OUTSOURCING ON THE DECLINE AS BPO GROWS

2006 has seen a decline in outsourcing across the globe, according to the latest quarterly index from TPI. The last quarter has been the worst in four years for the total value of major contracts awarded. The value of contracts let in the first three quarters of the year is down 2% on the same period of 2005, and some 11% down on 2004. The fall in contract values is partially due to an ongoing trend towards shorter contract terms and does not in itself necessarily indicate market decline. However, TPI’s data also points to an actual reduction in expenditure on outsourcing, with the firm predicting a 1 per cent fall in outsourcing providers’ annual revenues in 2006. This decline is being driven by an expected 3.6 per cent reduction in IT outsourcing (ITO) across the year. TPI expects the Business Process Outsourcing (BPO) market, by contrast, to have grown by almost ten per cent. July to September has seen more BPO contracts awarded than in any previous quarter, totalling some USD 4.5 billion.

Duncan Aitchison, Managing Director of TPI, commented, "The growth in BPO market and decline in ITO are not unrelated. As organisations place more and more processes in the hands of third parties they no longer require the associated infrastructure and hence have less IT to outsource."

Despite the overall shrinkage of the outsourcing market, deal activity remains buoyant. The number of major outsourcing contracts let in this year to date is more than ever before. These contracts have brought an extra USD 9.7 billion in annual revenues on stream, three per cent more than in the same period of last year and again a record high.

This apparent dichotomy between a shrinking market and the best ever year for new contracts lies in part in existing deals being terminated and in part in a growing prevalence of second-generation contracts, which tend to be of lower annual value. This year, 21 per cent of contracts, representing nearly a third of total headline contract value have been renewals or renegotiations of existing contracts. This is up from an average of 16% over the previous five years.

Duncan Aitchison explained, "Second-generation contracts tend not to entail the establishment of costly infrastructure, the capital cost of which is generally amortised across the contract term. We are also witnessing buyers adopting a more selective approach. As the outsourcing market has matured, there has been a shift towards smaller, single-process contracts awarded to the strongest providers in the area, 'best-of-breed' providers, combined with organisations bringing a limited number of operations back in-house."

Indian Service Providers Increase Their Market Share

The India-based service providers have continued to increase their share of major outsourcing contracts this year, securing 4.3 per cent of total headline contract value, up from little more than one per cent two years ago.

Duncan Aitchison commented, "While the India-based providers’ new contract wins are in themselves impressive, they do not show the full scope of their expansion. Many of these providers have adopted the strategy of 'growing from within', often signing small deals and then incrementally increasing their value as their capabilities grow. This approach lays the foundations for them to compete for larger contracts and is often an effective way of gaining muscle as they exploit the levers of familiarity with their clients’ businesses and established relationships."

Shorter Contract Terms

TPI’s research also reveals that average contract lengths in outsourcing have reduced by nearly a quarter (23 per cent) over the last ten years. The average contract term is now just under six years, while ten-year deals, nearly a third of all deals in 2000 now represent only 12 per cent of contracts signed.

Duncan Aitchison, said, "Shorter contract terms are placing a squeeze on service providers by making them more frequently accountable and reducing their security. Having said that, many service providers tell us that they are not opposed to shorter contract durations because of the high rate of retention in renegotiations and renewals, which in 2006 has been some 91 percent."