Why are PE firms souring on IT services?

Through this blog I am sharing thoughts that have surfaced through my conversations with Private Equity (PE) firms who own assets in the Information Technology (IT) Services space. The context is this: For the better part of two decades, IT services firms offered PE investors a well-understood and operationally grounded investment case.

Long-term outsourcing contracts provided revenue visibility and margin optimization through deal re-structuring. The cost of replacing an incumbent, transition risk, knowledge transfer, and service continuity, meant that most clients did not, making it a rare occurrence. The value creation levers were pricing discipline, utilization management, and portfolio repositioning, all within the PE firm’s direct control and none too dependent on market tail/head winds.

That thesis is now under pressure. Several of the structural conditions that made IT services attractive to PE investors are either weakening or reversing. If you are a PE firm evaluating an IT services asset today, or an IT services firm wondering why your recent conversations with PE sponsors felt different from the ones five years ago, this is worth reading carefully.

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Investment theses: What made IT Services attractive to Private Equity

The investment case rested on four concrete pillars.

Margin levers. Most acquirable IT services firms, whether promoter-owned or subscale, operated with governance standards below what institutional ownership would demand, in two key margin levers: pyramid rationalization and Internet Property (IP)-led differentiation. In a business where these levers had never been systematically pulled, the margin improvement available without any revenue growth was a primary investment case.

Service portfolio repositioning. Promoter-owned IT services firms tend to accumulate low-margin engagements because of “relationship obligations” and lack the governance to exit them. A PE owner with a defined hold period and a clear exit target can force that repositioning, retiring commoditized work and redirecting capacity toward higher-value portfolio (think the “digital engineering” fad we recently saw), producing a structurally improved margin profile. 

Bolt-on multiple arbitrage. IT services markets are fragmented, with a large number of subscale firms trading at lower multiples than a scaled, institutionalized business. Acquiring them folds their Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) into the original business, where it gets valued at the higher exit multiple of the combined entity. The return is generated directly from that pricing spread plus additional gains from operational improvement in the bolt-on. 

Specialization as a moat. IT services firms with deep expertise in specific platforms or regulated verticals commanded premium pricing , attracted larger engagements, and carried a revenue base that was expensive to displace. A new provider had to absorb years of institutional knowledge built around the client’s compliance requirements, legacy system dependencies, and operational workflows, at real cost and risk to the client.

For a long time, this was a clean and defensible playbook. Artificial Intelligence (AI) is now changing the conditions that made each of these theses work.

What AI Is doing to each of these theses

The four pillars are not equally affected. Some are weakening structurally. Others are weakening at the margins. One is holding. 

Margin levers: AI is attacking both pyramid rationalization and IP-led differentiation simultaneously. It is automating the work that justified the base of the delivery pyramid. AI-native, self-serve capabilities are disintermediating the need for the engineering-heavy customization and feature development that services firms built their value around. The sell-with motion with hyperscalers, Software-as-a-Service (SaaS), and enterprise software vendors is contracting for the same reason. As those vendors embed AI-native capabilities directly into their platforms, the implementation and solutioning work that services firms attached to those partnerships is shrinking.

Service portfolio repositioning: The premise was that a PE owner could move the firm up a stable hierarchy, retiring commoditized delivery and repositioning toward complex, judgment intensive work. AI is not dismantling that hierarchy from the bottom up in an orderly fashion. It is compressing the middle. Work that was considered specialized three years ago, including code review, test automation, first-pass documentation, and routine application support, is increasingly automatable. Repositioning toward higher-value work is harder when the definition of high-value is itself shifting every six months.

Bolt-on multiple arbitrage: This thesis required a fragmented market with enough viable subscale targets to sustain a buy-and-build strategy at a meaningful multiple spread. Subscale firms built around staff augmentation or volume-driven managed services are becoming unviable faster than they can be acquired. The pool of credible bolt-on targets is shrinking, and with it, the opportunity to generate returns from the multiple spread itself.

The 3C Moat: The only thesis that holds

Specialization is the most resilient of the four theses, and the one that PE investors should be screening for most deliberately. The firms that will remain attractive to PE investors are those that can demonstrate what I would call the 3C moat: Capability, Context, and Calibration. 

Moat #1 is capability in the form of specialization depth. A firm that has built genuine domain expertise, whether in a regulated vertical or a complex functional area, has Capability that a generalist firm cannot quickly replicate regardless of the AI tools available to it

Moat #2 is context awareness in regulated industries. The compliance landscape in financial services, healthcare, and government evolves continuously. An incumbent services firm that has navigated that evolution alongside a client carries context that cannot be transferred cleanly in a vendor selection process. That switching cost compounds with every regulatory cycle the incumbent survives.

 Moat #3 is calibration, what makes a firm irreplaceable in the agentic world. Enterprise functions are built around decision logic, approval hierarchies, and human judgment calls that no model inherits by default. A firm embedded in how those functions actually operate knows where to agentify.

This is where agentic AI changes the calculus entirely. Deploying agents inside enterprise functions requires understanding the decision logic, the compliance constraints, and the human judgment points that govern how those functions actually run. A firm without that embedded knowledge cannot design the deployment credibly, regardless of its technical capability. As enterprises move from AI experimentation to agentic deployment at scale, the 3C moat becomes the only basis on which a PE investor should be underwriting an IT services investment. For IT services firms, it is the only repositioning that matters.

If you enjoyed this blog, check out, AI Infusion in Private Equity: A $200 Billion+ Opportunity – Everest Group Research Portal , which delves deeper into another topic relating to PE.

If you are interested in discussing this topic deeper, please reach out Abhishek Singh ([email protected]).