The Impact of an Economic Slowdown on Outsourcing

May 19, 2008 on 9:33 am | In Uncategorized |

Jagdish Dalal, Managing Director, Thought Leadership, IAOP

Despite Washington’s denial of the “R” word, clearly the economy is in a negative growth situation. There are many factors driving it; some are long-term — the U.S. national debt and oil prices — while some are short-term, like the sub-prime loan situation. Although this economic crisis is largely created by business conditions in the U.S., the world economy is not quite strong enough to offset its impact on the global economy. Economists everywhere are pontificating about it, so let us look at the impact of a slowing economy on the subject of our interest — outsourcing.

Buyer’s point of view (A Mixed Environment for Outsourcing):
Businesses are beginning to see the impact of lower economic growth on their financial results, and we are seeing more stories about cutbacks on spending to retrenchment of expansion plans. Increased profit pressure on businesses will drive them to evaluate their cost basis and look for opportunities to reduce expenditures. For example, information technology (IT) spending is expected to be lower in 2008 than the previous year (see inset). We believe that similarly, other functions — human resources, logistics, real estate spending — will see a slowdown in budget growth for the coming year.

Text Box: Ø “In the U.S., budgets are still growing, at 2.3 percent, but that represents a drop from 3.1 percent in the last study.” Gartner Study, April 2008 Ø IDC is predicting that global IT spend will be lower by 0.5-1.0%. December 2007What does this mean for outsourcing? We believe that the companies needing to lower costs will explore outsourcing as a means of achieving that goal. Additionally, the uncertainty of economic conditions will encourage them to lower their “fixed” costs and seek a “variable” cost basis provided by outsourcing. Uncertain market conditions will lead companies to examine capital spending and look toward outsourcing to lower investment requirements. Thus, we predict a mixed business environment where demand is smaller due to decreased spending, but increased transaction activities increase due to businesses’ need to outsource more. Major U.S. based outsourcing providers have predicted in their first quarter financial analyses stable growth for their businesses in 2008. However, experts believe that the uncertain business climate will slow corporate decision making. (See the interview with Atul Vashistha, chairman and founder of neoIT and a founding member of IAOP after this article).

Provider’s point of view (A challenging environment for business):

It is unclear how much impact the economic slowdown will have on outsourcing providers. Lower demand due to reduced budgets may be offset by an increased demand for the benefits of outsourcing. However, it is clear that providers will face a tougher negotiating environment where businesses will try to maximize their benefits from outsourced work. This, coupled with their own belt tightening will reduce margins from the outsourcing work and force providers to look for alternatives for increasing their profits (See article by D. Davison and E. Kublanov of neoIT posted on Firmbuilder.com: Navigating Economic Uncertainty: Leveraging the Services Globalization Advantage).

Additionally, globalization puts another key economic factor into play for outsourcing providers — currency values. The U.S. dollar is near an all-time low, and the Indian and Chinese currencies are at an all-time high. This gap in currency translation will induce pressure on the labor savings projected by providers. To further complicate the profitability picture for providers, wages are not expected to drop significantly, and there will be continued pressure for wage increases. Rising prices of commodities and fuel will increase raw material costs (for example, rising utilities and transportation costs, short-term credit interest rates and postage rates) and impact cost and operations for providers, as well.

Summary:

So, what does this all mean for outsourcing? Turbulent times require companies to manage operations with great discipline, and we can expect companies to plan, negotiate, implement and manage outsourcing agreements more efficiently and effectively. As these stakes get greater, companies increasingly expect outsourcing to be handled as a new management science based on standards, proven methodologies, and industry best practices. This is giving rise to companies seeking to employ Certified Outsourcing Professionals (COPs) who understand and apply best practices in the marketplace. IAOP already has seen a dramatic increase in demand from companies (and individuals) looking to attend classes to become a certified professional.

One way that providers also can demonstrate sustained value for their clients is through greater attention to outsourcing’s relationship to social issues.In today’s environment, social responsibility is not only good policy, it’s good business. It’sone categoryof risk that companies can directly influence through their own actions. This “socially responsible outsourcing” is a new phenomenon, and IAOP will explore it further throughout the coming year and even dedicate a track to it during the 2009 Outsourcing World Summit.

We would love to hear from you: jag.dalal@outsourcingprofessional.org.