Wednesday, January 28, 2009

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Outsourcing faces new era of scrutiny

Source: The Economic Times

Adding to the sector's troubles is the massive corporate fraud uncovered recently at Satyam Computer Services Ltd, India's fourth largest software services provider. The scandal has Satyam customers scrambling to find alternative providers.

Other offshore services providers report stepped-up scrutiny from clients of their own corporate governance and financial viability. It has also revived questions about the trustworthiness of Indian accounts and the adequacy of corporate controls.

That's a big black eye for an industry that sells risk management and corporate governance services as a major client offering. It may raise the risk premium investors require for holding these stocks.

Rising competition isn't the only threat to offshore outsourcers' margins.

Many of the more profitable, longer-term contracts worth tens or hundreds of millions of dollars are being put on hold as companies scramble to reassess their business strategies.

Customers want more control over projects and are demanding fixed-price deals that are more likely than not to limit margin growth. Infosys, Tata and others say they are doing their best to make up for price cuts by driving greater sales volumes.

The trend is disguised by the long-term nature of many existing software services contracts. Recent reports suggest many customers are scaling back or cancelling long-term "mega-deals" until they can get a handle on the impact of economic decline on their own businesses.

The industry is subsisting on short-term, quick-fix contracts aimed at cutting operational costs as fast as possible. These price-sensitive deals are what software services firms had been trying to move away from in favour of higher-value projects to create new businesses for customers, not just manage existing software or customer services.

There is a big cultural change underway in global corporations that may be less friendly to outsourcing. Fallout from the financial crisis is likely to mean far greater pressure on chief executives to run a tighter ship. There's likely to be less merger activity, less headlong expansion and less resulting need to consolidate organizations using external services.

Chief executives are sure to be more closely scrutinized for the operational choices they make, instead of farming out responsibility to lower level technical managers in order to focus on deal-making.

Inevitably there is a lack of control involved in contracting business operations out around the globe. This more constrained environment could be less favourable for outsourcing than downturns of the past.


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