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Tough Times Create Opportunity for Vendors and Buyers of IT Services
By Denny Wayson, vice president and chief analyst, Gartner Dataquest IT Services group
While the current economic downturn and climate of uncertainty has
pushed enterprises toward outsourcing IT services for the need to cut
costs and increase IT efficiencies, what really is going on behind
outsourcing decisions is far more complex.
In the not-so-distant past, the market for IT services grew at a phenomenal
rate, with some segments experiencing in excess of 20% compound annual
growth rates.
Those days appear to be gone, and though demand may still exceed supply,
making money as an IT solution provider has become a lot more difficult.
Though IT services are somewhat less affected by economic downturns
than other parts of the IT sector, growth in IT services during the
past two years has been hampered by reductions in IT budgets, deferred
projects, and smaller projects. However, Gartner, Inc. – the world’s
leading technology research and advisory firm - anticipates an IT spending
recovery in late 2003.
The challenge then, in the short-term, is for IT solution providers
to sustain despite economic uncertainty. This will mean both hard-fought
battles for market share as well as new approaches to re-energizing
their businesses.
Outsourcing Provides Potential Win-Wins
On the client side, enterprises have sought to preserve assets and minimize
risk by being increasingly receptive to outsourcing relationships since
the start of the economic decline. This puts considerable pressure on
IT solution providers that rely on a portfolio heavily weighted with
project-based services to come up with some innovative ways to package
these services into relationship-based, longer-term agreements.
And on the positive side, enterprise decision-makers are increasingly
open to new types of contract and payment schemes with a growing tendency
to move away from time and materials pricing. Such arrangements create
opportunities for differentiation and potentially higher margins for
IT solution providers on certain types of deals.
What is Strategic Outsourcing?
Gartner’s definition of strategic outsourcing is “the dynamic
delivery of internal and external, business-oriented or IT-oriented
resources and services to ensure that business objectives are met.”
While the current economic downturn and climate of uncertainty has pushed
enterprises toward outsourcing IT services for the need to cut costs
and increase IT efficiencies, what is really going on behind the outsourcing
decisions is far more complex. Outsourcing is moving toward becoming
a strategic tool for enterprises to improve business processes and manage
IT. Enterprise executives are leveraging outsourcing as a strategic
weapon, and an important market trend exists in outsourcing strategies:
“more outsourcing” and “more leverage of competition”.
Figure 1
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Professional IT Services Market Drivers and Inhibitors
Market Drivers
Trend toward optimization of current environments sustains
some growth.
Demand to align business objectives with IT and produce return on investment (ROI).
Availability of cost-effective IT services resources from offshore vendors.
Investigation of new technologies such as Web services that
leads to increased technology pilots in late 2003 and 2004.
Public sector spending, fueled by e-government initiatives and homeland security.
Market Inhibitors
The economic slowdown in the U.S. diminishes IT spending in North and Latin America
through much of 2003.
Layoffs in the technology sector produce an oversupply of skilled labor that allows enterprises to hire their own IT resources and forgo working with external services providers.
Reductions in IT budgets result in deferred and smaller projects.
There is an industry downturn in financial services, high technology, and telecommunications, typically the bastions of IT services spending.
Fees from offshore service providers are subject to downward pressure.
The downturn in enterprise applications software market reduces the market for implementation.
The need for cost reductions and predictable IT expenses is causing enterprises to move toward managed services rather than consulting and SI projects.
Large software vendors and SIs are giving away business consulting services and using them as sales support techniques to gain sales during lean economic times.
Source: Market Analysis - Americas: Consulting and Systems Integration Market, 2002-2006 by Michele Cantara, Gartner Dataquest 12/16/02. Entire contents 2002 Gartner, Inc. All rights reserved.
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Outsourcing Relationship Models
The outsourcing relationship models for a client and an IT solution
provider are useful for representing the strengths and challenges of
a service relationship, almost regardless of the actual content of the
service to be delivered. The most relevant outsourcing models that are
in use in many different organizations worldwide include:
Internal Delivery – The internal organization provides services
to the enterprise, and implements new services and architectures through
internal projects.
Multisourcing – A separate contract is established for selected
IT functions or business processes using a best-of-breed tactical
approach and competitive deals.
Insourcing – The IS or process organization provides the
enterprise with services on a business-rules basis such as semiformal
contracts, service-level agreements, and tariffs for services.
Joint Venture – The enterprise builds a separate service
company and shares it with a market provider.
Full Outsourcing – The most classic outsourcing model where
a single, long-term contract with a single ESP is signed for all the
in-scope services.
Best-of-breed Consortia – Based on the enterprise’s
request, or the ESP’s decision, a consortium is built and one
of the providers takes the role of the main contractor.
Brand Services Company – A company is built to provide services
to a large organization or a group of business-oriented companies,
and the services company leverages ESPs, selectively outsourcing part
of their services.
Prime Contractor – An organization manages and integrates
multiple providers to derive a single or global solution or service
for the client.
In the outsourcing realm, there is no single perfect relationship
model and no single choice for everyone and forever. Nevertheless,
the different outsourcing models clearly demonstrate that an outsourcing
strategy is always based on an individual case:
The starting point is different.
The vertical industry and, therefore, the vertical market business requirements and issues are different.
The country, business culture and legal, financial and taxation requirements are different, building to a different solution or different path-to-solution.
As an outsourcing strategy progresses (over a matter of years, not months), the business changes, the competition increases, the internal know-how evolves, and the technology advances.
All of this makes an outsourcing strategy a continuous alignment
between business strategy, business processes, and IT services on
behalf of the organization’s strategic achievements.
That said, the model that enterprises most often adopt today for
IT services is the multisourcing approach – selecting the best
IT solution provider for a given need. Also known as selective outsourcing,
it is a separate outsourcing contract that is established for selected
IT functions or business processes using a best-of-breed tactical
approach and competitive deals. Although selective outsourcing is
easy and natural to implement tactically, it is the most difficult
sourcing model for the enterprise to manage.
Some important changes have been transforming the enterprise use
of IT services. Increasingly, the “client” isn’t
a single, monolithic organization but an aggregate of different business
units differentiated by business focus, geography and sometimes even
business culture. Further, line-of-business managers are more heavily
involved in making and influencing decisions throughout the outsourcing
life cycle than IT managers and CIOs are. And Gartner surveys of CIOs
cite their topmost concerns as aligning IT with business strategies,
providing guidance to CEOs and the board of directors, and demonstrating
the business value of IT.
Vertical Industry Outsourcing Buying Trends
There are several indicators of how industries differ in their use of IT solution providers:
Energy and utilities companies are significantly less likely to focus on using their internal IT department and more likely to focus on the strategic use of solution providers. In contrast, industries with a higher proportion of companies that are more focused on using internal IT capabilities are education, financial services and communications.
Among the organizations showing continued high interest in creative outsourcing possibilities include:
Companies in services and transportation industries are more likely
to view their organizations as "outsource-oriented", whereas healthcare
organizations (primarily providers) are the least likely.
Government agencies are the least loyal to established providers,
which indicates that they are the least likely to prefer to work with
their current solution provider rather than looking for new providers.
Changes in Purchasing External Resources
Through 2003, most companies expect to either maintain a similar approach to purchasing IT services or increase emphasis on using external resources. The industries that are most likely to maintain their current strategies are healthcare (primarily providers) and process manufacturing organizations. Among the industries that do anticipate change, these are the most active:
Discrete manufacturing is the most likely industry to increase emphasis on using external resources in 2003, with transportation second in anticipating an increase in use.
Energy and utilities, and government are the two other industries that expect to increase emphasis on use of external resources during this timeframe.
Retail and education are the most likely industries to increase their use of internal resources.
Zeroing in on Current Opportunities
Many IT solution providers are focusing on outsourcing services to offset market variability. To obtain a more predictable revenue stream and improve profitability, Gartner recommends that IT solution providers explore the following approaches:
Leverage the Trend Toward Outsourcing
Although the opportunity to leverage buyer interest in outsourcing is excellent, it requires that IT solution providers focused on project-based services develop, internally or through alliances, the ability to deliver ongoing IT management services. Take the emphasis away from cost reduction, and focus instead on the higher-valued transformational services that can be delivered with a combination of project-based and ongoing management services.
Explore Global Sourcing Strategies
Improve productivity and therefore profitability, by leveraging the opportunities for global sourcing through geographically dispersed offshore delivery centers. The goal is to work where it makes economic sense and to provide 24x7 service. In addition to offshore development centers, providers are experimenting with global software development teams and shifting delivery of second- and third-shift activities, such as maintenance and customer support, to more user-friendly and cost-effective time zones. Global sourcing strategies require the investments in the development of relationships and the deployment of processes and systems to ensure effective communication and delivery.
Build, Buy or Partner to Complement a Portfolio with Outsourcing
There are fewer and fewer pure play IT professional services firms in today's market. Many IT solution providers are adding types of outsourcing services to their portfolio, with applications management services being one of the most popular. Those that do not plan to include outsourcing services should look for outsourcing partners who would benefit from the particular skill sets, business focus areas, or geography focus they offer.
Successful outsourcing deals are well-balanced and take into account client as well as IT solution provider needs. The theory of win-win deals would require that value for the client is exchanged for profit for the IT solution provider. However, the reality is often far from it. Therefore, understanding the logic and mechanism of the relationship is more important than in other business transactions for both client and provider. Understanding both points-of-view enhances the negotiation process and improves value of the deal for both parties.
Opportunity Exists for the "Adaptable"
Outsourcing has changed and it continues to change with the evolution of the IT services market.
Many IT solution providers have been trying to "be all things to all people". However, only a few will be able to build global, full-service portfolios capable of serving multiple vertical industries. Most will be forced to focus on fewer service areas that leverage their strengths. Being a successful IT solution provider is increasingly difficult due to the rapidly changing market and the growing sophistication of buyers. Winning the best opportunities will require a very focused and entrepreneurial approach.
On the other hand, at the enterprise level, it is increasingly difficult for the internal IS group to satisfy growing business needs through an internal sourcing strategy. Increasingly, enterprises will have to deliver IT services through a portfolio made up of internal and external resources. In a selective outsourcing world, managing a portfolio of internal resources and external providers is a very tough task; and managing the end-to-end service quality requires another whole set of management skills. Effective and sought after solution providers will be those capable of partnering with clients to make sure that both of these management activities are successfully achieved.
Denny Wayson is the Managing Vice President of Service Lines and Market Statistics in the IT Management Division of Gartner Research. You can discuss outsourcing and a range of IT services topics one-on-one with Denny at EnterpriseVision Summer 2003. For details, go to sally.hewett@gartner.com
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Article based on the following Gartner Dataquest Research:
Consultants and Systems Integrators Maintain Vigil for Market Recovery
Market Trends, February 12, 2003
By Michele Cantara
Sourcing Strategies: Relationship Models and Case Studies
Strategic Analysis Report, February 7, 2003
By C. Da Rold, T. Berg
Americas: Consulting and Systems Integration Market 2002-2006
Market Analysis, December 16, 2002
By Michele Cantara
Vertical Industry Buyer Behaviors Impact Service Providers
User Wants and Needs, October 30, 2002
By Cynthia Moore
Focusing on Profitability in a Lower-Growth Market
Research Brief, May 8, 2002
By Denny Wayson
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