The size of ITO contracts continues to be smaller because of multi-sourcing. Karas predicts that by 2008 multi-sourcing even among offshoring deals will be mainstream such that buyers will pass over providers offering delivery from only one country.
Pat Adamiak, Vice President Portfolio Marketing and Alliances, Outsourcing Services, HP, says the main trend in ITO today is "a lot of pressure from customers to deliver a lot more innovative ways to do ITO." He cites two examples. Today, most data centers are still architected on a deal-by-deal basis. "But in the future, there will be a world-class center based around blades, world-class architecture, etc., which will allow transfer of data center deals to move faster."
Desktop services are another example. Today, the desktop is very multi-tower and cobbled together. "In 2008, we will see a much more integrated desktop offering. It will focus categories more on end-user perspectives and needs instead of today's desktop, with categories that are by process," she says. For example, the desktop of 2008 will be more advanced for mobile people, along with the categories for standard needs. The desktop needs of a clerical person or call center person are different from a road warrior.
Another reaction to client demand is that 2008 will also bring a move toward automating how service providers deliver services, Adamiak states. This will bring a lot of provider consolidation to allow more leverage. HP purchased Mercury and Opsware this year to have a stronger software services arm. IBM made several similar acquisitions in 2007. "Combining automation with the trend of local delivery makes it easier to move to a sophisticated global delivery and move services around," he says.
Market Growth
According to Everest Research Institute, the overall IT Outsourcing (ITO) market will continue on a steady mature growth. Everest's analysis shows that ITO penetrates the Fortune 100 by about 80 percent already. Ross Tisnovsky, Vice President, Research (ITO), says this penetration suggests that most of the ITO activity in 2008 will be happening in the mid-size (e.g., Fortune 1000) client segment.
"We are also likely to see further decline in mega-deals, both in terms of number and the size," Tisnovsky predicts. "As fewer mega-deals get announced, most of the play in the mega-deal segment will shift to renewals and re-competes. These trends are likely to intensify competition resulting in additional pricing pressure across ITO."
Although the small and medium business (SMB) segment remains largely under-penetrated in terms of ITO, Everest Research Institute does not predict major changes and efforts coming in this market segment. Everest expects it to remain under-leveraged, due to the issues of low-scale of outsourced processes and the provider's high cost of the sale. "Both are hard to overcome in the SMB market," Tisnovsky explains.
Infrastructure
Infrastructure outsourcing (IO) will continue growing at a sustained pace in line with the rest of the IT industry. "Under the calm surface of the market, we will see significant share shifts as the Remote Infrastructure Management Outsourcing (RIMO) model continues gaining market share, growing at 60 to 70 percent," Tisnovsky predicts. As RIMO gains share, the traditional model of IO will start to show a declining trend around 2010.
Tisnovsky advises buyers looking to make decisions in the next two to five years to investigate whether RIMO is good or bad for them. "Some will find that RIMO is not cost-effective for them. Others will want to get rid of assets, and RIMO won't work in that case."
A shift toward asset-light deals in both RIMO and traditional models will result in revenue deflation as assets start getting excluded from the scope of IO engagements. "We estimate that the asset-light deals are usually 60 to 70 percent smaller than the corresponding asset-heavy deal. Thus, the shift toward the asset-light deals is likely to result in improved margins, but will affect the top-line growth, says Tisnovsky.
He adds that aggressive adoption of labor arbitrage by both RIMO and traditional providers is also likely to add to the pricing pressure in the IO industry.
Karas of Luxoft predicts that the strong adoption of ITO in European companies in 2007 will continue in 2008, with companies actively seeking services delivered by a nearshore, Eastern European provider. But not all locations--nearshore or offshore--are equal, and value depends on expertise as well as other cost factors.
He points out Eastern Europe is not a good location for application maintenance, for example, because it requires more expensive skill sets. China is great, he says, for low-complexity, large projects where communication and time zone differences are not critical (as they are in application maintenance). In application development, where project specs and architecture may not be very clear, the location of the development team is critical because interactions need to take place in real time.
"New regions, such as Russia and Ukraine are now included in Gartner's "leaders" tier; this allows companies to fight for sending work to providers in these regions. Outsourcing to a service provider in a non-mainstream region still sometimes raises eyebrows because of common stereotypes and perceived risks," says Karas.
But he predicts that labor arbitrage will inevitably go away as the market becomes more efficient and hourly rates for certain skills become the same.
Application Development and Maintenance
According to Everest Research Institute, demand for ADM services is likely to continue slowing down, resulting in a more sustainable pace of growth of about seven percent (down from its 12 percent growth in the last couple of years).
"We estimate that the penetration of offshoring into the ADM headcount of IT services companies is approaching about 40 percent and is likely to start showing signs of saturation," says Tisnovsky. Most buyers are already comfortable with their current ratio of offshore work.
This maturation of the offshore trend will result in a shift of value in ADM from labor arbitrage into more complex areas of ADM (e.g., process improvement and application portfolio rationalization). Tisnovsky predicts this value shift will result in buyers' driving consolidation of their service provider portfolios and push toward more partnership-based relationships.
Luxoft's Karas says software performance and product testing has recently made its way into the outsourcing arena. He says in 2008 the scope will broaden beyond traditional functional and system integration testing to also encompass overall system performance and scalability, usability, and security, thus bringing higher value to the client organization. This will require suppliers to offer new outsourcing services in the market in the areas of system performance engineering, test automation, and regression testing efficiency.
Karas says, "Providers providing ground-up software product development and engineering support for client offerings will pick up steam in 2008 as transformational and innovative outsourcing grows, especially in the automotive, industrial, electronics, and telecommunications equipment industries."
He predicts that Agile, which started taking root in the development community and in outsourcing engagements during 2007, will see greater adoption in 2008, as a strong tool in helping to speed time to market. "It will be critical to have a provider that has mastered Agile," Karas states.
He also points to a trend of major multinationals selecting providers other than the large Indian players "when there are a lot of parameters around the criticality--such as mission-critical applications, and real-time transactional systems." Deutsche Bank, for instance, chose Luxoft over large Indian players for its global CRM application. "Some companies feel they will have more leverage, more control, and more escalation power with a mid-size provider," Karas says. "Deutsche Bank communicates directly with our senior executives, and that level of relationship takes on a tremendous role in achieving value."
"The economy is changing pace and it's a global world, so competition is tighter and companies need to replace their applications with minimum risk," states Keras. He predicts companies in 2008 will "do even bolder moves with outsourcing and it will become more like an ecosystem."
He notes another trend: verticalization. Karas predicts it will become an important provider-selection criteria. "Service providers with certain domain expertise that can speak the language of the business, think and talk like the client, and thus react more quickly will easily differentiate themselves from other providers," he explains.
ITO in Health Care
Siemens has noticed a trend of fewer large outsourcing deals in the healthcare industry. Further, the provider notes that most deals are shrinking from longer historical contract term lengths to five to seven years now. While both of these trends can signal a strategy toward best-of-breed multi-sourcing deals, Jim Way, Vice President Managed Services Operations, Siemens Medical Solutions, says they signal a different phenomenon in healthcare outsourcing.
"Potential clients are saying to us, 'Come in and do a good job on our pain points; and if you do well, we'll give you more work,'" says Way. He explains this demand arises from two areas. First, many healthcare organizations are still dipping their toes in the waters of outsourcing.
Second, more and more CIOs are now involved in the outsourcing decision, not just the CEO and COO, and fewer CIOs are losing their jobs to an outsourcing provider. "This frees them to consider using outsourcing solution instead of a threat to their jobs," says Way.
Still, the CIOs currently have a comfort level with doing only pain-point deals. The main pain points areas today are: (1) help desk, (2) application support (legacy systems, implementing and supporting new systems, and (3) the one-time project of improving the network infrastructure (enabling implementing new advanced systems).
Way notes that the clinical concentration for systems now is not financial. It's implementing new systems, transitioning from old systems, and also outsourcing the help desk. He adds that "at Siemens, we're changing the way we support some services, such as the help desk, because more and more incoming calls are from physicians and clinicians who don't have time to troubleshoot anything."
Finally, the Siemens executive says, "Our potential customers are now demanding 'What are you going to do to help my business?' and 'How can IT enable what we want to do?'"
Buyers and providers, more than ever, need to remember that relationship management is critical for outsourcing success, he warns. "It's the key to ensuring a satisfied client and extending the contract."
Lessons from Outsourcing Journal:
- Cost is still a major factor in IT outsourcing, but globalness is the main driver today, along with access to skills not available in house.
- By 2008, multi-sourcing even among offshoring deals will be mainstream such that buyers will pass over providers offering delivery from only one country.
- 2008 will see a much more integrated desktop offering. It will focus categories more on end-user perspectives (such as mobile workers) and needs instead of today's desktop, with categories that are by process.
- ITO penetrates the Fortune 100 by about 80 percent already. This penetration suggests that most of the ITO activity in 2008 will be happening in the mid-size (e.g., Fortune 1000) client segment.
- Although the small and medium business (SMB) segment remains largely under-penetrated in terms of ITO, this market segment is expected to remain under-leveraged, due to the issues of low-scale of outsourced processes and the provider's high cost of the sale.
- The remote Infrastructure Management Outsourcing (RIMO) model continues gaining market share, growing at 60 to 70 percent. As RIMO gains share, the traditional model of IO will start to show declining trend around 2010.
- A shift toward asset-light deals in both RIMO and traditional models will result in revenue deflation as assets start getting excluded from the scope of IO engagements. Asset-light deals are usually 60 to 70 percent smaller than the corresponding asset-heavy deal.
- The strong adoption of ITO in European companies in 2007 will continue in 2008, with companies actively seeking services delivered by a nearshore Eastern European provider.
- For ADM, major multinationals are selecting providers other than the large Indian players when there are a lot of parameters around the criticality--such as mission-critical applications and real-time transactional systems.
- Agile, which started taking root in the development community and in outsourcing engagements during 2007, will see greater adoption in 2008, as a strong tool in helping to speed time to market. It will be critical to have a provider that has mastered Agile.
- Verticalization is another ITO trend and will soon become an important provider-selection criteria. Service providers with certain domain expertise that can speak the language of the business, think and talk like the client, and thus react more quickly will easily differentiate themselves from other providers.
- In health care outsourcing, more and more CIOs are now involved in the outsourcing decision, not just the CEO and COO, and fewer CIOs are losing their jobs to an outsourcing provider. This frees them to consider using outsourcing solution instead of a threat to their jobs.
- Health care CIOs currently have a comfort level with doing only pain-point deals. The main pain point areas in health care today are: (1) help desk, (2) application support (legacy systems, implementing and supporting new systems, and (3) the one-time project of improving the network infrastructure (enabling implementing new advanced systems).
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