Advisors harbor a rosier outlook than providers in the third quarter. Making a sound business case, high costs, and internal politics remain barriers to wider adoption of HRO.
EquaTerra recently completed its third-quarter pulse surveys with those on the front lines of the BPO industry: its own global advisors and the industry’s service providers. Starting in 2004, they offer in-the-field insights into sector trends and projections. Each quarter, 75 to 100 EquaTerra advisors and approximately 20 service providers answer our questions on the ITO and BPO markets on a proprietary and confidential basis. Key findings from the 3Q06 quarterly survey are described below.
Outsourcing demand continued to improve but slowly, according to 59 percent of EquaTerra’s advisors this quarter, versus 55 percent in the prior quarter. While demand slowly improves, constrained provider capacity will slow fourth-quarter market opportunities and keep volume for the year in line with 2005 levels and below 2004. During the past seven quarters, you can see that both communities have consistently agreed that demand has trended downward, except in the most recent quarter, in which advisors generally reported improvement while providers did not.
Why this disparity in responses? Demand has increased, per EquaTerra advisors’ discussions with clients, who see demand waiting in the wings. What has decreased is providers’ ability to adequately serve additional clients. Interesting and troubling, the provider community doesn’t necessarily see its supply constraints as a problem.
NEW DEAL PIPELINE GROWTH
In the third quarter, only 48 percent of service providers reported that their new-deal pipeline was up, compared with 67 percent in the previous quarter. This is the first time in two years that this category fell below the 50-percent mark. Declines in the current pipeline, lower-than-expected growth levels for the fourth quarter, and an increased number of recompetes and renegotiations indicate a slowing-to-flat outsourcing market into the first half of 2007.
The quarter also witnessed more competitive pricing, which favors buyers; 28 percent of EquaTerra advisors cited pricing as favoring the service provider compared with 22 percent in the second quarter. Some 60 percent of EquaTerra advisors who work primarily in the ITO space cited pricing as becoming less aggressive, i.e., favoring service providers. Key determinants in pricing include service provider selectivity, provider capacity, new entrants trying to “buy the business” via below market bids, and the degree of remote/offshore versus onshore (i.e., higher cost) service delivery.
There are numerous challenges in the development of a compelling business case for outsourcing. These include the cost of doing a deal, internal political pressure, and inadequate retained organization redesign. However, EquaTerra advisors’ three most commonly cited reasons for outsourcing deals not closing in the quarter were inadequate management support (49 percent), inadequate business case (43 percent), and poor service provider quality (41 percent).
Inadequate outsourcing business cases have been on the rise, with 37 percent of EquaTerra advisors in the fourth quarter of 2005 citing it as a problem; that number increased to 39 percent in the first quarter of this year and 43 percent in the third quarter. This means that prospective buyers have poorly documented processes, volumetrics, and financial base cases.
Even more distressing is the increasing number of citations for poor service provider quality, which is largely coming from the HRO marketplace. In the third quarter of 2005, 22 percent of EquaTerra advisors cited this as a negative factor, compared with 30 percent in the first quarter of this year before rising to 41 percent in the third quarter. The number of HRO clients who have cited poor-quality transition resources and are experiencing poor service delivery in the first two years of their contracts has risen, making it tough on HRO providers to provide sterling, referenceable clients.
Both sides of the outsourcing equation are suffering. Service providers lack capacity and are suffering from poor service delivery problems. Prospective buyers are faced with inadequate management support and weak business cases. Unless these problems are addressed, the first half of 2007 will not usher in a banner year for outsourcing.