Soaring interest in business process outsourcing by UK local governments, following the pressure to lower costs and improve efficiencies, will ensure strong growth for BPO companies such as Capita Group in the next three years.

The UK's business process outsourcing market, which is estimated at Pounds 95 billion (US$193.7 billion) -- according to Cazenove -- is forecast to grow by 10 percent per annum until 2011. In the fragmented UK market, only Pounds 4 billion to 5 billion ($8.2 billion to $10.2 billion) of this is outsourced, creating further room for expansion and consolidation.

A report produced by Ovum -- telecoms, software and IT research analysts -- showed that with the market size crossing the Pounds 5 billion ($10.2 billion) mark and the high fragmentation of the market, BPO companies have endless growth opportunities.

Slow Public Spending

Last week's Comprehensive Spending Review further enhanced these opportunities by identifying Pounds 30 billion ($61.2 billion) of efficiency savings to be achieved before 2010.

Cazenove analyst Robert Plant explained that UK government needs efficiency savings because overall public spending growth has slowed from 4 percent to 2 percent, therefore savings in back and middle offices are needed.

BPO companies such as Capita or Mouchel Parkman will benefit from further efficiency savings as their business will take over from the public sector and perform better at reduced cost, said Plant.

Capita Likely to Profit

One analyst who preferred not to be named explained that such a report is extremely positive for BPO companies because of the unique way UK companies achieve cost savings.

"UK's local governments look for cost savings by outsourcing their back office operations," he said adding that Capita -- the company behind the London congestion charging system -- is most likely to profit as it is the market leader having about 21 percent of the market share.

Capita's chief executive Paul Pindar told Thomson Financial in a telephone interview that Capita can reach between 10 pct and 15 percent cost savings for local governments and between 20 percent and 30 percent for central government.

Less Than Impressed

However, chief executives from both Capita and Mouchel Parkman said they were not impressed with the findings of the review.

Mouchel Parkman's chief executive Richard Cuthbert said in an interview with Thomson Financial "we've had the 3 percent growth for the past 10 years" adding "I don't see a major change in the BPO market after the review."

Capita's chief executive Paul Pindar agreed, saying that he was not impressed with the findings either. Pindar told Thomson Financial in a telephone interview that although "local governments have a lot of impetus and imagination in creating efficiencies and cutting costs" UK's central government could do much more.

He added that "we will see a large level of activity in partnerships and contracts coming from local governments...[but that] central government is too conservative."

Pindar commented on the review saying "it is disappointing that there hasn't been effort to crystallize those saving ... as there is no doubt that there are efficiencies to be achieved across the government."

Segment Digging

However, despite the disappointing outcome of the Comprehensive Spending Review, Capita's changing business mix highlights the strength of the BPO market.

Although Capita's private/public sector mix has remained close to 50-50 in recent years, the underlying mix changed dramatically as the management went further into segments such as "local government" and "life and pensions," which are the two most active large-deal sectors in UK BPO.

Capita's local government division, which used to make up 16 percent of the company's revenue in 2004, today accounts for more than 20 percent including contracts with Birmingham, Cumbria, Blackburn or Southampton.

Life & pensions grew as well, now making up about 9 percent of total revenue. Additionally, Ovum researchers estimated that the activity in UK's life & pensions would grow about 16 percent between 2005 and 2009. One analyst, who preferred not be named, estimated Capita's full-year earnings growth at 20 percent because of its leading position in the BPO market.

Mouchel Parkman entered the BPO market through the Pounds 46.24 million ($94.3 million) acquisition of HBS, which enabled it to provide in-house BPO services when bidding for bundled Local Authority contracts. The company now has contracts with Bath, Milton Keynes and Lincolnshire, which makes about Pounds 35 million ($71.4 million) per annum.

Ovum also said that because of the wide fragmentation, the BPO market is ripe for consolidation.

Capita's CEO Pindar said "there will always be consolidation" citing Mouchel's acquisition of HBS. He added that Capita's strategy for consolidation is "little and often" with the average price for the companies acquired being Pounds 8 million ($16.3 million).

Organic Growth

Mouchel Parkman identified most of its growth as organic. Cuthbert said that of its 20 percent growth target 10 percent to 15 percent is organic, while the rest will be attributed to acquisitions.

Capita has a future bidding pipeline of Pounds 2.6 billion ($5.3 billion) made up of 12 bids where Capita has been short-listed to the last four or better. These bids are capped at Pounds 500 million ($1 billion).

While Mouchel Parkman Tuesday announced a record bidding pipeline of Pounds 2.5 billion ($5.1 billion), including the Pounds 1.1 billion ($2.2 billion) brought in by HBS.

A Panmure Gordon analyst said that despite growth rates for the industry reaching as high as 10 percent, there remains enormous opportunity for growth and "it should take decades before the trend matures."