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Can Cloud, Digital Save Big-Ticket IT Outsourcing?

The European IT outsourcing (ITO) market has evolved into one of the most active IT services markets in the world. The volume of ITO contracts recorded by Ovum’s IT Services Contract Analytics (ITSCA) tool continued to grow strongly in 2015, driven by small applications- and workload-centric contracts. But it’s not these low-end (sub-$25m) contracts that are having the greatest impact on the European ITO market. In 2015, ITO contracts with a TCV of more than $100m accounted for only 6% of contract volumes, but 62% of contract values. Although the volume of large $100m-plus contracts was virtually static compared with 2014, the total value of these contracts rose 35% to $16.8bn. A small number of large corporations and government agencies have embarked on major cloud and digital IT transformation programs, prompting a return to big-ticket ITO deals and strategic sourcing decisions.

How are outsourcing deals changing?

Overall, the volume of IT infrastructure services deals signed in Europe increased year-on-year in 2015, much as it has done for three successive years. The rate of increase was slower for infrastructure services than for applications outsourcing: the volume of infrastructure services deals recorded in ITSCA increased 11% in 2015 versus a 24% increase for applications services. This is consistent with the prevailing trend of the past three years. The increase in the volume of ITO deals is being driven primarily by smaller, shorter applications services contracts. Infrastructure deals are also getting shorter, though not by as much: there was a 9.5% year-on-year reduction in the average length of infrastructure deals down to 50.4 months in 2015 versus a 14% reduction for applications services, which averaged 45.9 months.

The increase in the number of smaller ITO deals coming to market in Europe is no surprise. Many systems integrators have highlighted the demand for small project-based applications contracts. Vendors that were previously almost exclusively focused on large infrastructure deals, such as CSC, Atos, HCL, and Wipro, have built up their applications development and modernization capabilities during the past several years. The shorter contracts have a less demanding and less costly sales cycle and vendors such as CSC have emulated their Indian competitors in adopting a “land and expand” strategy: start by winning small contracts, impress the client, then expand the scope of the original contract or compete for additional business when the customer is ready to renew other contracts.

The sort of applications development and deployment projects most in demand are social, mobile, digital front office, migration to Office365, and increasingly, mid-market ERP moving to infrastructure-as-a-service (IaaS) or software-as-a-service (SaaS). Sometimes such projects are the prelude to a bigger, more comprehensive outsource; sometimes they’re already part of a much larger deal.

Over the past decade, the nature of IT outsourcing deals in Europe has changed from large full-scope bespoke engagements to smaller more targeted engagements, as Ovum’s ITSCA data shows. The majority of deals announced in 2015 were small (sub-$25m TCV) applications-focused deals, though the biggest increase in contracts by value in 2014/15 was for deals with a TCV of more than $25m up to $50m. There’s an increasing use of commodity platforms, such as Office365, and Amazon Web Services (AWS) and Microsoft Azure for new application projects. More substantial enterprise applications (most often SAP, but also Oracle) and core applications suites (mostly banking and financial services) are also moving to cloud infrastructure, but private cloud, either hosted or on-premise, rather than public. In 2015, 15% of all European ITO contracts recorded in ITSCA explicitly included a cloud component delivered or managed by the outsourcer, but these deals accounted for more than a third of all ITO contract value.

Contrary forces at work in high-end contracts

While small application- and workload-centric contracts are driving the expansion of the European IT services market, large deals with a TCV of more than $100m still account for the highest proportion of total contract values in any given year. Anecdotally, there are fewer large deals for vendors to play for and large contract renewals have gotten smaller. Customers have moved from single-supplier to tower-based sourcing models and are now seemingly further subdividing towers among suppliers – legacy applications to one, new projects to another; data-center consolidation and cloud to vendor A, workplace and managed public cloud to vendor B. Competition from offshore providers has also played its part in reducing the cost of large traditional infrastructure outsourcing contracts. Between 2013 and 2015, enterprises could expect to see 10–20% price reductions on large infrastructure services contracts signed in the previous five or more years.

However, cost and scope reduction are only part of the story. While there has been a reduction in TCV on many large infrastructure outsourcing deals as customers reduce scope or subdivide ITO towers into smaller units, the pendulum has also swung the other way and contract values, scope, and length have increased for a few very large infrastructure deals. Although only one more $100m-plus ITO deal was announced in Europe in 2015 than in 2014 (29 deals versus 28), the total value for $100m-plus contracts recorded in ITSCA increased 35% to $16.8bn in 2015 compared with $12.4bn in 2014. The average TCV for $100m-plus contracts announced in Europe increased 30% from $443m in 2014 to $578m in 2015.

At one end of the European ITO market (sub-$50m deals) then, there’s increasing fragmentation around small application-/workload-centric outsourcing deals and new SI projects. “Traditional” infrastructure outsourcing contracts are also getting less expensive, thanks to increased competition from offshore providers and a willingness to sign 5-year rather than 7-year deals. However, it’s at the high end where a return to a longer-term strategic view of ITO is having the biggest impact on the market in revenue terms.

Customers return to SIs for help in transforming infrastructure

The changes in the high-end segment of the market include the return of long-term transformational ITO contracts. These are primarily infrastructure outsourcing contracts centered either on the data center or on end-user workplace services. The transformational element in most of the contracts involves either evolution from legacy systems to a private cloud-based hybrid IT environment or the implementation of end-user workplace/front-office digitalization projects. The length and complexity of such contracts comes from the need to strip out layers of legacy platforms and applications in the data center and replace them with new or modernized applications on on-premise or securely hosted cloud-computing stacks. Increasingly, this is done to support digitalized end-user and client-facing services, with the aim of emulating the speed and efficiency of a public cloud provider, but with the resilience and security of business-critical systems.

Such deals are inevitably long-term and “transformational” in nature. Most legacy systems from mainframes to Unix to Windows were originally introduced to support what were at the time innovative new applications and workloads such as transaction processing, ERP, CRM, and Web serving. Over the years, these applications have come to support core business processes and have been strengthened to deliver the resilience and availability that businesses take for granted from their back-office systems. Many traditional bricks-and-mortar businesses have multiple “layers” of legacy IT in their data centers. The process of selecting and prioritizing applications for the cloud, whether they are to be re-hosted, have their code translated, be replaced by commercial applications, or be completely re-architected is inevitably a long-term process that requires the ongoing management of an evolving hybrid IT environment. These are systems that have evolved into the underpinnings for business- and mission-critical processes where resilience and security eclipse “fail fast” every time. Not all legacy systems will move to a cloud: heavy users of mainframe technology will most likely want to retain highly resilient and secure technology, but move to a more modern mainframe operating environment and re-architect applications accordingly.

Digital transformation projects, on the other hand, are expected to deliver continuous enhancement and improvement in line with the expectations of their end users and customers. The new generation of back-office systems and private clouds that support such digital processes will likewise need to deliver enhancements, features, and functions at the cadence of an AWS – a tough call for SIs that lack the levels of investment of an Amazon or Microsoft, but one of the reasons why partnering with AWS, Microsoft, and other cloud providers is crucial to the strategies of SIs such as Accenture, Capgemini, and Wipro.

Digital and cloud are at the heart of business transformation

When cloud first came on the scene, the SIs’ reputation for transformation was tarnished by their failure to deliver the agile and flexible systems that customers and businesses wanted. Yet large corporations that have seen challenges from disruptive start-ups in their own or other industries are now determined to deliver a best-in-class digital experience to their customers. They need to optimize and automate back-office processes to support that aspiration and to deliver efficiencies within their organizations as they become ever more dependent on technology. As ever, skills and cost are significant challenges: even large corporations lack the skills and experience to build, integrate, and manage hybrid IT. If they’re already heavily outsourced, the cost of bringing those skills back in-house can be prohibitively expensive.

It seems that a growing number of very large corporations are once again prepared to weigh the risk of long-term outsourcing relationships against the risk of failing to modernize core IT and restricting the opportunities to benefit from increased automation, greater agility, and the ability to compete via digital channels. Their willingness to enter such relationships reflects the strategic importance of IT transformation to the business. As technology becomes embedded in the fabric and processes of the modern enterprise, selecting a long-term IT outsourcing partner is no longer about cost optimization. It’s about selecting a strategic business partner that can transform the enterprise though cloud and digital, while optimizing the industrial-strength heart of IT. Transformation is back on the ITO agenda for a number of large enterprises and government agencies, but not all suppliers will be equally successful in delivery.

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Ian Brown is senior analyst for IT services at Ovum. Read more Ovum blogs here.

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