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ROSS INSIGHTS REPORT

OUTSOURCING TRENDS AFFECTING THE MID MARKET, 2003

PUBLISHED APRIL 2003

Distributed as Free Market Intelligence in lieu of the April 2003 newsletter issue of “Outsourcing Thought Leadership”

“The overarching theme resulting from Ross Research’s analysis points to the fact that mid market companies are getting smarter with regard to outsourcing…and the opportunity that this segment represents cannot be ignored.” (See Executive Summary of Key Findings inside.)

Copyright 2003 Ross Research www.rossresearch.com Reproduction is permitted and encouraged.

TABLE OF CONTENTS RESEARCH OVERVIEW ..................................................................................................................................... 1

PURPOSE OF THIS STUDY............................................................................................................................................ 1 RESEARCH OBJECTIVES .............................................................................................................................................. 1 METHODOLOGY.......................................................................................................................................................... 1 DEFINITION OF MID MARKET ..................................................................................................................................... 1 PRESENTATION OF RESULTS & ANALYSIS ................................................................................................................... 2 RELATED RESEARCH .................................................................................................................................................. 2

ABOUT ROSS RESEARCH................................................................................................................................ 3

WHO WE ARE ............................................................................................................................................................ 3 FOCUS AREAS ............................................................................................................................................................ 3 LINES OF BUSINESS .................................................................................................................................................... 3 WHAT MAKES ROSS RESEARCH UNIQUE?................................................................................................................... 4

EXECUTIVE SUMMARY OF KEY FINDINGS ............................................................................................ 5

RECOMMENDATIONS ........................................................................................................................................ 7

FOR VENDORS, ADVISORS, AND BUYERS OF OUTSOURCING SERVICES ........................................................................ 7 #1. Get Ready Now............................................................................................................................................... 7 #2. Focus on Delivering and Obtaining “Value” ............................................................................................... 7

ADDITIONAL RECOMMENDATIONS FOR OUTSOURCING FIRMS & ADVISORS................................................................. 8 ADDITIONAL RECOMMENDATIONS FOR MID MARKET SOURCING BUYERS................................................................... 8

MID MARKET LANDSCAPE OVERVIEW................................................................................................... 10

OUTSOURCING IN THE MID MARKET......................................................................................................................... 10 LACK OF FOCUS ON THIS MARKET SECTOR............................................................................................................... 10 THE GROWING IMPORTANCE OF THE MID MARKET ................................................................................................... 11

Figure 1, The Outsourcing Sales Cycle Through the Lens of Service Providers................................................. 11

TOP OUTSOURCING TRENDS AND THEIR EFFECTS ON THE MID MARKET....................... 12

TREND # 1: MORE OUTSOURCING IS BEING DONE, AND WILL CONTINUE… .............................................................. 12 Table 1, Savings Targets for Select Outsourcing Deals, 2002 ............................................................................ 12 Table 2, Outsourcing Firms and Transferred Employees for Select Outsourcing Deals, 2002........................... 13

TREND # 2: DEALS DESIGNED TO “WOW” THE SHAREHOLDERS................................................................................. 13 TREND #3: FOCUS ON THE INTERNATIONAL MARKETPLACE ...................................................................................... 14 TREND #4: FOCUS ON THE FINANCIAL SERVICES INDUSTRY ...................................................................................... 15 TREND #5: OUTSOURCING FIRMS TEAMING UP TO PROVIDE SOLUTIONS ................................................................... 16 TREND # 6: NO CLIENT MONOGAMY ........................................................................................................................ 16 TREND #7: THE OUTSOURCING SALES PROCESS IS CHANGING .................................................................................. 17 TREND # 8: MORE CREATIVE DEALS......................................................................................................................... 18 TREND #9: INCREASING USE OF SOURCING ADVISORS.............................................................................................. 19 TREND #10: BPO GAINING GROUND, BUT LINES ARE BLURRING ............................................................................ 19

CONCLUSION....................................................................................................................................................... 21

© 2003 Ross Research. All rights reserved. Page 1 of 21

RESEARCH OVERVIEW Purpose of This Study Mid market companies in the United States and abroad – those with annual revenues between $100 million and $1 billion – comprise a huge, yet relatively untapped market for outsourcing service providers and sourcing advisors. While both providers and advisors must begin to target this market segment due to saturation in the Global 1000, one is hard pressed to find any substantive writing or research about this large subset of companies. Granted, servicing the mid market outsourcing segment has very distinct challenges, but competition and glut demands that vendors and advisors begin to pay close attention to this market’s needs – with regard to both information technology (IT) and business processes. To help service providers, advisors, and buyers gain insights into opportunities in mid market outsourcing, Ross Research conducted an overall analysis of the major trends affecting this sector. This resulting report provides trend data that arms sourcing advisors and providers with the intelligence they need to begin planning their mid market sales and delivery initiatives. As the old saying goes, “Forewarned is forearmed.”

Research Objectives The primary objective of this Ross Research report is to examine and understand the major outsourcing trends affecting the mid market. The focus is on the U.S. marketplace, although many of these trends can be applied to European and Asian market conditions. This report answers the following key issues:

• What are the major trends? • How do these trends affect mid market companies? • What do these trends mean to outsourcing service providers and advisors? • What do these trends mean to sourcing advisors? • What do these trends mean to buyers of outsourcing services? • What opportunities do these trends offer?

Methodology Ross Research studied hundreds of outsourcing deals consummated in 2002 to understand the types of contracts that have been let recently as well as the intricacies involved in each one. The primary focus of review included contracts being managed by IBM Global Services, EDS, and Accenture. Being amongst the biggest outsourcing providers worldwide, these service providers “lead the pack” in influencing and even determining the trends of today and tomorrow. They represent a valuable gauge on what is, or will soon be, happening in the market. In addition to this source of data, Ross Research relied on its analysts’ knowledge capital in the outsourcing industry, gained from years of research and observation. To a great extent, this know-how represents the essence of this report.

Definition of Mid Market The definition of a mid market enterprise varies greatly in the industry; there is no general consensus or guideline as to how one could measure it. The mid market, often also referred to as the middle market, is

To help providers, advisors, and buyers gain insights into opportunities in mid market outsourcing, Ross Research conducted an overall analysis of the major trends in this sector.

Ross Research studied hundreds of outsourcing deals consummated in 2002 to understand the types of contracts that have been let recently as well as the intricacies involved in each one.


defined typically in terms of ranges, either on the basis of annual revenue or the number of full-time employees, and sometimes both of these. Revenue ranges can be as low as $1 million to as high as $2 billion, whereas the number of full-time employees can vary from as low as 20 to as high as 20,000. Ross Research defines the mid market as those companies with annual revenues of between $100 million and $1 billion. Employee size within these companies generally ranges between 1,000 and 5,000; but a small percentage of mid-market companies have between 5,000-10,000 employees, and another small portion consists of companies with fewer than 1,000 employees and even less than 500 employees.

Presentation of Results & Analysis This report begins with an Executive Summary outlining the key findings from this research and Recommendations to service providers, advisors, and buyers to capitalize on mid market outsourcing opportunities. These two chapters are followed by a brief discussion of the mid market landscape and current state of the industry. The report then examines the top ten major trends identified by Ross Research as affecting mid market companies. It concludes with a summary highlighting the most salient points made in this analysis.

Related Research The following additional reports are part of Ross Research’s Global Sourcing Advisory Services report series:

• Outsourcing Advisory Services: A Global Market Overview and Service Provider Analysis, 2003 (to be published April 2003)

• Outsourcing Consultants & Legal Firms: Who’s Who, What’s What and How Do You Choose? (published in February 2003)

• Influencing the Outsourcing Influencers: Who They Are and How Service Providers Can ʺWowʺ Them (published in December 2002)

• Getting An Outsourcing Deal That Works: Buyers’ Perspectives on the Value of Using External Sourcing Advisors (published in October 2002)

Ross Research defines the mid market as those companies with annual revenues of between $100 million and $1 billion.


ABOUT ROSS RESEARCH Who We Are Ross Research (www.rossresearch.com) is a market research and advisory firm focused on helping outsourcing service providers and sourcing advisors increase their win ratios. Since 1999, we have researched, analyzed and delivered the market intelligence companies need to improve their go-to-market strategies, work better with prospects, and refine their marketing and sales activities worldwide.

Focus Areas Ross Research specializes in two distinct areas and has deep expertise in each:

• Mid Market Outsourcing: Concentration on helping service providers and sourcing advisors define and implement their business development activities in this unique market segment (companies with between $100 million to $1 billion in revenues)

• Following the Sourcing Advisory Services Market: Emphasis on providing service suppliers with the intelligence they need to develop stronger relationships with sourcing advisors AND helping sourcing advisors craft strategic growth plans in a wide range of geographic, demographic, and vertical markets

We possess vast knowledge in the following outsourcing arenas: Finance & Accounting, Government, Healthcare, Human Resources, and Offshore.

Lines of Business Ross Research offers three lines of business: Research Reports, Custom Advisory Services, and Free Market Intelligence. All services and products are available on a standalone basis or via a customized annual subscription which includes a flexible combination of all business lines.

• Research Reports – Monthly/bi-monthly, fee-based reports with a specialized focus in two areas: Mid Market Outsourcing and the Sourcing Advisory Services marketplace. We have five discrete practice areas: Finance & Accounting, Government, Healthcare, Human Resources, and Offshore Outsourcing. Reports are available via subscription and off the shelf. Current and upcoming topics include:

° Business Process Outsourcing (BPO) 2003: What Buyers Really Want ° Outsourcing Trends Affecting the Middle Market, 2003 ° Influencing the Outsourcing Influencers: Who They Are and How Service Providers

Can “Wow” Them ° Human Resources Outsourcing Buyers’ Perspectives: Lessons from the Trenches ° Healthcare Outsourcing 2003: Opportunities, Trends, and Key Issues ° Finance & Accounting Outsourcing 2003: What’s on the Mind of the Buyer ° Offshore Outsourcing 2003: Buyers’ Reactions and What They Would Do Differently

• Custom Advisory Services – tailored to meet our clients’ unique objectives, like: sourcing

business strategy and marketing consulting, virtual analyst time, multiclient studies, webcasts,

Ross Research is a market research and advisory firm focused on helping outsourcing service providers and sourcing advisors increase their win ratios.

Ross Research offers three lines of business: Research Reports, Custom Advisory Services, and Free Market Intelligence.


and on-site sessions with our clients and their customers/prospects. Examples of custom projects include:

° Market Opportunity Analysis ° Competitive Intelligence ° Sales Prospect Analysis ° Win/Loss Ratio Analysis

° Market Visibility Services ° Voice of the Customer Analysis ° Influencer Marketing Advisory ° Private-Label Research

Clients we have advised include: Accenture, Caspian Group, Extreme Networks, HROToday Magazine, International Data Corporation (IDC), IT Services & Marketing Association (ITSMA), Kennedy Information, Lexmark, McKesson HBOC, Rockwell Automation, Sybase, TPI, Williams Communications, and Wipro Technologies.

• Free Market Intelligence – Ross Research offers many free market research products: ° “Outsourcing Thought Leadership,” the only monthly outsourcing-focused newsletter

written by independent thought leaders, savvy industry influencers, and market advisors from around the world. The goal of this information-packed publication is to provide succinct, on-target opinions about delivering, marketing, selling, and receiving BPO and IT outsourcing services. Every issue focused on a specific theme. Editorial contributors have included: AT&T, CSC, EDS, Everest Group, Gartner, IBM Global Services, Milbank Tweed, Outsourcing Institute, SBPOA, Shaw Pittman, Sourcing Interests Group, TPI, and others.

° “Rapid Read,” the only mid-month, online opinion piece worldwide focused on various BPO and IT outsourcing topics. This online write up includes analysis, commentary, and tips written by Ross research analysts and consultants.

° Ad Hoc Publications, including white papers, industry announcements, and articles.

What Makes Ross Research Unique? Ross Research is a different type of market research and advisory firm. Our commitment to helping the outsourcing service provider and sourcing advisory communities achieve greater success is amplified by our:

• Exclusive focus on outsourcing industry • Unique specialization on Mid Market Outsourcing and the Sourcing Advisory Services

marketplace, with deep knowledge in: Finance & Accounting, Government, Healthcare, Human Resources, and Offshore Outsourcing

• Proven expertise in servicing sourcing suppliers, buyers, advisory firms, and research organizations globally

• Cost-effective market intelligence solutions • Knowledgeable, experienced, business-savvy analysts and consultants

For details about Ross Research’s subscription services, custom consulting offerings, publications, or expert analyst team, visit our website at www.rossresearch.com or call +1/617-787-2580.

For details about Ross Research’s subscription services, custom consulting offerings, publications, or expert analyst team, visit our website at www.rossresearch.com or call +1/617-787-2580.


EXECUTIVE SUMMARY OF KEY FINDINGS The overarching theme resulting from Ross Research’s analysis points to the fact that mid market companies are getting smarter with regard to outsourcing…and the opportunity that this segment represents cannot be ignored. The middle market segment serves as the next promising frontier for outsourcers with its substantial projected growth. Ross Research has observed the following current and future outsourcing trends affecting the mid market:

• Though the middle marketplace has been lingering on the sidelines, it will not do so much longer. Ross Research predicts that mid market enterprises will be the next target for outsourcers as outsourcing opportunities dwindle among large clients, in previously promising industries, and the international marketplace. This market shift is likely to happen within the next 12-18 months and is occurring already to a limited number of cases.

• So far, most outsourcing vendors, in particular the large providers, have not been actively

pursuing the mid market. There are several reasons for this, but the primary and obvious one is that the deals are typically much smaller than with large clients. In addition, the sales process can often be lengthy, cumbersome and thus costly. For example, the cost/price-consciousness of these clients (sometimes in the extreme) results in protracted and complex contract negotiations. Besides, mid market companies are run frequently by founders who may be ambivalent about turning over any part of the business to an “outsider.”

• A strong push into the mid market, especially by the large outsourcers, will begin when:

o Global 1000 megadeals become harder and harder to come by and most large U.S. and international outsourcing agreements are still pending with little left to outsource.

o Outsourcing companies get over their fear of shareholder retaliation if they begin to pursue the smaller deals that invariably come with mid market companies.

o Outsourcing firms succeed to communicate effectively to mid market senior executives the value of outsourcing and determine how to deliver and sell their services in a mutually beneficial way.

o Mid market companies begin to represent a large enough critical mass with a rapidly growing demand for outsourcing to become an irresistible market force. After all, the lion’s share of the overall economy – in a pure numbers sense – consists of small to medium-sized enterprises (SMEs).

o Outsourcing market reaches a level of maturity where most processes and procedures are standardized to such an extent to render outsourcing with mid market companies as efficient, fast, and thus profitable for large outsourcers.

• As outsourcing in the mid market develops, deals that involve two or more companies providing

an outsourcing solution to one buyer will become commonplace. In particular, it would make sense for the large vendors to partner with companies with extensive experience with mid market companies since many of these service providers have limited familiarity with this market segment.

The middle market segment serves as the next promising frontier for outsourcers with its substantial projected growth.


• Mid market buyers typically seek an outsourcer that can deliver the best services at the best price because these companies tend to represent a very price-sensitive segment of the marketplace. Therefore, there may be little customer loyalty among these companies. Still, trust, flexibility, and relationship are key success factors for buyer-vendor relationships, so the service provider successful at achieving these attributes has a much stronger chance at remaining in the game over the long haul.

• Today, outsourcers stress the importance of providing “value” as opposed to just services to

their clients. This is a particularly important message for the mid market. With a weak global economy and continuous emphasis on cost-cutting measures, the value delivery strategy is key in becoming successful in this market.

• Along with the focus on delivering “value” and results, outsourcers are increasingly becoming

involved with some rather unusual and creative deal structures. These types of deals are especially attractive to mid market companies given their limited financial resources in many cases. Value-based pricing or contingency fees is an example of this. In such cases, the outsourcer shares with the client a certain % of the savings obtained from outsourcing. There are, however, risks entailed with these deals – so buyer beware.

• Outsourcing deals are becoming so complex and multi-faceted that more and more companies

are finding it necessary to turn to sourcing advisors with expertise in handling outsourcing negotiations and contracts. This is particularly germane for mid market companies due to their often limited experience with outsourcing. Many mid market enterprises are incapable of managing the outsourcing process on their own and must turn to either consultants or attorneys or even both to assist them.

• Consistent with the trends towards complexity, IT and BPO outsourcing services are blurring,

thus becoming less distinguishable. Ross Research has observed that an increasing number of last year’s sourcing deals involved both of these services. As vendors begin to standardize these services, it will become financially feasible for them to offer such combined services to mid market companies also.


RECOMMENDATIONS For Vendors, Advisors, and Buyers of Outsourcing Services

#1. Get Ready Now In the next 12-18 months, we can expect the middle marketplace to become the focal point of outsourcing vendors, be they large or small providers. This marketplace will become what global financial organizations are to the outsourcing industry today. As the non-U.S. deals start to dry up and the international market will look less and less attractive, they will make their move. In the meantime, they’re engaging in thought leadership initiatives to make the case for outsourcing for every organization. Accenture is already conducting these initiatives in the form of reports, white papers, and exclusive studies. To vendors, Ross Research gives the following advice: Start your mid market marketing and sales efforts today. And to mid market buyers, Ross Research recommends: Start thinking what business processes and/or IT functions you would like be managed by a specialist, because it will not be long before an outsourcing vendor will begin to make inquiries, if they have not done so already. Be prepared.

#2. Focus on Delivering and Obtaining “Value” Outsourcing vendors are changing their tune of what outsourcing really means to a mid market buyer: it’s no longer a “service” but a “value” that’s being provided. Increasingly, deals ought to be designed so value can be added and improved upon over time and the savings and value to the buyer is being realized – and spotlighted – a lot quicker than before. Ross Research also recommends that outsourcing providers seek partnerships with software companies and other so-called “technology partners” to provide outsourcing services that they may otherwise be unable to offer at an optimum level on their own to medium-sized companies. The sum of all trends is: buyers are getting smarter and they’re not sticking to one outsourcing provider because they’re only going to outsource a business process or IT function to the firm that can deliver the best results (i.e. value). Outsourcers should continue to strive to overcome the myth that outsourcing is a commodity service. Through creative deals, innovative partnerships, and value-added services, these firms can win this battle.

• Contingency Fees: When the middle market finally receives the attention it deserves, contingency fees or value-based pricing may be used quite frequently, since these firms may not have a good deal of money and/or may require that the outsourcer be truly vested in their sourcing and business initiatives. And the outsourcing provider can make more money than most standard deals if the performance metrics are met. The buyer must, however, ask some serious questions before signing such an arrangement, such as:

° Do I want this outsourcing company to share the value of what they’re providing my

company? ° Is this deal going to compromise, in any way, shape or form, the independence of the service

provider? ° When the service provider offers a solution, is it going to be in my best interests or theirs? ° Is this service provider really going to share the risks, or just the rewards?

In the next 12-18 months, we can expect the middle marketplace to become the focal point of outsourcing vendors, be they large or small providers.

Outsourcing vendors are changing their tune of what outsourcing really means to a mid market buyer: it’s no longer a “service” but a “value” that’s being provided.


° What is my company going to do if the agreed upon goals aren’t met? ° How do we determine the risks and the rewards in a fair and equal manner? ° How can we distinguish which party – the vendor or the client – has contributed to the

savings achieved?

Additional Recommendations for Outsourcing Firms & Advisors

• Think of how you’re going to serve the mid market. It shouldn’t be a question of “if” you can serve, but “how”. Your firm may be developing ways to increase the margins – and simplify the deals – of your larger clients; figure out how to apply those same principles to the mid market. Bring in your best outside-the-box thinkers and determine how this mid market group can be served without sacrificing your own revenue and market share goals. It may be necessary to standardize/automate the processes and procedures used for large clients so that they can be packaged and applied to smaller organizations more cost effectively and efficiently.

• Show the mid market community your knowledge. Firms like Accenture are masters at creating

thought leadership initiatives via reports and white papers. Conducting research about the future state of outsourcing will give your firm the added benefit of starting relationships with mid market enterprises. Even if they just answer a phone survey, they’ll still have your firm in mind when the time comes to outsource.

• Invite mid market company leaders for a roundtable discussion on what they believe their needs

are in terms of outsourcing.

Additional Recommendations for Mid Market Sourcing Buyers

• Look deep within your organization and determine what is core, what is non-core, what is better suited being done in-house, and what the candidates for outsourcing might be. Contact – informally at first – a colleague at an outsourcing service provider and open a dialogue on what could feasibly be done. If you know other mid market business owners (preferably in your industry or similar to your company size) who have successfully outsourced processes or IT functions, talk with them on how they created their relationships, what they gained (and lost) by outsourcing, and what they’d do differently next time if given the chance. Or hire a consultant and/or advisor to discuss your unique business needs.

• Keep abreast of trends and shifts in the outsourcing marketplace by watching the news and

internet sites of outsourcing providers and reading hard copy and online industry periodicals. A site by Ross Research, www.sourcinginfo.com, is slated to launch mid this year and will be a valuable resource to mid market companies

• Attend outsourcing seminars and conferences. As you mingle with the thought leaders in the

outsourcing market, gather information and ask how your firm can benefit from outsourcing

Bring in your best outside-the-box thinkers and determine how this mid market group can be served without sacrificing your own revenue and market share goals.

Keep abreast of trends and shifts in the outsourcing marketplace by watching the news and internet sites of outsourcing providers and reading hard copy and online industry periodicals.


services. If many mid market executives attend a conference and ask related questions, the outsourcing vendor community will soon recognize that opportunities exist in your market segment possibly than they have predicted.


MID MARKET LANDSCAPE OVERVIEW Outsourcing in the Mid Market Long-overdue attention will soon be paid quite heavily to mid market enterprises, especially by the large outsourcers. Some organizations, like IBM Global Services, have already thrown their caps over the wall to separate themselves from the “gargantuan” and focus on opportunities within the mid market. For example, on June 24, 2002, IBM announced a “Manage It for Me” program aimed at mid-sized businesses. The “Manage It for Me” program is a suite of service offerings and attractive financing that allows companies of 1,000 employees or smaller to outsource their computer operations to IBM Global Services. The 20 services in the suite focus on the following areas: Assurance Services, Infrastructure Management Services, Application Hosting and Management Services, and the IBM Virtual Help Desk. Most service providers are looking to the mid market, recognizing the importance and significance of growth in this sector. Not only do mid market companies need outsourcing services, but also many of these firms could one day become major corporations and look to their long-standing relationships with outsourcers to meet deep strategic business goals.

Lack of Focus on This Market Sector But why have outsourcers, especially the large service organizations, waited so long – and most are still waiting – to serve this market? For example, most of the 2002 deals by EDS, IBM Global Services, and Accenture studied for this report included Global 1000 companies, with no discernable trend towards moving to smaller companies as 2002 progressed. Most will agree that “big likes to buy from big” and “big likes to sell to big”; however, there are other reasons the mid market has been largely untapped:

• Longer Sales Cycle: Most large clients understand the value of outsourcing upfront and many have already had business processes or IT functions outsourced to suppliers for years. On the other hand, medium-sized businesses have not been exposed to outsourcing nearly as much. So in many cases, outsourcing vendors would need to really hold the hand of the mid market company owner or chief executive to get them to comprehend what outsourcing means. In addition, a lot of mid market company owners have built their organizations from the ground up and pride themselves on managing every piece of their enterprise. The thought of turning the reins over to someone else, an outsider, tends to make them squeamish.

• Smaller Organizations, Smaller Deals: Even if a vendor is savvy – and patient – enough to lure a mid market company into wanting to outsource a business process or IT function, the size of the deal may be too small to be financially beneficial to the vendor. Most outsourcing deals aren’t nearly as lucrative as consulting or Y2K engagements among mid market companies during the 1990’s, and with mega-deals still to be sealed, it has made far more economic sense for vendors to pursue the Global 1000 market – so far.

• The Nature of the Mid Market Enterprise: Many mid market companies are growing rapidly and are en route to become Fortune or Forbes list makers in the future. The very nature of their businesses – and their IT and business process needs – can be erratic as their businesses grow. In this kind of setting, mid market companies want to form relationships with outsourcing firms

Most service providers are looking to the mid market, recognizing the importance and significance of growth in this sector.


that could easily change the parameters of their deals when necessary. This is the third leg of the mid market stool: megadeals have enough hardships, but a medium-sized enterprise, new to the outsourcing universe, would need more time to be sold on the deal itself and could likely demand more changes more often than their larger counterparts.

The Growing Importance of the Mid Market Ross Research believes that the reluctance to serve the middle market among large outsourcers is likely to change in the near future. Our claim is based upon the following observation: Figure 1 below shows the outsourcing spectrum and where the market is headed currently. Initially, the primary focus of outsourcing providers, especially the large ones, is the pursuit of large clients. These clients, simply put, represent the most lucrative opportunities. Eventually, prospects in this market dry up as it reaches a certain saturation level. At this time, the international arena becomes a major point of interest. This is where much outsourcing activity can be found today. But as the international market becomes more and more crowded and difficult, vendors seek new opportunities and turn their eyes toward the mid market. This process, as presented in Figure 1, then comes full circle. Since the average deal length is fairly short – namely 6.3 years – this cycle is completed quite rapidly. Ross Research predicts that in the first round of this cycle, mid market companies will be served only marginally well until the large U.S. buyers need their contracts renewed. Then, the cycle will start all over again, with vendors focusing on their large clients. By the next pass, mid market companies, warmed to the idea of outsourcing by their peers and experiences, will finally receive significant attention by the large outsourcers and other service providers who have moved into the mix to meet their needs.

Figure 1, The Outsourcing Sales Cycle Through the Lens of Service Providers

Source: Ross Research, 2003

Ross Research believes that the reluctance to serve the middle market among large outsourcers is likely to change in the near future.


TOP OUTSOURCING TRENDS AND THEIR EFFECTS ON THE MID MARKET

Trend # 1: More Outsourcing is Being Done, and Will Continue… Today is a great time for sourcing organizations. Their business is booming, and outsourcing is taking off at such a speed it almost appears trendy. There are very few large organizations left in the United States – if not the world – that aren’t involved in or have more than a passing familiarity with outsourcing. Even better, most know from colleagues and the media that outsourcing is a worthwhile endeavor. Mid market companies have not been immune to this wave of outsourcing activities among their larger peers. Our current economic climate has forced organizations of all sizes to turn toward or at least consider outsourcing as a way of cutting costs and making business processes and IT functions work better and more efficiently. It is becoming apparent to most companies the substantial savings that can be gained from outsourcing, regardless of the size of the organization. Some outsourcers are wising up to the fact that the savings over the life of the contract is a significant determinate of its pursuit by a mid market buyer. Tables 1 and 2 below demonstrates some of the 2002 deals announced by IBM Global Services, Accenture, and EDS that point out the savings targets for their customers. Though every outsourcing arrangement is certain to save money for a buyer – otherwise there would be little reason to outsource – many press releases from these three firms during 2002 had the expected costs savings clearly spelled out, as illustrated in Table 1.

Table 1, Savings Targets for Select Outsourcing Deals, 2002 Date (2002) Firm Name Buyer Name Value of

Deal (US$)

Length of

Deal (Years)

Savings Target (% or US$)

Jan. 9 EDS Bumiputra-Commerce

Bank

$250M 10 20% (presumably over the life

of the contract (OLOC)

Jan 18 IBMGS Nextel

Communications

$1.2B 8 $1B (OLOC)

Mar. 7 EDS Bank of Queensland $250M 10 $52M (OLOC)

Apr. 1 IBMGS Shiseido Co. NA 10 $8.5M (OLOC)

Apr. 15 IBMGS Amtrak NA 7 $85M (OLOC)

Apr. 29 EDS Baylor Health Care

System

$200M 10 10% - 15% (OLOC)

May 29 EDS Vitro NA 5 20% (OLOC)

Oct. 1 IBMGS Boots Company $1.1B 10 $200M (OLOC)

Dec. 17 Accenture Neptune Orient Lines NA 8 30% (OLOC)

Dec. 30 IBMGS Deutsche Bank $2.5B 10 $1B (OLOC)

Source: Firms and Ross Research, 2003

As a part of the dollar savings, outsourcing companies more often than not transfer a number of the buyer’s applicable personnel to the firm once the deal is finalized. Some of the employees are offered similar positions at the outsourcing organization, while others may be let go. In either event, the persons

Our current economic climate has forced organizations of all sizes to turn toward or at least consider outsourcing as a way of cutting costs and making business processes and IT functions work better and more efficiently.


are now the responsibility of the outsourcing firm, and the more individuals transferred, the more human savings can be realized in a deal. However, this information isn’t always readily available to the public. As noted in Table 2, IBM Global Services is the most forthcoming in revealing the number of transferred employees right in their press releases. But still, IBM and other firms noted that there are more variables in an outsourcing deal than the number of relocated personnel.

Table 2, Outsourcing Firms and Transferred Employees for Select Outsourcing Deals, 2002 Date

(2002)

Firm Buyer Industry Size of

Deal

(US$)

Length of

Deal

(Years)

Employees

Transferred

Feb. 25 IBMGS American

Express

Finance $4.0B 7 2,000

Apr. 9 IBMGS Manulife

Financial

Finance $563M 10 400

Jul. 9 IBMGS Noritake Co. Manufacturing $41M 10 30

Aug. 14 IBMGS Sun Life

Financial

Finance $164M 7 111

Aug. 14 IBMGS BNSF Transportation NA 10 120

Oct. 1 IBMGS Boots

Company

Healthcare $1.1B 10 400

Oct. 17 Accenture Slovnaft Oil & Gas NA 6 100

Oct. 21 Accenture Exel High Tech NA 5 130

Nov. 12 IBMGS DBS Bank Finance $1.2B 10 500

Nov. 28 IBMGS Thai Farmers

Bank

Finance $230M 10 270

Dec. 10 EDS Bank of

America

Finance $4.5B 10 1,000

Dec. 18 IBMGS Deutsche Bank Finance $2.5B 10 900

Dec. 30 IBMGS JP

MorganChase

Finance $5.0B 7 4,000

Source: Firms and Ross Research, 2003

In an age where consultants, formerly the white knights who’d step in to save a company in distress, cannot often promise savings in an engagement, outsourcing providers are the new heroes. After studying an arrangement and analyzing their own capabilities, they can show a mid market buyer – who is particularly sensitive to cost issues – a piece of paper with the projected savings range and number of employees expected to be transferred from the organization. Even after the economy rebounds, the focus will continue to be on that kind of cost savings and greater efficiency.

Trend # 2: Deals Designed to “Wow” the Shareholders The best way to understand why the middle market has been ignored is to look no further than any outsourcer’s press release of a new outsourcing agreement which invariably will indicate that Wall Street

In an age where consultants, formerly the white knights who’d step in to save a company in distress, cannot often promise savings in an engagement, outsourcing providers are the new heroes.


and the sentiments of shareholders drive them to focus on megadeals. The contract value, often in the tens or hundreds of millions of dollars, is prominent in the title. The length of the contract is given. The rest of the announcement is just idle chatter about the benefits of the deal. What is done in the deal itself is often murky, at best. The entire release contains language that communicates information straight to the shareholders of the company. The United States has reached an age where the attitude of the shareholder means everything to the economy. There is an incredible amount of pressure on CEOs and corporate boards to do everything they can – and sometimes things they shouldn’t – to keep their existing shareholders happy and to attract new ones. Announcing the megadeal is all about that. Outsourcing firms aren’t announcing how their solution is going to help a mid market manufacturing company outsource its IT functions, and it isn’t about providing BPO solutions to a mid-sized wireless communications company. It is about how much money they are making. It is entirely possible that many large firms aren’t chasing the mid market today simply out of fear: announce too many small deals and your shareholders may think you’ve become a small fish. One incident in 2002 worth noting occurred on Monday July 1, when EDS put forth a release saying it had terminated discussions with Procter & Gamble (P&G) for an outsourcing transaction. Almost immediately, EDS’s stock plummeted to $30.45 – after closing at $37.15 on the last trading session of the previous Friday (June 28). It’s a pretty clear indication that shareholders (and Wall Street analysts) are paying attention.

Trend #3: Focus on the International Marketplace There are plenty of organizations around the world in need of outsourcing services that have the money to pay for them despite a somewhat gloomy global economy. About two-thirds of the year 2002 outsourcing deals studied by Ross Research took place in non-U.S. countries. Since most of the U.S.-based deals were announced in the first half of the year, the trend points to a continued focus on global clients in 2003 and most likely into the early part of 2004. As discussed in the outsourcing sales cycle we introduced in the previous chapter (see Figure 1), mid market companies are “next in line” to be serviced by large outsourcers. The main reasons for this focus on the global outsourcing arena are follows:

• The slowdown in the U.S. economy – which has been going on since mid 2000 - is forcing U.S. companies to scale back everything they’re working on. While some would argue that the prime time to outsource IT functions or business processes is while money is tight, a lot of companies are faced with such daunting uncertainty that they’re choosing to “stay the course” until things look brighter.

• Saturation of the U.S. market - There is plenty of opportunity in the U.S. market to serve medium sized organizations, but a good chunk of the large companies have outsourcing deals pending. Therefore, there isn’t a whole lot else to do but continue to serve these large clients in hopes to get a renewed contract and to convince them to finance other projects. Moreover, to compete successfully in the United States, outsourcers now have to get in line with a lot of other providers to pitch deals. This invariably leads to longer sales cycles and even smaller margins.

It is entirely possible that many large firms aren’t chasing the mid market today simply out of fear: announce too many small deals and your shareholders may think you’ve become a small fish.

About two-thirds of the year 2002 outsourcing deals studied by Ross Research took place in non-U.S. countries.


• Growing Opportunities in Europe, Asia, and ROW – are too good to pass up when one considers the first two reasons. The global economy isn’t as good as it once was, but there are plenty of organizations around the world in need of outsourcing services that have the money to pay for them.

• Service Capabilities Available in Offshore Locations – As “offshoring” becomes a more acceptable operational alternative in remote locations like India, the Philippines, and even Mexico – primarily due to the cost effectiveness of services in this region -- mid market companies will continue to conduct business outside their traditional borders.

As noted previously, Ross Research believes that the outsourcing industry is in the stage of expanding in non-U.S. territories; yet, with global economic uncertainty and increasing competition, vendors will turn to the middle market because frankly there will be increased pressure to drive in revenue to their bottom lines (a concept introduced in the previous chapter, see Figure 1). Interestingly, European countries represented the top organizations named in overseas deals for the first six months of 2002, whereas countries like Australia, Japan, Singapore, and Latin American countries dominated the second half of 2002. This data suggests that Europe –especially the U.K. – may be reaching a relative point of saturation and that other parts of the world are becoming more vested and available for the outsourcing concept. But for now, deals will continue to spring up all over the world.

Trend #4: Focus on the Financial Services Industry Financial services organizations made up approximately 25% of the year 2002 outsourcing contracts studied by Ross Research Though most of those deals took place in the first half of 2002, financial services will continue to be a prime focus in the future among outsourcers – both large and small. Mid-sized financial services companies, like most organizations, are looking harder than ever for ways to reduce costs. There has also been much consolidation in this industry – not just among major corporations but also among mid sized enterprises – leading the new and much larger institutions to turn to outsourcing providers that wring out costs, eliminate redundancies, and make operations run more efficiently for their customers. Shareholders understand the value of pursuing the financial services industry as well. In fact, when EDS announced a 10-year, $4.5B managed network outsourcing agreement with Bank of America last year, it claimed it was “the global leader in deploying technology for financial institutions” and went on to say that revenues from financial services accounted for about 17% of its previous year’s revenues. This doesn’t necessarily mean that other vertical industries do not provide opportunities in the mid market also. Medium sized wireless communication companies, some recently created with enormous critical mass, are beginning to use outsourcers. Other high tech companies – plus energy companies – are seeing an increased use of outsourcing too.

Financial services organizations made up approximately 25% of the year 2002 outsourcing contracts studied by Ross Research.


Trend #5: Outsourcing Firms Teaming Up to Provide Solutions In the latter half of the last decade, management consulting firms formed strategic alliances with software companies to provide enterprise resource planning (ERP) and Y2K solutions. Similarly, as the outsourcing market matures, deals that involve multiple companies teaming to provide outsourcing solutions to buyers will become commonplace. In particular, partnerships would make sense for outsourcing vendors serving the mid market sector for the following reasons:

• Varying sales channels and capabilities – Certain outsourcers may lack reach into particular mid market segments, may not have in-house expertise in the area the client requires, or may be incapable or unwilling to “swim downstream” enough to fulfill specific needs by mid market companies. By availing themselves to business partners, sourcing providers essentially open up opportunities for new business.

• Increased margins – Forming an alliance with a technology partner, e.g. a software company, is likely to lower the cost for the outsourcer, as they can “leverage versus build.”

• Improved capability – Creating alliances allows outsourcers to provide more services for more buyers. In essence, the “outsourcer is outsourcing” to increase its delivery capabilities and reach a greater client base.

For example, Accenture recently announced that it teamed with Mincom, an Australia-based software company, to provide implementation and support services for IT systems to Goro Nickel S.A., an Australian client. And in the other direction – in which smaller service providers have taken the partnership-establishment lead, Verizon IT, a subsidiary of Verizon, has made several recent announcements of partnerships with IT firms, e.g. Sun Microsystems and CTG, to help it provide outsourcing services to the mid-market. Likewise, (i)Structure stresses the importance of partnerships in delivering outsourcing services to its mid-market clientele; it currently partners with IBM, Cisco, Symmetry, EMC, and Computer Associates. Of course “technology partnerships” can be made by any outsourcing company to provide a wider range of outsourcing services. The intent is of course to make money and provide better services to buyers. When the mid market is finally fully penetrated, it will likely be because service providers teamed to serve this market more effectively.

Trend # 6: No Client Monogamy Buyers are more sophisticated, the deals are getting more complicated, and now that buyers know more, they’re demanding more. A buyer of outsourcing services may not always buy from the same vendor every time the organization wants to outsource a business process or IT function. Buyers today, including mid market companies, are looking to find an outsourcer that can deliver the best services at the best price. For example, Nextel Communications, the wireless communication company based in Reston, Virginia awarded an eight-year, $1.2B CRM outsourcing agreement to IBM Global Services on January 18th, 2003. Five days later, EDS announced it had received a $140M, five-year contract from Nextel to outsource their corporate data center, database administration, desktop services, helpdesk, and other technical functions.

When the mid market is finally fully penetrated, it will likely be because service providers teamed to serve this market more effectively.

A buyer of outsourcing services may not always buy from the same vendor every time the organization wants to outsource a business process or IT function.


There are several explanations for this. First, there is a limited number of outsourcing providers that are best at multiple types of outsourcing services. Second, since few buyers have a Chief Outsourcing Officer in charge of creating and managing deals, it is possible for many different outsourcing providers to sell to different parts of an enterprise and be ignorant of the efforts of one another. In some cases, the client itself may be unaware of the various vendors it has contracted. Third, and probably most likely, buyers simply want to go with the provider that will do the best job at the best price even if it means starting a new outsourcing relationship with a provider they have to become familiar with. This means that outsourcing providers trying to pitch a deal to a certain company should not be surprised that the same company might have signed a similar contract with the outsourcer’s competitor a few days before. On the flip side, this trend also means that any given buyer may not ever develop true loyalty to a sourcing firm, so getting a contract with a buyer doesn’t necessarily mean that the outsourcer is “in.”

Trend #7: The Outsourcing Sales Process Is Changing In the beginning, outsourcing firms had a tough sell: mid market firms hadn’t been outsourcing much of anything, and managers were skeptical about turning over something vital – though non-core – to a third party. Furthermore, few mid market executives or IT directors knew others who were involved in a successful outsourcing engagement. Now, these buyers generally have heard a great deal about outsourcing’s pros and cons. They are more knowledgeable and sophisticated than ever before. Mid market outsourcing deals are becoming more complicated; now that buyers know more, they are demanding more. As a result, outsourcing firms are changing the way they are pitching their services to this segment. The ways the outsourcing sales process is changing, especially as applied to the mid market, are as follows:

• Change from “providing services” to “providing value” – In the beginning, many outsourcing firms pitched their services as simply services. But with a weak economy and everything under the sun being trimmed, the approach or strategy among outsourcers has changed to providing value – sometimes referred to as “shareholder value.” After all, outsourcing isn’t supposed to be a frill; it’s a valuable service to a company that wants to save money, make things more efficient, and above all, create a positive impact to the bottom line. Besides, it’s every outsourcer’s nightmare to have to “race to the bottom” to win an outsourcing assignment. Every outsourcing provider, large or small, is offering value-based services in their contracts in an attempt to counteract the commodity perception.

Though all organizations care about business results, mid market companies are particularly receptive to the value message. For one thing, mid market companies tend to be considerably more cost/price-conscious than larger corporations, anxious to take further cost-cutting measures to improve earnings. After all, investors, shareholders, AND employee owners are carefully watching profitability of every company these days.

Mid market outsourcing deals are becoming more complicated; now that buyers know more, they are demanding more.


• Focus on the money saved by outsourcing – Two years ago, it was nearly impossible to find an outsourcing firm that would provide any information in its press releases about savings in a given outsourcing deal. Now, this is a rather common phenomenon. In addition, companies like to spell out their outsourcing success stories on their websites. For example, (i)Structure, an outsourcer that targets the mid market, makes the following statement on its website:

“ … Together, (i)Structure and the customer worked through several scenarios and came up with a plan that would save the customer money while upgrading their existing hardware with additional processing power and room for growth. Since that proposal in 2001, (i)Structure has saved the company 30% and has won the trust of the new management.”

• Creative deal making – The new sales approach has also led to a growing emphasis on trying to cut more creative and unusual deals – this is another trend that we will discuss next.

Trend # 8: More Creative Deals The partnering of outsourcing companies to provide services to a buyer is one thing, but some of the deals in 2002 and the ones we’ll see in 2003 reveal that outsourcers are beginning to approach deal structure more creatively than ever before. Outside-the-box contracts will be more of the rule than the exception. As outsourcers try to create the perception for mid market companies that they are more amenable and flexible than they are with large clients, more creative deals within the middle marketplace will become an imperative. One “creative” approach emerged in the 1990’s when several leading and mid-sized consulting firms began to use “contingency” or value-based fee arrangements. It usually worked like this: A company would hire a consulting firm to do cost-cutting arrangements, and its fee would be a percentage of the amount of money saved. In some case, consultancies would invest money in their clients through their investment arms. This type of arrangement has been especially alluring to mid market companies that could not afford the high consulting fees of these management consultancies. The method was often used for cash-strapped, albeit promising start-ups. As the perception of outsourcing shifts from a service to a value, outsourcing providers are likely to be tempted to cash in on the business value of what they’re providing. With the emphasis on achieving value along with the need to respond to a price-sensitive executive of a mid-sized company, the temptation becomes almost irresistible. However, the use of contingency fees is more often than not a risky endeavor. Not only does it force the outsourcing service provider to make contractual promises that they later have difficulty delivering, but also the risk/reward sharing part can often become very tricky. In the most extreme cases, it may even lead the outsourcer to cut things from the buyer that don’t need cutting just so the service provider can share the savings. At that point, the service provider isn’t working for the buyer; it’s in business for itself. Another creative idea, promoted by some of the large outsourcing vendors, was simply to purchase the necessary services from another company in order to obtain the necessary expertise to enter a market or impress a certain client or clientele. For example, in December of 2002, Accenture announced a BPO

As outsourcers try to create the perception for mid market companies that they are more amenable and flexible than they are with large clients, more creative deals within the middle marketplace will become an imperative.


payroll processing and administration agreement with Telecom Italia in which Accenture acquired TESS, Gruppo Telecom’s payroll services company from Telecom Italia for about $8 million. In other words, Accenture purchased those services from a telecom company required for the firm to obtain the necessary capability to sell its service offerings to Telecom Italia. In a way, outsourcing is becoming a lot more like management consulting with its creative and colorful language, but hopefully it won’t reach the same ambiguity in its promises.

Trend #9: Increasing Use of Sourcing Advisors Many of the trends discussed already point to an emerging phenomenon – namely, that outsourcing engagements are becoming increasingly multi-faceted and complex. In fact, they are becoming so complex that more and more companies are finding it necessary to turn to advisors with expertise in handling outsourcing negotiations and contracts. This is particularly germane for mid market companies, given their limited experience with outsourcing. Many medium-sized enterprises are incapable of managing the outsourcing process on their own. This is particularly true if they want to derive business value from the deal with a significant impact on their bottom line. Ross Research believes that in an increasingly complex outsourcing environment, it becomes essential for companies – especially mid market enterprises with little expertise with the sourcing process -- to turn to advisors to help manage the outsourcing buying cycle. Sourcing advisors can provide a variety of services to help mid market companies obtain the best possible outsourcing deals at reasonable prices and with fair terms. First, they can help executives understand the pros and cons of outsourcing and whether or not outsourcing is truly the right strategy to address their “unique” business challenges. Second, they can help executives with the important selection of appropriate vendors. Third, advisors play a pivotal role in helping companies determine the right technology solutions and how to most effectively derive most business value from outsourcing. Contract reevaluations, renegotiations, and even post-contract relationship management are other services commonly provided by advisors. Sourcing advisors are comprised of many different types of firms, although nearly all of them tend to focus their offerings on the large company market segment. Advisors may represent law firms with expertise in a variety of legal matters pertaining to outsourcing, especially with regard to contract issues. Shaw Pittman and Milbank Tweed are two of the major law firms with a specialization in sourcing advisory services. Or, consultants may come from some of the major management and IT consulting firms, e.g. PA Consulting, or niche sourcing consultancies, such as TPI or Everest Group. Other sources of advice may come from Gartner or META Group, which are major market research firms.

Trend #10: BPO Gaining Ground, But Lines Are Blurring Much attention today is being paid to business process outsourcing (BPO). In fact, IBM’s acquisition of PwC Consulting focused squarely on PwC’s BPO capabilities and client list. But while more BPO deals are announced, they are becoming increasingly multi-faceted while at the same time less distinguishable from IT outsourcing services. Many of the major sourcing vendors have begun to offer a laundry list of outsourced business process services in combination with the management and support of IT functions.

Ross Research believes that in an increasingly complex outsourcing environment, it becomes essential for companies – especially mid market enterprises with little expertise with the sourcing process -- to turn to advisors to help manage the outsourcing buying cycle.


As noted before, outsourcing suppliers face tremendous pressure from their shareholders to make their contracts as large (and complex) as possible. And economies of scale dictate to negotiate over as many outsourcing arrangements as possible rather than just one. Moreover, this trend is also consistent with the trend discussed earlier with regard to providing value-based solutions. Without a doubt, it will eventually become increasingly difficult to discriminate between BPO and IT outsourcing.

Without a doubt, it will eventually become increasingly difficult to discriminate between BPO and IT outsourcing.


CONCLUSION Companies in the middle market are, in many ways, no different than those traditionally being served by outsourcing providers; yet, the opportunities inherent in this segment for new and recurring revenue are particular attractive to outsourcing service providers and advisors currently facing difficult global economic conditions. Mid market companies have the need, willingness, and knowledge about the outsourcing process, for the most part, to initiate new IT outsourcing and BPO arrangements. They may need more hand holding than outsourcers are used to, may be more expensive to service initially, and may be more complicated to understand in terms of needs – operationally AND culture/relationship wise. With many outsourcing service providers popping up to serve this unique market segment, it will only be a matter of time until some service provider and advisor somewhere emerges as a true thought leader in the mid market outsourcing landscape. For the time being, the marketplace is entirely open.

With many outsourcing service providers popping up to serve this unique market segment, it will only be a matter of time until some service provider and advisor somewhere emerges as a true thought leader in the mid market outsourcing landscape.

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ROSS INSIGHTS REPORT - Neo · PDF fileThe primary objective of this Ross Research report is to examine and ... outsourcing, Ross ... • Free Market Intelligence – Ross Research