Outsourcing profit margins will trump deal size
By John Keppel
"Service providers are no longer focused on maximising revenue from, or growing the size of each deal and the focus is moving towards the improvement of profit margins.
The traditional approach
Traditionally, service providers have delivered services to conform to the client's way of doing things, even if this is inefficient. The "customer is always right" mentality comes into play here and for the provider, it is more important to keep the client happy - the primary goal is to retain or grow the contract rather than simply to streamline processes.
Up to a point, this model works for both sides. Clients inherently will experience some savings, because service providers are good at what they do. Providers, meanwhile, are able to grow revenue by delivering more and more resources to meet the client's increasingly complex and customised needs.
A shift in dynamics
However, this traditional approach is rapidly changing, since standard service delivery models are fundamentally transforming the nature of IT outsourcing relationships. Specifically, clients and providers are beginning to recognise the benefits of using standardised processes for IT service delivery and of taking a collaborative approach. Clients are also acknowledging that their way of doing things isn't necessarily right, and that they can achieve significant savings by implementing "vanilla" processes across business units.
This shift is hugely significant as it disrupts the traditional outsourcing model, with clients no longer dictating terms to a service provider who then customises service delivery on a per-client basis. Instead, clients are becoming more aware of the benefits of process optimisation and why this is more valuable than just reducing short-term costs. Consequently, the onus of delivering savings lies no longer solely with the service provider.
As a result of this, service providers are no longer focused on maximising revenue or growing the size of each deal (by adding more people to run inefficient operations). Today, the priority is shifting to improving profit margins. While it may seem counter-intuitive, providers are embracing the concept of standard services, as it gives them greater control to leverage economies of scale across multiple clients and to demonstrate their expertise in delivering services efficiently.
Pace of change
When we started talking about this trend a few years ago, sceptics argued that this was the stuff of ivory tower theory, and that providers would never accept shrinking revenue. Today, in the real world, we're increasingly seeing providers move toward this higher margin/lower revenue model. Some recognise the inherent benefits and are leading the charge, while others are grudgingly responding to competitive pressure.
This year, we expect the pace of change to accelerate as social, mobile, analytics and cloud (SMAC) technologies enter the mainstream, and as operational transformation increasingly becomes the rule rather than the exception.
Technology and outsourcing
Automation is also playing a key role in revolutionising the traditional model. While traditional outsourcing derived cost efficiencies through labour arbitrage and moving jobs to low-cost labour centres, today's emerging model employs labour automation largely to remove wages from the equation altogether.
We are already witnessing the integration of discrete automated solutions in a wide range of functions, such as help desk and infrastructure support, as well as in a variety of sectors. For example, consider how x-rays are reviewed. Currently, U.S.-based radiologists ship digital x-ray images offshore to be read by Indian doctors who conduct a preliminary evaluation and send the results back. This division of labour produces savings in two ways - first, by allowing the initial evaluation to be conducted by a lower-cost resource, and second, by making the U.S.-based radiologist more productive. Today, automated software tools are increasingly being deployed to evaluate x-rays and automatically generate reports, thereby bypassing the step of the initial human review. The result: higher productivity (the automated tools read x-rays much faster than the Indian doctor) at lower cost (after the initial investment, the tools don't have to be paid).
Needless to say, these developments further undermine the traditional deal size and revenue maximisation model. 2014 promises to be an interesting year indeed."