall, we believe that long-term growth will be robust.

Sale of captives

Cost control has become a big issue. Given the current economic scenario where everybody is looking for liquidity in the market, availability of quick cash is an attractive proposition. This is an opportunity to monetize investment in captives (for example the recent sale of Citibank’s captive).

These captives will be good prospects for cash-rich and reliable service providers looking to strengthen their BPO capabilities. With captives looking at ways to transform from a cost center to a profit center, we believe that there will be more such deals where captives will sell out their businesses.

Shake-out likely

In the current uncertain economic environment, mid-sized and smaller service providers are worst affected. Many weaker players will start fading away from the competitive landscape. This will include many smaller BPOs and KPOs, especially those with focus on the financial services sector. Service providers offering services to multiple verticals or relatively recession-proof sectors like healthcare will be better positioned to weather the storm.

In line with this trend, we will see accelerated consolidation in the industry. Small service providers will be forced to innovate with a focus on "differentiating" their services and/or partnering with other service providers. A large number of cash strapped mid-sized players will look to exit the game. On the other hand, this is a good time to buy companies, at cheaper valuations, and expand service or vertical offerings.