Information technology outsourcing is very big business. A simple fact in this line of work is that outsourcing companies are vulnerable to the fortunes of their clients. When things are going well, companies can afford to outsource their record keeping and other menial tasks. When times get lean, this sort of work is usually one of the first cost-cutting casualties.
Some firms lead, while others play catch up. There are a large number of firms in this business but we're going to take a look at two exemplars to see what we can learn.
A Global Presence
Information Technology outsourcing company Electronic Data Systems (NYSE:EDS) was formed by Ross Perot in 1962. With a market capitalization of $11.9 billion, it generates $21.6 billion in sales from 21 different countries. Although EDS has $3 billion in cash and equivalents it also has $3.1 billion of debt and below investment grade credit rating. Whether it is "junk" or "junque" is a matter of opinion.
Management got the message and has invested $3 billion over the last three years on infrastructure and other capital investments to bring new services to market. Electronic Data Systems has also formed alliances with Cisco (Nasdaq:CSCO), Dell (Nasdaq:DELL) and Microsoft (Nasdaq:MSFT). Execution of this new strategy is key, as EDS has several competitors hoping it will stumble.
Although EDS's revenue growth has averaged a -0.3% for the prior three years, last year it improved to 7.7%. Earnings growth was flat for the three priors years and a 74.1% last year. The firm has to work on its 13.6% gross margin, 3.0% net margin and 7.8% return on equity.
The India Advantage
Infosys Technologies (Nasdaq:INFY) is based in India and was formed in 1981 by seven software engineers with the equivalent of $250. Today, it can boast of a market cap of $27.8 billion, and it generates just over $3 billion in sales. Infosys was also the first Indian firm to be added to the Nasdaq 100 Index. The firm enjoys a reputation for delivering high quality results, on time and has inherent cost advantages being located in India.
From a market share perspective, Infosys has plenty of room to grow as it has penetrated only about 1.5% of the market. Of that market share, 95% of its clients are repeat customers. Although its market share looks small at 1.5%, the firm's financial results speak volumes. Revenue growth hovers around 43% for both a three average and last year, while earnings growth has averaged 43.6% for the last three years and 50.8% last year. This firm derives a 27.5% net margin from a gross margin of 42.5% and returns an impressive 37.3% to equity.
Bottom Line for Investors
In this instance, the market capitalization to sales ratio says it all. Electronic Data Systems sits at 0.55 and has appreciated about 10% over the past three years. Meanwhile, Infosys is at 9.7 and has appreciated around 70% for that same three year period. Infosys has had great success with India as a base of operations. The cost advantages are impressive, and it could mean that we'll see more and more firms following Infosys' lead.
To learn more about outsourcing, read The Globalization Debate.
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