Conventional wisdom holds that the outsourcing industry runs countercyclical to the economy. As the economy weakens, outsourcing contracts increase as companies spend money in order to save money. Forecasts from large IT consulting firms, including Forrester Research Inc. and Gartner Inc., bore that out, showing high single-digit growth in IT services spending, even as recently as the summer.
The latest data from TPI, a global advisory firm that tracks large business processing and IT outsourcing deals, finds the model may not hold up in this downturn.
Outsourcing fell off a cliff in the third quarter, as both the number and total value of outsourcing contracts decreased by double digits compared with the prior quarter, according to TPI.
The number of outsourcing contracts fell 22% in the third quarter ending Sept. 30, compared with the second quarter, said TPI, in its latest report. The $14.4 billion in total contract value and $2.8 billion in annualized contract value realized during the third quarter represented a 50% decrease from the prior quarter.
"The third quarter was a shocker to everybody in the industry," said Mike Slavin, head of information technology outsourcing (ITO) at TPI.
"Labor Day Rush" comes late, less robust
Outsourcing activity typically slows in the third quarter, Slavin said. And, weirdly enough, 2008 is still on track to outperform the $85 billion in outsourcing activity realized in 2007. Year-to-date, the number of contracts has risen nearly 5% compared with last year at this time.
But the contraction in total deal value in this most recent third quarter was lower than the historical average by almost 20%, Slavin said. ITO business fell to its lowest level in more than a decade. And the big outsourcing contracts signed in the first half of the year that put 2008 on track to be the biggest outsourcing year ever? Nowhere to be found.
Indeed, after three successive quarters of more than $9 billion each in mega deal total contract value, only one mega deal of just more than $1 billion was signed in the third quarter, TPI reported. The last time the industry had "one or fewer mega deals in a quarter was in 1996," TPI reported.
In Europe, the Middle East and Africa, the value of the 56 contracts signed during the third quarter totaled about $5.5 billion, down a dramatic 70% from the $18.5 billion realized in the prior quarter. Information technology outsourcing fell 56% from the second quarter.
Another telltale sign that this year is different from years past was the onset of what TPI calls the "Labor Day Rush" -- the annual push by companies to structure outsourcing deals that will reap results by the end of the year. This year's rush didn't start until late September.
"It's a fascinating time, because other than in Europe, the mega deals are dead. And even Europe, after a blockbuster 2006 and 2007, is on a downward trend," Slavin said. Yet 2008 is holding up despite the precipitous drop in mega deals and without the big kahuna of the outsourcing industry -- the financial services sector, which started to tank at the end of 2007.
As for what happens next?
"You can't go too far forward right now," Slavin said. He said he'll be watching closely three weeks hence, around Thanksgiving, when firms like TPI will have a better sense of how 2009 is shaping up for outsourcing contracts.
One trend is obvious: Smaller deal size -- $5 million to $15 million scope, not the $50 to $100 million scope of past years -- is the norm rather than the exception now.
"Organizations with a smaller problem set are coming to the party," Slavin said. And these organizations are looking for immediate results, he added, meaning smart contracting is more important than ever.
Forrester: Exploit IT services to boost your business
One expert who agrees with that advice is Paul Roehrig, who covers sourcing and vendor management at Forrester Research Inc. in Cambridge, Mass. He's in the camp that believes outsourcing will continue to grow, a slow third quarter notwithstanding.
"Today's global economic pressures are already forcing firms to drive cost-cutting even harder," Roehrig writes in an Oct. 9 report, "New Market Pressures Will Drive Next-Generation IT Services Outsourcing."
In a Q2 poll of 258 companies with 20,000 or more employees, Forrester found that 43% of respondents had already cut their IT budgets because of current economic pressures.
The data showed that spending on services was not immune from cuts. But even as companies were cutting back on some external service providers for special projects work, they were accelerating spending on IT outsourcing to cut costs.
CIOs should sharpen their pencils. The same economic pressures on IT budgets are also forcing providers to deliver more efficiencies, as customers demand better terms on existing and new contracts.
Let us know what you think about the story; email: Linda Tucci, Senior News Writer