Offshoring and bargaining by cost-conscious clients has caused the operating profit margins of US tech services vendors, including IBM, Accenture and Electronic Data Systems (EDS), to fall from 17% in 1974 to around 6% today, says a study by Alsbridge Inc., a Dallas, Texas-based outsourcing advisor.
Competition from Indian and Filipino software and back-office firms have encouraged several large multinational technology firms to locate operations in these countries. Large customers such as General Motors and General Electric are increasingly pushing for lower prices from their IT vendors.
According to the study, the only time in the past 33 years when operating profit margins were lower was in the early 1990s, when the US economy was in recession. The US continues to remain the largest market for outsourced services. Ben Trowbridge, chief executive, Alsbridge, called the drop disturbing. “(US) providers are at their breaking point. As margins dropped below 10%, providers lost the ability to hire and maintain the best people, create research and development centres, or compete with the in-house offerings developed by their customers,” said Trowbridge in the report released on Friday.
Sources in the tech industry, who did not wish to be identified, said a software project executed in offshore locations such as India is billed at around $20 (Rs880) for each hour an engineer spends on it. This billing is between a fifth and half of that for a project executed in the US.
Over the past few years, Indian software companies such as Tata Consultancy Services (TCS), Infosys Technologies and Wipro have been increasingly muscling into the global tech and business process outsourcing (BPO) market dominated by firms such as IBM, EDS and Accenture.
“Some of the rising stars, such as Infosys, TCS and Wipro are characterized by a tremendous annual growth rate at 30% since 2003, which is double the industry average,” said the report. This has put pressure on the pricing of services of the US firms. Accenture, for instance, reported operating margins of 12.8% for the three months ended 30 November 2006, compared with TCS’ 26.1% in the three months to 31 December.
According to an analyst, Indian tech vendors, too, would face similar pricing pressure in the years ahead. “The offshoring phenomenon has caused this erosion in operating margins for the US-based outsourcing providers,” said Siddharth Pai, a partner at Bangalore-based Technology Partners International, an outsourcing advisory.
“However, as leading Indian players expand global operations, they cannot remain immune to declining margins either,” he added.
According to the Alsbridge study, offshoring transactions account for a quarter of the total amount spent by companies on outsourcing deals, and the proportion could increase in the future.