I recently decided to take a look at the impact of recession on offshore outsourcing: that the players will face pricing pressures, reduced profitability and less growth compared to the golden times, and that there will be an imperative to deliver tangible business value to customers. I looked for evidence in the quarterly results of outsourcers and, despite the absence of the predicted boom, I found that they had held on pretty well. And I decided to re-examine the results after another quarter passed.
First up, the global outsourcers. In its latest quarter, Accenture's outsourcing revenues were up seven per cent year-on-year and its outsourcing margins increased due to more work shifting offshore. Management said that they have not witnessed any change in cancellations or deferrals, and now see the period of indecision coming to an end. They also see an increased demand for BPO and application outsourcing services. The growth rate, it should be noted, is half of the previous quarter.
IBM's strategic outsourcing business saw a three per cent decline in revenues but an improvement in margins. On a like-by-like basis HP's services revenues declined 15 per cent, but like IBM, it did see an increase in margins. HP saw a significant decline in its application services business as discretionary project work fell away. CSC also saw its outsourcing revenues decline by 13 per cent, attributed to client delays and pull-back of discretionary projects. Outsourcing bookings during the quarter were also down 50 per cent, but like the others, it did improve its profitability.
Overall, since last quarter, the exuberance about revenue growth has become quite muted. On the positive side, companies are improving profitability and streamlining their operations, including increased reliance on offshoring.
In the European outsourcers category, Capgemini saw its quarterly organic outsourcing revenues increase by three per cent year on year (overall growth was one per cent), but its outsourcing bookings declined by 37 per cent. During the last quarter it increased its offshore headcount by over 1200 (compared to an increase of 50 for onshore). Profits improved marginally but the company said that it can't see business with any real confidence beyond June, guiding towards a modest first-half 2009 revenue and a margin decline.
Logica's Q4 revenues went down 11 per cent, and its operating profit for the full year declined 22 per cent. It has been making aggressive strides into offshoring and boosted nearshore and offshore headcount to 5000 (2009 target is 8000), adding 900 employees in six months at its new India center. Logica sees good demand with more, larger outsourcing opportunities in the pipeline, but has forecast flat first-half sales. Atos Origin's Q4 revenues declined nine per cent, and it expects a slight decrease ("roughly -2 per cent or something like that") in 2009 revenue. It also plans to increase offshore headcount by 1000, while reducing onshore headcount.
All in all, muted growth, operational streamlining and increased offshoring are the common themes.
Next let's move on to the Indian Offshorers.
We'll begin with the Tier 1 players. TCS' quarterly revenues remained flat year on year, in sharp contrast to the 25 per cent growth last quarter and its statement that it does not expect revenue to be impacted by the turmoil. Net profit declined 18 per cent. It is witnessing pricing pressure on new contracts, but on a positive note, net employee addition was more than 8500 – its highest in the past few quarters.
Infosys' quarterly revenues grew by eight per cent compared to 19 percent the previous quarter, and it added about 2800 employees. Management stated that the velocity of business has come down, decision-making is slow, budgets are not finalized and scrutiny is higher.
Wipro reported a 12 per cent annual increase in IT service revenues and its margins diminished. It also reduced its IT services headcount by more than 1000 employees.
HCL Technologies saw an 11 per cent revenue growth, boosted by acquisitions. Net income was down nine per cent and total employee count was almost flat. HCL stated that "the pricing environment is quite bad and customers are saying that we should contribute and help in reducing their spend on IT".
The best performer was Cognizant which reported a 25 per cent increase in revenue and a 34 per cent increase in profits. It even saw a 19 per cent increase in its financial services segment, and added 2200 employees during the quarter. On the flip side, the company's outlook for 2009 is a 10 per cent revenue growth and broadly flat margins.
It is a significant shift from the position last quarter. Tier 1 players have seen their growth rates tumble (Cognizant is an exception here) and visibility become poorer. Operationally though, they are adjusting well and focusing on working with customers to address their challenges. Currency fluctuations remain a cause of concern for them, and 'constant currency basis' is the new buzzword.
Moving on to the Indian Tier 2 players, where growth rates for the leaders in the last quarter has come down from 30 per cent plus to 20 per cent for Mindtree and 17 per cent for Tech Mahindra. Mindtree suffered significantly on the profitability front with a 88 percent decline in profit after tax. Talking about variability in performance, Polaris saw 32 per cent revenue growth while Patni saw a one per cent revenue growth and a 45 per cent decline in profitability.
Finally, the Indian Tier 3 players. Hexaware saw flat reported revenues but a significant improvement in operational efficiency and resulting profitability. It continued on its headcount reduction spree with 300 reductions last quarter, taking the tally to about 1000 reductions over two quarters. Sonata, whose revenues rose by 25 per cent and who did not foresee any adverse impact, saw its growth come down to seven per cent, even though profitability increased 27 per cent.
So high variability in Tier 2 and 3 segments but they are now feeling the full impact and their irrational exuberance is fading away. Realistic growth rates, pricing pressures, currency effects, project cancellations/deferrals and longer sales cycles are being evidenced among the players.
How does all the evidence compare with the situation at the end of last year? , evidence broadly supports the assertions-players are witnessing pricing pressures, reduced profitability, (much) less growth compared to golden times and an imperative to deliver tangible business value to customers.
However, I do recognise now that there are exceptions and in some cases, the ability to withstand the macro environment and make corrective adjustments has been, frankly speaking, quite impressive. Special mention must be made of the increased use of offshoring by global and European outsourcers, and the emphasis on productivity and delivering value by select Indian players. We will see an increased use of offshoring, no doubt, but in a rational, rather than blind, way. It's fair to say that the recession is wiping away the inefficiencies of the system. Those who recognize and adapt will be the real winners.
Arpit Kaushik runs the London-based outsourcing service design firm, Crystals, that helps forward-looking companies to realise the promised benefits of outsourcing.