Economists are right to point out that one of the most prevalent motives for a corporate merger is the existence of unhealthy marketplace dynamics, including pricing pressures, diminishing rates of growth, and the like. By all reasonable measures, the global outsourcing marketplace possesses none of those characteristics. Yet, I think we’re in for a year of mergers and acquisitions among the players in this industry.

Most of the companies that are in the business of providing outsourced services (generally, corporate support functions) on the basis of “fee for service” are enjoying healthy rates of growth and reasonable profits. Yes, there exists some fair degree of pricing pressure, largely attributable to the rapid emergence of a strong and growing universe of competitors in far corners of the world. But, astute market participants will tell you that the outsourcing industry is not one driven entirely, or even predominantly, by price.

To generalize, there are really two distinct segments of players in the global outsourcing world. The first comprises companies that are essentially the founding fathers IBM, CSC, EDS, Accenture, Unisys, and a dozen or so others. These are the companies that have largely succeeded through technology-driven services provided to some of the world’s largest corporations.

The second segment are the up-starts, relatively recent entrants who have shown an astounding amount of traction in leveraging lower-cost sources of skilled labor for offering similar services. Companies in this segment include Wipro, TCS, Infosys, Cognizant, Patni, and a large universe of contemporaries.

There are many differences between the companies in each segment, but two stand out for me in considering the likelihood of an acquisitive year.

First, there is an obvious difference in the profiles of the companies in these two segments. The multi-national firms have largely Western management, with deeply established employee rolls in relatively higher-costing Western economies. Sure, they’re all moving to India and China, but their challenges in doing so are significant.

Conversely, the newer entrants are generally growing at rates that are hard to fathom, with thousands of new employees added each month and rates of attrition that would stress any going concern.

Can the multi-nationals re-engineer their business fast enough to ward off the surging demand for offshore solutions? Can the offshore providers sustain their astronomical rates of growth without fracturing the essential processes required to manage a global work force that might exceed 500,000 for some of these companies?

The second difference is related capital intensity of the respective business models. The multi-national providers earn reasonable profit margins, but those results pale in comparison to their offshore-oriented competitors, due in some large part to the degree to which their respective business models depend on capital investments. The free cash flow of multi-national firms lags behind their offshore counterparts by a significant degree for this reason.

So, can the multinational providers sustain their growth without moving their center of orientation to the East, to include embracing a truly global work force? Can the offshore providers, many based in India, continue to grow without fracturing their support systems and without embracing the need to apply more capital to their service offerings? Benefits based on labor arbitrage alone are temporary.

For these reasons, I anticipate a continuation and acceleration of the tendency to combine the business models and operations, much as EDS and mPhasis did in 2006. It’s a strong and growing industry, but one that is ripe for consolidation. — Peter Allen

Peter Allen is a partner and managing director for market development with the sourcing advisory firm Technology Partners International. You can reach him at peter.allen@tpi.net.

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