With independent outsourcing companies achieving depth and scale, more and more foreign firms are expected to go the outsourcing way rather than the offshoring way
2007 may be the year when offshoring investment research into India comes of age. Though it did not start out in quite the same way as the mainstream BPO or IT outsourcing nor been around for so long, this Rs 600 crore industry is tipping in favor of the Indian companies in the sector.
Recent trends indicate that the industry, which started off due to regulatory changes in the US in 2003, is increasingly junking its bias in favour of ‘captive centers’ and looking at outsourcing more and more from independent vendors.
Offshoring of investment research involves a chartered accountant or an MBA-Finance graduate sitting in India and helping another analyst, usually in New York or London, to decide whether or not to buy investment products, such as shares, bonds and bills. While the final decision is still taken by the analyst sitting abroad, Indian professionals, after undergoing training to familiarize themselves with market dynamics, share his work-load by studying company fundamentals and even market and economic trends. When the Indian analyst is directly employed by the foreign firm, it is called offshoring or the establishment of a ´captive centre´ and when the analyst is employed by a different company, usually Indian, it is called outsourcing.
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Till now, the off-shoring model has been favored by most investment banks and brokers (or sell-side firms, so called because they are the agents for companies to sell their equity shares or bonds to the public). However, buy-side firms (funds) such as hedge funds, mutual funds and pension funds have largely stuck to third-party outsourcing so far.
The initial wave of offshoring was started off by Wall Street firms as a result of a landmark $ 1.3 billion agreement with the US securities watch-dog Securities and Exchange Commission (SEC) in April 2003. The agreement was the culmination of a two year inquiry into allegations that all the major Wall Street firms including Citigroup, Goldman Sachs, Morgan Stanley and JP Morgan, were using their research departments to give favourable ratings to equity and bonds issued by them.
A large part of the revenues of these firms came from helping companies sell their equity and other instruments to raise money from the public. It was alleged that a favourable coverage by the firm’s investment research wing was being traded as a part of the overall sales pitch to companies looking to to issue new shares. While the 10 firms neither accepted nor denied the charges, they were forced to cut costs on investment research as it was seen as less crucial to their core activity of corporate finance. This in turn led a lot of them to explore the option of sending part of their research work to India, which had already become famous as a value-for-money outsourcing destination.
Initially the firms trusted only captive centres or offices fully owned and operated by them. Even now, the centres run by the likes of Goldman Sachs and Morgan Stanley are as big as, if not bigger than, any run by the big four outsourcing vendors in the investment research space. A large number of the estimated 2,500 or so analysts working with the independent providers work for smaller clients - usually buy-side entities like hedge funds, mutual funds etc.
¨We expect the (international financial services) companies to increasingly shift to the outsourcing model and away from the captive research centre model,¨ says Aditya Bhandari, senior financial services industry analyst with the consultant Frost & Sullivan. Bhandari estimates that captive centres run by big Wall Street firms like Goldman Sachs, Lehman Brothers, JP Morgan and UBS employ a total of around 3,500 analysts in India, against around 2,500-3,000 analysts working for around 10 independent KPO players. In terms of revenues, the share of the captive industry will be even higher as the per-employee costs are estimated to be around 20% more compared to third-party outsourcing.
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Like most people familiar with the industry, Bhandari too believes that that the initial preference for captive centres on the part of the firms is on the vane due to various reasons. ¨Even from a management bandwidth perspective, choosing outsourcing instead of offshoring can cut down work load on senior management of these firms by 20-30%,¨ he says.
Another important reason for the change from offshoring to outsourcing is the increasing expertise and depth of talent of the independent outsourcing providers. For example the four India-based independent providers of such outsourced services - Gurgaon-based Copal Partners and Evalueserve, the Bangalore-based Amba Research and the Chennai-based Irevna have seen their employee numbers go up by around 50-60% this year. All four will have more than 500 investment analysts by the end of this year.
The service providers attribute this to a shift in work allocation by sell-side firms, besides the usual growth in demand. ¨The trend is that even the companies who have a fully-owned captive centre in India are outsourcing a part of their work to independent providers,¨ says Ashutosh Gupta, head of transitions for Evalueserve, one of the biggest providers of third-party KPO services in the country. The Gurgaon-based company, seen as a leader in the KPO business, did not initially offer investment research services when it started out in 2000. Though Evalueserve too started offering investment research services only in 2003, the division accounts for nearly a fourth of its 2,100 employees. Similarly, located a stone´s throw away, Copal Partners, started by former McKinsey employee Joel Perlman and GE Capital veteran Rishi Khosla, too has seen its numbers explode from just 10 employees in 2003 to over 500 now.
Analyst Sudin Apte of Forrester Research sees a pattern behind the increasing traction behind the outsourcing vendors. Apte, lead author of a paper titled ¨Shattering The Offshore Captive Center Myth¨ which came out six months ago, is firmly of the opinion that captive centres do not allow the company to take full advantage of the globally distributed sourcing model. Due to this, he expects BPO and KPO industries to gain at the expense of captive centres in future.
¨Our research shows that many captives are in trouble. While few will admit it, Forrester believes that more than 60% of captive centers fail to meet expectations. There are several common reasons for failure: a poor delivery track record, operational problems, a lack of scale, poor morale, rampant attrition, and high costs,” Apte points out in his report.
Apte points out that companies who have offshored or outsourced to India across a variety of sectors spend an average of around $4,950 per head while an outsourcing vendor spends around $4,230 - a difference he attributes to a variety of factors such as higher expenditure on both salaries and office premises and unexpected expenses such as legal fees, head-hunting and marketing expenses etc..
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