In the last few months the global economic uncertainty has become so widespread and the path to economic- recovery so obscured that ‘cautiously optimistic' is the most positive position most organisations can muster. With a globally connected economy and intertwined market behaviours that tether multiple vertical sectors to each other, the complexity is almost unfathomable.
In this uncertain and rapidly changing environment, the outsourcing market represents something of a dichotomy.
On the downside, organisations' outsourcing strategies may negatively impact market growth (that is, IT budget constraints, lower-cost deals and contract renegotiations will occur), but at the same time, the upside is that outsourcing can help organisations to work through financial and competitive challenges. The potential for outsourcing to address immediate cost pressures as well as long-term recovery goals will be unprecedented in the coming months and years. However, only organisations that are diligent about understanding the pitfalls of cost-focused outsourcing, and that apply business-outcome-focused outsourcing, will be successful.
Looking back at the contracts signed in 2008, many of our points of analysis - contract size, contract terms, vertical uptake, deal type and ‘mega-deals' - show continuations of past trends. Yes, there was some softness in large deal signings, but no catastrophic declines. In part, this continuation of past behaviours is because external forces don't change the basic drivers of outsourcing - firms still outsource for cost, efficiency, access to skills, focus on core business, innovation, modernisation and business transformation.
Looking forward, however, things are likely to be less predictable. One thing we can say for sure is that, for the next year at the very least, organisations will be under extreme pressure to cut IT costs. For most buyers, a concerted and deliberate focus will be put on cost cutting or driving predictability of costs through outsourcing.
Some organisations will renegotiate existing outsourcing contracts, and others will sign new contracts focused on reducing costs and getting cash for adjustments.
Unfortunately, because of this focus on low-priced IT services provisioning, some bad deals that have no provision for enhancement or innovation when recovery begins will also be signed. More first-time outsourcers will fall into the trap of signing long-term cost-cutting deals that will turn into bad deals for both parties within two years. Shortcuts on sourcing strategy development and provider selection will be common. In order to counteract these trends and avoid unsatisfactory relationships, firms of all sizes must develop sourcing and vendor management competency, and invest accordingly.
Another given in the current market is that more requests for proposals (RFPs) will focus on price comparisons and price competitions for deals, particularly for standardised IT outsourcing services, where competition will be fierce.
In some cases, best practices in sourcing strategy and management will be given short shrift and buyers will be lured by lowball pricing from providers trying to make quarterly revenue goals or build market share. In other cases, providers will be pressured to accept low margins for revenue growth and buyers will make decisions based on who will promise the lowest cost. Either scenario paints a grim future one or two years into the deal if the provider's cost to deliver increases or exceeds revenue and service quality degrades. Providers and buyers must work together to apply sourcing discipline and craft outsourcing relationships that address near-term cost objectives and longer-term scalability and enhancement when growth rebounds.
Executive scrutiny of IT budgets and internal costs controls will lead many to focus on outsourcing as a means to reduce labour costs. However, risk avoidance will also inhibit some firms from outsourcing, even though they could gain efficiencies from managed services and performance-based contracts with an external provider.
Green and lean
Green IT issues are likely to grow in importance and will no longer be considered discretionary, but green IT initiatives will be fully embraced only if they reduce costs. Alternative delivery and acquisition models (ADAMs) will see a net boost in adoption as a direct result of economic conditions in 2009. ADAMs will increasingly deliver IT services through new approaches such as software as a service (SaaS), business process utility (BPU), infrastructure utility (IU), remote management services (RMS) and web platforms or cloud computing.
Bucking the trend of recent years where the proliferation of service providers has defined the competitive landscape, in 2009, only the strong will survive. Providers that have recurring revenue from outsourcing relationships will have the staying power and competitive edge. As a consequence of heightened competition, merger and acquisition activity will accelerate; targets will be other service providers of all sizes, captive centres of organisations, and tier-two and tier-three offshore providers struggling to achieve revenue growth.
Cash-rich providers will be well positioned to make strategic acquisitions for technical, vertical or geographic competencies, leading to the potential for Indian-based companies to take their place among the top-five global service providers.
Indeed, the current environment will establish cost as the necessary competitive condition, regardless of other service characteristics such as breadth, scale or differentiation. The combination of the restrictive economic scenario and the growing maturity of business process service providers will accelerate the adoption of outsourcing services on a worldwide basis.
As a result, 2009 looks like a good year for outsourcing providers in many developing economies. ‘Chindia' may well be work in progress, but early signs indicate continued positive movements; both China and India are growing individually at the same time that they are growing relationships between the countries. Similarly, 2009 will be the year that the Latin American countries join the offshore services race in earnest. Mexico will continue to be an attractive near-shore services destination for US organisations although the Mexican economy, being strongly tied to that of the US, will undoubtedly suffer more than other Latin American countries. Conversely, the strong Brazilian internal economy and its broad portfolio of international trade partners will lessen the impact of the economic downturn, making it one of the least affected countries. Near-shore outsourcing from Eastern Europe will continue to grow and increased investment is expected in areas such as North Africa.
Wherever you are in the world, the demand for strategic business value from outsourcing will percolate upward as the economic downturn continues. Flexibility is the operative word for outsourcing strategies and contracts because, ultimately, outsourcing can never be separated from business goals. To drive the desired results, outsourcing must constantly evolve. Firms with successful outsourcing relationships will understand where they are in the business cycle and make adjustments. In economic downturns, cost will be paramount, but when growth returns, organisations and their service providers must be -prepared to adjust their sourcing goals.
Outsourcing prices to shrink by up to 20 per cent, says Gartner
Prices of IT services in outsourcing are anticipated to shrink by between five and 20 per cent during 2009 and 2010, according to Gartner.
Gartner said that this fall in prices will occur due to increasing competition in the market between traditional and new providers as more providers compete aggressively to keep revenue growth on target, while ensuring margins.
Furthermore, cost-focused buying behaviours in the current economic phase will be a key factor behind the reductions for IT infrastructure outsourcing services from 2009 to 2010, with a great variability based on every deal.
To reach the agreement on the potential price impact, Gartner analysts started from measures (price points, benchmarks) of the price reductions associated with the last recessionary period (2001 to 2003) and added current trends and current price/cost measures. Then, a panel of analysts agreed on the reported price trends for 2009 and 2010 in North America and Europe. The Gartner analysts calculated the percentages based on the economic pressure or recession, and other applicable trends, including industrialisation of services, clients' SLA/T&C renegotiations and offshore service dynamics.
Potential Average Outsourcing Price Reductions in 2009/2010 (Source: Gartner)
- Outsourced services Average price cuts
- Datacentre services 5% to 15%
- Desktop/help desk 5% to 10%
- Network services 10% to 15%
- Application hosting 10% to 20%