Growing rift between enterprises and service providers

As the services industry shifts into a digital world, there is a growing misalignment in interests among service providers, their critical stakeholders and investors, and their clients. Why should clients care about this growing rift with their service providers? Because it changes the service providers’ investments and commitment. Here’s what I see clearly happening.

In a nutshell, clients are voting through their wallets and basically forcing the service providers into a digital business model. And they’re being very clear: if the existing providers don’t want to change to a digital business model, they will switch to providers that do. But at least initially, the new digital models don’t yield the same profit margins as the providers’ longstanding labor arbitrage model.

Profit margins in the mature labor arbitrage space have been historically abnormally high. Service providers have enjoyed gross margins in the 40 percent range and net margins in the 20s. But the new digital models are not yielding 40 percent gross margins. (I want to be clear that I’m talking about service models that don’t have intellectual property (IP) ownership. When you move to IP/software ownership, you can get high gross margins in the 80+ percent range and profit margins in 40+ percent. But in this blog post, I’m referring to service firms, not IP firms.)

Read more at my CIO blog.