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A “New Normal” for the Outsourcing Market?

Keppel, John
by John Keppel

The global outsourcing market is increasingly characterized by growing volumes of contracting activity, coupled by a decline in total contract value.

This was a key finding that emerged from the Q413 ISG Outsourcing Index, which we discussed recently on a conference call with analysts, clients and the service provider community. The Index, which measures commercial outsourcing contracts with annual contract value (ACV) of $5 million or more, showed the number of contracts awarded during the fourth quarter of 2013 climbed by 13 percent, while ACV dropped 12 percent, to $4.6 billion. For the year as a whole, the number of awards edged up 2 percent, while values fell 18 percent, to $18.7 billion.

It’s becoming increasingly clear that, rather than a short-term anomaly, this shift to higher deal volumes/lower contract values reflects a fundamental change in the marketplace and represents a post-recessionary new order of things.

What’s driving this change?  Contributors include fewer “mega relationships” (those with ACV of $100 million or more), as well as declines within the manufacturing and financial services sectors, weakness in business process outsourcing (BPO) and a trend to smaller deal sizes, as more enterprises converted long-term deals with a single supplier into shorter-term contracts with multiple providers.

From another perspective, we see that higher volumes of smaller and shorter deals reflect market maturity and the growth of multi-sourcing, as clients become increasingly comfortable with engaging best-of-breed suppliers and managing multiple relationships. We also recognize that, while the potential benefits are significant, multi-sourcing also poses some challenges; specifically, how to ensure collaboration among a disparate team of providers.

In this post-recessionary period, moreover, we’re beginning to observe shifts in demand for sourcing.  Rather than used solely as a tool for exploiting rapid cost-savings potential, sourcing is increasingly applied for strategic advantage as enterprises begin to move into growth modes.

Another emerging sea change: profit margins, rather than revenues, are becoming the new benchmark for service provider success.  As we’ve discussed elsewhere, this trend reflects increased market maturity, client/provider collaboration and acceptance of standard service delivery and automation-driven solutions.  Providers that embrace these developments and work with their clients to continually drive down operating costs will emerge as the winners.

Against this backdrop, for the first half of 2014, we expect positive results across the broader market, based on a strong industry pipeline and a softer comparison with a weak first half of 2013.  Specifically, we’re forecasting growth in ACV of between 3 percent and 5 percent for the first six months of this year.

Looking back, I believe 2013 represents a real inflection point for the sourcing industry.  Going forward, a number of significant forces will combine to shape sourcing in the post-recessionary world, among them the challenge of maturity and saturation in the large traditional markets and industries, a lack of penetration into the emerging markets for a number of major global players, ever-increasing competition, and a decline in the cost of sourcing.  We will see a continued shift from West to East, and further growth in under-penetrated industries, market segments and geographies.

As we come to grips with the “new normal” of today’s market, let’s not get complacent. With rapidly changing competitive dynamics, and with the increasing intrusion of automation and the disruptive SMAC technologies, things are unlikely to stay “normal” for very long.

About the author

John is a proven executive leader with strategic, transaction and post-transaction experience. John has helped many large, global enterprises introduce and cultivate innovation as a part of the transformation process. Many of John’s projects have led to groundbreaking transactions, particularly in the UK Life and Pensions market, where John is a sought after C-suite advisor in the strategic sourcing of insurance operations. John has also conducted significant transactions in both IT infrastructure and applications environments. As a Partner and President, he sits on the ISG Executive Board and leads ISG EMEA and Asia.