When Ray Lane speaks, the technology industry listens. I read his SandHill.com column on a trip to India. There, the fast-growing business process outsourcing (BPO) market thinks Ray did not go far enough in his advice to the software industry. Vendors need to provide software as a service ? a BPO service.

The Indian view is corporations increasingly want ?cooked food? whereas the software industry still wants to sell raw food and Weber grills to customers so they can cook at home. And of course, many Indian vendors do not feel obligated to use currently available software platforms for their offerings. Still other vendors are on the lookout for software platforms to acquire and transform into services plays.

We all know that India (and other offshore markets) has become a hive for software development and support. In the coming BPO wave, existing offshore IT vendors and other offshore start ups are offering to take over horizontal business processes (finance and accounting, human resources), vertical processes (mortgage processing, media animation), and knowledge-based activities (analytics, market intelligence) for their customers. In doing so, they are cannibalizing the need for licensed software either in implemented or ASP mode. So even if software vendors move to subscription and other service-based offerings as Ray recommends, many may find themselves increasingly locked out.

Somewhat reminiscent of vertical marketplaces we saw in the late 90s like Neoforma and PlasticsNet, a number of BPO offerings aimed at ?micro-markets? - mid-sized CPAs, logistics services, debt collection services ? are being spawned. And if you roll your eyes at the VC money that was sunk in to those marketplaces, this time around most of the BPO offerings are customer funded ? many by blue chip companies.

Recently, I partnered with ValueNotes, an Indian market research firm, to conduct a study of 50 Indian BPO firms. We found the average revenue of the firms surveyed was approximately $27 million after an average of four and one-half years in operation. In other words, these BPO providers are just about to hit their stride.

While larger vendors may not feel intimidated by this, a number of focused software vendors should be concerned. I was not around Florence during the Renaissance, but I suspect the creative energy then resembled what you see in the BPO market today.

Of course, BPO is not just an offshore phenomenon. EDS, Accenture, HP, IBM ? all of them offer their own variants. ADP and Hewitt have offered HR/payroll outsourcing for decades, UPS supply chain outsourcing and so on. What is scary (or exciting depending on your perspective) is the price points, the ?micro-market? focus and the performance standards of the offshore vendors.

Benefits of BPO Offerings
The BPO providers deliver many of the product characteristics that software vendors have struggled with for years. Here is what corporations will increasingly be able to buy from these firms, and software vendors will have to compete against:

? Genuine SLAs. Not just a 30 day warranty, but a defined, multi-year, high threshold service level agreement with specific penalty clauses for non-performance.
? Freedom. Insulation from the - software license, implement, upgrade, bug/fix, pay annual maintenance, train/retain unique software talent - cycle.
? Budget predictability. Customers can count on a defined budget rather than that amorphous word most software vendors offer ? TCO. (Okay, so I was guilty of building ERP TCO models while at Gartner, but in the decade since, TCO is still wildly divergent from customer to customer?)
? Demand-driven capacity. More variable sourcing tied closer to demand metrics ? not just pricing based on secondary metrics like revenue or users that the software industry commonly uses.
? ?Everyday? low pricing. New price points which will make even world class leaders in Hackett Group?s benchmark of white collar processes (e.g., the cost to cut an AP check) look inefficient.

Tactics for Software Vendors
Although the BPO value equation is compelling, software vendors still have several defensive and offensive tactics they can adopt to ward off the BPO threat:

? Adopt a new mindset. To many software executives and financiers, ?services? is still a dirty word. In the last decade, well-managed services firms like Infosys and Cognizant have shown they can consistently deliver high margins and scale linearly ? two traditional criticisms of services. And Wall Street is rewarding these companies with valuations of more than 10-times revenues. And its not just BPO - there are opportunities for new sets of services e.g. bundle annual maintenance (the vendor portion) with application maintenance outsourcing (the user portion) to take over the entire support supply chain. To do this, software companies need to learn employee ?re-badging? and knowledge capture/playback techniques ? skills service providers like Accenture and Wipro have honed for years now.
? Get serious about process benchmarking. How many software executives can cite with authority key business metrics (inventory turns, closing cycles, rejection rates etc) at even their largest customers? There are too many ?ROI? case studies in the industry today masquerading (poorly) as serious customer benchmarking efforts. These are the metrics the BPO vendors are focused on ? so should software executives.
? Protect your channel. As we know, product development is far easier than customer acquisition. The offshore BPO vendors are still in the early stages of customer acquisition. Go back to your existing customer base and offer them your own BPO services (with your own offshore delivery capability or BPO partner). As an alternative, CEOs and VCs should increasingly view BPO firms as attractive ?exits.?
? Use BPO to enter new markets. Instead of a software offering for a new vertical or functional area, enter with a service offering, and let the early adopters fund a software offering as a result. This is somewhat the reverse of the typical, long and expensive software development and customer maturation lifecycle common in the industry today.
? Re-evaluate your partners. Are there enough process engineers - not just technicians - in your service partner/reseller ecosystem? And do they expect a premium for that process skill set? I asked an Indian BPO executive about EDS? recent announcement to partner with SAP, Oracle and Siebel for its BPO offerings. He smiled like the Cheshire Cat, clearly relishing the prospect of competing against those multiple, premium-priced offerings. (Of course, he had not focused on the channel power of these brands, but he was right to be confident he could price much more competitively.)
? Differentiate even more. Continuing the prepared food analogy, the proliferation of restaurants has not eliminated home cooking. However, folks seek more convenient, organic or other differentiated products and often pay a premium for that. The same will apply in the software industry.

In India, a major topic of conversation continues to be the recent tragic tsunami. While I was there it occurred to me, that in the tech world, software and services are adjacent ?tectonic plates?. They periodically encroach each other (remember Accenture with Mac-Pac?), but generally have stayed as distinct cultures and business models. I could not help but think that in the next couple of years, these two ?plates? are going to become much more abrasive and eventually produce a quake which will power a different kind of tidal wave. And it is headed straight at the software industry. Fortunately, we have a few years of warning before the BPO wave hits us.


Vinnie Mirchandani is CEO of Deal Architect which helps technology buyers procure software, offshore and other technology contracts. It also works with technology vendors and investors on strategy and merger transactions. Mr. Mirchandani was previously a Gartner analyst and an executive with PwC (now part of IBM). He can be reached at contact@dealarchitect.com -