Which planet are equity analysts from?


If you’ve spent a lot of time with service provider leadership, you’ll know they spend an inordinate amount of time preparing stories for equity analysts to regurgitate.

I'm telling you… shipping back office work to India is going to be HUGE

HfS Research Fellow, Deb Kops, has been on both sides of the fence – as CMO for a service provider tasked with painting pretty pictures for Wall Street, to being entrenched with many enterprises who actually consume these services.  And after many years dealing with – and observing – these beings, she finally begs the question:

Mars, Venus or Saturn… which planet are equity analysts from?

As a child, I had a very fertile imagination. When I came up with a story that had no semblance of reality, my father would ask “Which planet are you from?”

Ever read an equity analyst’s report on the outsourcing market or a particular provider, and wonder whether you are located in the same solar system? When they put an outperform on a provider that everyone else in the industry thinks is a weak sister, or talk up a stock, missing the fact that revenue growth is  mainly coming from a savvy hedging strategy. When they classify the provider as a business process outsourcer while the market knows that said provider is an app dev company with a whiff of business process outsourcing revenue. Why don’t equity analysts following the outsourcing industry start asking the questions that really matter when putting out their recommendations?

Even though I don’t consider myself naïve, it always surprises me how limited analysts’ knowledge of outsourcing company operations sometimes is. I know that the job of good investor relations teams is to tell a favorable story to the analysts—in fact, I’d be the first one to admit I gamed the messaging in a previous life. But when I read the analysts’ reports, I am often flummoxed by the recommendations, and amazed by the commentary. Don’t some of these guys have the time…or the inclination… to get under the covers? Or are they creatures of habit, only getting under the covers when there’s a marked quarterly change in performance trends? Sometimes I wonder whether the sole basis for rating stocks is handicapping the odds–will said company meet annual guidance?

It’s time to move beyond calculating 90 day rolling averages, or looking at the impact of increased float as a result of a sale of a block of shares as a basis for a buy recommendation. Analysts, let’s forget about the oh so-last decade hype around the strong long-term growth in markets like India, and acknowledge that clients are looking for contextual prowess that many offshore providers just don’t have. Let’s admit that that pricing is now commoditized for most processes, and profitable deals are fewer on the ground… Let’s go beyond the term “compelling value proposition” to understand that clients are thirsting for value beyond wage arbitrage. And when it comes to the onshoring trend, perhaps it’s time to stop blaming the pressures on politics, and start looking at the fact that increasingly customers are unhappy with the quality of service coming from offshore delivery centers, and are now looking for alternatives onshore.

The risks analysts note encompass so much more than in-house alternatives, currency fluctuations, and geo-political concerns about a war between India and Pakistan. Competitors are already aggressive in an increasingly undifferentiated market, often buying logos when the deal is a “must win,” so competition is not a special risk worth calling out, but an everyday occurrence.

Would investors evaluate the industry differently if equity analysts dug deeper, perhaps developing models that associate the real impact of double digit wage increases with rising attrition?  Or if they quantified the growing trend toward the implementation of hybrid shared services models as opposed to the adoption pure outsourcing models?  Perhaps analysts ought to look at the reality of provider dominance in certain verticals so when a new entrant declares they are going to achieve substantial growth in pharmaceuticals or publishing or whatever; their aspirations can be appropriately discounted.

Now if I was an analyst, what are the questions I would ask?

Quality of the sales force. Ask questions about experience, longevity, and who’s making their quotas. Find out how many sales guys failed to make a sale last year, and the year before that. Ask if the sales function is a revolving door, and how the top rainmakers are incentivized to stick around. Determine whether the front end folks have deep backgrounds in the industries they are focused on, and if they have experience actually selling, say BPO, or whether they are IT retreads. In fact, look at the cost of sales to revenue—if 98 percent of provider revenues are from existing clients, while SG&A is in the 95th percentile, it would be fair game to ask what the dickens the sales force is doing with their time.

Channel dependency. It’s great for the provider to build good traction with advisors, or obtain the majority of leads off the Internet, but when one channel becomes dominant, there’s a major pipeline risk. The source of leads should be balanced; influencer (read advisor)-led, direct calls/relationships, and marketing channels should all feature in the mix. For example, if the provider’s influencer relations leader leaves, and he/she is any good, the channel will likely dry up. Cut dollars for digital marketing, and that channel goes fallow. Ask what the source of deals actually is.

Effective shop window. Marketing is no longer a nice-to-have; it’s a have to have in order to differentiate a provider in a market where sameness is becoming the norm. Clients now buy brand. Open the provider’s front door and take a real look at their branding and marketing. Is it differentiated? How much do they spend annually? Look at their messaging—can you tell the difference between Providers x and y and z? Perhaps you don’t think it’s a problem now based upon historic performance, but trust me, clients will increasingly buy brand.

Logo frenzy. While collecting nine new logos in a year is music to the ears of analysts, it can be a red flag for financial performance, at least in the near term. First year deal performance will hit margins hard, even without the risk of poor execution, while too many new logos could suggest that the provider is out buying deals.  Look under the covers of new client announcements to understand what is causing the velocity of deals—pricing, new markets opening up, or even a differentiated offering—in order to determine whether it’s luck, aggression or a seminal trend that creates shareholder value.

Source of organic growth. Growth is so much more granular than the simple categorization “organic” and “inorganic” that analysts focus on; it’s down to the percentages that come from hunting and farming. If absolute inorganic growth coming from farming the existing stable of clients is much less than 40-50 percent, it says something about focus and the quality of account management, suggesting that there’s a weak spot in the provider’s talent base, the company isn’t as tight with its clients as advertised, or perhaps the provider is taking their existing customers for granted. That means there’s trouble down the line.

Domain depth. One or two clients does not a vertical make, yet some industry analysts are bamboozled by a lonely name brand around which a provider declares they are building a fast-growing vertical. Ascertain whether there’s room for another entry into an industry, and how what the current sourcing saturation really is to see whether Provider X can really grab enough market share to create a viable business. After all, when a provider announces that they are entering a new vertical, chances are that a number of competitors are already pretty well ensconced.

Real attrition numbers. Creativity has found a home in the calculation of provider attrition; figuring out how the numbers are actually put together is critical. But attrition is much more than the number of staff going through a revolving door; it’s one indicator of the strength of management.  Delve down into service and geographical attrition to find out if there is a root cause—poor management in a region, or lack of training. Ask where staff is going; if they are leaving the provider to go into industry, it suggests a market trend; if substantial numbers are going to other providers, it may mean adverse working conditions, difficult cultures, poor hiring practices or sub-market compensation. Ask who is leaving—women versus men, associates as opposed to supervisors and managers. And don’t just focus on attrition in the offshore delivery centers; pay particular attention to onshore attrition as a harbinger of sales and account management challenges.

Number of toys in the toy box. In other industries, equity analysts’ mantra is ‘few things well,” or “focus, focus, focus,” yet in the outsourcing industry, there seems to be a premium placed on having the widest array of offerings and verticals to avoid economic ups and downs. As a result, many of our providers are trying to be all things to all people, often in an effort to show diversity in vertical, offering and geography. Very few providers cover all the function/process/industry bases with equal depth.  Count the toys, and judge whether management is making the appropriate investment based on market potential.

Training dollars. Training is always one of the first areas to be cut when providers are under margin pressure, yet, in a business that depends upon the quality of talent, cutting investments in people is a fool’s errand .Ask how much is spent on training per capita after year one. Find out whether training is “train the trainer,” often known in the industry as the “blind leading the blind,” or true, process- and industry-intensive training. Ask how often the courseware and curricula are refreshed. And delve into the training methodology in place to train supervisors; after all, they are the lifeblood of provider delivery success.

Management layers. Leadership layers are a bit of a problem in the ranks of outsourcing providers; since talent is relatively cheap, the fix for poor delivery is often to add additional layers of management, rather than to up-skill the base talent. Clients often complain about the number of levels they have to navigate in order to determine who’s actually responsible for a problem…and its fix. If the provider’s management layers start looking like the tiers on a wedding cake, performance issues may be endemic.

Educational levels. While the number of university graduates available in offshore locations is certainly seductive, with in market economic growth, top university talent offshore is now shying away from outsourcing careers. At the same time, as providers move operations to lower cost Tier 2 and 3 cities, the number of available…and talented… graduates declines. Track educational levels year-on-year to get the real talent story.

Globalization of management. Origin matters. If the majority of the management is either located in one country, or is transplants, it suggests that the company is not fully global in its outlook and approach.  Ultimately providers, especially those with offshore legacies, must evolve into global companies with substantial diversity in their top leadership and management teams. Ascertain where strategic and operating decisions are actually made, and by whom.  Look at the roster of leaders to see how many represent different cultures. Ask whether talent is seconded—not just from India to the US, but from client-proximate locations offshore.  Depending on visas does not grow a business onshore.

Deborah Kops, Research Fellow at HfS (click for bio)

Effectiveness of acquisitions (after two years). So many of our industry’s acquisitions fail to move the dial for the acquirer. Yet a few years later, amnesia sets in and analysts stop asking the right questions relative to their success. Notice whether the last time you heard of the acquisition was at announcement. Find out whether the acquired team’s management stayed beyond the payout, or left after a short transition period. Ask whether the acquisition changed the game through platform expansion or new business growth.

Bottom-line: It’s time for these guys to get under the covers and quit the puffery

Now, if equity analysts started to look under the covers and actually asked these questions, what might they really find? And would their ‘buy’ and ‘sell’ recommendations vary greatly?  Would we all be on the same planet when it comes to understanding what drives outsourcing provider value? One can only live in hope…

Posted in : Business Process Outsourcing (BPO), Cloud Computing, HfSResearch.com Homepage, IT Outsourcing / IT Services, Outsourcing Advisors



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  1. Wonderful capsule on this area. Couple of points that require mentioning is the lack of global context understanding (through Western eyes Eastern operations are measured… not exactly like evaluating the wealth and family stability of your neighbor using binoculars from across the street) and it was refreshing to see some of our GSC (Global Star Viability Certification) covered. I would have thought that some of that would have rubbed off on a few since a few use our model in assessing both investments and M&A potential.

  2. Excellent article Deborah.

    Recently we conducted some research for a private equity firm on the KPO and analytics operations of some outsourcing firms. We found that Linkedin is a better source of information (number of sales people, number of people in each geography, attrition rate, client names) than the financial statements alone.

  3. A well written article, Deborah. You touch on an issue that has been plaguing services for many years. The equity analysts are trained primarily to analyze balance sheets and are clueless about strategy. Plus, many of the service providers are only too happy to have analysts who believe their marketing hype. You think they’d want to have the level of investigation on their business models that you propose? The current state of “blissful ignorance” is perfect for them.

    Andy Mason

  4. Thanks, Jerry, for commenting. You suggest a point i haven’t thought about–how many equity analysts have spent much time, if any, actually on site with providers? I am not talking about those lovely staged investor relations conferences at swish hotels.

  5. Raj and Andy, thanks for commenting. Good point about LinkedIn as a source of info, and there are many other hidden sources if one looks.

    Eric, i don’t know Bud, but one can’t know too many smart cookies.

  6. Deborah,

    Bud Fox (in the picture) was the young investment broker player by Charlie Sheen in the 1980s classic movie “Wall Street”.


  7. Deborah – this has been an ongoing issues for many years and noone’s had the guts to point it out so publicly – so kudos to you.

    These “analysts” only comment on deals and use guesswork when it comes to any strategic insight (or regurgitate what Gartner says). Can’t see how this is going to change anytime soon – most of the incumbent providers are happy because they have a easy ride with them, and institutional investors just want to know the numbers.

    This train left the station a long, long time ago.

  8. Thanks, Anon. While I certainly don’t believe that the world will suddenly turn upside down, it was time to give voice to a situation many of us are all too familiar with.

  9. Hi Deborah,
    I got to this one late. You totally echo my thoughts on the vainglory of the analyst community. Ask me….here in India, the analyst gurus draw conclusions on the dynamics of the global industry based on Infy or TCS results. And to top that, so much money changes hands based on these pontifications.

  10. Deborah, nice piece that adds to millions of similar articles/thoughts against equity analysts. You put in many things together which followers of equity markets know, but then putting in at one place makes sense. However, an industry (equity analysis in this case) is a creation of the market. Therefore, had equity analysts be so useless, they would be out of job, but they are doing well. More so, what are the incentives for equity analysts to go beyond the surface? Why should they invest time when their clients are more than happy to buy their reports or act on their recommendations? The answer of “digging deep gives personal satisfaction, can find out unheard trends, can make the analyst a star or rebel etc.” does not really cut much ice. If the clients (investors) know that equity analysts are not diving deep (most of them know), still buying research for whatever reasons, its not really entirely correct to blame equity analysts.

  11. I used to run investor relations at a midsized IT services and training company in the early 2000s and my impression of equity analysts — we mostly talked to the folks who made the Institutional Investor lists so maybe their reputations were well earned — was very different. I’ve spent endless hours on one-on-ones and at investor conferences (yes, the swish hotels were very nice) dissecting the business for them. Most of them were hard nosed and inquisitive and politely skeptical of management briefings — excellent traits in an analyst. On the whole, I found the analyst community intellectually honest — barring the poor sods who were ‘encouraged’ by the broking side of their fund houses to game a report when an investment deal was imminent. But then, nobody believed those reports anyway.

  12. Excellent points, Deborah.

    I wanted to add another perspective.

    I am just back from India where I visited a top 3 IT services vendor. It was clear to me that senior leadership is well aware of the threat to their business model coming from cloud and SaaS models. The feeling was that plain old offshoring for cost arbitrage will sustain them for quite some years but will come to an end sooner or later. They are exploring alternative business models involving onshore management consulting (competing with Deloitte’s of this world on deals that combine management consulting and implementation services) and some cloud implementation offerings. They are also encouraging internal entrepreneurship with small internal Venture Capital fund to facilitate innovation. In a nutshell, I walked away feeling that this firm is doing strategic experiments and it is not clear if any of them will pay off. They realize that the current model will not survive the threat of cloud computing long term.

    I wonder to which degree analysts in this sector are looking 5 years out asking providers what they have cooking in terms of new service offerings that will survive cloud computing revolution and aggressive moves by management consulting firms into IT space (e.g., McKinsey).

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