Acquiring Outsourcing Companies: Not for the Squeamish
Feb 24, 2009 4:00 AM PT
Shrinking client pools, lack of access to credit and competition from offshore destinations are squeezing some business process outsourcing service providers in the United States. With declining revenues come cheaper valuations. This creates opportunities for other entrepreneurs seeking to expand their outsourcing business quickly through acquisitions.
With opportunities come risks. The best way to address risks is for buyers and their advisors to recognize them and plan their strategies accordingly, as described below. Identification of target markets presents the first challenge.
Market expansion opportunities are increasing at the same time that the outsourcing field is undergoing transformation, thanks in part to its own success. Outsourcing formerly represented a separate, recognizable business field with distinct boundaries.
While we can still identify leading service providers and industry trends, especially in voice-based general customer service operations, the non-voice or blended voice/non-voice outsourcing field has become increasingly vague. Where has it gone? It has diffused into the industries in which it serves.
In the human resource field, for example, distinctions between offshore outsourcers and onshore providers with global operations are blurring. Globalization, increases in the offloading of business processes and the common practice of handling some tasks with both onshore and offshore providers simultaneously is changing the face of outsourcing.
Buyers seeking to acquire specialty outsourcing companies will benefit from looking at market behavior within specialty outsourcing sectors rather than general merchant outsourcing. Specialty sectors are not always easy for international buyers to identify independently, especially in countries where large conglomerates dominate the economy and are highly integrated both vertically and horizontally. This is particularly the case in South Asia, where large organizations do not customarily break out specific business functions for outsourcing with the frequency that we see in the United States.
The role of acquisition advisors begins by helping buyers identify different market-entry points, verticals and niches. This can occur as part of a strategic market study, conducted as the first task in a merger and acquisition project.
Aligning Expectations With Market Realities
The initial challenge for advisors in an acquisition process is to align buyer expectations with market realities. The next challenge is to educate buyers how to realize the best value for the money that will be spent in the acquisition. We begin here with client expectations and a focus on South Asian buyers.
Most South Asian buyers and entrepreneurs find it difficult to translate valuations of American companies into economic figures that make sense in South Asian terms. In South Asia it is possible to spend US$300,000 (after transaction costs) to acquire a financially healthy company with headcounts in excess of 50-100 people. In the United States, in contrast, there are catering trucks that do more than $300,000 in business annually.
In 2006, when we examined prices for small (less than 125 seats), marginally profitable operations, we found that most arrangements for buying Indian call centers were cash neutral. Buyers relieved sellers of lease obligations and equipment rental contracts with no valuation premiums.
The appearance of valuation disparities is aggravated by a lack of credit facilities for South Asian companies, especially in the outsourcing field. Without a strong secondary market for private bonds in South Asia, companies rely heavily on stock issuance to meet their capital requirements. Consequently, market capitalizations based on outstanding stocks multiplied by current stock prices will appear inflated by U.S. standards.
South Asian companies tend to buy companies or operations that are too small to efficiently benefit from having fresh access to offshore production or service centers. Firstsource (formerly ICICI OneSource) and vCustomer are notable exceptions in this regard and in how effectively they handle post-acquisition brand management, a subject addressed below.
On the question of identifying suitable targets, each outsourcing specialty has a point at which acquisitions and rollups become financially feasible. In the accounts receivable field (which includes the collections industry), acquisition prices below $10-$20 million present challenges in terms of generating economies of scale and sufficient work volumes that can be shifted to lower-cost destinations. The "sweet spot" for profitability for an acquirer does not begin until $40 million and up.
A key task for advisors to offshore buyers is to align buyer expectations with market realities. This begins with strategic advice on where and how to enter a market. It extends to post-acquisition brand management and process migration. For additional information, see this article on the role of investment banks as acquisition advisors.
Post-Acquisition Brand Management
Another common failure point for offshore buyers is in regard to post-acquisition brand management. Essar's acquisition of Aegis (Aegis Communications Inc. -- not Aegis.com or Aegis LLC) provides one example of lackluster brand support following an acquisition. Aditya Birla Minacs provides another. The Resource Group provides 19 examples of investments and acquisitions since 2002 that have not been used to produce a strong client-facing brand but rather one designed to appeal to investors.
In making acquisitions of U.S. business units, offshore buyers may not fully grasp where the value rests in their acquisitions, preferring to focus too heavily on headcounts and on tangible assets such as the number of computer terminals. As a consequence, buyers can depress the valuations of their newly acquired assets -- effectively overpaying for them.
An example of post-acquisition brand dilution is provided by Indian conglomerate Aditya Birla, which entered the customer service business in June 2003 with the acquisition of Transworks, a highly regarded Indian call center company with facilities in Mumbai and Bangalore. This was followed in June 2006 by Aditya Birla's acquisition of the Canadian call center company Minacs.
The Transworks brand was discontinued in favor of the brand Aditya Birla Minacs. In place of Transworks (strong, memorable) is a string of three words that are not familiar to Americans and not easy for American clients to recall with positive connotations. The new three-word nomenclature is not consistent with the goal of having a short, snappy brand that appeals to customers, is easy to spell and remember, and is represented exactly in a corresponding dot-com domain.
How many people could remember how to spell and find their way back to the subdomain www.minacs.adityabirla.com? Without the words 'call' or 'voice,' how easy will it be for search engines to associate that homepage and its associated brand with call center outsourcing?
The old Minacs Web site is still up, orphaned at http://minacs.com. Meanwhile, two unrelated parties are preying on the brand confusion and drawing clients away with Aditya.com and Adityaa.in. The response of Aditya Birla Minacs? Still waiting...
The Ten Commandments of Branding provides tips on brand management for outsourcing and customer service companies. It defines outsourcing version 1.0 as a sellers' market, when clients were likely to initially seek out a single prime vendor and were often willing to overlook brand issues, padded prices and service providers that lacked marketing savvy.
Beginning in late 2006 and early 2007, outsourcing version 2.0 became popular as clients found that outsourcing had become a buyers' market. Buyers gained confidence in managing multiple vendors and found it easier to obtain more competitive prices. Service providers in outsourcing 2.0 attract clients through a combination of brand image, quality and value.
For Touchstone Communications, outsourcing version 2.0 meant adapting offshore staff to American standards rather than adapting Americans to offshore standards. As described in Offshore Lessons, this led Touchstone to strengthen process migration and training and to create an American workplace culture in their offshore financial-services facility.
Process Migration and Training
Conducting business remotely and with international customers requires skill sets that are not always easy to learn. It requires focused efforts at training and monitoring.
Human resources outsourcing and recruitment process outsourcing (HRO/RPO) is the subject of rising competition from Indian vendors, some of whom are expressing interest in acquiring established brands in the United States. At the same time we see widespread shortcomings in process migration and training by incumbent offshore vendors in this field.
A year ago, I reviewed the outcome of an offshore outsourcing arrangement that a major onshore HRO company had achieved in outsourcing resume screening to a merchant facility in India. The Americans provided inadequate training and support for their outsourcing partner, with predictable consequences. The Americans blame the Indians. I blame the Americans.
Following an acquisition, the risk of inadequate training and support for process migration can be aggravated by financial demands that international buyers place on themselves.
Carrying Double Expenses
Except at the top of the market, South Asian facility owners commonly invest in physical capacity and then hire staff before they arrange for business to fill that capacity. As a result, facility owners come to the table with negative cashflows and seek to shift work offshore as quickly as possible.
The acquisition of a North American outsourcing operation commonly incurs double-cost charges for the buyer, who can expect to maintain overlapping capacity for six months or more after the deal is closed. There will be continuing needs for training offshore staff, even for simple things such as U.S. geography, accents and labor categories. Failure to support offshore staff will result in revenue decreases because of client flight.
The buyer will also need to retain or expand sales operations in the United States, despite internal (offshore) resistance. Wipro and Infosys advertise business development positions in the United States that start out at a base rate of $81,000 per year, plus generous bonuses. Wipro and Infosys have learned that paying 10 times more to American salespeople than to offshore staff makes sense economically. That view is not widely shared among lower ranking Indian competitors.
The role of advisors to offshore buyers is not simply to educate clients on how to make an acquisition in the United States. The role often extends to educating clients on how business is conducted in North America. Roles are reversed for Americans seeking to set up operations offshore.
Anthony Mitchell , an ECT News Network columnist, has been involved with the Indian IT industry since 1987, specializing through InternationalStaff.net in offshore process migration, call center program management, turnkey software development and help desk management.