Cloud Computing Shakes Up Traditional IT Outsourcing

For all the vagaries of IT services, traditional IT outsourcing has always been quite tangible—servers, data centers, networks, specifications, man-hours, lines of code. The rise of cloud computing, however, is changing all of that with flexible, asset-free IT services available on an as-needed basis for more aspects of enterprise technology.

Cloud services are a boon for many IT departments willing to forego customization: They help IT organizations chip away at hefty capital expenditures from back-end infrastructure to customer-facing software and everything in between. Consequently, the cloud is turning the traditional IT services industry on its head.

“Cloud computing represents a fundamental shift in how companies pay for and access IT services,” says Susan Tan, IT services and sourcing research director for Gartner.

In fact, Gartner predicts that by 2012, 20 percent of businesses will own virtually no IT assets. That will be a game changer—for better or worse—for outsourcing vendors of all stripes, from traditional onshore and offshore IT service providers and consultants to system integrators and new, niche vendors.

“If [the] cloud was only about gutting the clunky, expensive and environmentally-unfriendly infrastructure, and having Amazon and company deliver the computing power, then it’s really just an infrastructure utility offering,” says Phil Fersht, founder of outsourcing consultancy Horses for Sources. “However, if you’re going to have your data and applications hosted externally in the cloud, do you really need to manage them yourself anymore? Do you really gain a competitive edge with the way you process your insurance claims, or isn’t it time to find a services vendor that will host the app, the associated infrastructure and even process the transactions for you?”

Fersht calls cloud services the foundation for next-generation enterprise sourcing solutions. He believes cloud services will make traditional delivery of IT services more efficient and cost-effective. “They also help create a delivery mechanism for true business process services,” he adds. “This new class of [outsourcing] has the potential to unlock tremendous value for customers.”

Cloud Computing’s Threat to Traditional IT Outsourcing

Traditional, asset-heavy IT outsourcing deals won’t go extinct overnight. (Remember the predicted death of the mainframe? Big iron is still humming along.) But the clock is ticking.

“While adoption of cloud services is still low, outsourcers need to adapt to this change. The days of dedicated data centers are probably limited,” says Tan. “A lot of outsourcing hinges on having external providers manage assets—both infrastructure and applications—owned by IT departments. This part of the market will decrease. Outsourcers need to invest in cloud services and cloud-based offerings or risk being marginalized.”

IT services customers have been looking for something better, faster, cheaper since the first outsourcing contract was signed. Today, they’re even more demanding of a new model. “…the pull from clients for new levels of value is getting stronger by the week,” says Fersht. “Enterprise decision makers are rightfully fed up with old-school, black-box, ten-year handcuff deals.”

Many traditional IT service providers and offshore vendors are beginning to work cloud service into their portfolio—or at least give the appearance of doing so. “Whether cloud computing emerges as a bona fide model or not, service providers must react to it to give the image of currency with the market,” says Doug Plotkin, head of U.S. sourcing for PA Consulting Group.

Outsourcers also need to build cloud-based, multi-client data centers to lower their own costs and increase their service provisioning speed.

IBM Global Services and HP are serving up more and more ‘x-as-a-service’ items on their menus, from infrastructure to storage. Infosys is offering end-to-end IT and business processes—Source-to-Pay for procurement, Hire-to-Retire for HR—on a pay-per-use basis built on a cloud backbone. Wipro Technologies is piloting a central computing cloud to study the potential of the trend. Patni Computing Systems is selling a “cloud acceleration service” to help developers migrate their processes to a cloud-based model the way it did internally and is experimenting with testing-as-a-service.

“The shrewd outsourcers will take advantage of this opportunity to embed cloud services within their broader outsourcing offerings and become cloud services providers themselves,” says Tan. “Such innovative offerings can potentially open up segments of markets, such as the small and mid-size businesses.”

Those outsourcing vendors that don’t develop cloud options will have to align with partners that do, says Fersht. Otherwise, he adds, they risk falling behind the way those providers slow to embrace the globalization trend did.

Some of the alliances between cloud providers and outsourcing vendors could become permanent. “Customers care about where their confidential information is housed, and many will prefer it to be within the confines of a trusted service vendor,” rather than that vendor’s alliance partner, says Fersht. “Don’t be surprised to see mergers between strong infrastructure services and BPO vendors in the coming months as the move to cloud services picks up more steam. “

In the years ahead, cloud services will separate the basic IT and business process body shops from the innovators. “Vendors pushing standard labor arbitrage services under a thin veneer of ‘cloud marketing’ will quickly get cast aside,” Fersht says. “The emergence of next-generation solutions requires a high degree of provider flexibility and management will to embrace new ways of [working]. It’s likely that this trend will further segment the provider topography.”

But traditional providers should temper their cloud transformations, says PA Consulting’s Plotkin. “Large established firms should research the market for the areas they can participate in without going overboard on the idea that they should completely re-architect their solutions and delivery mechanisms,” Plotkin says. “Much of their business for the next few years will, in any event, still be comprised of unique solutions for large customers with complex environments to support.”

Short-Term Winners: New Firms, Consultants

The biggest cloud-based opportunities could exist for the newer members of the outsourcing industry, like Salesforce.com, Rackspace’s Jungle Disk (encrypted cloud storage and automated file backup using Amazon S3) and Dropbox (cloud-based file sharing).

“Smaller, less established firms [should] use the cloud as a disruptive technology to supplant the established firms,” says Plotkin.

Consultants and systems integrators will benefit from the emergence of enterprise cloud-computing in the short term while the market is characterized by confusion. Medium term, they’ll see net new revenue generated from cloud strategy and planning, private and public cloud building, and helping independent software vendors retool for the cloud, according to Tan.

“Equally important, but often overlooked, is the indirect impact of pulled-through work that will likely be generated as a result of the cloud model, such as application consolidation and portfolio rationalization, and helping CIOs figure out the cost of providing [cloud] services internally,” says Tan. “Although there are some insidious threats, they will only become impactful in the longer term.”

The question is whether players in the cloud services market—traditional IT service providers, offshore outsourcers, consultants and systems integrators, new vendors—will figure out their place in the new outsourcing world order before then.

“We knew back in 1995 that e-commerce was the future of retail, but it really took a decade for it to become widely adopted,” says Fersht. “Cloud will likely take three to five years to become fully formed as a business utility offering, but we can be sure its seeds have been sewn and its roots are already taking shape.”