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Summary

The changing sociopolitical climate across major markets, coupled with anticipated tightening in immigration rules in the US under the Trump presidency, will impact enterprises' ability to outsource workloads to take advantage of lower costs offshore. The captive model for insourcing will reemerge as a viable option for enterprises seeking greater control over their operations as they seek to make the most of a difficult situation.

Insourcing will become attractive for both enterprises and vendors

Change is the only constant in today's dynamic and evolving business environment, particularly as public and private agencies look to deliver superior customer engagement. An increasing number of variables are at play and the traditional cost arbitrage model is losing its sheen as cloud, as-a-service, and automation become mainstream. Outsourcing margins are no longer in the 20%+ range, with most vendors declaring single digits to be an achievable target in 2017. Industry growth has also slowed down with NASSCOM, India's association for outsourcing companies, forecasting industry growth rates to slow down to between 8–10% for 2017, from 12–14% a few years ago.

Until now, insourcing through the use of captive centers was leveraged as an alternative to outsourcing when the nature of certain work was complex, proprietary, and required a higher degree of control. If indeed the suggested reforms in the visa policies in the US (proposed to be changed from a lottery system to one where the petitioner agrees to pay higher wages) make it prohibitively costly for enterprises to outsource to a third-party vendor, we anticipate the captive model to reemerge as a viable alternative that provides some of the cost benefits of outsourcing. In fact, NASSCOM reported that captive centers in India had grown from 760 in 2012 to 1,000 at the end of 2015 and account for 15–17% of India's $150bn IT exports market. It is clear that outsourcing hotspots, such as India, Southeast Asia, and Eastern Europe, can sustain both the outsourcing and captive models with their abundance of skilled talent and favorable cost dynamics (for now). This, however, would go against Trump's expectations for bringing back high-paying jobs to the US just as previously proposed visa reforms have proved to be a double-edged sword.

Traditionally, large vendors (except for HCL Technologies, which helped Citibank and UBS set up captive centers a few years ago and often plays in this space) have shied away from the captive business where the vendor charges a portion of the ongoing delivery cost and helps the client set up its operations on either a "build-operate-transfer" (BOT) model or assisted model (where the operations and employees remain on client payroll from the beginning). Smaller and midsized vendors are the ones most active in this space and also the ones who will stand to make the most of this anticipated growth in captives. However, this area will also become an attractive alternative to larger vendors as a short-term fix to stem falling revenues and we expect that more of them will enter the fray.

In the short term, outsourcing vendors will need to increase the number of local hires in their onshore centers as well as look at increasing the size of centers in tier-2 locations within the US. On the other hand, client enterprises will need to be prepared to absorb the additional cost this will entail while continuing to re-evaluate alternative avenues that can allow them to leverage the advantages of a globally distributed delivery network. The challenge will be to find the right mix of outsourcing-insourcing to balance changing enterprise needs, because what is a good mix today may not be so in a few years' time and the investments required for the captive model to succeed might end up outweighing the cost advantages in the long run.

Appendix

Further reading

Innovative Cloud Services from National Telcos in Asia, IT0019-003595 (January 2017)

"2017 will be a mixed bag for Indian IT services," IT0019-003602 (January 2017)

2017 Trends to Watch: Application Services, IT0019-003590 (December 2016)

"IT service providers should be very afraid – AWS is about to disrupt your business again!," TE0005-000885 (December 2016)

Author

Hansa Iyengar, Senior Analyst, Large Enterprise Services

hansa.iyengar@ovum.com

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