Frenetic activity. That's what best describes the goings on in India's business process outsourcing and call centre industry right now. Consider this: A total of about 13 important deals have taken place in the sector in the last four months alone. And they range from Indian companies acquiring overseas firms (eight such deals), overseas firms acquiring Indian ones (five), and then some with miscellaneous deals like partnerships, joint ventures, mergers and the rest of it, which indicate that the sector is in top gear as far as its consolidation drive goes.

All this from an industry that was barely even understood until about a year ago. In fact, the oldest players in the business are barely into their fifth year. Most BPO companies gained critical size only over the last three years, and the first full-fledged sector report, the much-quoted NASSCOM-McKinsey study, was released as recently as 2002, but to instant fame as it predicted BPO revenues of $24 billion (Rs 1,10,400 crore) by 2008. The evolution of this sector is quite unlike anything seen in Indian business just considering the fact that it has hit consolidation phase within about three years of its birth, something that its older sibling, the it services sector, achieved over probably a 15-year time frame.

So why are we going over these much talked about factoids? Simple, it's just an effort to make sense of what's going on. It isn't every day that a sector sees overseas acquisitions (however small they may be) at the rate of nearly 15 in four months and an overall deal rate of over 10 deals each month for the last six months.

So, once again, why are Indian BPOs going shopping abroad? "Our priority is organic growth, but acquisitions help us fill (portfolio) gaps and also aid in skill acquisition," says WNS President, Neeraj Bhargava, whose company has completed two overseas acquisitions-Claims BPO, a US-based healthcare insurance service provider and Town & Country, a UK-based property insurance service provider. Bhargava's logic explains the hectic activity on the BPO deal street, where acquisitions (both overseas companies acquiring Indian companies as well as the reverse) have become the order of the day.

Investment banks specialising in deals in the BPO and call centre business such as Avendus Advisors and Edelweiss Capital are seeing a flurry of activity on the deal front. Avendus' Ranu Vohra says the company is currently handling about eight deals in the BPO space. Edelweiss Capital's Rashesh Shah pegs the number of BPO deals he is currently doing at five. Some other industry players reveal that they receive a couple of e-mails every week from unknown overseas BPOs asking if they could talk about a deal.

Clearly there is big action on deal street but the deals themselves are mostly very small in size. Barring the Essar Teleholding acquisition of US-based BPO outfit Aegis, which was for nearly $29 million (Rs 133 crore), most of the other overseas acquisitions have been in the $2-5 million (Rs 9-23 crore) range at best. Among the more recent deals, Hinduja tmt's acquisition of Manila-based call centre c3 was wrapped up at under $4 million (Rs 18 crore). Godrej group's Lawkim is understood to have acquired Upstream at under $1 million (Rs 4.6 crore).

Progeon's Akshaya Bhargava: No such thing as a small BPO

Analysts at global research firm Gartner feel that Indian companies should be careful whilst acquiring overseas firms at rock bottom prices as they could turn out to be little more than shell companies. But why are these firms selling themselves so cheap in the first place? Answer: falling net margins for BPO firms overseas, the pressure from investors of domestic firms to scale up operations, and a growing realisation of just how tough the BPO business is. "Overseas BPO companies today are seeing valuations which are at half their revenue," says an analyst with a leading consultancy firm. So, typically, an overseas BPO company that sees revenues of $4 million can actually be bought for $2 million or less.

"In the West, the BPO business has turned into a low margin one with net margins of 3-4 per cent, while in India we are still talking of net margins of 15 per cent plus, so overseas BPO firms feel they can command better value here," says Akshaya Bhargava, MD & CEO of Progeon. Moreover, faced with competition from Indian firms, whose operating costs are as much as 60 per cent lower, there is very little possibility of an improvement in net margins-no doubt one of the triggers for the near-panic sale by the overseas firms.

Domestic service providers meanwhile have their own set of needs which could be fulfilled by an overseas acquisition. Some of these are the need to cut the sales cycle, which could take upto 18 months per customer (during which time the company is often faced with excess capacity), the need to scale up to a critical size that will allow for an exit option for the investor (often VCs) possibly through an IPO, and finally the need to build a large BPO business because, as Progeon's Bhargava says, "There is no such thing as a small BPO business; you will need at least 5,000 billed people and a $100 million in sales to survive."

Chasing Scale

Why is that? The math is pretty straightforward. The BPO business depends entirely on economies of scale. It is a capital intensive business where every additional client would require an additional investment in infrastructure (read seats). Seat optimisation would depend on the number of clients the BPO is able to bag across geographies (varying time zones are a prerequisite for the seat to be used across shifts). This fundamental premise coupled with the fact that the BPO is fighting falling prices, a margin squeeze and an increasingly competitive situation vis-a-vis captive BPO units, would mean that it needs to build a business that is large enough to be derisked.

Some others, like Daksh eServices' CEO Sanjeev Aggarwal, see an early global presence as an opportunity for Indian companies to establish global leadership at least in the BPO industry. In fact, before the end of next fiscal, Aggarwal plans to have a call centre up and running in a South East Asian location, possibly Manila, Philippines. But the rush on deal street is largely attributable to this realisation and growing need for Indian BPOs to achieve scale that will ensure their survival. For traditional business houses like Essar and Godrej who have deep pockets, the falling valuations of overseas firms has come as a boon that allows for a late entry into the business and an opportunity to catch up with the early birds.

All said, it is a race to the finish as BPO firms across geographies fight for scale. Says P.V. Kannan, CEO, 24/7 Customer: "We have less than 10 US/UK companies in India that have used either third-party providers or by themselves scaled to 2000+ in India. In phase two, this will increase to over 25 and in the next two to four years we will have at least 100-150 companies with such scale. At that level, the top five third-party providers together will be employing over 200,000 people. And the top 10 captives will be employing 100,000+ people put together." In the Indian market there is a buzz about several impending IPOs, including those of ExlService, Daksh, ICICI OneSource, among others. The rush for scale, therefore, could also be in a bid to shore up revenues before the companies hit the market.

In course of time, the sector will also see some innovative models of partnership that allow companies to achieve that scale without adopting the traditional merger and acquisition route. On the valuations front, however, the scales seem tipped in favour of Indian firms at the moment. Little wonder, they seem to be making the most of it.