The End of Outsourcing (As We Know It)

In the next five years outsourcing as we know it will disappear. The legion of Indian service providers will be sidelined or absorbed. U.S. and European companies that pioneered this corner of the high tech industry will suffer similar fates if they don't wake up. Who will emerge as the new leaders? Google (GOOG) and Amazon.com (AMZN), brands that we associate with search and retail, will become better known for outsourcing.

Ludicrous? Not if you follow this industry. Desktop computers yielded to laptops. Web portals AOL (AOL), MSN (MSFT), and Yahoo! (YHOO) are giving way to social media sites Facebook, Twitter, and LinkedIn. Software once distributed by disk is now available as apps over the Web—often for less than the cost of a slice of pizza. And so it goes. The same Darwinian process is creating a fresh ecosystem in outsourcing, one that will usher in an era of consolidation and a new way of working with clients.

Traditionally, outsourcing companies sell customers deals that can span a decade and easily run to tens of millions of dollars. The service provider takes on the expensive, time-consuming task of building and operating the digital tools that the customer requires to vanquish the competition, often involving development of custom software to get the job done. To do that, service providers need aisles of powerful computers, armies of programmers, and lots of applications, which are housed either at the client's site or located at a third-party data center that's usually owned and paid for by the client but managed and maintained by the outsourcer. Accenture (ACN) is a good example of the old model of outsourcing, which involves long-term contracts; customized software, legacy software, or both; and on-site systems integration work.

In the new model, outsourcers provide standard, off-the-shelf software on a "pay-per-drink" basis. For that, they will leverage so-called cloud technology, which lets users tap into computing power available via the Internet, rather than on a desktop or computer server housed locally. The appeal is scale, flexibility, and efficiency: Thousands of server computers can attack a task more quickly—and cheaply—or handle a patchwork quilt of different technologies that companies use to run their businesses. This approach will let businesses outsource entire tasks such as the tracking of inventory, paying only for the information accessed or used.

Why is this happening now? Let's start with the relentless pressure to cut costs. Outsourcing is about saving money. Sure the pitch usually revolves around improving business processes, but no client is going to pay more for the service than what it already costs to maintain their systems. Unfortunately, outsourcing vendors have maxed-out efficiencies, both from automation and from moving the work to lower cost-of-labor destinations, also known as "labor arbitrage." To get to the next level of savings, a ruthless search for greater economies of scale is necessary.

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