By Arpit Kaushik

Recently, I decided to take a look at the impact of recession on offshore outsourcing: that the players will face pricing pressures, reduced profitability and less growth compared with the golden times, and that there will be an imperative to deliver tangible business value to customers. I looked for evidence in the quarterly results of outsourcers and, despite the absence of the predicted boom, I found that they had held on pretty well. And I decided to re-examine the results after another quarter passed.

First up, the global outsourcers. In its latest quarter, Accenture’s outsourcing revenue was up 7% year on year, and its outsourcing margins increased due to more work shifting offshore. Management said that they have not witnessed any increases in cancellations or deferrals and now see the period of indecision starting to loosen. They are also seeing an increased demand for BPO and application outsourcing services. The growth rate, it should be noted, is half that of the previous quarter.

IBM’s strategic outsourcing business saw a 3% decline in revenue but an improvement in margins. On a like-to-like basis, HP’s services revenue declined 15%, but like IBM, it did see an increase in margins. HP saw a significant decline in its application services business as discretionary project work fell away. CSC also saw its outsourcing revenue decline by 13%, attributed to client delays and pullback of discretionary projects. Outsourcing bookings during the quarter were also down 50%, but like the others, CSC did improve its profitability.

Overall, since the last quarter, the exuberance about revenue growth has become quite muted. On the positive side, companies are improving profitability and streamlining their operations, including increased reliance on offshoring.

In the European outsourcers category, Capgemini saw its quarterly organic outsourcing revenues increase by 3% year on year (overall growth was 1%), but its outsourcing bookings declined by 37%. During the last quarter, it increased its offshore head count by over 1,200 (compared with an increase of 50 for onshore). Profits improved marginally, but the company said that it can’t see business with any real confidence beyond June, guiding toward a modest first-half 2009 revenue and a margin decline.

Logica’s Q4 revenue went down 11%, and its operating profit for the full year declined 22%. It has been making aggressive strides into offshoring and boosted nearsho re and offshore head count to 5,000 (its 2009 target is 8,000), adding 900 employees in six months at its new Indian center. Logica sees good demand with more, larger outsourcing opportunities in the pipeline but has forecast flat first-half sales. Atos Origin’s Q4 revenue declined 9%, and it expects a slight decrease (“roughly minus 2% or something like that”) in 2009 revenue. It also plans to increase offshore head count by 1,000 while reducing onshore head count.

Muted growth, operational streamlining and increased offshoring are the common themes.

Next, let’s move on to the Indian offshorers.

We’ll begin with the Tier 1 players. TCS’ quarterly revenue remained flat year on year, in sharp contrast to the 25% growth last quarter and its statement that it does not expect revenue to be impacted by the turmoil. Net profit declined 18%. It is witnessing pricing pressure on new contracts, but on a positive note, net employee addition was more than 8,500 — its highest in the past few quarters.

Infosys’ quarterly revenue grew by 8%, compared with 19% in the previous quarter, and it added about 2,800 employees. Management stated that the velocity of business has come down, decision-making is slow, budgets are not finalized, and scrutiny is higher.

Wipro reported a 12% annual increase in IT service revenue, and its margins diminished. It also reduced its IT services head count by more than 1,000 employees.

HCL technologies saw an 11% revenue growth, boosted by acquisitions. Net income was down 9%, and total employee count was almost flat. HCL stated that “the pricing environment is quite bad and customers are saying that we should contribute and help in reducing their spend on IT”.

The best performer was Cognizant, which reported a 25% increase in revenue and a 34% increase in profits. It even saw a 19% increase in its financial services segment and added 2,200 employees during the quarter. On the flip side, though, the company’s outlook for 2009 is 10% revenue growth and broadly flat margins.

It is a significant shift from the position in the previous quarter. Tier 1 players have seen their growth rates tumble (Cognizant is an exception here) and visibility become poorer. Operationally, though, they are adjusting well and focusing on working with customers to address their challenges. Currency fluctuations remain a cause of concern for them, and ‘constant currency basis’ is the new buzzword.

Moving on to the Indian Tier 2 players. Growth rates for the leaders in the previous quarter has come down from 30%-plus to 20% for Mindtree and 17% for TechMahindra. Mindtree suffered significantly on the profitability front, with an 88% decline in profit after taxes. Talking about variability in performance, Polaris saw 32% revenue growth, while Patni saw a 1% revenue growth and a 45% decline in profitability.

Finally, the Indian Tier 3 players. Hexaware reported flat revenue but a significant improvement in operational efficiency and resulting profitability. It continued on its head-count reduction spree with 300 reductions in the last quarter, taking the tally to about 1,000 reductions over two quarters. Sonata, whose revenue rose by 25% and who did not foresee any adverse impact, saw its growth come down to 7%, even though profitability increased 27%.

So there’s high variability in Tier 2 and 3 segments, but they are now feeling the full impact and their irrational exuberance is fading away. Realistic growth rates, pricing pressures, currency effects, project cancellations/deferrals and longer sales cycles are being seen among the players.

How does all the evidence compare with my original assertion five months ago? Well, the evidence broadly supports the assertions — players are witnessing pricing pressures, reduced profitability, (much) less growth compared to golden times, and an imperative to deliver tangible business value to customers.

However, I do recognize now that there are exceptions, and in some cases the ability to withstand the macro environment and make corrective adjustments has been, frankly speaking, quite impressive. Special mention must be made of the increased use of offshoring by global and European outsourcers, and the emphasis on productivity and delivering value by select Indian players. We will see an increased use of offshoring, no doubt, but in a rational, rather than blind, way. It’s fair to say that the recession is wiping away the inefficiencies of the system. Those who recognize and adapt will be the real winners.

Arpit Kaushik runs the London-based outsourcing service design firm, Crystals, which helps forward-looking companies realize the promised benefits of outsourcing.