The R-word and What It Means for IT Services Spending This Time | Blog

What factors make this economic downturn different, and is IT services spending recession-proof? Despite recessionary fears, digital transformation and post-pandemic demand will help maintain IT services growth with more cautious tech spend moving forward. Learn the three strategies service providers should take now to plan for the slide in this blog. 

By all accounts, it seems we are entering a cyclical phase of economic downturn. Gross Domestic Product (GDP) declined for the US, Italy, and Japan in the first quarter, while the UK, France, and Canada flatlined or deaccelerated meaningfully.

This has been visible a long way off, and the equity markets have adjusted their guidance for IT services stocks accordingly. However, we at Everest Group believe this is very different than past cyclical downturns.

To truly understand the nature of the impact on the IT services industry, we need to ask the following three questions:

  1. Is IT services spending truly discretionary?

Chart one tells us a few things:

  • During a downturn, IT services spending tends to follow a meaningful lag effect. Our channel checks reveal careful prioritization of fresh capital expenditure (CAPEX) items, but not cancellation of committed tech spend
  • Modern enterprises view technology and tech spend to transform their business and become more innovative and efficient. A downturn will sharpen the focus on pragmatic digitalization to create new revenue streams
  • A meaningful part of the inflationary pressures can be attributed to global fiscal expansion post-pandemic. This is not necessarily true for private businesses and tech spend. If anything, remnants of pent-up demand continue in the wake of pandemic-induced austerity

A combination of the second and third factors is leading to the divergence between the IT services and aggregated economic activity, as measured by the GDP.

Chart 1

Picture1 1

  1. How much has already been baked in?

Now, look at this second chart. Suffice to say that IT services stocks have taken a beating in 2022.

While some stock price erosion can be attributed to inflationary pressures leading to margin compression, a significant part is due to negative macro expectations.

Curiously, during the same period, consensus revenue estimates have continued to expand (Accenture, Cognizant, Infosys, Wipro, TCS), and book-to-bill ratios remain healthy (expanded Year-over-Year for Capgemini and IBM, with mild deceleration for TCS and Accenture).

Quite simply, this downturn was visible a mile off. All of us could see it, as could customers, economists, governments, central banks, and equity markets. And a little bit like seeing a slow train coming, we skipped the tracks and readjusted our expectations. Consequently, it’s unlikely we will see a trainwreck, but tech Return on Investment (RoI) will be increasingly scrutinized.

Chart 2

Picture2 1

  1. Are the usual lemons drying up?

Finally, we need to remember that the world is still coming out of COVID-19. Every enterprise made massive cost adjustments during the pandemic by automating routine tasks, moving to the cloud, and divesting non-core assets. In other words, many of the usual cost adjustment levers are already pre-adjusted, and one has to pause and ask – how much padding do we still have before we risk cutting too close to the bone?

What’s likely to happen – our prognosis

  • Yes, there will be a downturn in the IT services industry. But it is very unlikely to be severe. We forecast 6.7 % growth (organic, constant currency basis) as the base case for the year ending March 2023. This includes a set of very large supply side players with company-specific issues (e.g., Atos), while more resilient companies will comfortably beat the average. Irrespective, industry growth will be significantly above the pre-pandemic trendline. The reality is that we are in the midst of a decadal mega cycle of digital transformation, which will significantly counteract a slow-burning cyclical downturn
  • Enterprises will have to grow out of the recession through waste avoidance, innovation, and digitalization, and not through canceled tech spend
  • There will be limited manifestation of the usual downturn-linked opportunities (e.g., shared services divestments, vendor consolidation, etc.)

Three service provider strategies

Service providers will still need to readjust. Here are some recommended immediate steps to take:

  • Examine your portfolio: Not every industry and customer within the same industry will be impacted equally. Now is the time to critically examine your portfolio and evaluate every account. Ask yourself:
    • Which parts of my portfolio are critical to the customer’s business success? If they are not core, how can I gain share in business-critical categories?
    • Have parts of my portfolio already been adjusted for maximum efficiency during the pandemic? If not, what can I proactively do about this?
  • Focus on systems of growth: Systems of growth are digital platforms that help enterprises create new revenue streams and transform the customer experience. In a downturn where brute-force cost-cutting options are likely to be limited, having a robust strategy to help customers grow will be a true differentiator
  • Continue hiring: The talent market may move from “white hot” to “warm,” but the war for tech talent is not over by a long stretch. A temporary lull may represent a brilliant opportunity to attract and train differentiated talent. When the markets rebound, it will make a difference

What is your outlook for IT services spending? And how are you planning for the downturn? Please feel free to share your perspectives, email me at [email protected] or Contact Us.

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