Outsourcing 2006: At the Tipping Point (AMR)

The outsourcing market is in for a major shakeup over the next two years. The sun is already setting on the market share dominance of the six major outsourcing providers-Accenture, ACS, CSC, EDS, HP, and IBM-and the major Indian services firms have the potential to leap to the forefront.

The shakeup is because of three chief causes:

• A significant number of traditional, monolithic outsourcing deals are set to expire. According to outsourcing consulting company TPI, $100B worth of outsourcing contracts are due for renewal in the next two years. Of those, 72% are held by the Big Six, with IBM and EDS holding $50B of the contracts.
• Companies are taking a best-of-breed approach to outsourcing. Rather than outsourcing everything to one provider, companies are selecting partners based on accessing specific skills. General Motors is becoming the poster child for this approach, moving from one 10-year outsourcing deal with EDS to issuing 43 Requests for Proposal (RFPs) to cover $2.5B to $3.0B in IT spending per year. And ABN Amro has spread its $2B outsourcing work across five companies. An informal survey at a recent forum shows that the majority of CIOs are comfortable managing three to five large outsourcing relationships.
• Indian providers are growing their services portfolios and capturing increasingly larger deals. In its most recent quarterly financial report, Infosys reported 17 clients spending more than $50M, double the amount of a year ago. TCS reports five clients spending more than $50M per year, and Wipro reports three. Besides capturing larger deals, the major Indian players continue to grow much faster than the outsourcing market in general. All of the major Indian players reported revenue growth during the last quarter of 30% or more year over year.

Companies ending their traditional monolithic outsourcing contracts will be looking to reduce their spending for replacement services by capitalizing on competition across multiple suppliers and moving more work to offshore providers to take advantage of labor arbitrage.

The lower spending will increase pressure on the traditional Big Six players to shift their services to a more balanced global delivery model. We expect to see the following as the major services companies scramble to meet the new market realities:

• Consolidation among the Big Six. Already we're seeing merger and acquisition activity: HP joined private equity investors, led by the Blackstone Group, to express an interest in acquiring CSC. The Blackstone Group was in separate discussions with ACS (which have now since ended).
• Acquisition of a major Indian provider by one of the Big Six. This would help solidify global delivery capabilities. IBM is rumored to be interested in Satyam.
• Consolidation and acquisitions among the Indian providers. Although growing at phenomenal rates, the Indian companies have a long way to go before they reach the more than $10B in services revenue from Accenture, CSC, EDS, HP, and IBM. However, acquisitions among the top six Indian providers will help. An even bolder move would be for Tata, the parent company of TCS, to use its considerable size and acquire one of the Big Six.

Companies investing in outsourcing should expect churn across practice leads and senior staff as outsourcing company employees shift companies in anticipation of the industry shakeout. At the same time, global delivery models will become stronger, and pricing pressures will create outsourcing bargains. However, strong outsourcing governance will be the key to managing through the transition.