A mixed blessing for IT outsourcers

In most sectors of the IT industry, the impact of the 2008/09 recession was nothing short of disastrous. For a lucky few, such as software-as-a-service vendors, it was surprisingly positive. But for the IT services sector, the economic downturn was a decidedly mixed blessing.

Analyst company Gartner predicted as much at the start of 2009, when it forecast that while the IT services industry was by no means immune from the effects of recession, the potential cost savings associated with outsourcing were too good to be ignored for long.

Back then, Gartner highlighted the capacity of outsourcing IT as a means to alleviate immediate pressures on cost, but warned that unfavourable economic conditions would lead buyers to exercise more caution than usual in both their selection and retention of service providers.

Certainly, the downturn put even greater pressure on businesses to reduce the cost of their operations, and although it is the subject of endless debate, outsourcing is certainly seen in some quarters as a means to reduce operational cost.

According to Lee Ayling, managing director of UK IT services at outsourcing advisory firm EquaTerra, 2009 saw cost reduction – as opposed to, say, business transformation or technology upgrades – become far and away the most important reason to outsource.  

“There seemed to be a huge drive to use outsourcing as a mechanism to save money,” says Ayling. “For the first time since we started surveying the industry, all other drivers suffered at the expense of saving money.”

This meant that customers put their suppliers under even greater pressure to absorb the transfer costs of new engagements, says Ayling, while suppliers themselves underwent benchmarking studies to ensure their own offerings were competitive.

More significantly, though, the uncertainty of the past 18 months put a break on any long-term commitments, and the volume and value of deals dipped severely. In the first three quarters of 2009, according to outsourcing advisory firm TPI, the total value of outsourcing contracts (including both IT outsourcing and business process outsourcing) in Europe, the Middle East and Africa fell by 45% compared with the same period of 2008.

Why, then, did two of the biggest IT industry deals of the year – Dell’s acquisition of outsourcer Perot for $3.9 billion, and Xerox’s purchase of ACS for $6.4 billion, both in September – take place in the IT services sector?

The answer in part lies with the even graver fortunes of the hardware industry. IBM and Hewlett-Packard have proved that combining IT services with hardware distribution can be rewarding. Indeed, were it not for its 2008 acquisition of IT services giant EDS, HP would have suffered one of the industry’s most dire financial performances; as it was, it survived 2009 relatively unscathed.

But a secondary reason must be that these companies anticipate a return to growth for the sector, and there are already signs that this may come to pass. In November 2009, for example, insurance giant Zurich signed a $2.9 billion, ten-year deal with IT services provider CSC. 

Despite this, EquaTerra’s Ayling hints that caution will continue to characterise the IT services market in 2010: “The economy has got everyone to sharpen their pencils, and I think that next year is going to be more of the same, but with a bit more pent-up demand in the market which will start to be released.”

Offshore moves

It was an especially rocky year for the offshore outsourcing industry, for which 2009 began disastrously. The exposure in January of fraudulent accounting on a stratospheric scale at Indian IT services provider Satyam blighted the hard-fought legitimacy of the subcontinent’s offshoring industry and raised questions concerning its standard of corporate governance.

“There was a complete hiatus in using a lot of offshore providers in the first half of 2009,” says Ayling. “If buyers are going to hand over a significant amount of their investment spend to an offshore service provider, they want to know that they have robust corporate governance arrangements in place.”

This, combined with the above-mentioned dip in deal volume, caused many of the big-name Indian offshore providers, which have historically enjoyed regular revenue growth rates of 30% and above, to encounter growth rates in single or even negative figures.

Other Indian suppliers, meanwhile, thrived in 2009. A case in point is HCL Technology, a company that offers its customers ‘value-based’ pricing for its services. It will charge clients for an amount of cost reduced from a business process, for example, or for a percentage increase in the satisfaction of the clients’ customers. In the year ending 30 June 2009, HCL grew revenues by 40% and profit by 110%, a result it attributes directly to its ‘value-based’ service offering.

Other suppliers in the Indian IT services industry have taken note, and service offering innovation can be expected to blossom in 2010, even as customers maintain their high expectations for cost reduction.

Predictions for 2010: Outsourcing

Duncan Aitchison, partner and president for outsourcing advisory firm TPI in EMEA, predicts a return for major outsourcing deals in the coming year

"In 2009, we saw relatively slow large-scale outsourcing activity (those contracts valued at e20 million or more), but we expect to see an increase in the total value of contracts signed in this market in 2010.

The earlier slowdown of activity was driven by a lack in corporate decision making, as companies struggled to cope with the impact of the global recession.

With signs of confidence returning to the market, the larger businesses, which are the primary drivers of the outsourcing market, appear to be willing to make more strategic, long-term, decisions about their sourcing strategies. We believe we are likely to see a rise in the number of large-scale contracts awarded both globally and in Europe in the next six to nine months.

The majority of larger-scale outsourcing interest is still in the IT outsourcing arena, particularly in relation to infrastructure. We are also seeing a renewed interest emerging from the financial services industry, especially banking. Historically, this area has regularly been one of the biggest spenders on outsourcing, and its decline in activity in the past 18 to 24 months has had a significant impact on the overall market.

In the case of business process outsourcing (BPO), most contracts, with the exception of captive sell-offs, appear to be in the sub-€20 million value band."


Alan Dobie

Alan Dobie is assistant editor at Vitesse Media Plc. He has over 17 years of experience in the publishing industry and has held a number of senior writing, editing and sub-editing roles. Prior to his current...

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