2008 was brutal on many counts and I suspect most people will be happy to see it pass. Our two main markets – the US and the UK – suffered economic slowdowns, housing slumps, financial dislocation and more. In the US we’ve had twelve months of recession and things don’t look set to improve anytime soon.

Against this backdrop I think we’ve done pretty well – our revenues will be up just over 20% on 2007 which is good, but nothing compared with our 5-year CAGR to 2007 which approached 60%. And I think 2009 will be much harder than 2008: discretionary budgets will be lower and clients will focus on cutting costs where they can. Cost cutting is never fun but it is something we can do. Our business model means we can help clients move costs from fixed to variable as well as lower hourly rates, even compared to other offshoring and outsourcing options.

One welcome trend is that our work has been moving from ad hoc and occasional assignments to regular and planned work. We still do a lot of work as and when clients ask, but over recent years its gone from close to 100% ad hoc to about 50% regular. As they get to know us it’s an easy shift for clients to make – they get used to us through occasional assignments and then typically ask us to take on functions completed in-house or by other outsourcers. Clients seem to value being able to delegate away chunks of their business so they can focus on higher value tasks. This might mean we write newsletters, do daily or weekly searches to monitor issues, prepare competitor profiles, track earnings releases etc, leaving them free to do more talking, analysis and thinking.

I’m heading back to my Christmas slumbers but will back soon with a look forward to 2009…

The other day Gartner came out with its top 30 offshoring destinations. Unsurprisingly, India is the front runner but the range of choice is impressive:

New contenders are emerging to challenge the Bric (Brazil, Russia, India and China) countries’ dominance of the offshoring market.

While India was the “undisputed leader” followed by China in the list of the top 30 offshoring destinations, as compiled by analysts Gartner, this year’s list showed Mexico, Poland and Vietnam pushing their way up to take them on.

Ian Marriott, research vice president at Gartner, said these countries would be seeking to take advantage of the credit crisis to capitalise on organisations’ drive to save costs

You can see Gartner’s list here and some commentary here.

Around the same time the UK’s Computer Weekly came out with its Top five outsourcing destinations to watch for IT services and outsourcing. IT outsourcing is very different than BPO, but where IT leads, BPO often follows. Computer Weekly’s top five are:

1. Argentina

2. Bulgaria

3. China

4. Egypt

5. The Philippines

I was intrigued by the inclusion of The Philippines, a country where we already complete a fair amount of work - the time zone is great for overnight processing, the education system is good and, we find, people are keen to learn and ready to listen to feedback - important things when you need manage quality from many time zones distant.

Yesterday I wrote about the changing economics of outsourcing/offshoring to India and that got me thinking about our experience with this. About five years ago the focus was very much on price and outsourcing/offshoring to low-cost countries like India, the Philippines etc was very compelling.

But over the last six-months or so we’ve won a series of assignments and outsourcing contracts, usually taking over from Indian-based outsourcing companies. These aren’t one-off assignments, but rather ongoing work that for five or more years has been offshored to India but is now being repatriated.

So why? Clients give us a few reasons; some I could have predicted:

Staff continuity – Indian-based providers often have churn rates of 25% or more and for a client it becomes exasperating having to suffer the second-hand consequences as vendor staff leave and replacements have to learn the ropes afresh. We sometimes have the same problem but not to the same degree; our teams are made up of people working from home and good work-from-home opportunities are hard to find, which likely explains why our churn rates are 2-5%.

Ease of communicating – for all the apparent logic of pushing work to the lowest cost provider on the other side of the world, we repeatedly hear that clients prefer to deal with someone local  - they’re easier to reach in the working day and likely more familiar with the issues at hand.

But some reasons are unexpected, and here are two:

Diversification – we were recently asked to bid to provide research services to a large investment bank (not so large any more!) with the condition that all the work had to be completed outside of India. The client’s rationale was that they already had sizable exposure to Indian operations and wanted to hedge their bets.

The Mumbai attacks are likely to spur companies to diversify operations. A December 4 article in Financial Week - Attacks in Mumbai could force execs in U.S. to rethink outsourcing plans – carried a series of quotes and comments about the need for large corporations to diversify across multiple locations.

Moreover, the added security will increase costs of offshore providers, and this brings us to the most surprising reason we hear – Cost.  We all know that professionals in the US are paid way more than those in India, so how can this be?

While hourly rates in India remain much lower, the differential has fallen substantially.  Wage inflation at Indian KPO companies has been in the region of 14-16 percent annually, with increases approaching 30 percent for some of the higher-skill knowledge service areas; applied over ten years or so, this starts to make a difference.

Similar trends apply to other costs, like infrastructure and real estate. In an October 2007 article Anantara Solutions CEO, Mr Prabhat, said

“The cost of rentals and office infrastructure (including secretarial services) is higher by around 15 per cent in Chennai than it is for far superior infrastructure in places such as New Jersey” (Anantara Solutions has offices in both locations).

Perhaps most important, clients are getting better at fully costing outsourcing services. They are now starting to think about the costs of churn (and the additional training costs they bring), additional management time entailed in managing relationships, additional costs required for internal quality control, travel costs, rework time, the value of dealing with vendors on the same time zone, the costs of errors, the rising costs of IT security and so on.

None of these alone will make US professionals cost competitive with Indian professionals on an hourly basis, but bring it together and the case for wholesale outsourcing of many knowledge functions gets less compelling. Factor in things in which US professionals excel - quality, experience, local knowledge, benefits of same-day working etc – and the pendulum starts to swing.

I did a quick scan to see what is happening beyond our niche and it does show that some service providers and their customers are “rediscovering” the US. Companies like Accenture, BearingPoint and CapGemini are now setting up in smaller, less expensive areas like Kansas City; Hattiesburg, Miss.; and Tulsa, Okla., all of which has to be encouraging.

As an organization, Busines360 is indifferent to where the work goes – we have teams and individuals in all the main provider countries (as well as some well off the beaten track) – but from a personal perspective I’m really pleased to see that companies are at last starting to think beyond just hourly rates to comparing the full like-for-like costs of services.

Over the last five years or so the dominant direction of business process outsourcing has been to India, with other countries like the Philippines and China lagging behind but still taking a fair chunk of work from US and European professionals.

And the biggest reason was the chance to lower costs, mainly on the back of lower wages in these countries. The wage differential remains substantial but the case for pushing ever more work to these countries looks to be weakening.

A December 2008 report from TowerGroup points out that managers at some US companies are discovering that offshoring in India is not the cost-saver they imagined, especially for captive offshore operations, in which the US parent sets up and runs the outsourcing operation, usually employing local workers to staff much of the operation.

Reading this reminded me of a February 11, 2008 article in the Wall Street Journal –
Rethinking the India Back Office; Some Western Firms Weigh Selling Their Units as Costs Rise, Dollar Weakens. The author, Jackie Range, cited a study by McKinsey & Co. and Nasscom, the Indian tech and outsourcing industry group, which found that, on average, company back offices - “captives” - were less efficient than companies run by outsourcing firms that specialize in the business. For some types of back-office work, captives’ costs are 30% higher. The survey also found that the higher costs didn’t lead to lower staff turnover or better-quality work.

More recently, the September issue of McKinsey Quarterly had an article – Time to rethink offshoring? – that showed how shifting cost curves mean the US is becoming a more competitive place to manufacture high-tech products.

“The production of high-tech goods has moved steadily from the United States to Asia over the last decade. The reasons are familiar: lower wages, a stable global economy, and rapidly growing local markets. These factors combined to make nations such as China and Malaysia favored manufacturing locations. In the last two years, however, the favorable economic winds that carried offshoring forward have turned turbulent. The new conditions are undermining some of the factors that made manufacturers of every stripe, including those in high tech, move production offshore” – Ajay Goel, Nazgol Moussavi, and Vats N. Srivatsan, McKinsey Quarterly, Sept 2008

McKinsey’s argument rests mainly on higher wage inflation in offshore locations and transportation costs and here is their summary analysis:

Manufacturing high-tech products is obviously different from knowledge services, but it all goes to show that this change is affecting business across a number of fronts.

Also, since McKinsey complete its analysis the dollar has strengthened, especially against the Indian Rupee, and oil prices have collapsed, so their findings wouldn’t be as compelling today. But these are likely short-term affects that won’t affect the longer-term view.

All up, clients will start to be more discerning when it comes to outsourcing and offshoring. One to watch.