Frances Karamouzis

These past 3 weeks, I had the opportunity to visit four countries in CEE namely, Romania, Hungary, Czech Republic and Poland.  It was quite an interesting trip that was filled with a array of meetings with lots of different stakeholders and constituencies within the value chain of Global sourcing. While this was a three week trip, and I felt that I got an updated 2010 view of the region.  There is a great deal more to research and more input needed. 

I participated on individual visits with Shared Service Centers,  Centers of Excellence, vendor locations, workshop sessions with buyers and sellers (vendors), technology park visits, meetings with Govt officials and Trade Associations.

Clearly the region and the entire European economic landscape is experiencing lots of change and unrest.  Hungary just changed their government and everyone is braced for the unveiling and action plan for a new vision.  Poland recently lost a significant number of leaders to a plane crash.  Romania is a having protests in the streets related to the proposed Austerity decrees.  And the list goes on as it relates to exchange rates etc.  And right in the middle of the trip, there was a major incident with the Israeli’s in Gaza.

Amidst all of this change and shift, it was great to see a very enthusiatic group of stakeholders eager to take advantage of new disruptive technologies whether its cloud or SaaS or deliver core work within various functional areas of an enteprises.

The dilemma I found was that it was very hard to define a clear concise and definitive “brand” or “value proposition” that has been created to help differentiate each of these specific locations.  Everyone talks about India and China — and in fact, my previous post  a few days ago has had a very high hit rate.  I am very curious as to the responses to this post.

In my presentations to the stakeholders in the region,  I felt that one slide particularly resonated with the audience and creaeted lots of discussion regarding the future of the region (see a copy below).  The point of this slide is that I think that eventually, the global market will undergo an important shift from pure labor based driven models for value to Intellectual Property (IP) driven models.  If this does come to fruition, then countries in this region with populations of 10 or 20 million can play a significant role because this business model is not about scale rather about IP.  More importantly, the profit model in an IP driven business model is not about cost but rather about multiples of value. 

Please chime in with Thoughts, Comments, Ideas.

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Gartner’s analysis of a comparative cost structure assessment between India and the China reveals that a total cost of sourcing business case for a vendor or a captive center varies widely depending on enterprise specific business and IT requirements, scope, scale and appetite for risk. The variability is based on city locations (where coastal China cities might be as much as 30% more expensive that inland China locations), availability of specific skill sets, risk factors (country, security, competency, and maturity risk) as well as available vendor options.

Based on analyzing over 240 business case analyses over the last 2 years, Gartner research shows that there is not a simple or absolute ranking of global sourcing country locations by cost. Furthermore, given the current volume levels for China global sourcing, there is not enough critical mass of completed deals, or a critical mass of established vendors with extensive track records, and authenticated data. However, based on extensive analysis including breakdowns of major variables of costs, Gartner has concluded that the cost structures in China for the largest components of standard costs (namely, labor, real estate, telecommunications) are indeed within an extremely competitive range relative to many of the leading global delivery locations (including India). Therefore, the continued “cost is king” mentality of clients will inevitably continue to drive interest in the analysis of China as a global sourcing destination. Unfortunately, there is no clear yes or no answer as to whether China is cheaper than India, the answer is deal specific and primarily driven by scope, scale, skill set requirements, language requirements and risk thresholds.

A more detailed look at costs reveals that there a several factors that have a large variability across city locations in China, therefore, it is imperative that enterprises understand the factors with extensive hi-low ranges. These factors include: (1) the variability of wage rates and attrition across various cities in China (2) the short versus long term cost of real estate as rates vary dramatically over multi year periods given short term government or technology park subsidies (3) large standard deviations in the investment ranges required for human resources readiness (technical, language and soft skills training) as well as IT Services process business models (4) economic variations based regulatory requirements (5) government and legal requirements to manage risk (6) security issues (7) additional investment needed for low English speaking capability and/or cultural affinity.

Clients must explore and ensure deal-specific due diligence for the incremental globalization factors and analyze risk management costs. Clients need to ensure they assess a thorough total cost of sourcing analysis over a multi-year period in order to determine cost benefits and manage risks.

(1) Enterprise buyers (especially those who have sourced work in India) often compare a rate card from a Tier 1 vendor with operations in India (i.e. IBM, Accenture, Tata, Infosys or Wipro) to a rate card of a tier 3 or tier 4 vendor in China. Simply comparing a rate card for a specific skill set is not a proper comparison because the elements built into a rate that is quoted by a vendor include elements of disaster recovery, and business continuity

(2) Comparison of pure wage rate charts. For example, if you look at some wage rate charts in China, you may see a quoted number such as 9K per year for specific for a programmer. However, the total cost to the employer is far more because China has a federal tax that is required (similar in nature to US social security taxes) which are currently 50%. Therefore, the cost to the employer is actually 13.5 K (9K plus 4.5K). Beyond that, if the programmer requires a certain level of English proficiency, a premium of of 10 to 15% must be factored into the wage rate above and beyond the market based rate.

(3) Assuming competency and skill sets in China and India are equivalent. A project manager or business analysts or even a programmer as designated on an human resource inventory in each of the respective region are not at all equivalent. Project management expertise is quite different. For example, at this particular juncture, a “experienced’ project manager in India can claim a track record of projects involving significant complexity and project size that simply has not yet materialized in China as of yet. Also, the label of of progammer or software engineer in China often refers to someone with experience with embedded (R&D) engineering expertise versus the more commonly used reference in India is related to Enterprise Apps skills.

(4) Assuming that there is one singular China cost structure. China is a vast country with over 20 designated hub cities. Cost structures across these various cities may vary by as much as 30%.

(5) incorrect Calculation of Total Cost of Sourcing or Risk Adjusted Total Cost of Sourcing. Quite often enterprises do not properly account for or comprehensively analyze the following:

• multi-year sustainability of cost structures
• do not include differentials in program and project management overhead costs
• cross cultural communications impacts on costs
• vendor competency and execution differentials
• risk mitigation and/or risk management costs
• potential currency rate fluctuations

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As we approach the end of the year, I thought I take the opportunity to launch this blog with a question and hopefully engaging discussion about the extensively hyped topic of Cloud.   As a Gartner analyst, clearly our organization has put forth lots and lots of research regarding Cloud Computing.   However, I want to focus on “IT Services” and the Cloud.   Within Gartner, we are referring to this as Cloud enabled Services or Cloud enabled Outsourcing — or just Cloud Services for short.  Regardless of the name — the question on the table is how much money, marketshare, channel mastery and MOST importantly in the first 18 months (how much MINDshare) will be commanded by IT services companies (whether its some of the traditional providers like Accenture, Capgemini, ACS, CSC, or some of the Indian vendors (TCS, Wipro, Infosys, Cognizant, HCL, and the other 40+ Indian vendors OR other offshore vendors (Softtek, Neoris, EPAM, CPM Braxis, iSoftstone, VanceInfo,  etc. or some of the smaller emerging providers like AppsLabs, Appirio, Torry Harris etc.))

Please weigh in with your thoughts, comments, challenges …

To get the ball rolling, here is a prediction that I recently published along with European colleague (and veteran) Gatner analyst, Mr. Claudio Da Rold:  By 2012, India-centric IT services companies will represent 20% of the leading cloud aggregators in the market (through cloud service offerings).While in some ways, this can be perceived as bold prediction, we did analyze alot of different factors and while I feel that several Indian centric IT service providers will clearly have some challenges in truly driving sales and marketing of their Cloud service offerings — I do feel that there are some very interesting market forces on their side.  Pasted below is an excerpt from the published reserach that supports some of the thinking of the prediction  — LETS HEAR BACK what you think…. I also challenge companies like Accenture, IBM, HP, Capgemini, CSC and others to also weigh in.  The primary reason is that while I think some of the traditional outsourcing have some incredible assets (including clients, industry expertise, strong client base etc.)  in their favor as well as some strong leadership and experience — I look at a bellwether company like  Accenture and I find myself asking some interesting questions.   Accenture is a strong company and always a formidble competitor, however,  when it comes to Cloud – they have not been very Accenture-like.  Specifically,  I mean they have not visibly and prominently  stepped out in front as a thought leader, a market maker in this arena.  They seem to want to take a “follower” approach.  Maybe its because they have never had a big footprint in infrastructure and some of the earliest elements of cloud are mostly in the infrastrcture space.  Thus you see companies like IBM and CSC taking a more visible and “louder” stance with regard to cloud.  Clearly they have a much larger footprint in Infrastructure and IBM also has a big stake in software producsts as well.  Lets hear from you on this interesting debate…

Excerpt from Gartner research — supporting our prediction above

Gartner’s presentation in India at the annual NASSCOM event in 2006 declared that India-centric IT services companies have a Strategic IMPERATIVE to focus on exploring nonlinear revenue growth models (which are not directly correlated to labor-based growth). Finally, in late 2008 we came to see that many Indian vendors have embraced this.  Thus cloud services is an very interesting area to explore. Therefore, the collective work from India-centric vendors represents an important segment of the market’s cloud aggregators, which will offer cloud-enabled outsourcing options (also known as cloud services).  

A significant number of vendors from the infrastructure, software and IT services arenas are  investing in R&D and seeking to monetize a share of cloud-based solutions and offerings. This investment fervor indicates that cloud services, which consist of automated technology (services) and IT services (labor-driven managed service), will represent a substantial portion of the overall  market. It is also likely to constitute the most lucrative portion of the profitability margins that vendors attain (see the cloud-computing predictions report that investigates this in more depth).  Within the overall spectrum of vendors in the IT services landscape, India-based IT services company are interesting for the following reasons:  

Global delivery:

•  These vendors were instrumental in commercializing the global delivery model, which  involved the use of virtual decentralized teams across the globe. This model separated where providers create IT services from where organizations consume them. 
• These vendors succeeded in recalibrating the price points to address the long-standing enterprise demand for lower costs and in expanding the supply-side spectrum beyond the borders of individual local domestic markets to global markets for specific IT skills.  

Approach:

• The software engineering background of many of the India-centric vendor leadership teams has infused a different mentality and approach to upfront R&D investment in the IT services industry (especially in new disruptive technologies). Compared with the approach of traditional IT services firms, Indian providers tend to aggregate IT services, software and infrastructure in much more holistic ways with fewer internal barriers for developing solutions.
• Many of these companies first introduced themselves to buyers in the U.S. and the U.K. as software companies rather than as IT services companies, which indicates their mind-set in both IT services and software solution development.
• Many of these vendors have always sought out new and innovative delivery models that differed from large asset-intensive outsourcing approaches common to the longstanding IT services provider incumbents. For example, many of these vendors never focused on the transfer of employees or other capital-intensive assets.

 Financial viability:

• A huge majority of these vendors have little to no debt, and many have significant access to capital. In addition, the opportunity cost for these companies to develop their solutions is usually much lower, given the labor rates in India and the organizational structures of these companies.
• These providers have grown their businesses through a linear business model, oftenposting more than 30% growth on a compound annual basis for more than seven years.  This growth required the hiring of tens of thousands of net new employees per year, which is unsustainable for the long term. A new business model demands that some portion of the portfolio include nonlinear revenue that is unrelated to a labor rate per hour. Cloud service represents a valuable opportunity to achieve this.
• Indian providers do not own huge investments in traditional IT infrastructure and do not have a large portfolio of traditional infrastructure outsourcing deals. Therefore, their existing revenue and margins are less vulnerable to the displacement of revenue via cloud-based offerings than traditional large outsourcers are. Indian providers are more likely to invest in offerings that clients interested in migrating to private, public or hybrid forms of cloud services will demand. These vendors will likely offer strategic business and IT consulting services around the impact and deployment of cloud-based solutions. IT services providers that deliver professional services to help enterprises evaluate and assess cloud-based options, develop and integrate these solutions within the enterprise, and manage the company’s transition into new, more industrialized services and solutions are in a unique position to build viable cloud service offerings, given their intimate knowledge of enterprise preferences and strategic approaches.  Therefore, Gartner feels that the Indian providers are uniquely positioned to go beyond just assessments and integration services, and that they will develop and grow extensive cloud service offerings in the form of cloud-enabled outsourcing.

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