Subject which should be on the agenda of vendors, part 1

In this post I want to provide an overview of typical subjects I expect management teams of global operating vendors are looking into these days. I discuss the topic in two different posts as there are several items that the typical senior manager is busy with these days.

Low margins
A combination of the economic situation, new entrants in the market and over capacity results in a permanent pressure on vendors’ margins, especially in the area of ‘standard’ services and products. I expect this to result in a consolidation wave among Tier 2 and 3 players as soon as capital becomes less expensive to come by (so in 1-2 years). This should enable these smaller players to achieve economies of scale similar to the Tier 1 players. A combination of consolidation and a broad service portfolio is how these players earn their living.

Above average margins may be achieved only by innovation, customisation of services or serving niche markets. An in-dept understanding of the client's business and its market will be a key success factor in succeeding in these relative small market segments. These niche markets are typically serviced by small players which, when necessary, bundle their service with those from other niche players within their network to provide a broader portfolio. Their challenge is to get access to clients, innovate faster than the biggies and access to skilled resources.

Specific legislation aimed at outsourcing
In the United States negative national sentiment on offshoring jobs has led in the past already to proposals for legislation on both national and state level (See also: Benvenuto N., Brand D., Managing the Risks of Outsourcing in a Post-Sarbanes World, Information Systems Control Journal, Volume 5, 2004.). More recently is a proposal to increase the tax burden for American companies offshoring jobs (see this post).In Europe similar discussion about the pros and cons of protectionism and market capitalism are also regularly taking place, but did not result in any legislation (yet).

For the European suppliers is there however a set of new rules governing public procurement which could make the life of private sector suppliers more difficult. Under the new legislation, which is based on EU's Remedies Directive (2007), courts will have the power to cancel contracts that breach procurement rules and order a new tender process. The directive has currently still in the phase of ‘consultation’, but is expected to become a law to be implemented by the individual member states in the near future.

Reputation damage
Reputation damage can come in several different flavours and should not be underestimated (just look at what happened to Satyam). Some examples of risks that can result in damage to the reputation and thus future earnings and margin are:

• Fraudulent activities. One of the effects of an economic downturn is that fraudulent activities sooner come to the surface. While the whole world is under the spell of the $50 billion pyramid game of Madoff, the Indian market is under the spell of the fraud at Satyam and a bribe scandal at Wipro. Although the fraud by Satyams CEO of $1 billion is nothing compared to Madoff, the effects in India are not any less. As with banks, trust is very important for suppliers and the Indian government already has responded with proposals for additional regulation to limit the reputation damage.
• Theft or leaking of customer data. There are various examples of employees from vendors mistreating data of clients. To prevent this vendors go to great lengths to protect the availability, confidentiality and integrity of data as any breach is something any news reporter is more than happy to write about (especially those who see in it an argument not to outsource, like employees of the client organisation are all saints…). Besides a damaged reputation it can also result in legal penalties due to, for example, non-compliance to privacy laws like the Gramm-Leach-Bliley Act (GLBA) or Notification of Risk to Personal Data Act (NORPDA).
• Political and other types of instability. Although terrorism is not a recent development, recent attack in India (more than 600 deaths in the last 6 years), the Philippines (10 deaths in six attacks in just the month of July in 2008) and China (several attacks in 2008 with more than 25 deaths as a consequence) have lead to, among other, risk surcharges by suppliers because of higher insurance premiums. I do not expect that countries like Vietnam will now suddenly become much more popular than India as companies that dare to outsource in these uncertain times will opt for the familiar names, both in terms of countries and suppliers.
• Negative sentiments among politicians and voters. This item is related to the paragraph which discussed outsourcing and legislation.

More on this subject in part 2 of this post.

Added 21 june 2009: In this post I put margin pressures at the top of the 'worry list' for executives of IT Outsourcing (ITO) and Business Process Outsourcing (BPO) service providers and a couple of days after I red this piece in which Gartner warns for bankruptcies among service providers due to price discounting. I think especially European and American service providers which do not have enough low cost delivery capabilities will be the ones to put on the ‘watch list’ as they are likely to have the largest deficit between earnings and operating cost. See also this post.