How Is Accenture's Business Outsourcing Positioned?

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Accenture (NYSE: ACN) has a diverse revenue model, which consists of two self sustaining divisions, outsourcing and consulting. It is has a dominant position in outsourcing and leads its peers by a considerable margin.

According to the valuations offered by Trefis, even though outsourcing constitutes only 33% of its stock price, its share in revenues is at around 43%. The outsourcing business facilitated the company in sustaining through the sluggish macroeconomic environment in Europe during the last two quarters. However, the consulting business is expected to be the key revenue driver in the coming quarters.

Business process outsourcing still underperforming

Accenture is a leader in application outsourcing, and generates a large percentage of its outsourcing revenues through this vertical. The growth in application outsourcing is primarily driven through Accenture’s expertise in management and technology consulting, as well as by bundling outsourcing services with more traditional services.

Business process outsourcing only supports ordinary business operations; however, it does not offer the necessary tools essential for a firm to reduce its costs and incrementally develop on core competences. Moreover, such a process requires highly detailed understanding of business complexities, involving the company’s key operations; hence, several firms avoid business process outsourcing.

This has resulted in Accenture witnessing a serious taut in this division. Nevertheless, growth in application outsourcing is expected to offset the severe slump in business outsourcing.

In a sluggish macroeconomic environment, firms essentially outsource to reduce cost in order to sustain margins. Under the circumstances firms only try to survive to somehow break even with its costs, thus outsourcing becomes a popular option, as it enables companies in maintaining a low cost structure.

Accenture’s outsourcing business exhibited strong results during 2008/09, when the global meltdown forced several firms into bankruptcy. In weak macroeconomic conditions, this division becomes a key revenue driver for Accenture; however, with the global economy showing signs of improvement, the outsourcing business is expected to witness a slowdown.

Declining average bill rates

The average bill rate of Technology and Business Outsourcing divisions declined approximately 12% since 2006. Post the 2008/09 economic recession, several companies insisted on cheaper outsourcing services, which resulted in a substantial drop of bill rates. Additionally, rapidly increasing competition through Indian outsourcing firms that operate on low cost further reduced the average bill rates.

Going forward, I expect the bill rate to increase gradually on grounds of Accenture’s superior knowledge centers and its pool of experienced management and technology consultants. The consulting firm is well positioned to leverage its knowledge and know-how to increase its bill rates progressively in the future. Although, it is highly unlikely that Accenture will once again reach the heights of 2006.

Margins to remain under pressure

The EBITDA margins of the Technology Outsourcing division have improved gradually from 17.3% during 2008 to 18.7% in 2012. Similarly, the Business Outsourcing division also witnessed a marginal increase of 2% in EBITDA margins during the last four years. The moderate increase in margins can be attributed to the reduction in Social General & Administrative cost.

However, as the company puts in additional efforts in gaining new clients and sustaining the existing ones through costly augmented services, sales and marketing expenses are expected to rise. Administrative savings cannot provide sufficient cushion in order to cover the increasing operating cost. Thus, going forward margins will remain under pressure.

Competitive landscape

Accenture competes directly with IBM (NYSE: IBM) in the outsourcing business. Similar to Accenture, IBM offers a strategic outsourcing service to several large organizations. Such services facilitate its clients in reducing costs and improving overall productivity. The Strategic Outsourcing division is a part of Technology Services, and according to Trefis analysis, it holds an 11.0% value in IBM’s present stock price.

Strategic Outsourcing operates on an EBITDA margin of around 20%. Within this division, IBM possesses a huge competitive advantage over its peers, as it offers wide industry experience, significant resources (100,000 employees), scope, and considerable experience.

IBM generates the highest percentage of its revenues through technology services at around 38%, which is followed by Middleware Software at around 20%. Another 17% is contributed through its business services division. The remaining revenues are split between various divisions, such as financing, operating systems, servers and storage.

HP (NYSE: HPQ)is another IT outsourcing company that competes with Accenture. The company's Outsourcing division grew at a rapid pace, primarily due to its smaller base. Its revenue increased from $4.7 billion during 2007 to $15.2 billion in 2011, however, the rapid growth achieved has resulted from HP's acquisition of an outsourcing firm called EDS during 2008.

With big players such as IBM and Accenture already dominating the outsourcing segment, revenue growth through this division will be a key challenge for HP. During 2012, its revenues through this division experienced a marginal drop. Going forward, stagnation in revenue growth is expected on account of rapidly rising competition. 

Key takeaway

Outsourcing growth for IT giants such as Accenture, IBM and HP is a key challenge, which must be addressed. Going forward, Accenture can expect the consulting division to bolster revenues and drive growth.

Outsourcing contributes a large percentage to overall revenues and will continue to do so in the near term, as large global organizations continue to strive hard in order to reduce costs in a highly competitive environment.

Once the global economy starts to improve, the consulting division will be its key revenue driver. I believe, if Accenture is able to sustain its outsourcing revenues and report positive growth in consulting, then investors can expect robust payouts through this stock.

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Kiran Gulati has no position in any stocks mentioned. The Motley Fool recommends Accenture. The Motley Fool owns shares of International Business Machines.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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