Offshoring and Outsourcing in 2009: What Does the Future Hold for the IT Services Industry

All things considered, 2008 was a relatively stable year for the IT services industry. Deals got smaller and shorter, but they grew in number. The second tier providers and Indian vendors did well, along with Accenture and IBM Global Services. The outlier was EDS, where weakness led to its acquisition by Hewlett Packard.

IT outsourcing providers were largely unscathed by the economic downturn throughout much of the year. “It took almost two quarters for the effects of the slowdown to manifest in providers’ financial statements,” says Eugene Kublanov, CEO of San Ramon, Calif.-based outsourcing advisory NeoIT. By the end of this year, however, CIOs became too distracted by the economic destruction surround them to do any outsourcing deals. “As the markets crumbled and CIOs were confronted with the prospects of their personal employment, naturally, decision-making around strategic cost cutting and efficiency took a back seat,” says Kublanov.

That’s all poised to change in 2009. The only problem is, that may be bad news for both IT services providers and their IT leader customers.

Back to the Future: More—Not Better—Outsourcing

“Whenever there’s a downturn people outsource more, not less,” says Gartner analyst Linda Cohen. “Organizations want to take costs out wherever they can. CFOs are pounding on their CIOs to just outsource it, just offshore it.”

“The difficult economic conditions will push companies further than before to consider what stays in house and what gets done by others,” agrees NeoIT’s Kublanov. “Additionally, demands by the business for further cost reduction will need to be addressed in an environment where many companies have already leveraged labor arbitrage to source the low hanging fruit.”

CIOs may sign hasty deals for a short-term returns. In a case of what Cohen calls “convenient amnesia,” IT leaders may forget all the lessons they learned rushing into bad outsourcing arrangements and chasing elusive benefits. “Everyone has a gun to their head right now,” she says. “But the financial voodoo of outsourcing deals doesn’t work. You have to accept the reality that if you hand your mess over to a vendor, you’re going to eventually have to pay for that burden they take off your plate. You can pay it now or pay it later, but you’re going to have to pay.”

Bad deals can lead to degradation in service performance and price increases down the line. Smart buyers will ask for shorter term lengths, but in times of economic pressure rational thinking is hard to come by. “People do bad deals for short-sighted reasons,” Cohen says. “We’ve seen it before and we’ll see it again.”

For Vendors: Pain at the Margins

Service providers will be only too happy to sign on any new business in 2009. “They’re chasing the albatross of quarter-to-quarter earnings,” says Cohen. Outsourcers may do anything for revenue, even if it’s outside of their sweet spot. It’ll be like 2001 all over again. “It looks like good revenue, but in the later years, the provider starts to see profit problems,” says Cohen. Then the customer starts getting his “A” team replaced by a “D” team, prices creep up, everything is a change order.”

Providers with cash will be king, giving Indian vendors the upper hand. They may try to buy up second-tier companies in the U.S., Europe and Asia, or buy into deals at a discount, just to get a foothold in the U.S. They will even buy up customer assets, something they’ve been unwilling to do in the past. “They’ll do anything for cash,” says Cohen. But as with any other contract, “a deal that looks too good to be true will read better than it lives.”

But the offshore providers will face the additional pressure on their margins as the dollar continues to depreciate.

Outsourcing Innovation: Transformation? What Transformation?

Remember all that talk about how an IT services provider could be your partner in innovation? Forget about it.

“The focus will shift away from open-ended efforts,” says Stan Lepeak, research director of outsourcing consultancy EquaTerra. “Buyers will not have much appetite for transformation in 2009.”

“Innovation or big solution implementations will slow down dramatically,” agrees Cohen, “unless you prove I’m going to get back in cost improvements a lot more than I put out and it would have to be a pretty rapid ROI for any transformation.”

One Bright Spot: The Sustainability of Green

Although outsourced innovation will be set aside in 2009, the greening of IT outsourcing deals will not… if only because sustainability can mean cost savings. “Purely environmental desires will take a back seat to explicit cost savings desires,” says Lepeak of EquaTerra. “But green that hits the bottom line will flourish.”

The only question is—who will see that benefit on their bottom lines?

“There will be a push by buyers on service providers to lower their cost of operations by employing green techniques and pass that savings on to the buyer,” says Cohen. “Service providers are trying to go green for own profitability. Buyers will push for that to become a cost improvement for themselves rather than a profitability and performance for the vendor.”