The end of outsourcing

Most outsourcing analysts and consultants will tell you that the future of the traditional IT services industry is uncertain.

Arjun Sethi doesn’t equivocate. “In the next five years, outsourcing as we know it will have disappeared,” says the partner and head of the outsourcing practice at consultancy AT Kearney. “New players, which have yet to enter the market, will soon rule the industry.”

At the heart of Sethi’s prediction of a “massive reconfiguration of the outsourcing industry” is the rise of cloud computing. Most existing providers simply won’t adapt quickly enough. As a result, Sethi says, Amazon, Google or a vendor we’ve not yet heard of will become the market leaders. Meanwhile, traditional infrastructure providers like HP, Dell and Xerox may struggle to keep up, and many Indian providers will disappear completely.

We spoke to Sethi about his vision of the next generation of IT outsourcing.

Q: You say that the demise of IT outsourcing is imminent. That’s a bold prediction.

A: We define traditional IT outsourcing as multi-year contracts based on developing and maintaining custom code and running on the backs of legions of programmers and on-site systems integration work. We’re on the verge of a massive reconfiguration of the outsourcing industry. We foresee a new model wherein outsourcers will provide standardised software solutions on a per-use basis. For that, they will combine and leverage BPO services with cloud-based technology. This approach will enable customers to outsource entire business processes and just pay for whatever information is accessed or used.

Q: But aren’t most of the “traditional” outsourcing players-US-based multinationals and Indian providers-investing heavily in new, cloud-based approaches to IT services?

A: In the last 24 months, we have watched a variety of companies working on acquiring the complete stack of capabilities required to survive the shift and create a new business model for the outsourcing industry: hardware and connectivity that allows for hosting and network capabilities, standardised software that can be deployed on shared hardware platforms or the cloud, new service capabilities, and the commercial strength to move from a long-term contract model to a flexible, “pay-as-you-drink” approach. These are the preliminary steps toward what will end up being a revolution of the BPO and ITO marketplace.

Q: Yet you say major US outsourcing players like HP, Accenture and Xerox are potentially in peril.

A: HP, Accenture and Xerox have read the writing on the wall. They have made some investments, but there’s a lot more they need to do to make the most of the millions of dollars they have already invested in recent acquisitions. We therefore identify them as “fence sitters.” IBM, on the other hand, could be one of the leaders given its focus and investments in cloud-based services.

Q: How about the Indian providers? You don’t hold out much hope for many of them in this new IT services market.

A: We base this primarily on the evident reticence of some of the leading players like Infosys, TCS and Wipro, who are all sitting on a pile of cash but have not made any bold investment decisions to date. The question is how quickly they can hope to build enough scale, at a time when enterprise clients are still cautious about delivery capabilities, pricing models and data protection. The tier 2 Indian providers lack the scale or size of balance sheet to compete with their larger US and multinational counterparts like IBM, Google and Amazon.

Q: So Google, Amazon and IBM will be the big three in IT services in 2015. Won’t Google and Amazon themselves have to make some major changes to adapt to the requirements of Fortune 500 outsourcing customers?

A: Absolutely, Amazon and Google also will need to evolve. They could be the future leaders in outsourcing-if they figure out what their next growth engine will be. As with other players in the outsourcing space, they need to decide where to place their bets. Will Google decide to focus on the enterprise services market or on Android phones?

Amazon is already serving Eli Lilly, and other pharmaceutical companies like Pfizer are beginning to pilot cloud computing for research operations as well. Assuming Amazon and Google take on the challenge, what they bring to the table in terms of their huge data centres already in place, their mastery of economies of scale, and their track record with one-to-many platforms and distributed software services will make them clear leaders in the coming paradigm. What they don’t yet have in terms of assets or workforce or specific knowledge, they can easily pick up through targeted acquisitions of smaller outsourcers.

They also have unmatched brand recognition. The rising generation of corporate leaders already uses them for their personal e-mail, e-books, music files and the like, and they will be the first to come to mind when those leaders are looking for service providers.

Q: A good deal of current research around cloud computing reveals continued reluctance on the part of enterprise customers to put mission critical applications and infrastructure-the bread and butter of traditional IT outsourcing-in the cloud. Your predictions, however, are based on rapid adoption rates of these new offerings.

A: We are in the eye of the storm. Our recent experience with clients shows significant interest in the area, and we are helping clients close deals around fully hosted, managed and maintained IT services. Additionally, there is enough statistical evidence showing that this is an area of IT outsourcing that could grow to upwards of $50 billion in the next few years. UBS Investment Research recently estimated that the market for Amazon-like web services will be $5 to $6 billion this year and grow to $15 to $20 billion by 2014.

Q: You say that, in order to survive, IT service providers will need to own or manage the full stack of IT capabilities on a massive scale in order to provide deep expertise in delivery of services-on-demand. Yet many outsourcing analysts say that customers have been moving away from single-sourced IT outsourcing deals to a best of breed approach. How do you explain that disparity?

A: The jury is still out on what will be the sustainable model. We believe that the current dynamics in the supplier landscape – for example, Xerox acquiring ACS, Dell acquiring Perot, HP acquiring EDS, Google partnering with CSC, Amazon partnering with Capgemini – are a precursor of what will be adopted by customers.

Q: You predict that Microsoft and SAP could also be winners in the new world of outsourcing. They’re not names one associates with IT services per se.

A: Think of Microsoft and SAP in the cloud. Moves are already afoot. Of course, this will require a huge change in their company DNA. Microsoft would have to forsake the model that made its success and agree to replace selling millions of licenses for software installed in physical assets by distributing and operating its platforms remotely. Their success also depends on the speed at which they build up the capabilities they are missing in network services, infrastructure, and cloud computing. But if these organisations can figure out an effective business model, they could be huge winners.

Q: You argue that this coming revolution in IT outsourcing could mean more jobs in the US and less offshoring.

A: Costs will certainly be cut or contained as we go to significant scale advantages on the back of standardisation and one-to-many configurations in the cloud. And the flexibility brought about by Software-as-a-Service may actually favour domestic, low-cost locations like North Dakota or Georgia. High-speed Internet access has already helped smart companies tap into a rural, inexpensive but stable labour force working in small delivery centres or at home to staff back-office or call centre activities. Cloud computing and distributed applications may very well accelerate this trend and help retain entry- to mid-level jobs in the US.

Q: What has been the reaction to your predictions within the outsourcing industry-from providers, analysts or other consultants?

A: We don’t know yet, but we expect fear, apprehension and – in certain quarters – sighs of relief as we may be confirming what is understood but still not widely acknowledged.