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Financial Accounting Outsourcing (FAO) Annual Report - January 2007

IT Outsourcing in the Small and Medium Businesses

How is outsourcing like computers? Because the world seems to change in nanoseconds for both industries. In the case of outsourcing, current changes may have major ramifications for buyers and suppliers of second generation outsourcing deals.

We directed a study at the Everest Research Institute, analyzing deals in the public database that are up for renewal between 2006 and 2008. We estimate the annualized contract value (ACV) of those deals to be US$118 billion. Though the Institute estimates that buyers have already renewed a quarter of this (based on validation from key suppliers in Q1 2006), US$88 billion is still up for renewal in 2006-08. The 2005 total outsourcing market was about US $386 billion.

The key finding: incumbents, start thinking. We found that 41 percent of ACV still up for renewal between 2006-2008 face a medium-to-high risk of getting restructured. Restructuring includes increased offshoring of traditionally onshore deals, unbundling of mega-deals within ITO, and bundling of transactional business process outsourcing into larger multi-process deals. New players who weren't available or ready when you inked the first contract are now vying for the business and newer capabilities are increasingly becoming important to retain business.

The telecommunications industry is the verticalfacing the highest restructuring threat. Telecom contributes 27 percent of overall ACV facing medium-high risk is contributed followed by financial services at 18 percent.

What's Happening in ITO

This restructuring risk reflects key structural changes in the marketplace. On the IT outsourcing (ITO) side, we noticed buyers now want to unbundle their work. Specifically, buyers who originally outsourced their IT infrastructure and their applications, maintenance, and development (ADM) work in one large deal now want to divide the work and award it to different suppliers.

Unbundling is also visible within. There is an increase in the number of multi-vendor contracts to leverage the internal marketplace as well as new offshore players. We found that the total contract value (TCV) of ADM contracts with multiple vendors has gone up from 22 percent through 2000 to 49 percent during 2001-2005.

Similarly, within infrastructure outsourcing, we have seen evidence of buyers splitting the mega-outsourcing deals into the separate contracts with specialized suppliers.

In an attempt to create more value from outsourcing, buyers are adopting a best-of-breed approach. Other than increasing the focus on each service, this provides buyers with the ability to compete different processes independently and create higher value through outsourcing.

What's Happening in BPO

The opposite is occurring with BPO contracts. There, buyers are moving toward bundling. The trend is to combine distinct processes within an area (benefits and payroll in human resources (HR), for example) in one contract as opposed to outsourcing each process separately.

Through 2000, only three percent of the BPO deals were multi-process deals and 97 percent were transactional in nature. Share of multi-process BPO deals between 2000-2004 has gone up to eight percent and we project this to increase to 24 percent by 2010.

In addition, buyers are bundling the associated applications in their BPO deals, i.e. the human resources information systems technology is moving from a pure ADM deal to the HR BPO deal. Our research found that 81 percent of multi-process HRO contracts until Q1 2006 (there were 135) had HR IT included.

Implications for Suppliers

The top three suppliers--CSC, EDS, and IBM--face a bigger challenge because they have a large share of ACV up for renewal and face a relatively higher restructuring risk compared to other major suppliers.

Offshore players are stepping into the fray. They now have the required experience, coveted cost advantages, and the requisite size to be a compelling consideration. Today buyers can't afford to ignore their offerings.

Historically, the large suppliers subcontracted specific tasks to small specialists. Now these specialists are large enough to talk to the buyers themselves. In the past, they were not able to compete for the big deals because they were too small or they did not have the infrastructure competence. That competence is now unnecessary thanks to unbundling.

The Institute is receiving an increasing number of requests from offshore suppliers for upcoming deal renewal data. This is a sign that the current trends are catching fancy with these suppliers and they are preparing to take a larger slice of the outsourcing pie.

Deal competition costs will rise. Before, suppliers had to field only one team to try to win the entire deal. Now they will have to compete for many parts of the business.

As for buyers, this is a great time to sign an outsourcing deal. The suppliers will fight for your business.

Lessons from the Outsourcing Journal:

• Incumbents have to start worrying when their first generation deals expire. New players who weren't available or ready when they inked the first contract are now vying for the business. New competition will pose threat to 41 percent of the ACV up for renewal.
• The offshore players and niche players have grown in size and experience. They are now ready to give the top three suppliers a run for their money.
• ITO buyers now want to unbundle their work. Buyers who originally outsourced their IT infrastructure and ADM in one large deal now want to divide the work and award it to different suppliers.
• The opposite is happening in BPO; there, bundling is the key word. The Institute estimates that single process, transactional deals, which accounted for up to 97 percent of the business in 2000, will fall to 76 percent by 2010.

Publish Date: July 2006

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Copyright © 2006 - Everest Partners, L.P.

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