From European near-shoring to Indian and Chinese offshoring, the legal IT landscape is changing rapidly, say Bond Pearce's Claire Coleman and Jamie MacLeod

The global IT outsourcing landscape is currently in flux, impacted by several countervailing trends. Pressure on IT budgets makes cost reduction through offshore solutions an inevitable consideration in any sourcing decision. The impact of the financial crisis, an explosion in shared cloud services and increasing political backlash against the impact of offshoring on local job markets are all contributing to a more complex global IT outsourcing (ITO) landscape. Who will be the winners and losers in this changing environment? Are there signs that India is losing its magic? How will all of this impact on traditional ITO models in the future?

Impact of economic climate on ITO markets

Increased pressure on IT budgets has left many chief information officers (CIOs) exploring cost reduction through extending the range of IT services they are prepared to have delivered offshore. The Government ICT Offshoring Guidance issued by the Cabinet Office in July 2011 reminds Government departments of their obligation to achieve value for money in procuring services and encourages the exploration of offshore options. It outlines requirements for managing data security risks and consulting on potential job losses. However, far from discouraging offshoring, it has been described by one industry commentator as an "offshoring objection handling crib sheet".

global-workplaceNevertheless, UK political resistance to offshoring services at the expense of local jobs has impacted several recent IT offshoring plans in the public sector. Last year Birmingham city council was forced to retract a plan to offshore 100 jobs to India when faced with a public backlash and Hewlett Packard reversed plans to outsource 200 IT support jobs for the Department for Work and Pensions (DWP) to Bangalore after a House of Commons motion by Mary Glindon MP. Meanwhile, in Washington DC, a bill designed to discourage US companies from setting up offshore call centres is gaining support in the US House of Representatives.

Both Gartner and AT Kearney, in their 2011 Global Services Location Indices, show India remaining the most popular destination for IT offshoring (rated according to criteria including language, government support, labour pool, infrastructure, educational system, cost, political and economic environment, cultural compatibility, global and legal maturity, protection of intellectual property (IP), data security and privacy laws). In terms of offshore locations India has been, and remains, the market leader, with annual IT services revenues estimated at $70bn (£44bn).

China now ranks second to India in the analyst indices. The gap remains wide (with China's IT services revenue currently estimated at $20bn (£13bn) annually) but may show signs of narrowing as India continues to experience strong upward pressure on salaries, while China's wage inflation has been low thus far. India boasts the greatest breadth of coverage in terms of services, with leading offshore capabilities in business process outsourcing (BPO), ITO and Voice. China's focus remains on software and product development. Malaysia and Philippines are also key players in the Asia-Pacific region, highly rated for infrastructure and, like China, benefiting from significant Government support.

Wage and currency fluctuations resulting from the financial crisis have impacted the recent Global Services Location indices. Central European countries providing highly qualified labour have returned to prominence amid currency devaluation, with Estonia moving into 11th place and Latvia 13th (in the AT Kearney index) amid ongoing austerity programmes.

Near-shore Central and Eastern European offshoring locations hold new attraction (with timezone benefits), where India in the past may have been the clear front-runner. The Indian Government's popularity has slumped due to a slowing economy and a number of scandals and policy failures. The overall fiscal deficit is approaching a 10th of gross domestic product and there is evidence of increasing currency instability.

On 16 March fury was sparked by the Indian budget, which contained proposals to allow the Government to tax overseas transactions dating back to 1962 in which an underlying Indian asset was transferred. The move appeared to override an Indian Supreme Court decision in January relating to Vodafone's liability to pay a £2.2bn tax bill on its 2007 acquisition of a stake in an Indian mobile phone business.

Some worry that the rule of law in India is being eroded and that overseas investors in particular can no longer make investment decisions with any confidence. Will these trends (coupled with the number of other increasingly attractive offshoring locations) eventually affect India's status as the preferred offshore destination?

Other IT sourcing trends impacting the global offshoring landscape

Increased pressure on IT budgets and the changing technology landscape leave traditional outsourcing models under threat. In future, we are unlikely to see the same volume of five to 10-year mega deals based on the development and maintenance of customer code requiring huge teams of software developers and systems integrators.

Organisations are prepared to consider offshoring a greater range of services as confidence in capabilities grows. However, lessons have been learned from the first wave of offshoring and customers are demanding more. As CIOs come under increasing pressure to deliver business growth through technology and attract and maintain new customers, supplier evaluation is not based solely on cost reduction.

Corporate leaders expect more commercial flexibility and maturity from suppliers and are seeking to reap increased organisational flexibility and agility through their global sourcing arrangements. The growth in cloud, multi-tenanted services from a variety of offshore locations (offering accelerated implementation, reduced capital expenditure and flexible pricing models based on usage) makes these goals more achievable than ever before for an organisation with a well-developed delivery model.

Gartner has predicted that by 2015 low-cost cloud will cannibalise up to 15% of top outsourcing companies' revenue and that by end 2016 more than 50% of global 1000 companies will have stored customer sensitive data in the cloud. Many organisations have been attracted by the clear business benefits but are concerned that some of the key risks inherent in offshoring (such as data security and IP protection) are magnified in the context of publicly available cloud offerings.

Tight European Union data protection legislation around overseas transfers of data together with additional requirements and controls on regulated businesses (such as the financial services industry) have impacted the adoption of cloud solutions. However, there are signs that the ITO industry is responding by setting up EU data centres to service European clients.

The new wave of offshoring deals, though shorter in duration, with new flexible pricing models and potentially multiple offshore components, are no less complex than those of the past. The UK Government is leading the way with initiatives such as G-Cloud, which will result in a greater number of smaller deals and increased agility and flexibility through shared services delivering low-cost, flexible cloud solutions. In contract discussions issues such as exchange rate risk, data security, IP rights protection and governance are more important than ever to get right. Large organisations may still need the skills of the major systems integrators but are requiring that they combine BPO services with best of breed cloud solutions. In these deals, ensuring the contract delivers robust supply global chain delivery and control is becoming ever more critical.

Recent trends show that there is still huge potential for growth in globalised IT service delivery. In a world where technology strategy and business success are becoming increasingly closely linked, the new wave of IT offshoring contracts must deliver the flexibility, agility and cost benefits that today's customers need.

Claire Coleman is a partner and Jamie MacLeod an associate at Bond Pearce.