As IT outsourcing becomes a top priority for many cash-strapped organisations, giant suppliers are reaping the benefits, potentially forcing smaller providers to offer services such as cloud and virtualisation in order to survive.

With many firms under pressure to cut their IT costs in light of the downturn, a number are turning to outsourcing. As the recession continues to drive prices down and encourages suppliers to offer more flexible terms, outsourcing is becoming more attractive to customers who had previously shunned it.

According to research by analyst Ovum, sectors including financial services, pharmaceuticals and life sciences, retail and travel are showing active interest in IT outsourcing, pointing to recent ?20m-plus deals between IBM and the Carphone Warehouse, CSC and Virgin Atlantic, and Xerox with nationalised bank Northern Rock, as “encouraging signs of such activity coming to market”.

Deal sizes are also getting bigger among outsourcing’s big boys. The 10 biggest UK IT outsourcing suppliers have boosted the total contract value of their deals signed in the first six months of the year by 31 per cent, Ovum’s research found.

Recent megadeals have included BT’s ?500m contract with the NHS, IBM and CSC’s ?300m deals with the government’s Identity and Passport Service, and a ?685m deal for HP-EDS at insurance giant Aviva.

The analyst house warns that while this is all good news for outsourcing’s top tier, the second and third tier players are struggling, with deals falling into the hands of fewer and fewer companies.

“Without a clear understanding of, and a strategic response to the challenges faced, this has the potential to spell the end for the second and third tier UK IT outsourcing market,” warns Ovum.

Pressure on smaller outsourcers could be a boon to customers, however: Ovum suggests suppliers should offer more for less by restructuring contracts, and offer new technologies such as virtualisation and cloud computing in order to win and retain business.

Such a shift will require significant time and financial investment on the part of suppliers, according to Ovum, “and will be a challenge to even the most financially stable vendors”.