The "R" Word: Further comments about recession's impact on LPO

The "R" Word - by David Perla, Co-CEO, Pangea3

Recession is on everyone's mind, but the word everyone is trying to avoid saying. For starters, let's acknowledge what we all know: The U.S. economy is in very bad shape, and it's going to either get worse or stay this way for the rest of 2008, and perhaps much longer. The question on everyone's mind in the legal process outsourcing industry, and in the outsourcing industry in general, is whether this will have a positive or negative impact on 2008 for LPO and for other outsourcing players. I just returned from India, and everyone on our team was talking, often softly but always inquisitively, about the U.S. economy. Not less than three of Pangea3's team members, one in each of our Patent, Litigation and Corporate channels, asked me largely the same question: "David - is the recession good for Pangea3 or bad for Pangea3? And what are our plans for continuing to grow in this recession?"

First, I'm always impressed that young professionals thousands of miles away appreciate and think about the global impact of the U.S. economy, both generally and on India outsourcing businesses specifically. Second, the question forces LPO players to think both about how we will be impacted and what we can do to make lemonade out of lemons.

In my humble opinion, the recession is going to be both bad and good for outsourcing and legal outsourcing businesses, depending on their size, market footprint, industry base and the amount that their clients spend on outsourcing as a proportion of the total amount spent on that function (such as finance, HR, legal, technology, etc.).

In short, I predict that the recession will have
(1) a positive impact on the LPO industry,
(2) a decidedly mixed-to-negative impact on the more developed areas of the outsourcing industry, such as technology and BPO and
(3) disastrous impacts for small players in all industries.

Here's why:
Cash is King: In a recession, cash is king, as companies undertake measures to bolster and protect the current assets portion of their balance sheets. In that environment, companies will cut spending in traditional areas, such as marketing, IT and R & D, but also look for ways to cut spending in more rarely touched cash-consuming cost centers, of which the corporate legal department is among the worst offenders. Moreover, because legal outsourcing is so new, most in-house legal departments have not yet taken advantage of the cash-preservation opportunities afforded by LPO. When those in-house legal departments get squeezed to spend less cash, as they surely will, legal outsourcing will offer them the opportunity.

Litigation: In this recession, everyone is looking for a culprit, and the litigation bloodbath is just beginning. Witness shareholder and related litigation on just the Bear Stearns debacle alone. Litigation activity related to the recession will increase, and the resulting litigations will be, not surprisingly, discovery heavy. Combine this increase in litigation with the need to preserve cash, and litigants will look to India as a discovery solution. It's happening already, as most of the top LPO providers have seen a marked increase in litigation business in the last six months.

Market Awareness: Coincidentally, this recession is hitting at exactly the same time that market awareness of LPO is exploding, along with the growing acceptance by law firms that they simply must find ways to help their clients reduce spending, especially on litigation. So the demand to cut legal costs, together with the increasingly widespread awareness and acceptance of outsourcing to India as a viable and desirable option, will move both in-house legal work and law firm work to India based legal outsourcing companies. Thus, I expect that legal outsourcing providers (at least the good/big ones) will see a spike in business in this economic environment. However, two types of outsourcing providers will suffer:
(1) small LPO providers and
(2) providers of outsourcing services where the client spend on that service is going to be cut, along with other expenses.

Small LPO's: Pangea3 and its peer LPO's are already seeing a massive influx of resumes from smaller LPO players - those same players that just last year were enthusiastically recruiting and creating wage inflation in the Indian legal services market. In a market like this, two dynamics work against a smaller/newer player. First, US and European companies flee to quality, because outsourcing legal services to India is no longer viewed as an experiment - it is a business imperative, for those companies going this route. Second, the market itself has delivered a double-whammy to LPO providers: (1) wage inflation, which was largely created by the new entrants themselves, and (2) a strong Indian Rupee. Combine those two factors with the relative glut of small players and an inability of those players to demonstrate true quality and staying power (both of which big law firms and in-house legal departments demand) and it's game over for many of them. All new and dislocative industries go through rapid growth followed by consolidation, and I think we're in the beginning of the consolidation phase. I lived through just this dynamic in the online recruitment industry while at Monster.com, from 1999 through 2004, and history tends to repeat itself - as least economic history. I'm not suggesting that we will see acquisitions or mergers of legal outsourcing providers this year, but I submit that there will be fewer players at the end of 2008 than there are now, but that the leaders and high-quality providers will emerge bigger, faster and stronger. The same thing occurred during our last recession, with the winners in Indian IT and business process outsourcing emerging as major global companies. The blogosphere has a long memory, so let's re-visit this a year from now.

Other Outsourcing Companies: The story is going to be slightly different for outsourcing companies outside of legal services outsourcing. In certain other outsourcing industries, outsourcing to India, the Philippines and other global destinations has become the norm rather than the exception. In those cases, the budgets being spent on outsourcing will be cut alongside the budgets for that function in general, such as IT, marketing and HR, to name just a few. So the consumers of those outsourced services certainly prefer buying those services offshore to onshore - but they'll cut the entire budget, including the offshore component. Witness the cancellation of certain big outsourcing contracts already, and expect more such cancellations and modifications. The exception will be those outsourcing companies that are perceived as best-in-class, which companies will be able to land more new business from clients that have not yet offshored core cost center services, and who will do so in 2008 and 2009 as a way to . . . preserve cash. So the best players (not necessarily the biggest) should stand to gain, while the mammoths run the risk of being the victim of contract cancellations. That's a long answer to a difficult but important question. However this plays out, 2008 is going to be a very bumpy year, with a lot of pain for a lot of people. But ultimately, expect to see LPO much bigger, much stronger and much more mainstream come Spring 2009.