Last December, for our year end blog post, we ran a random poll asking “what would 2009 be remembered for in the history of outsourcing industry” to get some ideas. The responses we received were pretty interesting however none as insightful as Jerry Durant’s reply . His observations were blunt, point blank and thought provoking. So the next thing we did was, dropped the idea of writing that blog and asked him if we can send him a bunch of questions to know his point of view in explicit detail. He not only agreed , he also gave some engrossing answers. Below are the excerpts of his interview. We hope that you will enjoy reading till the very end.

Jerry, you don’t seem to be too enthusiastic of the top level M&A happening around the industry.Why and can you throw some light on why the M&A happening on the Tier 2 & 3 level is more relevant in the today’s’ times?

The whole question about mergers and acquisitions is based upon the amount of outsource supply that exists. Although in terms of gross headcount we are adequate the sheer number of separate source providers is excessive. What ends up happening is that because of this buyers are forced to buy higher into the supply chain than what would otherwise be necessary. Now to answer your point directly and based on my earlier comments, we have an over abundance of tier 3 and small tier 2 companies. As a result no single company can garner enough business to move them up in terms of operational size. It also places at risk, under current economic conditions, their ability to survive. With this said the mortality rate will start to be seen during 2010 unless steps are taken today to join together. My concern about M&A at the top level is based on pricing. Tier 1 companies have significant operating cash demands that have to be met, the fuel of which is new engagements. Since companies in this category have pricing inflexibility, by comparison to the smaller companies, buyers will face less than desirable pricing. While in the short terms prices, below costs, can occur this will not be sustained in the long term. Further, many buyers do not need tier 1 sized organizations unless there is scaling in both price but also operational level matters (engagement core staffing size, administrative protocol).

What made you think that the advisory firms offer advisories based on unfounded information?

I would necessarily say it in this way. What I am saying is that there is a significant difference between a survey that is based on the use of a scientifically based population and an opinion poll that involves a set of questions being taken in general. Another area of particular concern is using this information and then predicting future outcomes. If one waits long enough the predictions taken on the appearance when in short they are simply a report about the present.

Can you cite a few instances wherein their predictions or suggestions went way off the mark?

Probably the most vivid of these were taking place in q1 2008 when almost every leading advisory group was reporting record outsourcing growth in virtually all sectors. As we now know these predictions did not materialize. What caused some of this ˜predictive’ inaccuracy was that trend data was viewed without consideration for factors outside of the sourcing sector. These ranged from housing starts (in Western nations) to currency trends, global instability, and balance of trade. If the range of view had been slight expanded to consider these then some hints would have become obvious.

Is the dreaded “R”word over?

I actually thought that we had slid through the “ R ” and hit the “ D ” word, hoping that the recovery would occur quickly such that no one would notice how far down we went. Based on review of trading trends, global profitability, governmental initiatives, and market innovation it is my personal opinion that we aren’t over the recessionary period. I also don’t believe that we will see this happening until the late summer (beginning of q3) of 2011. This is one of those cases where I am hoping that I am dead wrong. However, in order to have any form of economic improvement we have to order to our chaos and we are at the opposite end of the scale. The good news is that the pain that we are in will encourage M&A activities, foster innovation, and force the industry to take on a new and more productive direction.

What could be the long term and the short term implications of the recession on the industry?

The short term implication is that there will be companies lost and also companies that become consolidated in the sourcing sector. This will create a degree of disturbance for buyers as these companies get back in order. As a result, some buyers are apt to pay more to get the same service from larger providers in order to reduce the rift that the provider consolidations will be experiencing. This will however be short term. In the long term suppliers will better understand what is important to buyers. Buyers want service delivery but because of increased buying risk, caused by the economy, they will be looking intently upon outsource company viability. This will mean that buyers will have to self-invest to build their business and not simply view delivery as the reason why they would get business opportunities.

You are quite gung-ho about the micro destinations?

My main reason for being excited about micro or emerging nations is the ability to interact from top to bottom. From government office to outsource provider the full landscape can be engaged, understood and most importantly worked with. Since many of these locations represent smaller tier 3 companies they have optimal pricing and service flexibility. However, every cloud has a silver lining! it also means that even in these locations that some consolidation will have to take place. Whether this is carried out through M&A or simply through cooperative work contracts it will be necessary to do this in order for their sourcing sector to flourish in the long term.

How can they alter and impact the outsourcing industry’s landscape in the years to come?

Let’s start off by talking about the challenge that they face, and that is getting market visibility. It’s easy to buy from the big box store for outsourcing, be it India, China, Philippines, Brazil or Russia however when you buy from popular destinations you are lulled into comfort areas that may present issues. Buying big doesn’t necessarily mean buying best. On the other hand, buying small doesn’t always mean improved results either. Buyers must do the right job in order to get what they need at an affordable price. Suppliers business culture must come close to those of the buyer. There are literally hundreds of thousands of small to medium sized buyers in Western markets that can utilize sourcing to augment their businesses. The emerging nations cut through governmental red tape, lower the engagement barriers, and offer attentiveness that is customary to buyers. I also expect that a number of emerging nations will hit a plateau in terms of growth due simply to resource constraints whether in terms of population size or metropolitan capacity to which a service population can accommodate. Let me put my neck out a bit however, I also have enough trust and confidence in these emerging nations in that they will collaborate at a national level to reduce the effect of reaching a plateau barrier.

In your opinion what are the common issues between a outsourcing service buyer and supplier (in general) and how can they be minimized?

The common issue for both buyer and supplier is reaching a mutually beneficial relationship/deal. Both parties know what they are willing to do and for how much, it’s a matter of compromise. Unfortunately during tough economic times the shift tends to hit the supplier even though buyers are simply responding to business downturns themselves. We are seeing deals that are so skewed that it places at risk the very suppliers that the buyers are counting on. Part of this is driven by the lack of comprehensive viability assessment of suppliers by buyers. They are looking at a few choice areas and making a determination and not digging deeply into the business operational aspects of these companies. If they had, they would be making difference decisions about how deep to push the deal with the supplier partners. At the same time, buyers have been particular cavalier about running their business and self-investing. This is analogous to a young adult starting fresh on their life of independence. We have all been there and we spend money and not think about putting a little bit of money aside or making some investments that will serve us throughout our working career. Since it’s easy to become an outsourcer they often focus on the sale and the service, and aren’t quite as attentive to the “building the business” aspects.

As you are also one of the Senior Advisor for Global Outsourcing for the Beijing Association for Software Sourcing (BASS), in your opinion, what are the challenges that the Chinese Outsourcing industry needs to address before they could become a formidable force ?

There are two; language and self-investment. Let me also say that language is rapidly becoming a non-issue with major global outsourcing providers in China. It’s only at the smaller company level that it is much of an issue. Western buyers need to understand that if you are dealing with another country that you should not expect them to act like or talk like you do. I can assure you that even some Westerners do not have acceptable command of their language. None the less language is a barrier that every Chinese company will need to overcome, at least for the customer facing staff members. My second point is ˜self-investment’. Market driven economies, like China, follow what one might call a shop owner model (you set up a business and you sell product). This works well when you only intent is to sell within your community but once you venture beyond these safe areas you soon find out that more things have to be done. Because entering outsourcing is easy (business cards, website, mobile phone and a few computers you are in business) and access to the world is immediate we are lulled into the comfort that thinking that our shop owner paradigm can continue. Establishing credible business requires significant company building (to gain buyer trust), focused market understanding and strategic selling in order to grown a company’s viability.

As an industry the control (and vision) is carried out through the Central Government. They set the goals, rate of growth, approach and level of support necessary to carry out the plan. Each region and specific city is responsible for doing their part to realize these goals while still have the individual flexibility for delivery. Unlike NASSCOM which utilized a centralized approach to building the Indian outsourcing industry the China model relies on centralization to take place at the national level (allowing for regional implementation flexibility). I believe that in both cases (the NASSCOM & Chinese model 1000-100-10 plan) both can be successful due largely to their respective approaches matching the social framework for which they support.

Any prediction for 2010?

I had made my earlier prediction on economic recovery. Let me now make a few more. I predict :

  • That there will be at least one (possibly two) more large M&A deals during 2010. One deal will be based on gaining regional presence and the other will be based on an expansion of service delivery (such as an BPO/ITO marriage). In general, tier 1 operators will start to explore ways to segment their operation in order to gain pricing flexibility and operational informality.
  • There is the potential for at least a dozen more Satyam like company failures across all tier groups and outsource service disciplines (ranging from BPO to KPO). How many of these will be realized will be driven by the economy and possible M&A activity within period.
  • Expect to see some slight growth in the KPO sector. However be very careful, some will be as a result of mis-categorizing and there will be some that will drop out of the KPO service sector. Overall the net will look flat while in fact there is expected some slight gains. You may see some advisors move into the KPO to serve as paid-for-research organizations.
  • We will see outsourcing companies including non-national C-Level executives within their ranks. Past practice will be replaced by the need to put a familiar face before the buying public.
  • Expect in 2010 to see initial signs of supply side reductions caused by the economy. Measures that could have been taken in 2009, but were not, will be manifested as a matter of necessity.

About Jerry E Durant: Jerry serves as Chairman Emeritus (founder) for The International Institute for Outsource Management, a trade organization dedicated to the assessment, development, and guidance of outsource service providers in the ITO, BPO, Call Center and KPO domain areas. He has authored the Outsourcing Management Body of Knowledge & implemented the only outsource provider viability GSC model.