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1/7/2009
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Accounting Scandal Rocks Indian Outsourcer Satyam

Founder and chairman B. Ramalinga Ramu's quick departure sends customers scrambling to evaluate how the company's financial fraud will impact their own IT operations.

Satyam customers need to move swiftly in evaluating how the Indian outsourcer's newly revealed financial fraud will impact their own IT operations, say analysts.

In a bombshell disclosure, Satyam founder and chairman B. Ramalinga Ramu quit Wednesday, admitting in a five-page resignation letter that the company had been meticulously inflating its financial figures for years.

"People are blown away by this. There's never been anything close in scale to this fraud in the IT services business," said John McCarthy, VP of research at Forrester Research. "Clearly, customers can't ignore this situation." Satyam clients need to be assessing the impact "and rolling out recovery plans" for Satyam-provided IT services that now need to be moved to other vendors or brought back in-house, he said.

Outsourcing consulting firm NeoIT has several urgent recommendations for clients, said the firm's CEO, Eugene Kublanov. "Literally, in the next couple of days, the next week, be prepared with a risk mitigation plan," he advised Satyam customers.

Satyam customers need to "fully understand the Satyam situation," which in a worst-case scenario could have the company being unable to pay its workers and vendors and filing for bankruptcy, and in a best-case scenario containing the situation to "the boardroom" and emerging with a black eye, Kublanov said. The most likely scenario, though, is that the outsourcer will have "a change of control," with Satyam being bought or merged with another services provider.

"In any of these scenarios, there will be disruption in service" for Satyam clients, Kublanov said. "This situation is extremely shocking and, frankly, very disrupting to clients."

In an acquisition or merger, the new owners may not want to honor the contracts that Satyam signed with clients, especially if Satyam had been providing specific services at very low prices, said Kublanov.

"A big company may not accept those prices," he said. "These days, everything is up to negotiation." If a client has Satyam supporting critical applications, the client could find itself forced to renegotiate a new deal with a new owner "if all of a sudden a large company like IBM or HP is supporting those critical applications," he said.

"A lot will depend on buyer power versus supplier power," in getting an upper hand in any contract renegotiations, he said.

Forrester's McCarthy said that Satyam as of last June is estimated to have about 631 clients, from which about 60% of revenue comes from United States-based companies. However, only about 237 of Satyam's accounts spent more than $1 million a year of business with the company, he said. That means some of that work could be more easily absorbed by other parties, he said.

However, while most Satyam clients likely have diversified their outsourced IT work, with different aspects being performed by more than one IT services vendors, companies typically don't diversify vendors for the same kind of work. So, for instance, if Satyam is providing app development work, the customer's other IT services vendors are likely performing other types of service.

McCarthy agrees that Satyam's situation makes it a target for an acquisition, but said a potential buyer could be scared off by the lawsuits and other issues that will undoubtedly ensue. Still, a purchase of Satyam could be a good boost for a company that acts quickly to move in and contain an exodus of clients, McCarthy said. "A company that wants to bolster its SAP maintenance business could move quickly on this."

The Satyam fraud case doesn't necessarily mean U.S. customers will shun Indian outsourcing companies in general, because "fraud happens globally, in Houston with Enron, Louisiana with WorldCom, and now in India," said Kublanov. However, the situation could bring red flags to other Indian companies.

"This has implications on corporate governance, but also on regulatory oversight in India," he said.

The story was edited on Jan. 7 to clarify statistics from Forrester's report.

Please join us for InformationWeek's Editorial Webcast: "Offshore In India: What's Next?" on Thursday, Jan. 22, at 11 a.m. EST. Editor-In-Chief Rob Preston and a panel of top executives from the Indian IT industry will discuss these and other issues. Go here to register.

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