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The recession triggered a “hiatus on decision making” but leading indicators point to a pick-up in outsourcing activity

The practice of outsourcing was pioneered in the 1980s, but in the last decade it has become a mainstream function of business management. The outsourcing industry – encompassing both IT outsourcing (ITO) and business process outsourcing (BPO) – has therefore grown rapidly since the millennium.

Like most industries, however, it has had a difficult year so far. This is borne out in research by outsourcing advisory TPI, whose TPI Index tracks the total contract value (TCV) of all outsourcing deals in the private sector worth more than 20 million.

Globally, the total value of all such outsourcing deals made so far this year was $62.6 billion, down 10% from $69.9 billion in the same period of 2008. And 2009 has seen more of what TPI describes as ‘telco-to-telco’ outsourcing – whereby telecommunications carriers outsource their network operations – than ever before. With that segment discounted, the global TCV for the year so far was just $48.3 billion.

In Europe, the decline was more pronounced: the total value of outsourcing contracts in EMEA during the first three quarters of the year fell 45% to 18 billion.

The principal cause of this decline has been a “hiatus on decision making” among businesses, says Duncan Aitchison, president of TPI EMEA. Uncertainty about the future of the economy has prevented them from making the kind of multi-year commitments required in outsourcing agreements.

“When the recession hit, it caused everyone to pause. It was not that they were necessarily for or against outsourcing, but they didn’t know what to do,” he explains. “Some businesses took on small projects [during the recession] but they certainly didn’t make any plans for the next three or five years.”

Now though, there are signs that the tide is beginning to change. “Though nothing has happened to relax the pressures on businesses in terms of cost and efficiency, the fog of uncertainty has lifted and planning has come back,” Aitchison says.

He argues that recent growth in the US market and in the financial services industry – two segments that went into decline early on in the recession – are lead indicators for increasing use of outsourcing across all industries and locations. And he says that there have been anecdotal reports of big deals in preparation. “Personally, I think it’s a little early to call a recovery,” he says, “but there are reasons to be cautiously optimistic.”

Aside from its immediate impact on the spending plans of businesses, the recession has also reignited some cultural opposition to outsourcing, especially offshore outsourcing, as jobs have become scarce.

In some cases, the decision to move jobs offshore has resulted in industrial action. Aitchison says that this may temporarily slow the pace of the outsourcing industry’s growth, but that the cost benefits of offshore outsourcing will outweigh popular feeling. “I find it hard to believe that we won’t see the continuing migration of certain activities to other economies,” he says. “I believe that the use of global delivery models [by outsourcing companies] will only increase.”

Reshaping the industry

September 2009 saw two significant acquisitions in the IT outsourcing space, namely hardware manufacturer Dell’s
$3.9 billion purchase of IT services provider Perot Systems and printer-maker Xerox’s $6.4 billion acquisition of ACS.

Aitchison believes that the outsourcing industry will see yet more consolidation in future. “Its been looking like a market ripe for consolidation for some time, and I suspect we will see a reasonable pace [of consolidation] in the next 12 to 18 months,” he says.

The downturn is fuelling this consolidation in two ways, Aitchison argues. “We’ve had a period of slow organic growth which tends to promote acquisitions, and also there are some bargains to be had out there. There has been some mutual realism about the true value of certain companies,” he says.

It is currently voguish among outsourcing providers to speak of ‘value-based’ engagements, in which the customer pays for goals achieved, not simply man-hours and materials. However, Aitchison says that deals are still overwhelmingly priced on the traditional basis.

“On the whole, while there is much talk about output-based pricing, the majority of deals are still based on inputs,” he says. “There is still appetite among both buyers and sellers for more creative ways of pricing, but it often dissipates during negotiation, and people get back to things they understand.”

Another phrase often heard on the lips of outsourcing companies is ‘innovation partner’, reflecting their desire to move up from being mere service providers to become more consultative, and therefore better-paid, partners to their customers. Again, Aitchison says that the talk does not always match the reality.

“‘Innovation’ is possibly the most abused term in the industry, and not just by the vendors,” he says. “Buyers often talk about the need for innovation, but when you ask them what they mean they aren’t sure.

“Certainly, there remains a desire to attack problems more broadly, to look at total cost of ownership or end-to-end process efficiency, but that often involves more complex change management issues and organisational structure issues that are difficult to overcome,” he explains. “That said, vendors will continue to seek ways of demonstrably providing more value to their customers.“