Saturday, January 10, 2009

Satyam: Are the Outsourcers Melting Down Next?

Lately, I’ve been a little frustrated that I couldn’t blog about the Bernie Madoff scandal. (Actually, I could have but Larry said I’d just have to find another blog to do it at. He’s a stickler for staying focused.) Of course, I can look at poor Mike Huckman over at CNBC standing outside Federal court houses in the cold and rain during the Holidays waiting for a glimpse of the accused and console myself with being inside warm and safe. But, now, I may have a fraud of my very own to blog about. Granted, Satyam is a not a life sciences company but it does service them and there may be implications here.
Let’s start with the fundamentals of outsourcing. Essentially, commodity functions that are considered to be non-core activities are transferred to an outside vendor. The idea is that a vendor can take advantage of economies of scale and through continual process improvements to become best in class or the next best thing and make its money by spending far less to perform these services than is coming in. The problem is that classic economic theory teaches us that unusually high profits bring in more competition driving down prices and profits. And, this is where the fun starts. (And, this is where the hedge funds got into trouble.) It becomes increasingly difficult to post those double digit profit gains year over year when there’s more competition. Also, there’s one other aspect that most commentators miss. The early outsourcers got the easy deals, simple processes, large volumes, and low capital investment required. Those salad days are long gone now. So, a firm which is trying to support its stock price either to maintain executive compensation or values for future acquisitions starts to look at questionable practices for what they justify will be a short time. But, once down that slippery slope as probably happened to Bernie Madoff, there’s no going back. It takes a lot to avoid this temptation. Unfortunately, for Satyam, B Ramalinga Raju couldn’t resist temptation. Apparently, Raju overstated Satyam’s to 20 per cent from 3 per cent. I’ll hazard that the latter is more the norm for outsourcers than not these days.
One writer has described this financial scandal cum crisis as “India’s Enron”. What will happen to all those customers who have outsourced those back offices to Satyam? Now, I don’t know if any significant percentage of Satyam’s business came from life sciences, but, I think this could put a chill on future outsourcing deals. Looking at their website ( ) they appear to offer a fairly broad array of services in the life sciences sector. Coming so soon after the Mumbai terror attacks back in November this won’t be good for the Indian outsourcers. I also suspect that life sciences companies who had been planning to outsource their operations and reduce their costs while they were at it will now be having some second thoughts.
As always, we welcome your feedback. Please contact us at We look forward to hearing from you.

Contributed by Guy de Lastin

No comments: