There can be little doubt in the minds of IT services professionals: this is truly the worst of times. With only a few exceptions, services companies are operating against a backdrop of shrinking revenues and unprecedented losses, lay-offs and salary cuts, assignment cancellations and project downscaling.
But, for all that, there are plenty within the sector who believe that these could also turn out to be the best of times.
Over the past year, the IT services sector has been working its way deeper into the fabric of most large organisations in a way that could never have been achieved through its traditional mainstays: consulting, bespoke application development, systems integration, software package implementation or other project-based services.
As organisations have cut their IT budgets, in some cases disillusioned by IT’s consistent under-delivery, demand for project-based services has waned and organisations have focused the bulk of their attention on what has become the new bedrock of IT services – outsourcing.
In the process, the services industry is being reshaped. “IT outsourcing in the UK is virtually carrying the rest of the software and IT services sector through the troubled economic waters,” observe analysts at market watcher Ovum Holway.
A handful of deals in the closing months of 2002 alone epitomise that outsourcing pace in the UK: Boots passed its IT operations to IBM Global Services under a £710 million, 10-year contract; Royal Mail Group chose Computer Sciences Corp (CSC) to run its IT for the next 10 years for a £1.5 billion fee; and, underscoring how deals are being struck by organisations of all sizes, Bristol Water offloaded its computing operations to ITNet in a six year contract worth around £7.5 million.
The logic behind such deals is well-established: organisations want to reduce costs and remove the hassle of managing the IT infrastructure that diverts attention from core business activities. But while there is a clear acceleration in the IT outsourcing movement that started over a decade and a half ago, that by no means tells the whole story. Organisations – from insurance companies and telecoms giants to government departments and defence contractors – want to take outsourcing to the next plane. Increasingly they want to outsource whole business processes to services companies, and when IT represents a large component of these processes or can be applied to bring leaps in efficiency, IT services companies are well positioned to pick up such business processing outsourcing (BPO) contracts.
With that, “the customer is moving further up the value chain,” says Ismail Amla, vice president of BPO at CSC UK. What has made that outsourcing of end-to-end processes a reality is the maturing of IT. Above all, web-enabled access to applications, reliable bandwidth and the ability to integrate disparate technologies more easily has allowed organisations to consider building networks of collaborating suppliers to whom they can pass many of their non-core business functions.
By its very nature, BPO is “intensely collaborative”, says Peter Keen, BPO strategist and author of The Process Edge. “It rests on meshing the BPO client’s skills, technology base and processes with the BPO provider’s distinctive offerings. This aspect makes BPO very different from traditional outsourcing of tasks and functions which is largely subtractive – it aims at getting rid of something and is using an ‘out of sight, out of mind’ (and off my budget) tactic.”
The adoption of BPO is going to have dramatic results on the shape of the IT services market. According to IT industry research groups Gartner and Ovum, business process outsourcing was the fastest growing IT services segment in 2002 and will continue to be so for many years to come. “Outsourcing – and especially business process outsourcing (BPO) – is expected to grow strongly for the foreseeable future,” says Richard Holway of Ovum Holway. Ovum reckons the total UK market for BPO rose by 35% in 2002 to £4.7 billion and will continue to soar by around 30% for the next four years.
The upshot is that the value of BPO contracts will come to equal that of ‘traditional’ IT outsourcing deals, with both reaching about £10 billion in 2005, according to Ovum. “The development of a market that will match IT outsourcing by 2005 is something that no serious UK IT services company can ignore,” says the analyst group. And none of them are.
The outsourcing market is changing, says Holway. “Companies are now looking to outsource more than just IT. Whole business processes, including the IT element (although invariably some non-IT elements as well), are being handed over to suppliers to manage. Services companies will need to be tied into the outsourcing and BPO market in one way or another.”
But that BPO opportunity has some different characteristics that mean the current winners in IT outsourcing will by no means be guaranteed the lion’s share of the BPO market. For one, many parts of a business’s activities that can potentially be outsourced do not have a high enough IT quotient to make them attractive to IT services companies. Secondly, many suppliers from the IT sector can only boast expertise in a limited number of industry areas.
Moreover, unlike the generic IT infrastructure outsourcing market, where size and longevity are key, the BPO marketplace is characterised by a need for a deep understanding and experience in the sector. Customers have to be able to trust that a company knows how to run the aspect of their business they intend to hand over better than they could themselves.
That means organisations need to make careful decisions when selecting their BPO partners. And that decision-making process is not being made any easier by claims from most mid-sized and large IT services companies that they have already built a comprehensive BPO service in key areas.
What is needed instead is some clear evidence of successful BPO projects and analysis of the depth of domain expertise of suppliers.
Certain processes that are commonplace within many businesses are high on the BPO agenda: human resources (HR), call centre operations, accounting, logistics and procurement. And the early flow of major deals has been in these areas.
Interestingly, some of the largest contracts in the UK have not been won by longstanding IT services giants, but by pure-play BPO start-ups. Xchanging, a start-up established by former executives from Accenture and BP, won a £250 million contract in 2001 with BAE Systems to run the defence contractor’s HR operations. That was followed by an additional £800 million contract
for procurement services. Xchanging also clinched a £400 million deal with insurance market Lloyd’s of London and the International Underwriting Association to handle policy, premium and claims administration.
Though large, these kinds of deal sizes are by no means exceptional (see box, BPO mega-deals). On a similar scale, IT services company Capita, the market leader in the UK BPO market, won its largest ever contract – a £500 million, 10-year deal – in February 2002 to administer the BBC’s TV licensing.
Patterns are certainly emerging around the kinds of deals IT services companies are getting involved in. Capita rival CSC, for example, is focusing its BPO ambitions on specific targets: HR, claims processing for healthcare and insurance companies, accounts processing, procurement and customer support. What that suggests is that BPO suppliers from the IT services side are being fairly cautious in the business processes they want to address, aware that they have to build credibility one niche at a time.
Not that they are restricted by any lack of opportunity. The fact is, say analysts at Ovum , “this is a market that is currently only limited by supply, rather than demand. [The vendor activity at this point] could be described as ‘cherry picking’ on a grand scale, so there is plenty of business for allcomers, and that is likely to be the case for another couple of years.”
That surplus of opportunity has triggered a stampede by many different types of supplier into BPO, all bringing their individual historical strengths and value to the table. Alongside IT services players, transaction and data processing organisations such as Ceridian, ADP, First Data and Centrefile are picking up deals, especially in HR administration.
Consultancies such as Accenture and WS Atkins also have established major BPO initiatives that span multiple domains. In addition, the providers of traditional business services are expanding their IT interests to pull in more BPO deals. And, perhaps most notable are the pure-play BPO companies (some with a sole focus on select vertical markets, others addressing widely used processes).
Today, IT services companies only control about a quarter of the BPO market. The lion’s share (41%) is held by business service companies such as Serco, Hays and Amey. As the market matures, a major shift will occur. Although the segment controlled by the business services companies will grow by around 25%, their share of the overall market will fall to around 36% by 2005. And that market share will go mostly to the BPO pure players.
Unlike many technology markets, BPO lends itself well to these dedicated suppliers. Companies such as Xchanging and Exult, as well as numerous joint ventures between traditional IT and business services companies and start-ups, have tapped into the opportunity, in many cases leveraging their founders’ roots as the management of key business processes within large corporations.
In Ovum’s view, such companies are likely to fare better than most technology start-ups. In fact, by 2005, pure-players will command almost one-fifth of the whole BPO market – a feat that will be achieved by companies maintaining an astonishing average annual growth rate of 90%.
That manifests itself in contracts such as e-peopleserve and Accenture’s joint win of a five-year contract worth an estimated £80 million to provide outsourced accounts receivable functions and human resources services to UK telecoms group Cable &Wireless. As a measure of the scope for other deals, e-peopleserve, which was originally established as a joint venture between Accenture and BT, was acquired by Accenture in July 2002.
But, analysts are keen to warn that, for all its attractions, BPO is not a panacea for either the supplier or the user. “Outsourcing is easy. BPO isn’t,” says Peter Keen. “But it is essential. And the potential payback is immense.” It is essential, he argues, because it is an opportunity for companies to surround their operations with a network of ‘best practice’ partners. And, if executed well, the payback is huge, says Keen. Having access to ‘processes on demand’ will change the economics of the organisation. “It reduces capital demands and risk, and enables a firm to scale process volumes up and down, quickly and efficiently.”
As that message is more widely accepted, IT services companies – or at least those focused on BPO – will increasingly become part of the fabric of organisations. And as a result the sector may find itself bouncing back a lot more rapidly than was expected.