Although it sounds clichéd, the BPO industry is maturing and innovating at a frenetic pace. While the traditional 'low-cost' driver for offshoring will remain a big factor, forward-looking vendors and buyers are now moving towards 'strategic sourcing'. Even as large firms enthusiastically embrace the "globalization" of delivery capacity, there is a distinct move towards more innovative service offerings within established vertical practices. ValueNotes looks at some of the key emerging trends and how these might play out in 2007 and beyond.

Increasing margin pressures to affect Indian vendors

So far, Indian outsourcing rode the value proposition of significant labor cost savings. However, the easy returns for industry pioneers has led to an explosion of service providers, and those ready to provide funds to them. This will result in services getting commoditized at a more rapid rate than most anticipated. Coupled with an adverse exchange rate (Rs/$) trend, and rising wages (and attrition) this is likely to lead to decreasing margins for many Indian vendors. While this has long been visible in low-end, traditional BPO processes, commoditization will quickly becoming a reality even in relatively higher value (KPO) services.

To meet the challenge of margin pressures, vendors will aggressively innovate within their existing service offerings and across a wider range of services, to enable "differentiation".

Large BPOs will play the "Transformation" Card

Though most large BPOs already offer a range of higher-end and knowledge services, and will continue to widen their range of offerings; going forward, consulting led "transformation" and process re-engineering will become the key differentiator for large providers. Already, across the spectrum, from pure play BPOs to the IT-owned BPOs, the marketing language of firms like EXL, Cognizant, Infosys and others now address "transformation" and "re-engineering" to lower costs and raise productivity - rather than mere labor arbitrage opportunities.

The accent will shift from, "I can save you money because of cheaper labor" to "I can save you money by doing it smarter". This trend will take offshoring and outsourcing from the discrete provision of varied services at a lower cost to a more holistic delivery of integrated services that "create value" for the buyer. From the vendor perspective, this implies far greater investments in technology, process knowledge, regulatory compliance and global delivery. As a result, the larger companies will keep racing towards greater and greater size to achieve scale economies.

This will create a marked differentiation between the capabilities of Tier-1 and Tier-2 players who can make the switch, and small and mid-sized BPOs offering discrete generic services.

Specialization amidst growth in the "Knowledge" Space

One of the available options for smaller companies will be to specialize so that they can charge higher billing rates. Successful players will be able to position themselves as good acquisition targets, or even, exist profitably as a boutique firm. Fortunately, the explosion of opportunities in the knowledge services will create plenty of new niches.

Even as knowledge services grow in maturity, we are poised to see the introduction of a much wider range of new services being offered, along with very focused and specialized vendors. As the globalization of services takes root in the new 'knowledge economy', numerous new opportunities (in terms of new or differentiated services) will lead to the creation of a large number of new 'niche' providers.

These niche players, typically small, start-up companies will be born out of continuous exploration of new markets and verticals, as they evolve along the outsourcing value-chain driven by the continuous need for cost-cutting and value addition. In parallel, many of today's niches will become much more mainstream.

For instance, in December 2005, when we released our report on "Offshoring Legal Services to India", there were only a handful of service providers in this area. But in the past one year, a large number of new entrants has meant that we now have more than 100 service providers. With many more expected to enter in 2007! This trend will play out and gather steam in 2007, across a wide range of "knowledge" services including engineering design, investment banking, pharma R&D, analytics, logistics and many others.

Within these broad areas, though the offerings of most entrants are likely to be "undifferentiated", a significantly large number of firms are moving rapidly towards "differentiation" and specialization. This trend is most visible amongst analytics firms, many of which are positioned in very well defined niches, for instance analytics for pharma marketing (MarketRx), banking (Fractal Analytics, Copal Partners), HR (Kenexa), Telecom (GSG).

From Indian to Global…

Indian vendors are aggressively working to minimize their over-dependence on India, as well as build a strong global front-end. The trend towards rapid creation of delivery and marketing capacity across the world will ensure that Indian providers will start resembling global tier-1 providers. In parallel, the global giants are rushing to expand India (and other offshore) capacity.

Already India-centric IT firms like Infosys, Cognizant, TCS and Wipro are beginning to look like Accenture, EDS, Cap Gemini, etc… even if they're still much smaller!

This globalization of Indian vendor capabilities will be under-pinned by an increasing appetite for M&As. Interestingly, the money for all this will be provided by global equity and private equity investors. WNS and EXL now have market capitalization's that make for some serious $ currency that can be leveraged for acquisitions.

Even a start-up like Quatrro BPO raised $100 million from a private equity investor, and while other deals are not as large and high-profile, there are plenty of investors looking to buy into the India outsourcing story. This trend highlights the growing strength of the Indian vendors: driven by the cash to shop for acquisitions around the world.

Brand Philippines to add 'knowledge' to its offerings

The now $2.1 billion Philippine BPO industry originally made its presence felt in the call center space. However, the image of the 'Philippine brand' in the outsourcing space is rapidly improving and we believe that from 2007 onwards the country will emerge as a serious contender in the knowledge services space. Even if the breadth of offerings and industry scale do not match those of India, in several niche areas such as legal publishing, legal research and animation services, Philippine vendors are likely to pose a serious challenge to Indian players.

Scalability is not so critical in many knowledge services, where the primary requirement is the availability of high-quality, skilled professionals. Given that Philippines has some natural advantages in greater familiarity with the US legal and financial systems, India's looming talent shortage (and rising wages) will force buyers and vendors to diversify - and Philippines is well positioned to pick up the slack. The next few years are likely to be an exciting growth period for the Philippines BPO sector with a new 'knowledge tag' to the country's image.

Interestingly, much of this Philippine capacity creation will be driven by Indian and North American vendors, as these players currently have the most money to invest! While a large number of locations will vie to take advantage of India's rising costs and buyer's needs to diversify risk, we believe that Philippines will be one of the biggest beneficiaries.

Towards Hybrids and the "Global supply chain" in services

Globally, businesses are facing greater complexity in terms of increasing cost pressures, stricter regulatory compliance, reducing time-to-market and rising customer demands on the quality of products and services. The typical captive or third party outsourcing / offshoring arrangement in isolation has worked well to lower costs, but has been unable to deliver on all the strategic goals.

We believe that going forward, organizations will continue to seek greater balance between the risks and value-proposition offered by the two "extreme" models (captive and third-party), towards greater "hybridization". We have already seen evidence of a variety of 'hybrid' operating models emerging in the recent past.

In 2007, we will see companies increasingly experiment with arrangements such as multi-shoring, multi-vendor contracts, new engagement and risk-sharing models: all with the aim to maximize labor arbitrage as well as enhance value creation. From shared services to Build-Operate-Transfer, from unbundling of contracts to the concept of a lead integrator, from fixed price to risk sharing; buyer and vendors are scrambling to find new solutions.

There is no "perfect" solution, but in fact, outsourcing is moving towards a "global supply chain", similar to models that exist in manufacturing. This presages that in future, outsourcing decisions will be taken more strategically, and less in a piecemeal manner. Multiple sourcing models (increasingly hybridized) and an improving and widening array of options in terms of locations and vendors; will enable buyers to leverage best-of-breed capabilities and global arbitrage opportunities.

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