July 7, 2017
The Indian media has been busy sounding the death knell for the US$150 billion IT and BPO services industry. Doom generates page views and can make for compelling reading, but do the facts justify the rising sense of despondency? Not quite, we believe. The retrenchments and the modest guidance are real. But they are neither indicative of a civilization-ending AI, nor a whole-scale repudiation of the founding pillars of the offshore services industry. What it is also not is a direct consequence of protectionist policies. That might be the proximate cause of the some of the recent announcements around onsite hiring. But proximate causes are limited in their explanatory power. It would be absurd to say that Kurt Cobain of Nirvana died of blood loss. Factual, yes, but not quite a helpful account of the musician’s travails and eventual tailing off at age 27. So instead, we’d would like to say the following structural forces are in play:
- Managed services will see a significant topline erosion. The numbers are worrying. The average offshore services firm makes about 60% of its revenues from the annuity revenue streams of infrastructure management services, application maintenance and support, and business process outsourcing. Forces of automation, cloud, and SaaS will reduce it by a factor of up to 40%. This excision of a quarter of total revenues would happen over the 2017-2020 period. As an aside, the bulk of the automation is not AI, and is not really new. As always, things happen in enterprise software not because the tech is new but because the time is right.
- Projects need to make up for the loss, but the projects of yore won’t help. The offshore services industry built its reputation on large transformational ERP projects and point solution implementation projects. These aren’t dead, but will not grow fast enough to make up for the decline in the managed services revenue. The industry needs a big hit, a double-digit growth driver to rival the ones it scored at the turn of the century.
- Digital will help but not without hard to build competencies. Digital is high growth, but winning isn’t easy. Clients are no longer asking for “100 warm bodies for my recent Adobe license binge”. Instead, they want outcomes. Outsourcing principals want guidance — on design, on customer experience, and on how specifically the disruptors can be kept at bay. These require more than what a monoculture of Indian developers can deliver. More worryingly, when software is built for performance, UX, and adaptability, and not for costs — a large offshore contingent appears less attractive. Indian IT, always more axe than scalpel, was designed for large, complex reliable software, built at a reasonable pace. That behemoth needs to now adapt to software that isn’t as complex, but must come fast, and change fast . This is a tall order, not least because they transcend the realm of mere competency, and enter what allegedly devours strategy for lunch: culture.
The above secular forces conspire to generate the following newsworthy items:
- Retrenchment. This isn’t the binary of enter AI, exit the IT worker. Instead, firms are using the opportunity to clean up the stables. The most successful offshore firms have grown at double digits for decades while maintaining 20%-25% margins. That kind of success can hide a lot of naked swimming. However, it is true with automation you need fewer people for the same unit of work. So, reduced hiring is inevitable.
- Low growth. The cannibalizing effect of automation is playing out now. The digital story hasn’t fully entered the period of big spending. And of course, the offshore firms are still at work building their digital story. There is also the cyclical nature of deals, the sheer size of these firms, and the realities of a high base. Low growth therefore is understandable. However, it is inaccurate to say recent events necessarily portend doom. Outsourcing engagements are notoriously sticky, and the majors have large war chests. There is definite wiggle room, both for failure and failed experiments. But it is also true that not every offshore firm would emerge out of the current morass victorious. Not everybody is taking automation head on. It is useful to keep in mind that it is the incumbents’ reluctance to migrate work offshore that gave an opening to the current crop of giants. History might just repeat itself. However, decline is likely to come in a long, slow, and torturous tailing off and not in a cataclysmic dip for those who don’t win at the current reshuffling of the pack.
- Onsite hiring. Hiring in North America in greater numberswas in the works even before Donald Trump entered the Oval Office. However,protectionist policiesdoubtlessly forced the offshore firms to act faster than they would have. So, timelines were compressed, but business realities rendered greater onsite hiring inevitable some time ago. In addition, it is not the case that the work is moving in bulk to the industrialized economies. Instead the needle is moving to the 30%-35% mark. Remarkable, certainly; but catastrophic? Not quite.
We will explore the three structural forces through a series of blog posts. This was the first. Stay tuned!