Average ACV of AO deals up for renewal increases from US$12.2 million over the next 12 months to US$18.8 million in the 12-24 month period
AO ACD varies by industry and contract renewal timing
Driven by reform mandates – particularly the move to the electronic health record (EHR) – the vast majority of ITO contracts are structured around ADM, testing, databases, and network service.
You’ve heard it … read it in the news … and probably even participated in the discussions about it. “It” is the impact of the cloud model on the third-party service provider marketplace. What are the cloud’s potential disruptive effects? As the cloud and outsourcing meet head on, will the cloud make hiccups or ripples, or will it become a crushing force? How big a threat is cloud to the outsourcing space?
To answer those questions, I think we have to pull apart the services spaces, as the cloud’s impact will differ widely in various areas.
Let’s start with where cloud has the highest potential for disruptive impact.
Impact on IT infrastructure services
The cloud model’s impact on the traditional IT infrastructure outsourcing space has been modest to date and, surprisingly, has not had as strong an impact in disintermediating the existing marketplace as RIMO (Remote Infrastructure Management Outsourcing) had.
Although the impact to date has been modest, the cloud model has a very high potential to disintermediate business in this space and is in a position to drive increased run-off out of traditional infrastructure models.
Threat profile — High. I believe the cloud’s disruptive impact in this area is a question of when, not if.
Impact on the applications space
Here the story is quite different. Unlike the infrastructure space where cloud is poised to take away existing revenues, in the applications space it has at least as many positive impacts as negative. In fact it has the potential to be a growth engine.
As companies prepare to evolve and move into the as-a-service world or migrate their applications to the cloud infrastructure models, the substantial amount of SI and applications effort to transition into the new models will create growth in the outsourcing marketplace.
However, there is a caution sign. The kind of work best suited for the cloud model often goes to new market entrants rather than the traditional players. We’ve blogged before about the shift of decision rights into the business stakeholders’ realm rather than the CIO, and this is driving growth in the cloud market. So there are some issues associated with positioning, but it’s driving growth in the overall marketplace.
Threat profile — Initially modest to high disruptive impact for traditional players. But as the traditional providers resolve their positioning issues with the new consumerized decision-making realm in clients’ businesses, the cloud should have a net positive impact on the outsourcing providers’ growth, rather than a disruptive impact.
Impact on the BPO space
On the BPO side, the cloud model is even more immature and it’s less clear what eventual impact it will have. We certainly see cloud engines being incorporated into the BPO or BPaaS model. But here it’s more of a change in one of the component parts, rather than affecting the overall business model.
Threat profile — Modest to flat impact.
Our overall assessment is that the cloud’s clout to disrupt the existing marketplace in the outsourcing world is modest to high — but the changes will carry both negative and positive consequences.
On January 15, rival IT service providers CSC and HCL made an announcement that they were joining hands to deliver application modernization services. The partnership entails modernizing legacy applications (the HCL angle) and hosting them on cloud platforms (the CSC slant). CSC and HCL will open delivery centers in Bangalore and Chennai as part of this alliance, with a CoE for banking, and will share equally all revenues and costs of these operations.
The announcement sounds a lot like the one from Accenture and Dell a month ago where the two companies teamed up along similar lines. Read the release here. So what makes the CSC and HCL announcement more interesting? For starters, the simple fact that it is not the announcement we were anticipating (or were made to believe). The anticipation was for a broader alliance for infrastructure services, which would have had far significant implications on the supply landscape.
In reality, the announcement is not that big of a deal.
In our opinion this is more of a sales and marketing alliance versus a strategic re-alignment. But since it did catch our attention, here’s a brief analysis:
So why is this important?
Our research on cloud services shows that buyers place a high value on application modernization. While clients acknowledge the value of cloud adoption in order to transform their operating models and save costs, cloud-incompatible legacy applications limit the ability to harness this value. But oftentimes they are reluctant to make significant monetary investments for this pursuit and are looking for self-funding mechanisms. CSC and HCL, exploring mutual synergies, will theoretically be able to lower the risks and costs for clients transitioning to the cloud.
How does it benefit CSC and HCL?
CSC will get an additional channel for its cloud platform (BizCloud, a private cloud offering for the enterprise) and gain access to HCL’s offshore delivery capabilities in applications services. Also, this alliance will enable CSC to offer Proof of Concept (PoC) for its cloud platform to its clients at a lower price, something not feasible earlier with its U.S.-centric workforce.
For HCL, the alliance promises to:
Interestingly, CSC and HCL have been rivals traditionally with HCL being highly vocal about being a “replacement” for the likes of CSC. Like shrewd warring factions, CSC may have just married its enemy, turning it into an ally. The alliance likely enables CSC to not only protect its market share but also offer a compelling alternate proposition, to existing and new clients.
Key questions that this alliance raises
It is still too early to answer any of these questions. But one thing is clear – cloud and next-gen IT certainly create some strange bedfellows.
The results of Everest Group’s recently released research study, IT Outsourcing in Capital Markets – Service Provider Landscape with PEAK Matrix™ Assessment 2013, make it abundantly clear that intensifying competition is putting unprecedented pressure for innovation on IT service providers catering to capital markets. Indeed, this year we saw considerable shake-up among the Leaders, the Major Contenders, and the Emerging Players.
The most notable highlight of this year’s PEAK Matrix is the reshuffle in the Leaders category, with Infosys dropping back to the Major Contenders category due to its shrinking capital markets AO revenue and client concerns around leadership talent retention. In fact, the total market share held by the Leaders category was negatively impacted by Infosys’ departure. On the other hand, ongoing provider portfolio restructuring by capital markets buyers to address concentration risks and to counter the complacence of incumbents drove growth in market share for Major Contenders.
As service providers of all sizes continue investing in next generation themes and honing their transformational value proposition, it is becoming increasingly critical for buyers to look beyond scale alone. This also opens up the opportunity for buyers to diversify their provider portfolio by including mid-sized firms that can play the role of a “challenger,” thereby enabling them to manage concentration risks and foster healthy competition among providers.
To cater to the needs, demands, and increasing sophistication of buyers, service providers need to develop customized solution frameworks per buyer requirements, because a one-size-fits-all approach is unlikely to succeed in this evolving AO marketplace.
Following are other highlights from the research:
Given the stiff competition among service providers in terms of market share, it will indeed be interesting to see how these service providers will respond to the challengers, and how the new evolving business models will shape the industry.
Are the systems integration (SI) and application outsourcing (AO) spaces converging? We’ve been asked this question numerous times.
It does appear that in the large-company buying group that there is a trend to combine SI and AO services. By combining them, customers seek to reduce or eliminate the premium pricing on their SI services, which typically are much higher than AO fees.
While this sounds like a smart purchasing move — and in some instances it may be — don’t overlook the facts that this strategy comes with risks. If your organization is considering plunging into this strategy, you need to realize that it can shift to become a disadvantage.
Here are two ways that can easily happen.
Apples and oranges are priced differently for a reason
AO and SI skills are not the same. Systems integration services come at a premium price because they require more onsite resources plus a more senior blend of skills and usually more industry knowledge in the blend. The classic offshore talent so often used for AO services is less beneficial in SI services.
By combining the services for a lower price, you run the risk of your service provider populating your SI project team with AO-skilled resources. This will significantly increase the risk of your SI project failing.
Look out for the bursts
If SI and AO services converge to the same pricing for both, you will lose your flexibility. Providers utilize personnel assigned to SI groups differently than those assigned to AO groups. It’s an important distinction for the customer’s benefit.
Fundamentally SI projects are unpredictable and require burst capacity to satisfy customer needs at such time. An AO team has a consistently known quantity that the provider maintains and optimizes; but AO resources lack burst capacity to handle variations in project needs.
Don’t dilute
Our advice is to remember the fundamental resource capacity and skill problems that drove you to outsource SI and AO services in the first place and don’t dilute the power of your outsourcing strategy.
Although signing a contract for SI and AO services priced the same eliminates the SI premium and looks like significant savings — on paper — you will essentially put your project at risk because of not having the right level of skills and the burst flexibility to address your changing needs.
Enterprise buyers are increasingly realizing the need to improve their application outsourcing (AO) productivity levels in order to curb the spiraling costs of their application functions, whether they are delivered by the internal IT organization, global in-house centers, or a service provider. Many buyers are also decreasing the volume of work that they outsource, due to their increasing frustration with their external service providers’ lack of ability to deliver greater productivity.
Some of the traditional measures buyers have adopted to mitigate these issues include automation of ADM processes, service provider consolidation, sourcing mix optimization, and application rationalization. However, they are not entirely satisfied with the outcome of these initiatives, and believe they can further improve. Everest Group believes they must not only augment these initiatives, but also start an organization-wide reform of application service delivery processes that includes development models, enterprise architecture, sourcing strategy, best practices, etc.
In order to derive meaningful impact and achieve sustained AO productivity improvement, buyers must:
Such measures could be initially painstaking and effort-intensive, but are bound to provide sustainable benefits in the long run.
Moreover, buyers need to hold their service providers accountable for productivity enhancement. Most buyers believe that their service providers lack the capability to provide further cost and productivity improvements. Therefore, as noted above, a significant number of buyers are bringing select pieces of work back in-house to gain better control of their processes.
Everest Group believes that if service providers are unable to match buyer’s expectations around productivity improvement, they will witness a significant churn in their client portfolio. Service providers need to first deploy the tried and tested methods of improving productivity (e.g., automation, delivery mix, etc.). However, they need to adopt additional measures, as outlined above, in order to bring about sustained productivity improvement.
For further insights, please read Everest Group’s, “Application Outsourcing (AO) – Annual Report 2013: Declining Productivity Rising Anti-incumbency.” The report discusses the limitations of conventional strategies being adopted by buyers to improve the productivity of their AO functions, and the need for enterprises to evaluate broader organization-wide strategies in order to boost AO productivity.
The report also highlights other interesting trends including a rebound in the European market and the increasing impact of mobility and analytics on application services.
Have you the noticed the growing ripples of marketing messages from Genpact? The firm is already a leader in the global services market, but Bain Capital is aggressively pushing Genpact to grow faster and become more dominant in the market.
Bain — which is known for taking well-run, aggressive firms and super-charging them — provides capital to Genpact, has a seat on the provider’s board, and is becoming far more active in its management meetings. Acquisitions, organic growth, and looking outside the Indian heritage for Western talent are all on the strategic agenda along with refreshing marketing activities.
They moved from purely F&A services and solutions and now have compelling offerings in enterprise application services and IT infrastructure services. In today’s environment, there is plenty of room to grow their share of the pie. Genpact already had one of the higher win rates in the global services industry and now, with increased focus on marketing, should capture more wins.
If you’re a global services buyer, these observations portend to Genpact coming to visit you soon.
If you’re a service provider, you likely have reasons to be frightened by the moves Genpact is making to step up to a higher level in the market.
Recently Infosys posted better-than-expected earnings. But it also indicated an upcoming adjustment in strategy, stating it plans to pursue growth through traditional outsourcing contracts and will deemphasize its focus on software as a source of growth.
Infosys has long been a stalwart of the Indian heritage firms and built its impressive growth and profitability through the outsourcing and services space. However, the company is not as well positioned to drive growth in these areas as it once was.
Historically it was a powerhouse in application outsourcing (AO), and Infosys still maintains this strength. However, AO’s growth rate is slowing and there are fewer large AO opportunities available in the marketplace.
Outsourcing growth has shifted to both the BPO and infrastructure spaces. In these areas, Infosys is not as strong as it is in AO and is not as strong as its competitors.
Therefore, if Infosys looks to drive growth rates above the industry average in large outsourcing transactions, it will need to significantly improve its positioning in either or both BPO and infrastructure. In today’s marketplace, we believe Infosys lacks the ability to grow organically in these areas at the rate required to meet the company’s overall growth objectives.
To execute its growth path, Infosys needs to adopt an acquisition strategy and grow inorganically. Before it can grow, it needs to make a significant move to acquire assets upon which it can build and grow in the attractive BPO and infrastructure spaces.
We believe this is the most effective strategy Infosys can utilize to achieve the necessary growth rates within its investors’ time frame to meet its objectives.
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