One of the biggest issues the outsourcing industry is facing is a major case of the jitters. Despite the natural advantages of outsourcing – cost-cutting, headcount reduction and ability to refocus on core competencies – offering a major positive in troubled times, firms are naturally suspicious of each other, knowing that financial stability cannot be taken for granted.

With this in mind, the recent events at Indian outsourcing provider Satyam could not have come at a worse time. Satyam is struggling to maintain customers following revelations of a billion-dollar accounting fraud perpetrated by its founder Ramalinga Raju, which came to light at the beginning of January when he admitted, in a letter to the Bombay Stock Exchange, that he had been cooking the books for years.

Although shares in the firm – which initially dropped 75% when the news broke – have recovered somewhat with the possibility of a takeover, it is too late to undo the damage this has done, both to the Indian market and to outsourcing as a whole.

Satyam itself has already lost major clients including Merrill Lynch (which also stepped away from advising the firm after just a week), Australia’s NAB and US-based State Farm Insurance. Although Merrill has moved the majority of its rumoured $40 million contracts to another Indian outsourcing provider, Tata Consultancy Services, rather than taking them back onshore or inhouse, concerns remain about what effect this will have on the industry as a whole.

Bob McDowall, research director, Europe at TowerGroup, comments: “Satyam raises the issue of the transparency of financial reporting in outsourcing organisations. You can evaluate the quality in terms of processes, but there are concerns on financial integrity and the quality of the company. Is it a family, private or listed company? What is the quality of its auditing? People are looking at the issues of the corporate governance of organisations and reputation. It has not helped the rest of the industry.”

In its recent report, Global Sourcing Trends in 2009, legal group Morrison Foerster concurs: “Consolidation in the service provider community may mean less leverage for customers in future negotiations, and the recent high-profile Satyam scandal in the Indian service provider market may prompt a ‘flight to quality’ by outsourcing customers.”

The issue, of course, is how this ‘quality’ can be measured at a time when the most stable of financial institutions are sitting on somewhat shaky foundations. Simon Pilkington, senior vice president at State Street, notes that each RFP the bank receives in its role as operational outsourcing provider to asset managers has a section looking to determine the company’s strength, stability and ratings. “It’s one of the first questions we’re asked now,” he adds.

The outsourcing industry has additional battles to fight at the moment, one of those being the problem of rising unemployment. At a time when firms in all industries are shedding jobs at a rate of knots, the notion of outsourcing precious jobs to an offshore provider is losing much of its shine, particularly for those institutions surviving on government handouts.

In the US, as Morrison Foerster comments in its 2009 sourcing report: “The new administration of President Obama has an overt US jobs-creation policy. Combined with organised labour pressure and caps on visas, this could mean more outsourcing solutions biased towards onshore delivery.”

Other jurisdictions, particularly in Europe, share this view; labour laws in countries such as Germany, for example, have long made outsourcing challenging. So with the Indian markets already struggling with a tarnished reputation, does this sound the death knell for offshore outsourcing?

The TowerGroup’s McDowall believes a strategic approach is called for, at least in the short-term. “If some can be done onshore, it sweetens the pill. Companies can outsource within the US, etc. The location where services are provided becomes sensitive due to the job situation. It may not be the most efficient or cost-effective solution for the outsourcing provider, but it may help them to keep business. They need to wait for conditions to change.”

There are also other options for outsourcing providers keen to lower their costs and access the skill base they need to provide a competitive service to their clients. Callatay & Wouters, for example, has set up a ‘near-sourcing’ software factory site at Marche-en-Famenne, 100km from its main office in Brussels, which allows the company to cut some of the overheads associated with being based in the capital and source the skilled staff base that is overstretched among all the companies located in Brussels.

Marc de Groote, chief executive at Callatay & Wouters, notes that there are too many problems now associated with offshoring. “The issues that people have with offshoring are cultural differences, resources that are not as good as expected, creating overheads and communication problems, and people move companies easily for the right money. Paradise will end in India – the prices are going up, and there are not enough skilled people. Near-sourcing gives the resources we need.”

Other issues are also putting pressure on the outsourcing providers. At a time when financial firms are putting all their energy into staying afloat, it is difficult to think strategically, and a long-term strategy is fundamental to any outsourcing deal. While firms may look at the cost-cutting benefits and hope for a short-term fix, this is often not the case.

Nick Atkin, director in consulting and head of the Outsourcing Advisory Service practice in the UK for Deloitte, notes: “In the current environment, there is a degree of knee-jerk cost-cutting, and there is a danger of jumping in too soon. We recommend that people look at outsourcing as a business transformation. There are still risks to manage including those related to data security and service quality, and we are anxious that clients may try to move too soon without looking at the traditional risks.”

Consolidation is also an issue, for both outsourcing providers themselves and the clients they are seeking to service. Although in theory any existing deals should not be affected by a consolidation, this is not always the case: note the difficulties in, and eventual termination of, the ABN Amro/EDS deal when ABN was taken over by RBS in 2007.

The consolidation issue also harks back to the offshore conundrum: will banks now wholly- or partly-owned by the government be permitted to drop domestic jobs in favour of creating positions offshore? As McDowall comments: “If consolidated entities become wholly or partly state-owned, they can’t change things but it will make the suppliers nervous, especially if they are offshore.”

The decision of some firms to either exit or sell off areas of their business may also have an effect on outsourcing providers, and both this and the consolidation issue throw up another problem that may stop some deals dead in the water before they begin: the challenge of getting out of an agreement once it is underway.

So, among all the doom and gloom, are there any rays of light for outsourcing providers? Yes, of course there are. It has often been the case that the trend towards outsourcing has risen during a recession, and although this time may turn out to be the exception, the drivers and benefits are still the same.

Companies are still looking for ways to decrease expenses significantly and quickly, to streamline operations and to reduce head count and save money. Outsourcing offers cost-cutting measures via, for example, offshore labour arbitrage, but also by enabling companies to shed fixed costs in favour of the variable pricing that characterises many outsourcing deals.

Robin Kneale, head of strategy, Securities Processing Solutions International, at Broadridge Financial Solutions, comments: “This climate also provides opportunities for start-ups and these firms need to get up and running quickly, committing as little capital as possible to infrastructure. In some of the merger situations a shift to an outsourced vendor is a more cost-effective alternative than attempting to merge disparate in-house platforms.”

Many firms are still renewing their contracts, although sometimes for shorter periods as they struggle to think strategically in the current climate. New deals are also still being done: State Street’s Pilkington reports a steady flow of enquiries and deals coming through in the asset management sector, while Logica has just announced a multi-year, ?22 billion deal with Dutch firm KPN.

Deloitte’s Atkin notes: “People are still looking to outsource. In the UK, the decision-making process from clients has been taking longer. In the US, this trend began from last summer, but from November/December US clients began to look longer term and at what they can achieve now. More recently, the European market has been taking the same path, and looking for long-term savings.”

The trouble, of course, is that firms looking to outsource will hoping to drive much harder bargains than previously, and there are certainly some deals to be had for those firms brave enough to try for them.

State Street’s Pilkington says: “The drivers have not necessarily changed, but the pressures have changed. Asset managers may find that their assets under management are worth less, and that they are getting less revenue. Asset managers are looking to cut costs; in any service, clients always want services at a lower cost, so we’re seeing a continuous pressure to provide a service at the lowest cost possible.”

However, he qualifies this with a return to the ‘flight to quality’ issue: “Asset managers still want a viable quality service provider – the strength of companies is important as they need to sustain momentum.”

Where concerns remain over the stability of service providers, some jurisdictions have already put measures in place that allow outsourcing but in a controlled way that affords additional protection for the outsourcer. In Luxembourg, for example the previously stringent rules controlling outsourcing have been changed to a concept of ‘Professional of the Financial Sector’.

C&W’s de Groote explains: “Companies such as Callatay & Wouters can join this scheme, but they must comply with all criteria and will be controlled by the same authorities as the banks. We have set up a SaaS offering for Clearstream, and we are governed by the same ratios and procedures.” An extension of this kind of project to other jurisdictions may promote confidence in the outsourcing system.

There is still much hope for the outsourcing industry, but the next year or two is likely to be a time of treading water. Few people would expect the remainder of 2009 to be a time where firms are able to think strategically enough to enter into long-term outsourcing arrangements. There may be good times around the corner, but it will be a case of who is left standing – providers and customers – to enjoy them when they arrive.