Value-added BPO is new outsourcing mantra

With ITES/BPO mirroring the software industry and entering a commodity phase, Tier-I ITES players are adopting riskier models to steer their ships away from the commodity crowd and ensure higher margins. Players are not only signing deals with pricing linked to the success of a project, but are even linking their billing rates to reduction in the TCO of a particular process. Srikanth R P analyses the paradigm shift taking place in the Indian ITES industry

Guruprasad Sowle of Hexaware believes that a TCO-based model will separate mature BPO players from routine data and voice shops

When the big guns of the Indian software industry saw margins reaching shallow depths where only small scale and SME players could play profitably, they decided to move on to the IT consulting platform, which promised fatter margins. And while margins caught up with India Software Inc. after years and years of extremely good going, the ITES/BPO industry seems to have been bitten much earlier in its life-cycle. As margins are squeezed in the booming ITES/BPO industry, some Indian vendors are now experimenting with flexible new models that ensure prices of contracts are structured based on actual success rates achieved in the respective process being handled. Some vendors are even going one step ahead and are taking up contracts where billing rates are linked to the actual reduction in the total cost of ownership (TCO) achieved for a particular process. These new value-based models are diametrically opposed to the traditional per seat fixed-cost model.

Not just price

Take Daksh, where several telemarketing contracts are linked to the success rate the company actually achieves, as opposed to charging a client for the number of calls made. The focus is on providing value to the client rather than the familiar cost arbitrage advantage offered by every vendor. The client has the option of paying the ITES vendor only when he has achieved a certain threshold (say $20 million worth of policies to be sold). Obviously, the client benefits as the ITES vendor is more aggressive in the new scenario, which helps in increasing sales.

Indian players who have strong domain knowledge in a particular industry are excited about this model simply because it gives them a chance to demonstrate their capabilities and differentiate themselves. For instance, an Indian BPO player specialising in banking could reduce the cost of a given process in a bank by a greater percentile and with much lesser manpower than a normal BPO player, simply because of domain expertise.

Says Guruprasad Sowle, who was instrumental in the initial build-out of Exult in India and is now vice president with Hexaware, "The trend is very much visible and Indian service providers eventually will have to move to a value-based model than that of cost." He goes on to tell about a healthcare claims service provider Hexaware is working with, where large volumes of claims are handled. "For the first three months, we worked on a fixed-cost per hour, per full-time employee model. But as the level of complexity for every claim is different, we have now structured parameters and built it into the contract so that the billing rate will be on the type of claim and complexity. We have moved from a per annum to a per transaction cost model."

The new model also makes the service provider a stakeholder in the new business of the client. Unlike the traditional model where financial stakes are retained by the client, in this model the financial stakes are shared with the service provider. The service provider thus not only shares risks but also greater spoils if the business succeeds. Vendors are also going one step ahead and offering a TCO-based model as opposed to the traditional cost model. For example, analysts believe that future contracts could be decided on the basis of reduction in TCO that a vendor promises every year, as opposed to the cost model.

Domain players like Kanbay, which have significant expertise in banking, are naturally upbeat about this model. Says Akhil Agarwal, vice president (Special Initiatives), Kanbay, "As companies mature and their understanding of processes increase, they are likely to use the TCO approach to create a differentiator from the competition."

Research and advisory firms like Gartner believe that this model will separate the serious players from the me-too guys and mould an industry that’s more mature. Says Ravindra S Datar, principal analyst (IT services & BPO), Gartner, "The main advantage of this model is that it will make vendors as well as enterprises look at the decision in a comprehensive way. Non price differentiators could make a lot of difference once TCO becomes the benchmark as opposed to the billing rate-based competition. It would lead vendors to build value-addition in the solution route beyond the labour rate arbitrage, while enterprises would also be more open to spending more to get more value."

Avinash Vashishta of NeoIT believes that most mature BPO transactions in the industry will be priced by transaction and contracts would be TCO-based

Shifting trends

Very clearly, unlike the software service industry’s migration towards fixed price contracts, in the ITES/BPO industry, it is the other way around. Avinash Vashishta of NeoIT sums up the scenario perfectly when he says, "In the software services sector, the next stage in moving up the value chain is to "outsource" (not just ‘out-task’) IT offshore. This also moves pricing and cost from T&M towards ‘fixed price’. It will take IT vendors a few years to reach this destination."

He adds, "However, on the BPO front, outsourcing and offshoring is relatively new. Most processes are core to clients. BPO is more transaction-based than being a support or a development exercise like IT. The transaction process in BPO can be re-engineered to leverage technology, processes and people to deliver the transaction with better quality of service and cost. It is possible to measure the number of transactions and also to be able to price the transaction end-to-end. We believe that mature BPO transactions will be priced by transaction and these contracts will be TCO-based."

Global trend

While this is still an emerging trend in India, globally, many contracts are TCO-based and linked to the actual success of the project. For instance, the IBM-Xcel Energy deal that happened last year is a landmark deal and most incentives of the IBM team working on the project are linked to Xcel’s share price. IBM not only helps in cutting costs but also advises the client on new opportunities using IT. The model can be compared to that of a consultant—the only difference being that the vendor sometimes takes the risk of investing in the business and also reaps subsequent rewards.

Key challenges

While the model looks like a win-win situation for both vendors and clients, there are significant challenges on both sides. And Indian vendors who have always competed keeping only the price factor in mind might find the going tougher, as compared to normal outsourcing deals. Although many offshore ITES/BPO providers are offering TCO-based contracts, very few Indian players have actually embarked on these new deal structures. One key indicator is the experience of the US-based outsourcing and software services industry.

Says Puneet Shivam, associate principal, Inductis, "In our view, Indian vendors would find it difficult to offer TCO-based contracts. The reasons are clear: TCO benefits are very hard to quantify and hence hard to put down in executable contracts. A TCO promise requires high degree of credibility and proven track record that today does not exist for India-based BPO providers. Additionally, capital requirements to invest in, support and guarantee TCO type of gains are very high. Indian BPO firms may not be best positioned yet to take that level of capital investment. Our view is that there will likely be more TCO type deals in the future but it is unlikely to be the majority trend. The main hurdle is unlikely to be the conceptual agreement over the idea; it is the practicality of the deal which will be a challenge."

Shivam also points out another interesting trend that the TCO-based model is driving. He explains, "The underlying and very interesting trend behind this model is that if a significant and sustainable TCO opportunity is present in an industry, it usually leads to a disaggregation of the value chain. For instance, when electronic booking and distribution systems for airlines really became best-in-class and most efficient, i.e. lower TCO, they were spun off into separate entities such as Saber. Similarly, as credit card systems became best-in-class they got spun off as Mastercard and Visa." Closer home, this example can be seen in the case of WNS. The company was formed as a captive ITES facility for airline giant British Airways. But after effectively scaling up operations from a 30-member centre to more than 1,000 seats and achieving proficiency in the airline industry, British Airways sold off a majority stake to Warburg Pincus, a leading global private equity investor. Today the company not only gets business from British Airways but is attracting attention from other airline firms since it has one of the best processes for the airline and travel industry.

Ravindra Datar of Gartner says that once the TCO model becomes the benchmark, it would lead vendors to build value addition through the solution route, beyond the labour rate arbitrage

Industry veterans like Sowle believe that though the model is well suited for consulting firms, Indian companies too can play this game after going through the necessary transition phase. Says Sowle, "TCO-based trends are very visible in consulting engagements involving creation and delivery of strategy on shared services or BPO. Several consulting firms do link a part of their fee to accomplishment of certain defined milestones. But one must note that pure-play BPO players whose revenue model is not based on consulting, but linked fundamentally to process outsourcing would be more comfortable moving to TCO-based contracts after going through at least one cycle of delivery of SLAs over a period of 6-12 months."

As TCO-based contracts are prevalent in large deals in excess of $10-20 million, the vendor has to have adequate resources in terms of both financial and human capital as well as hedge options to mitigate risks. This has meant that only large players like IBM or Accenture have tried to introduce such a model. While Indian vendors are still way behind a takeover approach wherein a service provider buys the assets of a particular company and runs processes for it, most Indian players are trying the value approach and linking their billing rates to the actual objectives they achieve. Though this model is risky, Tier-I players are keen to play this game since it ensures better billing rates. And eventually, with MNC organisations setting up captive bases in the country, Indian vendors have no option but to move in the direction the industry is swinging towards.

Future view

Says Arjun Vaznaik, COO, Tracmail, "The entry of BPO players such as Exult and Convergys will help the industry to mature in terms of process excellence, scale and eventually best practices. Indian vendors will need to necessarily move up the value chain to firstly acquire clients who are willing to offshore their business processes within the TCO model and then eventually create a name for process excellence through best practices. We ourselves are actively engaged with our partner organisations in creating IPR for specific business processes."

Going forward, analysts believe that the industry will eventually go in for a hybrid model with larger deals based on TCO and smaller deals (where only a portion of the business process is outsourced) on a fixed price model. But in the end, Tier-I players are optimistic about the impact of the TCO model on the BPO industry. As Sowle says, "The TCO-based model would separate the mature BPO players from routine data and voice shops as the stakes get higher and well defined. Hence it is important for Indian firms to approach the market selectively and not bid for every contract in the market place. For instance, in the US, there have been examples of very large BPO companies failing in spite of significant investments and work to do. As the BPO market is huge, the key question to ask is, ‘who is my customer’ and keep that focus."