Cloud computing drives down both average contract length and value

Posted by Mike Vizard on Feb 9, 2016 12:59:39 PM

Average contract valueThe good news is demand for the outsourcing of IT services appears to be on the rise. A new global outsourcing report from the research firm Information Services Group (ISG) finds that the IT outsourcing industry had one of its best performances ever in the fourth quarter of 2015, capping a year that saw a record number of contracts.

But, here's the catch. The value of outsourcing contracts tied specifically to information technology infrastructure declined a precipitous 12 percent.

Data from the ISG Outsourcing Index, which measures commercial outsourcing contracts with annual contract value (ACV) of $5 million or more, shows that for the fourth-quarter of 2015 ACV rose 5 percent to $7 billion, the highest quarterly ACV in the past four years. ISG says those results were fueled by nine mega-relationships (contracts with an annual value of $100 million or more) in the quarter, which as a general rule are an anomaly that runs counter to the prevailing trend toward smaller contracts.

Blame it on the cloud

For the full year, volume reached a record 1,445 contracts, up 2 percent over 2014. But with $23.7 billion generated in 2015, ACV actually still declined 8 percent. ISG says almost all of the ACV shortfall can be pegged to the information technology outsourcing (ITO) market, which declined in annual value by $2 billion from last year as more infrastructure moves to flexibly priced cloud computing environments.

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ISG notes that the number of restructured contracts (484) also reached a new high, and new scope awards (961) reached a near-record best, even as their annual values declined 6 percent and 9 percent, respectively, for the year.

Trends in the American markets

In the Americas, ISG says the outsourcing market appears to be stabilizing, and the region posted its eighth consecutive quarter of ACV above $2 billion. ACV in the region, however, was flat in both the fourth quarter ($2.6 billion) and full year ($9.8 billion) versus a strong 2014. The 687 contracts signed in the Americas during 2015 was a new record, driven in part by a record number of restructured contracts (252), valued at an all-time high of $4.5 billion.

ITO in the Americas was pushed to record highs for value ($6.7 billion) and volume (444 contracts) by application design and maintenance (ADM) work, which accounted for $3.5 billion of the region’s ITO awards in 2015. Business process outsourcing (BPO), on the other hand, saw its value decline 11 percent, to $3.1 billion, but volume increased 16 percent on contact center and R&D/engineering work.

Struggles overseas

Meanwhile, EMEA remains the world’s largest outsourcing market, with ACV rising 17 percent in the fourth quarter to $3.9 billion, fueled by the signing of five mega-relationships. For the full year, however, the region could not overcome a sluggish first half, with ACV declining 8 percent, to $11.7 billion, and volume in 2015 down seven percent to 601 contracts. All of the decline in ACV for the year was attributable to a falloff in ITO, as the number of large infrastructure awards dropped sharply and value was lower on smaller deals overall. BPO, meanwhile, grew by double digits, both in value and volume.

The biggest drag on the index is clearly the Asia Pacific region. Given the economic volatility in the region, ACV in the fourth quarter and full year were each down a full third over the prior year, sinking to its lowest full-year level since 2006. Contract volume declined 8 percent for the year as well. Both new scope and restructured contracts saw drops in value and volume, and results overall were held back by the lack of large ITO deals. BPO, meanwhile, rose 14 percent off a small base.

Challenges for IT service providers

The most challenging issue overall, however, is that all contracts were generally both for lower falues and for shorter periods of time. For IT services providers that means achieving profitability by front loading costs at the beginning of services contract is now a major challenge. Overall, ISG says outsourcing contracts on average now last 3.5 years, which is 15 percent shorter than it was three years ago. Specifically, ISG notes that given that average there must be more deals spanning three years or less than ever before.

Put it all together, and the outsourcing market in various geographies differs substantially based on the prevailing economic winds. But it's clear that the rise of cloud computing is now having a major impact on outsourcing contracts, and IT services providers can no longer afford to ignore it.

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Topics: IT Services Trends

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