APSM Project Effective Strategies in Domestic BPO Market

Advance Program in Strategic Management Project on Effective Strategies in Domestic BPO Market

Project Team Members

Mohammad Mohsin Chakradhar Nalam Hemant Kewalya Mohd Anwar Pasha

APSM Batch 03

-1-

@2010 Indian Institute of Management Calcutta

APSM Project Effective Strategies in Domestic BPO Market

Table of Contents
1. 2. ABOUT THE STUDY ------------------------------------------------------------------------------------------------3 DOMESTIC BPO MARKET OVERVIEW -----------------------------------------------------------------------4 FACTORS LEADING TO DOMESTIC BPO GROWTH --------------------------------------------------------------------5 CURRENT DRIVERS OF OUTSOURCING --------------------------------------------------------------------------------5 INHIBITORS OF DOMESTIC BPO GROWTH IN INDIA -------------------------------------------------------------------6 3. DEMAND ANALYSIS OF DOMESTIC BPO -------------------------------------------------------------------7 VERTICAL SECTOR-WISE ANALYSIS OF DOMESTIC BPO------------------------------------------------------------7 HORIZONTAL SERVICE LINE-WISE ANALYSIS OF DOMESTIC BPO -------------------------------------------------9 4. EVOLVING BUYERS SIDE - GROWING AWARENESS ------------------------------------------------ 10 VENDOR SELECTION CRITERIA: DOMESTIC BUYERS PERSPECTIVE -------------------------------------------- 10 CHALLENGES FACED BY BUYERS ------------------------------------------------------------------------------------- 11 ROAD AHEAD FOR DOMESTIC BUYERS ------------------------------------------------------------------------------- 12 5. THE SUPPLY SIDE - INCREASED CAPABILITY --------------------------------------------------------- 13 DOMESTIC SUPPLIER: CRITICAL SUCCESS FACTORS ------------------------------------------------------------- 13 KEY CHALLENGES FACED BY DOMESTIC SUPPLIERS -------------------------------------------------------------- 15 6. DOMESTIC BPO - MARKET DYNAMICS -------------------------------------------------------------------- 17 DOMESTIC OPERATING MODELS -------------------------------------------------------------------------------------- 17 DOMESTIC PRICING MODELS ------------------------------------------------------------------------------------------ 18 COST STRUCTURE OF THE DOMESTIC BPO MARKET -------------------------------------------------------------- 19 KEY DOMESTIC BPO DEALS ------------------------------------------------------------------------------------------- 20 KEY TRENDS IN DOMESTIC BPO INDUSTRY ------------------------------------------------------------------------ 21 7. STRATEGY FOR A NEW PLAYER ---------------------------------------------------------------------------- 23 ROAD AHEAD : BENEFIT FOR BUYERS & SUPPLIERS -------------------------------------------------------------- 24 KEY ACTION POINTS FOR THE FUTURE GROWTH OF DOMESTIC BPO ----------------------------------------- 24 SWOT ANALYSIS: DOMESTIC BPO MARKET ------------------------------------------------------------------------ 25 8. REFERENCES ------------------------------------------------------------------------------------------------------ 26

APSM Batch 03

-2-

@2010 Indian Institute of Management Calcutta

APSM Project Effective Strategies in Domestic BPO Market

1. About the Study

India is at the forefront of the rapidly evolving Business Process Outsourcing (BPO) market and is well established as a destination of choice among global outsourcers. Over the past decade, Indian BPO industry has grown exponentially in size and has significantly matured in export service delivery capability and footprint. Now, it is at an inflexion point with the unique opportunity to spread into the rapidly growing domestic market. The following study outlines the domestic BPO market in India, and provides an insight into the future outlook for the industry by analyzing current trends and industry practices. Indias impressive economic growth, resulting in increased consumption, has fueled its growth across various sectors in India. There is significant headroom in the addressable BPO opportunity for domestic buyers and providers, and there are sizeable untapped opportunities across a wide spectrum of segments. Further, the countrys domestic BPO industry is favorably positioned to benefit from its established delivery capabilities, which exert a considerable influence on buyers decision to opt for outsourcing. This study is based on research covering the demand and supply side of the domestic BPO market in India and primary research covering five areas: service-line demand evolution, sector-wise demand evolution, buyers and suppliers landscape and key future trends. Cross-case analysis.

APSM Batch 03

-3-

@2010 Indian Institute of Management Calcutta

APSM Project Effective Strategies in Domestic BPO Market

2. Domestic BPO Market Overview

A glance at Indias overall BPO industry growth helps put the dynamics of the domestic BPO market in perspective. BPO services, accounting for over 20% of the Indian IT Industry (including hardware), is the fastest growing segment across software and services, driven by scale as well as scope. The Indian BPO industry, currently sustaining an employee pool of over 700,000, can be broadly classified into Exports and Domestic. Exports - The exports segment grew from USD3.1 billion in fiscal 2004 to USD11 billion in 2008 and currently accounts for 37% of the global business process offshoring pie. As per estimates in a business as usual mode, Indias BPO exports will grow to USD28-30 billion over the next four to five years. With proactive measures, it has the potential to reach USD50 billion by 2012, with a maximum addressable opportunity of USD220-280 billion. Domestic - The domestic BPO market, with a growth rate of 50% over the last five years, grew faster than the exports market to reach nearly USD1.6 billion in FY2008. At a conservative CAGR of 38%, the domestic BPO market is slated to reach USD6 billion by 2012. It presents a huge untapped growth opportunity with addressable market opportunity is in the range of USD1619 billion by 2012.

APSM Batch 03

-4-

@2010 Indian Institute of Management Calcutta

APSM Project Effective Strategies in Domestic BPO Market

Factors leading to domestic BPO growth

There are three primary reasons why the domestic BPO market is expected to emerge as a sizeable segment over the next few years. First, its exponential growth across multiple industries will require companies to focus more intensely on their specific core capability areas. The telecom and BFSI industries are the early exhibitors of this trend. Second, as competition intensifies due to rising domestic competition and lowering of international trade barriers, the domestic industry is expected to face increasing cost pressures and a need to match global cost structures/best practices Third, increased capability in the supplier community is also encouraging Indian companies to move towards outsourcing. Having grown via the export market, many large suppliers have developed end-to-end capabilities that are large enough to attract domestic players looking at high-volume growth. Additional factors include the reduced cost of connectivity, the rapidly growing Indian economy, rising customer expectations, the global aspirations of Indian companies and global firms entering the Indian market. The changing rupee-dollar equation and the slowdown in the US economy, which is forcing players to look at other markets, have added to the momentum.

Current Drivers of Outsourcing

Unlike in the case of the exports business, cost benefit alone does not drive the domestic BPO market. While government organizations such as BSNL and the Railways are primarily driven by cost benefits, private giants such as Bharti and Vodafone are primarily driven by value generation and quality. At the generic level, the key drivers of outsourcing, in order of prominence, include: Cost benefit: Cost benefit arising from economies of scale is an important driver of domestic outsourcing. Third-party vendors bear the cost of infrastructure, human resources, training, etc, thereby enabling buyer companies to scale up easily. Value generation through third-party vendors: The competitive landscape of Indian industries is straining companies operational models. Hence, companies in various industries are turning to vendors who can help them overcome some of the challenges associated with fast growth, e.g., managing huge volumes and setting in motion a large network that can reach out to different corners of the country rapidly. As competition intensifies, companies look to third-party providers with significant past experience across customers to bring in best practices. Manpower management issues arising from rapid growth in volume and size of operations: This is cited as another key reason for domestic outsourcing. To overcome challenges of manpower expansion and management, companies are outsourcing their noncore activities to suitable vendors

APSM Batch 03

-5-

@2010 Indian Institute of Management Calcutta

APSM Project Effective Strategies in Domestic BPO Market

Inhibitors of Domestic BPO growth in India

Lack of Experience with Outsourcing: - Inexperience of potential client organizations with organized/large scale outsourcing may constrain the growth of the domestic market. This may be manifested in several ways, such as mistrust regarding sharing of data, inability to identify appropriate processes and/or vendors in the selection process, drafting of inadequate SLAs, etc. Any or all of these factors may lead to some bad experiences of client organizations acting as a deterrent to other client organizations attempting such a move. Relatively lower cost arbitrage in the domestic business compared to offshore outsourcing: - The absence of a comparable labor cost advantage in the domestic business (as compared to that enjoyed by US/UK customers) makes selling these services a little more difficult. Absence of third-party service providers with significant scale:- Unlike the exportoriented vendor landscape where there are several third-party players with a scale of operation of over 5,000-6,000 employees, the largest vendors serving the domestic market still have only 3,000 - 4,000 employees each. For this segment to grow rapidly, the vendor landscape will be required to develop equally rapidly to keep pace with the forecast demand. Slow build-up of scale in contracts in the domestic market: - Given that the cost advantage in the domestic business is relatively lower, this segment is more prone to margin pressures. As a result, the ability to rapidly achieve scale opportunities is essential for service providers to make this a viable business opportunity. Although a few recent deals and announcements indicate sizeable scale of business, a slowdown in large-scale deals could inhibit growth in the domestic market. Government procurement policies: - There is a concern that restrictive procurement policies adopted by some government departments, such as insisting on high levels of earnest money deposits (leading to additional capital costs), may deter some service providers from bidding for their contracts (this has been observed in the IT services space as well). Other obstacles that could slow growth in the domestic market:- Lack of interoperability norms that restrict service providers from offering a national toll free access number, lack of adequate funding avenues for domestic market players.

APSM Batch 03

-6-

@2010 Indian Institute of Management Calcutta

APSM Project Effective Strategies in Domestic BPO Market

3. Demand Analysis of Domestic BPO

Vertical Sector-wise Analysis of Domestic BPO
It is estimated that the domestic BPO opportunity is spread across a number of key market segments. Important opportunity areas include banking, insurance, telecommunications and government verticals.

Emerging Sectors
As per estimates, the telecommunications industry followed by the banking services industry are the early adopters in the domestic BPO segment. It is also expected that BPO adoption patterns will differ across industries. For example, the telecom industry is likely to see rapid initial adoption, which is expected to slow down over time. On the other hand, the BFSI industry may show slower initial adoption levels, which are likely to accelerate in the future.

Vertical Sector-wise Growth Analysis of Domestic BPO

Short Term 2-3 years
Telecom

Mid Term 3 - 7 years

Retail

Banking
Insurance Travel & Hospitality

Healthcare
Government Media / Consumer Goods

APSM Batch 03

-7-

@2010 Indian Institute of Management Calcutta

APSM Project Effective Strategies in Domestic BPO Market

Other emerging vertical markets with significant potential for already established service lines such as Customer Care and Sales and Marketing include aviation, hospitality, retail and media. Moreover, learning from other sectors, the manufacturing sector, which covers areas such as consumer durables, packaged consumer goods and automobiles, has started signing discrete outsourcing contracts. Customer-contact activities for support, loyalty initiatives and promotional campaigns are the key activities being outsourced in this segment. Service-line Demand: Value Chain Analysis The domestic BPO market is currently driven by the need to offer quality services in areas such as Customer Care and Sales and Marketing. While Customer Care and Sales and Marketing have been evolving from basic voice-based (outbound call center) services to high-end quality voice-based (inbound customer service centers) services, the market has strong potential to grow into non-voice services, as well as back office and expert services segments. Domestic market has been evolving from a Tier I and II player-dominated market into a more consolidated Tier I players market. Customers who earlier banked on Tier II and III players for basic out-bound voice-based services such as telemarketing and sales are now seeking high-end in-bound voice-based services such as customer service (including upselling and cross-selling) from more experienced Tier I players. The domestic BPO market is evolving along a similar path as the past evolution of the BPO export market. The BPO export industry has matured over the years while moving up the value chain. The domestic BPO market offers a similar opportunity to progress up the value chain. An existing supplier base and emerging new entrants can leverage this opportunity.

Current Service Offerings Basic Services

Basic Customer Support
Sales and Marketing

Future Scope of Services

Technical Support
Technical Customer Support Back office Processing

High-end Support
High-end Customer Support Sales and Marketing Select Processing Services (HR)

Expert Services
Decision Making Problem Solving

APSM Batch 03

-8-

@2010 Indian Institute of Management Calcutta

APSM Project Effective Strategies in Domestic BPO Market

Horizontal Service Line-wise Analysis of Domestic BPO

Customer Care and Sales and Marketing are the two largest service-line segments and accounted for over 70% of the overall market in 2008. While Customer Care and Sales and Marketing are expected to grow steadily in the future, there are indications that HR and F&A will also show positive growth in the next two to three years.

Horizontal Sector-wise Growth Analysis of Domestic BPO

Current
Customer Interaction Management

Future
Finance & Accounting

Sales & Marketing

Back office Processes Technical Support

Human Resources
Knowledge Services Procurement

While key service areas include query handling, sales and marketing support and payroll processing, the near future is likely to see a growing demand for F&A and knowledge services, which are expected to exhibit significant activity and growth. As the industry evolves, other processes will be increasingly outsourced. In India, there are limited discrete outsourcing contracts in specific areas. However, these are still quite small. Specific examples of activities, in this category include participant/audience contacts for television game shows, e.g., Kaun Banega Crorepati, Indian Idol, etc., which are outsourced by the respective channels to specialist service providers such as Dialnet, which manage services such as Interactive Voice Response (IVR) systems for their customers. Order management: While this 3PL (third-party logistics) service is still at the developmental stage in India, there are specific instances where logistics vendors are taking up total end-to-end logistics deals. TCIL formed a JV with Mitsui of Japan in 1999 to set up Transystem Logistics International (TLI), a unique dedicated automobile logistics service provider to Toyota Kirloskar Motors Ltd. (TKM) at Bangalore, a pioneer in automotive logistics. The JV handles the entire in-bound and out-bound logistics of Toyota vehicles in India. Opportunities await BPO firms to provide specialized services to newly emerging industries such as retail, fashion apparel or automobile components, e.g., customer relationship management (CRM), market research, accounting, and inventory and supply chain management. An early adopter, Dabur, one of the largest fast-moving consumer goods (FMCG) companies in India, signed a 10-year agreement with Accenture, outsourcing the IT work of its supply chain and secondary sales functions to Accenture.

APSM Batch 03

-9-

@2010 Indian Institute of Management Calcutta

APSM Project Effective Strategies in Domestic BPO Market

4. Evolving Buyers Side - Growing Awareness

Domestic buyers go through a learning curve on outsourcing. During phase 1, they become aware of outsourcing through marketing hype. They quickly learn about potential benefits, costs and risks by talking to current outsourcers, consultants and service providers. Initially, they outsource pilot projects (basic and non-core in nature) to reduce costs on a few selected activities (phase 2). As they move up the learning curve, they move to phase 3, when they exploit outsourcing for quality as well as for cost reasons. In phase 4, mature adopters utilize outsourcing to enable corporate strategies such as increasing business agility, bringing products to market faster and at a lower cost, financing new product development, accessing new markets or creating new business. While it takes some organizations years to move up the learning curve, the pace slows down at the end of phase 1 and throughout phase 2, when many companies are focused on cost benefits and at the same time are fearful about outsourcing. Currently, the majority of domestic Indian clients are in phase 1 and phase 2 of the process. However, the domestic market has significant addressable opportunities as companies move up the learning curve.

Phase 4 Phase 3
Size of Market
Institutionalized Focus on Value-added Transformation

Phase 2 Phase 1
Hype and Fear Early Adopters

Market Matures

Best and Worst Practices Emerge Focus on Cost

Richer Practices Emerge Focus on Quality

Time

Vendor Selection Criteria: Domestic Buyers Perspective

The Domestic Buyers are of the view that the key criteria for vendor selection are as follows: Existing client credentials for providing voice and non-voice BPO services Financial and managerial capability of service provider to sustain and grow in line with increasing demand Cost and quality efficiency Existing relationship with service provider

APSM Batch 03

-10-

@2010 Indian Institute of Management Calcutta

APSM Project Effective Strategies in Domestic BPO Market

Existing Relationship

Capability to Scale up

Core Efficiency

Vendor Selection Criteria

Prior Experience

Managerial Capability

Proven Credentials

Large service providers have a greater capability to scale up vis--vis smaller players. This is resulting in some buyers terminating contracts with smaller players and consolidating their operations with larger ones. To be successful among a sea of suppliers, service providers need to demonstrate their financial and managerial capability. Existing BPO relationships with service providers will not be a key influencer in future BPO vendor selection decisions. The bulk of the activity will go to a provider with proven capability and credentials in the voice and non-voice BPO services domain. While contemplating outsourcing for the first time, companies base their selection on past credentials and reliability information gathered from the market. Although prior experience in a related field is desired, vertical-specific experience is not a necessity for all buyers.

Challenges faced by Buyers

The challenges faced by buyers while outsourcing include the following: Long stabilization time: Currently, outsourced activities/processes take roughly six to eight months to be successful y integrated, stabilized and functioning efficiently. This long period poses a challenge for buyers. Lack of industry experience: While the domestic supply side is capable of successful y managing activity-based operations, it has not as yet gained recognition for end-to-end process outsourcing in an industry-specific environment. Certain buyers find it challenging to collaborate with suppliers who lack such experience. In-house restructuring: Buyer companies face significant challenges internally. Currently, employees are averse to outsourcing and incorporating new processes and structures. This

APSM Batch 03

-11-

@2010 Indian Institute of Management Calcutta

APSM Project Effective Strategies in Domestic BPO Market

can be a hurdle for government agencies as they general y have unions and may face resistance from employees. Lack of control: In the case of third-party outsourcing, buyers perceive a lack of control over the outsourced entity from a day-to-day operations standpoint. This makes it even more challenging to incorporate change and achieve high levels of quality.

Road ahead for Domestic Buyers

While buyers look to continue outsourcing large volumes of non-core processes, core processes are likely to remain in-house for another two to three years. This is due to lack of confidence in domestic suppliers. Further, the level of automation within buyer companies will directly impact outsourcing. Higher levels of automation will facilitate outsourcing in the future. Outsourcing engagements are currently activity-based. The next two to three years are likely to see them evolving into end-to-end process-based outsourcing as companies look to avail bundled service offerings. With the emergence of local and global players in the market, outsourcing may be split up between new vendors to leverage expertise and existing vendors to move up the value chain. However, the choice of a vendor will be driven by the cost and transactional benefits achieved; there is no perceived advantage of associating with global vendors. New domestic buyers will prefer to adopt the captive shared-services model over outsourcing to thirdparty vendors to streamline their activities, thereby paving the way for outsourcing.

APSM Batch 03

-12-

@2010 Indian Institute of Management Calcutta

APSM Project Effective Strategies in Domestic BPO Market

5. The Supply Side - Increased Capability

There are over 700 vendors offering a variety of BPO services to domestic clients. Most of the top vendors have grown their domestic BPO operations by over 60% over the last one year. The total number of professionals employed by the domestic BPO market has grown from 141,000 in 2005 to about 332,000 till date and is likely to increase over time. The domestic market, which was earlier served by small Tier I vendors, has evolved over the past three years. Relatively large and experienced Tier I players are now looking to capture the domestic pie. Further, the domestic market is slated to see rapid consolidation among suppliers as a result of buyers looking to scale up and have a wider portfolio of services under a single vendor Tier I and II players are expected to merge with big players to match the various profiles demanded by clients. Although domestic suppliers offer an entire portfolio of services, as offered to international markets, the domestic market has limited services currently. A per estimates, 90% of business is voice based and 10% non-voice based. While most inbound call center processes are serviced by Tier I players, outbound calls (telesales) are predominantly handled by Tier I and II vendors. Tier II and III players are preferred for outbound telesales because of their geographic presence and lack of bundled services offerings. In addition, they offer much more flexibility than larger players.

Key Domestic Players

Pureplay BPO Providers Multi-tower Outsourcing Firms

Intelenet Global Services Infovision (Serco) Sparsh Aegis BPO Services Hewitt Associates Andromeda
IT Outsourcing New Market Entrants

IBM Accenture Wipro HP

Niche Specialists

MphasiS EDS

Firstsource BillJunction HTMT Venture Infotek Dialnet Communications

Domestic Supplier: Critical Success Factors

The domestic BPO sector requires focused initiatives from the domestic BPO supplier community to successfully tap the market potential.

APSM Batch 03

-13-

@2010 Indian Institute of Management Calcutta

APSM Project Effective Strategies in Domestic BPO Market

Ability to Scale-up & Speed of Setup

Geographic Spread / National Presence

Multi-lingual Capability

Critical Success Factors

Capital and Infrastructure Capability

Communicate Value Proposition

Wide Service Portfolio

Providers need to communicate their value proposition better, especially due to the lack of cost arbitrage-driven propositions for domestic BPOs. The absence of a clear value proposition for domestic buyers is a strong deterrent to the markets growth. The speed of setting up and training employees within service provider organizations will be critical for supplier success as domestic BPO buyers look to scale up operations faster, to compete in a rapidly growing economy. For voice services, service providers will need to have the capability to scale up in terms of volumes as well as in their ability to provide multi-lingual support. Operations need to be spread across the Indian geography, for language support and also to provide near-shore delivery capabilities, if required. Wide service portfolio: Service providers will need to demonstrate their non-voice BPO capabilities through their existing credentials in their specific industry and non-voice BPO service segment. These credentials can be from the service providers global clients. Indian buyers are more likely to outsource BPO and application outsourcing (AO) or IT infrastructure outsourcing (ITO) to the same service provider. Service providers should, therefore, consider bundled service offerings (BPO with AO/ITO) or business-process-unit-type arrangements, to improve client stickiness in an engagement. Service providers with process transformational capabilities and world-class IT infrastructure will be better positioned to attract non-voice engagements. They will also need to have a vertical industry-specific focus to demonstrate the required competency for delivery of nonvoice business processes.

APSM Batch 03

-14-

@2010 Indian Institute of Management Calcutta

APSM Project Effective Strategies in Domestic BPO Market

Key Challenges faced by Domestic Suppliers

Slow Adoption Government owned Banks and Insurance Companies which form a major chunk of the Indian BFSI Segment will be slow to outsource due to Union pressures

Technology Platform
Indian Service Companies in the Public and Private Sectors are Underinvested in Technology on a Per Capita and Per Sale basis

Tier II & Tier III Locations

To be Economically viable, Companies need to move Operations into Tier II and Tier III Cities

Profitability Pricing in India is estimated to be 30-60% lower than its Global Counterpart

BPO firms in India will find the domestic market more challenging than those in developed countries. Government Control & Regulation -To begin with, a significant number of Indian companies in several service industries, including those in the banking and financial services industry (BFSI) segments, are wholly owned by the government. BFSI companies have been the biggest opportunity for outsourcing service providers in the markets of the West Pressure from Internal Staff/ Unions - Although these companies present the best opportunity for BPO firms, state-owned banks and insurance companies such as the State Bank of India and the General Insurance Corporation of India are likely to be very slow to start outsourcing on a large scale, largely because of the immense pressure they will face from their unions, who do not want to lose their jobs to the private sector. The way it happened in Jet airways any company outsourcing would need to reallocate or tone down the workforce Technology Adoption by Domestic Players - Another challenge BPO firms will face in India is the fact that any organizations decision to outsource its needs is heavily embedded in its technological architecture. Indian services companies in either the public or the private sector are heavily underinvested in technology on a per-capita and per-sale basis, as compared to those in the US and Europe. Indian services companies are far more labor-intensive and do not have technology platforms that will facilitate outsourcing, except in the case of financial services companies such as ICICI or HDFC. Lack of Standardization - The internal processes of most Indian services companies are idiosyncratic and are not standardized as in large retail organizations such as Wal-Mart or US

APSM Batch 03

-15-

@2010 Indian Institute of Management Calcutta

APSM Project Effective Strategies in Domestic BPO Market

healthcare companies. For players who are looking at scale, and who have national ambitions in the domestic BPO market, this means managing a large range of complexities. Availability of Skilled Manpower Third, for economics to be viable, players will need to move from larger cities and set up their operations in Tier I and II locations. It is true that the domestic market does not require that BPO agents be trained by way of their voice, accent and culture; therefore it is less expensive and easier for service providers to move into smaller cities. But the challenges posed by less than adequate infrastructure, political challenges, extortion and the availability of senior management who are willing to relocate to such cities need to be dealt with effectively. However, these challenges can be overcome by assessing Tier II and III cities before setting up shop. Profitability -The biggest challenge, however, could be around profitability. Although infrastructure, salary and training costs are lower in the domestic market, so is the pricing. In the India BPO market, pricing is estimated to be anywhere between 30% and 60% less than in its global counterpart, although more experienced players insist that domestic BPO margins are comparable with their global businesses or only marginally lower. With the outsourcing market in India still not mature, readiness to pay for world-class services remains a challenge.Even in global markets, variations in margins are phenomenal. Therefore, the success of such ventures actually depends on how effectively vendors are able to deliver by way of their cost structure, people management and value creation. Managing rapid growth while maintaining competitive costs and quality will be critical for the growth of BPO service providers. Building and developing specialized services and solutions that provide greater value will be a key challenge for vendors, so that they are able to sustain profitable growth in the long term.

APSM Batch 03

-16-

@2010 Indian Institute of Management Calcutta

APSM Project Effective Strategies in Domestic BPO Market

6. Domestic BPO - Market Dynamics

Domestic Operating Models
Currently, close to 80% of the industry comprises captive shared service centers. The rest of the industry is highly fragmented. Estimates suggest that 650 to 700 firms constitute the unorganized sector. As the industry gains in size and stature, a fair bit of consolidation is expected. Third party service providers, many of whose revenues are growing around 100% a year, are expected to increase their market share significantly. Although the captive shared services model is popular among new buyers, the third-party segment of this market is expected to grow much faster at over 50%, projecting that the third-party share will grow from 18.5% in FY2008 to 31% in FY2012.

APSM Batch 03

-17-

@2010 Indian Institute of Management Calcutta

APSM Project Effective Strategies in Domestic BPO Market

There are three primary reasons that contribute to the rapid growth of third-party vendors: With most underlying customer industries growing at between 2070% per annum, there is an increasing realization of the need to focus on ones core business while partnering with thirdparty vendors for non-core operations. Several large third-party players, with proven delivery experience, a robust and scalable client infrastructure and a strong reference base, have emerged. Increasing realization about the attractiveness of the Indian domestic BPO business is resulting in many large players, who were previously focused on international BPO, turning their eyes toward the domestic sector.

Domestic Pricing Models

Per Seat or Full Time Employee / Month

Per Unit Time / Variable Cost

BPO Pricing Models

Activitybased Pricing

Gain Share Model

Hybrid Pricing Model

Various pricing models can be differentiated by the parameters used for billing: Per unit time/variable cost: This is the most common pricing model in the industry with the client guaranteeing a minimum amount of business. This is billed on a per hour or per seat basis. Per seat or full-time employee (FTE) per month: The client guarantees a minimum amount of business for a number of FTEs on a monthly basis. Activity-based billing: The client is billed by the volume of activity. Gain-share models: The client is billed on the quantifiable value delivered, e.g., the success rate and conversion ratio, based on mutually agreed parameters. Hybrid pricing models: This is a combination of two or more models, which typically incorporate a fixed volume rate plus a marginally higher rate for peak load absorption.

APSM Batch 03

-18-

@2010 Indian Institute of Management Calcutta

APSM Project Effective Strategies in Domestic BPO Market

Indian BPO clients are more inclined toward the output-based pricing model. The preferred payment scheme is payment-per transaction and a shared-risk-and-reward model. Slightly more than three among five users in India prefer the per-transaction model, and one in five opts for the fixed-fee model.

Cost structure of the domestic BPO market

Percentage

LEGEND Depreciation Indirect Salary Rent & Utilities Sales & Marketing General and Administrative Direct Salary

Year
Personnel costs currently account for over 46% of revenues. Wage costs have been increasing steadily at 10% annually in all the major cities in India. Entry-level salaries for domestic BPO are between USD136182 per month. However, with most BPOs turning to Tier I and II cities, wage costs are slated to decrease. Salaries in Tier II and III cities are 5060% of those in Tier I cities. Telecom and connectivity costs account for 8% of total revenues. Over the last few years, telecom costs have been steadily decreasing. Rent and utilities account for 8% of revenues and are increasing at 5% annually. Sales and marketing costs account for 8% of revenues. General and Administrative Costs account for 11% of revenues. These costs are expected to spiral with an increase in the scale of operations. Depreciation costs account for about 6% of revenues. This figure may remain at the same level for some years to come. A tax rate of 33.99% is applicable for the domestic BPO sector.

APSM Batch 03

-19-

@2010 Indian Institute of Management Calcutta

APSM Project Effective Strategies in Domestic BPO Market

As compared to export-oriented BPO, the annual revenue per full -time employee is 2.5 times in favor of export BPO. However, the domestic BPO industry is expected to ride on huge size and volume, and net margins are anticipated to gradually increase to about 12.5% by 2012 from about 9% in 2008. Further, tighter cost control by moving to Tier II and III cities, leveraging economies of scale and a modest increase in price are likely to boost margins for domestic BPOs; steady state net income margins of 12.5% can be expected for most established players by 2012. The key difference in net margins between the export and domestic markets is the result of the tax exemption granted to global BPOs in India. Although attrition rates are higher during the initial stages of setting up domestic BPO in Tier II and III cities, due to difficulties in cultural adaptation and change, in comparison to export BPO, the overall attrition rate is lower in the domestic industry. Tthe gross margins in handling international call s is around 35-40%, while it is around 25-30% for domestic calls. Although international clients pay almost three times of what a domestic client is prepared to pay, the costs involved in handling domestic calls are also proportionally less. This is because connectivity charges are borne by domestic clients. High GDP growth rates are also driving growth. This BPO has over 40 customers in the domestic business, including a leading global telecom player.

Key domestic BPO deals

APSM Batch 03

-20-

@2010 Indian Institute of Management Calcutta

APSM Project Effective Strategies in Domestic BPO Market

Key Trends in Domestic BPO Industry

Increasing Third Party Vendors
Movement into Tier II and Tier III Cities

Key Trends in the Domestic BPO Market

Emergence of Scale Players

Market Consolidation

Increasing number of third-party vendors: It is a severe drain on the management bandwidth to continuously recruit, train and monitor back-office staff when their core business is accelerating steadily. This has resulted in the emergence of and rapid increase in the
-21@2010 Indian Institute of Management Calcutta

APSM Batch 03

APSM Project Effective Strategies in Domestic BPO Market

number large third-party players. The third-party model has witnessed considerable activity over the past few years - a direct consequence of the emergence of world-class service providers. The preference for this model may be attributed to the shorter payback period (between six months to a year), lower exit costs and the fact that third-party models hold the maximum potential for leveraging economies of scale, thereby reducing costs and maximizing efficiencies. However, the nature of work outsourced is typically non-core and non-critical and has a perceived lower level of data security. Emergence of scale players: With client industries growing at 20-70% annually, it is critical for them to partner with vendors who are capable of growing in similar fashion. The last few years have seen the emergence of large scale players such as Sparsh, Infovision, Aegis, etc. It is anticipated that this trend will continue in coming years. Movement into Tier II and III cities: Almost all the new facilities are coming up in Tier II and III cities to leverage a ready pool of low-cost resources, which are well-versed in the vernacular language. In 2007, MphasiS and Idea set up a new BPO facility at Indore. MphasiS will provide contact center services to Idea Cellular. This is the fourth MphasiS BPO facility in a Tier II or III city that caters exclusively to the domestic BPO space, the other three being Ahmedabad, Noida and Pondicherry. Tier I cities offer a cost advantage due to the relatively lower cost of living in such cities. For instance, according to a BPO major currently considering setting up operations in Chandigarh, it is 60% more expensive to live in Delhi-NCR, a traditional BPO hub, as compared to Chandigarh, a Tier II city. The advantage of the strategy that leverages Tier I cities is that these cities, though low in infrastructure facilities, are significant contributors to the talent pool. In other words, while infrastructure is concentrated in Tier I cities, human resource talent is distributed all over India. Market consolidation: The leading providers of the domestic BPO industry are cash rich, with high market valuations and are looking to grow. In the near future, you can expect them to gobble up smaller competitors. Tier II providers are struggling, unable to attain the growth of global providers and lack the scale of an IBM or MphasiS. As a result, they are likely to become the acquisition targets of larger providers or private equity firms.

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@2010 Indian Institute of Management Calcutta

APSM Project Effective Strategies in Domestic BPO Market

7. Strategy for a New Player

A new entrant in the Domestic BPO Market can enter the market using either one of the strategies or it can also enter with a combination of strategies depicted in the diagram below:

1
Horizontal Services Segments
Horizontal Services F&A Knowledge Services Vertical Sectors Telecom BFSI Horizontal Services Customer Interaction & Support HR Vertical Sectors Telecom BFSI

2
Horizontal Services F&A Knowledge Services Vertical Sectors Government Retail/ Consumer Goods Media / Airlines Horizontal Services Customer Interaction & Support HR Vertical Sectors Government Retail / Consumer Goods Media / Airlines

Existing

New

Existing

Vertical Sectors

New

Path 1: Offer services that are new to the domestic market (similar to services offered to the export market) to currently dominating sectors in the market, e.g., Telecom and BFSI. Path 2: Offer currently dominating service offerings in the domestic market, e.g., Customer Care and Sales and Marketing, to new/growing vertical sectors such as Retail, Media, Airlines and the Government. Path 3: Offer services that are new to the domestic market, e.g., F&A and Knowledge Services, to completely new/ emerging vertical sectors such as retail, media, airlines, etc.

Any new player entering the Domestic BPO market has to consider the following factors Companys Strategic Position to enter into Domestic BPO Industry Scope & Potential Competency in BPO Industry Experience in handling BPO operations Vertical & Horizontal Expertise

APSM Batch 03

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@2010 Indian Institute of Management Calcutta

APSM Project Effective Strategies in Domestic BPO Market

Road Ahead : Benefit for Buyers & Suppliers

The rise of the domestic BPO segment will result in benefits for buyers as well as service providers. The growth of the domestic BPO market will enable the Indian BPO sector to tap into an additional resource pool of over one million Indians in the country. The export BPO sector is expected to catalyze the growth of the domestic BPO market, as providers utilize the capabilities gained by serving international clients, while the insights and learning generated by serving a domestic market with minimal cost-arbitrage can be ploughed back into higher order value propositions for the export market. Additionally, the domestic BPO sector is likely to increase the ability of providers to aggressively tap Tier II and III cities within India, and also provide a career path for employees as they move from serving domestic to international clients. Further, increased visibility in service levels and process metrics will help buyers to identify improvement and innovation opportunities. Providers that serve the domestic BPO market could potentially use this as a hedge against foreign exchange risks, while increasing utilization of available facilities. The fact that they do not need to offshore implies that providers could expand to offer a much wider range of services than is possible for the export BPO market. For example, it is possible for a supply chain and logistics provider to expand to cover the complete range of third-party logistics services. The knowledge and capabilities gained from this expansion can then be ploughed back to offer more comprehensive front- and middle-office services to the export BPO market. IT BPO firms, looking at servicing the domestic BPO market, have one more reason to do so. Domestic BPO clients have a higher acceptance of integrated IT-BPO deals, which implies that they are more likely to outsource both IT and BPO services to the same service provider.

Key Action Points for the Future Growth of Domestic BPO

The domestic BPO sector requires focused initiatives from stakeholders to achieve its market potential. Currently, regulatory barriers and perception issues are roadblocks in the uptake of domestic BPO. Regulatory barriers, such as linking the NFE (Net Foreign Earnings) requirements with extent of domestic operations that can be delivered from an offshore domestic delivery center. Hassle of obtaining prior approval for sharing telecom infrastructure between international and domestic operations, are restricting seat utilization and negatively impacting the margins of providers serving international and domestic clients. Indian providers have begun serving international clients in the Capital Markets vertical, but are prevented from providing the complete range of services to domestic clients in this space due to duplication of costs on account of regulatory requirements. These regulations need to be made conducive to give an impetus to the growth of domestic BPO. The absence of a clear value proposition for domestic buyers is another deterrent to the markets growth. Providers need to communicate their value propositions better, especially due to lack of an arbitrage-driven proposition for domestic BPO. Increased adoption of outsourcing by the Indian

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@2010 Indian Institute of Management Calcutta

APSM Project Effective Strategies in Domestic BPO Market

government and the development of model contracts are initiatives that can help the domestic BPO market grow further.

SWOT analysis: Domestic BPO market

Strengths
Booming growth across industries in the domestic market Rapid growth in the domestic BPO market (CAGR 50% over the last five years) Large volume and size of the domestic market Huge manpower resource pool of over 1 Million Mature suppliers with extensive operational experience Access to international best practices

Weakness
Existing Regulatory barriers; no tax benefits for the domestic market Lower net margins as compared to the international domain Domestic companies are underinvested in technology Adoption rate is low amongst PSU banks Labour arbitrage is not a significant value proposition in the domestic market

Opportunities
Scope to move up the service value chain Potential for large scale employment Opportunity to bridge urban rural divide by developing Tier II and Tier III cities Addressable opportunity of USD15-20 billion

Threats
Emergence of nearby off shore destinations Shortage of middle management personnel and sector specific talent High inflation and attrition rates Infrastructure, political and other challenges posed by Tier II-III cities

APSM Batch 03

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@2010 Indian Institute of Management Calcutta

APSM Project Effective Strategies in Domestic BPO Market

8. References
Destination India : An Insight into the Domestic BPO Market (2009) Ernst & Young Trends in Domestic BPO (December, 2009) ValueNotes Domestic BPO Growth (2009) - TechMahindra Indian Domestic BPO Market An Emerging Opportunity (January, 2008) Avendus Domestic BPO Scope (August, 2008) - NASSCOM India BPO Study (2008) - NASSCOM & EVEREST India Domestic BPO Market (2007) IDC Domestic Services Market Opportunity (2006) - NASSCOM & IDC

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@2010 Indian Institute of Management Calcutta