Sluggish demand for new scope projects, continued emphasis on cost reduction, large contract restructurings, and a wobbly macroeconomic situation in Europe are impeding full recovery of the outsourcing market.

The first quarter of 2010 indicated a 25 percent growth in total contract value compared to the same quarter last year. According to 1Q10 Global TPI Index, which measures commercial outsourcing contracts valued at $25 m and more, the total value of such contracts stood at $19.5 B. The story behind the quarter performance is interesting: 42 percent of the contracts were renewals of contracts that got expired or came up for renegotiation. This is an unusually high number according to TPI experts. Said Mark Mayo, Partner & President, TPI, “ The previous record for this was 29% and it happened way back in 2006. We didn’t expect this number to be so high for 1Q2010.” One reason for this is that many of these were contracts that were supposed to be signed in the previous quarter, but were pushed out into this one. Consequently, ‘new scope’ contracts fell by 15 percent.

Delving deeper into the quarter’s performance, it bears out that ITO dominated the story: application development and maintenance (ADM) and ADM combined with infrastructure services contributed the major share to the total contract value. In fact, three out of the four megadeals ( deals over 100M) were ITO. For the Americas, the quarter was a coup with 47 percent of the deals, which made it the best quarter since 2006. That said, it was the manufacturing, travel, transportation and hospitality verticals that lifted up the performance, unlike usual suspects like financial services and telecom.

The rest of 2010 has got quite a few contracts that would come up for renewal but Mark does not expect the proportion to be as high as in this quarter. Mark estimates that contracts with annual value of about $12 B are due to expire in 2010. These contracts would get restructured in 2010. When contracts come up for restructuring, companies look at breaking up the scope to include a few new vendors. Many of the Indian vendors are reaping benefits here because when these contracts were signed, typically five to seven years back, the global outsourcing vendors like IBM and Accenture measured up better in terms of capabilities. Over time, the Indian vendors have matured both in capabilities and in scale and are competitive in pricing. This explains the anomaly between the recent quarter performance of large global vendors and the India-based vendors. IBM and Accenture reported sluggish results whereas TCS, Infosys, and Cognizant amongst others had far better performance and outlook.

Companies have not exactly started opening their purses wide and cost reduction continues to be the dominant agenda in 2010. This works well in generating demand for cheaper India-based application outsourcing companies. On the BPO front, companies have changed tracks and instead of going for large multi-tower deals, they are looking for well-defined projects that are smaller in scope and shorter in duration. Says Mark, “Companies are taking a step back and rethinking the way BPO work is handled. Instead of going to one major player they are looking for a small group of preferred suppliers. This is very much unlike when companies signed up large multi-tower BPO deals.”  Overall, BPO remained slow as clients postponed transformational deals.

Europe, led by UK, has been an important market for outsourcing services. While the action is shifting away from UK to continental Europe, recent reports suggest that in the short term Europe would dampen the overall outlook for the industry. Companies like Cognizant and Tech Mahindra have already reported weakness in Europe in the current quarter. Recent incidents like the bailout of Greece, risks associated with other European economies, and other macroeconomic factors pose an additional risk to companies (like Accenture, Infosys, CSC, etc.) who have a substantial footprint in Europe.

Overall, the recovery of the outsourcing market is slow. Mark says,”It is going to continue to comeback slowly, in fits and starts, a bit of ITO here, a bit of BPO there. Definitely, it is not a   year of bouncing back.”