The outsourcing industry has experienced considerable change during the past few years. At a global level, demand for outsourcing generally remains robust as new contracts are signed, and old ones renewed or renegotiated. But in the more mature European markets, and particularly in the US, the shape of demand is changing.

IT managers’ increased experience in outsourcing, and the emergence of viable offshore alternatives for operational services, means more and more companies searching for greater benefit through sourcing strategies, with contracts structured in a more value-oriented way.

The outsourcing industry, in turn, must continue to raise its game to respond to changing market conditions and increasingly savvy IT managers. The following factors, along with a handful of others, have changed and are changing the outsourcing landscape:

• Service providers have become less inclined to take on capital assets on the scale they may have in the past.
• The explosion in the use of offshore delivery has resulted in less appetite for the wholesale transferral of internal staff to the provider.
• IT managers have recognised that the traditional “lift and shift” approach was not only complex, time-consuming and expensive, but was preventing the attainment of best-in-class services, as the model limited the ability of the provider to create new innovations.
• The growth in the number of second- and third-generation outsourcing buyers, with little in terms of their own assets and staff ­ – and the associated need for managed service alternatives.
• A higher level of outsourcing experience has led to increased sophistication in IT managers’ abilities to buy and manage sourced services through a portfolio approach involving a range of suppliers.

The impact of the above factors is clear. Five years ago, it was common for contracts to be of a relatively large value, typically broad scope, of seven to 10 years in duration, and single sourced to one of a dozen or so suppliers.

Today, service provider diversity and competition has increased considerably with 113 vendors winning contracts valued at more than 15.7m in 2007, compared with just 99 in 2003. Nearly a quarter of the 113 service providers signed five or more contracts, 14 suppliers won 10 or more, and five signed 20 or more contracts – ­ Accenture, BT, CSC, EDS and IBM.

The result is that multisourcing ­ – the concurrent use of several providers by one buyer to support one functional area – ­ is on the increase.

ABN Amro is a case in point, with the financial services specialist choosing to divide IT services work across several service providers ­ – IBM, EDS, Accenture, Infosys, TCS, Patni, Verizon and Avaya.

IT managers now demand access to specialist capabilities, using best of breed service providers in niche areas. Multisourcing can also reduce dependence on a single vendor, and allow some level of competition to be maintained between service providers beyond the procurement process.

Multisourcing does, however, bring increased service integration and governance challenges. While the market appetite for multisourcing shows no sign of abating, it is uncertain how well IT managers are coping with their more exacting management responsibilities.

The use of offshoring is also increasing, with more than half of all outsourcing contracts now containing some significant component of offshore delivery. Vendors, irrespective of their location, continue to expand their global delivery footprints ­ – and in doing so bring on new opportunities. The net effect on deal structures has been shorter-term contracts with a narrower scope. Contract terms have also steadily declined to an average of five to six years.

Looking forward

As outsourcing matures, IT managers are looking for value and a more defined business impact from their outsourcing relationships. Businesses are seeking more than transactional cost savings and incremental service improvements, much of which can be more simply achieved through offshoring.

We therefore expect to see a shift away from input-based contracting to productivity-driven deals based on outcome-based pricing. As contracts mature and service providers demonstrate their capabilities, more sophisticated outcome-based pricing may be tied to the vendor’s ability to provide productivity improvements.

We also expect a shake-out among industry service providers as the differences between US, European and India-based suppliers diminishes. All will be considered participants in a global economy.

Service providers that invest organically, and through acquisitions in deep domain expertise for attractive market segments, will be positioned for success. Such service providers will be focused; avoiding the temptation to be all things to all clients and expect an increasing emphasis on industry-oriented, vertically-defined offerings.
 
The IT industry will soon have adopted a greater level of coupling between infrastructure, applications and operations. And there are early signs of a significant shift away from pure labour-arbitrage contracting.

Driven by the desire to improve profitability during changing macro-economic conditions, we expect the service provider community to emphasise the model of defined services. Renewed emphasis on managed services ­ – and the bundling of infrastructure, applications and operations – ­ should increase the annualised value of an outsourcing contract.

We suspect that the value of business process outsourcing contracts will grow faster than those for information technology outsourcing. And we expect that suppliers will recognise that their competitive distinction comes through their brand, and ability to differentiate at the point of customer service.

The new corporate family jewels will be data regarding customers, products, risks and channels of distribution. Outsourcing agreements will be designed to recognise the central role of information and will construct services that process data in a more defined and standardised manner.

The industry is maturing and evolving, with more companies embracing outsourcing. We estimate that the global commercial outsourcing industry will continue to grow at a rate of about five per cent per annum and will produce about 55bn for service providers in 2008. Service providers are deciding now how they will service the markets of 2010.

Outsourcing will be contracted increasingly in such a way as to ensure flexibility around cost, capability and capacity on sound commercial terms, while still balancing the risks and opportunities that surround brand, data and the customer relationship.

Experienced IT managers ­ – and more focused, capable suppliers ­ – are starting to create a new world for service provision with the emphasis on outcomes.

Duncan Aitchison is managing director of TPI

The future of outsourcing

Outsourcing advisory firm TPI has identified cost, capability and capacity as the factors that will have the greatest influence on the market in the coming years.

Organisations will increasingly think of the value of services beyond unit rates. The capability to deploy new and innovative services to support business objectives, and the capacity to access resilient sources of talent and infrastructure, will be just as important to the experienced outsourcing user as cost improvements.

Experience shows that contracts comprising low unit costs often have little impact on the total cost of a relationship, when factors such as limited elasticity, under-funded innovation and the integration of multiple providers are considered.

The 3C framework – cost, capability and capacity – gives clients a foundation on which to structure sourcing evaluations and understand the range of flexibility that is likely to be available over time.

With such knowledge – factored against core business strategies such as acq uisitions, penetrating new markets or the introduction of new services – the IT manager can perform an informed evaluation that will assess the range of service delivery alternatives.

Faced with wage escalation, currency variations and the uncertainty of tax policies in some offshore destinations, many organisations are seeking to establish outcome-oriented and performance-oriented relationships.

In such situations, the unit cost of staff has less relevance than the cost of a transaction, the commitment to the quality and compliance of the operational process, and flexibility in the volume of transactions supported over time. The current economic climate is motivating organisations to convert to outsourcing models with greater levels of both variability and surety of cost than is possible via effort-based arrangements.

For service providers, the 3Cs offer the opportunity to articulate value propositions in terms that transcend unit costs, so that factors such as business resilience and access to investments and resources can be ascribed a value.

In times of economic uncertainty, service providers should place profitability ahead of revenue growth. TPI expects service providers to invest, organically and through acquisitions, in attractive markets that stand to benefit from the use of technology, investments and processes.

Financial services, healthcare, telecommunications and manufacturing are among the key sectors – and the service providers that are best positioned for the future are investing in industry-specific solutions.

By taking a more strategic and value-oriented view of outsourcing, rather than the recent emphasis on pricing, IT managers and service providers will achieve more success.

Outsourcing in summary

The outsourcing industry is evolving from the early days of “lift and shift” towards a model of defined services. Companies will increasingly look beyond the traditional focus on labour arbitrage to take a more strategic, and less tactical approach, to sourcing.

The new model will allow service providers to bring new innovations on board, and will enable users and vendors to think beyond unit rates and focus on longer-term valuecreation.

There will be a degree of consolidation among some service providers. Those with deep domain expertise, who are focused and avoid the enticement of having a finger in every pie, will be best positioned for success.

Outsourcing contracts in 2010 will be designed around the means of gaining cost, capability and capacity, while managing the risks and opportunities relating to brand,the customer relationship and data.

The capability to deploy new and innovative services to support business objectives and the capacity to access resilient sources of talent and infrastructure will be just asimportant to IT managers as cost improvements.