The outsourcing industry has experienced considerable change during the past few years. At a global level, demand for outsourcing generally remains robust as new contracts are signed, and old ones renewed or renegotiated. But in the more mature European markets, and particularly in the US, the shape of demand is changing.

IT managers’ increased experience in outsourcing, and the emergence of viable offshore alternatives for operational services, means more and more companies searching for greater benefit through sourcing strategies, with contracts structured in a more value-oriented way.

The outsourcing industry, in turn, must continue to raise its game to respond to changing market conditions and increasingly savvy IT managers. The following factors, along with a handful of others, have changed and are changing the outsourcing landscape:

• Service providers have become less inclined to take on capital assets on the scale they may have in the past.
  
• The explosion in the use of offshore delivery has resulted in less appetite for the wholesale transferral of internal staff to the provider.
  
• IT managers have recognised that the traditional “lift and shift” approach was not only complex, time-consuming and expensive, but was preventing the attainment of best-in-class services, as the model limited the ability of the provider to create new innovations.
  
• The growth in the number of second- and third-generation outsourcing buyers, with little in terms of their own assets and staff ­ – and the associated need for managed service alternatives.
  
• A higher level of outsourcing experience has led to increased sophistication in IT managers’ abilities to buy and manage sourced services through a portfolio approach involving a range of suppliers.
  

The impact of the above factors is clear. Five years ago, it was common for contracts to be of a relatively large value, typically broad scope, of seven to 10 years in duration, and single sourced to one of a dozen or so suppliers.

Today, service provider diversity and competition has increased considerably with 113 vendors winning contracts valued at more than £15.7m in 2007, compared with just 99 in 2003. Nearly a quarter of the 113 service providers signed five or more contracts, 14 suppliers won 10 or more, and five signed 20 or more contracts – ­ Accenture, BT, CSC, EDS and IBM.

The result is that multisourcing ­ – the concurrent use of several providers by one buyer to support one functional area – ­ is on the increase.

ABN Amro is a case in point, with the financial services specialist choosing to divide IT services work across several service providers ­ – IBM, EDS, Accenture, Infosys, TCS, Patni, Verizon and Avaya.

IT managers now demand access to specialist capabilities, using best of breed service providers in niche areas. Multisourcing can also reduce dependence on a single vendor, and allow some level of competition to be maintained between service providers beyond the procurement process.

Multisourcing does, however, bring increased service integration and governance challenges. While the market appetite for multisourcing shows no sign of abating, it is uncertain how well IT managers are coping with their more exacting management responsibilities.

The use of offshoring is also increasing, with more than half of all outsourcing contracts now containing some significant component of offshore delivery. Vendors, irrespective of their location, continue to expand their global delivery footprints ­ – and in doing so bring on new opportunities. The net effect on deal structures has been shorter-term contracts with a narrower scope. Contract terms have also steadily declined to an average of five to six years.

Looking forward

As outsourcing matures, IT managers are looking for value and a more defined business impact from their outsourcing relationships. Businesses are seeking more than transactional cost savings and incremental service improvements, much of which can be more simply achieved through offshoring.

We therefore expect to see a shift away from input-based contracting to productivity-driven deals based on outcome-based pricing. As contracts mature and service providers demonstrate their capabilities, more sophisticated outcome-based pricing may be tied to the vendor’s ability to provide productivity improvements.

We also expect a shake-out among industry service providers as the differences between US, European and India-based suppliers diminishes. All will be considered participants in a global economy.

Service providers that invest organically, and through acquisitions in deep domain expertise for attractive market segments, will be positioned for success. Such service providers will be focused; avoiding the temptation to be all things to all clients and expect an increasing emphasis on industry-oriented, vertically-defined offerings.

The IT industry will soon have adopted a greater level of coupling between infrastructure, applications and operations. And there are early signs of a significant shift away from pure labour-arbitrage contracting.

Driven by the desire to improve profitability during changing macro-economic conditions, we expect the service provider community to emphasise the model of defined services. Renewed emphasis on managed services ­ – and the bundling of infrastructure, applications and operations – ­ should increase the annualised value of an outsourcing contract.

We suspect that the value of business process outsourcing contracts will grow faster than those for information technology outsourcing. And we expect that suppliers will recognise that their competitive distinction comes through their brand, and ability to differentiate at the point of customer service.

The new corporate family jewels will be data regarding customers, products, risks and channels of distribution. Outsourcing agreements will be designed to recognise the central role of information and will construct services that process data in a more defined and standardised manner.