Outsourcing. Time to bring it back home?

Outsourcing has its limits

THE two consortia shortlisted for the biggest outsourcing contract in Europe this year had to bite their nails this week. According to weekend reports, the £4 billion ($7.6 billion) ten-year contract to manage 150,000 computers and networking software for British military personnel had been won by the Atlas consortium led by EDS, a Texas-based company that has a similar contract with the US Navy. But Atlas had to wait until March 2nd before the British government announced that it had won against the rival Radii consortium, led by another American company, CSC.

Europe is now the world's biggest market for outsourcing, according to TPI, a leading adviser on sourcing. In 2004 Europe accounted for 49% of the value of all new contracts worth more than €40m ($50m); the US for only 42%. The British market is well established, but outsourcing is relatively new to continental Europe, which has taken to it with enthusiasm. TPI reckons that last year Germany accounted for 12.5% of the world market, compared with next to nothing in 2001. As in other countries, the move is being led by the financial-services industry.

The “Big Six” outsourcing firms - Accenture, ACS, CSC, EDS, Hewlett-Packard and IBM - are all American. As the market has moved to Europe, their market share has shrunk. TPI reckons that it fell by almost two-fifths in 2004, with ACS the only one of the six to have increased its share during the year. Although the two consortia bidding for the British defence contract were both led by Americans, they had carefully selected European partners: in Atlas's case the Anglo-Dutch firm LogicaCMG and a British subsidiary of the defence group EADS; in Radii's case, British Telecom and Thales.

The growth in Europe has helped the continent's home-grown outsourcing providers - companies such as Germany's Siemens and the French group Capgemini. Last year Capgemini announced a $3.5 billion deal with TXU Corp, a Dallas-based energy company, proving that European firms can now compete in the Big Six's own back yard.

The outsourcing business has spread far from its origins setting up and running other people's IT systems. The fastest-growing part nowadays is the non-IT stuff, referred to as BPO (business-process outsourcing), where third parties provide companies with services such as finance and accounting, human resources, and design and engineering. The outsourcing business is now about two-thirds IT-related and one-third BPO.

Since the beginning of this year both Accenture and EDS have created new posts to head their firms' global BPO businesses. Kevin Campbell, the man appointed to the job at Accenture, says it could be a $500 billion market within five years. BPO is higher up the outsourcing evolutionary chain, and potentially more profitable for suppliers. But they will have to be careful how they price their services. Several have severely miscalculated the cost of the big long-term contracts common in the industry. EDS's contract with the US Navy, which involved consolidating 70,000 different IT systems, has left the Texas company $1.5 billion in the red, a sum it hopes to be able to recoup over the remaining life of the contract. To reduce the chance of similar mishaps, US Navy personnel have been involved in the negotiations with Britain's Ministry of Defence.

As with IT, the early demand for BPO came from the financial-services industry, but business is now spreading elsewhere. There is demand from automobile and aerospace manufacturers to outsource engineering and design work. But the fastest-growing business area is human resources. To consolidate its position in this market EDS has just set up a joint-venture (85:15) with Towers Perrin, a leading firm of human-resource consultants. Last year Hewitt Associates, one of Towers Perrin's main rivals, merged with Exult, a human-resource outsourcing specialist.

Future growth in outsourcing is going to be harder to find. The business is coming up against more and more objections from politicians and unions, especially when “offshoring” is involved - ie, when the outsourced work is sent abroad, as it is in roughly half of all deals. Last year two American states - Illinois and Tennessee - passed legislation aimed at limiting offshoring; this year 16 other states are considering bills that would limit state aid and tax breaks to firms that outsource abroad.

Objections raised

Moreover, companies are increasingly dissatisfied with the practical realities of outsourcing. A recent survey by Bain & Co, a firm of consultants, found that a hefty 82% of large firms in Europe, Asia and North America are today using outsourcing firms, and 51% are outsourcing offshore. But almost half say that their outsourcing does not meet their expectations. Mark Gottfredson, a Bain consultant, says that “companies are outsourcing more and more, and enjoying it less and less.”

Simeon Preston of Marakon Associates, another consulting firm, says that many companies took the decision to outsource their IT operations too quickly. Non-techy chief executives were happy to pass responsibility to others for something that they neither understood nor considered to be strategically significant. The same cannot be said for the new hot areas for BPO: human resources and R&D.

Mr Preston reckons that companies that want the cost benefits from offshoring in places such as India and central Europe should think carefully before handing control of their business processes to others. After all, few companies have yet outsourced control of their manufacturing to the Chinese, even though many of their factories are in China. Why should their services be any different?

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