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Piggy-back on outsourcing
Leslie D'Monte
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July 26, 2006

Clients who have outsourced their IT operations get tangible benefits in terms of a higher return on assets and earnings before interest and taxes and lower selling, general and administrative expenses.

Second, the larger the outsourcing contract, the more likely the improvement in the bottomline. Third, while globally, the value and number of outsourcing deals overall remains constant, it is growing in the Asia Pacific region.

And fourth, there has been a growth in number of small and medium deals. These are some of the conclusions of an analysis of companies over a five-year period by scientists at the IBM T J Watson Research Centre.

The 18-month study - unique insofar that most earlier research on this subject has been qualititative and short-term, relying on case studies, interviews and questionnaires - covered 38 non-IBM and 18 IBM publicly-traded companies.

Incidentally, an independent study released by the Katz School of Business (University of Pittsburgh) last year, concurs with the IBM research. It concludes that firms experience significant improvements in operating efficiency for each of the first three years following the outsourcing contract.

"The IBM research, which studied the long-term effects on companies that outsourced a major portion of their IT infrastructure between 1998-2002, concludes that executives are increasingly outsourcing information technology resources to help their companies reduce costs and better focus on core business strategies," asserts Mark Hulme, GM-Asia Pacific, IBM Global Services.

IBM should know given that the total contract value of IT outsourcing contracts in India over the last three years exceeds Rs 5400 crores (approx. $1.2 bn).

Almost three-quarters of the companies studied, observed significant reduction in SG&A expenses compared to sector peers. SG&A expense - also known as overhead - typically varies from 16-25 per cent of the revenue across industries, according to a 2003 Controllers report. IT expense is typically accounted for within SG&A expense.

It also varies sector by sector as a percentage of the revenue - from 1.43 per cent in construction to 6.64 per cent in financial services, states the Meta group. On an average, it is said to account for nearly 50 per cent of a company's capital expenses, according to Nicholas Carr in the Harvard Business Review.

When compared to their sector peers, the majority of infrastructure outsourcing clients experienced significant operational improvements within the first two years of engagement.

For instance, prior to outsourcing, the annual growth in SG&A expenses of these companies was already 4.2 points lower than the sector median "likely due to pre-existing corporate cultures focused on business improvement".

After outsourcing their IT needs, the SG&A expenses fell 9.9 points lower than the sector median.

Moreover, after three years of IT outsourcing, these companies witnessed a rise in financial parameters like ROA and EBIT. The ROA was 8.6 points higher thatn the sector median and the EBIT 11.8 point higher.

The IBM research also notes that companies with outsourcing agreements over $50 million achieved an annual growth rate in ROA of 8.6 points higher than the sector median. The SG&A expenses were 9.9 points lower and earnings improved.

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