MNC giants on the prowl in Indian BPO sector

The BPO industry resembles a jungle today. After Big Blue swallowed nimble-footed player Daksh in a landmark deal, business stakes have been raised to new levels. As MNC majors like Accenture and EDS hover around, pure-play Indian BPO companies could become the prey, says Srikanth R P

Avinash Vashishta of NeoIT believes that mid-sized BPO firms could be possible acquisition targets for large companies which want to test the waters for starting their own BPO operations

When the BPO story began, many analysts promptly dubbed it as the next senseless craze after the dot-com fiasco. In the early days, investors were wary, senior executives shied away from high profile BPO job offers and entrepreneurs dubbed BPO as mere low-cost labour. The BPO boom was seen as a balloon blowing up so fast that folks were sure it would burst anytime. However, the situation has changed today, and how—IBM’s landmark acquisition of Indian BPO player Daksh (in an estimated deal size between Rs 560 to 750 crore) has perhaps put the final seal of approval on Indian BPO. And of course, the deal has moved the consolidation and merger wave to a higher level. Just a few days after IBM announced the deal, Citigroup announced its intention to acquire outstanding shares of e-Serve International, in a deal valued at Rs 550 crore.

Not only was Citigroup ready to acquire all the outstanding shares of e-Serve (the group holds a 44.4 percent stake in the company), but more importantly Citigroup was ready to shell out a 27 percent premium over the listed price on the day the buyout was announced. The renewed interest in buying out existing BPO companies rather than building up a company was also seen when GE decided to put its BPO arm GECIS on the block. That offer not only attracted global giants like EDS and Convergys but also Indian companies like Wipro Spectramind and L&T Infotech.

While Accenture has been following an organic growth strategy, EDS has been on the prowl for acquisitions. But IBM’s deal may have upped the ante for growth. The deal has given IBM a big offshore component in India and will help it ward off threats from competitors. Accenture, for instance, has been growing its Indian base at more than 250 people per month and has close to 8,000 people for its BPO operations.

Telecom giant AT&T has also made an announcement that it is looking at acquiring Indian call centres in a bid to reduce costs. Looking at IBM’s deal and the flurry of expected acquisitions, analysts believe that an organic growth strategy as an option would have to be complemented with an inorganic growth strategy. Some market players also believe that in the future there will be few pure-play BPO companies as one-stop shops like IBM would be the preferred choice.

Forrester Research’s John McCarthy says that IBM’s Daksh acquisition proves that access to low-cost offshore labour is as important as transformational and re-engineering skills

Says Arjun Saxena, principal, Inductis, “There will probably be few pure-play BPO companies. Even worldwide, pure-play call centre BPO companies such as Skyes and West face low margins, few revenue growth prospects and low equity valuations. This business is likely to be dominated by one-stop general outsourcing companies that offer IT services outsourcing, IT infrastructure outsourcing, HR outsourcing and BPO/call centre outsourcing.”

Low-cost labour is a must

While IBM has over 22 business transformation centres, the choice of India as a low-cost base is key to its success. The low-cost Indian base is more significant in the current context as more and more clients are insisting on seeing real-time savings. Says Forrester Research’s John McCarthy, “This acquisition represents a reversal from IBM’s previous position of subcontracting work to third parties as part of its BPO deals. The acquisition demonstrates the move by IT vendors to build out their day-to-day operational capabilities. It also indicates that access to low-cost offshore labour is as important as transformational and re-engineering skills. And last it shows that offshore BPO investors, nervous about the market and issues like rising attrition, are open to selling out.” McCarthy says that the acquisition is significant as till recently IBM relied on third-party firms like Convergys for call centre operational service provision as part of its big customer service deals.

This deal also shows that low-cost labour is a must today to win deals. Says John McCarthy, “The offshore labour arbitrage has two huge benefits for users. First, it shortens their time to savings, users do not have to wait for years for shared service centre/re-engineering-based BPO initiatives to deliver results. Low-cost offshore labour can take over the process as is and deliver savings in six to 12 months after successful transition. Second, low-cost labour can be applied to any sub-process with more than 15 to 20 people working on it. Customers do not have to build up corporate courage and disrupt a large part of the organisation by outsourcing an entire process or set of processes.”

Adds Avinash Vashistha, managing partner, NeoIT, “IBM Global Services is the largest IT supplier in the world. BPO led by technology is going to be a bigger market than IT outsourcing. IBM wants to be a dominant player in this area as well. Offshoring is an important component of outsourcing. Currently and for three to five years to come offshoring will be dominated by call centres and India will continue to remain the best bet for voice-based BPO.”

Long-term viability?

The acquisition also points out to one more important point—the question mark over the long-term viability of Indian BPO providers. For instance, Daksh was seen as one of the best managed Indian BPO firms. Analysts like Gartner have raised doubts about the viability of Indian-owned BPO providers. Many market analysts believe that the decision of Daksh’s promoters to sell out on the verge of an IPO raises questions about the long-term vision of Indian entrepreneurs.

Says Arjun Saxena of Inductis, “Irrespective of the valuation of the Daksh deal, it is clear that even the largest of the independent BPO companies i.e. Daksh (over 5,000 employees, revenue growth better than Infosys/Wipro, albeit at a lower profit margin) is unlikely to enjoy the 8 to 9x revenue multiples enjoyed by the top-tier offshore IT companies. By selling out, Daksh’s investors are signalling that the opportunity to grow a large offshore pure-play BPO company is fairly limited. This should significantly depress valuations for some of the remaining independent BPO players who are looking to go for an IPO.”

However, it must also be mentioned that IBM would have used client pressure to turn the deal in its favour. For instance, IBM recently signed deals with Sprint and Aetna, two of Daksh’s largest clients. Sprint Telecom is incidentally Daksh’s largest client, accounting for close to one-third of its business. As Sprint recently entered into a five-year customer relationship agreement with IBM, industry analysts believe that IBM used this lever to push Daksh into deciding in its favour. IBM’s relationship with Sprint spans to IBM providing end-to-end solutions that includes hardware, software and cheap back-office support. This new relationship with Sprint could have taken a third out of Daksh’s business overnight.

In current times, when most Indian BPO vendors are dependent on a few clients, the capability of clients to influence acquisition or merger deals will be significant. In some cases, analysts even believe that customers may themselves buy out call centres or BPO units if they are convinced that it is a high growth area. Citigroup’s intention to acquire the outstanding shares of e-Serve International at a premium is a pointer in this direction. Citigroup has always been known as a very savvy investor, knowing exactly when to exit or up its stake.

Future

With the acquisition and consolidation tempo being raised to a new level, is this the end of the road for Indian BPO outfits? In a business where scale is the key to survival, pure voice-based BPO shops would find it tough to compete with majors like IBM who provide a full bouquet of services. While analysts believe that eventually there will be only two or three large BPO service providers, there is an optimistic belief that there will be room for specialised service providers. Many market players also believe that IBM being a gigantic company would not be able to bid for small deals as its cost structure would be high—a market that small BPO firms can tap.

Another major impact of the Daksh deal would be seen on the growth prospects of Tier II Indian BPO vendors. Before the Daksh deal, none of the MNC vendors could boast of the scale, experience and depth of management that Indian BPO companies had in India. This situation is fairly similar to that in the IT services field where until two years ago MNC companies like Accenture and IBM were not aggressive with their Indian offshore plans.

Says Arjun Saxena of Inductis, “With large, well-known MNC BPO players being able to offer similar pricing and being able to demonstrate scale and experience offshore, there will be lesser opportunities for Tier II BPO companies to compete for larger deals or really move up the value chain. This is because as most deals move from an request for proposal (RFP) to a negotiation stage, the shortlist of potential vendors goes down to five to six players. This basically means that all these companies that are still at 1,000-2,000 people need to start thinking of specialising if they want to have any hope of surviving as independent entities. It also implies that we are likely to see more defined layers among BPO companies (similar to the IT space) where the four to five large players enjoy significant scale and pricing advantages over other companies.”

The IBM-Daksh deal has also had a big impact on the acquisition front it puts pressure on players like Accenture who have been following an organic growth strategy. Additionally, now that Daksh is out of the running, large independent Indian BPO companies remain ripe for the picking by MNCs with deep pockets, who are looking at building up scale quickly. But contrary to market reports, market players say that most acquisitions by MNC players would be big acquisitions than mid-sized players. The only exceptions could be Indian BPO players who specialise in verticals like healthcare or HR.

Says Saxena of Inductis, “Given their own scale, the type and size of operations they bid on, the speed with which it is possible to set up a single site BPO operation and the amount of headquarter-level bandwidth and scrutiny involved, it does not make sense for an EDS or Accenture to even consider acquiring any company that does not possess a certain scale. By this, I mean a company having at least 2,000 frontline people and contracts with multiple clients, multiple locations and centres coupled with a seasoned management team with MNC work experience and background.”

But mid-sized players could be possible acquisition targets by big companies who want to test the waters for starting their own BPO operations. Says Avinash Vashishta of NeoIT, “We have a lot of clients who are interested in looking at BPO but do not have delivery capabilities. A lot of our clients believe that acquisitions could be a good entry strategy to their BPO strategy.”

Saxena says currently Indian BPO companies like EXL Service, Epicenter, ICICI Onesource and vCustomer could be companies that prove ripe for acquisition by MNC majors. As investors in most BPO companies are already looking for an exit route, Indian BPO players could find it tough to scale their operations unlike their IT counterparts. In this scenario where scale is essential for survival, analysts believe that Indian BPO companies would be forced to partner or consolidate.

Going forward, we believe Indian large BPO firms would have no option but to go in for mergers or acquisitions to stay in a race that has been forced on the fast track by IBM’s move.

srikanth@expresscomputeronline.com