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Wednesday, May 23, 2007

Lifeline for smaller BPO outfits

Almost 3 out of every 4 IT startups in India have some or other offshoring / outsourcing focus. Especially after the recent trend of imploding captives, this trend is increasingly becoming widespread and the lineup is only getting longer. Forrester believes that more than 60% of Captive centers set up (by large businesses) in places like India fail to meet expectations. Common reasons for failure: a poor delivery track record, operational problems, a lack of scale, poor morale, rampant attrition, and high costs.

There are more than 3,000 smaller companies in India focused on BPO, call centers and software development. These smaller firms are ripe for acquisition as their margins suffer from the combined effects of rising wages, difficulty attracting talent and now, rupee appreciation versus the dollar. Consequently the expectation is that a lot of smaller 'mom and pop' IT shops in India will be forced to sell to survive. The small shops lack the scale and customer base to weather 18% annual wage inflation on the back of rupee appreciation.
'Captive' IT companies, serving dedicated western clients will have to consolidate to drive scale and increase attractiveness to talented prospective employees. The attraction for larger players to buy them out is on account of their highly trained staff and acquiring a marquee western client (or a few clients) in the process. Captive units of large global businesses providing offshoring services may also find the going unattractive and may opt for buy v. build.

Third-party service providers generally outperform captive offshore facilities because of their expertise, familiarity with local employee psyche and specialization. But the fragmentation in the industry is getting way too much and is almost getting commoditized. It is in this context that Deloitte’s initiative in Private Equity needs to be seen – to enable smaller IT service providers to grow inorganically by consolidation, leaning on private equity support if necessary. If it works well, it’s quite a lifeline for the smaller players.
Sadagopan has a few interesting posts on the subject here, here and here. Vinnie has a different view and his argument is that the 40% margins enjoyed by offshore IT companies is the main driver (aside of IP protection, data security) for clients to bring deals back in, which he articulated so well thro his reply to Sud’s comment under his post – “it's like saying home cooking has failed because restaurants are doing well” – I loved the comment…but captive implosion argument is not entirely devoid of merits.
Will the small Indian BPO players choose to consolidate...Frankly I don't think they've got too many choices.

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