From East to West
Indian-oriented service providers are looking with great interest at Continental Europe – and this interest extends to acquiring to grow their presence in the region. This was one of the key takeaways from our many discussions with vendors during the NASSCOM Indian Leadership Forum in Mumbai in February.
Increased interest by firms in Continental Europe in near/offshoring for IT outsourcing service delivery
While discretionary IT spending has not really recovered since 2008, there is palpably an increased interest by firms in Continental Europe in migrating more outsourced activity (both current and new) to lower-cost locations. Unsurprisingly, in non-English-speaking countries this means to nearshore locations where the activity is voice-based (e.g. service desk), extending to offshore, where feasible, for non-voice activities. This stronger appetite for global delivery is evident for both IT infrastructure management and applications outsourcing.
In this respect, there is a clear maturing in the IT services market in Continental Europe, not just in the Nordics, but also in the key markets of Germany and France. Two obvious factors driving the increased appetite for global delivery in Continental Europe are:
- A desire for lower-priced services in the more traditional areas of IT services.
- A perceived lack of available local IT talent: particularly evident in Germany.
What does this mean for vendors?
In response to pricing pressure in the more traditional areas in IT infrastructure management and applications outsourcing, the major offshore-centric providers continue to work on improving staff utilisation and productivity, doing more work under fixed-price agreements in order to sustain their operating margin. But this can take them only so far. And for a vendor such as TCS that is already working at 81.7 per cent utilisation, there is only so much this lever can be pulled.
The larger Indian-oriented service providers (and indeed the global and major European SIs) continue their drive to reduce the cost of service in these traditional service lines. The extent of industrialisation, standardisation and automation in offshore delivery “factories” and the reuse of IP are becoming key attributes that distinguish between those vendors who can achieve and maintain healthy operating margins in traditional IT services such as applications development and applications maintenance, and those who will suffer from reducing margins.
In response to the demand for more global delivery, NelsonHall has seen an increased recognition by Indian-oriented service providers that they need to increase both their local onshore presence in the key IT services markets in EMEA and also their related nearshore delivery capabilities. Larger firms such as TCS, Infosys and HCL Technologies appointed locals to country manager roles in their major target countries some time ago, and they have also been opening some level of nearshore capability in Eastern Europe. But in most onshore projects and also at the front-end of outsourcing deals, a lot of the work is still being done by Indian nationals who have been flown over. And this can pose language difficulties: Indian graduate education has its strengths, but teaching engineers to speak German (or French, or Danish) is not one of them. The actual onshore delivery capabilities is still typically in the tens, rather than the hundreds, let alone the thousands.
As various IT markets in Continental Europe open up to near/offshoring, so too does the attention of Indian-oriented service providers to acquiring in the region. Of course, setting up a nearshore delivery capability is a classic chicken-and-egg situation – in this case, between having the client contracts and having the capability.
Watchers of the outsourcing and IT service markets will be well aware that acquisition activity is nearly always bubbling away in the background, and for the usual set of reasons. But we have been seeing particular interest in Europe from a wider set of providers than the usually acquisitive firms.
Two recent examples have a number of similarities
Cognizant recently acquired six units of C1 Group, a Hamburg-headquartered IT services vendor with a headcount of 1,200 and 2011 revenues of $200m. The six acquired units have a combined headcount of 500 in Germany (~400) and Switzerland. Key clients include MAN, Telefonica Germany, Credit Suisse and UBS and C1 also has several mittelstand organisations as clients. The units have capabilities in SAP consulting and implementation services, and in testing. To date, Cognizant has tended to acquire on a once-a-year basis. Excluding BPO-centric captives, this is its largest acquisition in terms of headcount in the past five years. It strengthens Cognizant’s capabilities in Germany, a high priority market for the firm. Expect to see further acquisition activity by Cognizant in Continental Europe, a region which in 2012 contributed $431m, just 5.9% of its global revenues.
In August 2012 Infosys announced it was acquiring Lodestone Consulting for CHF 330m ($350m) to expand its consulting capability in Europe. Lodestone, headquartered in Switzerland, has 850 employees including 750 SAP consultants. The company had revenues of CHF 207m ($220m) in 2011 (50 per cent from Switzerland and 23 per cent from Germany) and a client base concentrated on the life sciences and automotive sectors. Infosys has for some years been considering an acquisition to strengthen its presence in Continental Europe in order to increase client intimacy and a local delivery presence for front-ending transformational engagements. Lodestone had been actively seeking a buyer following its recognition it had hit a “glass ceiling” and needed to complement its onshore and nearshore consulting capability with offshore SI capability, and it needed a more impressive balance sheet to compete for large, SAP-based transformational deals. When this is finalised, Lodestone will be Infosys’ largest acquisition to date. As well as bringing in a local presence in the DACHS region, this supports Infosys’ efforts to gear up its “transformation” business as part of an ambition to compete more directly with the likes of Accenture in pursuing large, complex engagements involving a wide range of services. Lodestone is a great first move in this direction; it will also make a significant boost to Infosys’ consulting revenues (and add two per cent to its overall top line).
These transactions have a number of factors in common. Both are large initiatives for the acquirer. Both bring in a local presence for SAP-based service in the DACHS region with the opportunity to add offshore-centric AM services while the acquired units continue to focus on project work. Both bring in an attractive client base in Germany and Switzerland.
Increasing interest in BPO in Europe
As well as increased interest in offshoring for IT service providers, several countries in Continental Europe are also showing signs – some might say “at last” – of increasing interest in BPO. This spans right across front-office (contact centre), back-office (HR, F&A, procurement) and also industry-specific business processes, and the interest includes firms with existing shared services functions.
At the same time, some Indian-oriented service providers are actively scouting for opportunities to expand their BPO portfolio.
So what type of M&A activity should we expect to see in Europe in 2013?
Firstly, expect to see activity from some of the smaller Indian-oriented service providers (with revenues of between $400m and $2bn) as they look to develop specific BPO capabilities in Continental Europe by acquiring captives in the region. The minimum size for such a captive to be scalable would be around 150/200 seats.
Areas of interest include:
- F&A, where one assumes the client would ideally have back-office operations in other geographies that could provide potential future opportunities.
- Industry-specific activities, for example in the insurance and pharmaceutical sectors.
The types of acquisition of smaller contact centre service providers that we have recently seen in EMEA by the likes of Xerox may also continue.
Looking at IT services, small to mid-sized IT services firms, particularly with data centres, and small software firms with capabilities in areas such as analytics, collaboration and mobile are attractive acquisition targets – and not just for Indian service providers.
The larger Indian-oriented service providers who have publicly expressed their interest in Continental Europe include TCS, Cognizant and Infosys, and Wipro – Azim Premji announced in May 2012 that Wipro is looking to spend >$1bn in acquisitions on overseas players by the end of 2013, focussing on transaction sizes of $50m to $300m. Areas of interest include healthcare, BPO, niche areas in banking, and also on developing its local presence in LatAm and/or Germany. And it is not just these larger firms – the likes of HCL Technologies, WNS and even BPO pure-plays such as Aegis and EXL have publicly expressed their interest in acquiring capabilities in Continental Europe.
The interest goes both ways: some European firms looking at inorganic growth in India
While Indian-oriented service providers are showing significantly increased interest in Europe, some of the European-headquartered firms are also keen to scale their delivery capabilities in India. Capgemini leads the Europeans in terms of the scale of its delivery presence in India – currently at 41,000. The company has publicised for some time its target of having an Indian headcount of 70,000 by 2015. With planned expansion of ~6,000 in 2013, growth in India will have to accelerate very significantly to achieve this target, and Capgemini is hinting that this may include through acquisition of Indian captives. The company has also indicated its intention to develop a product engineering services capability: maybe this is part of the acquisition strategy.
In summary, expect to see over the next year or so a series of small- to mid-sized acquisitions in Continental Europe of smaller onshore firms and of nearshore captives by several Indian-oriented service providers looking to enhance their ability to serve key countries in the region, in particular Germany and France. This type of transaction will be a feature of M&A activity within the region. In contrast, large-scale transactions such as we saw in 2011 with Atos (of Siemens IT Solutions & Services) and in 2012 with CGI (of Logica) are unlikely to feature.
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