Paul Hermelin has seen both sides of the offshoring phenomenon. When he took over as chief executive of Capgemini (CAPP.PA) in 2002, Europe's largest information technology services outfit was still struggling to get past its 2000 merger with Ernst & Young Consulting while facing competition from upstart Indian firms. Now, thanks to a lot of hard work by Hermelin and his executive team, the company is benefiting from the massive shift in outsourcing to lower-cost countries—where Capgemini's staff has more than doubled over the past four years, to 20,000 people.
On Feb. 14, Capgemini turned in a stronger-than-expected earnings report. Revenues rose 13%, to $11.9 billion, and net income nearly doubled, to $602 million. The company's operating profit margin came in at 7.4%, and Hermelin expects it to hit 8.5% this year. Because of the restructuring of a major contract with the British government, however, Capgemini is forecasting only a 2% to 5% revenue increase in 2008. After the quarterly update, Hermelin discussed the company's strategy with BusinessWeek senior writer Steve Hamm.
Capgemini had a strong 2007, both in revenue growth and operating margin improvement. How do you account for that?
We are probably the one Western company, along with Accenture (ACN), that has truly embraced a global delivery model. You can see the speed of growth of our offshore head count. It helps us to be more and more competitive. We now have people in several countries. We're mastering multishore delivery. Now, in the U.S., if there are 100 people working for an outsourcing client, probably 45 of them are based in India. That makes us a hybrid animal between the Indian pure player and the traditional Western player.
You say Capgemini and Accenture are the Western companies that have most embraced the global delivery model. What about IBM (IBM), which employs 70,000 people in India?
Nearly half of them work for IBM software and hardware departments. If you look at the number of IBM people in India who are actually servicing Western customers, as a proportion of their revenues, they are behind us. I do not see them as often with customers with global delivery as I see Accenture.
You have dramatically increased your offshore workforce, both by acquiring India's Kanbay and through hiring, giving the company 5,000 employees in India. What are the biggest challenges you have faced, and how have you overcome them?
What worked very well was to use offshore skill groups initially as sort of offshore subcontractors. I could say to my Dutch guy or French guy, "You own the customer and you're rewarded for the revenue generation, and you keep the profit." It was a good way to awaken our onshore people to the offshore model. But that's not a sustainable model, because if I do that, I contain the Indian employees in a role they don't like, and I can't retain the best talents.
We are moving now to a model where there's a seamless organization that integrates on- and offshore people in a consolidated business unit. It's a little more difficult, but it's far more rewarding. It [offers] the customer a kind of embedded interface between offshore and onshore that they don't have to build. We won back some contracts from the pure players, be they Tata or Infosys (INFY). We can do this because of the multicultural nature of our organization. They are global players, but they're Bangalore-centric. There are other global players, like IBM, but they're Armonk (N.Y.)-centric.
We are the only global player that's truly multicultural and distributed. That's because the last time Paris was the center of the world was when Louis XIV reigned, 300 or 400 years ago. We can't do that now. So our only chance for building a global powerhouse is to combine many cultures and have a global company based on entrepreneurship and multiculturalism.
Do you expect this rapid growth in offshore workers to continue?
The plan is to go from 20,000 to 45,000 in two years.
Is there any truth to the reports that India's Reliance Communications is seeking to buy Capgemini?
There's a journalist in India, from the Economic Times, who loves this kind of story. It's the third time he has written about us talking with an Indian company. I don't know why he has a Capgemini obsession. The thing is, Reliance closed a major alliance with Accenture. So if there's one Indian company that would never even talk to us, it's Reliance. The guy is not aware.
You have been working hard to get your outsourcing contract with Schneider Electric (SCHN.PA) on the right track. Where did that deal go wrong, and what are you doing to fix it?
It was a long process of renegotiation that was closed on [Feb. 8]. The initial contract was flawed. They had one obsession, which was building a globally integrated system, based on nearly every module of SAP's (SAP) software, to create the backbone of their company. That we knew. But it's a company with many baronies, and when we tried to build the system in order to overcome the resistance of some of their baronies, we had to design something significantly more complex than we had at first planned. To get buy-in of the different business lines, we agreed on something more complex and comprehensive, and we thus delayed the savings that we both hoped to achieve. The whole contract became unbalanced.
We now have a new contract. The system is nearly ready. We have delivered the first pilot in India. We'll deliver the second pilot in Europe about midyear. We're rolling out the solution, and the contract is more flexible to acknowledge some adaptation. We took some adjustments on price points, but if there are adjustments on volumes, it will be their responsibility. If they have more PDAs and BlackBerrys, for example, we'll track the volume of hardware and applications, and make adjustments.… Both parties are happy.
Why have business consulting services been relatively weak for Capgemini? Your revenues there only rose 4.5% last year. What are you doing about that?
In Europe, we had a nice ramp-up; it was 9% in the second half. In the U.S., we're lagging behind. We created a dedicated consulting entity in the U.S., which can be attractive for talent, and we may buy a company. It's a big differentiation against the Indians, because they don't have any consulting. In Europe, we're No. 1. We're big in France, Germany, and growing in the U.K. So I'm quite pleased. But in the U.S., we can't be at the level we need without an acquisition.
What new business initiatives will Capgemini launch in 2008?
It's still back on the onshore transformation. We don't want to make the Indians into a back office. We have to get our front-end people to understand that with a truly global delivery system they can gain market share. We have a program we're working on. This is the most demanding thing we're working on.
The other part is to monitor a quite unstable economic environment. If there is a downturn, the first thing people cut is consulting. The second is IT programs. We're exposed to a downturn. We're highly cyclical. We're in the people business, so we have to monitor this very carefully. In a recession, companies will try to get savings from handing over operations to a big outsourcer. They'll keep some projects that target cost savings. But they'll stop all projects that are related to their customers. Today there are a lot of customer management and marketing support projects. That will probably be frozen or sliced or delayed in a recession. In the last recession, people kept investing in their systems—upgrading applications. But they delayed things like new supply-chain engineering. That can be delayed a few quarters without harming the business.