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    Frost Report Frost Report Document Transcript

    • F Shared Services and Outsourcing (SSO) Hub Potential Analysis JULY 2007
    • GROWTH CONSULTING Table of Contents 1.0 Executive Summary ......................................................................... 3 2.0 Introduction...................................................................................... 5 2.1 Objectives................................................................................................... 5 2.2 Scope .......................................................................................................... 5 2.3 Methodology .............................................................................................. 7 3.0 Overview......................................................................................... 10 3.0.1 SSO Determinants ............................................................................. 11 3.0.2 SSO Trends........................................................................................ 18 3.0.3 SSO Locations ................................................................................... 25 3.1 Finance & Insurance................................................................................ 53 3.1.1 SSO Determinants ............................................................................. 53 3.1.2 SSO Trends........................................................................................ 62 3.1.3 SSO Locations ................................................................................... 67 3.2 FMCG & Retail.......................................................................................... 73 3.2.1 SSO Determinants ............................................................................. 74 3.2.2 SSO Trends........................................................................................ 81 3.2.3 SSO Locations ................................................................................... 89 3.3 Technology............................................................................................. 103 3.3.1 SSO Determinants ........................................................................... 104 3.3.2 SSO Trends...................................................................................... 112 3.3.3 SSO Locations ................................................................................. 118 3.4 Energy ................................................................................................. 127 3.4.1 SSO Determinants ........................................................................... 127 3.4.2 SSO Trends...................................................................................... 134 3.4.3 SSO Locations ................................................................................. 139 3.5 Healthcare .............................................................................................. 145 3.5.1 SSO Determinants ........................................................................... 146 3.5.2 SSO Trends...................................................................................... 153 3.5.3 SSO Locations ................................................................................. 159 3.6 Transportation & Logistics................................................................... 166 3.6.1 SSO Determinants ........................................................................... 167 3.6.2 SSO Trends...................................................................................... 171 3.6.3 SSO Locations ................................................................................. 176 3.7 Entertainment and Media...................................................................... 180 3.7.1 SSO Determinants ........................................................................... 180 3.7.2 SSO Trends...................................................................................... 186 3.7.3 SSO Locations ................................................................................. 191 4.0 Conclusion ................................................................................... 196 2007 ®FROST & SULLIVAN 2
    • GROWTH CONSULTING 1.0 Executive Summary After the technology bust of early 2000, corporations worldwide faced the challenge of arresting the decline in margins. To protect margins and enhance cash flows to fund future growth, large multinational corporations turned to Shared Services and Outsourcing (SSO), with many companies aggressively emulating success stories like General Electric’s captive shared services operations in India. Falling infrastructure costs, proven business models, the hunt for economies of skill, and fast evolving maturity of service providers from low cost locations, only helped to accelerate the growth in SSO, especially for offshoring. With the global economy recovering, these SSO operations have played a significant role in boosting the profits for companies across several verticals to record levels. Frost & Sullivan has estimated the SSO market for 2006 to be around US$ 930 billion, projected to grow to US$ 1,430 billion by 2009, growing at a CAGR of 15%. Offshoring, which constituted a miniscule part of the total pie, is expected to grow at double the rate for overall SSO. The key drivers for SSO have continued to be cost benefits through standardization, leveraging of scale benefits, and cost arbitrage in countries like India and China. Other benefits include ability to free up of precious management time to allow them to focus on core competencies; drive business innovation even in non-core areas; and reap benefits from standardization and resulting efficiencies; which have forced large corporations to explore further expansion of their current SSO operations or setting up new centers. On the other hand, concerns with SSO such as threat of loss of control and compromising confidentiality; potential reduction in service quality levels; risk of breach of intellectual property and shortage of skilled people through high attrition resulting in escalating costs, etc.; have forced some companies to reconsider against ramping up their SSO operations. Restrictive government regulations and political backlash in “send” countries have also forced some companies to adopt a more cautionary approach towards SSO. While the Finance and Insurance vertical together with Technology continues to remain the largest verticals for SSO, constituting over 50% of the total spend on SSO, other verticals have developed effective operating models for SSO for functions such as IT services, finance and accounting, HR services, customer support and call center. Sectors like healthcare have gone to the extent of outsourcing core R&D functions while telecom companies in countries like India have outsourced network management, a function 2007 ®FROST & SULLIVAN 3
    • GROWTH CONSULTING considered core for telecom operators. While the captive model and the third party model have become dominant, increasing instances of hybrid models involving equity participation, joint ventures and project funding, are being witnessed. Most governments in top SSO locations offer various incentives to attract capital; however, structural factors like low labor costs and abundant supply of relevant skill have ensured that India remains as the prominent top of the mind location for SSO. But with high attrition rates and rising wage levels, India is facing threat from China which is emerging fast as an attractive location for IT, R&D and procurement services. Eastern European countries have been able to capitalize on their proximity to western European countries, while Malaysia and Singapore have continued to grow. Our study reveals that across the seven verticals India remains the top location for SSO, followed by China, Ireland, Singapore, Malaysia, Mexico, Czech Republic, Poland, Philippines and Canada. New locations are emerging for specialized functions (Russia for high end software development) or for particular verticals (Dubai for BFSI). This report by Frost & Sullivan elaborates on the current state of the SSO landscape including current trends for SSO, key drivers and constraints, SSO spend trends, location selection criteria for SSO and top of the mind locations; for seven verticals. The report leverages upon a survey of Fortune 500 and Forbes 2000 companies conducted as part of this study to benchmark the top locations for SSO for seven different industry verticals globally. 2007 ®FROST & SULLIVAN 4
    • GROWTH CONSULTING 2.0 Introduction 2.1 Objectives The objectives of the study are to profile leading global companies from the Fortune 500 and Forbes 2000 list and to understand their Shared Services or Outsourcing (SSO) patterns currently and in the future. This includes but is not limited to: Key Determinants Key Trends Key Location Selection and Criteria A vertical specific analysis was performed to establish insights in SSO patterns and location selection. An in-depth analysis of the top SSO locations was conducted to understand their positioning, strengths and weaknesses. 2.2 Scope To define the scope of this study, we have defined SSO as shown in Figure 2.1 Figure 2.1 Definition of Shared Services and Outsourcing (SSO) Definition of SSO Ownership Insource Outsource Offshore Integrate Foreign Source Foreign Capability Capability Location Integrate Domestic Source Domestic Onshore Capability Capability 2007 ®FROST & SULLIVAN 5
    • GROWTH CONSULTING The selection criteria for the companies include the following parameters: Companies from the Fortune Global 500 and Forbes 2000 Employ more than 1,000 employees with revenues exceeding US$1 billion Vertical coverage Figure 2.2 illustrates the seven verticals covered as part of this study. Figure 2.2 Verticals to be covered for the study Verticals for Analysis Energy solutions providers, power generation solution providers and petroleum Energy refineries. E.g., BP, Shell. Entertainment & Media Entertainment content providers, broadcasters and publishers. E.g., Time Warner Financial services institutes such as banks, insurance and wealth management Finance & Insurance companies. E.g., Citigroup Fast moving consumer goods producers and retailers. E.g., Nestle, McDonald's and FMCG & Retail Wal-Mart Automotive, ship, plane and parts manufacturers and logistic solutions providers Transportation & Logistics (ground, sea, air). E.g., Toyota, Boeing and Fedex Solutions, services and equipment providers for information technologies and Technology communications. Examples are IBM, Vodafone and Nokia Includes pharmaceutical solutions and equipment providers and healthcare insurance Healthcare providers. Examples are Pfizer, Aviva and United Health Group Figure 2.3 illustrates the functions typically covered as part of SSO operations: Figure 2.3 Functions for SSO Functions for SSO Back-Office Processing Sales & Sales Generation Finance & Accounting Data Processing Lead generation Transaction Management Data Imaging & Digitization Lead Qualifying General Accounting Data Maintenance & Support Telemarketing Treasury & Risk Mgmt. Data Archiving Booking & Reservation Tax Management Customer Service IT Services & Support Corporate Learning Programs & Call Centers Customer Support Application Support Curriculum development Customer Retention System Design & Upgrades Learning program Inquiry & Complaints Hardware Maintenance Strategic / Capability Human Resources Procurement Development Health & Welfare Admin Sourcing Management New/ Emerging Technologies Talent Management Continuous Savings Design/ Testing of new products Performance Management Transaction Management Prototyping/Development Compensation Administration 2007 ®FROST & SULLIVAN 6
    • GROWTH CONSULTING This report highlights the findings based primarily primary and secondary research, and focused group discussions held in India, Singapore and the US. 2.3 Methodology Frost & Sullivan has used primary research, secondary research and Focus group discussions (FGD) to develop both the interim and the final report. The overall methodology for our study has been illustrated in Figure 2.4. Figure 2.4 Overall Methodology Overall Methodology Primary Analysis & Scoring Output & Recommendations Interviews across 7 industry Overall Cross-validation of primary verticals Impact of SSO on companies: Revenues, Profits and and secondary results Market Capitalization Based on companies Forecast of vertical wise Top 10 SSO hubs across 7 verticals identified through secondary SSO spend SWOT analysis of key SSO hubs research Analysis of primary Questionnaire based on research (how were Industry Vertical Specific Frost research & analysis drivers, constraints, Drivers for SSO: Current and Future locations, trends ranked) Concerns for SSO: Current and Future Secondary Development of weights for Spending Trends on SSO scoring/ranking of locations Spending Levels of SSO by Business Processes Identification of companies Evaluation of SSO hub Evaluation of business processes for SSO as per perceived for 7 verticals based on attractiveness for each strategic value Fortune Global 500 and vertical SSO Party of Choice: Subsidiary, JV, 3rd Party Forbes 2000 list SSO Location Selection Criteria in terms of Importance Additional research on Recommenders and Decision Makers on SSO selected countries, Benchmarking of SSO Locations: Overall & Function-wise companies and SSO Benchmarking of Top Locations as per key SSO location consideration parameters Primary Research As part of our primary research, we had established contact with 338 companies who have been selected based on the predetermined selection criteria to form the basis of analysis across the seven verticals. The primary research has served as the basis for the quantitative analysis to rank the countries for each vertical and across verticals. The methodology used for our analysis has been explained in Figure 2.5 and 2.6. 2007 ®FROST & SULLIVAN 7
    • GROWTH CONSULTING Figure 2.5 Methodology for Analysis: 1 Methodology for Analysis Weights used for overall analysis: Total companies : 338 • In a vertical, countries scored on basis Healthcare of whether they have been ranked BFSI 57 among top 3 by surveyed companies 80 • 50% weight if ranked as1st preference; 30% if 2nd preference, 20% if 3rd Technology 59 preference 59 Energy • Ranking of locations in each vertical allocated weights proportionate to the 25 8 vertical's projected SSO spend in 2006 FMCG/Retail 50 E&M to arrive at overall score T&L Figure 2.6 Methodology for Analysis: 2 Methodology for Analysis Cost Efficiency 5 -Labor -Infrastructure -Tax & Regulatory costs Business Environment Conduciveness -Political stability Quality of Human Capital -Infrastructure quality -Labor force skills and availability 5 5 -Cultural adaptability -Education and language level -Intellectual Property Regulation -Attrition rates • Companies asked to indicate their top three SSO locations • Companies asked to rate the importance of each location selection criteria to get relative importance of each • Companies asked to rate their top three locations against each criteria Secondary Research Extensive secondary research has been conducted to serve the following purposes: Comprehensively profile the selected companies for primary research Understand recent trends in SSO Develop an understanding of the strengths and weaknesses of top SSO locations 2007 ®FROST & SULLIVAN 8
    • GROWTH CONSULTING Focus Group Discussions As part of the project, three focus group discussions are to be conducted in India, Singapore and the USA. While the FGD in India was focused on the Technology sector, the FGD in Singapore was focused on the Finance and Insurance vertical. The FGD in the USA targeted participants from companies involved in SSO across verticals. Participants for all the FGDs are from senior management levels from Fortune 1000 companies. 2007 ®FROST & SULLIVAN 9
    • GROWTH CONSULTING 3.0 Overview The overview section (Section 3.0 and its subsections) summarizes the key findings across all verticals. We have highlighted the key issues and considerations for an SSO operation, the key drivers and concerns for SSO, functions typically conducted under SSO, nature of ownership of SSO operations, key criteria for location selection for SSO and top of the mind locations. For each of the verticals (Sections 3.1 – 3.7 and their subsections), we have detailed these findings with the sections for each vertical comprising of the following subsections: Overview: General overview of the vertical SSO Determinants: o General Perception: Summary of SSO trends for the vertical o Issues/ Considerations: Issues and considerations faced by a company in the vertical before starting or running existing SSO operations o SSO Drivers: Key drivers for setting up or expanding SSO for the vertical o SSO Constraints: Key constraints impeding setting up or expanding SSO for the vertical SSO Trends: o Spend on SSO: Overview of spend by the companies in the vertical on SSO o Degree of SSO by type: Functions for the vertical witnessing maximum SSO activity o SSO Party of Choice: Nature of ownership of SSO operations prevalent for the vertical SSO Locations: 2007 ®FROST & SULLIVAN 10
    • GROWTH CONSULTING o Selection Criteria: Key parameters considered by the companies in the vertical for evaluating a location o Top of the mind Locations: Overview of top SSO locations for the vertical 3.0.1 SSO Determinants 3.0.1.1 Issues/Considerations Companies across all the verticals studied have some form of SSO operations and many of them are in the process of expanding existing or setting up new locations. The following issues and considerations, as highlighted in Figure 3.1 are important factors that need to be integrated while setting up an SSO operation: Figure 3.1 Issues and Considerations for SSO set-up Issues and Considerations Regulations & Compliance Risk Diversification Cultural Differences Impact on “Send” Complexity & Risks SSO Operations (Company) Economy Identification of Vendor Selection & Processes Suitable for Management SSO Adherence to regulations as well as other compliance factors Regulations and initiatives such as Sarbanes-Oxley (SOX), Basel-II and Data Protection laws significantly impact SSO operations. While the impact of regulations can be most acute for the BFSI and healthcare verticals; they often impact the feasibility and attractiveness of any SSO decision. The US government including the FDA has been increasing the regulatory burden on life sciences corporations. This will impact not only the companies in the vertical themselves, but also their shared services or outsourcing 2007 ®FROST & SULLIVAN 11
    • GROWTH CONSULTING service providers. Stringent regulations are also present in many host countries that impact the attractiveness of the location as an SSO destination. For example, India has strict laws regulating conduct of clinical trials. Malaysia similarly has provisions with respect to storage of data involving Malaysians. A detailed study of relevant regulations in both “host” and “send” countries is essential to build in both the essential safeguards and correct evaluation of SSO locations. Diversification of risks for SSO initiatives on a global scale While Asia has been a favorite offshoring location for many years, many large companies have set up facilities with excess of 10,000 employees in a few countries like India and China. This concentration often exposes the company to several risks and serves as a critical parameter when they consider expansion of SSO operations. The Tsunami in 2004, flooding in Mumbai in 2005 and the political turmoil in Thailand in 2006 are examples that show the need for SSO location diversification. Management of Impact on “Send” (Company) Economy Often benefits from offshoring and outsourcing are perceived to be enjoyed at the cost of job losses in the ‘send’ countries. In most cases, the internal staff is handed over to the outsourcing provider; however, some job losses are inevitable, especially when offshoring is involved. An example is the deal between Wyeth and Accenture as part of which 150 of Wyeth's clinical data management (CDM) staff work for Accenture at Wyeth's facilities. In the European Union, regulations that protect employees against retrenchment pose a great restraint to companies planning to outsource non-core functions. In the USA as well, with the presidential elections coming in 2008, retrenchment due to outsourcing or offshoring may re-emerge as a key issue. Any offshoring decision is often accompanied by widespread publicity campaigns against the companies involved which may seriously impact the brand image. Therefore most Fortune 500 companies typically maintain a low profile whenever they take such decisions. Companies are also working with local and federal governments to ease the pain of employees affected through outsourcing or offshoring. Identification of Processes Suitable for SSO: outsource/ offshore or onshore Different verticals have different pecking order for services or functions when it comes to outsourcing or offshoring. For instance, FMCG & Retail companies would not outsource 2007 ®FROST & SULLIVAN 12
    • GROWTH CONSULTING Strategic/ R&D for the reason that it is too core and critical to their overall marketing and product competitiveness in the market. BFSI companies are often forbidden by regulations to outsource certain processes and even when there are no such constraints; they prefer to retain, in-house, activities such as interaction with premium customers. Functions such as IT Services and Support of Back Office Processing, which are not seen to be the core competencies for most companies, are often the most outsourced activities. Companies in Japan and Korea are the exception as most of them are still exploring the idea of SSO and are not ready to dabble in either outsourcing or offshoring. However, as a first step, companies need to ask themselves, “Why choose SSO” in the first place? Long-term planning often times falls prey to the operational needs and tactical decisions of the daily business. A closer look at the overall implications and fit into the firm’s strategy as well as cost/benefits is required before arriving at the conclusion of SSO being the optimal solution. Management of Complexity and Risks Companies are extremely concerned about losing control over their businesses in pursuit of SSO, given that this could have a serious impact on their reputation and competitive position. Especially for the financial services industry, which handles extremely sensitive customer data, a loss of such data could seriously damage a firm’s reputation and overall business. In 2006, an employee in India was arrested at a data processing center for allegedly siphoning US$420,000 from the accounts of 20 HSBC customers. Although offshoring and outsourcing services can have a significant impact on a company’s cost efficiency, incidents like the one at HSBC holds companies back from fully exploring those benefits. Because of this policy, proper risk management is a top priority for companies planning to take SSO further. A key issue for companies considering SSO is the monitoring of processes given that offshoring and outsourcing exposes the company to several constraints: from time zone, language and cultural issues to poorly defined contracts and Service Level Agreements (SLAs). Lack of monitoring can easily result not only in higher costs than planned but also damages to a firm’s reputation and fines from industry regulators. Proper monitoring through established policy operational guidelines and supporting reviewing mechanisms can also help companies avoid substantial risks. For example, for Northwestern Mutual (NM), IT workers at the insurance company’s provider, India-based Infosys are only provided terminals that do not allow users to alter, record or print data. Terminals are 2007 ®FROST & SULLIVAN 13
    • GROWTH CONSULTING linked to NM’s servers in the US via secure, high-speed phone lines. Vendor selection & management For any company wanting to outsource their business processes, the key question to be answered is which vendor should they select? Should they entrust a single vendor to provide for all their outsourcing needs or should they be faced with management complexity issues and challenges by outsourcing to multiple providers for different functions? An example of a cancelled deal is the one between J. Sainsbury with Accenture. The service level agreement (SLA) commitment needs to be clearly spelled out and understood by both parties to avoid future misunderstandings or disappointment. Continuous and open feedback and communications are pivotal to keeping good working relationships between the buyers and the providers (3rd party providers). Strong cultural fit and compatibility with the outsourcing service provider is a must for the success of outsourcing relationships. A global logistics company highlighted that oftentimes, senior management are highly focused on the cost-benefit aspect of shared services and outsourcing at the expense of such real-world elements as language and cultural barriers that could potentially arise in call centers, as well as a general tendency among call center staff to be overly mechanical in carrying out seemingly routine tasks. Therefore, companies often prefer to offshore business to countries with strong cultural affinity to its home market. Eastern Europe has benefited a lot from offshoring based on this criterion from other EU countries. Voice based centers located in Philippines have also been able to capitalize on their historic relationships with the USA to gain business. Proximity to customers appear to be the key criteria that media and entertainment outfits select shared service and outsourcing locations. 2007 ®FROST & SULLIVAN 14
    • GROWTH CONSULTING 3.0.1.2 SSO Drivers The key drivers for SSO across the studied verticals have been highlighted in Figure 3.2 Figure 3.2 Drivers for SSO across verticals Drivers Improve employee 1% 54% 45% 1% productivity 1% 43% 43% 12% Improve asset utilization 20% 53% 27% Enhance competitiveness 6% 1% 73% 20% Focus on core competencies 1% 37% 45% 17% Improve customer service 10% 44% 46% Reduce operating costs 43% 37% 20% Access scarce talent 1% 34% 55% 10% Overcome HR shortages * Percentages shown are % of total response Very Low Low Medium High Very High Small and large organizations across most if not all sectors analyzed in this study cite cost savings as the decisive driver of their shared service and outsourcing initiatives, generating savings ranging from 10 to 30% annually. In a similar vein, such initiatives allow many organizations to reduce operating costs by up to 40%, largely brought about by relatively lower wages in offshore locations. 90% of survey respondents highlighted potential reduction of costs as either High or Very High in terms of its importance as a driver. The fact that shared services and outsourcing enable organizations to hone a sharper competitive advantage is widely recognized as a key motivator by companies in the BFSI, technology, energy, and transportation and logistics sectors. For technology companies, the deployment of shared services and outsourcing facilitates their efforts in improving products and service quality. 80% of survey respondents cited ability to enhance competitiveness as either High or Very High in terms of its importance as a driver. The ability to focus on core strengths and free up resources to better serve customers and stave off competition is another critical driver, especially for the BFSI and technology sectors. Over 90% of survey respondents highlighted the ability of SSO operations to 2007 ®FROST & SULLIVAN 15
    • GROWTH CONSULTING allow corporations to focus on core competencies costs as either High or Very High in terms of its importance as a driver. The need for greater access to talent to help overcome skill shortages, especially in areas that require specific skill-sets, is what drives transportation and logistics as well as FMCG companies to pursue shared services and outsourcing. Multinational organizations have an inherent need for a centralized unit to perform key corporate tasks to support the operations of multiple offices worldwide. To that effect, shared services allow for centralization, enabling multinationals to achieve greater business efficiencies. Continued business innovation, commonly regarded as a critical factor that shapes a company’s success, drives companies in the technology and media and entertainment sectors to embrace shared services and outsourcing. The creation of innovation hubs in offshore facilitates technology companies’ efforts in driving innovation. Similarly for the technology sector, the abundance of talent in a given offshore location addresses the perceived shortage of qualified R&D personnel in the parent company, thus driving technology companies to look overseas to serve their R&D needs. Other key drivers include the ability to decrease time to market, particularly in the drug discovery arena. The prevalence of international mergers and acquisitions in the energy sector is spurring the need for greater streamlining of activities, uniformity and standardization. The fact that these may be achieved through shared services drives energy conglomerates to adopt this practice. This view is also shared by large automobile makers that regard shared services as playing a pivotal role in helping them manage complex internal business processes. 2007 ®FROST & SULLIVAN 16
    • GROWTH CONSULTING 3.0.1.3 SSO Concerns The key drivers for SSO across the studied verticals have been highlighted in Figure 3.3 Figure 3.3 Concerns for SSO across verticals Concerns Compromise 1% 19% 3% 46% 32% confidentiality Loss of control 6% 18% 60% 16% Increased costs 10% 29% 52% 9% Reduced service level of 3rd party 3% 29% 49% 18% Lack of knowledge 27% 58% 4% 11% about outsourcing Lack of competent 5% 34% 38% 16% 6% mgmt. staff Over-reliance on 4% 1% 36% 47% 12% external party Stability of 3rd party 9% 1% 23% 55% 13% Org. de-skilling 6% 2% 23% 46% 23% Very Low Low Medium High Very High The top three concerns cited by the surveyed companies across the verticals are potential compromise with confidential information, loss of control and organizational de-skilling. The risk of compromising confidentiality brought about by the widespread customer data theft and poorly enforced data protection laws in some outsourcing countries is holding back many companies particularly in the BFSI, FMCG and transportation and logistics sectors from offshoring non-core tasks. Companies are becoming increasingly wary of the high risk of breach of intellectual property, or IP, especially in countries that ostensibly lack a strong mechanism to safeguard IP rights. The risk of de-skilling along with concern for loss of control that may potentially arise from outsourcing functions that support core components is diminishing the appeal of outsourcing in favor of fully owned shared services centers. A common concern shared by companies across all verticals is an acute shortage of suitably qualified personnel to manage a particular outsourced function and a lack of domain expertise among existing staff. 2007 ®FROST & SULLIVAN 17
    • GROWTH CONSULTING A poor understanding of customers and cultural nuances are widely viewed as a deterrent for offshoring call centers overseas. The risks associated with government regulations governing outsourcing pose another obstacle to outsourcing and offshoring, particular for BFSI, technology and healthcare companies around the world. Other deterrents include over-dependence on external organizations, inadequate world- class infrastructure and manpower and not least reduced service levels. High attrition rates associated with increasing wage levels in some offshore countries have also been cited as a concern by many organizations. 3.0.2 SSO Trends Total spend on SSO operations by the seven studied verticals are expected to grow from a base of US$ 930 billion in 2006 to over US$1,430 billion by 2009. Technology and BFSI are expected to constitute over 50% of spend on SSO by 2009. Healthcare and Technology are expected to be the key growth verticals; SSO spend by these two verticals are expected to grow at a CAGR of 26% and 22% respectively between 2006 and 2009. Figure 3.4 highlights the spend on SSO by each vertical and the corresponding growth rates. Figure 3.4 Spend on SSO by verticals and projected growth Spend on SSO Operations Spend on SSO by Vertical ($ bn) CAGR in SSO Spend by Vertical (2006-2009) SSO Revenue 1500 Healthcare 26% re ca lth 258 FMCG Retail ea 17% H l ai 1200 et 94 Healthcare ;R Technology G 22% C gy FMCG Retail M F lo 900 no 130 420 ch Technology T&L 9% Te 59 L T& T&L 600 233 E&M 10% 147 &M 52 E&M E 113 100 Energy 6% 39 Energy y 84 rg 300 ne E 361 BFSI BFSI 10% 273 I FS B 0 2006 2009 Average: 15% 2007 ®FROST & SULLIVAN 18
    • GROWTH CONSULTING While the overall spend on SSO is expected to grow at a CAGR of 15% between 2006 and 2009, this spend as a percentage of overall revenues across these seven verticals is expected to remain stagnant. While sectors like healthcare and entertainment and media will see a significant increase in adoption of SSO; BFSI, technology, travel and logistics and FMCG/ Retail will witness limited increase for the same parameter. The energy vertical is expected to witness a decline for SSO spend expressed as a proportion of revenues for the vertical. This is because the revenues for the vertical is expected to grow significantly given the projections for oil prices while SSO activity is expected to grow at a relatively lower rate. Figure 3.5 tabulates the projections for the spend on SSO and the same expressed as a percentage of overall revenues, as well as the outlook for spending for the key functions. Figure 3.5 Spend on SSO across verticals and key functions Spend on SSO Operations Spending Trends on SSO Functions for SSO (Spending Levels) SSO spend as % SSO Spending of Revenue (US$ ‘000 Million) 12% 30% 31% 20% 8% Strategic/R&D 10.0% 1500 IT Services & 9% 0% 1% 43% 47% Support 1432 2% 18% 6% 38% 36% Back-Office 8.0% 1200 Processing 1240 36% 50% 13% Sales & Sales 1% 1080 Generation 6.0% 900 930 4%12% 43% 33% 8% Corporate Learning 4.0% 600 2% 31% 44% 22% Customer Service & Call Center 15% 53% 21% 9% Procurement 2% 2.0% 4.1% 4.1% 4.1% 4.1% 300 4% 3% 29% 43% 21% Human Resources 0.0% 0 2006 2007 2008 2009 1% 29% 30% 30% 10% Finance & Accounting * Percentages shown are % of total response Very Low Low Medium High Very High 3.0.2.1 Degree of SSO by type Results from our research shows that while many companies have some or the other experience with SSO activity, the degree to which the companies are willing to embrace SSO and outsourcing operations vary significantly from company to company. Our study has observed the usage of SSO across all functions, however, with different emphasis, as highlighted in Figure 3.6 2007 ®FROST & SULLIVAN 19
    • GROWTH CONSULTING Figure 3.6 Mapping of functions for SSO and their adoption by verticals Functions for SSO and their adoption by verticals Function Verticals with significant adoption of SSO Finance & Accounting Energy, FMCG & Retail, Media & Entertainment, Technology, Transport & Logistics Back-office Processing BFSI, Energy IT Services & Support Common across all industries Customer Service BFSI, FMCG & Retail, Media & Entertainment, Technology, Transportation & Logistics Human Resources Common across all industries Corporate Learning Energy Procurement FMCG Research & Development Healthcare, Technology This section gives an overview of the degree of SSO by various types of operations e.g. IT Services & Support, Human Resources, etc. IT Services & Support As IT becomes more and more closely integrated and an inseparable part of the business environment, organizations feel that the operations and support functions can be handled best if they are either outsourced or centrally managed through a few captive centers around the globe. All verticals have seen instances of companies outsourcing IT services and support to specialized players like IBM, EDS, and Accenture etc. as a part of multiyear and multimillion dollar deals. The deals when looked at in isolation appear to be very costly, however, when looked at from the strategic vision the company, a few hundred million dollars spent now will potentially save the company billions in cost savings on non-core functions in the coming few years while ensuring excellence and business innovation A good example to illustrate this type of outsourcing is Vodafone. In Oct. 2006, Vodafone decided to outsource its IT operations to IBM and EDS in a multiyear contract that spans for seven years. The company has not released any financial details of the deal, however said that it will help it save US$ 600 million in maintenance costs. 2007 ®FROST & SULLIVAN 20
    • GROWTH CONSULTING Human Resources With business going global and having multiple locations, managing human resources across the organization is becoming more and more challenging. Human Resources departments not only have to deal with host of specialized functions like payroll operations, benefits administration, employee records and data management and asset management services. The answer to this problem has emerged through HR outsourcing. There are a host of companies specializing in this field, e.g. Hewitt Associates. Sony Electronics has outsourced its HR functions to Hewitt Associates. Sony claimed that Hewitt's HR outsourcing services will enable Sony Electronics human resources to focus on its strategic human resources functions, freeing the HR staff from day-to-day management of essential but non-strategic duties. Standard Chartered for example set up an HR Shared Services Center in Chennai, India with the aim to deliver a consistently high service for its global operations. Services like payroll operations and benefits administration fall under these initiatives. Finance and Accounting Among the SSO services within this category include: General Accounting (Bookkeeping, A/P, A/R), Bank Statement Consolidation, Payroll and Tax returns, Financial Analysis and Reporting (Balance Sheet Analysis), Non-Profit Accounting, and Check Processing. SSO for finance and accounting services is especially common for FMCG/ Retail and Energy verticals. BP outsourced its finance and accounting to two centers, one in Budapest to serve the European customers, while the other in Calgary to serve the American customers. The Budapest center is run by EDS, with an investment of US$ 8.5 million. The Calgary center is run by IBM, a three-floor data centre. Exxon Mobil also runs a shared service in Czech Republic for the finance and accounting. Customer Service Call center off-shoring has been motivated by two key factors – cost and operation efficiencies. The technology, BFSI, FMCG/Retail and Transportation and Logistics sector has many examples of companies which have either outsourced customer service and call centre functions to third party providers in low cost countries or have set up their own 2007 ®FROST & SULLIVAN 21
    • GROWTH CONSULTING captive centers in low cost destinations to serve its customers globally. HP is one good example; HP runs its entire call centre operation through its centers in India. Research & Development Outsourcing of R&D functions has been a topic of hot debate for the last couple of years. For example in the technology sector, companies are trying to answer one important question – What started as Original Equipment Manufacturing (OEM) outsourcing and transformed into Original Design Manufacturing (ODM) is now going to transform into full fledged outsourcing of R&D functions? Similarly, in the pharmaceutical sector, generic drug companies from Asia which were considered a threat to big pharma from the USA and Europe have now become strategic partners in the quest to discover new chemical entities and drug discovery. These generic drug companies also offer a host of specialized services in the clinical trails phase. FMCG companies on the other hand typically tend to keep R&D in-house. Corporate Learning Programs In lines with HR processes, several companies have also outsourced Corporate Learning programs to specialists. BP outsourced corporate learning programs to Exult that provides global access for all BP employees to a tailored digital skills curriculum to support the development of IT skills and a global hosting environment for custom BP e- Learning. Back-Office Processing Back-office processing make up the largest portion of the BFSI SSO market, credit card and other transaction processing, for example. Bank of America has a shared services center in India for back-office processing. HSBC set up its Electronic Data Processing unit in Hyderabad, India which controls back-office processing in Bangalore, Visakhapatnam. The three processing centers have a staff of more than 4,500 employees. Citigroup chose China as a location for its back-office operations. Procurement Procurement has emerged as a key business processes for SSO for FMCG/ Retail vertical. It is also extensively practice by IT verticals especially for IT related procurement. 2007 ®FROST & SULLIVAN 22
    • GROWTH CONSULTING Tasks within this function include supplier sourcing and management (supplier’s pricing & performance), continuous savings implementation and transaction management. Walmart, in China, procured more than US$ 7.5 billion worth of Chinese goods through its procurement center in Shenzhen, Guangzhou province (south of China), which is more than half of its global volume of direct imports. While some firms prefer to have a wholly owned procurement unit, some companies outsource this function to specialized procurement service providers. For instance, Kimberly Clark hired procurement specialist ICG Commerce in 2005 for its procurement needs, as part of a five years contract. 3.0.2.2 SSO Party of Choice There are currently three models of SSO being adopted by the Global Fortune 500 and Forbes 2000 companies. They either own the operations fully, set up joint-venture with reputable third/external party or completely outsource the operation to SSO providers. Their preference for either mode of operations is shown in Figure 3.7 Figure 3.7 SSO Party of Choice across verticals SSO Party of Choice SSO Party of Choice SSO Party of Choice per Function Strategic / R&D 87% 10%4% IT Services & Support 33% 29% 38% Third Party Back-Office Processing 53% 33% 14% 17 % Sales & Sales Generation 91% 1% 8% 64 % 17 % Corporate Learning Programs 64% 22% 13% Customer Service 46% 14% 40% and Call Centers Joint Venture Procurement 77% 16% 7% Wholly Owned Human Resources 49% 23% 29% Finance & Accounting 76% 16% 8% * Percentages shown are % of total response Wholly Owned Joint-Venture Third Party 64% of the SSO operations of the surveyed companies are wholly owned; the corresponding numbers for Joint Venture and 3rd party outsourcing are 17% each. 2007 ®FROST & SULLIVAN 23
    • GROWTH CONSULTING Own Facility In this model, the organization owns all the physical infrastructures. In addition, the company is directly responsible for its employees’ recruitment and welfare needs. Companies which are concerned about loss of control, protection of intellectual property and might face regulatory hurdles choose this model. This model is most extensively used by BFSI companies for their business processes which cannot be outsource due to regulatory constraints and also by companies in other verticals willing to maintain greater control. For example, Shell runs five shared service centers that are fully owned subsidiaries of Shell. They are located in Cyberjaya (Malaysia), Glasgow (UK), Krakow (Poland), Manila (Philippines) and Guatemala. The reasons for Shell to choose fully owned centers are concerns about losing command and influence with outsourcing. Boeing and Maersk’s corporate learning programs are conducted internally while Qantas and Northrop Grumman’s procurement activities are centrally managed from their respective shared service centers. Hybrid Relationships The two most common forms under this model are joint ventures and collaborative partnerships. This model is sometimes preferred because of the element of control it provides without the risks of running subsidiaries. In 2004, Quintiles and Solvay entered a unique risk-sharing agreement under which Quintiles will invest US$25 million worth of development services for ten of Solvay’s phase II projects from 2004-06, thereby bearing around 50% of the risk. Solvay would provide Quintiles with milestone payment for each of these projects reaching phase III. Unlike similar previous deals, however, Quintiles will not receive royalties from drug sales Third Party Provider This model is where third parties carry out majority if not all of the organization’s specified business processes. This model has been most prevalent for IT services across all verticals. As part of a US$1.8bn outsourcing initiative, Dutch bank ABN Amro, in 2005, signed a deal with Indian IT services companies Infosys and TCS for application support and enhancement. The bank already had a US$1.5bn desktop outsourcing deal with EDS for its wholesale operations. 2007 ®FROST & SULLIVAN 24
    • GROWTH CONSULTING As HR outsourcing matures, we are likely to see this model adopted in for HR services as well. In February 2007, TalentTrack, announced outsourcing agreement with Tenet Healthcare Corporation to assist its hospitals in developing an efficient, consistent and centralized physician recruitment process that will support the system’s targeted and aggressive growth initiatives. Similarly, companies are increasingly outsourcing their call centers to external parties. BSkyB is just an example of an increasing number of companies that have outsourced their call center operations, in this case, to U.K. based Response Handling. 3.0.3 SSO Locations 3.0.3.1 Selection Criteria Key factors considered while deciding upon location for SSO are compensation, infrastructure, and tax and regulatory costs; labor force experience and availability and regulatory environment for IP as highlighted in Figure 3.8 Figure 3.8 Location Selection Criteria for SSO across verticals SSO Location Selection Criteria IP regulation 37% 15% 55% 28% Cultural 23% 51% 36% 6% adaptability Infrastructure 7% 20% 69% 10% quality Political stability 29% 11% 59% 27% Attrition rates 1% 41% 37% 49% 9% Education & 1% 26% 16% 48% 25% language Labor force 19% 6% 63% 29% experience Labor force 11% 28% 41% 23% availability Tax & regulatory 1% 30% 10% 53% 32% costs Infrastructure 11% 15% 51% 33% costs Compensation 12% 23% 40% 34% Costs Very Low Low Medium High Very High 2007 ®FROST & SULLIVAN 25
    • GROWTH CONSULTING Labor Costs and Availability Historically, companies have regarded labor costs and availability as paramount to their decision in its selection of SSO locations. Across verticals, search for low cost options for operations have driven SSO activities. As an example of labor cost arbitrage: In Ireland, a call center agent’s average salary is around US$ 23,000 – US$34,000 annually as compared to a US$2,800 annual salary for a similar position in developing countries such as Malaysia and the Philippines. A growing number of Hollywood studios are already harnessing the scalable pool of animation talent that India has to offer at half the cost of performing the same services in the United States. In the healthcare vertical, CROs are expanding into low cost geographies especially to India and China. Costs are low in these countries not only because of shorter time taken to recruit patients for clinical trials but also due to lower salaries for the employees involved. The presence of excellent institutes for higher education in India, China, East Europe and Russia has made these locations attractive for high end R&D activities, especially for the healthcare and technology sector. However, high demand has caused attrition rates and remuneration to increase sharply in India, especially for jobs that require better skilled programmers and for middle management. Firms like ABN Amro face situations where they invest several months into training individuals only to see them shift to competitors after one year for higher salary. It is this wage inflation that made companies to consider countries like China which are at the earlier stages of SSO demand. The problem with alternatives in the region is that in the case of China for example, graduates and professionals are not necessarily equipped with sufficient language and domain skills. Intellectual Property & Confidentiality Protection A location’s ecosystem for protecting intellectual property plays a key role while deciding SSO locations, especially for functions involving data or concepts essential to core competitiveness of the company. Companies typically ask the following questions to evaluate a location in this respect: Does the country under consideration have a history of enforcing international IP laws? 2007 ®FROST & SULLIVAN 26
    • GROWTH CONSULTING Does the country in question have a transparent and honest court system that is efficient and sophisticated enough to effectively deal with an IP problem before market share is diluted and customers stolen? What measures are in place in the country to prevent IP thefts (are there effective criminal and financial penalties as deterrents)? The US and especially the EU have laid down strict and clear provisions over the transfer of data to third countries. As a consequence, some FMCG & Retail companies rather set up their SSO operations in the USA, UK or other European locations where the regulatory systems are well enforced and clearly written. Several SSO locations are now taking active measures to address these concerns. For example, India is initiating to draft bills which are similar to UK’s Data Protection Act and would negotiate for an agreement that resembles the US-EU efforts in providing for ease of transferring data between EU nations and the USA documented in the US Safe Harbor framework. Infrastructure Costs and Quality Across verticals, infrastructure quality and cost is a key determinant to its overall attractiveness for SSO. For example, BMW regards telecommunications costs as an important consideration in its selection of offshore locations. Top energy vertical companies such as Exxon Mobil, Shell and BP have their shared service centers located in South East Asia and Eastern Europe where the infrastructure cost is much lower compared to North America and Western Europe. Many respondents feel that even though India’s overall labor costs is low, the cost benefit is to an extent overrun by its poor infrastructure. Apart from power supply, logistics and transportation infrastructure are critical for FMCG & Retail companies, especially for its procurement centers where China scores substantially better than India 2007 ®FROST & SULLIVAN 27
    • GROWTH CONSULTING Government incentives (Tax and Regulatory costs) Many companies have highlighted favorable government policies to be a compelling reason as to why they want to start their SSO operations in a particular country. Czech Republic provides up to 50% of eligible business expenses as subsidy, 35% of special training costs and 60% of general training costs for companies interested in setting up their SSO centers there. China has Special Economic Zones (SEZ) that promote high international quality standards in the Hainan Province, Shenzhen or Shantou with financial incentives. India is also deploying a comprehensive SEZ scheme. Flexible labor laws that make it easy to attract foreign talent are key drivers as well. Locations like Singapore and Dubai deserve special mention in this context. Among other factors, proximity to key markets have also been highlighted as a key decision criteria. Proximity to Key Markets Another criterion that is growing in importance is proximity to key markets to help monitoring and eliminate language and cultural issues when it comes to SSO. Many utilities and media companies chose to set up their shared service center in their home country. These companies are generally not multinational companies and hence, prefer to stay in home country. Often these companies are also the chief source of employment in the region and fear political backlash if they were to offshore functions. Another trend for large companies is to have one hub in Asia to serve the APAC region, one hub in Europe to serve the European region, one Latin American country to serve the South American markets, and so on instead of one or two hubs to serve many regions. Denmark, that provides good geographical position to enter the Nordic region, has been thereby able to attract companies like Christian Dior and the Gillette group (under Procter & Gamble). As many companies have highlighted that even though there are many cheaper locations for them to choose from such as Russia, India or China, they feel more comfortable if they are able to fly their team in within a short span of time (less than 6 hours) if there are any issues in their SSO centers to resolve those problems. Coca-Cola 2007 ®FROST & SULLIVAN 28
    • GROWTH CONSULTING for instance, kept their shared services center onshore in Tampa, Florida, USA which is only a mere 1.5 hour’s flight to its headquarters in Atlanta, Georgia, USA. When it comes to decision making, key decision makers are the CEO, COO and Functional heads. Regional/ Geographic managers and interdepartmental teams are the key people involved when it comes to recommending locations for SSO. Figure 3.9 highlights the findings from the survey with respect to key decision makers and recommenders for SSO. Figure 3.9 Key People involved in SSO decision making for SSO across verticals Key People involved in SSO decision making Recommenders Decision Makers CEO 65% 24% COO 37% Functional Heads Interdepartmental 25% 47% (IT/HR/CFO) Team 52% Interdepartmental Team 15% SSO Location Managers 43% Regional/ Geographical Mgrs 16% External Consultants Others 1% Others * Percentages shown are % of total response 3.0.3.2 Top of the Mind Locations Based on the research and interviews with companies across all seven industry verticals, we have identified India and China as the top locations for SSO. Ireland, Singapore and Malaysia are ranked third, fourth and fifth respectively with limited difference between their overall scores. Compared to our previous study, the preference for Malaysia and 2007 ®FROST & SULLIVAN 29
    • GROWTH CONSULTING Mexico as an SSO location has improved whereas that for Philippines and Canada has dropped. Figure 3.10 highlights the top 10 locations and their overall scores while Figure 3.11 shows the relative position of each country for the seven verticals studied. Figure 3.10 Top SSO locations across verticals Top SSO Locations Rank Overall Score* 1 India 2.25 2 China 1.76 3 Ireland 0.77 4 Singapore 0.72 5 Malaysia 0.70 6 Mexico 0.30 7 Czech 0.26 8 Poland 0.24 9 Philippines 0.17 10 Canada 0.16 * Score based on percentage of respondents having chosen as one of their top 3 locations for SSO (50% weight for 1st preference, 30% for second preference; weights of each vertical applied subsequently) Figure 3.11 Positioning of countries as SSO location for the seven verticals Top Locations across Verticals Verticals FMCG Media Transportation BFSI Energy & Retail Healthcare & Entertainm. Technology & Logistics Locations Canada China Czech Republic India Ireland Malaysia Mexico Philippines Poland Singapore Australia Dubai Eastern Europe* France Russia UK US *Excludes Czech, Poland Significant & Emerging location Stable Declining Growing 2007 ®FROST & SULLIVAN 30
    • GROWTH CONSULTING The section below provides a detailed overview of the top ten countries. India (Rank 1) Figure 3.12 Country snapshot: India Country Snapshot SSO Environment Snapshot Business Lower labor cost as compared to western countries Environment Large pool of professional & English speaking graduates Absence of unions in IT/ITES sector Conduciveness Democratic and stable government Presence of Software Technology Parks (STPs) and Export Processing Zone (EPZs) in most states. Cost Booming economy with more than 8% growth annually for the Efficiency last few years. Rapidly rising wages, almost 30% annually Rising prices of prime real estate near metros Loss of efficiency due to poor road and domestic air transport infrastructure. Appreciating Indian Rupee against the US dollar is a concern GDP per Capita US$3,700 GDP Growth 8.4% Quality of Huge labor force Human Highest number of English speaking graduates annually Capital worldwide Population 1.13bn Total Workforce 509.3m Favorable Conditions Average Conditions Not Favorable Conditions Current SSO Situation India is the leading SSO destination in the world. Providers are maturing and moving up the value chain. The market is experiencing consolidation and high levels of absorption. Providers are expanding their onshore presence to strengthen their global delivery capabilities. Demand for experienced professionals is outpacing their supply and attrition levels in the industry remain between 25-40 percent. India hosts both captive and outsourced operations of major corporations like JP Morgan, British Airways, GE, Accenture, IBM, etc. with several of these centers employing in excess of 10,000 employees. 2007 ®FROST & SULLIVAN 31
    • GROWTH CONSULTING Strengths & Weaknesses Strengths: Large talent pool, English speaking labor force, cost efficiency are some of the strengths that India possess as an offshoring destination Weaknesses: Poor infrastructure, rising wages, and the appreciation of the Indian Rupee against the US dollar Government Initiatives to promote SSO The central and state governments have whole heartedly supported the industry. Some of incentives provided are – Special tax arrangements, rebate on cost of land, concession in power tariff, special incentive packages for project valued at more than US$ 10 million. Indian state Governments have taken the following steps to boost the growth of the SSO industry within their domains: A majority of the states have enacted laws to allow employees to work on National Holidays; allow women to work in night shifts; and offices to function 24 hours a day, all through the year (i.e. 24x7x365). State Governments have announced IT policies that seek to create (through focused Human Resources Development (HRD) programs), a trained pool of manpower with the skills and aptitudes appropriate for the SSO industry requirements. Bridge programs for engineering graduates, communicative English, soft skills, accent neutralization, ITES sub-domain level training, etc. have been given focused attention by the state governments. Most of the states in India have Software Technology Parks (STPs) and Export Processing Zones (EPZs) offering world-class infrastructure with reliable data communication facilities. Further, to leverage private sector investments, the state governments have proactively come out with several special incentives such as Special Tax Incentives, Rebate on Cost of land, Rebate on stamp duty on sale/lease of land, Rebate on stamp duty on sale/lease of land, Concession in power tariff for new units, Self–certification under various Acts, Special incentive packages for mega projects (> US$ 10 million) 2007 ®FROST & SULLIVAN 32
    • GROWTH CONSULTING SSO Outlook India will continue to be a leading destination for offshoring in the near future. The advantages which India offers far outweigh the concerns. Indian outsourcing outfits are growing rapidly and becoming global players, in addition to this, already established global players continue to add to their headcount in India. India is also emerging as a location of choice for high end research and design work especially in the technology, automotive and the pharmaceutical sector. 2007 ®FROST & SULLIVAN 33
    • GROWTH CONSULTING China (Rank 2) Figure 3.13 Country snapshot: China Country Snapshot SSO Environment Snapshot Business Politically stable given a single party ruling, the Communist Environment Party of China. Rated poorly in terms of corruption 45,400 km of expressway, Conduciveness 78,000 km of railway network in 2007 as well as over 500 airports. Spent just over US$ 136 billion on R&D in 2006 and it now ranks second worldwide with 926,000 researchers Cost GDP growth at 10.5 % Efficiency Annual salaries for entry level staff starts at US$5460, Team Lead with 2-3 years experience can earn US$8,800 annually and managers with 5 - 8 years of experience can obtain a salary package of US$ 13,732. GDP per Capita US$7,600 GDP Growth 10.5% Quality of 629 higher learning institutions across China with the Human most famous being Tsinghua and Beijing University, the Capital equivalent of MIT and Harvard in China Population 1,3bn Out of the 202,600 graduates in China, 38,400 are PH.D and 164,200 are master's degree holders. Total Workforce 918m Favorable Conditions Average Conditions Not Favorable Conditions Current SSO Situation China remains a favorable hub for SSO activities given its talent, ability to scale, huge local market, world class infrastructure in major cities and other attractive factors that will spur China ahead such as the hosting of the Olympic Games in 2008 in Beijing as well as the Expo 2010 - World Fair in Shanghai in the year 2010. China has managed to attract names like IBM, Accenture, SONY, NEC, Rockwell, BearingPoint, Matsushita, Ericsson, Nokia, GE, Dell, SAP, Satyam and other MNCs to establish their application development centers as well as BPO and IT Services centers in software parks across China. From the banking industry, powerhouse Citigroup chose China for its back office operations in addition to its existing center in Singapore. Japanese outsourcing to Dalian, China, reached US$ 375 million in 2004. Major pharmaceutical companies such as Roche, GlaxoSmithKline and Eli Lily have established their R&D centers in Shanghai, China thus implying the high quality of Chinese talent in the R&D segment of biotechnology and healthcare. For the FMCG & Retail sector, China is at the forefront for procurement tasks. Strengths & Weaknesses 2007 ®FROST & SULLIVAN 34
    • GROWTH CONSULTING Strengths: Abundance of human capital especially for R&D functions, relatively cheaper human resource than most competing nations Weaknesses: No single government body to handle and coordinate SSO enquiries/ investments, lack of English speakers Government Initiatives to promote SSO There is no single government body such as MDeC in Malaysia or iDA in Singapore to handle all SSO matters. Corporate tax rates are non-uniform across China. For example, Shanghai and Guangzhou taxes are at the high end of 33% and 30% respectively whereas Zhuhai stands at an attractive rate of 15% and Dalian at 24%. The Chinese government has designated several cities in China to be the hub of excellence for SSO activities, namely, Beijing, Shanghai, Hangzhou, Tianjin, Nanjing, Chengdu, Xi’An, Shenzhen and Dalian. SSO Outlook China is unique compared to other SSO contenders due to its ability to cover lower end functions such as back office processing to high value functions such as R&D. Even though the Chinese government has earmarked many major cities in China as hub of excellence for SSO, there is a lack of collective measures from the various government agencies involved to ensure the success of these cities. However, China will remain as one of the strongmen in the arena of SSO given its labor force skills and availability. 2007 ®FROST & SULLIVAN 35
    • GROWTH CONSULTING Ireland (Rank 3) Figure 3.14 Country snapshot: Ireland Country Snapshot SSO Environment Snapshot Business Total investment of approximately US$ 250 billion for national Environment development in the next 7 years. Ranked 2nd out of 60 countries in World Competitiveness Conduciveness Report for education system and 3rd for per capita productivity One of the most beneficial corporate tax regimes in the world with 12.5% corporate tax. Cost Labor costs are fast increasing; higher than many EU Efficiency countries GDP per Capita US$43,600 GDP Growth 5.2% Quality of 3rd out of 60 countries for per capita productivity in the World Human Competitiveness Report 2005 Capital Over 39% of Irish people aged 25-34 have a third level Population 4.1m education Highest output of Science and Engineering graduates within Europe. Total Workforce 2.1m Favorable Conditions Average Conditions Not Favorable Conditions Current SSO Situation The base layer of the offshoring value pyramid – running infrastructure and applications – is currently where most of the action is in the Irish offshoring market; however this tends to be a commodity business and therefore Ireland is losing its share. However, many healthcare and technology companies have established their R&D centers in Ireland with the entertainment and media vertical exploring the location for their offshoring initiatives. Global leaders such as Accenture, Allergan, Black & Decker, Citigroup, Colgate, Oracle, Pfizer, Microsoft, Whirpool, Xerox, Hertz, IBM, Dell, RCI, AOL, eBay, SAP, Siemens, Bertelsmann have located pan-European/EMEA/Global centres in Ireland. 2007 ®FROST & SULLIVAN 36
    • GROWTH CONSULTING Strengths & Weaknesses Strengths: World class infrastructure, talented workforce and government support Weaknesses: Small size of labor force and high cost of living Government Initiatives to promote SSO Ireland has one of the most benevolent corporate tax environments in the world. A corporation tax rate of 12.5% applies to all corporate trading profits. Tax credits are provided for incremental expenditure on Research and Development. Ireland also has a favorable holding company regime and double taxation agreements with 44 countries. SSO Outlook Ireland is likely to loose share in low value operations. Though it has held on to its position as a top location for SSO, its value proposition is eroding fast. However, it is generating significant interest for higher value activities like R&D. 2007 ®FROST & SULLIVAN 37
    • GROWTH CONSULTING Singapore (Rank 4) Figure 3.15 Country snapshot: Singapore Country Snapshot SSO Environment Snapshot Business Stable political system Environment Minimal corruption Low income and corporate tax system Conduciveness Ease of starting a business Safe location for sensitive high-end activities Cost GDP growth at 7.3% Efficiency Low inflation at 0.8% No threat of expropriation, and contracts are very secure GDP per Capita US$30,161 Quality of Highly flexible employment regulation GDP Growth 7.3% Human High wages, low workforce numbers Capital 71% of the population is literate in English Multi-lingual capability Population 4.5m Total Workforce 2.3m Favorable Conditions Average Conditions Not Favorable Conditions Current SSO Situation Singapore is considered a leader in high-tech outsourcing for many large corporations in the world. In 2006, Singapore hosted 95 off-shoring projects in total. Some notable examples are SAP SSC, Citibank, DBS, etc. Singapore hosts more than 7,000 MNCs with over 60% based in Singapore as regional headquarters. Strengths & Weaknesses Strengths: Highly skilled and educated workforce, extensive communications infrastructure, free trade agreement with USA, secure location for sensitive high-end activities Weaknesses: Relatively high wage levels, small labor pool 2007 ®FROST & SULLIVAN 38
    • GROWTH CONSULTING Government Initiatives to promote SSO The Government has increased the capacity of technical schools and universities as well as made it easier to recruit foreign professionals to work in service centers. The US- Singapore free trade agreement that emphasizes on the Intellectual Property protection will help promote Singapore as the main hub for knowledge-based outsourcing SSO Outlook Singapore’s outlook as an SSO location is promising, with its highly skilled labor pool and commitment to business continuity and disaster recovery. Flexible labor policy to attract foreign talent will ensure that any corporations who would like to set up SSO centers in the island would be able to find the required-skills for their operations. 2007 ®FROST & SULLIVAN 39
    • GROWTH CONSULTING Malaysia (Rank 5) Figure 3.16 Country snapshot: Malaysia Country Snapshot SSO Environment Snapshot In terms of political ratings, Global Insights gave Malaysia a Business score of 1.75 (1 means low risk and 5 means high risk). Environment Malaysia is ranked 39 out of 159 countries in the world Conduciveness according to the Corruption Perception Index study by Transparency International. There are 49,935 km of paved roads in Malaysia and an estimated RM 159.4 billion (~ US$ 47 billion) in funds will be invested in infrastructure building and upgrade in 2007. Cost GDP growth at 5.9 % Efficiency Malaysia has a low wage inflation (5.5%) compared to many other top Asian countries. In 2005, Malaysia's salary increase budget ranged from 5.4% to 6.1% GDP per Capita US$12,700 GDP Growth 5.9% Quality of Attrition rate in Malaysia remained almost static at 12.5% Human up from 12.4% of 2004. Capital Ministry of Education statistics show that 11,619 turned Population 24.8m out to be ICT graduates in 2003. By 2006, the country projected a total of 43,757 ICT Diploma and Degree graduates. Total Workforce 10.6m Multilingual and multicultural workforce Favorable Conditions Average Conditions Not Favorable Conditions Current SSO Situation Malaysia has established itself as a strong player in BFSI, T&L and Energy verticals and as an emerging location for Technology. Recent SSO investments include Dell Malaysia Enterprise Command Center, Satyam’s Global Solutions Centre and Al-Jazeera’s regional broadcast center. Successful SSO operations include DHL, Shell, HSBC, Standard Chartered’s Scope International shared services center, Monster Technologies, TRW and British American Tobacco’s Group Service Delivery (GSD). Malaysia is also witnessing continued expansion from existing players such as IBM with its recent Asia Pacific Finance Regional Support Center. Strengths & Weaknesses Strengths: Multilingual and multicultural workforce to serve different regions, low wage inflation and the lowest turnover of staff in Asia Pacific indicating the overall loyalty that the workforce has Weaknesses: Lack of qualified human resource especially in the field of R&D Government Initiatives to promote SSO 2007 ®FROST & SULLIVAN 40
    • GROWTH CONSULTING MSC (Multimedia Super Corridor) status companies operating in Cyberjaya, Technology Park Malaysia, Kuala Lumpur City Centre, Kuala Lumpur Tower, Bayan Lepas, (Penang) and Kulim High Tech Park in Kedah enjoys the following incentives: Pioneer status with a tax exemption of 100% of the statutory income for a period of 10 years or Investment Tax Allowance of 100% on the qualifying capital expenditure incurred within a period of 5 years to be offset against 100% of statutory income for each year of assessment R & D grants (for majority Malaysian owned MSC status companies) Other advantages of MSC include duty-free import of multimedia equipment, Intellectual property protection , a comprehensive framework of cyber laws, no censorship of the Internet, world-class physical and IT infrastructure, globally competitive telecommunication tariffs and services, high-powered implementation agency, the Multimedia Development Corporation to provide consultancy and assistance within the MSC, high quality, planned urban development, excellent R&D facilities and lastly, a green and protected environment. On human capital development, initiative such as MSC KDI (K-workers development institute) in Malaysia to help graduates develop and acquire the necessary skills in ICT is lauded by many respondents as a great measure to improve the technical skills of SSO workers in Malaysia. SSO Outlook It is estimated that there are currently about 30,000 to 40,000 people who are working in Malaysia’s SSO companies and in the long run, Malaysia may not be able to meet the growing requirements of SSO operations as compared to countries with an abundance of workforce such as China and India. 2007 ®FROST & SULLIVAN 41
    • GROWTH CONSULTING Mexico (Rank 6) Figure 3.18 Country snapshot: Mexico Country Snapshot SSO Environment Snapshot Business Strong cultural affinity with the U.S. Environment Liberalization of national infrastructure underway to catalyze upgrading initiatives Conduciveness Government incentives and subsidies to promote growth of IT industry Labor and tax reforms needed Although politically stable, some instances of corruption persists Cost Access to inexpensive labor pool Efficiency Low inflation at 3.4% Relatively low foreign exchange - 10.899 Mexican pesos/US$ 90% of trade under free trade agreements with over 40 countries; key member of NAFTA GDP per Capita US$10,600 Quality of Supply of highly skilled labor outweighed by blue collar GDP Growth 4.8% labor pool Human IT-related courses gaining popularity in universities and Capital technical schools Population 108m Relatively low attrition rate at less than 5% Ample supply of native Spanish speakers to serve Total Workforce 38m growing Hispanic market in North America Favorable Conditions Average Conditions Not Favorable Conditions Current SSO Situation The SSO landscape in Mexico is characterized by an ever increasing presence of established IT service providers – EDS, IBM, ACS, Gedas, and HP to name but a few. Growing at an annual rate of five percent, Mexico’s outsourcing industry is driven primarily by offshore outsourcing initiatives adopted by global automobile conglomerates and major international airlines. ACS’ center situated in Ciudad Juarez manages a significant portion of Air France’s outsourced passenger revenue accounting business. IBM, on the other hand, has data centers in Guadalajara and Monterrey with 1,200 staff serving numerous clients in the large corporate and medium enterprise segments worldwide. Announcing plans to hire some 5,000 workers in its recently launched software development center in Guadalajara, TCS is the latest in a growing list of major global IT service providers to set up shop in Mexico. The center is designed to perform certain tasks currently completed in India. This move is principally driven by mounting labor costs witnessed in India. Not least, given that business emanating from the US accounts for the consultancy’s largest source 2007 ®FROST & SULLIVAN 42
    • GROWTH CONSULTING of revenue, TCS believes Mexico’s low labor and infrastructure costs combined with the low Peso, relative to a rising Rupee, may help boost the company’s earnings from the US market. The continued presence of established IT service providers with strong links with the automotive sector has been crucial in attracting the likes of Volkswagen, General Motors, Nissan and Mercedes Benz to deploy their outsourcing initiatives in Mexico. Similarly, the growth of call centers in the country is propelled by demand from U.S. firms seeking to reinforce their services for the growing Hispanic customer base across North America. Strengths & Weaknesses Strengths: Relatively low labor and infrastructure costs coupled with being a nearshore alternative for U.S. businesses Weaknesses: The growth of Mexico’s SSO industry is impeded by systemic flaws, primarily rigid labor laws and the continued displacement of skilled labor resulting in an unbalanced labor market Government Initiatives to promote SSO In partnership with Canieti, a Mexican IT trade group, the Mexican Ministry of the Economy launched MexicoIT to raise the country’s visibility as an IT and business process outsourcing destination. One of the program’s objectives is to promote several technology clusters situated in Mexico City, Monterrey, Jalisco, Tijuana as software development and business process outsourcing centers. To that effect, the Mexican government has implemented affirmative measures toward creating a conducive business climate. Such measures include financial incentives for conducting technology research and development in the country, as well as grants and scholarships for enrollment in IT training programs. Additionally, the government, via Prosoft, also offers support for startups in obtaining software quality certification. 2007 ®FROST & SULLIVAN 43
    • GROWTH CONSULTING SSO Outlook Global IT service providers with strong links with the automotive sector play a pivotal role in attracting major automobile players to deploy their outsourcing initiatives in the country. Similarly, the growth of call centers in Mexico is propelled by demand from U.S. firms seeking to serve the ever growing Hispanic customer base witnessed in the North American market. 2007 ®FROST & SULLIVAN 44
    • GROWTH CONSULTING Czech Republic (Rank 7) Figure 3.18 Country snapshot: Czech Republic Country Snapshot SSO Environment Snapshot Business Czech Republic scored 4.3 in the Transparency International Environment Corruption Perception Index . Measured on a per capital basis, Czech Republic is by far the Conduciveness most successful country in attracting FDI in Central Europe. Czech Republic is strategically located and its capital, Prague, is only 354 km from Berlin, Germany, 1,229 km from London, UK, and less than 2,000 km to most major European cities. Cost GDP growth at 5.43 % Efficiency Real wages, with inflation taken into account, increased by 3.9%. The wage-growth rate is healthy and is not endangering the economy's competitiveness thanks to increasing labor productivity. Inflation rate of 2.9% according to IMF, World Economic Outlook Database GDP per Capita US$13,654 GDP Growth 5.43% Quality of The Czech Republic has a total of 67,535 students in Human higher learning institutions with 7,168 of them being Capital graduate students. Population 10.2m Close to 70 per cent of the Czech population is able to speak a foreign language where English and German are most widespread. Total Workforce 5.27m Favorable Conditions Average Conditions Not Favorable Conditions Current SSO Situation Czech Republic is considered by many large MNCs for functions such as Finance & Accounting and also IT Services & Support though in recent years, Czech Republic is determined to position itself as a hub for R&D excellence. Examples: InBev Business Services Czech which was set up with a cost of US$ 2.57 million, Accenture (US$ 2.75 million), CSC (US$ 1.88 million), Global Tele Sales Brno– Lufthansa’s call center (US$ 1.55 million), IBM Global Services Delivery Center (US$ 4.18 million). To date, Panasonic, Honeywell, Mercedes Benz, Motorola, Rockwell Automation, Thermoking and Visteon are among the many global enterprises who have established their R&D or design centers in Czech Republic. Major finance & accounting SSO deals include investments from pharmaceutical and consumer powerhouse Johnson & Johnson, UK’s Tesco, Energy giant Exxon Mobile, Siemens, SAP and Philips whereas top logistics players such as DHL, global IT player IBM, Tesco and one of the largest job search engine in the USA, Monster Technologies, makes the most substantial investments in the IT Services & Support SSO scene. DHL Information Services (Europe) s.r.o. was set up with a cost of close to US$ 200 million and Sun Microsystem’s software development center was started at a cost of US$ 22.81 million. Strengths & Weaknesses 2007 ®FROST & SULLIVAN 45
    • GROWTH CONSULTING Strengths: Quality workforce with good qualification, a huge percentage of German speaking population to serve German-speaking nations, spending on R&D is higher than most Eastern European nations highlighting Czech’s determination to be a hub of excellence in Eastern Europe for R&D functions Weaknesses: Lack of scalability given its small population size Government Initiatives to promote SSO The Framework Program for Support of Technology Centers and Centers of Business Support Services offers subsidies for business activities in the areas of technology centers and business support services as well as training and re-training. Subsidy up to 50% of eligible business expenses (wage/ capital expenditure on tangle/ intangible assets), paid during the period of a maximum of 10 years will be provided along with a subsidy of up to 35% of special training cost and 60% of general training costs. Czech Republic has a fairly open immigration policy which offers selected qualified foreign workers the option of obtaining permanent residence permits after only two and a half years of living and working in the country. With an open immigration policy, it is hope that more talent will be attracted to Czech Republic to plug the gaps. SSO Outlook Given Czech Republic’s small population size, many players foresee a difficult market in terms of getting qualified labor and even Czech Republic’s openness to highly skilled labor immigration may not be quick enough to respond to growing needs from the SSO market. Due to lack of scalability, Czech Republic may lose out in the long run to labor rich SSO hubs such as India and China. However, its strong value proposition of proximity to Western Europe will drive its growth in the near term. 2007 ®FROST & SULLIVAN 46
    • GROWTH CONSULTING Poland (Rank 8) Figure 3.19 Country snapshot: Poland Country Snapshot SSO Environment Snapshot Business Political unstable with new government's Environment anti-foreigner stance Conduciveness Relatively fast to start a business EU member Low corporate tax rate Significant corruption Cost GDP growth at 4.6% Efficiency Low inflation at 2.4% Allows for 100 percent foreign ownership of domestic businesses but sets ceilings on the share of foreign ownership in various industries GDP per Capita US$8,655 Quality of Inflexible employment regulations GDP Growth 4.6% Human Matched language to Europe countries (English and Capital German) Population 38.5m High labor productivity growth rate Total Workforce 17.1m Favorable Conditions Average Conditions Not Favorable Conditions Current SSO Situation Poland is considered a leader in call center outsourcing for European corporations or corporations with substantial business activities in the Europe. Currently, Poland has 1210 shared service centers with an average of 10 to 30 consultants in each center. Some notable examples are Royal Philips Electronics, Thomson, Lufthansa, Citigroup and Accenture. Apart from the productivity and low staffing cost, Poland has multiple cities such as Gdansk, Warsaw, Krakow and Lodz with large populations of 1 million, 2 million, 750,000 and 1 million respectively. To put the factor in perspective, Poland has 42 cities with more than 100,000 inhabitants, while Hungary has 9 and Czech Republic has 5. Thus, corporations have higher flexibility in locating their SSO centers in Poland. Strengths & Weaknesses Strengths: Labor availability, skills and productivity, relative low wage compared to Ireland, more choice of SSO locations Weaknesses: Competition with neighboring locations due to wage inflation, poor transport infrastructure 2007 ®FROST & SULLIVAN 47
    • GROWTH CONSULTING Government Initiatives to promote SSO Polish Information and Foreign Investment Agency (PAIIZ) is established in June 2003 to stimulate FDI and offer information and support to investors. Poland has low corporate income tax rate of around 19%. SSO Outlook Cost advantage is eroding due to increasing wages in Poland. Poland has poor transport infrastructure; however, the Ministry of Infrastructure is undertaking a program for fundamental adaptations of the road network to EU standards by 2015. However, given the country’s ample supply of labor force, with their highly skilled language capabilities as well as cultural similarities to the western Europe, Poland is likely to remain a competitive player in SSO. 2007 ®FROST & SULLIVAN 48
    • GROWTH CONSULTING Philippines (Rank 9) Figure 3.20 Country snapshot: Philippines Country Snapshot SSO Environment Snapshot Business Political instability Environment Moderate effort to start a business Relatively high income and corporate tax rates Conduciveness Wide spread corruption Cost GDP growth at 5.4% Efficiency High inflation rates at 6.9% Maintain two negative lists as entry barrier for foreign investment GDP per Capita US$5,000 Quality of Rising cost of staff recruitment and retention GDP Growth 5.4% Human English and Filipino are the first language Capital Significant experience in serving offshoring business targeted at US markets Population 89.5m Total Workforce 36.7m Favorable Conditions Average Conditions Not Favorable Conditions Current SSO Situation Philippines hosts over 60 service providers with 22,500 full time employees involved in back office segment and the estimated revenue in 2005 is US$180 million from the segment. Several notable SSO centers in Philippine include HSBC’s BPO delivery center, Citigroup’s SSC, Dell’s SSC, Safeway’s SSC and Global eXchange SSC. Several companies have also relocated their SSO operations to Philippines. IBM, for example, shut down a large site in Bangalore and moved the site’s operation to Philippines. Similarly, Skyes closed the Indian operations and moved to Philippines. Strengths & Weaknesses Strengths: Manpower competency in English and ICT, low cost of labor and operation, traditional tie with USA Weaknesses: Limited city for SSO (Manila and Cebu city only), wage inflation and attrition Government Initiatives to promote SSO 2007 ®FROST & SULLIVAN 49
    • GROWTH CONSULTING The Government has been actively promoting the American financial certifications such as Series 6 and 7 that are compliance with the needs from the American and many other countries’ enterprises. SSO Outlook The Philippines is expected to remain popular for back office operations, especially for call center and tech helpdesk functions. However, Philippines will need to diversify its SSO locations and choices from its only current main hub in Manila and Cebu city. This is due to the high wage inflation and attrition in Manila where call centers are facing a situation where the employees are expected to demand an average of 70% salary increment in the near future. Furthermore, due to its heavy exposure to American corporations, the Philippine may lose its SSO attractiveness with the near-shoring option for American corporations to outsource to Latin America. Also, the Philippines has limited capability to serve high value functions like R&D. 2007 ®FROST & SULLIVAN 50
    • GROWTH CONSULTING Canada (Rank 10) Figure 3.21 Country snapshot: Canada Country Snapshot SSO Environment Snapshot Stable political system Business Minimal corruption Environment Moderate income and corporate tax system Conduciveness Almost US$13.7bn in outsourcing revenues About 32,000 ICT companies operating in the country Government spending in ICT sector about US$4.9bn (2005) High government expenditures due to elaborate social programs Cost GDP growth at 2.8% Efficiency Low inflation at 2% Great natural resources and substantial economic surplus Government restrictions for certain industries (telecoms, BFSI, broadcasting, newspapers, energy monopolies, book publishing, filmmaking and distribution and air transport) Labor costs up to 20% lower than in US GDP per Capita US$35,200 Quality of Labor pool size of 17.6m Highly skilled labor pool GDP Growth 2.8% Human 69% of workforce employed in services sector Capital Long experience in BPO, especially serving US market Population 32.5m Government continuously invests in enhancing education and skill sets Total Workforce 17.6m Favorable Conditions Average Conditions Not Favorable Conditions Current SSO Situation Canada is a world leader in IT-outsourcing with a specialization in call centers, BPO and IT services. With high levels of education and trained workforces and excellent infrastructure, Canada can attract especially high-end projects. Particularly for the U.S.A, Canada is a favorite outsourcing destination due to geographic, cultural/language advantages and regulatory similarities i.e. Sarbanes-Oxley. US-related outsourcing projects occupy around 180,000 workers in Canada with 50% being call center-related. Companies that use Canada as outsourcing destination are Dell with centers in Ottawa, Toronto and Edmonton, US Robotics, 3Com, Fujitsu, Unisys, etc. Procter & Gamble (P&G) and Lufthansa both set up shared services centers in Canada. While P&G is using its center to serve US customers, the German airline offshored HR functions. 2007 ®FROST & SULLIVAN 51
    • GROWTH CONSULTING Strengths & Weaknesses Strengths: Excellent ICT infrastructure, mature market for provision of outsourcing services, highly educated workforce (~20% lower labor costs compared to US), native English speakers, ideal nearshoring location for US Weaknesses: Overall costs higher than Asian competitors, small labor pool compared to India, China Government Initiatives to promote SSO Canada is working on positioning itself as a preferred location for complex processes such as HR outsourcing, niche IT development or R&D services together with continuous investments in education and infrastructure areas will complement the plans. SSO Outlook Canada will continue to be key SSO location for firms based in the U.S.A. or companies needing to serve US customers. Canada will also profit from firms with negative offshoring or outsourcing experiences in low-cost (Asian) countries. In the years to come, more and more elements of Canada’s USP will be successfully replicated and offered by Asian peers, thus threatening to slow down long term growth given its limitation of having a comparatively small workforce. 2007 ®FROST & SULLIVAN 52
    • GROWTH CONSULTING 3.0 Vertical Analysis 3.1 Finance & Insurance The Banking, Financial Services and Insurance industry (BFSI, or FSI for short) consists of major players such as Citigroup, Goldman Sachs, American Express or American International Group. Increasing pressure to outperform competitors and the search for new revenue streams is driving the overall business landscape and strategies of the industry. Just recently the biggest merger talks in Europe were announced: Barclays Plc is offering about US$80bn for Dutch-based ABN Amro to help the bank pursue its aggressive growth targets, according to Barclays CEO John Varley. FSIs will further try to profit from the favorable economic conditions to widen their reach and improve product and service portfolios. Size matters – and is leading FSIs into developing markets that provide access to a vast customer base – e.g. China. Apart from a strong and ideally global presence, FSI’s find that their customers want to be treated with excellent services and products that are tailored to their needs. All these factors need to be juggled with while adhering to increasingly strict regulatory requirements such as Basel-II and Sarbanes-Oxley. The following sections provide an overview on how Shared Services and Outsourcing affect the BFSI industry as it strives for increasing competitiveness while reducing costs. 3.1.1 SSO Determinants 3.1.1.1 General Perception The financial services sector considers SSO as a key element to remain competitive while streamlining processes and cutting down on costs. Companies tend to set up either their own operations, team up with service providers or a combination of both. Offshoring to destinations such as India, China or the Philippines are mostly preferred by the industry. However, strict regulations and data protection laws such as in the European Union prevent BFSIs to fully tap on the possibilities of SSO. As a result, destinations in the Central and Eastern European countries are very popular for European-based FSIs since they are not just part of the EU but also provide a highly skilled workforce at better prices and in close proximity. Overall it can safely be assumed that offshoring and outsourcing will continue to grow at levels over 20% in the coming years but witness a shift to other locations for cost and risk-diversification reasons. More and more companies will try to 2007 ®FROST & SULLIVAN 53
    • GROWTH CONSULTING achieve “Best shoring” which essentially means tapping on different locations globally that best address a financial services company’s SSO needs. In the following sections an overview of the key elements that determine and influence SSO decisions is presented and explained. 3.1.1.2 Issues/Considerations When considering SSO initiatives, companies face a variety of challenges they need to consider. The following issues and considerations are important factors that need to be clarified in the beginning: Strategic justification and planning of increasingly complex SSO initiatives While many companies in the finance sector use SSO to drive down costs and focus on core competencies the first question often asked is “Where to set-up a shared services center” or “Which country to choose to outsource and/or offshore processes” instead of “Why choose SSO” in the first place? Long-term planning often times falls prey to the operational needs and tactical decisions of the daily business. In the heat of the day and under constant pressure to cater to stakeholders of the firm, SSO might at first seem the right path to choose to show the determination to cut costs, streamline processes and improve competitiveness. A closer look at the overall implications and fit into the firm’s strategy as well as cost/benefits could reveal that SSO in fact may not the optimal solution at times. Adhering to requirements from government regulatory bodies as well as other compliance factors Regulations and initiatives such as Sarbanes-Oxley (SOX), Basel-II and Data Protection laws significantly impact FSIs when it comes to SSO. In 2004, Lloyds TSB in the UK was facing a complaint that it had acted against the UK Data Protection Act 1988 and the applicable European Directives with its offshoring plans to India. The company was accused of failing to seek written content of its customers to the transfer of sensitive data outside the EU. While the European Union recognizes few selected countries outside of its boundaries as meeting the required data protection standards (e.g. Switzerland, 2007 ®FROST & SULLIVAN 54
    • GROWTH CONSULTING 1 Canada, Argentina) it does not include popular offshoring locations such as China or India. As a result, financial institutions’ plans to offshore processes that involve dealing with sensitive customer data (even be it for disaster recovery) often face regulatory and compliance issues which impact the potential benefits offered by SSO. Need for diversification of SSO initiatives on a global scale Asia has been a favorite offshoring location for many years. The most popular locations like India and China attract MNCs with their abundance of (skilled) labor at low costs. FSIs have now started to apply a rule which they often tell their customers “diversify to spread the risk”, i.e. spreading SSO initiatives in different countries and regions. The Tsunami in 2004, flooding in Mumbai in 2005 and the political turmoil in Thailand in 2006 are examples that show the need for SSO location diversification. Monitoring of outsourced and offshored processes Another key issue for FSIs is the monitoring of processes, once they are outsourced to a third party or offshored to a location thousands of miles away. Lack of monitoring can easily result not only in higher costs than planned but damages to a firm’s reputation and fines from industry regulators. Reasons that influence monitoring issues start from time zone, language and cultural issues to poorly defined contracts and Service Level Agreements (SLAs). The major rule to ensure proper monitoring and a successful SSO is “responsibility and accountability”. Although a process is situated in another country or outsourced to a third party provider, the financial institution has to remain in control by treating the respective process as if it was still a part of the firm. Negligence created by relying on the reputation of a provider or the belief that the process is non-critical and thus less relevant might soon catch up negatively impact the company’s competitive stand. One example that show the need for monitoring was Lehman Brother’s decision to shift parts of its computer help desk from India back to the US citing of lack of specialized training and the difficulty the sustain knowledge transfer. Outsourcing providers such as 1 For further details see: http://ec.europa.eu/justice_home/fsj/privacy/thridcountries/index_en.htm 2007 ®FROST & SULLIVAN 55
    • GROWTH CONSULTING Infosys or TCS have opened subsidiaries in Canada that can be more easily monitored by US-based companies. Choosing a competent partner, that offers strategic and operational fit while using SLAs and continuous monitoring is key to realizing the targeted beneficial effects of SSO plans. To reduce security risks and privacy leaks Northwestern Mutual (NM) applies several approaches. IT workers at the insurance company’s provider, India-based Infosys are only provided terminals that do not allow users to alter, record or print data. Terminals are linked to NM’s servers in the US via secure, high-speed phone lines. Northwestern Mutual feels that this way, access to customer data can be granted to a provider in an offshore location. The move was essential since originally NM only sent IT applications to India which did not involve sensitive information. If all states in the US follow lawmakers in California which decided to impose restrictions on offshoring personal data, such 2 initiatives might soon not be possible any longer. Rising complexity of SSO and increasing need for risk management In 2006, police in India arrested an employee at a data processing center for allegedly siphoning US$420,000 from the accounts of 20 HSBC customers. Although offshoring and outsourcing services can have a significant impact on a company’s cost efficiency, incidents like the one at HSBC holds banks and regulators back from fully exploring those benefits. Especially the financial services industry handles extremely sensitive customer data, a loss of which could seriously damage a firm’s reputation and overall business if it is abused. Ever tighter compliance and data protection laws force FSIs to be extremely careful and transparent when it comes to things like offshoring credit card processing. As a result, the responsibility of offshored processes remains with the financial services institution – and not with the provider. If problems or cases of e.g. data theft occur, the FSI is accountable. Whenever offshoring comes into the picture, risk management and compliance with regulations are the top priority in this industry. 2 Under the Gramm-Leach-Bliley Act of 1999, financial services companies are not prevented from transferring customer data to offshore third parties for processing. Customers need to be informed by FSIs about these practices but cannot opt out of such activities. 2007 ®FROST & SULLIVAN 56
    • GROWTH CONSULTING 3.1.1.3 SSO Drivers Cost benefits are they most common key drivers mentioned by respondents when asked what made them turn toward SSO. Digging deeper into the rationale behind this revealed further factors that influenced companies’ decisions: Figure 3.1.1 Finance & Insurance: SSO Drivers 21% 67% 12% Improve employee productivity Improve asset 56% 44% utilization 14% 74% 12% Enhance competitiveness Focus on core 37% 39% 24% competencies 42% 11% 33% 14% Improve customer service Reduce operating 23% 77% costs 12% 57% 31% Access scarce talent Overcome HR 8% 68% 24% shortages * Percentages shown are % of total response Very Low Low Medium High Very High Cost Benefits All interviewed companies found that the realization of cost benefits is the key driver for engaging in SSO. While 23% considered the reduction of cost benefits important, 77% of companies selected it to be of “very high” importance and by far the most important factor. Benefits are derived from countries that offer skilled labor but at lower wages. For many processes, India is a preferred location since it offers an abundance of skilled workers with English language skills that are available at much lower salaries compared to Western countries. In 2004, ABN Amro started a restructuring effort that included the consolidation of its back-office to achieve an estimated cost saving of US$300 million. In general, industry analysts estimate that by moving IT work offshore FSIs can cut costs by up to 40%. 2007 ®FROST & SULLIVAN 57
    • GROWTH CONSULTING Focus on Core Competencies Focusing on core competencies frees resources to better serve customers and increase innovation to keep competition away which was confirmed during interviews as no company found this to be a low-priority factor. Over 60% categorized the focus on core competencies as either high or very high for the business. Wachovia sealed a US$1.1bn deal with Genpact in India to outsource parts of its finance and accounting processes. According to company sources the move was driven primarily to reduce cost and boost the core business. In recent years, FSIs have realized that the increase in global competition and the pressure to become more profitable and still deliver best of breed service to customers can only be achieved by doing what the firm does best. While the first challenge lies in the identification of a company’s core strengths, the second is to find somebody whose key strength lies in the processes that should be outsourced. Firms like JP Morgan develop shared service center that streamline processes, making it possible to focus more on core competencies without the involvement of an external party and maintain control and data internally. In 2004, Merrill Lynch signed a deal with IBM for Systems Integration Services for its Corporate Technology Group that manages the firm’s technology for Corporate Services, Finance, HR, Marketing & Communications, Research and Treasury areas. Access to Qualified Personnel Often it is not just pure cost-savings that make SSO an essential component of an FSI’s strategy. The continuous increase in demand for IT professionals can only be satisfied by tapping into the pool of graduates churning out of universities in Asia and Eastern Europe. China is on its way to overtake India not just in numbers of IT graduates, but also works closely with the financial services industry to educate students in areas specifically catering to the needs of financial services companies. Although quantity of a country’s labor pool is a very critical rationale to overcome HR shortages as stated by over 90% of interviewees which found it to be a high or very high driver, companies also consider the level of education and skill sets as this determines the types of processes they can offshore and the overall value-for-money of such employees. As a consequence, companies in the BFSI sector have started to work with universities in countries like China to ensure that skill sets are taught which cater to the firm’s specific needs. 2007 ®FROST & SULLIVAN 58
    • GROWTH CONSULTING Enhance Competitiveness What could be considered as an “umbrella term” for other drivers such as cost reduction and process improvement is the constant aim to enhance competitiveness. Bank of America set up its back-office processing center in India to help the firm stay on top of the competition. By turning towards SSO for outsourcing processes or to set up a captive operation in a country like China or India FSIs improve the company’s performance that help it to focus on processes and services which promise an increase in profitability, streamlined processes and better customer care. As a result of globalization it is easier than ever for companies to set-up operations in foreign markets and take away domestic business from already established players. The ability to offshore functions like call centers to a low-wage country frees cash-flows to be used in product development or setting up operations in a promising new market. Shareholders put ever increasing pressure on financial service companies to show better results each year while keeping the competition at a safe distance. Outsourcing or offshoring to low-cost destinations are key elements to help fulfill these goals. As one of the major outsourcing providers estimates, the demand for SSO in the financial service industry will continue to grow around 25% per year in the coming years. 3.1.1.4 SSO Concerns While SSO may at first seem to be the solution to many of a company’s goal (i.e. reduce costs and improve the market position) there are several key concerns that should be considered to prevent issues and complications that could otherwise have been avoided. During our research, we have identified several factors that companies from the BFSI sector need to consider before embarking on the SSO journey since they could significantly influence the success of the operation. 2007 ®FROST & SULLIVAN 59
    • GROWTH CONSULTING Figure 3.1.2 Finance & Insurance: SSO Concerns Compromise 31% 69% confidentiality Loss of control 21% 56% 23% Increased costs 18% 46% 36% Reduced service level of 3rd party 6% 51% 43% Lack of knowledge 22% 78% about outsourcing Lack of competent mgmt. staff 19% 38% 43% Over-reliance on external party 21% 56% 23% Stability of 3rd party 5% 15% 68% 12% Org. de-skilling 4% 7% 44% 44% * Percentages shown are % of total response Very Low Low Medium High Very High Loss of Confidentiality/Control The major concern companies in the BFSI sector see when turning towards SSO and outsourcing in specific, is the risk of losing control and sensitive information. About 70% identified this to be the factor with a very high concern to their SSO plans. Several factors can cause a bank or an insurer to lose control over an outsourced or offshored process. Interviewees cited that especially when they first turned towards SSO, inexperience in planning and negotiations with service providers were main problems. Nowadays, firms seek to have close ties with service providers and use cross-functional teams to best manage and implement SSO plans and the realization of goals. As an interviewee from a major US bank put it, “senior management commitment is essential”. About ¾ of interviewed executives put a high or very high importance to both monitoring third parties and ensuring their compliance with contracts and Service Level Agreements (SLAs). It is for these reasons that SSO initiatives needs to be driven top-down together with all the necessary support. Furthermore, properly defined SLAs and constant monitoring of the process needs to be in place to ensure that loss of control never becomes an issue. Losing confidential data like customer account numbers or credit card details is a prime 2007 ®FROST & SULLIVAN 60
    • GROWTH CONSULTING concern when engaging in SSO. In August 2005, former employees of Mphasis in India (now owned by EDS), misused access to customer data from Citibank that resulted in damages of US$350,000. Although such incidents are rare there are indications that confidential information is easier available than thought. In 2006, a report by Channel 4 in the UK revealed that credit card and bank details from British customers are available in India for around US$10 each. Allegedly technical support staff that visit call centers downloaded not just bank and credit card details but also security codes and passport details. These examples show that it is even more critical to ensure that offshoring and outsourcing to third parties, which still poses a risk to the handling of confidential information, needs to be addressed by all parties involved. Otherwise serious compliance issues and damages to a firm’s reputation could easily outweigh the advantages of SSO. The risk of De-skilling A director in charge of services at a major European bank warned that not all that can be outsourced should be outsourced. Before processes are outsourced, a company needs to understand how all processes are interlinked and “identify critical core and sub-core components”. In some cases it seems easy at first to pinpoint whatever can be handled by a third party but upon a closer look, “you realize that certain components are essential to support core processes and outsourcing them would result in weakening the overall business in the long term”. Almost 90% of interviewees shared this opinion and rated de- skilling as either a high or very high concern in the study. When a financial institution announces an SSO initiative there is also the risk that through lack of communication and involvement of all stakeholders involved (i.e. employees) a company risks losing valuable employees because they “do not see a fit in the new structure” as a UK-based head of outsourcing put it. Another key concern highlighted by several companies was regulations and government restrictions. Regulations and Government Restrictions Offshoring initiatives are under close scrutiny by governments and regulators in the EU and the US. Fraud cases like the one in India which affected HSBC customers, triggered politicians and regulators to put tight restrictions in place. Certain states in America prohibit offshoring jobs if it can be done domestically. In the EU companies that outsource 2007 ®FROST & SULLIVAN 61
    • GROWTH CONSULTING or offshoring to other European states get tax incentives and the processing of sensitive customer information outside the union is prohibited. 3.1.2 SSO Trends 3.1.2.1 Spend on SSO Based on global demand, it is estimated that the BFSI sector constitutes for around 25% of demand which makes it one of the two biggest industries together with the technology sector which accounts for around 29% respectively. We believe that in the coming years, demand from the BFSI vertical will continue to grow at a CAGR of approximately 10% between 2006 and 2009, thus increasing SSO spending from US$ 273m to US$ 361m. This represents a healthy growth rate but is lower than the 15% overall growth which the industries combined will experience. Figure 3.1.3 Finance & Insurance: Spend on SSO SSO spend as SSO Spending % of Revenue (US$ ‘000 Million) 43% 43% 14% Strategic/R&D 10.00% 400 IT Services & 6% 16% 78% Support 350 361 31% 69% Back-Office 8.00% Processing 326 300 300 57% 43% Sales & Sales 273 250 Generation 6.00% 3% 13% 47% 38% Corporate Learning 200 4.00% 29% 48% 24% Customer Service 150 & Call Center 4.75% 4.87% 4.95% 5.13% 100 22% 78% Procurement 2.00% 50 Human Resources 29% 48% 24% 0.00% 0 27% 60% 13% Finance & 2006 2007 2008 2009 Accounting * Percentages shown are % of total response Very Low Low Medium High Very High The SSO spend of the BFSI industry will increase slightly during the same period from 4.75% in 2006 to about 5.13% in 2009. A key factor that can influence the spending is changes in the regulatory environment which could further restrict processes that can be offshored. Since the United States will be electing a new president in 2008, outsourcing of US jobs to other countries could become a political interest, especially if the economy should experience a major slow-down. As for the SSO process focus, non-critical processes, especially IT services & support and back-office processing will continue to be the primary focus for SSO projects aiming to streamline processes and reduce costs. Since these processes have been a focus 2007 ®FROST & SULLIVAN 62
    • GROWTH CONSULTING area for quite some time and considering that the BFSI sector has been getting more and more comfortable with SSO, we see that new areas will attract more attention in the future, keeping compliance and regulations in mind. Finance & accounting, corporate learning and procurement are three such processes, where BFSIs will increasingly explore opportunities to achieve cost efficiency and streamlining overall business. 3.1.2.2 Degree of SSO by type For the financial services sector, IT-related services still remain the first candidates that come into people’s mind when it comes to outsourcing. Finance & Accounting, HR and Procurement are also on the list for SSO. While in general processes that are non-core, do not fall under strict compliance or regulatory laws and can be better handled by a third party are selected, it is often not an easy process to determine which processes fall into that category. As mentioned previously, a thorough analysis of the overall processes needs to be done to identify areas that are non-core and should not remain in-house to prevent de-skilling or may affect the competitive position. On top of that, FSIs should not try to outsource or offshore processes that have flaws and show signs of inefficiencies or other issues. Outsourcing a process only to hope that a third party can fix it and do it better will only turn out to be wishful thinking. Generally the SSO initiative should have the support and commitment of the top level management and fit into the overall strategy of the firm. Furthermore, rather than following a trend the FSI needs to clearly determine which processes can be considered for SSO and if they should be outsourced or if a captive, offshored solution is ideal. The following description and examples of selected types of SSO should be used as an indicator. Back-Office Processing Back-office processing make up the largest portion of the BFSI SSO market e.g. Credit card and other transaction processing. Bank of America has a shared services center in India for back-office processing. The key reason for choosing India stated by Bank of America was that the country “is a leader in information technology and processing and has a large English-speaking workforce and good infrastructure. HSBC set up its Electronic Data Processing unit in Hyderabad, India which controls back-office processing 2007 ®FROST & SULLIVAN 63
    • GROWTH CONSULTING in Bangalore, Visakhapatnam. The three processing centers have a staff of more than 4,500 employees. Citigroup chose China as a location for its back-office operations. Finance & Accounting Services that are suitable in this category are: • General Accounting (Bookkeeping, A/P, A/R) • Bank Statement Consolidation • Payroll and Tax returns • Financial Analysis and Reporting (Balance Sheet Analysis) • Non-Profit Accounting • Check Processing In India, Mumbai and Delhi are considered prime F&A offshore centers. Morgan Stanley, Lehman Brothers, Citibank and JP Morgan set up there centers in Mumbai, while Fidelity selected Delhi for its operations. Colombo in Sri Lanka is emerging as a hotspot for F&A since it offers the highest number of UK certified accounts and setting up a center here is relatively cheaper than in India. HSBC is one example that chose this location. For institutions in Europe, Krakow in Poland is a prime destination for F&A offshoring. The city has some 30,000 graduates each year – 21,000 of them in economics. Other locations in Central and Eastern Europe (CEE) are Bratislava in Prague and Budapest in Bucharest. Even the United Kingdom manages to attract firms like The Bank of New York and The Royal Bank of Scotland which set up F&A centers in Manchester, due to its good transport and business infrastructure, a wide pool of talent and compliance with regulatory and customer expectation – despite higher costs than the aforementioned locations in CEE. IT Services & Support IT Services & Support such as help desk assistance, remote personal computer repair 2007 ®FROST & SULLIVAN 64
    • GROWTH CONSULTING assistance or disaster recovery operations are potential functions that a financial services company considers for SSO. As part of a US$1.8bn outsourcing initiative, Dutch bank ABN Amro, in 2005, signed a deal with Indian IT services companies Infosys and TCS for application support and enhancement. The bank already had a US$1.5bn desktop outsourcing deal with EDS for its wholesale operations. Human Resources Increasingly, FSIs are adding HR operations to their outsourcing/offshoring list. Standard Chartered for example set up an HR Shared Services Center in Chennai, India with the aim to deliver a consistently high service for its global operations. Services like payroll operations and benefits administration fall under these initiatives. Customer Service and Call Centers By setting up call centers in offshore locations financial institutions not only aim at reducing costs but also to leverage on language and cultural similarities. US companies like American Express prefer the Philippines for the language skills (US English) on top of the cost benefits it is able to generate by setting up a call center here. These moves however do not always work as planned. In 2006 Lloyds TSB Group dropped its Indian call center since its new automated answering service had cut the number of customers wanting to talk to live people by almost 30% which was much higher than the estimated 8%. As a consequence the company’s spillover call center in Mumbai was not needed any longer. Lloyds TSB Union on the other hand claimed that it was in fact a petition signed by 400,000 of the British banking and insurance giant which opposed the handling of their financial services abroad that led to this decision. Whatever the reason was, this example shows the importance of proper planning and handling of offshoring processes in general and those that handle sensitive customer information in specific. 3.1.2.3 SSO Party of Choice In financial services, companies tend to either rely on their own facilities for offshoring services, select a third party or a combination of both, i.e. the formation of a joint venture. 2007 ®FROST & SULLIVAN 65
    • GROWTH CONSULTING Figure 3.1.4 Finance & Insurance: SSO Party of Choice Strategic / R&D 87% 7% 6% IT Services & Support 8% 23% 69% Third Party Back-Office Processing 8% 57% 35% 29 % 37% Sales & Sales Generation 77% 16% 7% Corporate Learning Programs 25% 55% 21% 34 % Customer Service 30% 8% 62% and Call Centers Joint Venture Procurement 35% 54% 11% Wholly Owned Human Resources 17% 46% 37% * Percentages shown are % of total response Finance & Accounting 47% 44% 10% Wholly Owned Joint-Venture Third Party While all three types of setting up SSO operations are used, those that are pursued by a BFSI firm on its own or together with a third party are preferred by almost ¾ of interviewees over outsourcing the process completely to an external provider. The main rationale for remaining in full control or maintaining a significant involvement through a partnership solution is to be able to ensure full compliance as well as minimizing the risk of potentially compromising or even losing sensitive customer data. This is reflected in the study with 93% of companies stating that they prefer to conduct R&D-related processes under full or significant control rather than leaving it completely to a service provider. Similar results were shown for Sales & Sales Generation, although with 16% almost twice as many firms referred to JVs in this case. Own Facility By choosing this option, financial services companies remain in full control over the operation and can monitor and modify its performance and set-up directly. This choice gives a company excellent insight and experience into SSO which can later be used when the firm wants to shift to an outsourcing or third party operation. In some instances like JP Morgan and IBM in 2004, the FSI can even realize that service like IT are an essential part of the core business and as a consequence should be handled in-house. In JP Morgan’s case this resulted in the cancellation of the US$5bn IT outsourcing contract with IBM. 2007 ®FROST & SULLIVAN 66
    • GROWTH CONSULTING Hybrid Relationships Joint ventures and other types of partnerships have the advantage that an FSI can split responsibilities. Deutsche Bank and Accenture formed a joint-venture where Accenture to manages their Accounting, IT and HR functions. Important in this type of arrangement is the proper management of the relationship to avoid tensions and confusion with responsibilities. Third Party Provider Leaving a process in the hands of a third party which is thousands of miles away is a challenge for FSIs. Key issues with this form of SSO is managing and monitoring the performance of the third party which is also operating in another country or even continent – which can include cultural and time-zone challenges. As a consequence, only non- critical processes such as IT support mainly fall into this category. Exceptions involving sensitive customer data are credit card processing which is outsourced by some banks to providers such as First Data or even other large financial institutions which provide processing for smaller to mid-sized institutions. 3.1.3 SSO Locations 3.1.3.1 Selection Criteria In the BFSI sector, three parties are involved in the decision making process, i.e. the CEO, COO and the functional heads. Interestingly only the COO position is participating in both recommendation and decision making process. Although it was not analyzed how significant each of the recommenders party is with respect to suggesting suitable locations, it can be assumed that external consultants, especially those that are involved in consulting and implementing SSO projects, tend to play a major role in identifying suitable locations. 2007 ®FROST & SULLIVAN 67
    • GROWTH CONSULTING Figure 3.1.5 Finance & Insurance: SSO Recommenders & Decision Makers Recommenders Decision Makers CEO 100% 38% COO 63% Functional Heads Interdepartmental 100% (IT/HR/CFO) Team 100% Interdepartmental Team 100% SSO Location Managers 100% Regional/ Geographical Mgrs 100% External Consultants Others Others * Percentages shown are % of total response Figure 3.1.6 Finance & Insurance: SSO Location Selection Criteria IP regulation 28% 58% 14% Cultural 51% 49% adaptability Infrastructure 14% 86% quality Political stability 1% 85% 15% Attrition rates 3% 72% 25% Education & 61% 39% language Labor force 1% 86% 14% experience Labor force 9% 71% 20% availability Tax & regulatory 1% 54% 45% costs Infrastructure 10% 54% 36% costs Compensation 1% 35% 64% Costs * Percentages shown are % of total response Very Low Low Medium High Very High 2007 ®FROST & SULLIVAN 68
    • GROWTH CONSULTING For the location selection process all factors listed in Figure 3.1.6 play an important role in finding a suitable country. Cultural adaptability however is seen as somewhat important but not as critical as education and language for example. In the medium to long-term the scale might tip toward more firms ranking this factor as increasingly highly important since being able to cater to different cultures in an appropriate way might be the next wave of achieving competitive advantage through cultural differentiation as seen with Islamic banking. While all criteria have been acknowledged to play a crucial role, the following ones were mentioned specifically during the research process. Low wage structures & Education Attractive, i.e. low wages for skilled employees, are still the key reason to go offshore. Compared to a UK graduate a financial service company can get five or more employees in countries like India and China. High demand has caused attrition rates and remuneration to increase sharply in India, especially for jobs that require better skilled programmers and middle management. Firms like ABN Amro face situations where they invest several months into training individuals only to see them shift to competitors after one year for higher salary. It is this wage inflation that made companies starting to wonder if they should consider countries like China which are at the earlier stages of the SSO demand. The problem with alternatives in the region is that in the case of China for example, graduates and professionals are not necessarily equipped with the understanding necessary for the industry and thus would need intensive training – apart from potentially higher problems in communicating in English. Infrastructure The availability of suitable infrastructure is a key component for any SSO efforts. While one component is a government initiative to set up e.g. Special Economic Zones or corridors that boast excellent communications infrastructure, things such as uninterrupted power supply and connections to transportation infrastructure play an important role as well. In the case of China, the Olympic Games 2008 are a key driver that results in overall improvements of ICT and other infrastructure. 2007 ®FROST & SULLIVAN 69
    • GROWTH CONSULTING Attractive government policies In order to attract foreign companies to set up SSO operations, countries need to create an atmosphere that provides the right elements to MNCs. Locations like Singapore and Dubai promote themselves as (upcoming) financial hubs and make it easy for firms to settle down due to tax incentives and employment laws that make it easy to attract foreign talent. Countries like Malaysia set up Multimedia Super Corridors that offers tax breaks, facilities and excellent infrastructure to foreign companies. China as well has Special Economic Zones that promote high international quality standards such the Hainan Province, Shenzhen or Shantou. Events such the political coup in Thailand in 2006 or the bird flu outbreaks in the region have the potential to cast a minor shadow on such efforts. 3.1.3.2 Top of the Mind Locations As in the previous study the top two locations remain China and India with Singapore coming in at number three. While the first two locations are primarily selected due to the size and low cost labor pool, Singapore manages to position itself as the primary location in Asia for firms that look for first class business environment and highly skilled labor to cater to any level of SSO operations. 2007 ®FROST & SULLIVAN 70
    • GROWTH CONSULTING Figure 3.1.7 Finance & Insurance: Top SSO Locations Top SSO Locations % of Respondents who Rank ranked among top 3 1 India 15% 10% 2 China 12% 6% 3% 3 Singapore 3% 2% 7% Emerging Eastern Europe, Dubai, Locations Malaysia, Philippines Stable/Declining Locations USA, UK * Percentages shown are % of total response Ranked #1 Ranked #2 Ranked #3 Despite the high attrition rates and wage inflation, respondents believe that India will remain top choice for FSIs in the medium term. For China companies predict that the country has the potential to eventually overtake India and claim the number one position. Apart from also having a huge and highly educated workforce, China attracts companies with lower wages, and improving English language capabilities. BFSI companies work together with local universities to develop curriculums that especially cater to their needs and churn out graduates that are perfectly trained for the companies’ needs. With the 2008 Olympics coming up, the event may give the country a big boost that will further stimulate its attractiveness as offshoring location. 2007 ®FROST & SULLIVAN 71
    • GROWTH CONSULTING Figure 3.1.8 Finance & Insurance: Ranking of Top SSO Locations Ranking of Top Locations Overall Score across Key Parameters Score India 4.3 4.2 3.5 4.0 China 3.9 4.1 4 3.5 Singapore 3.6 3.9 3.4 3.9 Cost Efficiency Bus. Envt. Quality of Conduciveness Human Capital In regions outside of Asia, looking at the restrictive environment in the EU, BFSIs in this region look towards Eastern Europe for their language abilities and similar cultural basis. Although those locations do not have wages as low as Asian countries, but they offer a highly skilled workforce that is available next door for a good price. For North America, destinations like Canada or South America are attractive for the same reasons. Although countries in Asia may offer lower wages, firms find it easier to handle SSO operations if the offshoring location is nearby, i.e. can be reached within one or two hours by plane and offers language as well as cultural similarities. Other emerging locations include Dubai, Malaysia and Philippines. Malaysia has been attracting companies from the BFSI sector with its favorable environment consisting of good infrastructure and low cost, the Philippines is especially preferred for customer service and call center functions. 2007 ®FROST & SULLIVAN 72
    • GROWTH CONSULTING 3.2 FMCG & Retail With a predicted rise of global middle class by the World Bank, and most Fortune 500 and Forbes 2000 retail & FMCG companies recording double digit growth in terms of net income and sales in 2006, the sector looks set for a rosy and healthy future. The FMCG (Fast Moving Consumer Goods) industry, also known by its other name, Consumer Packaged Goods (CPG), generates products that have a quick turnover, and relatively low cost targeting mostly the consumer market. Some household names in this sector include Kellogg’s, Nestle, Unilever, Procter & Gamble, Kimberly Clark, Coca-cola, etc. The retail vertical caters to the sale of goods or merchandise, from a fixed location such as a department store or kiosk, in small or individual lots for direct consumption by the purchaser. Examples of major retailers include Seven & I Holdings and AEON group in Japan, USA based retail giants like Walmart, Target, Krogers, Walgreen, Swiss grocery chain retailer Migros, US based Tesco, and Marks & Spencer. USA based retail & FMCG companies account for a large majority of both the Fortune 500 and Forbes 2000 lists covering a total of 54.1% and 47.95% respectively in terms of number of companies in the lists. European based companies come in second place at 34.43% in the Fortune 500 and 28.77% for the Forbes 2000 list. In other words, any hiccups or movements in the USA and European based FMCG & Retail companies would have a major impact on the overall market worldwide. Combining both lists, the total revenue generated in 2006 for all these companies tallies up to more than US$ 2.7 trillion. In mature markets, retail sector companies are constrained in their ability to grow and maintain profit margins as a result of a pressure on prices, market saturation, and slowing population growth. Threat to house prices in the US also poses risk for consumption growth. As a consequence, the strategic focus of the sector is moving towards the emerging economies and expanding consumer markets of Asia and Central & Eastern Europe - China and India in particular - which offer new opportunities for growth through global sourcing, off-shoring and the development of modern retailing. 2007 ®FROST & SULLIVAN 73
    • GROWTH CONSULTING 3.2.1 SSO Determinants 3.2.1.1 General Perception Going forward, the FMCG & Retail vertical will see SSO as a path to get access to better talents and conduct efficient operations while reducing operating expenditure, though data security, organizational de-skilling and a lack of qualified management staff will continue to plague this industry. Finance & Accounting, IT Services & Support, HR, Procurement and Customer Service & Call Centers remain the most popular functions for SSO and wholly owned shared services units are the most favored form of SSO type. In terms of location selection criteria, labor force experience and availability are two pivotal factors in attracting SSO investments though business environment, HR and cost efficiency issues play a role for FMCG & Retail firms when deciding on where to hub their SSO activities. The vertical also looks into other unique factors such as scale and geographical proximity to key markets or headquarters when deciding on SSO locations. Finally, top of mind locations for the SSO for the FMCG & Retail vertical are the UK, India, Poland, Czech Republic and the USA. 3.2.1.2 Issues/Considerations FMCG & Retail companies are typically faced with the following issues and considerations before starting or running existing SSO operations. Vendor selection & management For FMCG & Retail companies wanting to outsource their business processes, the key question to be answered is which vendor should they select? Should they entrust a single vendor to provide for all their outsourcing needs or should they be faced with management complexity issues and challenges by outsourcing to multiple providers for different functions? These are extremely critical questions to ask as selecting the wrong vendor would lead to disappointment and possibly even cancellation of a contract that will ultimately translate to loss of money, time and resources. An example of a cancelled deal 2007 ®FROST & SULLIVAN 74
    • GROWTH CONSULTING is the one between J. Sainsbury and Accenture. Management of these SSO hubs will also be a sticky issue for FMCG & Retail companies as they will need to hire highly qualified SSO managers with substantial skills in liaising with the external providers or people with the management skills in dealing with internal shared services centers’ matters. The service level agreement (SLA) commitment needs to be clearly spelt out and understood by both parties to avoid future misunderstandings or disappointments. Continuous and open feedback and communications are pivotal to keeping good working relationships between the buyers (FMCG & Retail companies) and providers (3rd party providers). Identifying functions to outsource/ offshore or onshore It is no longer a question of whether FMCG & Retail companies should outsource or not. Neither is it a question of whether they go onshore or offshore. Most, if not all the major North American and European Fortune 500 and Forbes 2000 FMCG & Retail companies have SSO operations in one way or the other. Hence, the more critical question to be answered would be: Which functions need to be outsourced, offshore or onshore? Many FMCG & Retail companies have cited tactical reasons when determining the right function to outsource or for shared services. For instance, FMCG & Retail companies would not outsource Strategic/ R&D for the reason that it is too core and critical to their overall marketing and product competitiveness in the market. Functions such as IT Services and Support of Back Office Processing, which are seen to be not the core competencies of these companies, are often the most outsourced activities. Asia-based Fortune 500 and Forbes 2000 companies are the exception as most of them are still exploring the idea of SSO and are not ready to dabble in either outsourcing or offshoring. Japanese companies are especially cautious about working with non- Japanese companies due to a cultural factor known as keiretsu (set of companies with interlocking business relationships and shareholdings) thus impeding the possibilities of offshoring or outsourcing for Japan based companies for their business processes. Interestingly enough, Japanese companies seem rather open about outsourcing jobs to one nation - China, where an abundance of Japanese speaking graduates is available, especially in the city of Dalian. This may be a strategic decision of convenience since China is the manufacturing ground for many Japanese products. It should be noted that this trend is still not as prevalent in the FMCG & Retail sector yet as compared to the 2007 ®FROST & SULLIVAN 75
    • GROWTH CONSULTING Technology sector. 3.2.1.3 SSO Drivers The FMCG & Retail sectors have expressed improving competitiveness along with cost reduction and better access to talent as the major drivers for their enterprises’ SSO decisions. Figure 3.2.1 FMCG & Retail: SSO Drivers 4% 20% 56% 20% Improve employee productivity 4% 48% 48% Improve asset utilization 4% 52% 44% Enhance competitiveness 12% 16% 20% 28% 24% Focus on core competencies 4% 72% 24% Improve customer service 4% 44% 52% Reduce operating costs 4% 28% 64% 4% Access scarce talent 4% 48% 32% 16% Overcome HR shortages * Percentages shown are % of total response Very Low Low Medium High Very High According to most FMCG & Retail respondents of the survey, the top 3 most important drivers for their sector would be to improve employee productivity, enhance competitiveness as well as to reduce operating costs. Better access to talents with specialized skill sets is also another factor behind SSO adoption. Improve employee productivity The FMCG & Retail sector, like many other industries have a multitude of functions to handle on a day to day basis. The core ones being procurement, research & development of new products, marketing, sales, etc and functions which are not the core competencies of these organizations such as finance & accounting, IT services & support, corporate learning programs, etc. To ensure that their staff are not drown in handling a diverse 2007 ®FROST & SULLIVAN 76
    • GROWTH CONSULTING array of tasks that may ultimately lower productivity as it takes time away from their main tasks, FMCG & Retail companies decided that it is best to consolidate the tasks for shared services centers to handle or just outsource them to a third party expert. Before shared services came along, McDonald’s used to have their restaurant workers take time away from serving customers at the store front to attend to drive through customer orders. This lowers the overall productivity of some staff because the traffic at drive through lanes is not always high and it would not be feasible for a staff to run in and out of the drive through lanes to check. In July 2006, all major drive through counters of McDonald’s in the USA have call center staff who sits in Gillette, Wyoming to answer customer orders and sends the order to the right McDonald’s kitchen. According to McDonald’s spokesperson, average time to respond to a customer waiting to order is less than 5 seconds as compared to 30 seconds previously. Enhance competitiveness: Improving efficiency through centralizing Four thousand different financial controls across worldwide operations that do not appear to communicate with one another is one gigantic financial accounting mess. This problem may seem pretty unlikely but was once a major financial issue that plagued FMCG giant, Kimberly Clark, before it established its Finance & Accounting shared services center in Brighton, England. In 2005, Kimberly Clark finally decided to perform a clean up of their financial system to improve their overall efficiency which they hope would help life their overall efficiency. Before 2000, Tate & Lyle deployed various accounting systems throughout its offices in Europe. Today, it has a shared services center for finance & accounting in Finland which handles up to 100,000 invoice credit notes annually for cost centers across France, UK, Belgium, Netherlands, Luxemburg, Germany, Spain and Italy. Tate & Lyle group is much more competitive and efficient today with a recorded jump in operating profit by 26.1% in its half yearly results in 2006. As Cadbury Schweppes’ Business Services and Strategy director puts it, shared services helps in “…improving efficiency in support of increased profitability”. Reduce operating costs One of the most compelling reasons for FMCG & Retail companies to own SSO is the cost benefit associated with it. UK based Tesco, for instance, owns a procurement shared 2007 ®FROST & SULLIVAN 77
    • GROWTH CONSULTING services center in India that has helped the British consumer goods retailer realize cost savings of 30% of its procurement costs. In fact, it is looking forward to double its head count in this center. Another example, British American Tobacco’s Group Service Delivery (GSD) center in Malaysia, the global shared services organization for British American Tobacco (BAT), has so far saved the BAT group more than 30 million British Pounds (around US$ 59.7 million), an equivalent of 10 to 3% savings annually. Other key driver mentioned by the respondents is better access to talent. Better access to talent Most respondents have highlighted that improved access to scarce talent and overcoming human resource shortages are the key rationales for their SSO decision. It should be noted that one of the most popular functions for SSO in this industry is Finance & Accounting that is known to require very specific skill-sets such as transaction management, accounting, treasury & risk management and tax management, all of which are scarce amongst existing workforce worldwide. In addition, many enterprises owned or still own a multitude of financial controls across borders; consolidating them into a single system is often a key part of their SSO operations. The task of congregating a diverse array of systems into a single unified financial system, in addition to the need to retrain staff on the new system would only be possible with the best talents around. 2007 ®FROST & SULLIVAN 78
    • GROWTH CONSULTING 3.2.1.4 SSO Concern FMCG & Retail companies are faced with the following challenges and concerns when considering new SSO operations or running existing SSO centers. Figure 3.2.2 FMCG & Retail: SSO Concerns Compromise 4% 4% 36% 56% confidentiality Loss of control 8% 72% 20% Increased costs 28% 20% 52% Reduced service 36% 56% 8% level of 3rd party Lack of knowledge 16% 52% 24% 4% 4% about outsourcing Lack of competent 48% 36% 12%4% mgmt. staff Over-reliance on 32% 64% 4% external party Stability of 3rd party 12% 16% 56% 16% Org. de-skilling 12% 60% 28% * Percentages shown are % of total response Very Low Low Medium High Very High Some of the major concerns highlighted by this industry are the compromise of confidentiality, loss of control as well as organizational de-skilling. Another slightly less important concern would be the lack of competent management staff for SSO. Compromise confidentiality Industry players have expressed their concerns over any forms of compromise in data confidentiality and one particular incident was that of theft of customer information by a call center staff named Arif Azim in Delhi. Even though India convicted its first cyber criminal, Arif, in February of 2003, this does not help in mitigating the loss of confidence in the ability of outsourcers to secure data. Moreover, a generally higher attrition rate in the outsourcing industry further undermines the industry’s ability to sufficiently screen through the backgrounds of their staff thus implying a higher possibility of hiring wrong staff who may not abide to processes and regulations when handling client information. 2007 ®FROST & SULLIVAN 79
    • GROWTH CONSULTING Moreover, there is often a lack of enforcement of data protection laws in major outsourcing countries such as India and China, posing a major hindrance according to a major retail player in the USA. Loss of control New product development and innovation are the most crucial competitive advantages for an FMCG & Retail company and they would guard these with all their might to ensure that sensitive information does not fall into the hands of their competitors. Hence, for sensitive task like research and development, an FMCG & Retail will never want to lose control over it to an outsourcer. Even when it comes to shared services, they will only select specific locations which are closed to their HQ or even within their HQ for their R&D function given the impact the organizations will experience if any product/ marketing sensitive data leaks out. Procter and Gamble for instance does not outsource their R&D function and would only allow for programs like “Connect + Develop” to gain access to products/ patents developed outside of Procter and Gamble. Organization de-skilling Within the FMCG & Retail industries, a majority of SSO activities involve wholly owned shared services centers. Some of the major shared services deals include Johnson & Johnson’s Finance & Accounting shared services center in Czech Republic, Tesco’s Finance & Accounting and IT support centers in Czech Republic and India, Coca-cola’s HR shared services center in Tampa Bay, Florida, USA, Marks & Spencers’ HR and Finance & Accounting functions in Manchester, UK, Kimberly Clark’s Finance & accounting shared services center in Brighton, UK and the list goes on. This indicates that most organizations are concerned over the loss of particular skill sets as a result of outsourcing, preferring to operate fully owned shared services centers. As they are still exploring external parties’ fit, they would not want to be faced with the situation where they need to build up an entire team from scratch should any major problems force them to cancel their outsourcing or joint venture contract and bring the business process back in-house. Other key concern mentioned by survey respondents is the lack of competent staff to manage the area. 2007 ®FROST & SULLIVAN 80
    • GROWTH CONSULTING Lack of competent staff to manage the area SSO is a fairly new playground for most retailers and FMCG companies with most of the SSO contracts or centers being signed or established over the last five years. Hence, there may not be sufficient talent with the right skill sets for managing the SSO centers and teams and at the same time have an in-depth functional knowledge and background in the FMCG & Retail industries. 3.2.2 SSO Trends 3.2.2.1 Spend on SSO Most firms interviewed cited that they have spent in the range of less than 3% of their annual revenue on SSO and will continue in similar fashion for future SSO investments. Certainly, the cost of establishing an SSO operation differs by the location selected. For instance, Marks & Spencer spent close to US$ 450 million on its Brighton (UK) facility whereas BAT only had to foot an initial investment of around US$ 5 million in its Group Service Delivery (GSD) center in Malaysia. Supervalu has spent around US$ 50 million for a period of 5 years for its SSO operations in India. In the outsourcing space, the scenario is similar with Altria investing US$ 1.7 billion (less than 2 % of its US $ 101 billion annual revenue in 2006) with EDS for IT services, and Cadbury Schweppes investing US$ 25 million over a 5 years contract with CSC. 2007 ®FROST & SULLIVAN 81
    • GROWTH CONSULTING Figure 3.2.3 FMCG & Retail: Spend on SSO SSO spend as SSO Spending % of Revenue (US$ ‘000 Million) 4% 36% 44% 8% Strategic/R&D 5% 100 IT Services & 4% 4% 72% 16% Support 94 12% 60% 20% 4% Back-Office 4% Processing 79 48% 48% Sales & Sales 68 Generation 3% 8% 12% 52% 24% Corporate Learning 59 50 2% 8% 32% 44% 16% Customer Service & Call Center 2.15% 2.15% 2.16% 2.17% 12% 24% 52% 12% Procurement 1% 4% 4% 24% 68% Human Resources 0% 0 4% 28% 52% 16% Finance & 2006 2007 2008 2009 Accounting * Percentages shown are % of total response Very Low Low Medium High Very High The spending on SSO in 2006 was US$ 55 billion, which is 2.15% of the total industry revenue and is expected to grow to US$ 68 billion in 2007. The SSO spending is likely to grow to US$ 79 billion and US$ 94 billion in 2008 and 2009 respectively. The percentage of SSO spending as part of revenue is not expected to rise significantly according to most respondents as the spending for SSO for the next five years has been well provisioned for and is only expected to fall in the range of less than 3% of an organization’s total revenue. Spending on SSO is on the rise especially for functions such as Finance & Accounting and Procurement which we shall see as the two most common SSO functions for this industry. Spending for customer service & call center is expected to fall because this is one of the earliest industry to experiment with this function and most of the initial setup costs has been spent. Recurring costs for customer service & call centers are usually not on the high end. 3.2.2.2 Degree of SSO by type The trend amongst FMCG & Retail companies is to primarily establish shared services and outsourcing for Finance & Accounting functions, followed by IT Services & Support, HR, Procurement and Customer Services & Call Centers. Many interviewed respondents emphasized and insisted that they will not outsource R&D 2007 ®FROST & SULLIVAN 82
    • GROWTH CONSULTING functions as it was too critical for their organization’s strategic competitiveness and they would not risk any chance of leaking out any information that may be an issue. Brief description and examples for selected types of SSO are discussed next. Finance & Accounting Many enterprises within this industry had in the past acquired different Finance & Accounting systems for individual offices around the globe and this often led to chaos when these systems did not talk or operate with one another. With finance & accounting tasks comprising of transaction management, finance, general accounting, risk, tax and treasury management, it became impossible for FMCG & Retail companies to hang on to an array of different financial reporting systems. Moreover, Sarbanes-Oxley act has established stricter provisions which US based companies have to adhere to in its accounting architecture. Thus, it is no surprise that a majority of this industry’s firms push for greater standardization of its finance & accounting functions. Example of firms having finance & accounting SSO centers are Procter & Gamble’s Global Business Services Office for accounts payable transactions, Johnson & Johnson’s in Czech Republic, Nestle’s regional treasury center in Singapore, Unilever’s financial shared services center in Chile serving the South American market, Christian Dior’s finance center in Copenhagen, Denmark to serve the Baltic region, Kellogg’s European Financial Services center in Stretford, Manchester servicing 11 European markets dealing with financial reporting, cost accounting, fixed assets management and credit control, etc. Hubs interested in gaining more investments from this sector would need to make significant investments in its workforce by encouraging the labor force to take up financial or accounting based certifications such as CFA (Chartered Financial Analyst) and CPA (Certified Public Accountant). A pool of ready financial and accounting talent would be critical in attracting the set up of financial & accounting shared services centers by companies from this industry. 2007 ®FROST & SULLIVAN 83
    • GROWTH CONSULTING IT Services & Support Given that IT Services & Support is not the core competency for FMCG & Retail companies, there is a trend for a majority of these companies to outsource this function as oppose to setting up a shared services center of their own. Some of the major IT Services & Support outsourcing deals signed off are Cadbury Schweppes’ US$ 25 million with CSC for a period of 5 years, Office Depot with ACS, Kimberly Clark with Cognizant, Sara Lee with HP, Target with India’s Tata Consultancy Services, Procter & Gamble’s 10 years contract costing US$ 3 billion with HP and Krafts’ US$ 1.7 billion deal with EDS spanning a total of 7 years. Certainly, there are shared services set up for IT Services & Support as well and examples of such set-ups are Supervalu’s center where they have incurred an investment of US$ 50 million over a period of 5 years, Tesco’s Hindustan Service Center in India and Royal Ahold’s shared services center in the USA. Human Resources In the last five years, many FMCG & Retail companies have resorted to outsourcing, off- shoring or on-shoring of their HR Services. Unilever outsourced its HR function to Accenture under a seven year contract as part of the “One Unilever” program covering Europe, Americas, Asia and AMET (Africa, Middle East and Turkey) providing services to nearly 200,000 employees from centers in Bangalore (India), Manila (Philippines), Dalian (China), Bucharest (Romania), Prague (Czech Republic) and Curitiba (Brazil). Examples of services provided by Accenture include payroll administration, recruitment, reward administration, performance management, workforce reporting, core HR administration and third party provider management services. Gillette (under Procter & Gamble) and Johnson & Johnson have also set up shared services centers for their human resources needs. Altria has two HR shared services setups in Krakow, Poland and Buenos Aires, Argentina to serve Europe and Latin American markets whereas Coca-cola prefers to have an on-shore center in Tampa Bay, Florida, USA which was set up with an initial investment of US$ 2.4 million. Nike found the need to service their employees in Europe via the HR center in Hilversum, Netherlands whereas Kimberly Clark and Coles Myer found that they could outsource this function to 2007 ®FROST & SULLIVAN 84
    • GROWTH CONSULTING external parties like Accenture and EDS. The sophistication of this function for this vertical is still very limited as it involves mainly processing of information such as payroll administration instead of higher end functions such as performance and talent management and recruitment. In view of this, we may see a trend of movements of HR SSO centers to developing nations such as India, China, Malaysia, Philippines, etc from existing hubs. In the long run, cost will be the differentiator for a hub. As the Business Services and Strategy director of Cadbury Schweppes said, “… cost and capability will be the main reasons for us to outsource this function”. Other key areas for SSO mentioned by respondents include procurement, customer service and call centers, and strategic sourcing (R&D). Procurement Procurement is one of the most important business processes for an FMCG & Retail company whereby more cost effective purchasing would mean better margins for these firms. Tasks within this function include supplier sourcing and management (supplier’s pricing & performance), continuous savings implementation and transaction management. Given the importance attached to this function, it would not be surprising that procurement is a function for which FMCG & Retail firms would prefer to have a more centralized set-up. Walmart, through its Indian procurement arm, Walmart Global Sourcing India Private Limited, directly purchased more than US$ 400 million worth of goods from Indian suppliers. This phenomenon is even more astounding in China where Walmart procured more than US$ 7.5 billion worth of Chinese goods through its procurement center in Shenzhen, Guangzhou province (south of China), which is more than half of its global volume of direct imports. While some firms prefer to have a wholly owned procurement unit, some companies outsource this function to specialized procurement service providers. For instance, Kimberly Clark hired procurement specialist ICG Commerce in 2005 for its procurement needs, as part of a 5-years contract. As volume and costs are the two major factors for procurement, it should be no surprise that India and China are the two most preferred locations for this function. Unless a hub is able to provide the scale and diversity of products that China and India are able to offer at 2007 ®FROST & SULLIVAN 85
    • GROWTH CONSULTING similar or lower prices, this will remain the stronghold for the two giant nations. Customer Service and Call Centers The FMCG & Retail sector is probably one of the earliest sectors to experiment with customer service and call centers given the closeness of this industry to serving its clients. Unlike other industries where call centers and customer service centers are driven mainly by cost and cultural adaptive-ness, the FMCG & Retail industry places its focus on language capability and locality. As Marks & Spencer’s director of shared services, Dan Foley, puts it, it is a tactical decision for FMCG & Retail companies to want to keep their Customer Service & Call Centers onshore. A few examples of customer service & call centers are Supervalu and Avon, which are both located in the USA, Nike’s customer service center for Europe in Hilversum, Netherlands and Marks & Spencer’s Manchester (UK) customer service center in Manchester city, UK. Hubs wishing to build a reputation as the preferred customer service & call centers hub for this vertical would need to position itself as a hub serving the regional market that it is located in since it is the industry’s preference for geographical proximity for this function. For instance, Malaysia or the Philippines can be positioned as an FMCG & Retail company’s call center & customer service hub in South East Asia. Strategic Sourcing (R&D) The key competitive difference between FMCG & Retail companies is no less than the products that they market and this requires substantial strategic planning and lots of research & development efforts. Given the high strategic value of this function, this is one function that most FMCG & Retail companies prefer to not outsource or even offshore. However, FMCG & Retail companies are often comfortable with working with an external party in obtaining new products or patents in specific situations. Procter & Gamble for instance, has a Connect + Develop program aimed at discovering new product innovations which external parties have developed. They have been rather successful in 2007 ®FROST & SULLIVAN 86
    • GROWTH CONSULTING this program and some of the well known products acquired through this program are Bounce (dryer added softener invented by an independent inventor), SpinBrush, Olay Skin Care pump developed by a European packaging product company and Swiffer dusters developed by a Japanese company. 3.2.2.3 SSO Party of Choice Three major categories have emerged for SSO within the FMCG & Retail industry. Either the enterprises are using their own facility and resources, or entering into a joint venture with 3rd party providers or totally outsourcing to an external service provider. Figure 3.2.4 FMCG & Retail: SSO Party of Choice Strategic / R&D 57% 14% 29% IT Services & Support 13% 13% 73% Third Party 31 % Back-Office Processing 70% 15% 15% Sales & Sales Generation 87% 0% 13% 59 % Corporate Learning Programs 33% 10% 57% 10 % Customer Service 56% 12% 32% and Call Centers Joint Venture Procurement 80% 8% 12% Wholly Owned Human Resources 59% 6% 35% Finance & Accounting 75% 25% * Percentages shown are % of total response Wholly Owned Joint-Venture Third Party The most common SSO choice is wholly owned (i.e. the purest form of shared services) according to closed to sixty percent of the respondents. Third party outsourcing is the second most popular choice at closed to one third of the respondents and joint venture is the least mature at a mere 10%. As IT Services & Support is not the core competency for this industry’s organizations, most companies prefer to outsource it to third party vendors, thus explaining the high percentage of third party preference at 73%. For functions which have direct strategic importance to the FMCG & Retail organizations (e.g. strategic/ R&D, sales & sales generation and procurement), wholly owned is still the preferred choice. Own Facility 2007 ®FROST & SULLIVAN 87
    • GROWTH CONSULTING Most FMCG & Retail companies prefer this operation as it facilitates better control over issues such as retaining of knowledge, better data security protection, better recruitment of talent and better commitment & management. J. Sainsbury, a UK’s leading food retailer, made a decision in 2005 to cancel its IT outsourcing deal of US$ 4.18 billion with Accenture and this major blow to Accenture signals that FMCG & Retail companies have a want to bring back their functions in-house. Additionally, most FMCG & Retail companies prefer to offshore or onshore their operations as opposed to outsourcing to an external party. Examples are Procter & Gamble, Johnson & Johnson, Tesco, Coca-Cola, Inbev, British American Tobacco, Carlsberg, Kellogg, Levi Strauss etc. Joint venture This is the least common form of collaboration given that FMCG & Retail companies are still relatively new to SSO as can be seen by the fact that most SSO contracts or centers were only set up only in the last five years. They still prefer to have control over their operations or fully outsource as a way to test if they can go into future collaborations with their outsourcer. Third Party Provider FMCG & Retail firms have less preference for using Third Party provider and would only outsource less strategic functions such as IT Services & Support, HR and Finance & Accounting. Examples of third party arrangements include Target and Best Buy with Tata Consultancy, Procter & Gamble with HP, Altria with EDS, Unilever with IBM & Accenture, Sara Lee with HP, Office Depot with ACS, Cadbury Schweppes with CSC, Colgate Palmolive with IBM, etc. Outsourcing is a good test bed for FMCG & Retail companies to try out if their outsourcer is a fitting partner should they decide to convert their outsourcing contract to a joint venture operation, according to most respondents interviewed. Even though FMCG & Retail companies are in the midst of testing out their partners through outsourcing, they are mostly only willing to work with the better known outsourcers or service providers such as IBM, HP, Accenture, TCS, Infosys, CSC, ACS, EDS, etc. This would pose a challenge for local outsourcing companies who are interested in penetrating the FMCG & Retail sector. 2007 ®FROST & SULLIVAN 88
    • GROWTH CONSULTING 3.2.3 SSO Locations 3.2.3.1 Selection Criteria For FMCG & Retail companies, the most critical selection criteria is labor force experience & availability though many other factors play critical roles in attracting these companies to set up their SSO operations in a particular country. Figure 3.2.5 FMCG & Retail: SSO Recommenders & Decision Makers Recommenders Decision Makers CEO 36% 7% COO 43% 23% Functional Heads Interdepartmental 21% (IT/HR/CFO) Team 24% Interdepartmental Team 13% SSO Location Managers 14% Regional/ Geographical Mgrs 13% External Consultants Others 1% Others * Percentages shown are % of total response As can be seen from the chart above, CEOs, COOs as well as functional heads are the ultimate decision makers for SSO whereas interdepartmental teams and functional heads serve as key recommenders to an organization on where to set up their SSO operations, who to outsource it to, what functions should be a shared service, etc. Interestingly, external consultants play a part in influencing the SSO decision making thus implying the need to have joint thought leadership campaigns with consulting houses on SSO as means of influencing the SSO location suggestion. 2007 ®FROST & SULLIVAN 89
    • GROWTH CONSULTING Figure 3.2.6 FMCG & Retail: SSO Location Selection Criteria IP regulation 16% 28% 56% Cultural 76% 24% adaptability Infrastructure quality 4% 72% 24% Political stability 20% 60% 20% Attrition rates 40% 60% Education & 4% 20% 68% 8% language Labor force 12% 80% 8% experience Labor force 4% 72% 24% availability Tax & regulatory 8% 76% 16% costs Infrastructure 4% 68% 28% costs Compensation 52% 48% Costs * Percentages shown are % of total response Very Low Low Medium High Very High IP Regulation, Infrastructure Costs and Compensation Costs form the three most important location selection criteria in the minds of the respondents when selecting a country for their SSO location. Other factors play important roles as well and the elaboration of most of the key selection criteria is summarized as of below: Business Environment Conduciveness • Similar legal systems on data protection (under IP Regulation) Across functions, be it Finance & Accounting, Back Office Processing, Human Resources or IT Services, the volume of sensitive data involved are mountainous and different countries have different regulations pertaining to the transfer of data across national borders. The EU (European Union) for instance have laid down very strict and clear provisions over the transfer of data to third countries in “Transfer of Personal Data to Third Countries – Article 25” and the European Union Directive on Privacy Protection while the USA is less regulated about transferring data across country borders though for the financial institutions, they are regulated by the Gramm- Leach-Bliley Privacy & Safeguards Rules and the HIPAA regulation is enacted for the healthcare sector. Many FMCG & Retail companies are taking extra precaution when dealing with the 2007 ®FROST & SULLIVAN 90
    • GROWTH CONSULTING sending and receiving of data to ensure that they do not violate any data protection act in the countries which they operate from. Hence, some FMCG & Retail companies rather set up their SSO operations in the USA, UK or other European locations where the regulatory systems are well enforced and clearly written. A country worth mentioning is India which is initiating to draft bills which are similar to UK’s Data Protection Act and would negotiate for an agreement that resembles the US-EU efforts in providing for ease of transferring data between EU nations and the USA documented in the US Safe Harbor framework. Given India’s commitment to heighten privacy protections, FMCG & Retail companies may be more enticed to enter India or engage India-based companies for the future SSO needs. • Favorable government policies Many FMCG & Retail companies have highlighted favorable government policies to be one of the most compelling reasons as to why they want to start their SSO operations in a particular country. Two popular Eastern Europe SSO hubs amongst FMCG & Retail companies, Poland and Czech Republic, have relatively enticing perks for companies to set up their SSO operations there. Czech Republic provides up to 50% of eligible business expenses as subsidy, 35% of special training costs and 60% of general training costs for companies interested in setting up their SSO centers. Poland on the other hand has allocated over 90 billion Euros for development, infrastructure and human capital building for investors to leverage upon and up to 14 Special Economic Zones and Technology Parks with special incentives for investors who plan to et up SSO operations in those parks. • Infrastructure quality For SSO centers to run smoothly and continuously non-interrupted power supply is critical and many respondents interviewed have highlighted the power problem that plagues some developing nations, especially India. Even though India’s overall labor costs is low, poor infrastructure partially wipes out those benefits. Some companies resorted to purchasing extra generators as power supply backup thus increasing the 2007 ®FROST & SULLIVAN 91
    • GROWTH CONSULTING operational costs of their SSO centers. Apart from power supply, logistics and transportation infrastructure are critical for FMCG & Retail companies, especially for procurement centers. Logistics is one of India’s weakest links as compared to the excellent logistics and transportation that China has built. China was reported to have 45,400 km of expressway out of the total 1.92 million km of roads at the end of 2006, second only to the USA and around 78,000 km of railway network in 2007. Airport wise, China has over 500 airports with world class facilities such as the Shanghai Pudong International airport, Hong Kong Chek Lap Kok International Airport and the Beijing Capital International airport. India has around 63,000 km of railway track and only 4,885 km of expressway. It has around 340 civilian airports, out of which 20 are international airports. Hence, many FMCG & Retail companies have cited China to be a better site for procurement SSO purposes given China’s edge in providing better logistics and transportation infrastructure. Cost Efficiency • Infrastructure cost As mentioned in the section for infrastructure quality, some respondents highlighted the problems of power failure in developing nations such as India that led to the need for extra investments in power generators as well as redundant centers. Also, due to lack of deregulation of the Telco markets in many countries, monopoly of a single Telco provider is very much prevalent and that kept telecommunication price at an artificially high level. Most respondents have highlighted the high infrastructure cost tied in even when they invest in the so-called ‘cheap’ locations like India because of poor infrastructure and/or high telecommunication costs. Hence, many FMCG & Retail companies actually prefer to locate their SSO operations in more developed nations such as UK and the USA for the very reason that the efficiency and quality of infrastructure found in those countries can very well cover for the ‘perceived’ high costs of locating in those countries. • Labor cost - It is not just about being cheap 2007 ®FROST & SULLIVAN 92
    • GROWTH CONSULTING Similar to most industries, FMCG & Retail companies are concerned about keeping costs low; however, when it comes to SSO operations, it is not always the cheapest location that wins out. It is usually the most cost effective hub that is able to best serve the function that will emerge as winner of choice. In a rather surprising turnout, many ‘expensive’ locations such as UK, USA, Netherlands, Denmark, Finland, etc are preferred destinations for SSO within the FMCG & Retail industry. Denmark’s city, Copenhagen, is the world’s 8th most expensive city; Helsinki in Finland is the 25th most expensive city whereas Amsterdam st in Netherlands is the 41 most expensive city according to a cost of living comparison study. The high living cost indirectly correlates to higher wages and yet many FMCG & Retail companies rather onshore in UK and USA or offshore to dearer locations in Western Europe. However, these locations are more cost effective for several reasons and one major reason is driven by logistics. Many FMCG & Retail companies highlighted that even though there are many cheaper locations for them to choose from such as Russia, India or China, they feel more comfortable if they are able to fly their team in within a short span of time (less than 6 hours) if there are any issues in their SSO centers to resolve those problems. The earlier an SSO center issue gets resolved, the lower their loss incurred. Coca- Cola for instance, kept their shared services center onshore in Tampa, Florida, USA which is only a mere 1.5 hour’s flight to its headquarters in Atlanta, Georgia, USA. Moreover, many FMCG & Retail enterprises state that the overall infrastructure of the more developed nations are much better and saves them from other operational costs such as purchasing of additional generators as power supply in the event of a power failure in India or Philippines or even having to set up ‘redundant’ back up centers in more than one location in the event of any major cable breakdown such as the recent connectivity failure which struck many parts of Asia due to damaged underwater cables as a result of the Taiwan earthquake. Quality of Human Capital • Labor force experience & availability This is one of the most important selection criteria for FMCG & Retail companies. One 2007 ®FROST & SULLIVAN 93
    • GROWTH CONSULTING of the favorite regions for FMCG & Retail companies to establish SSO operation, Europe, is seen to have a pool of talent with good skill sets particularly in Finance & Accounting and IT Services even though their average salary may be many times more than their developing countries’ counterparts. In Ireland, for instance, a call center agent’s average salary is Euro 17,000 – 25,000 (around US$ 23,000 – US$34,000) annually as compared to a US$ 2,800 annual salary for a similar position in developing countries such as Malaysia and Philippines. FMCG & Retail companies with SSO operations in UK highlighted Britain’s high quality educational system which churns out qualified graduates to work in the shared services industry. A fairly expensive city in the UK, Manchester, has managed to attract many FMCG & Retail MNCs to set up their shared services centers there. Some examples include Australia’s Woolworths group, US based Kellogg’s, home grown retailer Marks & Spencer and packaging giant Tetra Pak. These shared services center can tap into the graduate talents from nearby universities such as the University of Manchester, Manchester Metropolitan University and so on. Manchester city also offers a unique BTEC certification in “Providing Shared Services” and the North West Shared Services Forum which is supported by a government agency, MIDAS (Manchester Investment Agency). India is one location outside of Europe which has the talent with the right experience. India as a nation has over 20 years of experience in SSO and its workforce clearly has the right transferable skills in SSO operations that are valuable across different industries. NASSCOM (National Association of Software & Service Companies) of India has taken further measures in ensuring that its graduates are marketable for the SSO industry by launching ‘finishing school’ courses in seven National Institutes of Technology (NITs) and at IIT-Roorkee. This is a six to eight weeks program which will concentrate in building up both the soft skills and technical skills of their graduates. Given India’s initiatives in developing its labor force for SSO, many FMCG & Retail companies have found India graduates to be suitable for their SSO operations. Locations interested in becoming the next SSO destination for FMCG & Retail companies will have to showcase its efforts in developing its human capital. Initiatives such as MSC KDI (K-workers development institute) in Malaysia and the funding provided to software vendors for international-standards certification such as Microsoft Certified Professionals (MCP), Oracle and SAP by China are good efforts that need to 2007 ®FROST & SULLIVAN 94
    • GROWTH CONSULTING be broadcasted. Distinctive competencies • Scale For the FMCG & Retail industry, scale in terms of choice of goods for procurement purposes is critical. Both China and India are excellent destinations, especially, for retailers in setting up procurement centers as both countries are able to offer a broad range of goods at a very low price. Again, Walmart is a testament as to how great a scale of procurement can be made in these two countries. If Walmart is taken as a country, it would be one of China’s largest trading partners, ahead of Russia, Australia or Canada. In the long run, China will still lead the pack for procurement SSO operations if India does not improve its infrastructure for transportation & logistics at the rate that China is improving the same. No other nation at the moment has the scale and range of products that India and China can offer for FMCG & Retail companies to procure upon. Thus, these two nations are predicted to still be the two preferred hubs when it comes to procurement. • Geographical closeness A fairly interesting element of SSO within the FMCG & Retail sector is the preference for geographical closeness. This means that FMCG & Retail companies would prefer to have one hub in Asia to serve the APAC region, one hub in Europe to serve the European region, one Latin American country to serve the South American markets, and so on instead of one or two hubs to serve many regions. Bart de Boever, former Managing Director of Christian Dior’s Nordic region shared services center in Copenhagen, Denmark cited that Denmark provides good geographical position to enter the Nordic region in addition to ease of establishing a company and hiring of new recruits. Christian Dior could have earmarked India to serve the Baltic region and yet it did not and instead, it chose a fairly expensive 2007 ®FROST & SULLIVAN 95
    • GROWTH CONSULTING location like Copenhagen to do so. Apart from Christian Dior, the Gillette group (under Procter & Gamble) is also active in Copenhagen, Denmark with its financial shared services center. There are fewer tendencies for FMCG & Retail companies to choose a single location to serve multiple locations across the globe. For instance, Procter & Gamble has shared services centers in Newcastle (UK) to serve UK and Ireland, Manila (Philippines) to serve primarily English speaking nations, San Jose (Costa Rica), Warsaw (Poland) to serve Eastern Europe, Brussels (Belgium) to serve the Benelux region, Singapore to serve South East Asia, Cincinnati (USA) for their USA offices and Toronto (Canada). Another example would be Cadbury Schweppes which has a Shared Business Services (SBS) center for its Cadbury Schweppes American Beverages unit in the USA and a Global Strategy & BPO Delivery Unit for Finance & Accounting unit in another location to serve the European region. 3.2.3.2 Top of the Mind Locations Some unlikely names are not only the top of mind locations for SSO operations but also actual sites which host a multitude of SSO functions for many Fortune 500/ Forbes 2000 FMCG & Retail companies. The most commonly heard names are UK, India, Poland, Czech Republic and the USA (not mentioned in any particular order). China is not on the list as many FMCG & Retail companies view it as only a great hub for procurement but not other functions. 2007 ®FROST & SULLIVAN 96
    • GROWTH CONSULTING Figure 3.2.7 FMCG & Retail: Top SSO Locations Top SSO Locations % of Respondents who Rank ranked among top 3 1 India 20% 32% 20% 2 USA 20% 4% 12% 3 UK 12% 16% Emerging East-EU: Czech Republic, Poland; Hungary Locations Mexico, Malaysia Stable/Declining Locations UK, USA, Canada, Ireland * Percentages shown are % of total response Ranked #1 Ranked #2 Ranked #3 After tallying in the top of mind rankings from the FMCG & Retail industry respondents, it is learned that India, USA and UK are the top 3 SSO locations for this vertical with India and USA tying in terms of the number of number 1 rankings (20% each). 2007 ®FROST & SULLIVAN 97
    • GROWTH CONSULTING Figure 3.2.8 FMCG & Retail: Ranking of Top SSO Locations Ranking of Top Locations Overall Score across Key Parameters Score India 3.7 4.1 4 3.2 USA 3.4 4.2 3.6 3.7 UK 3.4 4 3.4 3.6 Cost Efficiency Bus. Envt. Quality of Conduciveness Human Capital In terms of overall score, India leads in terms of overall cost efficiency due to its relatively cheaper wages. USA leads the pack in terms of overall business environment conduciveness and that is not difficult to see why because many FMCG & Retail companies are headquartered in the USA and the familiarity to the USA helps to boaster its image as a hub of excellence for SSO operations. In terms of human capital quality, USA workers emerge at the top. As a whole, both India and USA tie at a score of 3.7 ahead of UK’s 3.6 and Malaysia’s overall score of 3.5. Malaysia is seen as an emerging location for FMCG & Retail companies to locate their SSO operations to and the small fraction of difference in score from the top 2 locations is a sign that Malaysia is beginning to emerge in the minds of these Fortune 500/ Forbes 2000 companies as a possible future SSO location. India – labor force availability and scalability The next location, India’s ability to attract major retailers such as Supervalu (US), Tesco (UK) and Target (US) along with FMCG giants such as Unilever (Netherlands), Procter & 2007 ®FROST & SULLIVAN 98
    • GROWTH CONSULTING Gamble (US), etc are testaments to India’s attractiveness as a shared services and outsourcing center. India is able to provide the labor force scalability and low labor force cost in spite of raising concerns about wage hikes and high attrition rates especially among call center workers which one retailer highlighted could be as high as a 100% (an entire team gone). India is especially favored for IT Services & Support function, which many FMCG & Retail companies feel that India has a sufficient pool of such talents from shared services & outsourcing centers from other verticals with the necessary transferable skills. Scalability is also not an issue for SSO centers operating from India as can be seen by Tesco’s interest to double its Hindustan Center headcount and many other FMCG & Retail companies’ future plans to increase headcount for their SSO operations in India. United States of America – the familiar turf for FMCG & Retail companies The homeland to most FMCG & Retail companies, USA is also within the radar of being one of the hot favorites for FMCG & Retail companies to base their SSO operations in. It should be noted that most FMCG & Retail companies in the Fortune 500 and Forbes 2000 lists are headquartered in the USA, which explains why they prefer to work within a familiar territory. Some respondents cited familiarity with the legal systems especially for finance & accounting functions to be the most important factor that draws them to set up their SSO operations in the USA. Coca-Cola’s Finance & Accounting shared services center in Florida, Royal Ahold group’s IT services operations in Pennsylvania and the State of New York and Levi Strauss in Oregon are some of the many examples of FMCG & Retail SSO sites in the USA. For European FMCG & Retail companies which set up SSO operations in the USA, the U.S. Safe Harbor framework played a leading role in their decision. On October of 1998, the European Commission’s Directive on Data Protection went into effect that would prohibit any transfer of personal data to non-European Union nations that do not meet the standards set for privacy protection. The United States takes a different approach when handling data transactions across borders so in order to bridge the gap, the U.S. Department of Commerce in consultation with the European Commission developed a "safe harbor" framework. This framework prevents companies from experiencing any interruptions in their business dealings with the European Union or having to face any prosecution by European authorities under European privacy laws. The registration to this safety harbor is totally voluntary and many leading FMCG & Retail companies such as 2007 ®FROST & SULLIVAN 99
    • GROWTH CONSULTING Johnson & Johnson, Procter & Gamble, Best Buy, ConAgra Foods, Pepsi, etc are registered in this list. United Kingdom – a showcase that cost is not the most determining factor UK has not only been very successful in convincing many of its ‘local’ Fortune 500/ Forbes 2000 companies to host their SSO functions there but also attracted many ‘foreign’ FMCG & Retail companies to establish their SSO presence there. For instance, US based Procter & Gamble has a Global Business Services Center in Cobalt Park which serves the European, Middle East and Africa markets, home grown retailer Marks & Spencer operates its HR, Finance & Accounting and Customer Service & Call Centers in Manchester, US based FMCG giant Kimberly Clark currently hosts a Finance & Accounting shared services center in Brighton, England’s own J. Sainsbury established a Finance & Accounting in Streatham, and US food company Kellogg’s has a Finance & Accounting shared services center in Manchester city. The presence of all these brand names in UK indicates the country’s good standing as a shared services hub and many respondents highlighted that UK was chosen due to its close proximity to many European countries, the English language capability, the experienced workforce for high end functions such as risk & tax management and the excellent educational system which churns out valid and marketable graduates for the shared services and outsourcing industry. Marks & Spencer said that they initially chose Manchester because Manchester is easily accessible for the workforce living outside Manchester city and thereby ensures the availability of labor force for future growth. It also finds the certification in shared services program by MIDAS (Manchester Investment Agency) in joint efforts with AstraZeneca, the Royal Bank of Scotland, Tetrapak as well as Marks & Spencer is essential and helpful in developing the much needed talent pool that is tailored for the shared services industry in UK. Poland – the unlikely Eastern European hub A surprising face to SSO is probably Poland given the fact that Warsaw, Poland is one of the most expensive cities in the world according to a survey conducted by the Economist Group. Hence, the country’s USP has very little to do with costs. Poland has been 2007 ®FROST & SULLIVAN 100
    • GROWTH CONSULTING pushing to develop itself into the financial center and Silicon Valley of Central & Eastern Europe and this effort is strongly backed by its government. With around 126 state higher education academies including 17 universities, 18 universities of technology and 301 private higher institutions with over 2 million of its young population currently in universities, Poland offers a highly educated workforce. It also encourages companies to locate their SSO operations in Special Economic Zones, which provide lucrative tax exemptions and thus far, successfully attracted more than 45 foreign MNCs across different verticals to establish their shared services & outsourcing centers in multiple locations across Poland with Warsaw and Krakow being the two most popular locations. Some examples of FMCG & Retail companies include Avon in Warsaw, Electrolux and Philip Morris in Krakow and Carlsberg in Poznan. FMCG & Retail companies are attracted to Poland due to Poland’s high quality workforce and this again shows that low wage is not necessary the winning recipe. Czech Republic Another Eastern Europe hub mentioned in interviews is Czech Republic which has been aggressively promoting itself as an SSO Hub through its investment agency, CzechInvest. Subsidies of up to 50% of eligible business expenses (wage or capital expenditure on tangible & intangible assets) paid during the period of maximum 10 years and up to the state aid ceiling and up to 35% of special training costs subsidy make for extremely attractive perks to draw FMCG & Retail companies to set up SSO operations in Czech Republic. Companies like Tesco, Johnson & Johnson and Inbev set up there SSO operations here. Though Prague is still the Czech Republic’s heart for SSO activities, recent development in the South Moravian Region has made the city of Brno another center for IT, software development and research. 42.4% of South Moravian Region’s population holds a university degree or has completed upper-secondary education. There are 12 universities and higher education institutions in this region, producing more than 65,000 graduates in 2005, according to the Institute of Information on Education. To add to the benefits, 2 Brno’s office rent is significantly lower than that of Prague at 10 Euros/m /month as compared to 18 Euros/m2/month in the capital city. 2007 ®FROST & SULLIVAN 101
    • GROWTH CONSULTING Combining the forces of these two cities, Czech Republic looks set to attract more SSO activities. 2007 ®FROST & SULLIVAN 102
    • GROWTH CONSULTING 3.3 Technology Technology industries — semiconductors, software, computers, telecommunications and networking — are increasingly affecting our lives in ways which would have been a thing of science fiction a few years ago. Though the sector has matured over the past 25 years, technology companies have to wrestle with constant challenges. Access to capital, faster time-to-market, and finding and keeping the right talent are more critical than ever. So is managing stakeholder and financial market expectations. Some of the top of mind issues which the technology industry is facing are as follows: Convergence – With the birth of devices to harness broadband, consumers and businesses are pushing hard and fast to accelerate and incorporate technological changes. Companies can harness the opportunities around convergence and translate them into value creation. The corporate winners will be companies that manage change nimbly, fusing state-of-the-art technology with a clear vision of the future. Mergers and Acquisitions – A merger or acquisition can add considerable value to a business, but making sure that each stage of the transaction process — from valuation to negotiation and completion — is successful demands considerable experience and knowledge. As a result of the global economy such opportunities can arise anywhere in the world and M&A plans can face considerable challenges from regulatory restrictions to tax issues. Maximizing the value of Intellectual Property - Leapfrogging technologies pressure companies to take a closer look at exploiting and protecting their intellectual capital. The selling and buying of intellectual property assets can reduce risk, accelerate time-to-market, and offer companies a real competitive advantage. At the same time, protecting intellectual property from patent and copyright infringement is equally critical. Intellectual property is a business, financial, and competitive asset to be managed, protected, and maximized. Global expansion - Technology companies tend to venture abroad quickly to grow revenues, secure market share, and gain access to low-wage knowledge workers. As a result, this borderless industry challenges companies to manage a global work force, currency risks, technology transfers, and global supply chains, all while being able to respond to different relationships with governments and 2007 ®FROST & SULLIVAN 103
    • GROWTH CONSULTING regulators. Offshore outsourcing to lower costs makes technology companies vulnerable to supplier’s financial instability, intellectual property breaches, legal and regulatory risk, labor and social issues, insufficient and ineffective supply chain control procedures, and environmental issues. Talent management – Knowledgeable people are a technology company’s competitive edge. But it is not easy to attract and keep the best employees. Shifting global pools of talent, disruptive and expensive turnover, ever evolving technical skill needs, and a looming talent shortage as baby boomers prepare to retire create constant challenges. To attract and retain key people, technology companies must strategically align recruiting, HR programs and systems, management style, incentives, and corporate culture. To beat the competition for the top brains the strategy must be competitive yet cost efficient. Outsourcing and offshoring - Outsourcing is not new, but it can be more complicated to evaluate and implement offshore. The functions and processes that lend themselves to outsourcing for technology companies include software development, application hosting, data centers, network management, and back office functions. The promise of immediate cost-savings can be a major incentive to explore overseas outsourcing options. But some companies fail to understand the practical considerations and risks. The issues that eat offshoring cost savings include extra overhead, the threat of IP slippage, and poor communications. The most successful companies start off shoring low-value, non-core functions. Once they understand the process and cost model required to be effective and efficient, they can make educated outsourcing/offshoring decisions for other areas. 3.3.1 SSO Determinants 3.3.1.1 General Perception The technology sector has been one of the earliest pioneers for Shared Services or Outsourcing (SSO) to capture cost benefits and competitiveness from scale of operations and synergy in integration of geographies and functions. Starting with low end back office jobs, the technology sector has slowly moved the nature of work outsourced toward more specialized jobs. Outsourcing providers have also steadily increased their competencies and taken the opportunity to move up the value chain. 2007 ®FROST & SULLIVAN 104
    • GROWTH CONSULTING However, issues like IP rights protection and shortage of talent still hamper the technology sector from taking full advantage of outsourcing and SSO activities. 3.3.1.2 Issues/Considerations Companies have to handle a variety of issues and considerations before starting SSO operations. If the SSO operations are already in place, they have to adapt themselves to changing business and regulatory environments from time to time. The following are some of the key issues that organizations have to tackle when planning their SSO strategy. Manage remote operations and responsiveness It is important that the limitations and challenges of remote operations be recognized and dealt with. In addition to the usual challenges associated with managing and monitoring relationships at arms length, remote locations can introduce particular difficulties with respect to the provision of customer service. Increasingly customers express anxiety and discomfort at the prospect of using overseas call centers. The challenges of SSO are not only restricted to possible adverse consumer reactions. As the practice moves up the value chain and starts to encompass more complex business processes, firms should be concerned about the migration of knowledge to providers and other third parties, and the impact that this may have on their own competitive levers. A case in point is the scrapping of Apple’s technical support center in India. While commenting on the closure, sources familiar with this situation have been quoted as saying, “India isn't as inexpensive as it used to be. The turnover is high, and the competition for good people is strong.” Managing Job Losses In their bid to increase shareholder value and boost profit margins, companies worldwide are offloading non core functions like customer service, IT help desk operations, accounting, human resources to specialized outsourcing providers. However these benefits are enjoyed at the cost of jobs in the USA. and Europe. In most cases, the internal staff is handed over to the outsourcing provider; however, some job losses are inevitable. 2007 ®FROST & SULLIVAN 105
    • GROWTH CONSULTING In the European Union where employees are well protected against retrenchment, this poses a great concern to companies planning to outsource non core functions. A recent example is Deutsche Telekom’s plans to outsource over 45,000 call center jobs and extend working hours at call centers. In the USA, job losses due to outsourcing have become a socio-political issue. With the imminent presidential elections in 2008, retrenchment due to outsourcing will be in the news time and again for at least the next year. Resolve the increasing regulatory requirements governing SSO and responsibility for compliance The regulatory environment is becoming stricter to prevent the recurrence of events akin to the accounting scandals publicized in recent years. Compliance with numerous regulatory initiatives from Sarbanes-Oxley to International Accounting Standards is perceived by many as a burden. In addition, some European firms are subject to increasingly intense regulatory scrutiny on matters related to business continuity and provisions of the Data Protection Act. Compliance with these requirements may be more complex once third parties, distinct cultures and legal systems come into the fold. Country Specific Economic and Regulatory Factors Economic factors such as outsourcing incentives offered by developing countries have led to the recent R&D outsourcing trend. Distinct social and economic factors prevalent in a particular country may make it better suited for certain outsourcing operations. For example, India is found to be more suitable for call center customer support due to an ample supply of English speakers, whereas China is perceived to have a more conducive environment for R&D. A robust legal framework with legislation governing the management of patents, trademarks, designs, and copyrights forms a strong foundation for the protection of intellectual property while outsourcing. Similarly, it is desirable for the outsourcing destination country to comply with the provisions of the World Trade Organization’s 2007 ®FROST & SULLIVAN 106
    • GROWTH CONSULTING (WTO) Trade Related Aspects of Intellectual Property Rights (TRIPS) agreement. This pact deals with issues related to copyright, patents, trademarks, geographical indicators, and industrial designs. 3.3.1.3 SSO Drivers The drivers for setting up SSO operations for the technology sector can be cost savings, increasing output, shortening time to market and so forth. The following are some of the drivers believed to be the most important as highlighted in Figure 3.3.1 Figure 3.3.1 Technology: SSO Drivers 0% 3% 25% 70% 2% Improve employee productivity 0%20% 73% 7% Improve asset utilization 0% 58% 42% Enhance competitiveness 0% 13% 73% 14% Focus on core competencies 0% 24% 72% 4% Improve customer service 0% 6% 61% 33% Reduce operating costs 0% 58% 32% 10% Access scarce talent 0% 13% 43% 40% 4% Overcome HR shortages 0% 27% 72% 0% 1% Others * Percentages shown are % of total response Very Low Low Medium High Very High Reduce operating costs Over 90% of respondents cited cost savings as a key rationale for SSO, particularly those destined for low wage countries. As well as short-term gains in cost reductions, SSO helps firms reduce their need for long-term investment in human capital and fixed assets. Vodafone outsourced its IT operations to IBM and EDS under a seven year contract signed in 2006. The projected cost saving through this deal is US$ 600 million. Nokia extended its outsourcing contract with Hewlett-Packard for five years to 2010 to manage Nokia's IT infrastructure and operations as well as messaging and groupware systems. 2007 ®FROST & SULLIVAN 107
    • GROWTH CONSULTING Under this renewal valued at about US$ 100 million annually, Nokia will move to a service-based model aimed to help it cut costs. Focus on core competencies Over 85% of respondents cited this factor as prominent in deciding which functions to outsource. Unlike many other sectors, R&D and innovation are crucial for technology organizations to achieve competitive advantage and sustain long run growth. However, with growing global operations, firms require sound business, marketing and operational strategies in addition to technical expertise, which usually translates into higher operating costs. SSO appears as another cost effective alternative, allowing these firms to refocus and allocate more resources to develop core activities. Many technology organizations are increasingly looking into the outsourcing options available for human resources, accounting, supply chain solutions and customer service. By outsourcing its human resource functions to Hewitt, Sony Electronics is able to focus on its strategic human resource functions, freeing the human resource staff from day-to-day management of essential but non- strategic duties. In a unique deal of sorts Philips Electronics appointed Merrill Lynch for seven years to manage its in-house portfolio management operations in 2005. Improve employee productivity Time to market and time to volume of electronic products are major factors that drive outsourced R&D. Electronics products are following a rapid trend of obsolescence. For example, the advancement of processing speed follows Moore's law. Miniaturization of semiconductors plays a major role in rendering electronic goods and appliances obsolete rapidly. The onset of R&D has reduced the time to market for an electronic product drastically. Similarly, the need to develop multiple products for multiple markets has posed a significant challenge for the R&D operations of original equipment manufacturers (OEMs). In the case of mobile phones the time to market has reduced to 4 to 6 months. A delay in the time to market and time to volume would in turn reduce the competitiveness of the product in the market. Timely product launches in geographically dispersed markets across the world are the foremost concern of OEMs. As such, OEMs in the United States and Europe find outsourcing R&D an inevitable exercise. The widespread 2007 ®FROST & SULLIVAN 108
    • GROWTH CONSULTING presence of R&D centers worldwide enables transnational corporations to pursue round- the-clock R&D. Other drivers cited by respondents as drivers for SSO include ability to access scarce talent, and improved products and services quality. Access scarce talent The Asian region is well known for its pool of human resources and talent, especially in China and India. With R&D being offshored progressively to China and India, corporations in these locations face stiff competition in retaining the services of engineers, doctorate holders, and programmers. This phenomenon is due to the gradual escalation of salaries and high demand for talent. Improved products & service quality Collaborating with outsourcing service providers can improve overall process quality. This is because providers tend to have the highest possible quality certifications, for example, the Capability Maturity Model (CMM) - the highest level of software development process quality - and Six Sigma. Additionally, providers are usually selected from bidders with established competencies, often the best in their particular areas. However, from the growing debate on poor service deliveries by offshore call centers, it may appear that outsourcing may not always improve service quality. 2007 ®FROST & SULLIVAN 109
    • GROWTH CONSULTING 3.3.1.4 SSO Concerns Even as the promise of immediate cost-savings can be a major incentive for considering overseas outsourcing options, some companies fail to recognize the practical considerations and risks. Key concern areas affecting SSO operations are highlighted in Figure 3.3.2: Figure 3.3.2 Technology: SSO Concerns Compromise 0% 28% 59% 13% confidentiality Loss of control 0% 4%11% 64% 21% Increased costs 0% 2% 13% 66% 19% Reduced service level of 3rd party 0% 5% 48% 39% 7% Lack of knowledge 50% 50% 0% about outsourcing Lack of competent 0% 43% 40% 12%5% mgmt. staff Over-reliance on 0% 4% 42% 54% external party Stability of 3rd party 0%18% 52% 22% Org. de-skilling 0% 5% 25% 49% 21% Others 0% 47% 36% 17% 0% * Percentages shown are % of total response Very Low Low Medium High Very High Loss of Control and Over-Dependence In a competitive environment where innovation is key, conducting new R&D activities offshore is a major concern. Companies may not have the best control over intellectual property as compared to onshore operations. Loss of control may arise as companies lack the capability or experience to manage outsourced activities and providers or simply do not actively manage the provider-outsourcer relationship. Some companies use dedicated liaison teams to actively manage the relationships. These usually comprise of managers and other employees with prior experience in outsourcing, joint ventures or cross-functional teams. Importantly, for some respondents, not only are these teams able 2007 ®FROST & SULLIVAN 110
    • GROWTH CONSULTING to help develop a provider’s strategy, but also ensure it is aligned with their firm’s overall corporate strategy. Issues associated with control over intellectual property have a major impact on long run sustainability. Offshore outsourcing allows outsource service providers access to intimate knowledge on a company’s activities that is, in turn, subject to potential misuse. Increasing the transparency of the entire process comes at higher costs, diminishing outsourcing advantages. Over 80% of respondents rated this as a major concern. Close to 70% of respondents also feel that outsourcing will put their organization at a risk of de-skilling internal employees. Rising Costs and Hunt for greener pastures Although India remains a leading offshore outsourcing destination due to its early mover advantage, companies are looking toward other countries due to rising costs. In 2005, more than half of India's IT employees received at least a 15% salary hike with the top 10% of the workforce receiving an average raise of more than 40%. The growing demand for outsourcing jobs in India is attracting several new entrants into the business, increasing competition and lowering prices. Some Indian companies, for instance, are currently billing US$ 20 per programming hour for US software outsourcing contracts, down from over US$ 60 in 2000. Several American companies, including Coach, Motorola, and Target, also have begun deploying IT or IT-driven business-process work to China, accounting for about 15% of the country's outsourcing contracts. The monthly salary for programmers in high-tech hot spots such as Beijing, Shanghai, and Shenzhen is between US$ 600 and US$ 960, according to a survey conducted by InformationWeek China. This represents about half the salary paid for a similar position in India and less than a quarter of that in the United States. Rates are even lower in secondary locations. For instance, the average salary for a programmer in Dalian is US$ 450 per month. Other concerns highlighted by respondents include Implementation & project management factors, and political and regulatory risks. Implementation & project management factors Many companies that outsource business processes and R&D for the first time have an uphill task managing outsourced operations. One of the major factors that contribute to 2007 ®FROST & SULLIVAN 111
    • GROWTH CONSULTING making outsourcing cost-effective is the optimization of offshore establishment costs. Failed strategies of outsourcing processes lead to excessive expenditure, or in worst case scenarios, failure of the entire outsourcing project. Issues associated with vendor selection pose the foremost challenge. The protocol to be followed to transfer work offshore involves substantial expenditure. The onshore problems arising from outsourcing are the costs involved in job layoffs and the legal implications. In many cases, intensive training of overseas employees is required to inculcate cultural aspects and language skills to establish smooth channels of communication. The cost of ramping up productivity and managing offshore operations are prime factors that need to be optimized. Political and regulatory risks As the numbers of offshoring and outsourcing activities constantly increase in the technology sector, governments are looking into the possibilities of regulating or discouraging outsourcing. As mentioned earlier, new opportunities in offshore locations are created at the cost of employment opportunities in the parent country. Thus increasing pressure from the public forces the government to pursue necessary action. 3.3.2 SSO Trends 3.3.2.1 Spend on SSO The spending pattern on SSO activities depends mainly on factors such as what according to the company are their core activities, strategic goals, scale of the business, geographical spread of the business etc. Figure 3.3.3 Technology: Spend on SSO SSO spend as SSO Spending % of Revenue (US$ ‘000 Million) 27% 29% 28% 15% Strategic/R&D 1% 10.0% 450 IT Services & 51% 49% Support 400 420 Back-Office 8.0% 29% 37% 34% 350 Processing 352 300 20% 52% 25% 3% Sales & Sales Generation 6.0% 293 250 5% 33% 37% 25% Corporate Learning 233 200 4.0% 3% 30% 33% 34% Customer Service 150 Call Center 5.8% 5.9% 5.9% 6.0% 100 20% 44% 23% 11% Procurement 2% 2.0% 50 4% 5% 27% 40% 24% Human Resources 0.0% 0 2006 2007 2008 2009 43% 16% 33% 8% Finance & Accounting * Percentages shown are % of total response Very Low Low Medium High Very High 2007 ®FROST & SULLIVAN 112
    • GROWTH CONSULTING Technology companies started their SSO activities by spending on low end functions such as claims processing, customer call handling, billing etc. As the outsourcing and SSO industry matured the spending patterns have shifted towards more specialized and skilled functions such as design, testing and measurement etc. Primary research indicates that spending on SSO activity in the technology sector is on a steady rise, albeit only marginally. While findings from this study show that spending on SSO activities was 5.8% of the total revenues for the technology vertical, this ratio is expected to increase to 6% by 2009. Actual spending on SSO activities will rise from US$ 233 billion to US$ 420 billion by the end of the forecast period. Spending on almost all SSO activities is slated to increase over the forecast period. IT services and support, human resources and increasingly, finance and accounting are the most heavily outsourced functions. 3.4.2.2 Degree of SSO by type Increasingly companies in technology sector are transforming themselves in companies with three major characteristics – brand recognition, massive intellectual property and constant innovation. Any function on the periphery of these three activities is a potential target for SSO. IT services & support More and more technology firms view the maintenance of IT services and support for internal operations as a challenge amid the rising cost of keeping systems up to date and IT services at a level suitable for a regional/global operation. Increasingly, more firms are willing to evaluate and let third parties take over the management of IT services and support so they can focus their resources on keeping abreast with industry trends and ultimately, stay ahead of their competition. The following are some examples of recent deals. In October 2006, Vodafone decided to outsource its IT operations to IBM and EDS in a multiyear contract spanning seven years. Although financial details of the deal were undisclosed, the deal is believed to help Vodafone save US$ 600 million in maintenance costs. 2007 ®FROST & SULLIVAN 113
    • GROWTH CONSULTING In a deal signed in 2003, Telecom Italia engaged HP for IT management services for its 90,000 users. HR Services Outsourced HR services typically include payroll operations, benefits administration, employee records, data management and asset management services. Sony Electronics believes that outsourcing its HR functions to Hewitt Associates would enable it to focus on strategic human resource functions, freeing the HR staff from day-to- day management of essential but non-strategic duties. Hughes Electronics, well known for its subsidiary DirecTV, began to outsource various HR functions to pursue a cost avoidance strategy. The main cost the global communications company wanted to avoid was that of upgrading its legacy mainframe system to meet the growing HR service levels demanded by its 13,000 employees. Developing additional in- house administrative capabilities was certainly not the answer. And creating a new internal system was not considered realistic. So a task force at the company conducted an eight-month study of options for both its DirecTV subsidiary and corporate headquarters--seeking a better HR solution. The choice soon came down to buying a product off the shelf or outsourcing, and ultimately the task force determined outsourcing to be significantly cheaper. Hughes began off loading its payroll, hiring procedures, compensation management, and other HR functions to Fidelity Employer Services Co. (FESCo), the unit of Boston-based Fidelity Investments that was handling Hughes's 401(k), defined-benefit plan, and health and welfare administration. Organizations are primed for human resources (HR) outsourcing as they look to standardize HR processes and focus on business issues, according to a new survey by Hewitt Associates, a global human resources services company. Customer Service and Call Center Call center offshoring has been motivated by two key factors – cost and operation efficiencies. The technology sector is awash with examples of companies which have 2007 ®FROST & SULLIVAN 114
    • GROWTH CONSULTING either outsourced customer service and call centre functions to third party providers in low cost countries or have set up their own captive centers in low cost destinations to serve its customers globally. HP is one good example; HP runs its entire call centre operation through its centers in India. Other functions considered suitable for SSO operations include R&D and Finance & Accounting services. Finance & Accounting BT outsourced its Finance and Accounting operations to Xansa, the financial terms of the deal were not disclosed but the two parties have said that the projected cost saving for BT is a approximately US$ 185 million spread over seven years. Xansa's combined BPO and IT capability offered BT the ideal solution, not only transferring staff, services and supporting technology but also, guaranteeing savings through improved service delivery. This innovative agreement was based on a strategic partnership with shared governance. The integrated service provided by Xansa includes the largest Oracle payroll in Europe (as of July 2002). Together with the processing of over 100,000 pay slips they also process 40,000 expense claims every month. Xansa manages three million BACS payments, accounts payable (£13bn), financial accounting and reporting. Commenting on the deal, Ian Livingston, BT Group Finance Director said "Our partnership with Xansa increases our ability to support our core business pro-actively and economically." Research & Development Outsourcing of R&D functions has been a topic of hot debate for the last couple of years in the technology sector. Companies are trying to answer one important question – What started as Original Equipment Manufacturing (OEM) outsourcing and transformed into Original Design Manufacturing (ODM) is now going to transform into full fledged outsourcing of R&D functions? When Western corporations began selling their factories and farming out manufacturing 2007 ®FROST & SULLIVAN 115
    • GROWTH CONSULTING in the '80s and '90s to boost efficiency and focus their energies, most insisted all the important research and development would remain in-house. But that pledge is now passé. Today, the likes of Dell, Motorola and Philips are buying complete designs of some digital devices from Asian developers, tweaking them to their own specifications, and slapping on their own brand names. It's not just cell phones. Asian contract manufacturers and independent design houses have become forces in nearly every tech device, from laptops and high-definition TVs to MP3 music players and digital cameras. 3.3.2.3 SSO Party of Choice Three major categories have emerged for SSO within the technology sector. Either the enterprises are using their own facility and resources, or entering into a joint venture with 3rd party providers or completely outsourcing to an external service provider. Figure 3.3.4 Technology: SSO Party of Choice Strategic / R&D 82% 9% 9% IT Services & Support 20% 10% 70% Third Party Back-Office Processing 21% 36% 43% Sales & Sales Generation 77% 15% 8% 40 % 45 % Corporate Learning Programs 51% 16% 33% Customer Service 17% 0% 83% 16 % and Call Centers Joint Procurement 71% 22% 7% Venture Wholly Owned Human Resources 13% 16% 71% Finance & Accounting 51% 16% 33% * Percentages shown are % of total response Wholly Owned Joint-Venture Third Party Own Facility Some technology firms prefer this arrangement because it allows greater control over issues such as staff selection and training as well as product and service quality. It also allows the company to guard its intellectual property in a more secure way. This is 2007 ®FROST & SULLIVAN 116
    • GROWTH CONSULTING important specifically now that high end design and development work is being done in Asia. China and India though have repeatedly shown commitment towards IP protection but the legal frameworks in both countries is still weak. Out of the companies which Frost & Sullivan interacted with 45% said they prefer to set up their own facilities to carry out SSO functions. These functions are generally high end jobs like R&D, procurement and sales. More than 82% companies indicated that they either carry out or would like to carry out R&D activities in their own facilities. There are numerous examples in the technology sector where companies have set up captive centers in low cost destinations and relocated non core activities to these centers. Dell, HP, Ericsson, Texas Instruments, Motorola are some of the companies which have captive centers in India. Samsung set up a China International Outsourcing Center which has 10 offices based in Hong Kong, Shenzhen and Tianjin under it. The main objective to set up these facilities is to lower Samsung’s production costs. The total investment for this project is approximately US$ 18.5 billion. Joint venture In 2005, NEC Corporation set up a joint venture with HCL Technologies in India to provide offshore software engineering solutions for NEC. The JV, in which the Japanese firm would hold the majority stake of 51 per cent, provides offshore solutions in embedded software, hardware design, network and security, mobile technology to NEC. Besides, it would also conduct Research and Development (R&D) in high performance computing for NEC, its subsidiaries and their clients in Japan and worldwide. The venture, based in Noida, was projected to generate $25-million in three years and up to $100-million revenue a year in a five-year period. Similar relationships are expected to increase in number and scope going forward. Joint ventures are still not a well established model for carrying out SSO functions, only 16% companies surveyed indicated that it is their preferred model for SSO. Back office processing was one of the main functions that companies would consider delegating to a joint venture facility. 2007 ®FROST & SULLIVAN 117
    • GROWTH CONSULTING Third Party Provider IBM Global Services, Computer Sciences Corporation, EDS, Accenture are some of the leading companies offering services in this space. In addition to these multinationals, Indian companies are also making their presence felt in the global services arena. Infosys Technologies, Wipro Technologies, HCL Technologies and Satyam are the big four which have the capability to dethrone the western big wigs in the services arena. Over the years, third party providers have become highly skilled in carrying out low cost functions, 40% of the companies surveyed felt that it was best to delegate functions like IT services and support, HR, etc. Telstra, the Australian telecom major, has contracted its IT operations to Infosys and Satyam. The initial phase of a massive overhaul of its US$ 1.3 billion-a-year information operations to India has already been completed. Nokia entered into a contract with HP in 2004, to manage the IT infrastructure and operations for Nokia's network and for its messaging and groupware systems. The contract is for five years and billed at US$ 100 million annually. Vodafone awarded a seven year contract to IBM and EDS to manage its IT operations as a part of its cost cutting plans and pressure from shareholders. 3.3.3 SSO Locations 3.3.3.1 Selection Criteria The very philosophy of outsourcing and SSO hinges on the principles of cost cutting, so it is but natural that the first and foremost selection criteria for a company. However this is not the only factor under consideration when companies choose an SSO location. This section will take a closer look at some of the factors which influence the choice of location for SSO operations. 2007 ®FROST & SULLIVAN 118
    • GROWTH CONSULTING Figure 3.3.5 Technology: SSO Recommenders & Decision Makers Recommenders Decision Makers CEO 48% 15% COO 18% 24% Functional Heads Interdepartmental 34% (IT/HR/CFO) Team 19% Interdepartmental Team 4% SSO Location Managers 9% Regional/ Geographical Mgrs 25% External Consultants Others 1% Others * Percentages shown are % of total response SSO has now become an integral part of operational strategy for a large number of companies. Executive level staff is routinely involved in site selection for setting up SSO facilities. Functional heads and external consultants are mostly used to recommend SSO locations and the final decision lies with CXO level staff. Figure 3.3.6 Technology: SSO Location Selection Criteria IP regulation 15% 56% 29% Cultural 70% 15% 1% adaptability Infrastructure 12% 72% 16% quality Political stability 12% 73% 15% Attrition rates 50% 36% 10% Education & 32% 49% 13% language Labor force 6% 62% 32% experience Labor force 42% 40% 12% availability Tax & regulatory 12% 72% 16% costs Infrastructure 13% 47% 40% costs Compensation 43% 39% 18% Costs Very Low Low Medium High Very High 2007 ®FROST & SULLIVAN 119
    • GROWTH CONSULTING Costs The cost of labor and cost of infrastructure will be the foremost parameters under consideration. In this regard, developing countries in Asia, Latin America and East Europe are very attractive destinations. For lower order Business Process Outsourcing (BPO) activities where cost is the major factor in selecting an offshore location, Indian cities are attractive. Delhi, Chennai and Bangalore all feature in the top five cities, along with Manila and Buenos Aires due to their low labor costs, and are likely to attract relatively routine BPO and call centre activities (e.g. ticketing, account administration and claims processing). Real estate, while not a major factor in selecting a city for off shoring, influences this decision by contributing to the overall business cost. The lack of suitable real estate delivery options may also reduce the attractiveness of some cities. Indian and Chinese cities are less attractive in terms of the real estate market structure and availability of space, with cities like Kuala Lumpur, Manila and Johannesburg being more attractive on this indicator. Various cost issues – Tax and regulatory costs, infrastructure costs and compensation costs were rated highly by companies while selecting sites to set up SSO facilities. Tax and regulatory costs were rated high and above by 88% companies, infrastructure costs were rated high and above by 88% of the companies surveyed and compensation costs was rated high and above by 57% of the companies. Intellectual Property & Regulatory Issues Intellectual property (IP) is a hot topic in all developed countries and is of particular significance in the information technology sector. Offshore outsourcing companies have to be given source code to work from, have to be educated on business processes, and taught how their IT services or products will be used in higher cost countries. This in turn creates a situation where a company from a higher cost country could be creating a potential competitor 1-2 years down the road that not only knows how to create a highly effective competing product or service, but also knows who your customers are. Most offshore outsourcers would never consider stealing intellectual property, but that doesn’t preclude some of their employees from doing so. 2007 ®FROST & SULLIVAN 120
    • GROWTH CONSULTING Questions regarding the safety of technology IP in some lower cost countries have been a significant restraining factor to offshore outsourcing as well as off shoring. IP risks rank quite high when companies are selecting a SSO site, 85% of the companies which participated in the survey gave IP risks a high rating. Labor force experience and availability Two major issues are under consideration when one talks about human resources – size of the overall labor pool and the quality of labor. The world’s mega cities score most highly in labor supply. These mega cities are spread between Latin America (Buenos Aires, Sao Paulo, Mexico City) and Asia (Shanghai, Manila), and offer large pools of potential labor for companies considering off shoring. With the exception of Manila, these cities do not have significant levels of BPO off shoring at present. The advantage of less competition for staff in these cities will however be offset by the smaller pool of employees with relevant experience. Where labor quality is concerned, Manila, Moscow and Budapest rank highly on the aggregate index. However, at the level of the individual indicators which comprise the composite index, there is significant variation. Bangalore, Delhi, Chennai and Manila all score particularly high on the availability of IT skills. In India, there is a vast pool of IT graduates in the tier one and two cities. Some 300,000 graduates become available for work every year in Bangalore alone. The pool of tertiary qualified staff is somewhat lower in Latin American and European cities. Attrition rates and labor force experience and availability are some of factors on which we sought opinions during the survey. 94% of the companies gave labor experience a high and above rating. 2007 ®FROST & SULLIVAN 121
    • GROWTH CONSULTING 3.3.3.2 Top of the Mind Locations The most preferred locations for SSO operations for the technology vertical are India, Ireland and China as highlighted in Figure 3.3.7 Emerging locations include east European countries, Malaysia and a few Latin American countries. Figure 3.3.7 Technology: Top SSO Locations Top SSO Locations % of Respondents who Rank ranked among top 3 1 India 12% 4% 4% 2 Ireland 11% 4% 2% 3 China 6% 6% 1% Emerging East-EU: Czech Republic, Poland; Locations Lat Am: Peru, Mexico; Malaysia Stable/Declining Locations UK, USA, Canada * Percentages shown are % of total response Ranked #1 Ranked #2 Ranked #3 2007 ®FROST & SULLIVAN 122
    • GROWTH CONSULTING India ranks very high on all parameters as highlighted in Figure 3.3.8 Figure 3.3.8 Technology: Ranking of Top SSO Locations Ranking of Top Locations Overall Score across Key Parameters Score India 4 4 3.4 3.8 Ireland 2 4.4 4.5 3.3 China 3.5 3.4 3.7 3.3 Cost Efficiency Bus. Envt. Quality of Conduciveness Human Capital India – Constantly moving up the value chain In recent years it has been observed that more and more foreign companies are delegating work of strategic importance to their development centers in India. This is further established by the fact that many of them have set up their largest R&D centers outside their country of origin in India. India has one of the highest numbers of engineering graduates in the world and the largest base of Java certified developers in the world. India is close to the fast-growing Asian markets, and many development centers here work to cater to these markets. Also, a prime motive behind the allocation of research work on emerging markets to R&D centers in India is that India itself is an emerging market, and a company's proximity to such markets would help researchers do efficient first-hand work. The Indian government has also been instrumental in helping MNCs set up R&D centers in India, and is helping them with tax exemptions and other incentives. Information technology and English skills are the main factors that drive 2007 ®FROST & SULLIVAN 123
    • GROWTH CONSULTING western countries to outsource from India. India is surging as a top destination for venture capital financing. The trend is due to India's capabilities in information technology services and business process outsourcing. India ranked number one with 12% of the companies recommending it as its first choice for SSO operations. India achieved an overall score of 3.8 over 5 in terms of cost efficiency, conduciveness of business environment and quality of human capital. Ireland – Still a preferred location One of the reasons why so many companies choose Ireland is because of the unique workforce - Ireland has one of the youngest populations in Europe with over 36% under the age of 25 years. Ireland's unique population and age structure that has fuelled much of Ireland's recent prosperity will continue for the next 15 years with a key focus on education and research in Ireland. In a study of demographic trends, economists at NCB Stockbrokers forecast that projected population declines across much of Europe meant Ireland's already strong economy would look even more attractive in a European context over the next decade. The population of the Republic will grow by 30% to over 5.3 million by 2020 and to six million by 2050. The population between the ages of 15 and 64 will rise by 700,000 in the next 15 years. Sustained strong growth in the labor supply will maintain a capacity for growth in Ireland that will far outstrip that in other EU countries where the demographic outlook is much less favorable the report states. Irelands total investment in knowledge (including investment in public and private spending on higher education) increased by an average annual rate of over 10% over the past decade compared with averages of around 3% by the EU and the OECD. The overall tax burden in Ireland is the lowest among all other EU member states. A focus of Ireland's strategy to attract investment is to create a favorable economic and fiscal environment which is supportive of industry. This is evidenced by various investment incentives which are in place, creating a unique business opportunity in Ireland. Following are some of the most attractive features for investors in Ireland - • Ireland has one of the most beneficial corporate tax environments in the world. A 2007 ®FROST & SULLIVAN 124
    • GROWTH CONSULTING corporation tax rate of 12.5% applies to all corporate trading profits. • Tax credits for incremental expenditure on Research and Development. • A favorable holding company regime • Double taxation agreements with 44 countries Ideas and knowledge have transformed business and industry and have been crucial in the development of the Irish economy. The Irish Government's economic policies are directed towards the creation of a stable economic environment that is supportive of the needs of business. Ireland's economic growth rates in recent years have consistently been among the highest of the OECD countries. Ireland achieved an overall score of 3.3 out of 5 and 11% of the companies surveyed said that it would be their first choice of location. Technology companies present in Ireland include AOL, Analog devices, Microsoft, and Lucent. China The rationale for US companies to outsource IT jobs to China is obvious: cheap labor costs. This can translate into up to 40% less in application development costs than even India, the erstwhile low-wage haven for companies looking abroad. In terms of R&D export, China's main advantage for the future is the presence of a clear government strategy for software and R&D. Enshrined within the tenth Five-Year Plan (2001-2005) is a policy of prioritizing R&D, especially software and software exports, in the hope of emulating India's success – a hope that World Trade Organization entry may greatly advance. This has recently brought tax breaks for software development, access to cheap capital, and relaxation of rules on sending employees abroad. China also has a strong telecommunications infrastructure and an appropriate educational system that delivers software labor with lower costs. Japan has proven to be a force to reckon with in terms of product innovation, whether in electronics, software or the automobile industries. Now, China is following a similar path. It boasts engineers who produce today's most advanced computer chips. They also design some of the most sophisticated software available; handwriting recognition 2007 ®FROST & SULLIVAN 125
    • GROWTH CONSULTING software on tablet PCs, for example. China now graduates more engineers than any other country, and three times the number of engineers as does the U.S. Eastern Europe Eastern Europe is emerging as a top outsourcing destination next to countries such as India and China. The enlargement of the European Union (EU) is a factor, which is driving this trend. Companies such as Bulgaria, Romania, and Estonia are gaining prominence as low-cost IT outsourcing destinations. Bulgaria and Romania are expected to become members of EU in the year 2007. Skype, the program for making free calls over the Internet is a product of Estonian developers. The economic growth of Estonia is the second fastest in Europe. Countries such as Poland, Czech Republic, and Hungary are also emerging as low-cost R&D destinations. The three countries better known for electronics manufacturing are now restructuring themselves as R&D destinations. Hungary has a high percentage of technical workers among its total graduate work force. GE and IBM have made investments of US$1.3 billion combined. The Czech Republic is home to six technical institutes with electronics specializations. These institutes are rich sources of graduates having IT and electronics-related competencies. Salaries for engineers in these countries could be up to five times lower than western European countries. 2007 ®FROST & SULLIVAN 126
    • GROWTH CONSULTING 3.4 Energy The Energy sector can be broadly represented by 2 categories. They are Oil & Gas Operations (Petroleum Refining) and Utilities. Oil & Gas Operations companies occupy 74.2% of the total energy companies in the Fortune 500 segment, based on revenue calculation in 2006. Top 5 Oil & Gas Operations include Exxon Mobil, Shell, BP, Chevron and ConocoPhillips while top 5 Utilities include State Grid, EON, Électricité De France, Suez and Gazprom. Oil & Gas Operations generally have operations worldwide while Utilities only have offices and are usually the main energy providers in their home countries. According to OECD, global demand is expected to grow by more than half over the next quarter of a century. Investment needs exceed US$20 trillion, mainly because of higher unit costs. With oil and gas prices are at record highs, and are not expected to decline given the growing demand for these resources. Energy companies are diversifying their product mix, as non-traditional fuel sources become more price competitive, and alternative fuels are gaining interest. New investment in LNG, oil sands, oil shale, ethanol and other sources and products are showing rapid growth. Things are equally turbulent for the utilities sector where previously sacrosanct national boundaries are falling as cross border investment progresses, particularly in the EU. 3.4.1 SSO Determinants 3.4.1.1 General Perception Companies in the Energy vertical have been experiencing fast paced and unusually diversified organic growth, together with heightened activity involving overseas acquisitions. The growth poses multiple challenges because the energy companies have to adapt to different languages and cultural varieties, multiple taxes and regulatory requirements, internal control, availability of multi-skilled labors as well as scalability of infrastructure facilities. Hence, in deciding on locations for SSO, companies in the energy vertical would look at the above constraining factors before deciding on the best location for their SSO operation. 2007 ®FROST & SULLIVAN 127
    • GROWTH CONSULTING 3.4.1.2 Issues/Considerations In choosing between shared services and outsourcing, the energy vertical companies have indicated that outsourcing providers can ensure faster operation and thus providing them an opportunity to learn from these providers’ experience. However, setting up captive shared service centers will cost less from their perspective. For example, Centrica set up an HR Shared Service Center in 2002. However, the entire shared service center was outsourced to Hewitt in 2006 since Centrica realized a specialized provider would have the right skills to handle the operation. Although outsourcing may limit their flexibility due to contract lock-in, and significant people change, Centrica identified that the option could allow greater momentum and focus, as well as learning from the outsourcer’s experience. As a result Centrica would be able to benefit from a 30% cost reduction after three years of outsourcing. However, outsourcing poses more issues when the company is acquired by another entity. The new entity will need to inherit the contract tied up to the former company. This can cause complications if the new entity objectives’ are not aligned with the “inherited” contract. For example, when Powergen acquired TXU, Powergen "inherited" a major outsourcing contract between TXU and Vertex. That was a contract for various customer management services which was worth in excess of US$200 million per year. Significant re-negotiations took place in 2003 and 2005 (in 2005 against a background of alleged breach by Vertex), during which the value of the contract was sharply reduced. 3.4.1.3 SSO Drivers The key drivers for SSO activities in the Energy vertical are cost reduction and mitigation as well as enhancing competitiveness. Apart from these, overseas merger & acquisition (M&A), activities streamlining, and need for process excellence, uniformity and standardization are also some other drivers that most Energy companies highlighted. 2007 ®FROST & SULLIVAN 128
    • GROWTH CONSULTING Figure 3.4.1 Energy: SSO Drivers 57% 43% Improve employee productivity Improve asset 21% 67% 12% utilization 6% 51% 43% Enhance competitiveness Focus on core 13% 53% 33% competencies 11% 42% 33% 14% Improve customer service Reduce operating 40% 60% costs 25% 38% 38% Access scarce talent Overcome HR 18% 46% 36% shortages Note; Streamlining of operations acquired from M&A is a key driver * Percentages shown are % of total response Very Low Low Medium High Very High Reduce operating costs All Energy companies indicated that reducing operating cost is their main driver to adopt SSO. Energy companies are traditionally very large organizations. These companies do not invest extensively on talent management on non-core activities (nor should they do so). Often, third party outsourcers can provide these companies with proper talents together with cheaper cost. On the other hand, using third party outsourcers can also provide a substantial reduction in CAPEX, and this is critical to companies who are concern about their financial volatility. A smoother spending, via the outsourcing method, can reduce the fluctuations in balance sheet statements, by transferring the initial investment outlay to future OPEX spending. This allows the companies to achieve top quartile operating and cost performance. TXU, for example, managed to gain a 30% saving via its 10 years outsourcing deal with Capgemini Energy LP and Hewitt Associates. Similarly, when BP outsourced their HR processes to Exult, it managed to recover the costs of the initial seven years contract in only three years. 2007 ®FROST & SULLIVAN 129
    • GROWTH CONSULTING Accenture and Sadiel manage and support the development of Endesa’s commercial IT systems while Capgemini, Indra and IBM are involved in the development of Endesa’s distribution, generation and internal management systems. The five year contracts allow these vendors to integrate and manage Endesa’s range of disparate systems in 1998 in preparation for competition (it was running up to 10 legacy end user management platforms as a result of M&A activity). Endesa managed to gain cost savings of US$71 million. Its tactic of outsourcing different parts of the core systems infrastructure is an important part of this cost cutting strategy. Enhance Competitiveness and focus on core competencies 94% of the Energy companies indicated that enhancing their competitiveness is the main driver for SSO adoption. Intense competition — in conjunction with outdated information systems and manual processes in key business areas — made it difficult for many energy vertical companies to sustain a high level of efficiency. Halliburton, for example, found that production planning had become cumbersome, time-consuming and costly, resulting in excess inventory and limited capacity knowledge. The company also felt customer pressure to reduce cycle time, increase flexibility and responsiveness and speed delivery time. By outsourcing to IBM, the inventory levels were reduced by 30%, the on-time delivery was improved to 90% and the cycle times were shortened by 15%. This has significantly improved the efficiency and competitiveness of Halliburton in the oil and gas industries. Other drivers mentioned by survey respondents include streamlining of operations acquired through M&A, and achieving Process Excellence, Uniformity and Standardization. Streamlining Merger & Acquisition (M&A) Activities In 2001, many utility companies were becoming financially strained due to poor investments in energy trading or merchant operations and unsuccessful forays into 2007 ®FROST & SULLIVAN 130
    • GROWTH CONSULTING international markets. Hence, many energy vertical companies were involved in M&A exercises to reinforce their financial profile. Such exercises required uninterrupted integration with the existing business operations. SSO activities become prominent since involved parties found setting up SSO centers as an effective solution for integrating operations. In fact, when BP acquired Amoco in USA, it managed to accelerate the acquisition integration by reducing the cycle time by approximately 40% with SSO. The SSO center also helps BP to improve the quality of data and operations by reducing closing cycle time from 18 to eight days. Thames Water, the world’s third largest water company, on the other hand, sought Xansa’s expertise to deliver the initial phase of a BPO operation. Thames Water and Xansa have worked together for over 15 years. As a preferred supplier of IT services, Xansa has supported Thames Water's transition through de-regulation, its merger with RWE and its e-business developments. Process Excellence, Uniformity and Standardization Renewed focus on optimizing core power generation and delivery assets requires emphasis on process excellence, uniformity and standardization. Customer care improvement, investments in technology, infrastructure, and people resources compete for capital spend for core business functions while operating processes and procedures are significantly lagging best in class in call center industry practices. Energy vertical companies have benefited from the streamlining of activities when setting up the shared services center or outsourcing the mundane process externally. 3.4.1.4 SSO Concerns Energy companies are faced with the challenges and concerns as highlighted in Figure 3.4.2 when considering new SSO operations or running existing SSO centers. These concerns include reduced service level of 3rd party, organization de-skilling and lack of competent management staff. 2007 ®FROST & SULLIVAN 131
    • GROWTH CONSULTING Figure 3.4.2 Energy: SSO Concerns Compromise 30% 70% confidentiality Loss of control 5% 23% 72% Increased costs 6% 71% 24% Reduced service level of 3rd party 68% 32% Lack of knowledge 41% 31% 28% about outsourcing Lack of competent mgmt. staff 21% 56% 23% Over-reliance on external party 29% 59% 12% Stability of 3rd party 22% 78% Org. de-skilling 78% 22% * Percentages shown are % of total response Very Low Low Medium High Very High rd Reduced Service Level of 3 Party rd All Energy companies indicated that reduced service level of 3 party is the main concerns for SSO adoption. Service level, by definition, is the benchmark used to measure performance of any process in order to ensure consistent revenue growth in any rd enterprise. Since 3 party service providers are not tied up to the business revenue growth by default, the service level may be reduced because the outsourcing task is contracted in the initial phase before the end performance is identified. Shell, for example, has opt to set up shared service centers instead of outsourcing for certain business processes in order to ensure high service level required in the company. Organization de-skilling All Energy companies indicated that organization de-skilling is the main concern for SSO adoption. Most enterprises find that de-skilled workers become alienated from their work due to the perceived lower class of jobs. These workers are unable to find an association with their company’s business growth direction, since they are working on such jobs requiring little training. Continuous staff motivation is perceived to be required by Energy 2007 ®FROST & SULLIVAN 132
    • GROWTH CONSULTING companies who would like to adopt SSO. Lack of Competent Staff to Manage the Shared Service Centers 79% of the Energy companies indicated that lack of competent management staff is the main concerns for shared service adoption. Companies from the Energy vertical are facing issues with the lack of competent staff to handle their shared service centers. Progress Energy, for example, voiced out their intention to set up a shared service center but to no avail due to the lack of experience in handling such activity. This is particularly acute for energy companies which have grown large through a series of M&A activities and therefore are required to set up large SSO centers for their business processes. A few players, particularly originating from develoing markets, indicated that they were unable to utilize win-win benefits from SSO as a result of lack of experience in executing any well-established model. Win-win Benefits not Visible in Terms of Cost and Service Quality A majority of the energy companies mentioned that there is a lack of understanding in doing detailed quantitative analysis to understand total financial impact of setting up SSO centers. Often, there are no visible benefits in terms of cost and service quality that could be enjoyed by the companies that set up the shared service centers. For example, Reliance Industries could not identify the win-win benefits of setting up the shared service center for its Group Company. This delayed the intention of setting up a center in Mumbai, India. No Clear Effective Model for Shared Services While companies with several years of experience in outsourcing, offshoring or running shared services centers have developed a proper operational model for most of the business processes represented, Energy companies in many emerging markets have several issues while setting up new SSO centers. Reliance Industries of India has further emphasized that process excellence; service quality and delivery were surprisingly not the focus areas in their present shared services model, thereby reducing the organization’s 2007 ®FROST & SULLIVAN 133
    • GROWTH CONSULTING enthusiasm for SSO. 3.4.2 SSO Trends 3.4.2.1 Spend on SSO Most companies in the energy industry indicate that SSO spending is amounted to at most 3% of the revenue earned over any year. Apart from the top five energy vertical companies, namely Exxon Mobil, Shell, BP, Chevron and Total who have more visible SSO activities in place, most other companies’ (such as ConEdison and Reliance Industries) SSO activities are at its nascent stage. Spend on SSO is expected to grow at a CAGR of 6%, from US$84 million in 2006 to US$100 million in 2009 due to expanded volume of business, mainly in the Oil & Gas sector. However, spending as a percentage of revenue is expected to drop from 1.9% in 2006 to 1.2% in 2009. This is because the increased revenue foreseen in the next 3 years are mainly from expected increase in oil prices, which is not likely to influence the increased spending in SSO. Figure 3.4.3 Energy: Spend on SSO SSO spend as SSO Spending % of Revenue (US$ ‘000 Million) 15% 70% 15% Strategic/R&D 4.0% 150 IT Services & 21% 45% 34% Support 14% 74% 12% Back-Office Processing 100 57% 43% Sales & Sales Generation 100 93 4% 44% 22% 30% Corporate Learning 2.0% 89 84 11% 43% 46% Customer Service & 50 Call Center 1.9% 10% 90% Procurement 1.6% 1.4% 1.2% 47% 53% Human Resources 0.0% 0 13% 53% 33% Finance & 2006 2007 2008 2009 Accounting * Percentages shown are % of total response Very Low Low Medium High Very High 2007 ®FROST & SULLIVAN 134
    • GROWTH CONSULTING 3.4.2.2 Degree of SSO by type The trend amongst Energy companies is to primarily establish shared services and outsourcing for IT Services and Support, Back-Office Processing, Finance and Accounting, and Human Resources. Brief description and examples for selected types of SSO are discussed next. IT Services and Support Almost 80% of the Energy companies would like to or have already set up SSO for IT services and support. Most energy companies usually take IT services and support as their first business process for migration to shared service or outsourcing. For example, EDP transferred Edinfor, its IT services subsidiary to LogicaCMG in 2006. BG Group’s IT systems are run by Accenture. AEP set up a shared service centre with some 2500 employees and contractors to run the IT system. As an example of offshoring, Shell runs an offshore regional centre in Malaysia providing centralized IT services and solutions. It has another offshore regional center in Philippines providing back office operations. Exxon Mobil, on the other hand, has a project and support shared service centre in Singapore. The centre has 60 employees, comprising experienced systems engineers and business specialists. The centre is equipped with Global Enterprise Management System (Gems), an advanced information system that supports common worldwide business processes, including procurement, production planning and quality management and customer orders. Back-Office Processing Outsourcing of back office process to low cost countries like India has become popular with energy companies. 86% of the Energy companies would like to or have already set up SSO for back-office processing. British Gas, the largest supplier of residential gas and electricity in Britain, outsourced its back office operations to ExlService Holdings in 2005. British Gas is the brand name for energy and energy-related services offered by Centrica plc in the UK. Centrica used 2007 ®FROST & SULLIVAN 135
    • GROWTH CONSULTING rigorous selection criteria to evaluate suppliers in India and eventually selected EXL reportedly for its excellence in professional management, rigor in migration and expertise in back office operations. The operations in their steady state will be serviced from EXL’s facilities in Noida (part of the National Capital Region) and Pune. The main drivers for the outsourcing by Centrica are to improve productivity and reduce costs. Another example is Exxon Mobil which runs an offshore shared service in Malaysia for its back-office processing. Finance and Accounting 86% of the Energy companies would like to or have already set up SSO for finance and accounting. BP outsourced its finance and accounting to two centers, one in Budapest to serve the European customers, while the other in Calgary to serve the American customers. The Budapest center is run by EDS, with an investment of US$ 8.5 million. The Calgary center is run by IBM, a three-floor data centre. Exxon Mobil also runs a shared service in Czech Republic for the finance and accounting. Other functions cited as being prominent in witnessing SSO activities are human resource related functions and corporate learning programs. Human Resources 53% of the Energy companies has already set up or intend to set up SSO for Human Resources. Several energy companies have either set up captive HR shared service operations or have outsourced HR functions to specialists. Energy companies are concerned about the retention rate, and hence consider it important to educate their SSO staff of the value of their works. Furthermore, energy companies would like the SSO centers conform to certain quality control in order to deliver the optimum performance. Cultural adaptability is also critical in the HR SSO in order to ensure a smooth transition. Chevron started the Manila Shared Services Center in 1998. The HR Shared Services are expatriate-managed. Another similar center is located in South Africa. The Manila site supports Asia Pacific and USA while the South Africa site supports seven African countries. The HR Shared Services provided include HR data maintenance, recruiting, 2007 ®FROST & SULLIVAN 136
    • GROWTH CONSULTING expatriate administration and compensation & benefits. In dealing with the HR Shared Services, Chevron has identified a number of challenges that need to be solved in order to ensure the success of the center. One of the main challenges is the need to show its staff that they are part of the company and not a cost saving tool. Chevron helps each of the employees to develop a career path in order to avoid high attrition. Centrica has entered into a seven year contract with Hewitt Associates to outsource their HR services that include payroll, reward operations, and performance management. The outsourcing arrangement affects 135 roles within the company. 66% of HR processing work would be performed offshore in Glasgow and India, both of which have Six Sigma capabilities. The company will also outsource the voice related services to Krakow in 2009. Duke Energy signed an outsourcing contract with Hewitt Associates in 2005. Under the agreement, 100 Duke Employees were shifted to Hewitt. The majority of them had stayed on with the outsourcing company for six months to oversee the transition after which Hewitt reviewed its workforce needs. Among those 100 employees were a few managers who have stayed at Hewitt for the long term to help the outsourcing company get a sense of and preserve Duke's culture and needs. Corporate Learning Programs In line with HR processes, several energy companies have also outsourced Corporate Learning programs to specialists. BP outsourced corporate learning programs to Exult that provides global access for all BP employees to a tailored digital skills curriculum to support the development of IT skills and a global hosting environment for custom BP e-Learning. BP employees use Exult’s SkillSoft catalogue to support the continued development of e-Learning within BP. BP has an 8% stake in Exult, an example of evolving relationship between client and SSO service provider. 2007 ®FROST & SULLIVAN 137
    • GROWTH CONSULTING 3.4.2.3 SSO Party of Choice Three major categories have emerged for SSO within the energy sector. Either the enterprises are using their own facility and resources, or entering into a joint venture with rd 3 party providers or totally outsourcing to an external service provider. Figure 3.4.4 Energy: SSO Party of Choice Strategic / R&D 82% 18%0% IT Services & Support 18% 55% 27% Joint Venture Back-Office Processing 27% 55% 18% 28 % Sales & Sales Generation 82% 18%0% 36 % Corporate Learning Programs 45% 45% 9% 35 % Customer Service 27% 18% 55% and Call Centers Third Party Procurement 55% 36% 9% Wholly Owned Human Resources 27% 36% 36% Finance & Accounting 55% 36% 9% * Percentages shown are % of total response Wholly Owned Third Party Joint Venture Own Facility For many energy companies, a major concern with outsourcing is that they will lose value add, knowledge and intimacy. With this in mind, 36% of the Energy companies preferred to set up their own facility (shared service centers) to centralize the business processes across different countries. The favorable business processes for this method are R&D and sales related activities. For example, Shell runs five shared service centers that are fully owned subsidiaries of Shell. They are located in Cyberjaya (Malaysia), Glasgow (UK), Krakow (Poland), Manila (Philippines) and Guatemala. The reasons for Shell to choose fully owned centers are because during the time of set-up, Shell did not exactly understand the essential parameters. They are also concerned about losing power and influence with outsourcing. 2007 ®FROST & SULLIVAN 138
    • GROWTH CONSULTING Third Party Provider Energy companies typically use outsourcing arrangements for non-core activities like HR, business processes and IT services. This is the next preferred method by 35% of the Energy companies. A unique case was when TXU decided to spin off the HR outsourcing from Capgemini Energy (JV between TXU and Cap Gemini) to Hewitt. The agreement frees Capgemini Energy to focus on its core offerings in finance and accounting, as well as on growing opportunities in procurement. The other business processes that favor this method are IT services & support and back-office processing. Joint venture This is one of the emerging forms of collaboration between energy companies and service providers, with 28% of the Energy companies favor this approach. Capgemini Energy, a joint venture between Capgemini and TXU is a good example of a joint venture. This new company provides information technology and business process outsourcing services to the electric, gas and water utility industries in the USA. Capgemini owns 97% of the new firm, and the remaining is held by TXU. Capgemini Energy also has a US$3.5 billion transformational outsourcing agreement with TXU. It has the mission of improving service levels and reducing US$150 million per year in operating costs for TXU across human resources, finance & accounting, IT, customer care, revenue management and supply chain. This approach is most visible in the customer service and call centers set up. 3.4.3 SSO Locations 3.4.3.1 Selection Criteria For energy companies, the most critical selection criteria are labor force experience, infrastructure quality, and political stability though many other factors play critical roles in attracting these companies to set up their SSO operations in a particular country. Usually, the interdepartmental team, SSO location managers, regional managers and/or external consultants will recommend the ideal locations for SSO activities while the final decision is made by CEO and/or COO as shown in Figure 3.4.5 2007 ®FROST & SULLIVAN 139
    • GROWTH CONSULTING Figure 3.4.5 Energy: SSO Recommenders and Decision Makers Recommenders Decision Makers CEO 100% 25% COO 75% 64% Functional Heads Interdepartmental 36% (IT/HR/CFO) Team 100% Interdepartmental Team 100% SSO Location Managers 100% Regional/ Geographical Mgrs 100% External Consultants Others Others * Percentages shown are % of total response Figure 3.4.6 Energy: SSO Location Selection Criteria IP regulation 14% 64% 23% Cultural 67% 33% adaptability Infrastructure 7% 71% 22% quality Political stability 49% 51% Attrition rates 14% 64% 23% Education & 14% 74% 12% language Labor force 40% 60% experience Labor force 14% 74% 12% availability Tax & regulatory 13% 44% 44% costs Infrastructure costs 14% 64% 23% Compensation 21% 67% 12% Costs * Percentages shown are % of total response Very Low Low Medium High Very High 2007 ®FROST & SULLIVAN 140
    • GROWTH CONSULTING The elaboration of the key selection criteria are summarized as of below: Labor Force Experience and Availability Labor force experience plays a significant factor in SSO hub selection process, with all Energy companies indicating it as highly important. Shell Shared Service Centre in Glasgow, UK is an example where labor force experience and availability factor became an important consideration. Shell picked Glasgow for its availability of experienced manpower with accounting and finance skills as well as foreign language skills to cater mainly to the European customers mainly. The centre’s employees cover 34 languages. Political Stability The first criterion that all Energy companies would perform in selecting SSO location is to pick a country with stable politics. As indicated by most Energy companies, political stability is a pre-requisite before they even start to do a thorough understanding and analysis of other factors such as labor force’s and infrastructure’s availability and cost. Factors to be considered in the political stability criterion include frequency of change in the top governmental officers, terrorism level, currency fluctuation, inflation and economic growth. Infrastructure Quality and Cost 93% of the Energy companies consider infrastructure quality (as well as cost) an important criterion when selecting locations for SSO activities. Top energy vertical companies such as Exxon Mobil, Shell and BP have their shared service centers located in South East Asia and Eastern Europe where the relative infrastructure cost is much lower compared to North America and Western Europe. Since infrastructure cost occupies the major portion of cost of running an energy company, the reduction in infrastructure cost will also reduce the operating expenses. In fact, for Centrica, the outsourcing effort will drive down the operating cost by 40% by the third year of the contract. 2007 ®FROST & SULLIVAN 141
    • GROWTH CONSULTING Cultural Adaptability (unique to Utilities) Many utilities companies chose to set up their shared service or outsourcing in their home country. These utilities firms are generally non-multinational company and hence, they don’t see the need to venture offshore. For example, ConEdison has its shared service center in New York, where their energy operation is located while Progress Energy outsourced its business processes in North Carolina, where one of their energy operations is located, the other one being in Florida. Employees in these SSO centers understand the local culture and are able to handle the situation better with the local communities. 3.4.3.2 Top of the Mind Locations The most preferred locations for SSO operations for the energy vertical are the Singapore, Malaysia and Philippines as highlighted in Figure 3.4.7; emerging locations include Poland while Ireland is witnessing decline. The comparison of top locations is shown in Figure 3.4.8. Figure 3.4.7 Energy: Top SSO Locations Top SSO Locations % of Respondents who Rank ranked among top 3 1 Singapore 5% 3% 4% 2 Malaysia 3% 5% 5% 3 Philippines 3% 4% 7% Emerging Locations Poland Stable/Declining Locations Ireland * Percentages shown are % of total response Ranked #1 Ranked #2 Ranked #3 2007 ®FROST & SULLIVAN 142
    • GROWTH CONSULTING Figure 3.4.8 Energy: Ranking of Top SSO Locations Overall Score across Key Parameters Score Singapore 3.7 4.2 4.4 4.1 Malaysia 3.7 3.9 4.1 3.9 Philippines 3.9 3.9 3.8 3.9 Cost Efficiency Bus. Envt. Quality of Conduciveness Human Capital Singapore Singapore, with its strong business environment conduciveness and high quality of human capital, becomes the top of the mind SSO location. There are more than 7,000 MNCs in Singapore, with many of which have established regional or international headquarters. As their operations expand, these companies have found that it makes increasing sense to consolidate certain business processes in one location. The ease of recruiting talents, robust infrastructure and logistics together with stable politics form some of the factors that have attracted these companies to locate their SSO centers in the island. For example, ExxonMobil has a 60-high quality team in Singapore, comprising experienced systems engineers and business specialists, and the country is the Asia- Pacific project and support centre for its Global Enterprise Management System (GEMS). The GEMS platform supports common worldwide business processes, including procurement, production planning and quality management and customer orders. Malaysia Malaysia ranks in the second place in the top of the mind SSO locations ranking. The country provides a relatively high standard of labor force in the region, with multi-lingual capability at relatively low cost. The macro condition is highly favorable, with stable politics and strong economic growth. Shell Information Technology is a notable example as it serves as a regional centre to provide centralized IT services and solutions. ExxonMobil Business Support Centre, on the other hand, provides regional shared services and data support activities to its internal customers. 2007 ®FROST & SULLIVAN 143
    • GROWTH CONSULTING Philippines Philippines, with its strong cost efficiency, clinched the second place, together with Malaysia, in the top of the mind SSO locations ranking. Philippines provide high standard of infrastructure quality at a lower cost due to its liberalized telecommunications industry. Furthermore, its strong tie with USA in the past provides an attractive force to American companies and a strong momentum for European companies to set up SSO in the Philippines. For example, Chevron set up its Manila Shared Service Center in 1998 to support the Asia Pacific and US operations. The center offers 3 services, namely Finance and Accounting, SAP support and HR support. The other notable shared service center that follows the trend is Shell Shared Services. Poland (emerging country for SSO in Europe) Poland is one of the main SSO hubs for major European companies, due to its geographical proximity and cultural similarity advantages. For example, Shell has a shared service centre in Krakow while Centrica plans to open a call centre in the same place in 2009. Poland employee commands an average salary of US$7,432 while the similar person would command US$37,160 in Ireland. The attraction of the market is the 38 million people, a skilled and relatively low-cost workforce and good languages. It has a low corporate income tax rate of around 22%. USA (especially for the Utilities Companies) Many utilities companies located in USA prefer to set up domestic SSO centers. This is because they are often not a multinational entity with most employees residing in the home country like in TXU’s case. While the infrastructure cost is high, most of these costs are sunk costs by nature. The utilities are not able to take advantage of the lower tax incentives in the foreign countries because much revenue is still derived within the country. And even with tax saving in certain states, the saving will usually pass to the consumers due to intense competition. Furthermore, most utilities are one of the major recruiters in any city and fear potential political backlash in case they relocate operations. 2007 ®FROST & SULLIVAN 144
    • GROWTH CONSULTING 3.5 Healthcare Patient and managed care, pharmaceuticals and life sciences & biotechnology constitute the healthcare sector. Rising costs, expanding market demand, and increasing customer dissatisfaction with failing healthcare systems or a lack of the same will characterize healthcare in this decade and help redefine the roles of patients, providers and payers. Simply put, healthcare organizations face a growing imbalance of supply and demand. On the demand side is a large population of aging patients, specifically in the USA and Western Europe, in deteriorating health who demand more services, pharmaceuticals, and medical breakthroughs. The supply side, however, is hampered by a shrinking pool of investment capital, a shortage of willing caregivers, and aging physical plants straining under the current volume of patients. Clearly, demand is driving the system and flipping the traditional paradigm in which many health systems attempted to control costs by controlling supply. Under these conditions, healthcare providers must meet the challenge of effectively managing patient demand while payers must drive patients to the most cost-effective providers. The healthcare organizations that prosper in this environment will be those that recognize the supply/demand imbalance and respond with flexible and effective processes for delivering superior customer service. Investor interest in biotechnology and medical devices has never been higher. Consumer demand for improved healthcare relentlessly drives the life science industry to find new and ever more innovative therapies and delivery technologies, promising a combination of medical breakthroughs and significant financial rewards for investors. This dynamism also translates into an ever-increasing number of joint ventures and strategic alliances as companies scramble to be first to market while expanding their inventory of intellectual property. Pharmaceutical and life sciences companies are among the most analyzed and evaluated organizations in business today. Each company's financials, strategy and plans are scrutinized and compared to both current and historical benchmarks. In recent years, profitability has been lagging as many companies have been unable to sustain the robust growth that was once a hallmark of the industry. Considering the broader picture, analysts expect that the existing "blockbuster model" will be viable for the foreseeable future, but over time they suggest that a new approach will be needed to successfully address the 2007 ®FROST & SULLIVAN 145
    • GROWTH CONSULTING difficult challenges ahead. The challenges are well known and include declining profitability, thinning pipelines, growing generic competition, and skyrocketing operating and marketing costs. In the future, the approach that companies pursue will depend in large measure upon their individual goals. Whether they choose an innovation-based model built on the promise of personalized medicine or instead focus on an alternative operating structure such as the virtual organization, inevitably companies will need to decide how to satisfy contending stakeholder demands while pursuing sustainable growth in a highly competitive market. 3.5.1 SSO Determinants 3.5.1.1 General Perception As costs continue to rise against depleted budgets, healthcare organizations are in search of effective cost-reducing solutions. Many have turned to outsourcing as a way to combat their organizational inefficiencies. Today, the outsourcing of technology as a cost- reducing method has taken full force across a broad spectrum of industries, including the healthcare segment. With an increasing awareness for greater efficiency and output standards, the healthcare marketplace holds tremendous outsourcing opportunity and a substantially expanding pipeline. Life sciences companies have set-up extensive operations in low cost countries for activities ranging from basic drug discovery R&D, clinical trials, manufacturing to customer support. 3.5.1.2 Issues/Considerations Regulatory Compliance The Health Insurance Portability and Accountability Act (HIPAA) establish strong guidelines for data transfer, storage, and reporting. The US government including the FDA has been increasing the regulatory burden on life sciences corporations. This will impact not only the companies in the vertical themselves, but also their shared services or outsourcing service providers. 2007 ®FROST & SULLIVAN 146
    • GROWTH CONSULTING Manage the risks associated with increasingly complex SSO arrangements Healthcare providers and pharmaceuticals alike are extremely concerned about losing control over their businesses in pursuit of SSO, given that this could have a serious impact on their reputation and competitive position. SSO risks are increasing in the healthcare industry, with greater degree of offshoring. Data security risks and privacy concerns are high on companies’ agenda, and these risks increase when data is being stored or transferred across borders. Managing compliance risk is particularly difficult when off shoring is used. As a result, transparency and effective risk management have never been more important to the industry. Healthcare companies are under pressure to provide ever more complex and frequent reporting to the regulators and investment community. Companies which offshore processes are still accountable for them, if a service provider fails to comply, the source company is still to blame. Because of this policy, proper risk management is a top priority for companies planning to take SSO further. Developing Strategic Fit between Outsourcers and CRO In the past, outsourcing was conducted in a non-strategic, piecemeal fashion. Executives simply outsourced to resolve a shortage in R&D resources without taking a long-term perspective of focusing on particular aspects of R&D and externalizing others. Most pharmaceutical and biotech companies were and continue to be uncomfortable with outsourcing the entire portfolio of drug discovery to single contract research companies. The increasing pressure on pharmaceutical and biotech companies to improve research productivity has led to more strategic relationships being formed between the sponsors and contract research companies. The value of such a strategic fit is being appreciated much more today with an increasing number of companies looking to add research capabilities through their contract research partnerships. The need for developing a strategic fit has been further fuelled with a spate of biotech companies working on technologies complementing research done by pharmaceutical companies. These strategic fits are difficult to achieve and pose a big challenge. With a number of macroeconomic factors coming into play, it is becoming increasingly difficult for global outsourcing companies to locate and develop strategic partnerships with their contract research companies. Global drug discovery contract research companies in search of 2007 ®FROST & SULLIVAN 147
    • GROWTH CONSULTING success in the near future need to necessarily ensure that they strategically fit the outsourcing of global biotech and pharmaceutical majors. While understanding the strategic needs of the global outsourcers could be an important hurdle to overcome, developing the strategic fit might involve prohibitive investments. Investments in infrastructure, manpower, and technologies, which could undo plans of a number of companies aspiring to dominate the drug discovery contract research space. Establishing Credibility Given the proprietary knowledge and the high quality work involved, global sponsors of drug discovery contract research would prefer associating themselves with the best of breed companies in the market as long as the price is right. Companies vying for revenues from drug discovery contract research would be at an advantage if they get their credibility in place before scouting for work. Credibility of an existing contract research player is revealed through its past track-record including contract research work carried out in terms of type of work, sponsors involved, quality of work done, etc. Add to these elements such as domain expertise and the high quality manpower, infrastructure, etc., the combination would build credibility. No doubt macroeconomic variables like the country’s regulatory norms such as protecting IPRs decide the quantum of contract research work as well as its position in the R&D value chain. Credibility of new entrants is built on the technical skill-sets of people, the domain expertise, and the track-record of the scientists who would be undertaking the project. Building credibility in the market would be the first and most important challenge that needs to be overcome by industry participants in order to succeed in today’s competitive market scenario. 3.5.1.3 SSO Drivers The healthcare sector is struggling with high operating costs (especially sales and marketing costs), falling margins and drastically reducing pipelines. Faced with challenges like these, cost cutting is the foremost priority. In addition to this, companies are also trying to reinvent themselves by outsourcing non core functions and keeping the core functions in house. Following are some of the key drivers that motivate healthcare companies to look at SSO and outsourcing. 2007 ®FROST & SULLIVAN 148
    • GROWTH CONSULTING Figure 3.5.1 Healthcare: SSO Drivers 56% 44% 0% Improve employee productivity 44% 43% 13% Improve asset utilization 21% 52% 27% Enhance competitiveness 6% 74% 20% Focus on core competencies 38% 44% 17% Improve customer service 10% 44% 46% Reduce operating costs 43% 37% 20% Access scarce talent 34% 56% 10% Overcome HR shortages 9% 77% 14% Others * Percentages shown are % of total response Very Low Low Medium High Very High Reducing Operating Costs Most respondents cited cost savings as a key rationale for SSO and, particularly so for those destined for low wage countries. As well as short-term gains in cost reductions, SSO benefits firms by reducing their need for long-term investment in human capital and fixed assets. Pfizer outsourced its IT operations to Infosys and Satyam of India as a part of its US$ 4 billion cost saving plan in 2005. In early 2007, Pfizer also announced that it will relocate its IT helpdesk operations to the HP Global Solution Center in Dalian, China. The company is already in the process of moving all of Pfizer's helpdesk operations in Japan to the site, which will be up and running by mid 2007. Following this, HP will also relocate the helpdesk outfits of 13 other countries in the Asia-Pacific to the Chinese site, over three stages. The countries involved in the reshuffle are Thailand, Indonesia, Pakistan, Australia, New Zealand, China, Korea, Taiwan, Hong Kong, Malaysia, Singapore, Philippines and India. Overcoming costs is one of the important hurdles in pharmaceutical and biotech research and development. In the late 1970s, according to a study by the Tufts Center for the Study of Drug Development, the average cost of developing a drug from target compound through animal models and clinical trials to market was about US$54 million. From early 2007 ®FROST & SULLIVAN 149
    • GROWTH CONSULTING 1990s to the end of that decade, estimated cost more than doubled from about US$230 to around US$500 million. As per a recent study released by Tufts Center for the Study of Drug Development, it takes US$810 million and 10 to 15 years to get a drug to market today. With pharmaceutical and most importantly, biotech companies being hard-pressed to show a strong bottom-line, convincing shareholders to spend millions on drug discovery is becoming harder by the day. Increasingly, the global trend of pharmaceutical and biotech companies is to outsource research to cut costs and make new drug discovery a viable option. For one, the drug discovery contract research organization complements the pharmaceutical and biotech company with proprietary technology/product and most importantly, it contributes to reducing the cost of discovery through economies of scale. With more and more drug discovery contract research companies offering a strategic fit to their sponsors, cost advantages offered by them are sure to drive this market in the years to come. Over 90% of the companies surveyed gave this metric a very high or high ranking, this reaffirms that rising operating costs are a significant restraint on the healthcare costs. Enhance competitiveness by Reducing Time for Labor Intensive R&D Processes Biotechnologies such as genomics, gene sequencing projects, high-throughput screening, combinatorial chemical synthesis, pharmacogenomics, and proteomics studies are creating massive volumes and multiple sources of biological and chemical data. This data is threatening to create a bottleneck that might hamper the growth of biotechnology itself. Optimization of the drug discovery process has been the prime concern of both biotech and pharmaceutical companies. Currently, there is increased pressure to develop breakthrough drugs and shorten the drug discovery time and costs involved. Pharmaceutical and biotech companies are increasingly looking at genomics to find solutions. It has been estimated that about 20% of the current novel discovery programs are based on genomics. It is predicted that virtually all new discovery programs over the next five years will be genomics-based. Increasingly, pharmaceutical and biotech companies are appreciating the need to delineate the focus on time and laborious drug discovery processes and outsource. This would not only result in cost savings for the pharmaceutical and biotech companies but also help them in optimizing drug discovery resources. The consequent increase in time and a more labor intensive drug discovery 2007 ®FROST & SULLIVAN 150
    • GROWTH CONSULTING process is sure to drive drug discovery contract research in the near future and its impact will be felt across all steps in the drug discovery process. Cognizant Technologies is fast becoming a global leader in sectors like clinical data management. Cognizant does outsourced clinical data management for Pfizer. TCS recently struck a deal with the British pharmaceutical giant GSK to provide outsourced drug discovery support. The contract has cost GSK approximately US$ 20 million. GSK is also involved in research collaboration with Ranbaxy Laboratories, India’s largest drug maker, to jointly develop drugs in areas such as urology, diabetes and asthma. 3.5.1.4 SSO Concerns Healthcare companies are faced with the following challenges and concerns when considering new SSO operations or running existing SSO centers. Figure 3.5.2 Healthcare: SSO Concerns Compromise 14% 52% 34% confidentiality Loss of control 19% 67% 14% Increased costs 37% 46% 17% Reduced service level of 3rd party 23% 69% 8% Lack of knowledge 53% 22% 7% about outsourcing Lack of competent 33% 40% 21% 6% mgmt. staff Over-reliance on 45% 45% 10% external party Stability of 3rd party 3% 33% 59% 5% Org. de-skilling 53% 37% 10% Others 9% 84% 7% * Percentages shown are % of total response Very Low Low Medium High Very High 2007 ®FROST & SULLIVAN 151
    • GROWTH CONSULTING Compromise confidentiality (Lack of Strong IPR Protection) Strong intellectual property rights (IPR) protection is vital for a knowledge intensive industry like the healthcare and biotech sector. With the cost of research being astronomical today, loss of intellectual property could cost pharmaceutical and biotech companies billions of dollars. Hence when pharmaceutical and biotech companies evaluate strategic SSO and contract research partners, they necessarily check if the concerned firm has adequate IPR or not. With a number of pharmaceutical and biotech companies in regions such as the Asia Pacific vying for drug discovery contract research opportunities, strong local patent protection laws within the country are an important consideration. With the enforcement of WTO regulations and TRIPS agreement, the outlook towards IP protection in developing countries looks increasingly encouraging. Over 86% companies rated confidentiality concerns highly and over 81% companies felt that losing control over operational detail could be a restraint while outsourcing. Lack of Domain Expertise and Reduced service levels Drug discovery contract research opportunities are growing by leaps and bound with more and more pharmaceutical and biotech companies identifying the competitive advantage of strategic outsourcing of drug discovery. While opportunities arise, the domain expertise and abilities of a drug discovery research organization in meeting the requirements of the sponsor companies is a strong limiting factor. With pharmaceutical and biotech companies increasingly looking at niche discovery contract research companies with proprietary technologies that complement its focus, it is becoming increasingly difficult for discovery contract research organizations to offer competitive advantages or complementary technology. Pharmaceutical and biotech companies outsourcing discovery research are increasingly favoring companies with platform technologies to partner. For companies to develop such platform technologies, huge investments are needed, making it beyond the means of most companies seeking contract research opportunities. As these high value opportunities mean moving up the value chain and enriching the core expertise of the company, lack of domain expertise is an important limiting factor to contract research opportunities. Lack of domain expertise also restricts the number of segments of drug discovery contract research that an organization could get into and becomes a hurdle in moving up the value chain of drug discovery. 2007 ®FROST & SULLIVAN 152
    • GROWTH CONSULTING Unavailability of World-Class Infrastructure and Manpower One of the defining factors for success in the global drug discovery contract research markets is the availability of world-class infrastructure and manpower. The manpower managing the drug discovery process needs high technical and management skills. Obviously, pharmaceutical and biotech companies prefer to liaison with drug discovery contract research organizations that boast of the best breed of infrastructure and manpower. With the cost of setting up world-class infrastructure increasing by the year, companies in drug discovery contract research struggle to meet the demands of sponsors. With brain drain impacting most of the regions such as Asia Pacific, getting the best of breed manpower is proving a nightmare for most contract research organizations. With prohibitive costs involved, this restraint is likely to impact the market strongly during the forecast period. Another key concern mentioned by healthcare companies as a key concern area is regulatory hurdles. Regulatory Hurdles Several developed economies have established regulations on the conduct of clinical trials in developing countries as a safeguard against dubious practices. Even host countries often have guidelines that hinder growth of outsourcing. For example, conducting phase 1 trials in India is not allowed unless its part of global simultaneous trials. India also allows only limited testing on primates. 3.5.2 SSO Trends 3.5.2.1 Spend on SSO Primary research indicates that the spending on SSO activity in the healthcare sector is on a rise steadily. Our findings show that spending on SSO activities was 5.5% of the total revenues for the healthcare vertical. This ratio is estimated to reach 7% by year 2009. Actual spending on SSO activities will go up from US$130 billion to US$258 billion by end of the forecast period. Spending on almost all SSO activities is slated to increase over the forecast period. R&D activities are likely to be heavily outsourced during the next few years as healthcare companies try to find new drugs and reduce operating costs. In addition to this 2007 ®FROST & SULLIVAN 153
    • GROWTH CONSULTING spending on other SSO activities is expected to increase. Figure 3.5.3 Healthcare: Spend on SSO SSO spend as SSO Spending % of Revenue (US$ ‘000 Million) 8% 21% 37% 34% Strategic/R&D 10.0% 300 IT Services & 12% 54% 34% Support 250 25% 50% 25% Back-Office 8.0% 258 Processing 200 63% 15% Sales & Sales 208 Generation 6.0% 7% 60% 31% 2% Corporate Learning 167 150 4.0% 30% 54% 16% Customer Service 130 7.0% & Call Center 6.5% 100 5.5% 6.0% 44% 46% 10% Procurement 2.0% 50 29% 37% 34% Human Resources 0.0% 0 2006 2007 2008 2009 36% 22% 32% 10% Finance & Accounting * Percentages shown are % of total response Very Low Low Medium High Very High 3.5.2.2 Degree of SSO by type IT Services & Support Increasingly, more healthcare firms are willing to evaluate and let third parties take over the management of IT services and support so that they can concentrate their resources on keeping abreast with industry trends to stay ahead of the competition. Global pharma major Pfizer, engaged Infosys and Satyam in 2005 on a multiyear contract to manage its IT operations as a part of its US$ 4 billion cost cutting plans. GlaxoSmithKline engaged ACS for five years at a cost of US$ 100 million. Under terms of the agreement, ACS will provide remote server management and monitoring services for more than 5,000 UNIX, Wintel, OS390 Mainframe, and Open VMS servers located at GSK data centers in the U.S. and United Kingdom (UK). ACS became an IT outsourcing partner to GSK in June 2003 when ACS began supporting GSK's legacy business systems. In 2004, ACS signed a subsequent agreement to custom build a new Registration and Medication Ordering System (RAMOS), supporting GSK's RAMOS clinical trials. 2007 ®FROST & SULLIVAN 154
    • GROWTH CONSULTING Research & Development R&D outsourcing is fast becoming the cash cow of the healthcare outsourcing market, so much so that it merits a stand alone analysis as a market in itself. As costs of management rise, profits decline, pipelines shrink and generic drug makers enter the market, R&D outsourcing in healthcare cannot be taken lightly. Pharmaceutical R&D in developed countries is very costly. The estimations from industry sources reflect that the cost of bringing one new molecule into the market amounts to US$800 million. Also, the process of drug development and commercialization is a lengthy and risky process. It is estimated by The European Federation of Pharmaceutical Industries and Associations (EFPIA) that on an average, out of 10,000 molecules developed in laboratories, only one or two will successfully pass all the stages of drug development and finally be commercialized. It is also stated by the EFPIA that the total European pharmaceutical R&D investment in 2004 was approximately US$ 26.1 billion. Termed as Research Process Outsourcing/Off shoring (RPO), this is potentially the fastest SSO growth area for the healthcare industry. All major pharmaceutical companies have become active proponents of RPO and specialized service providers like Albany Molecular, Siro Clinpharm, etc. have seen strong ramp-up of their business over the last five years Additionally several deals have been observed in the area of HR services. Human Resources HR outsourcing is becoming an important SSO area for the healthcare industry. Pfizer, the world’s largest pharmaceutical company, for instance, outsourced managed care plan administration service to Hewitt Associates. In February 2007, TalentTrack, announced outsourcing agreement with Tenet Healthcare Corporation to assist its hospitals in developing an efficient, consistent and centralized physician recruitment process that will support the system’s targeted and aggressive growth initiatives. The contract gives TalentTrack complete end-to-end responsibility for all Physician recruitment functions, including third party vendor management, for each of Tenet’s 52 hospitals. The centralized approach will be one that is measurable and has common standards across the system. TalentTrack’s focus will be to ensure that there are immediate, dedicated resources and a seamless process to recruit upwards of 300 physicians a year. Because 2007 ®FROST & SULLIVAN 155
    • GROWTH CONSULTING the market for physician manpower is highly competitive, TalentTrack will be responsible for building an internal candidate database as well as providing documentation and tracking of all recruitment activity to improve existing processes. 3.5.2.3 SSO Party of Choice Within the healthcare sector, three main models have emerged from the practice of off shoring. Firms are either using their own facility, forming relationships with third parties, or relying solely on the third party outsource provider. Figure 3.5.4 Healthcare: SSO Party of Choice Strategic / R&D 30% 22% 48% IT Services & Support 5% 16% 79% Third Party Back-Office Processing 35% 14% 51% Sales & Sales Generation 91% 0%9% 42 % 45 % Corporate Learning Programs 52% 30% 18% Customer Service 27% 0% 73% 13 % and Call Centers Joint Procurement 75% 17% 8% Venture Wholly Owned Human Resources 29% 7% 64% Finance & Accounting 65% 9% 26% * Percentages shown are % of total response Wholly Owned Joint-Venture Third Party Wholly owned A wholly owned arrangement allows the company to guard its intellectual property in the most secure way compared to partnerships or outsourcing arrangements. This is important specifically now that high-end design and development work is being done in Asia. China and India though have repeatedly shown commitment towards IP protection, but legal frameworks in these countries are still weak. GSK has sizeable research operations in Bombay and Bangalore and employs 2,400 people in India, where it controls 5.9% of the pharmaceuticals market. Pfizer’s clinical research operations in India, set-up in 1996, has invested US$13 million in clinical trials in India over the past seven years; current activities include data management-biometrics, medical writing, clinical trials management etc. Novartis has staffed its clinical trials set-up in China by bringing in European experts. 2007 ®FROST & SULLIVAN 156
    • GROWTH CONSULTING Majority of the companies in healthcare sector prefer to have a wholly owned facility. Finance and accounting, sales and corporate learning are some of the functions which are run out of wholly owned facilities. Hybrid Relationships (Alliances) The two most common forms are joint ventures and collaborative partnerships. Pfizer has investments valued at more than US$1.70 billion, supporting strategies that are designed to maximize research and development productivity. Of this nearly US$700 million has been spent on alliances/outsourcing in the past decade (US$780.3 million from 1986 to 2002) and half in assembling more than 500 quality alliances, which span from gene and lead identification to developing smarter clinical trials and extending the utility of medicines. The alliances for cancer research and development have been mainly for screening of potential candidates or developing leads based on targets identified by Pfizer in-house. The company also aims at understanding the tumor growth regulation through its alliance with OSI, which is a major partner in this sector. Other partners are Abgenix, Onyx, and Repligen. GSK’s cumulative contract/collaborative research payout was US$597.9 million for period 1987 to 2002. The alliances included in its portfolio are those made independently by Glaxo and SmithKline Beecham prior to the merger as well as early collaborations formed by Burroughs Wellcome prior to its merger with Glaxo. Oncology research dominates the sector wise external alliances formed by the pharmaceutical giant. The company’s focus for contract research in this area has been on vaccine development, oligonucleotides, and novel concepts like mitotic kinesin inhibitors. A significant alliance made in this sector both in terms of scope and value is with Corixa for vaccine development against several types of cancer. Other alliances are with Cytokinetics, Coley Pharmaceuticals, and Biovex. The company has also harnessed expertise in immunohistochemistry-based diagnostic analysis to identify target markets for novel cancer therapy. In 2004, Quintiles and Solvay entered a unique risk-sharing agreement under which: Quintile will invest US$25 million worth of development services for ten of Solvay’s phase II projects from 2004-06, thereby bearing around 50% of the risk Solvay would provide Quintiles with milestone payment for each of these reaching phase III 2007 ®FROST & SULLIVAN 157
    • GROWTH CONSULTING Unlike similar previous deals, however, Quintiles will not receive royalties from drug sales Project and annual spending limits are specified; spending beneath these limits may be carried over to other projects or another year, but may not exceed the overall US$25 million limit With this deal, Solvay expects to double early clinical capacity. Quintiles will receive early revenues as more projects move faster into phase III and are funded by Solvay under pre-existing preferred partnership agreements with Quintiles. Instances of hybrid relationships are still rare. Only 13% of the companies surveyed indicated that they prefer this mode of SSO operations. Strategic R&D is likely to adopt this model in the coming few years as healthcare companies and contractors try to hedge their risks using a risk-reward model. Third Party Provider The development outsourcing market (US$ 11 billion in 2004) is expected to grow at a CAGR of ~15% for the period of 2004-2009. Innovators are increasingly partnering with CROs and CMOs for early-stage synthesis, process development and scale-up to increase speed of development. The Wyeth-Accenture deal of 2004 was a landmark agreement for data management. Wyeth outsourced entire clinical data management (CDM) to Accenture for 10 years with defined targets with Accenture to pay Wyeth if targets are not met as part of the deal 150 of Wyeth's CDM staff work for Accenture at Wyeth's facilities, remaining 150 posts at Wyeth were eliminated. Target results (over 10 years) included the following: 80% reduction in “last patient visit to database lock time” by 2007 35% reduction in CRF processing cost Keep Wyeth in the top 5% of industry efficiency benchmarks Execute anticipated threefold increase in clinical trials without increasing staffing Specialized third party providers are preferred mode of outsourcing for non core functions 2007 ®FROST & SULLIVAN 158
    • GROWTH CONSULTING like IT operations, back office processing and customer call services. Over 40% companies prefer this model for their SSO operations. 3.5.3 SSO Locations 3.5.3.1 Selection Criteria Cost is often not the only factor under consideration when companies choose an SSO location. This section will take a closer look at some of the factors which influence the choice of location for SSO operations. Figure 3.5.5 illustrates the key recommenders and decision makers while Figure 3.5.6 highlights the key location selection criteria. Figure 3.5.5 Healthcare: SSO Recommenders & Decision Makers Recommenders Decision Makers CEO 42% 16% COO 22% 19% Functional Heads Interdepartmental 46% (IT/HR/CFO) Team 26% Interdepartmental Team 6% SSO Location Managers 5% Regional/ Geographical Mgrs 20% External Consultants Others 1% Others * Percentages shown are % of total response 2007 ®FROST & SULLIVAN 159
    • GROWTH CONSULTING Figure 3.5.6 Healthcare: SSO Location Selection Criteria IP regulation 5% 61% 34% Cultural 33% 61% 6% adaptability Infrastructure 16% 74% 10% quality Political stability 48% 45% 7% Attrition rates 29% 64% 7% Education & 21% 66% 13% language Labor force 66% 34% experience Labor force 30% 45% 25% availability Tax & regulatory 21% 66% 13% costs Infrastructure costs 25% 60% 15% Compensation 6% 61% 33% Costs * Percentages shown are % of total response Very Low Low Medium High Very High Cost efficiency Countries like India and China have emerged as low cost locations for carrying out clinical trials. Costs are low in these countries not only because of shorter time taken to recruit patients but also due to lower salaries for the employees involved. Similar rationale also applies to setting up R&D labs where salaries of PhDs are much lower in India and China. CROs are expanding into these low cost geographies especially to India and China; large CROs have presence in 20 or more countries. M&A and alliances among CROs have been intense to gain complementary capabilities and enhance geographic presence. Quintiles, a leading CRO, currently employs over 850 people in India and has three offices in China. Covance, another top five CRO has a partnership with SIRO in India and a partnership with Excel in China. Infrastructure costs, tax and regulatory costs and compensation costs some of the cost factors which over 90% of companies rated highly while selecting SSO locations. 2007 ®FROST & SULLIVAN 160
    • GROWTH CONSULTING Intellectual Property & Regulatory Issues Intellectual property (IP) is a hot topic in all developed countries and is of particular significance in the healthcare sector. Offshore outsourcing companies have to be given access to proprietary knowledge about chemical entities and molecules developed in house by companies when doing R&D to expand on the research further or do validation or clinical trials. This in turn creates a situation where a company from a higher cost country could be creating a potential competitor 1-2 years down the road that not only knows how to create a highly effective competing product or service, but also knows who your customers are. Over 95% of companies felt they need to give high importance to the IP regime governing the location where SSO operations are going to be established. Quality of Human Resources The presence of excellent institutes for higher education in India, China, East Europe and Russia has made these locations attractive for high end R&D activities for the healthcare sector. Labor force availability also rated highly, over 75% indicated that they give this factor high importance when deciding on the location for their SSO facility. All the surveyed companies also look at the quality of man power available at the location of SSO operation. 2007 ®FROST & SULLIVAN 161
    • GROWTH CONSULTING 3.5.3.2 Top of the Mind Locations The most preferred locations for SSO operations for the healthcare vertical are India, China and Ireland as shown in Figure 3.5.7 while Figure 3.5.8 provides their comparison. Figure 3.5.7 Healthcare: Top SSO Locations Top SSO Locations % of Respondents who Rank ranked among top 3 1 India 10% 7% 3% 2 China 12% 4% 1% 3 Ireland 11% 2% 5% Emerging East-EU: Czech Republic, Poland; Locations Singapore Stable/Declining Locations UK, USA, Canada * Percentages shown are % of total response Ranked #1 Ranked #2 Ranked #3 India was ranked as the number one choice for SSO operation by 10% of the companies. Even though China was indicated as the first choice by 12% of the companies, factors like quality of manpower, cost effectiveness etc. tilt the balance in favor of India as the most preferred destination. Ireland came in third as most preferred destination for healthcare SSO operations. 2007 ®FROST & SULLIVAN 162
    • GROWTH CONSULTING Figure 3.5.8 Healthcare: Ranking of Top SSO Locations Overall Score across Key Parameters Score India 3.8 4 3.8 3.8 China 3.4 4.1 3.4 3.6 Ireland 2.7 4 4 3.3 Cost Efficiency Bus. Envt. Quality of Conduciveness Human Capital India – The Mecca of Outsourcing India has already established itself as the leading destination for IT and IT enabled services. Leading global players from the healthcare industry have relocated their IT and IT services centers to India, however, in this section we would like to highlight the specialized capabilities that India has been building in the healthcare and pharmaceutical outsourcing. Pharmaceutical industry in India is one of the fastest growing sectors. The industry has achieved global recognition as a producer of generic products and low-cost high-quality bulk drugs and formulations. Majority of the leading companies have established market presence in more than 60 countries, which also includes the United States and major European countries. Currently, Indian companies are spending less than 5% of their revenues in R&D, while this percent is as high as 18% for multinational pharmaceutical majors. However, the increasing realization of potentials in Pharma R&D is moving Indian pharmaceutical industry to a more research-driven business strategy. Companies such as Ranbaxy, Dr. Reddy's Laboratories are successfully setting the standards for other Indian companies such as Cipla, Wockhardt, Nicholas Piramal and Torrent, which are now engaged in R&D activities post-patent reform in 2005. There is also an increase in collaborative outsourcing to India. For example, Ranbaxy has made an agreement with GlaxoSmithKline in discovering and developing new NCEs for some of the selected 2007 ®FROST & SULLIVAN 163
    • GROWTH CONSULTING therapeutic areas. According to Confederation of Indian Industry (CII), R&D in India has rapidly grown from US$52 million in 2000 to US$74 million in 2002. CII expects R&D investments to be US$320 million in 2005, which will account for 5% of total turnover. It is estimated that in the coming eight to 10 years, the total pharmaceutical R&D outsourcing from the United States to India will value at US$1.5 billion. CII also suggests that the cost of clinical trials in India is less than one-tenth of the costs in Western countries. It is also shown that the total R&D investment from India's top 10 pharmaceutical companies crossed US$170.0 million in 2004. The number of international pharmaceutical firms with a research presence in India has increased significantly during the past five years. AstraZeneca had established a major R&D facility in 2003, and also expanded its pharmaceutical division during 2004. At present, Sanofi-Aventis, Eli Lilly, Novartis, Pfizer, GlaxoSmithKline, have established clinical research studies in India. While the CRO market is fragmented with a number of small companies, reputed players have gained significant traction with over 50% CAGR over last three years. Global majors like Quintiles, PPD, Parexel, MDS and ICON have either set up their own operations in India or have partnered with local players. Larger Indian CROs are tying up with global majors to obtain relationships and expertise in project management e.g. Siro-Covance. Many of the CROs who initially offered only BE studies have invested in clinical trials, e.g. Lotus labs. While there are few dedicated companies which provide only support services for clinical trials, some Indian CROs are providing complete services by including back office support, medical writing, statistical analysis, SAS programming, data management, site management etc. India achieved an overall score of 3.8 based on its cost effectiveness, business environment and quality of human capital. China – Gateway to a the biggest market through Outsourcing Today, the Chinese pharmaceutical market is growing at an impressive double digit pace with a projected value of US$ 25 billion by 2008. A rising activity in the Chinese life sciences arena has been reported with the increasing high-level support from the government. The thriving generic and bulk active drugs market continue to be the mainstay for the Chinese domestic drug industry with an estimated 90% of the drugs in the market being generics. The Chinese pharmaceutical market is highly fragmented with thousands of small pharmaceutical companies involved in manufacturing one or two 2007 ®FROST & SULLIVAN 164
    • GROWTH CONSULTING generic drugs. Quality control and cost concerns are also present among the manufacturers in China. These led to increased supervision from the government to maintain the quality of the pharmaceutical products. Also, with the increased interference from the government, a gradual shift from generic to innovation led to the development of contract research markets, which resulted in increased partnership with multinational pharmaceutical companies and other bodies. The inherent limiting conditions prevalent in this country have curbed the Western firms from full capitalization on R&D potential. However, big pharma companies are increasingly interested in China. Roche has a US$11 million R&D center in Shanghai, one of five global R&D centers; also conducting genetic epidemiology studies on diabetes, Alzheimer’s etc. in collaboration with Chinese National Human Genome Centers. Eli Lily has a 100 people R&D center for chemistry services in Shanghai together with Shanghai ChemExplorer. Novo Nordisk has a R&D center in China, first outside Denmark for molecular biology, protein chemistry and cell biology, plan to grow from 20 to 60 scientists. GSK has established a Global OTC R&D center; GSK has invested US$2 million towards combinatorial chemistry R&D with the Shanghai Institute of Medical Materials (SIMM). According to China's Department of Drug Registration, demand for clinical trials in China has increased significantly. Applications for clinical trials increased by over 400% to 2,500 in the first half of 2003. Several new hospitals were added to the existing list of 165 hospitals permitted to conduct human clinical trials in China. However, a considerable proportion (47% in 2001) of the trials is for traditional Chinese medicines. The SFDA is taking steps to further increase the attractiveness of the Chinese trials market. Standard rules for conduct of trials were released in 2003 and 2004 and GCP training was made compulsory in April 2004. China achieved an overall score of 3.6 based on cost effectiveness, business environment and quality of human capital. Ireland Ireland achieved an overall score of 3.3 out of 5 and was the third most preferred location for SSO operations amongst the healthcare vertical. Pfizer, Takeda, Wyeth and GSK are some the major corporations to have set up SSO locations in Ireland. 2007 ®FROST & SULLIVAN 165
    • GROWTH CONSULTING 3.6 Transportation & Logistics One of the world’s largest industries, transportation & logistics covers a broad range of sectors ranging from automobiles, aircrafts, trains, logistics services as well as express delivery services. The global automobile landscape is rapidly changing as demand grows for lower priced automotive components, spurring component suppliers to look to China for low-cost production. Along with that, soaring global demand for Asian cars that are enjoying a rapidly expanding customer base worldwide has resulted in mounting pressure on major American automakers to adopt cost saving measures and regain market share in the face of escalating domestic labor costs and intense competition from foreign-based firms. Faced with mounting costs, stringent labor laws, and unfavorable government regulations, some European car manufacturers also continue to generate dismal earnings. The airline industry continues to be affected by staggering fuel prices, triggering increases in airfares by some airlines which, in turn, are intensifying already fierce competition between established airlines and discount carriers. With competition stiffer than ever, innovation is a vital ingredient for developing a sustainable competitive advantage. Leading the innovation race are airlines in the Asia Pacific region, most of which have already deployed in-flight communication technology in an effort to grow their market share of premium customers, particularly itinerant business travelers. Conversely, despite paving the way for many of the technologies that are now being harnessed by airlines globally, highly leveraged North America carriers are putting the brakes on technology innovation to focus on streamlining operations. Across all geographical regions, both established and budget airlines alike have mounted aggressive campaigns to reduce costs and ultimately, narrow the gap between the two airline segments as is evident from widespread investment in automated passenger facilities such as e-ticketing and self-service kiosks. In the logistics service industry, consolidation is becoming a widespread practice as more and more logistics service providers begin to recognize the benefits that may be realized through mergers and acquisitions, principally economies of scale and skills. 2007 ®FROST & SULLIVAN 166
    • GROWTH CONSULTING 3.6.1 SSO Determinants 3.6.1.1 General Perception Across all sectors that make up the transportation and logistics ecosystem, cost savings appear to be the key motivator for much of their shared services and outsourcing initiatives. In addition, innovation appears to be a common goal for a large number of organizations in this industry to develop and maintain a competitive advantage. To that effect, information technology plays a significant role in supporting efforts to achieve rapid innovation. As such, the need to reduce costs and the industry’s high dependency on IT services have resulted in the widespread outsourcing and offshoring of IT support functions. 3.6.1.2 Issues/Considerations A key consideration that needs to be evaluated prior to venturing into outsourcing initiatives is to ascertain whether there is a strong cultural fit and compatibility with the outsourcing service provider. This is to ensure that the two organizations are able to maintain synergies throughout the entire duration of the contract. Equally as important is the need to ensure that the service provider has a clear understanding of the outsourcer’s business model. A global logistics company highlighted that oftentimes, senior management are highly focused on the cost-benefit aspect of shared services and outsourcing at the expense of such real-world elements as language and cultural barriers that could potentially arise in call centers, as well as a general tendency among call center staff to be overly mechanical in carrying out seemingly routine tasks. This may hamper their ability to provide outside the box solutions to resolve customer issues. 3.6.1.3 SSO Drivers For the transportation and logistics sector, the decision to venture into shared service and outsourcing initiatives is principally driven by the need to enhance competitiveness, improve customer service and not least, realize cost savings as shown in Figure 3.6.1. 2007 ®FROST & SULLIVAN 167
    • GROWTH CONSULTING Figure 3.6.1 Transportation & Logistics: SSO Drivers 28% 46% 20% 6% Improve employee productivity 4% 50% 30% 12% Improve asset utilization 2% 20% 52% 26% Enhance competitiveness 2% 8% 66% 24% Focus on core competencies 26% 44% 28% Improve customer service 12% 58% 30% Reduce operating costs 56% 26% 14% Access scarce talent 2% 44% 36% 12% Overcome HR shortages 2% Others * Percentages shown are % of total response Very Low Low Medium High Very High Reduce costs and increase competitiveness Heightened security measures post 9/11 in 2001 cost the airline industry US$ 5.1 billion annually. Similarly, the availability of lower airfares offered by budget airlines has sparked fierce price competition, causing more established airlines to review their price structures with a view to stay competitive and maintain their market share. Invariably, these factors combined are spurring airlines to deploy various measures to reduce operational costs in order to maintain profitability. Along with this, the perceived commoditization of services offered by airlines has caused carriers to adopt both shared service and outsourcing strategies that would allow them to focus on introducing innovative services in order to enhance their competitive advantage. For such carriers as Air France, Jetstar – budget airline and subsidiary of Qantas – and Lufthansa, the need to improve competitiveness and enhance business innovation are perceived as equally significant drivers for their SSO initiatives as the need to reduce operating costs. For the automotive industry, the ability to offer a broad range of vehicles is a critical success factor. This, in turn, has resulted in the need for automobile manufacturers to 2007 ®FROST & SULLIVAN 168
    • GROWTH CONSULTING integrate the operations of their numerous vehicle brands in order to accelerate sales and distribution of their brands as well as maintain a high level of service to retailers and customers. To that effect, many automotive companies have created shared service centers to carry out such tasks. This strategy is apparent within the Premier Automotive Group, the Consumer Business Group of Ford Motor responsible for premium vehicles, to enable each of its brands namely Aston Martin, Jaguar, and Land Rover, to better leverage their individual positions within the luxury vehicle market and provide the resources necessary to support a stronger franchise network. Central to Audi’s decision to outsource some of its IT, finance and accounting, and human resource functions is to realize cost saving benefits. Access scarce talent On the other hand, the need to improve access to scarce talent and surmounting labor shortage are cited as key outsourcing drivers for BMW, outweighing other drivers such as reducing operating costs, improving competitiveness as well as customer service. In addition to cost reduction, another key driver for logistics companies, specifically Maersk, is to have greater access to scarce talent, specifically employees that have a keen familiarity with the complexities associated with the global logistics business. Manage Complexity Given that technology is seen as a key competitive differentiator by many express transportation companies, for instance to perform various IT-enabled services including real-time tracking of deliveries, such companies as FedEx recognize the need for outsourcing their IT operations to support their massive IT infrastructure. Equally as important for FedEx is the introduction and development of new systems to improve internal processes. 3.6.1.4 SSO Concerns It is observed that the key constraints arising from shared service and outsourcing 2007 ®FROST & SULLIVAN 169
    • GROWTH CONSULTING initiatives vary across the transport and logistics industry. Automobile manufacturers may encounter a host of concerns distinct from those of airlines. That said, Figure 3.6.2 illustrates that compromised quality of service by third party providers, lack of domain expertise and potential breach of confidential data emerge as universal concerns. Figure 3.6.2 Transportation & Logistics: SSO Concerns Compromise 2% 46% 40% 6% confidentiality Loss of control 2% 8% 38% 44% 6% Increased costs 2% 46% 46% Reduced service level of 3rd party 56% 26% 12% Lack of knowledge 10% 54% 28% 2% about outsourcing Lack of competent 2% 12% 32% 38% 12% mgmt. staff Over-reliance on 4% 2% 46% 38% 8% external party Stability of 3rd party 4% 20% 36% 22% 14% Org. de-skilling 2% 10% 36% 40% 8% Others 2% There is a growing trend toward nearshore locations. * Percentages shown are % of total response Very Low Low Medium High Very High Reduced Service Levels Reduced service level of external organizations is perceived by Lufthansa, Air New Zealand, Audi, BMW and Maersk as a key concern for some of their outsourcing initiatives. Similarly, the level of stability of and lack of confidence in external service providers are also cited as another albeit lesser constraint. Concerns regarding loss of confidential information The likelihood of compromising confidentiality presents a concern for some airlines, especially in areas that may potentially undermine their intellectual property. To put this into perspective, Jetstar is of the view that if a particular business function involves management of its intellectual property; the budget carrier would then opt to maintain, develop and nurture such functions internally. 2007 ®FROST & SULLIVAN 170
    • GROWTH CONSULTING Lack of Domain Expertise The degree of an external organization’s domain expertise is also perceived as a rising concern by automobile manufacturers. This was one of the key considerations in Volvo Car Corporation’s decision to extend its IT outsourcing contract to a service provider known for its high level of domain expertise in the automotive industry. Similarly, BMW also cited the lack of competent staff to manage IT-related services as a primary concern in its IT outsourcing initiatives. 3.6.2 SSO Trends 3.6.2.1 Spend on SSO As a whole, the transportation and logistics sector’s investment in shared services and outsourcing initiatives in 2006 ranges from three to five percent of annual revenues. Spend on SSO is expected to grow at a CAGR of 9% between 2006 and 2009 with IT services & support, finance & accounting, customer service & call centers & human resources services driving this growth. The total SSO spend by the sector is expected to grow from US$ 113 million in 2006 to US$ 147 million in 2009. The nature of the airline business is such that the costs associated with flight operations including cabin crew salaries, fuel, aircraft maintenance, air navigation, airport charges, make up the bulk of total operating costs, thus leaving a relatively small percentage to deploy for shared service and outsourcing initiatives. For Jetstar, this figure is quantified at approximately four percent of total revenue. BMW, however, spent between 35 and 50 percent of its revenues in 2006 on shared services and outsourcing. 2007 ®FROST & SULLIVAN 171
    • GROWTH CONSULTING Figure 3.6.3 Transportation & Logistics: Spend on SSO SSO spend as SSO Spending % of Revenue (US$ ‘000 Million) 6% 24% 28% 8% 8% Strategic/R&D 6% 150 IT Services & 2% 18% 46% 18% Support 147 135 2% 14% 18% 32% 10% Back-Office Processing 123 4% 113 100 20% 38% 16% Sales & Sales Generation 4%10% 40% 24% Corporate Learning 4% 30% 40% 8% Customer Service 2% 4% 4% 4% 4% 50 & Call Center 2% 36% 34% 4% Procurement 2%14% 22% 26% 16% Human Resources 0% 0 6% 12% 16% 36% 14% Finance & 2006 2007 2008 2009 Accounting * Percentages shown are % of total response Very Low Low Medium High Very High 3.6.2.2 Degree of SSO by type Within the transportation and logistics sector, a considerable number of companies are exhibiting a growing tendency to outsource IT services and support, whereas such functions as finance and accounting and human resources are retained within the organization and carried out internally at shared service centers. IT services and Support IT services and support are increasingly being outsourced in the transportation and logistics sector as is apparent in companies in the airline industry – British Airways; the automotive industry – Volvo; and logistics industry – Maersk, to cite a few examples. British Airways awarded framework contracts for software development work to NIIT and TCS in India which manage lower-level application development and programming for the U.K. carrier. Similarly, Volvo renewed its longstanding outsourcing contract with WM-data, a LogicaCMG company, which is responsible for developing, implementing, and supporting the Swedish automobile manufacturer’s global client and server platform for clients in Sweden and national sales companies across Europe. 2007 ®FROST & SULLIVAN 172
    • GROWTH CONSULTING Finance and Accounting It is also evident that finance and accounting functions are increasingly carried out on a shared service basis. FedEx set up a financial services center in Singapore in 2002, its first outside the United States, to serve the fledgling logistics business in Asia Pacific. With almost 300 staff, the center serves 14 markets including Japan, Taiwan, and Hong Kong and handles such transactions as invoices and collection for the package carrier’s operations across the entire region. Similarly, a shared services approach is also adopted by Air New Zealand and Lufthansa not only for their finance and accounting functions, but also for their human resource administration functions. Lufthansa’s shared service centers are currently located in Ireland, Canada, South Africa, Czech Republic, and Poland while Air New Zealand’s are located in Auckland, New Zealand and to some extent, Fiji. Customer Service and Call Center Some airlines demonstrate a tendency to outsource their customer service and call centers as is practiced by Jetstar which currently has Kuala Lumpur, Malaysia to serve the Asian market; Melbourne, Australia for the Australian and New Zealand markets; and Japan for the Japanese market. At the same time, a number of airlines are more inclined to retain their customer services and call centers within the organization, typically via shared services. This is largely to promote and maintain a consistent level of service provided by customer-facing staff. Given the knowledge intensive nature of customer services and call centers within the airline sector, an established North American airline stressed the importance of building specific know-how among its call center staff. Such knowledge ranges from airline bookings to frequent flyer programs, and the variable prices associated with multiple routes to the evolutionary nature of airline regulations. The same airline cited that although it takes six months to complete formal on-the-job training for call center staff, it may take up to one year for them to develop a strong familiarity with the intricacies of the airline’s call center business. For the airline sector, outsourced customer service functions even cover lost baggage services. Responding to more stringent EU regulations governing lost baggage claims, 2007 ®FROST & SULLIVAN 173
    • GROWTH CONSULTING Air France started outsourcing management of its lost baggage claims to Team Trackers, a move aimed at reducing the airline’s exposure during peak periods. Additionally, airline reservations are also performed through both shared services and outsourcing. Jetstar’s reservations are outsourced to Naditaire while a number of United States-based airlines choose to carry out their reservations internally via shared services. 3.6.2.3 SSO Party of Choice Two major categories have emerged for SSO within the Transportation and Logistics sector. Either the enterprises are using their own facility and resources, or outsourcing completely to an external service provider. In a unique case, British Airway’s subsidiary, WNS eventually listed itself in the NYSE and from thereon maintained arms length relationship with BA while offering its services to external clients. Figure 3.6.4 Transportation & Logistics: SSO Party of Choice Strategic / R&D 88% 9%3% IT Services & Support 19% 25% 56% Third Party Back-Office Processing 75% 8% 17% 22 % Sales & Sales Generation 100% 65 % 12 % Corporate Learning Programs 48% 12% 39% Customer Service 42% 15% 43% and Call Centers Joint Venture Procurement 69% 15% 15% Wholly Owned Human Resources 76% 24% Finance & Accounting 79% 8% 13% Note: Some airlines tend towards captive customer service & call centers, citing the relative ease of developing airline specific knowledge among customer-facing staff & achieving consistency in quality of service as key factors. * Percentages shown are % of total response Wholly Owned Joint-Venture Third Party 2007 ®FROST & SULLIVAN 174
    • GROWTH CONSULTING Outsourcing to Third Party The transportation and logistics sector demonstrates a proclivity to favor outsourcing of IT services to third party service providers. Conversely, there is also a growing trend toward adopting a shared services approach for such functions as finance and accounting, human resources, corporate learning programs, and procurement. This section serves to distinguish between the two approaches while providing examples of current practices adopted by major companies within the sector. British Airways formed WNS Global Services in 1996 as a wholly owned captive business process outsourcing division in Mumbai. The UK carrier’s initial objective of setting up an outsourcing arm in India was primarily to support the airline’s back-office operations and manage ticketing. However, the completion of WNS’ IPO on the New York Stock Exchange a decade after its inception ended the airline’s equity relationship with its Indian offshore outsourcing unit. Today, British Airways continues to be WNS’s third largest client accounting for 12% of its revenues amounting to US$ 202.6 million in FY 2006. Additionally and as indicated earlier, British Airways also has agreements with independent outsourcing service providers in India for software development work, as does Volvo with WM-data which is responsible for a considerable portion of the Swedish automobile maker’s IT support functions. Similarly, the bulk of Jetstar’s IT services and support functions are outsourced to a number of Australian service providers including Telstra, Optus, and Sonnet. Own Facility FedEx’s financial services are performed in its shared service center in Singapore whereas Air New Zealand and Lufthansa have both set up their own centers in various countries, including Ireland and New Zealand, to manage finance and accounting as well as human resource functions. Boeing and Maersk’s corporate learning programs are conducted internally while Qantas and Northrop Grumman’s procurement activities are centrally managed from their respective shared service centers. 2007 ®FROST & SULLIVAN 175
    • GROWTH CONSULTING 3.6.3 SSO Locations 3.6.3.1 Selection Criteria Among the more prominent criteria in the selection of locations are IP regulation, infrastructure quality and costs and not least, compensation costs. Agility and efficiency of service providers often override location specific factors. Figure 3.6.5 highlights the findings from the survey with respect to key decision makers and recommenders for SSO. Typically the CEO, functional heads and COO play a pivotal role in making SSO related decisions as illustrated in the following graph. Figure 3.6.5 Transportation & Logistics: SSO Recommenders & Decision Makers Recommenders Decision Makers CEO 46% 34% COO 8% 54% Functional Heads Interdepartmental 26% (IT/HR/CFO) Team 36% Interdepartmental Team 26% SSO Location Managers 32% Regional/ Geographical Mgrs 26% External Consultants Others 1% Others * Percentages shown are % of total response 2007 ®FROST & SULLIVAN 176
    • GROWTH CONSULTING Figure 3.6.6 Transportation & Logistics: SSO Location Selection Criteria IP regulation 2% 9% 4% 62% 23% Cultural 17% 32% 45% 6% adaptability Infrastructure 17% 53% 30% quality Political stability 2%13% 72% 13% Attrition rates 4%8% 29% 52% 6% Education & 2% 34% 49% 15% language Labor force 2% 28% 57% 13% experience Labor force 4% 19% 54% 23% availability Tax & regulatory 2% 21% 57% 19% costs Infrastructure 19% 54% 27% costs Compensation 15% 48% 38% Costs Very Low Low Medium High Very High BMW regards telecommunications costs as an important consideration in its selection of offshore locations. That aside, the performance car maker also places high emphasis on the presence of a robust mechanism to safeguard intellectual property rights. For Audi, more important than location factors like infrastructure costs, is the ability of external service providers to demonstrate prompt response to critical issues. For a number of airlines including Jetstar, location again may not be as significant a criterion as other factors such as the degree of adaptability and flexibility demonstrated by service providers, coupled with the total cost of ownership associated with outsourcing contracts. Along with factors that help airlines realize cost saving benefits, the availability of government subsidies and tax incentives are also viewed favorably especially by airlines which have been facing significant operating losses in recent years. 3.6.3.2 Top of the Mind Locations India, Singapore and Malaysia are the top three locations with parts of Eastern Europe and Latin America, China and South Africa the top emerging locations for SSO in the transportation and logistics sector as shown in Figure 3.6.7 The comparison of the top locations is presented in Figure 3.6.8 2007 ®FROST & SULLIVAN 177
    • GROWTH CONSULTING Figure 3.6.7 Transportation & Logistics: Top SSO Locations Top SSO Locations % of Respondents who ranked among top 3 1 India 8% 5% 2 Singapore 3% 4% 10% 3 Malaysia 6% 2% 5% Emerging East-EU: Czech Republic, Poland; Locations Lat Am: Peru, Mexico, China, South Africa Stable/Declining Locations UK, USA, Canada, Ireland * Percentages shown are % of total response Ranked #1 Ranked #2 Ranked #3 Figure 3.6.8 Transportation & Logistics: Ranking of Top SSO Locations Overall Score across Key Parameters Score India 4.3 4.4 3.5 4.0 Singapore 3.6 3.6 3.8 3.6 3.7 3.7 3.3 Malaysia 3.5 Cost Efficiency Bus. Envt. Quality of Conduciveness Human Capital While India attained the highest overall score, it also achieved the highest rating for cost efficiency and business environment conduciveness. On the other hand, Singapore 2007 ®FROST & SULLIVAN 178
    • GROWTH CONSULTING earned the highest rating for quality of human capital. The top three locations have also emerged as attractive hubs for IT support and customer services. Companies with finance and accounting, human resource, and call center functions carried out internally or outsourced to external organizations demonstrate a preference for locations that are situated near their source of business and/or markets. Air France’s finance and accounting functions are outsourced to external parties in France as well as Mexico and Peru, while Air New Zealand and Lockheed Martin’s human resource administration functions are performed at their corporate shared service centers in Auckland and various locations throughout the United States respectively. Although Jetstar’s call centers are currently based in Kuala Lumpur to serve the Asia Pacific market, the budget airline is also considering the Philippines for the provision of call center services. 2007 ®FROST & SULLIVAN 179
    • GROWTH CONSULTING 3.7 Entertainment and Media In considering the media and entertainment landscape, it is vital to take into account the prevailing trends that are evolving rapidly in diverse sectors spanning television and radio broadcasting, satellite and cable television, movie production, news and media agencies as well as information providers. The onslaught of alternative delivery methods such as IPTV combined with the availability of video and music entertainment on multiple platforms, including mobile phones and iPods, are allowing for broader choice and greater control among consumers while perpetuating more intense competition between traditional and new media players. For example, traditional cable and satellite television firms are contending with telecommunications companies offering triple play services – voice, television, and Internet services – to maintain their market share. Equally, traditional radio broadcasters are also struggling to maintain their listenership that is rapidly being undermined by satellite radio broadcasters; likewise, newspapers are also facing heated competition in maintaining readership as Internet-based news content proliferates. As such, all sectors of media and entertainment are facing the burgeoning issue of maintaining control of content and audiences while harnessing the potential benefits of a growing number of innovative digital delivery venues that continue to fuel the market with more and more options. 3.7.1 SSO Determinants 3.7.1.1 General Perception The outsourcing landscape in the media and entertainment sector is characterized by long-term mega deals with third party service providers performing a variety of tasks primarily IT services & support and finance and accounting, with contracts ranging from US$ 25 m to US$ 500 m for durations spanning from five to 12 years. Leading the list of big spenders are broadcasters as well as satellite and cable television providers. Joining them are movie production houses that are increasingly outsourcing animation-related graphics work to offshore locations and news agencies that have taken bold steps in outsourcing what was once considered core competencies such as editorial 2007 ®FROST & SULLIVAN 180
    • GROWTH CONSULTING and advertising design. 3.7.1.2 Issues/Considerations While movie production studios are on an aggressive pursuit for new destinations to outsource their animation work at fractionally lower costs, there is nonetheless a need prior to entering into a contract to ensure that offshore animators and co-production houses are sufficiently equipped with animation rendering facilities along with the requisite skill sets to deliver consistent quality while still meeting seemingly tight delivery schedules prevalent in the film industry. 3.7.1.3 SSO Drivers In figure 3.7.1, it is apparent that the need for cost savings outweighs other factors in driving companies in this vertical towards SSO. This is followed by the need to enhance competitiveness and improve customer service. Figure 3.7.1 Entertainment & Media: SSO Drivers 38% 13% 25% 25% Improve employee productivity 25% 38% 25% 13% Improve asset utilization 25% 38% 38% Enhance competitiveness 13% 25% 25% 38% Focus on core competencies 13% 25% 63% Improve customer service 25% 25% 50% Reduce operating costs 63% 38% Access scarce talent 75% 25% Overcome HR shortages * Percentages shown are % of total response Very Low Low Medium High Very High 2007 ®FROST & SULLIVAN 181
    • GROWTH CONSULTING Cost savings The primary driver of animation offshoring is cost savings, largely arising from the availability of low-cost animation platforms and state-of-the art animation labs in emerging animation hubs such as India, the Philippines, Korea as well as Taiwan. This is apparent within such global movie and entertainment giants as Disney, Sony Pictures and Fox Entertainment. The outsourcing of broadcasting technology is regarded by MTV Asia as more cost efficient than performing such services internally. The BBC’s practice of outsourcing and offshoring much of its finance and accounting and human resource activities as well as IT services and support is motivated principally by the need to enhance business innovation and reduce operating costs. The current contract that it recently sealed with Xansa for the provisioning of finance and accounting services is expected to generate savings of US$ 38 million annually. Cost savings appear to be the primary motivator for offshoring some aspects of journalism as is apparent with Reuters that is already taking advantage of the significantly lower costs of hiring financial journalists in Bangalore. Another driver for this emerging trend is to enable core journalists located in head offices to focus their time and effort on developing strategic stories. The next two subheadings underscore the growing importance of other key drivers, namely the need to achieve greater efficiencies and drive business innovation. Enhance competitiveness through greater efficiencies Among the key factors motivating the media and entertainment sector to adopt shared service and outsourcing initiatives are the need to drive greater efficiency across the entire organization as well as to realize the potential cost savings that may be accrued by outsourcing and offshoring selected business processes. The BBC’s practice of offshoring much of its finance and accounting and human resources activities as well as IT services and support is motivated principally by the need to enhance business innovation and reduce operating costs. Central to its stated objectives are to facilitate service transformation coupled with the need for greater business efficiency. British Sky Broadcasting regards the presence of a shared service center for the provisioning of human resource services would help improve asset 2007 ®FROST & SULLIVAN 182
    • GROWTH CONSULTING utilization, drawing other work streams away from human resource associated functions. As well as this, another driver for its formation of a human resource shared service center is to maintain control of such services, which it believes would be undermined if outsourced to external organizations. Drive Business Innovation McGraw-Hill believes the outsourcing of IT support services would better enable the publishing conglomerate to utilize innovative technologies, which in turn would provide the reinforcement necessary for business innovation. Similarly for satellite and cable television providers, DirecTV and Cablevision, harnessing potential cost savings as well as augmenting internal IT development capabilities are core drivers for outsourcing a significant portion of their IT services. 3.7.1.4 SSO Concerns Figure 3.7.2 illustrates the most commonly cited issues encountered by media and entertainment organizations. Dominating the list of inhibitors of outsourcing are loss of control, lack of competent management staff and inconsistent service levels among vendors. For some companies in this sector, these concerns may not necessarily be as worrisome as such issues as the limited understanding among offshore call center workers of local customers and cultural nuances, and inadequate staff training in external organizations that may potentially undermine the desired quality of service. Along with these, increasing costs coupled with staggering attrition rates witnessed in some offshore locations are also cause for concern. 2007 ®FROST & SULLIVAN 183
    • GROWTH CONSULTING Figure 3.7.2 Entertainment & Media: SSO Concerns Compromise 13% 63% 25% confidentiality Loss of control 88% 13% Increased costs 13% 63% 25% Reduced service 13% 38% 25% 25% level of 3rd party Lack of knowledge 25% 63% 13% about outsourcing Lack of competent 13% 38% 25% 13% 13% mgmt. staff Over-reliance on 25% 63% 13% external party Stability of 3rd party 13% 50% 38% Org. de-skilling 38% 63% * Percentages shown are % of total response Very Low Low Medium High Very High Loss of control (loss of understanding of Customers) There is a prevailing tendency among satellite and cable television providers to situate their customer service and call centers close to their markets. Although it may be more cost effective to offshore such services to locations where labor costs may be lower, there is a growing concern stemming from the fact that foreign call center workers may not necessarily understand their local customers. It is largely for this reason that Comcast opened a captive call center in Texas to serve the domestic market while stepping up efforts to provide more intensive training to justify higher costs associated with locally based call centers. Another mounting concern stems from the fact that local customers may not necessarily appreciate dealing with foreign call center workers adopting false personas as may be revealed by cultural and linguistic clues. Given that the BBC outsources much of its finance and accounting transactions to offshore locations, it nonetheless recognizes the possibility that the retained external organization may not necessarily make the provisions necessary for continuous talent development of staff that perform the stated function, a scenario that exposes the national broadcasting corporation to the risk of compromised quality of service. Other factors highlighted by survey respondents as concerns include cultural nuances, inadequate cost savings and high attrition rates. 2007 ®FROST & SULLIVAN 184
    • GROWTH CONSULTING Cultural Nuances The primary concerns associated with offshoring journalism arise from distinct work cultures in the United States and India coupled with differences in the style of communication. Reuters has cited that the laidback nature of the Indian work culture coupled with a broad tendency among Indian journalists to write overly wordy copy need to be surmounted by installing a sense of urgency and providing adequate training to ensure crisp and accurate copy. Inadequate Cost Savings Like the BBC, much of MTV Asia’s finance and accounting transactions are also outsourced to an external party; however, it has cited inadequate cost savings as a concern compounded by mounting costs related to outsourcing such services to its current provider. Not dissimilarly, the entertainment channel is also casting its net beyond Singapore for external providers of broadcasting technology that are able to help the Viacom subsidiary realize greater cost savings. The fact that there are a limited number of suitably qualified broadcasting technology service providers in the Southeast Asian region is cited as another inhibiting factor. While movie production studios are already realizing the much heralded cost saving benefits of offshoring animation work, they are also exposing themselves to the risk of inconsistent quality that may potentially arise in the delivery of post production work. High Attrition Rates Another constraint stems from high attrition rates among Indian journalists which Reuters describes as staggering as compared to those of their counterparts in other Reuters offices. Such high turnover is perpetuated by the rapid growth of financial journalism propelled by India’s economic boom and to a certain extent, the deregulation of television, resulting in the creation of half a dozen financial news channels on cable television. Invariably, this has led to a growing demand for financial journalists as well as escalating salaries, making it more challenging for news agencies such as Reuters to retain staff. 2007 ®FROST & SULLIVAN 185
    • GROWTH CONSULTING 3.7.2 SSO Trends 3.7.2.1 Spend on SSO The percentage of revenue invested by the media and entertainment sector in shared services and outsourcing varies widely. While most players in the sector spend between 3 and 10% of total revenue on SSO operations, a few broadcasters spend up to 45% of their revenues on SSO. Figure 3.7.3 illustrates that spend on SSO as a percentage of overall revenues is expected to grow at a CAGR of 10% between 2006 and 2009. The functional areas of IT services, finance and accounting, human resource services and customer service and call centers are driving this growth in the current media and entertainment environment. This trend is expected to change, however, with SSO spend in the upcoming areas of animation, broadcasting technology and journalism expected to spiral as more and more media and entertainment companies recognize the potential cost benefits that may accrue from outsourcing such tasks to less expensive locations. Leading the list of big spenders are organizations from the broadcasting segment as well as satellite and cable television providers. Along with them, movie studios are also demonstrating an ever increasing trend to invest generously in animation work in offshore locations. Figure 3.7.3 Entertainment & Media: Spend on SSO SSO spend as SSO Spending % of Revenue (US$ ‘000 Million) 38% 13% 13% Strategic/R&D 15.00% 80 IT Services & 13% 25% 25% 13% Support 38% 25% Back-Office 12.00% Processing 52 60 47 38% 13% 25% Sales & Sales 43 Generation 9.00% 39 50% 13% Corporate Learning 40 6.00% 25% 38% 13% Customer Service 10.00% & Call Center 9.00% 9.50% 8.50% 20 38% 13% 13% 13% Procurement 3.00% 38% 25% 13% 13% 13% Human Resources 0.00% 0 13% 13% 25% 38% Finance & 2006 2007 2008 2009 Accounting * Percentages shown are % of total response Very Low Low Medium High Very High 2007 ®FROST & SULLIVAN 186
    • GROWTH CONSULTING 3.7.2.2 Degree of SSO by type The functional areas commonly outsourced or carried out through shared services are principally finance and accounting, human resources, IT support services and customer service and call centers. Key activities in the aforementioned areas include accounts payable, payroll and managed services. Emerging areas that have entered the outsourcing fold are 3D feature animation films, broadcasting technology, and journalism. Other functions managed at shared service centers or outsourced on a relatively smaller scale include real estate and facilities management and fulfillment activities such as printing and binding services. Finance and Accounting Media and entertainment companies recognize the potential benefits that may accrue from outsourcing finance and accounting services. In a recently inked US$ 160 million finance and accounting services deal, the BBC engaged Xansa for the provisioning of a host of transactions including purchasing and sales transaction processing, artist and contributor payments, financial management and project accounting, payroll and expenses services. MTV Asia, a subsidiary of Viacom, also outsources its payroll services to a Singapore based service provider. HR Services Similarly, Vivendi Universal Entertainment currently engages Exult, Inc. for the provisioning of some accounting and human resource related processes including payroll and accounts payable. This is part of a 10-year agreement worth approximately US$ 60 million for Exult. Outsourcing aside, more and more media and entertainment outfits have also formed shared service facilities to manage their finance and accounting as well as human resource services. This practice is adopted throughout The Walt Disney Company where such services are managed by Disney Worldwide Shared Services in Florida. Similarly, throughout British Sky Broadcasting, or BSkyB, human resource related functions are centrally managed by an internal shared service team within the human resource 2007 ®FROST & SULLIVAN 187
    • GROWTH CONSULTING department. IT Services Specific examples of IT services typically outsourced to external service providers are managed services, data services and code development to name a few. The outsourcing of such services is apparent in the Walt Disney Company in which desktop computer support and network management are outsourced to IBM and ACS in the United States. By the same token, McGraw-Hill engages AT&T and Verizon Business for the provisioning of managed services while The Nielsen Company, formerly VNU, outsources a sizeable chunk of its data services to outsourcing providers in India. Customer Service & Call Centers Bucking the trend of outsourcing call center services, a growing number of cable and satellite television providers in North America and the United Kingdom have set up captive call centers as evidenced by Comcast’s call centers in Irving, Texas as well as those of Virgin Media dispersed throughout the U.K. Emerging Areas The fact that global movie production and entertainment houses from the United States, Canada, United Kingdom, France and Japan are increasingly offshoring 3D animation film work is testament to the rising prominence of this area in the outsourcing landscape. Entertainment conglomerates that have begun to outsource an abundance of development, production and post-production work, especially to India and to some extent the Philippines, include Disney, Sony Pictures, Viacom, Cartoon Networks and Fox Entertainment. More and more media organizations are increasingly offshoring journalism to cheaper locations overseas. Along with that, IT support services and content related tasks such as graphic design and copy editing are also being sent abroad. Led by Reuters, this practice has recently gained wide acceptance among similar news providers including 2007 ®FROST & SULLIVAN 188
    • GROWTH CONSULTING Columbus Dispatch and Dallas Morning News that engaging the services of advertising design to Affinity Express in Pune, India, and of which IT computer support is outsourced to India. In MTV Asia, broadcasting technology is currently outsourced to Ascent Media in Singapore, while a considerable portion of McGraw-Hill’s fulfillment activities for its portfolio of magazines are also outsourced to offshore locations. The Nielsen Company recently established its Corporate Real Estate Services to manage property and facilities related matters for its businesses worldwide. 3.7.2.3 SSO Party of Choice Entertainment and media companies typically use either third party outsourcing or wholly owned facilities for their SSO operations. This is illustrated in figure 3.7.4. There is a growing trend toward forming corporate centers of excellence for finance and accounting as well as human resource services. While third party outsourcing is prevalent in the provisioning of IT services, it is also gaining rapid momentum in animation and journalism. Figure 3.7.4 Entertainment & Media: SSO Party of Choice Strategic / R&D 67% 33% IT Services & Support 33% 67% Third Party Back-Office Processing 50% 50% 44 % 33% 67% Sales & Sales Generation 56 % 60% 40% Corporate Learning Programs 50% 50% Customer Service and Call Centers 50% 50% Procurement 60% 40% Wholly Owned Human Resources 60% 40% Finance & Accounting 60% 40% * Percentages shown are % of total response Wholly Owned Joint-Venture Third Party Outsourcing There is a growing trend among an increasing number of media and entertainment companies to outsource IT related services, principally telecommunications network management, code development work and data services, to independent service 2007 ®FROST & SULLIVAN 189
    • GROWTH CONSULTING providers. The outsourcing of such functions is widely practiced by Cablevision, McGraw- Hill and The Nielsen Company. Similarly, companies that continue to outsource their call centers to external parties demonstrate a tendency to engage local call center providers. BSkyB is just an example of an increasing number of companies that have outsourced their call center operations to U.K. based Response Handling. Own Facility Although the outsourcing of finance and accounting transactions and human resource services are becomingly increasingly prevalent in this sector, some media and entertainment companies are inclined to retain such functions within their shared service operations. Through Disney Worldwide Shared Services and The Nielsen Company’s corporate centers of excellence, respectively, these two media and entertainment conglomerates are able to streamline and standardize the processes necessary to manage their key corporate functions. Captive call centers are becoming increasingly prevalent within the cable and satellite television sector across the United Kingdom and North America as reflected in the call center operations of Comcast and Virgin Media. 2007 ®FROST & SULLIVAN 190
    • GROWTH CONSULTING 3.7.3 SSO Locations 3.7.3.1 Selection Criteria As seen in figure 3.7.5, the CEO, COO and functional heads play a key role in making SSO related decisions. Figure 3.7.5 Entertainment & Media: SSO Recommenders & Decision Makers Recommenders Decision Makers 38% CEO 63% 25% COO 38% 13% Functional Heads Interdepartmental 25% (IT/HR/CFO) Team 38% Interdepartmental Team 24% SSO Location Managers 25% Regional/ Geographical Mgrs 25% External Consultants Others 1% Others * Percentages shown are % of total response While infrastructure quality and costs, labor force availability and compensation costs appear to be the key criteria that media and entertainment outfits consider in selecting shared service and outsourcing locations, geographical proximity to customers is also growing in importance. Figure 3.7.6 Entertainment & Media: SSO Location Selection Criteria 2007 ®FROST & SULLIVAN 191
    • GROWTH CONSULTING IP regulation 50% 50% Cultural 43% 43% 14% adaptability Infrastructure 29% 29% 43% quality Political stability 57% 29% 14% Attrition rates 71% 14% 14% Education & 43% 29% 29% language Labor force 43% 29% 29% experience Labor force 29% 14% 43% 14% availability Tax & regulatory 57% 29% 14% costs Infrastructure 43% 14% 43% costs Compensation 43% 29% 14% 14% Costs Costs and Availability (Labor and Infrastructure) Very Low Low Medium High Very High The BBC regards labor costs and availability as paramount to its decision in its selection of offshore locations, primarily India and Northern Ireland, to host a variety of corporate functions. Global movie studios demonstrate a strong inclination to offshore animation and special effects work to locations that are able to offer a quality animation talent pool at substantially lower costs. To that effect, a growing number of Hollywood studios are already harnessing the scalable pool of creative animation talent that India has to offer at half the cost of performing the same services in the United States. Proximity to Customers Another important criterion growing in importance is geographical proximity to customers. Such is the case with satellite and cable television providers in the United States and United Kingdom that are entrenched in the practice of setting up captive call centers domestically to serve their respective markets. Equally, cultural affinity is also acknowledged as a key factor for situating call centers near the source of business. 2007 ®FROST & SULLIVAN 192
    • GROWTH CONSULTING 3.7.3.2 Top of the Mind Locations The US, India and UK are the top three locations with Ireland the top emerging location for SSO in the media and entertainment sector. Figure 3.7.7 Entertainment & Media: Top SSO Locations Top SSO Locations % of Respondents who Rank ranked among top 3 1 USA 50% 13% 2 India 25% 13% 3 UK 13% 13% Emerging Philippines, Ireland Locations Stable/Declining Locations UK, USA * Percentages shown are % of total response Ranked #1 Ranked #2 Ranked #3 While the US attained the highest overall score, it also achieved the highest rating for quality of human capital. A close second, India surpassed other countries with respect to cost efficiency. 2007 ®FROST & SULLIVAN 193
    • GROWTH CONSULTING Figure 3.7.8 Entertainment & Media: Ranking of Top SSO Locations Ranking of Top Locations Overall Score across Key Parameters Score USA 3.8 3 3.8 4.2 India 4.2 3.8 3.1 3.6 UK 2 3.8 4 3.5 Cost Efficiency Bus. Envt. Quality of Conduciveness Human Capital United States and United Kingdom The formation of corporate shared services is proliferating across the media and entertainment sector in both the United Kingdom and United States, primarily to serve a number of key functional areas including finance, human resources and procurement. For instance, British Sky Broadcasting’s (BSkyB) human resources are carried out at their shared service center in England. Additionally, in what is referred to as “Project Forward”, The Nielsen Company has established corporate centers of excellence in numerous locations in the United States to manage selected processes for its global businesses. Along with the aforementioned processes, such centers also have overall responsibility over real estate and facilities management and outsourcing. Broadcasting companies in the United Kingdom demonstrate a proclivity to maintain their 2007 ®FROST & SULLIVAN 194
    • GROWTH CONSULTING customer support services and call centers within the country as is practiced by the BBC and Virgin Media, which has call centers operating in various locations including Glasgow, Manchester, and Teesside. In the same way, cable and satellite television service providers in North America exhibit a similar inclination to keep their customer care services and call centers within the United States as is the case with Comcast and DirecTV. India Viewed as a prime location for IT services by numerous sectors, India is also regarded favorably by the media and entertainment sector as a preferred offshore destination for the outsourcing of IT support and services. The Nielsen Company started to outsource jobs at its marketing information division to India, primarily for data services. Cablevision has strategic partnerships with Indian IT vendors, both to augment internal IT development capabilities and to help plan, design and implement new projects. Similarly, McGraw-Hill has developed a strong partnership with IT service providers in India, outsourcing a fair amount of code development work to various locations across the country. IT aside, India has also grown in prominence as an offshore center for finance and accounting services. The BBC's financial and accounting services are housed from a mix of locations not only in the United Kingdom, but also in India. Not least, India is also gaining more and more impetus as a highly favored location for animation and content development outsourcing. Disney, Fox Entertainment, Lionsgate, NBC Universal and Sony Entertainment are just a handful of global entertainment outfits harnessing India’s 3D animation capabilities at fractionally lower costs. Ireland A considerable amount of IT and non-IT related activities are also outsourced to or carried out at shared service centers across Ireland and Northern Ireland. The BBC’s human resources are currently outsourced to a third party in Northern Ireland, while some non-technology related activities of McGraw-Hill’s global businesses are managed centrally at the publisher’s shared service operations in Galway, Ireland. 2007 ®FROST & SULLIVAN 195
    • GROWTH CONSULTING 4.0 Conclusion Companies worldwide have been using Shared Services and Outsourcing to cut down on costs and streamline their processes in an effort to improve overall business and strengthen their market position. As the 2007 Frost & Sullivan shows, MNCs across industry verticals are not just continuing but increasing their SSO efforts. The learning curve that built up in recent years by outsourcing and offshoring, mainly non-core, non- critical processes to low-cost countries such as China, India, Malaysia or Eastern Europe has increased companies’ comfort-level and SSO might slowly gain a foothold in more core areas. While some industries like BFSI might never be able to use the full potential of SSO due to the stringent regulations they are facing and the risk to their reputation among customers; others, like Technology or Healthcare are exploring or already pursuing such opportunities. On the other side of the scale, more countries are exploring ways to tap into the lucrative SSO market to boost their economies by attracting world class companies. As a consequence, such countries will have to ensure that they do not just offer cheap labor but more value for money in terms of tying close knots with the industry to understand their needs and provide excellent SSO solutions to cater to them. This includes a strong effort to ensure that whatever processes or data is outsourced or offshored, is both safe and protected by IP regulations which are strictly enforced to provide a high level of comfort and security to companies. There is no doubt that SSO will continue to be a key component of companies’ efforts to grow and improve their business. With MNCs at the forefront of the SSO movement and more medium and small service providers offering outsourcing and offshoring services, SMEs are in the starting position to take SSO to the next level by jumping on the wagon that promises lucrative benefits. 2007 ®FROST & SULLIVAN 196