It's not just cheaper prices pushing down IT outsourcing contract values. The 'new normal' for outsourcing presents risks and opportunities for customers and IT service providers.
IT outsourcing customers are signing more deals than ever before, but for less total value.
The total annual contract value for deals signed fell 8 percent from $14.7 billion in 2012 to $13.5 billion in 2013, according to year-end analysis by outsourcing advisory firm Information Services Group (ISG).
"Clients are opting for the flexibility of smaller and shorter deals with more providers and are willing to take on the additional management and governance responsibilities that come with that model." -- Kathy Rudy, ISG
That marks the fourth year of decline in contract values. Meanwhile the number of agreements signed continued to rise from 622 in 2010 to 793 last year, according to ISG. There were more than 1,000 small deals -- those in the $5 to $39 million-dollar range -- done in 2013 compared to 673 in 2008, ISG says.
[Related: 10 IT Outsourcing Trends to Watch in 2014]
The average amount spend per company has decreased by $6 million, and that's not just because IT services cost less today. "Part of it is cheaper prices," says ISG partner Kathy Rudy. "But the real key is that clients are focused on providers that can provide solutions that meet specific needs and are willing to go to multiple suppliers that can fill those needs in an optimal way, as opposed to taking a one-size-fits-all approach where a service provider is better in some areas than others."
But while customers are willing to take on multi-sourcing management, not all are necessarily able. "It's a mixed bag," says ISG partner Lois Coatney. "One key challenge is getting a lot of different suppliers with different agendas to collaborate on behalf of the client." Companies must invest in the appropriate people and mechanisms to manage their suppliers long term.
Bigger Deals Aren't Better for IT Outsourcing Customers
Large, single-sourced deals just don't work in today dynamic business environment. "Clients are seeing the impact that cloud and labor automation are having and they don't want to a big, long-term deal that locks them into a static solution that's going to become obsolete," Rudy says.
"Clients are opting for the flexibility of smaller and shorter deals with more providers and are willing to take on the additional management and governance responsibilities that come with that model," Rudy says.
Infrastructure outsourcing in particular was the biggest contributor to the decrease in contract values while network services and application development and maintenance (ADM) work increased slightly both in terms of deal values and counts.
The strength in application services is part of an overall shift in their outsourced models, according to ISG partner Steve Hall. "ADM deals are finally transforming to managed services versus staff augmentation or project-based deals," Hall says. "The operating models have matured, which has led to larger application maintenance sourcing deals with a higher annual contract values."
IT Service Providers Turn to Automation
Nonetheless with overall contract revenues decreasing, IT service providers will look to automation and as-a-service solutions to drive down their operational costs and increase their profit margins, according to ISG. And outsourcing clients seem OK with that.
"Clients have realized that outsourcing hasn't brought the promised cost savings, and they're also realizing that they themselves might be part of the problem," Rudy says. "Labor arbitrage can only get you so far, and clients are coming to understand that to realize significant savings you have to attack the processes and inefficiencies in service delivery."
Customized solutions are decreasing, with clients more willing to adjust their processes to the service providers' standards rather than the other way around. "This allows the provider to deliver services more efficiently, thereby resulting in a win/win: lower prices for the client, higher margins for the provider," Rudy says.
But that will require customers to manage the operational risk that comes with more standard solutions. "With point solutions, the onus of integrating these services and ensuring closure of any gaps in level of service will now be the responsibility of the client," says Coatney.
"In order to successfully plug in and integrate point solutions, clients must have a strong view of the architecture and portfolio of services they have in place to meet business needs," Coatney says. "It's becoming imperative to have the flexibility to scale these standard solutions so that they can respond to evolving business requirements."
Manufacturing IT Services
And as IT services become more homogenous, providers will need to implement a "factory-like" approach to service delivery in order to efficiently attract higher volumes of smaller opportunities, says Rudy.
At the same time, suppliers will have to find new ways to differentiate themselves in a crowded marketplace, such as industry-specific offerings and value-added services that solve business problems. "They also need to demonstrate success and credibility in new and innovative technologies," says Rudy. "Clients want the latest tools and technology but they don't want to be guinea pigs."
The upside of the evolving IT outsourcing market is that an increasing percentage of the IT budget will shift from utility services to value-added, industry-specific solutions, says Hall.
"IT is able to start focusing on value-added services and integrating solutions to drive higher business value," Hall says. "This provides an opportunity for providers to place larger bets on social, mobile, analytics, cloud, and business-process-as-a-service solutions that will continue to drive efficiency but also enable higher value projects such as mobility and analytics."
Read more about outsourcing in CIO's Outsourcing Drilldown.
This story, "Smaller, Shorter-Term Deals Shake Up IT Outsourcing Industry" was originally published by CIO.