Outsourcing gets a change in size

Customers are moving away from big services deals to smaller, more specialised contracts. This often means deals being split up and offered to more than one firm.

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By  Caroline Denslow Published  May 15, 2005

|~|main_outsourcing_page01.jpg|~|The days of one services firm being chosen to supply all of a company’s outsourcing needs are numbered, it would seem from current trends in the market place. While the number of big deals being signed is steadily declining, the overall value of outsourcing contracts is rising, according to Datamontior figures.|~|In March this year, French automaker Renault announced three separate deals worth a combined US$790 million split between Atos Origin (for applications outsourcing), CSC (for network and server outsourcing), and Hewlett-Packard (for desktop management). A month later, UK financial services company Lloyds TSB announced a US$323 million deal with Fujitsu Services to outsource the management of its desktops. This followed close on the heels of a £500 million voice and data communications outsourcing deal Lloyds TSB signed with IBM at the end of last year. Consumer goods giant Procter & Gamble and high street chemist Boots have done the same previously, opting for multiple partners for their IT outsourcing projects. The trend that began a couple of years ago is now gaining ground fast. According to market analyst Datamonitor, the average size of deals in the US$600 billion global IT and BPO services sector has been shrinking for three consecutive quarters now. The figures are telling: the average size of contracts fell by 18% to US$68.9 million in the first quarter of this year compared to the same period last year. The number of deals, on the other hand, went up by 5%. Most of the growth happened in the US$1 million to US$100 million band. Deals of over US$1 billion came down from five to four, while deals of over US$100 million fell from 76 to 67. IT outsourcing itself is on the rise, though. “The number of deals as well as the overall spending on outsourcing has been increasing. Even the number of US$100-million-and-above deals has been quite robust,” says Nick Mayes, principal analyst and editor of Global Computing Services, Datamonitor. So what the fall in average deal size suggests is that clients are signing smaller, more focused deals with more than one supplier. “The decline in average deal value is partly due to the rise of multi-sourcing, where clients work with a number of best-of-breed IT services vendors, rather than a single outsourcer under a far-reaching mega-deal,” adds Mayes. The first generation of IT outsourcing that took place involved big players such as IBM, EDS and Accenture, who had the capabilities to pull off billion-dollar deals involving long periods of time. It was a close-knit club that bid for most large projects, and there were no challengers to their scale or size. “Indian software companies were never in the reckoning for the billion-dollar deals,” notes Sudha Kumar, chief executive officer, Prayag Consulting, a Bangalore-based consulting firm focused on high technology market-space. What they got was sub-contracted work from the big players. But, says Mayes, “there has been a general disillusionment with the first and second generation of IT outsourcing.” The reasons range from the difficulty of measuring the success of very long-term outsourcing contracts (since companies go through dramatic changes within that time-frame) to the concentration of risk that happens when you deal with one supplier. Companies now want to hedge the risk of outsourcing by involving more than one player, and also want to outsource depending on the capabilities of the vendor. It won’t be unusual, for instance, for companies in the US to outsource “system integration and implementation to a US vendor, move out remote management of infrastructure and application management to India, do high-end product development in Russia, product support in the Philippines and localisation for the A-Pac region in China,” explains Sabyasachi Satpathy, director of research, NeoIT. Another reason for the decline of the mega deal is the growing popularity of business process outsourcing, which often includes parts of a service that would have previously fallen under an IT outsourcing contract. For instance, customer relationship enhancement would have been outsourced to an IT services provider earlier. Today, customer relationship management (CRM) is one of the most outsourced business processes. Having found higher returns and value in outsourcing specific business processes, enterprises are moving away from the all-inclusive mega deal.||**||India service|~|main_outsourcing_page03.jpg|~|Lloyds TSB has recently signed a US$235 million outsourcing deal with FJS to manage its desktop systems, its second such major deal in recent months.|~|The direct beneficiaries of this trend have been the IT services companies in India, which have seen no let up in business coming their way. “Indian companies are only on the way up. We’ve seen some churn in clients, but have certainly not seen contracts shrinking,” says Ranu Vohra, chairman and managing director, Avendus Advisors. That is because Indian software companies that were never in the reckoning for the billion-dollar deals are seeing the market they play in expanding. “If you look at IBM, you’ll notice that new contracts are pretty flat in 2004 compared to 2003. It’s the tier two group, consisting of Indian firms and others such as Atos Origin in France and Affiliated Computer Sciences in Texas, that’s witnessing accelerated deal signing,” says Mayes. With respective annual revenues of US$46 billion and US$21 billion, IBM Global Services and EDS rank as the top two dogs in the IT services sector. Both have witnessed a drop in the value of new contracts they have won: while EDS’ new deal signings were down 5% to US$3.8 billion in the fourth quarter of 2004, as compared to the same period a year ago, IBM’s contracts were down 27% to US$12.7 billion in the same period. Indian firms are benefiting both from being part of the multi-sourcing deals, as well as from increased business process outsourcing. According to Nasscom, an association of Indian software companies, revenues from the export of IT outsourcing services grew by 27% to US$2.5 billion between 2003 and 2004, up from US$1.9 billion in 2002-03. Take a look across the Indian IT sector, and signs of growth are evident. Infosys, TCS and Wipro, three of the top tier firms in India, have already become members of the billion-dollar club, while many others have crossed the US$100million mark in terms of revenues. Jayesh Chakravarthi, vice president and head, marketing, MindTree Consulting, puts it in perspective: “Last year, if we did three or four deals that were US$2 million and above, this year the number would be ten.” MindTree grew at 90% last year, and is expecting to grow at over 60% this year. At Satyam, director and senior vice president of corporate strategy, Shailesh Shah, is very happy that “the average deal size has gone up by 15% to 20% in the last three to four quarters.” Another Indian firm, MphasiS, has also been seeing an increase in deal sizes. “Two of our larger multi-million dollar deals have happened in the last six months,” says Ravi Ramu, chief financial officer, MphasiS. Of the company’s US$175 million revenues in 2004-05, IT services outsourcing accounted for US$107 million, while the rest came from BPO. Having tested the waters with Indian software companies, the existing clients are coming back for round two with bigger deals. According to Subroto Bagchi, chief operating officer, MindTree Consulting: “Companies like GE/AIG who created the global development model are shifting from larger partners to mid-size companies. It is not about cost: it is about access, attention and agility that they seek from younger, mid-size partners.” As the low-cost global delivery model — implying cost and efficiency advantages from being present in a certain geographical area — gains recognition, clients are increasingly testing the offshoring component directly with Indian firms. Such is the momentum around offshoring that even companies like IBM and Accenture are furiously building up an offshore presence. IDC predicts that offshoring is set to grow to US$17 billion in revenues by 2008 — clocking a five-year compound annual growth rate (CAGR) of nearly 20%. The future looks interesting for the IT outsourcing industry, no matter in whose favour the balance shifts. The industry would clearly stop being the domain of a few large players, and could see the emergence of global multi-national players, not American, not Indian, but truly global in nature. The trend of clients moving away from handing over the entire IT infrastructure to a single supplier under a far-reaching deal, towards more selective outsourcing models, also seems here to stay, judging by the evidence. Clients look likely to go for consortia of best-of-breed suppliers to source IT management and support skills. There is no denying that there will continue to be a role for the big boys of IT outsourcing. After all, no Indian firm can match the scale of an IBM or EDS. But the big fish may increasingly be seen as the ‘lead partner’ in multi-sourced deals. Indian companies, on their part, will have to grow in terms of domain knowledge and consulting expertise, as well as ramp up their local presence in areas where their clients are. Who will win? Most likely, “companies that use inorganic growth as a tool to acquire domain capabilities or deliver geographies will be the ones able to ramp up fast,” says Vohra. IBM and EDS have already started down that route. IBM, in fact, has been uncharacteristically prolific in its M&A activity in the last 12 months, moving into insurance transaction processing with the purchase of Liberty Insurance Services, procurement outsourcing with KeyMRO, and finance and accounting outsourcing with the purchase of Equitant. For its part, EDS has acquired the human resources outsourcing operation of Towers Perrin. What is clear is that no single vendor is going to be doing everything for an enterprise, at least not for long. According to NeoIT, nearly 60 deals are up for renewal in 2005. It would be interesting to see how these deals will play out in the current context. They just could be the ones that will decide if the days of the mega deal are over.||**||

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