The Satyam effect

The Satyam effect

The local view of offshoring has evolved from unease to acceptance - and now shock following the computer services giant's scandal. But we don't need to sacrtifice the benefits if we get tougher, and shrewder.

In the early part of the decade, an easy way to cause outrage in the media was to associate your business with an Indian outsourcer. The idea that teams of Indian workers could perform the same role as local techies, for less cost and with no discernible drop in quality, was enough to send talkback radio into a frothing frenzy. Things quietened down a bit in the last few years as offshoring became more commonplace, until we arrived at a situation where it was almost unusual for a major corporation not to have any of their work performed in far-off lands.

Many people still disliked the idea, but their guns had been silenced by a lack of ammunition. Even the local banks had started building their own operations in Bangalore.

Then, seemingly out of nowhere, in the quiet early January period when most Australian chief information officers were still pre-occupied with the choice between a trip to the beach or another hit of the ‘snooze’ button, all hell broke loose.

The chairman of Indian software services giant Satyam Computer Services, Ramalinga Raju, admitted to falsifying the company accounts to the tune of 50.4 billion rupees ($1.5 billion). It set in motion a chain of events that continues to rumble on, and has already seen Raju, his brother and the company’s chief financial officer languishing inside prison cells.

Apart from being a business scandal of Enron proportions, the news will have sent the stomachs of CIOs at some of the world’s biggest organisations plummeting towards their boots.

It was followed shortly after by the news that Satyam’s local rival Wipro had been barred from working for the World Bank for 18 months due to improper practices. This involved it offering World Bank employees, through its CIO, the chance to participate in a program to buy American depository shares in an oversubscribed initial public offering.

CIOs around the world clearly have some fresh thinking to do about their suppliers.

Satyam counts a third of the Fortune 500 companies among its client base, with some relying on the company for their most critical technology operations. Locally its client base includes such leading names as Qantas, National Australia Bank, Telstra, Optus, Suncorp and QBE Insurance.

In the immediate aftermath of the scandal businesses needed to assess the work they already had underway with the outsourcer, and more pressingly what would happen if the company disintegrated or was broken up.

Staff at Qantas spent the morning after the scandal broke in an emergency meeting, where contingency plans were discussed for its seven-year contract. Satyam provides the airline with IT application maintenance and support and the contract has so far run for just two years.

The outcome of the meeting was that a spokeswoman felt comfortable to assure reporters that any risk to the business was manageable, and that in the event that Satyam was unable to continue providing services, Qantas has the ability to activate alternative internal and external arrangements.

Suncorp CIO, Jeff Smith also expressed the opinion that he had been satisfied with the work conducted by Satyam staff within his operations, and was keen to keep the company on board if things were resolved in a suitable fashion.

However, other CIOs feel it is much safer to just pull the pin and walk away from the company. In early February Satyam, suffered its first local setback following the scandal when NAB confirmed it would suspend aspects of its outsourcing relationship.

NAB will continue to use Satyam for maintenance and support of some of its legacy software platforms while it waits to learn the fate of the company.

A bank spokeswoman says it had been decided that application development and maintenance work transitioned to Satyam in 2007 and 2008 will remain unchanged, and that Satyam continues to meet service-level commitments and contractual obligations.

"Until the longer term future of Satyam becomes clearer NAB has also decided to suspend all work currently in the early stages of transition to Satyam. This work will be carried out by NAB employees," she says.

The founder and director of Swamy & Associates, Sri Annaswamy, whose company gives advice on offshore outsourcing, says the worrying thing for CIOs is that it is highly probable that Satyam is not an isolated case. He says customers that outsource business processes rather than development or project assistance, are much more likely to suffer serious damage if their vendors were not properly vetted, and experienced a calamity.

“I work off the cockroach in the cupboard theory, whereby the minute you see a cockroach you know for a fact that it is unlikely to be the only one in there, and it is unlikely to be the smallest,” Annaswamy says.

“If a CIO is setting up a deal with a provider, they must now seek to structure the contract as a ‘build-operate-transfer’ arrangement which means that the minute you sense an issue, you take charge of the physical facility and all the people and have the right to fire the service provider and replace them with someone else.”

Annaswamy has developed a list of four early warning signs, which he says can alert CIOs to the probability of a prospective service provider going bankrupt (see breakout “Service Provider Warning Signs pg xx”.

He says the Satyam scandal should highlight the necessity for the boards of Australian corporates, particularly financial institutions, to get deeply involved in outsourcing and offshoring structures.

Former Qantas and Telstra CIO, Fiona Balfour says she believes it would be unwise for Satyam customers to make hasty decisions on their contracts in reaction to the scandal, without first understanding who might purchase the company’s assets.

“Changing now would not be sensible; contractually, most customers would have a ‘change of control’ clause in their contract with Satyam which – in the event that the new owner was deemed acceptable to the customer – would provide sensible arrangements for re-assignment without penalty,” Balfour says.

Annaswamy agrees that a level head is needed in the current climate and says it is important that businesses don’t take the mindset that it is now time to simply avoid Indian technology providers.

He says a number of service providers are very worried that they will simply be tarred with the Satyam brush, and that over a period of time customers will pull down the shutters on all kinds of offshoring. Annaswamy believes CIOs thinking about business process outsourcing or knowledge process outsourcing should adopt a more rigid focus on governance and modify their approach to deals.

“There is little point hammering away at the table with a 120-page contract when the service provider owns the infrastructure and people that are delivering your day to day operations,” he says.

He says that, among other ideas, businesses should avoid the standard five-year BPO model, and insist on upfront payments on all BPO and KPO transactions. He says CIOs should ensure they are viewed as anchor clients and only do meaningful, substantive deals as larger service providers would spare little time and effort on smaller pilot projects.

Irene Pimenthel, an analyst at research firm IBRS, says the Satyam scandal was particularly disappointing because Indian outsourcers had been building a strong customer base and reputation for being sturdy managed service providers globally.

She says that pulling companies like Wipro and Tata Consultancy Services into the discussion as a result of the Satyam scandal would be counter productive for the CIOs that may seek to buy their services.

“I think the contribution these types of companies make to the outsourcing industry has been invaluable, and the market is far more evolved because of mid-level and smaller service providers eliminating the dominance of the big three – IBM, EDS and CSC,” Pimenthel says.

“They are quality, reliable providers. This company [Satyam] has put a real dent in that, but it was the company, not the industry. A clear line between those two things has to be drawn before discussing other Indian companies.”

Annaswamy agrees that it is the process of selecting and managing outsourcing contracts, which needs to be more closely monitored. He says that singling out the Indian companies for greater scrutiny makes no sense given that almost all of the major non-Indian outsourcers have acquired Indian businesses to supplement their existing workforce.

IBM , for example, acquired Daksh eServices in 2004, which is now the hub for its BPO business, and EDS acquired MphasiS in 2006 which is at the centre of its financial services BPO business.

"In my view, there is no significant difference between Indian and non-Indian outsourcers," Annaswamy says. "India is the largest delivery hub for most non-Indian outsourcers including Accenture, EDS and IBM, and if that hub is impacted by a Satyam-type problem, they would be in as much of a soup as the Indian companies."

Annaswamy says company boards, and particularly risk-management committees, can no longer afford to treat outsourcing issues as operational or IT cost-reduction exercises to be left entirely to the CIO’s team.

“They have to ask the tough questions and get their own hands deep and dirty. How many board members of Qantas have actually physically turned up at Satyam’s campuses in the last 4-odd years? Do they even know where Hyderabad is on a map of the world?” Annaswamy asks.

Project management specialist Phil Belcher, CEO of PM-Partners, says that as soon as an organisation looks at a significant outsourcing program it raises a lot of questions for risk management professionals.

He believes the Satyam scandal will have caught a fair few businesses on the hop, and even if there was no great damage caused, it will have highlighted the need to run a thorough investigation of outsource providers and to present customers and shareholders with clear contingency plans.

Belcher says there are three key questions that all CIOs should ask when they are pondering major outsourcing:

1. How important in the greater scheme of my outsourcer’s business am I?

2. If anything happens to my outsourcer, how critical is that going to be to me?

3. What is my mitigation strategy?

They are simple thoughts that CIOs around the world will have pondered as soon as news of the Satyam mess had filtered through the haze of their Christmas holidays. As the dust settles further in the coming months, it remains to see whether confidence in the Indian technology sector has been irrevocably damaged.

Sidebar: Service Provider Warning Signs

Founder and director of Swamy & Associates, Sri Annaswamy believes the following signs can indicate impending bankruptcy in a service provider:

1. Majority private equity ownership of the outsourced service provider – Satyam is not, but others are. Double leverage involved. Significant management instability as compensated via stock options. Genpact is a big example.

2. Leveraged “transformational” acquisition strategies often in competitive bidding scenarios –

3. Operational leverage and client exposure concentration (industry/geography/service line) – a generic service provider today gets 40-45% of revenue from the US market and about 40% from the financial sector. Both are under pressure.

4. Conglomerate group-level structure and ring-fencing of group-level problems – this is what has happened at Satyam. Often, most of the service providers operate as part of a conglomerate group. Each of the group companies are listed or owned separately as happened in Satyam’s case. There is very little ring-fencing of group problems. The company may be doing okay but the problems of others in the group bring it down.

In Satyam’s case they had all the property/Maytas companies and tried to move undervalued assets into Satyam. It is these problems that have the tendency to bring those companies down.

Notes on a scandal

* January 7 – chairman of Indian software services provider Satyam Computer Services, Ramalinga Raju, resigns after admitting to falsifying accounts to the tune of $1.5 billion

* January 10 – Raju, his brother Ramu and Satyam chief financial officer Vadlamani Srinivas arrested and face charges of criminal conspiracy.

* January 12 – The World Bank confirms that Indian outsource provider Wipro has been barred from working for the company until 2011 due to improper business practices.

*January 14 – News comes to light that Satyam executives reaped $US1.8 million ($2.7 million) from share sales in the six months before the fraud inquiry that has led to a record fall in its stock.

* January 17 – A senior official involved in the Satyam investigation claims Raju skimmed as much as $US1 billion ($1.5 billion) in cash from the company, rather than padding its books as he has claimed. A "maze" of about 300 companies related to Raju had been uncovered.

* January 24 – PricewaterhouseCoopers Indian affiliate, the auditor of Satyam, says two partners have been arrested in the fraud inquiry. They were remanded on charges of conspiracy and co-participation.

* January 27 – The new board of Satyam appoints Boston Consulting Group and investment banks Goldman Sachs and Avendus to advisory roles as it attempts to recover from the scandal.

* February 5 – Satyam announces the appointment of AS Murty as new chief executive officer. Murty has worked for the company for 15 years.

* February 5 - National Australia Bank confirms it will suspend aspects of its outsourcing relationship with Satyam.

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Tags outsourcingfraudvendor managementeconomic crisis

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