The New Pattern in Moving Service Margins

In my last entry, I overviewed the fact that the margins in Technology Services have been steadily improving over the past five years. In this post, I want to discuss how this margin improvement has occurred and how the levers for margin improvement are shifting.

Three Big Levers

What levers have technology service organizations been pulling to steadily increase their margins by ten points over the past five years?  Analyzing TSIA benchmark data across multiple service lines (Support Services, Professional Services, Education Services), it is clear that the highest financially performing service organizations have mastered the following three tactics:

1. Global Sourcing (labor arbitrage): TSIA has aggregated multiple data points that demonstrate the positive impact of leveraging global resources to deliver ALL types if services—not just support services. This trend of global sourcing service delivery has been relentless. Service organizations that are not leveraging global labor pools are finding themselves at a significant cost disadvantage.  Even service organizations with highly differentiated brands and offerings are learning how to leverage global sourcing models to optimize delivery costs.  

2. Minimized discounting on service offerings: TSIA tracks discounting data. Even with the downturn in the global economy, technology service organizations have done a very good job of minimizing discounting on their service offerings. The days of “throwing in services” to get the product deal, went by the wayside with the advent of new revenue recognition rules in 1997 and the requirements to support VSOE.

3. Reduction in non-billable labor hours (less overhead): Last but not least, the most profitable service organizations run relatively lean and mean. These organizations spend less than 1% of services marketing and less than 5% on services G&A.

Right now, what type of companies achieve really high service margins? All types. The TSIA benchmark data has examples of big and small service organizations achieving high margins.

 

Seven Levers

So think of the levers a service organization can pull to improve financial performance. There are seven very common levers every service line could potentially pull to improve margins:

Optimizing each one of these levers can potentially improve financial performance.

Two years ago, Matt Denesuk, one of IBM’s services engineers spoke at a TSIA conference. In his presentation, he listed seven levers a service organization can pull to improve and grow a labor-based business. As you can see in his slides below slide, a lot of overlap with the levers I just listed and a conclusion that “reuse” is now a critical lever moving forward.

In December of 2010, I had the opportunity to address 3,000 global professional service employees from HP’s software division. During that conference, I polled the managers and asked them what levers they planned to pull to improve service performance in the future. Here is the summary of their response.

So here we have the two $100B behemoths of the industry—both signaling that labor arbitrage and operational efficiency are no longer the big levers to improve service performance.

This leads us to a new pattern that is emerging in technology services. Looking at a spider graph that shows what levers service organizations pull to improve financial performance, we are seeing a shift from the levers on the right, to the levers on the left. Reuse, revised selling models, and detailed customer analytics are the new levers. For many service organizations, NEW levers.

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