IT Outsourcing Trends: Slow Growth, Cloud Computing

The IT outsourcing sector is returning to growth, though now slower in the recession’s wake. Meanwhile, cloud computing is changing the IT outsourcing equation.


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Despite predictions to the contrary, IT outsourcing has contracted rather than expanded in the years since we entered the Great Recession, according to industry watchers. That shows signs of changing in 2010, but analysts forecast that IT outsourcing growth will remain slow for some time to come.

"Most companies in most of the categories we track are only partially outsourcing a function," said John Longwell, vice president of research at research firm Computer Economics. "Most of them are using outsourcing to fill in around the edges. A lot of those companies went back to reviewing and reducing their outsourcing [when the recession began]. The general trend was that companies were taking it back in house."

"When you look at areas like applications development, just the drop off in capital spending and investment in new systems is going to cause a reduction in that sort of outsourcing," Longwell added. "A lot of people renegotiated their contracts and a lot of people dropped their services and brought those functions in house. As we're coming out of the recession, that trend is going to reverse itself."

IT consultancy EquaTerra said that more than 75 percent of the service providers it polled in the third quarter of 2009 reported continued growth in their deal pipeline, which was up 10 percent from the previous quarter and 34 percent from the same period year-over-year.

Technology Partners International (TPI) echoed that sentiment. The most recent Global TPI Index indicated that the IT outsourcing market's total contract value in the fourth quarter of 2009 reached $19 billion, the highest quarterly total in six years.

To put it plainly, 2009 was the year of IT outsourcing deal renegotiation.

"One of the dominant features of the outsourcing market over the last 12 to 15 months has been the emphasis on cost above all else," noted research firm Morrison & Foerster in a report on IT outsourcing trends in January. "We have always believed that cost was (and remains) the primary driver in most outsourcing transactions. The difference is that during the boom years of 2002-2008, cost was often down-played by customers and, instead, emphasis was placed on other business benefits such as transformation, concentrating on core competencies, and speed to market. 2009 saw cost and, more particularly, immediate cost savings, take center stage when customers engaged with existing suppliers or contemplated new sourcing projects."

The analysts explained that this is why so many outsourcing contracts were renegotiated in 2009, with suppliers asked to share some of the pain of their customers. The renegotiations primarily took the form of reductions in pricing, relaxation of volume commitments and service levels, and bringing forward the financial benefits of transformation projects.

"Service providers often felt they had no choice but to agree to these changes and, often, it was better to keep an existing customer happy even at the cost of margin dilution," the Morrison & Foerster analysts wrote. "The main other benefits for service providers came in the form of contract extensions and renewals and the ability to show investors that the service provider's revenues were secure despite the overall financial turmoil in the markets."

Capital intensive forms of IT outsourcing, like application development -- far and away the most common form of IT outsourcing -- were hit especially hard, as businesses put those projects on hold, according to Computer Economics' Longwell. Application maintenance saw a similar story.

Future of IT Outsourcing

So what does the future hold? That depends on where you're doing business.

Morrison & Foerster noted that economists are now talking about a "LUV" recovery from the recession, with the letters representing the "shape" of the recovery: a very slow L-shaped recovery for Western Europe; a slower U-shaped recovery for North America; and a rapid V-shaped recovery for Brazil, Russia, India, China and other emerging economies.

KPMG and the Asian-Oceanian Computing Industry have forecast that Asia will account for 26.3% of the total consumption of IT and BPO services in the next 10 years.

In the realm of IT outsourcing, Morrison & Foerster said a rapid V-shaped recovery for the latter set of countries may encourage further spending on offshore outsourcing. In turn, that means service providers will have to carefully consider how to price new transactions in light of the "twin threats of cloud computing and continuing labor cost arbitrage." And, if parts of the world economy move at different speeds over the next 12 months, Morrison & Foerster said service providers will need to consider more varied pricing strategies.

Agility and Flexibility

Flexibility will be the watchword in outsourcing deals in 2010, according to Morrison & Foerster.

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Tags: cloud computing, outsourcing, cloud computing contract, IT outsourcing, outsourced IT

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